National debate urged on Brazil currency laws
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Emerging Markets

National debate urged on Brazil currency laws

A recent memorandum of understanding with Euroclear could pave the way for international settlement in Brazilian real, but not without a constitutional change

“Brazilian business leaders are pressing the government and the central bank to allow full convertibility of its domestic currency, as the authorities take the first steps towards possible international settlement in Brazilian real.

Marcelo Fleury, head of international business development at CETIP, Brazil’s national custody organization for fixed income securities, has called upon Brazil’s monetary authorities to adopt a more open approach to currency convertibility, amid growing calls from local and foreign investors for legislative change.

“The central bank is keen to talk about what Brazil needs to do to achieve investment grade status, this is a national debate. But no-one is talking about currency convertibility,” Fleury told Emerging Markets.

“To my mind, there is likely to be a correlation between the two: convertibility is obviously one of the factors that would help improve the credit ratings,” said Fleury, a former forex and sovereign debt trader.

His appeal follows a memorandum of understanding signed last month between CETIP and Euroclear, the leading international settlement system.

The MoU will allow the two bodies to exchange information and expertise. Moreover, such agreements have previously pointed the way for other national currencies to achieve full international settlement status. Euroclear status would allow issuance denominated in real on the Eurobond markets, without the need to settle in dollars.

In addition to helping the sovereign diversify its funding, this would benefit Brazilian companies whose earnings are mainly in local currency – such as in the telecoms or retail sectors. They would be able to tap the international investment pool without creating a currency mismatch with their revenues.

Denis Peters, spokesman for Euroclear, confirmed that free convertibility is a prerequisite for establishing a bilateral link to settle the currency. “That is not possible at the moment, and the central bank is aware of the issues,” he said.

Fleury believes the authorities are steering policy with one eye in the rear-view mirror, worrying about past speculative attacks on the currency, most recently during the 2002 election campaign. But with foreign exchange reserves reaching almost $154 billion in July 2007, the problem today is currency appreciation.

The real is up more than 10% year-to-date, and was largely unruffled by last week’s emerging market sell-off: the currency recovered quickly, despite the central bank’s dollar purchases as part of its ongoing bid to build reserves.

“Industrialists are complaining about the strength of the real and its effect on exports. The dirty float is partly to blame, as total convertibility would allow sales of real, easing upward pressures and helping the exchange rate reflect the economic cycle better. But so far, the government has preferred to help exporters with subsidies or tax breaks, rather than lifting currency controls,” Fleury told Emerging Markets.

Full convertibility would also have practical advantages to cross-border trade. Most trade with neighbouring Argentina is conducted in dollars, but Fleury said Argentine companies would find it easier to hold trading accounts in real instead. Emerging Markets understands that the government of Belize even considered adopting the real as its national currency, to aid stabilization efforts after it was forced into a sovereign debt restructuring in early 2007. Analysts muse whether this would be called “realisation”.

The idea of the Brazilian currency as a policy anchor underscores Fleury’s view that the economy has come a long way since the financial crises that the convertibility restrictions were designed to prevent.

“I was trading Brazilian assets in the pre-Brady, Brady, and post-Brady eras. So much has changed, it is time to be bold,” Fleury said.

Brazil’s central bank declined to comment.

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