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Brazil’s Currency Crisis. By Team IV ( Chris Trick, Austin Weaver, Tim Moore, Pat Heffernan, Chris Barnes. Why Brazil Matters. Biggest economy in Latin America One of the last big countries to attempt free trade and privatization; if this fails international investors discouraged.

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brazil s currency crisis

Brazil’s Currency Crisis

By Team IV ( Chris Trick, Austin Weaver, Tim Moore, Pat Heffernan, Chris Barnes

why brazil matters
Why Brazil Matters
  • Biggest economy in Latin America
  • One of the last big countries to attempt free trade and privatization; if this fails international investors discouraged.
  • Unified global economy is threatened if Brazilian currency fails.
  • Brazil had been through 6 currencies since the 1960’s
  • In 1994 the Real Plan was adopted
  • Before it were a series of failed plans (the Cruzado Plan of 1986, Bresser plan of 1987, and more)
  • It worked well to tame inflation and maintain exchange rate stability for 5 years
  • The Real was initially indexed one-for-one with the dollar
  • It was quickly allowed to float though
  • A policy of high interest rates to discourage speculation and over-borrowing quickly attracted a surge of capital inflows
  • By the mid 1995 the Real Plan evolved into a crawling peg
  • Said to be the worst currency crisis in the western hemisphere to date
  • The Real Plan was one of the longest running exchange rate stabilization programs
facts of life before crisis
Facts of Life Before Crisis
  • 43% of Brazilians – over sixty million people - lack the essentials of a decent life
  • One in three children drop out of school without completing primary
  • Drug gangs rule the favelas and the middle class lives behind bolted doors
  • Half a million North-eastern farmers watch crops wither in yet one more drought
  • The urban environment, home to four out of five Brazilians, is deteriorating fast
  • Blacks, over-represented amongst the poor, suffer social discrimination
  • Indians face severe threats to their economic and cultural survival
  • The income gap between men and women is the worst in Latin America
why peg to dollar
Why Peg to Dollar?
  • Needed to convince domestic and international investors that chronic inflation would be stopped.
  • Before Real Plan, inflation was 3000%.
  • Fixing the exchange rate was easier then reducing government commitments.
the fall
The Fall
  • It was in a financially fragile state
  • It required large capital inflows to build up the central bank to defend currency
  • This built investor confidence and led to exchange rate appreciation
  • This fueled import-driven consumption and stifles export growth
  • In order to attract the inflows the real interest rate had to rise
the fall1
The Fall
  • The high interest rates lead to a rising debt burden and a deteriorating fiscal balance
  • A rising budget deficit and deteriorating trade balance inevitably lead to devaluation
  • It just could not finance its current account deficit due to insufficient long-term instruments
the fall2
The Fall
  • Investors came to believe the capital inflows were insufficient to finance its current account deficit
  • Productivity did grow from the imported capital goods
  • The industrial restructuring it caused was not enough to fight off the deteriorating trade balance as unemployment rose
the fall3
The Fall
  • Speculative pressure built up and it became harder and harder for the central bank to maintain the rate
  • Eventually the peg had to break; calling for a floating rate.
other reasons
Other Reasons
  • The political power of the elite prevented tax hikes and to encourage exports it could not impose higher taxes on manufacturers
  • The public sector had won generous pensions and benefits that the government could not afford any longer
  • Dismantling these programs would have led to further social instability
other reasons1
Other Reasons
  • Given the political paralysis it is difficult to see how the prolonged overvaluation of the currency could have been avoided
how much was lost
How Much Was Lost
  • During the first 6 months of speculative attack currency loss totaled $35 billion!!!
  • After the first 3 months of 1999, US reserves went from $70 billion to about $32.9 billion.
foreign influences
Foreign Influences
  • The other currency crisis in Asia, Russia, and Mexico made the peg increasingly fragile
  • Short-term capital flew faster into Brazil and the government had to sell off 10 billion dollars in reserves and hike interest rates from 21 to 44 percent
  • This worked for a short time until the crisis hit January of 1999 unexpectedly
crisis recovery
Crisis Recovery
  • Managed a quick recovery compared to other major currency crisis to date.
  • Due to banking system being ready to handle both severe economic shocks and policies.
  • Commercial banks able to take extreme measures to calm and stabilize markets.

A guy who came to International Finance for the first time, his @$$ was a wad of cookie dough. After a few weeks, he was carved out of wood. -Johnny Stiver