Central Bank interventions: Brazil can use up to US$120 billion and keep adequate reserves

RIO DE JANEIRO, BRAZIL – The Brazilian Central Bank (BC) can use up to US$ 120 billion to act on the exchange rate when it deems necessary and still keep international reserves at an adequate level. The calculation is made by Bráulio Borges, senior economist at LCA Consultores, based on the ARA methodology (Assessing Reserve Adequacy).

A methodology used by the International Monetary Fund (IMF) to compare countries’ reserves with their financial obligations abroad, ARA establishes that the adequate level of reserves is between 1 and 1.5, on its own scale. Brazil ended last year with US$ 356 billion in reserves, which put the country at 1.51 on the scale, according to figures released by the IMF this month.

In Borges’ calculations, if the Central Bank disposed of US$ 120 billion, Brazil would still be at the lower limit of the adequate level, reaching 1 on the scale.

“The Central Bank has a lot of money in the syringe for this kind of injection that it is doing recently,” says Borges, who is also an associate researcher at the Brazilian Institute of Economics of the Getulio Vargas Foundation (Ibre/FGV).

In recent weeks, the monetary authority has accelerated its intervention in the exchange market. Borges believes that international reserves can be used – as defended by the Central Bank – mainly “to control volatility, and not to determine a level or act against major trends.”

But he affirms that by several available metrics the equilibrium exchange rate is around R$4. “The more the dollar moves away from R$4, the more justified the CB’s actions are, in order not to let the exchange rate stray too much, because this brings consequences in terms of inflation and financial instability [through the foreign liabilities of companies],” he says. “If the exchange rate were below equilibrium, at R$2 or R$2.50, it wouldn’t make much sense for the CB to act to avoid depreciation.”

The economist also cites a factor that can make the external accounts situation even more favorable than it is today. In the last two years, according to him, exporters left US$ 40 billion abroad, possibly because of the very low interest rates in Brazil.

With the beginning of a new cycle of Selic highs, the trend is that the entry of these capital funds into the country will gain strength, according to Borges, due to the increase in the basic interest rate and the probable appreciation of the real resulting from this adjustment. The tendency is that exporters bring the resources as soon as possible, in order to maximize the Reais exchanged for dollars, he says.

The ARA was developed by IMF staff in the first half of the 2010s. To build the methodology, the multilateral organ studied, for example, the balance of payments crises in Asia, Russia, Mexico and Brazil in the 1990s.

“As the lender of last resort of dollars for a large part of the emerging countries, the IMF is interested in making the best possible diagnosis of the credit risk of these countries,” says Borges.

Used for countries that do not issue reserve currencies, the ARA calculation is based on a few variables such as total reserves, short-term foreign debt, and imports forecast for the next 12 months.

Subsequently, the exchange rate regime of the country enters into the calculation. The IMF divides this regime into some ranges, and in practice, the more interventionist the country is, the lower its score.

China, for example, has US$ 3 trillion in reserves. But in addition to dollar obligations, the fact that its exchange rate regime is not floating puts the country below the appropriate ARA threshold, at 0.7. “They need more reserves to manage the exchange rate,” says Borges.

Reserves do, however, have a carrying cost. In Brazil, in a simplified way, this cost is measured by the difference between the Selic and the basic interest rate in the United States. Precisely because of this, the IMF has established a ceiling for the level considered adequate. “In this case, the sky is not the limit,” says Borges.

Source: Valor