Political crisis, pandemic, rising public debt and inflation, why hasn't Brazil imploded yet?

 

The international investor and the world look closely at events in Brazil. We are passing through difficult times. In the economic field, we had another lost decade with zero GDP growth per capita between 2010 and 2020. In the public health, we are going through a catastrophe due the pandemic been totally out of control. The Brazilian debt is already approaching 100% of GDP, considered very high for an emerging country. In recent months, inflation has negatively surprised part of economists as high levels of those indexes are impacting the citizens' lives. And the political scenario? Well, troubled is the least that can be said. But how, despite all these factors, does Brazil still stand? How have we not completely collapsed yet? The answer to that question is Brazil's foreign exchange reserves of USD 343 billion.

 

What are foreign exchange reserves?

Foreign exchange reserves are the value that the country has in the “safe” in a strong currency. In Brazil, our reserves are in USD. To be more precise, in US Bonds, considered the risk-free asset in essence in the international market.

Reserves are formed from the government's primary budget surplus, which is when more taxes are collected than spent. Part of that surplus is saved and converted into that financial cushion. The accumulation of reserves was greatly accentuated in the period known as the “commodity boom” in the 2000s. During this period, Brazil, which has a commodity export matrix as one of the pillars of its economy, benefited greatly from the strong international demand driven by Chinese accelerated growth. It was in this economic cycle that reserves jumped from USD 50B to USD 350B, an increase of 600% in approximately 6 years. Since then, the country has managed the reserves at that level.

 

Why are foreign exchange reserves so important?

The capital accumulated in the reserves is kept for use at specific circumstances, such as international crises, moments of low liquidity in the currency flow, interventions due to dysfunctions in the exchange rate quote. So, it should be used just in certain moments that demand immediate actions. Reserves in strong currencies are especially important for emerging markets as these players do not have a currency with the same credibility on the international scenario as the dollar, for example.

But in addition, the reason that will be listed below is perhaps the most important reason for international investors: Reserves are a guarantee that the country will not remain insolvent and will continue to keep its debt payment commitments. The simple fact that this reserve exists and is big, indicates that a risk of default is much less than countries that do not have this savings. This premise is valid for emerging countries, but not necessarily for developed countries or with a strong national currency. A great example of this is having in mind that Brazil has more international reserves in dollars than the entire European Union combined. They do not need a reserve in USD as they have the EUR as the national currency in most of the bloc's member countries.

 

 

Are the reserves the answer to all national problems?

This is also not the way. Reserves should only be used at singular times and for specific purposes as said above. They should not be used as a resource for paying mandatory expenses and recurring government spending as they are at serious risk of evaporating too quickly. To maintain the confidence of the international investor, the old recipe of raising more than spending remains the golden rule. For that, controlling the public spending is essential to balance the accounts.

 

But during the biggest health crisis in the last 100 years, wouldn't that be enough reason to use the reserves to fight the Covid on several fronts?

Some experts say yes. It was a good time to use foreign exchange reserves, or part of it, as a reinforcement of the cashflow to alleviate the evils of the pandemic, to be more aggressive in the purchase of vaccines, to increase the resource for the cash transfer program. But this was not the strategy used by the government and the Central Bank. The use of reserves was practically limited to interventions to contain the speculative advance against the Real by selling several billion dollars. And in the end, a question always remains in the air: Couldn't it have been done more and better with all this resource available?