A combination of policy moves and a slowing economy have weakened the Brazilian real by 4.8% since the beginning of March, making it the worst performing currency tracked by Bloomberg. For exporters, this is a welcome change from the 8.7% appreciation in the first two months of the year, consequently making it the best-performing currency.
President Rousseff has been traveling Europe lately railing against the “monetary tsunami” unleashed by easy money policies of the developed economies and promised vigilance in keeping the real at an exchange rate that supports exports.
The rhetoric is a sequel to the global “currency war” fought by Brazil’s Finance Minister Guido Mantega last year. Besides aggressively lowering the benchmark SELIC rate to 9.75% to spur growth and lower the spread with other rates, Brazil has also extended the 6% tax on foreign loans and bonds abroad to those with maturities up to five years.
The currency hit a 52-week high of BRL 0.65/$ last July during the height of last year’s currency war but quickly fell to a low of BRL 0.53/$ during the escalation of the eurozone debt crisis. While Rousseff et al. have been somewhat effective in bringing down the exchange rate, the current weakness is also partly attributable to a lowered growth expectation in China and slower domestic growth.
The average maturity of bond placements abroad is ten years, so carrying out the IOF tax to five years may not slow credit a great deal. Additionally, easing inflation and slower growth in China will most likely lead to another cut in the reserve requirement and driving up commodities and emerging markets. Barring another escalation of the crisis in Europe, strong capital inflows put the odds against Brazil being able to significantly weaken the currency or keep it low for more than a short period.
Either scenario sets up a possible profit in Brazilian steel producers like Gerdau (GGB) and Companhia Siderurgica (SID). A successful weakening of the currency will make exports more competitive against foreign rivals and could spur sales. While the weaker real will detract from dollar-based gains in the investment, once capital controls are removed the currency should revalue and add to gains.
A strengthening global economy will make it difficult to keep the real from appreciating. Investment in the steel makers should do well in this scenario as well with increased demand and additional gains from holding assets in a stronger currency.
Valuations are mixed in the group, with Gerdau looking a little expensive at 14.9 times trailing earnings but SID coming in below the industry average and valued at a much more reasonable 7.9 times trailing earnings.
Shares pay a respectable yield of 1.9% for GGB and 6.5% for the underperforming Companhia Siderurgica.
Disclosure: Long Brazilian Real futures.