Brazilians Feeling Heat Over the Real

When President Obama vowed to double U.S. exports by 2015, he probably didn’t mean inflation. But that is what lax monetary policy is causing to wash up on the shores of emerging markets.

Brazil on Thursday announced new reserve requirements targeting local banks’ short dollar positions. These should force some to be unwound, strengthening the dollar versus the real.

It is the latest in a drip feed of measures designed to check the Brazilian real’s strength.

Like China, Brazil is in a bind. Quantitative easing and weak economic growth in the developed world are driving investment dollars toward faster-growing, higher-yielding emerging markets. The weaker dollar is also pushing up prices of foodstuffs and raw materials, which figure large in emerging-market inflation baskets.

Raising interest rates is the direct way to curb inflation, but that also attracts hot money, pushing up the real and hurting exporters. Brazil also has other reasons to resist raising rates.

Industrial production there has been flat since mid-2010, as November data, released Wednesday, confirmed. With real interest rates of more than 5% already among the highest in the world, tighter money risks choking off economic growth. Moreover, Brazil has a ratio of investment to gross domestic product of just 18%, according to Lombard Street Research, and an infrastructure-intensive Olympic Games and World Cup tournament to host by 2016. Higher rates won’t help on that front either.

The problem is that “attempts to target both inflation and the exchange rate are basically impossible and will eventually break down,” as Win Thin of Brown Brothers Harriman says. That won’t stop central bankers from Brasilia to Beijing from trying, and dealing investors chasing hot markets the occasional nasty surprise.