Brazil Tries Reducing Banks’ Forex Positions

Brazil’s central bank moved Thursday to reduce the size of banks’ bets in the foreign-exchange market to protect the financial system, in the latest example of emerging markets looking to slow some of the heavy currency flows into their economies.

Brazilian banks had a net $16.8 billion in bets against the dollar at the end of 2010, a sharp swing from $3 billion against the Brazilian real at the end of 2009, Central Bank Director Aldo Mendes said Thursday.

The bets against the dollar are a constant source of pressure for the Brazilian real to appreciate, which worries the government because of the effect on exporters, particularly manufacturers. The short dollar positions could fall to around $10 billion as a result of the steps unveiled Thursday, Mr. Mendes said.

Around the world, major emerging markets with free-floating currencies are grappling with the problem of appreciation, from Brazil and Chile to Indonesia and India. While the U.S. and European Union economically flounder, these countries have roared back from the global financial crisis, and continue to absorb large amounts of capital.

In the short term, though, many governments have to deal with the political impact of strong currencies. Local manufacturers, in particular, see the price of their exports rise, and face a flood of imports made cheaper by the currency.

The International Monetary Fund–which opposed capital controls for many years–on Thursday reiterated that some barriers are appropriate for countries such as Brazil and India, to help stem the flow of speculative investments if such “hot money” threatens their economies.

Brazilian Finance Minister Guido Mantega said the central bank’s latest move would provide some relief, though it may not reverse the real’s climb against the dollar.

The Finance Ministry will follow the effect of the measure to determine if additional action is necessary to contain the real’s gain, Mr. Mantega said. The government didn’t raise reserve requirements on currency bets earlier because the jump in short dollar positions, which indicates investors expect the dollar to weaken, happened only in recent months, he added.

The head of the central bank, Alexandre Tombini, who took office earlier this week, pointed to the bigger picture, saying the U.S. economic policy of printing money to help boost growth was affecting global markets, and that emerging markets as a whole needed to take “prudential measures.”

For Jerome Booth, head of research at emerging markets specialist Ashmore Investment Management Limited, capital controls are “fairly temporary policy issues to try and either smooth or delay a currency appreciation.” There is “almost no evidence” that capital controls can work over the longer term, and “central banks understand that very clearly.”

Better coordination among emerging markets could do more to avoid “unnecessarily painful movements” in currencies, Mr. Booth said.

Banks have 90 days to implement the measures, so analysts said the real wouldn’t necessarily weaken immediately, but the step may remove one of the pressures on the currency to strengthen.

There would be greater risks if Brazilian banks kept large short dollar positions, as any volatility in global markets could lead to a rush to cover, the Central Bank’s Mendes said. He quickly noted, though, that no banks were at risk with their current positions. Similar steps would likely be taken in the future if positions again started to grow too much, Mendes added.