RIO DE JANEIRO: Brazil's central bank will likely scale back its foreign exchange intervention program within the next couple of weeks, hoping that a period of relative calm in global markets will help it unwind the plan without causing too much instability for the currency.
Brazil has tried a number of measures to stabilize its volatile exchange rate, which strengthened in 2011 to levels that threatened local industry but then weakened too fast in 2012-13, fueling inflation. Rising prices have hurt Brazilians' spending power, dragging down economic activity as well as President Dilma Rousseff's popularity.
In one of its most successful initiatives, the central bank last August started daily auctions of currency swaps. The derivatives allow the bank to support the real without selling a single dollar from its $380 billion in foreign reserves.As a result, the real has been largely stable at between 2.2 and 2.3 per dollar in recent months.
But for the program to work, holders have to be able at least in theory to trade the swaps for cash in moments of crisis, which means the value of swaps in circulation cannot exceed the size of Brazil's foreign reserves.
Some analysts warn that the prudent threshold is much lower than that, and recommend policymakers curtail the intervention program even further. The central bank has already reduced the pace of sales in December, but the stock of swaps has since swollen to nearly $90 billion.
"The central bank can't sell swaps forever. It ought to use this instrument in specific situations," said M?rcio Garcia, a visiting professor at Stanford University who has studied Brazil's intervention program.
"The forex market has been calm. It's not a moment for the bank to spend its dollar reserves or to sell derivatives that are backed by the reserves," added Garcia.
So far this year, the real has gained more than 5 percent against the dollar. The gains are partly a result of the steady supply of swaps but also due to prospects that US interest rates will not go up before mid-2015.
Unwinding the program has proved to be more difficult than it seems, however. When the central bank tried to slow the rollover pace of expiring swaps earlier this month, the real slumped 1.5 percent in one day, forcing policymakers to backtrack.
The bank not only returned to its previous rollover pace, but it promised to keep offering swaps past June 30, an action aimed at killing speculation that the intervention program's days are numbered.
Details of the length and the magnitude of the extended program are still to be announced and a central bank spokesman declined to provide any new information.
Currently, the bank offers as many as 4,000 swaps worth $200 million in daily auctions, on top of 10,000 contracts to roll over expiring maturities.
If the central bank keeps its intervention program unchanged, rolling over 100 percent of expiring contracts, its stock of swaps would grow to more than $115 billion by the end of the year, Credit Suisse analysts estimated.
By continuously intervening in the market, the central bank risks excessive distortions in the forex rate that could deepen Brazil's economic problems, including a low investment rate and a current account deficit of nearly 4 percent of gross domestic product.
The central bank could slow its intervention if the real is testing the 2.20-per-dollar area, said Win Thin, head of emerging markets currency strategy with Brown Brothers Harriman in New York. On Monday, it traded around 2.23 per dollar.
Jennifer Vail, head of fixed income at US Bank Wealth Management, estimates the central bank could still increase the amount of outstanding currency swaps by 30 percent before investors get worried about the stock of these derivatives.
"There are always risks if they increase their exposure (to swaps) but I don't think it reached levels that are concerning the officials at this point," she said.
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