20170113-法国巴黎银行-Lower_rates,_weaker_BRL__Actually_the_other_way_projecting_USDBRL_to_be_below_3.00_in_201_12页_290kb

Summary: Lower Rates, Weaker BRL? Actually the Other Way: Projecting USDBRL to be Below 3.00 in 2017

Core Content

This document discusses the Brazilian Real (BRL) exchange rate dynamics, emphasizing that lower interest rates may not lead to a weaker BRL but rather support its strength through improved fiscal and debt sustainability. It challenges the conventional belief that lower rates weaken the currency and instead presents a bullish outlook for the BRL in the medium term.

Main Points

• Conventional Fallacy: Lower interest rates are often seen as weakening the BRL, but this study argues that they can actually support the currency by improving debt and fiscal dynamics.
• Fiscal and External Dynamics: The BRL is influenced by two opposing forces: the external sector (which supports the currency) and fiscal sustainability (which can weaken it). The external sector has been robust, while fiscal improvements have been positive for the BRL.
• Currency Mismatch: Brazil has a relatively low currency mismatch (2.75x), which means that BRL depreciation can actually reduce the public debt-to-GDP ratio. This contrasts with other emerging markets where higher dollarization makes the currency more vulnerable.
• Debt Sustainability: The study uses a formula to analyze the public debt-to-GDP ratio, taking into account the exchange rate, domestic and foreign debt, and tradable/non-tradable GDP components.
• Carry and Risk Premium: The BRL benefits from carry trade dynamics, especially with the current low real interest rates. Lower risk premiums, due to improved fiscal sustainability, will more than offset the potential negative impact of a stronger BRL on the trade balance.
• Monetary Policy Impact: Lower rates are expected to support fiscal sustainability, leading to a stronger BRL in the long term.

Key Forecasts

• Q4 2016: USDBRL is expected to be at 3.15
• Q1 2017: 2.95
• Q2 2017: 2.90
• Q3 2017: 2.95
• Q4 2017: 3.00
• 2018 (Base Case): 3.25

The report also includes a distribution of potential errors, with the worst-case scenarios at 3.36 for the end of 2016 and 3.50 for the end of 2017.

Supporting Evidence

• Current Account and Trade Balance: The current account is expected to improve to -1% of GDP in 2016, while the trade balance is projected to reach an all-time high.
• Debt Composition: Brazil's public debt is composed of a significant portion in local currency, reducing exposure to FX depreciation.
• International Reserves: Brazil holds much higher international reserves than the IMF's recommended optimal level, enhancing its resilience to external shocks.
• Foreign Participation in Debt: Foreign participation in Brazilian debt is around 16.2% of total debt, which is relatively low compared to other EMs, indicating a resilient position.
• Central Bank Intervention: The BCB has reduced its FX swap outstanding position, signaling a shift in policy stance and support for the BRL.

Risk Factors

• Political Uncertainty: A sudden change in the political scenario that hinders structural reforms could negatively impact the BRL.
• US Dollar Strength: A renewed strong US dollar cycle, similar to 2015, could pressure the BRL.
• US Political Shock: Negative developments in US politics could also affect the BRL through its impact on global markets.

Conclusion

The study reinforces the view that lower interest rates and improved fiscal sustainability will support the BRL, leading to a favorable exchange rate outlook for 2017 and beyond. The BRL is projected to remain below 3.00 by the end of 2017, with a strong structural risk premium improving its long-term prospects.

Key Figures and Models

• Debt Sustainability Formula:
  $$
  d _ {t} = \left[ D ^ {L} + e ^ {} D ^ {F} \right] / \left[ P ^ {n} * Y ^ {n} + e ^ {} P ^ {t} * Y ^ {t} \right]
  $$

• CM (Currency Mismatch) Classification:

  • CM = 0: High exposure to FX depreciation
  • 0 < CM < 1x: Some exposure
  • CM > 1x: Debt-to-GDP ratio worsens with FX depreciation

• Fiscal Sustainability Formula:
  $$
  \Delta debt / GDP (y/y) = (r - y) * b + p + s
  $$
  Where:

  • $ r $: Real interest rate
  • $ y $: Real GDP growth
  • $ b $: Debt-to-GDP ratio
  • $ p $: Primary deficit
  • $ s $: Seigniorage

Additional Insights

• Carry Trade Dynamics: The BRL is among the top currencies in terms of carry and volatility-adjusted carry, making it attractive to foreign investors.
• Fiscal Improvements: The study highlights that fiscal sustainability improvements will lead to lower risk premiums and support the BRL.
• Monetary Policy Outlook: Aggressive monetary easing is recommended, as it will have a positive impact on both domestic activity and the fiscal front.

Disclaimer

This document is classified as non-objective research and is a marketing communication. It is not independent investment research and may be subject to conflicts of interest. It is intended for professional clients and eligible counterparties as defined by relevant financial regulations.