These adroit defensive maneuvers reinforced Fraga's reputation as Latin America's most skilled central banker, which he earned by stabilizing Brazil's economy after a scary devaluation two years ago. But there are some things even Fraga's monetary policy can't do, and keeping the real under control may be one of them. It recovered to 2.23 to the dollar in the wake of Fraga's moves, after falling to an all-time low of 2.48 on June 19. Yet analysts are skeptical that it will stay at its new level for long. "There are factors at play over which the Central Bank has no control," says Geoffrey Dennis, Latin America equity strategist at Salomon Smith Barney. Dennis expects the real to swoon again, to as low as 2.60.A VICIOUS CIRCLE. Don't fault Fraga if that happens. The real is being bombarded from all sides. There's the slowing world economy, which hits prices for Brazilian exports. There are investor fears that neighboring Argentina will devalue its currency, plunging the rest of Latin America into financial turmoil. At home, the government's ability to advance key reforms has been undermined by infighting and charges of corruption. Factor in an electricity shortage that will probably cut Brazil's growth this year from an anticipated 4% to less than 3%, and what you've got is a recipe for a weak currency.
Brazilian business has also played a role in the real's slide. As the currency started to slip in May, companies with future-debt obligations denominated in dollars rushed to buy greenbacks. With trading volume in the local currency markets thin, that created a vicious circle. "The real was falling because nobody was selling dollars, and nobody was selling dollars because the real was falling," explains Sergio Machado, head of currency trading at Banco Fator in Sao Paulo.
Fraga's aggressiveness has momentarily broken this pattern. And Brazil's money man has made it clear he intends to keep sparring with speculators. He has unveiled plans to raise $10.8 billion in hard currency through new issues of government debt and stock in state-owned companies. Part of the money will be available for buying reals. "It was a very clear signal," says Diniz Pignatari, head of currency trading at ING Barings in Sao Paulo. "The Central Bank wants the real to be stronger than 2.30 to the dollar." A weak real pushes up inflation by raising the cost of imports.
But Fraga cannot play cat-and-mouse with the currency traders forever. The benchmark interest rate cannot remain at its current 18.25% for long without inflicting serious damage on an already debilitated economy. At its last meeting, Brazil's monetary policy committee authorized Fraga to cut rates before its next meeting on July 18 if the action was needed. Of course, if Fraga cuts rates too soon, he risks triggering another tumble in the real.
Meanwhile, Fraga is making moves that seem to go beyond the role of a central banker. He recently announced that the government would send a package of measures to Congress that would, among other things, remove some taxes that crimp the competitiveness of Brazil's exports. That may help rein in a current-account deficit now running at 5% of gross domestic product. The deficit, along with concerns over how it will be financed, is another factor straining the currency.
One problem is that the Brazilian Congress is rarely quick to act. For the tax measures to ease pressure on the currency, legislators must vote on them before September, which is when politicians will begin turning their attention to next year's presidential election. Currency speculators may not wait that long to go after the real once more. By Jonathan Wheatley in Sao Paulo