August 15, 2016 / 1:12 PM / 2 years ago

UPDATE 2-Brazil has few options to limit real's surge, official says

(Adds market movement and analyst comment, paragraphs 5, 12-14)

By Alonso Soto

BRASILIA, Aug 15 (Reuters) - There is not much the Brazilian government can do to halt an appreciation in its real currency that is set to continue, given high liquidity abroad and less political uncertainty at home, a senior member of the economic team told Reuters.

The government will rely on reducing its traditional currency swaps position to limit the pace of appreciation of the real, which has hit local producers already struggling with a recession, said the official, who asked not to be named because he was not allowed to speak publicly.

He said the economic team was not considering direct U.S. dollar purchases or barriers to capital flows that, in the past, had proved harmful.

“There is not much that can be done and past experience shows that other types of intervention are not sustainable and end up being harmful,” said the official, who is involved in economic policy decisions but is not a member of the central bank.

After the report was published, the real extended gains to a session high of 3.1556 per dollar on Monday morning.

The real, now the world’s best-performing currency, has gained a quarter of its value this year to trade at near 3 per U.S. dollar, raising pressure on interim President Michel Temer to act and shield a still-nascent economic recovery.

Temer, who will be confirmed in the post if the Senate, as expected, impeaches President Dilma Rousseff in late August for allegedly breaking fiscal rules, voiced concerns over the stronger real and promised to “look for an equilibrium.”

Some prominent businessmen, such as Brazilian billionaire Abilio Diniz, third-largest shareholder of French retailer Carrefour, have even urged the government to raise taxes on capital inflows.

New central bank chief Ilan Goldfajn, however, has said the bank will be more cautious in its interventions, signaling policymakers will not be as heavy-handed in limiting the real’s gains as in the past.

A surge of the real to a one-year high last week prompted the central bank to raise its daily auctions of reverse currency swaps, which mimic the purchase of dollars in the futures market and reduce the bank’s traditional swaps position.

The central bank has reduced the volume of traditional currency swaps on its balance sheet from more than $100 billion last year to below $50 billion currently.

For some economists, the government should refrain from more intervention and focus on the approval of unpopular economic reforms.

“What the authorities should do to deal with currency appreciation pressures is not to escalate FX market intervention, but instead to accelerate the approval of meaningful structural reforms,” said Alberto Ramos, senior economist with Goldman Sachs.

“Stronger fundamentals would allow the economy to cope very well with a stronger currency.”

High interest rates, coupled with easing political turmoil with the conclusion of Rousseff’s impeachment, and measures to close a yawning fiscal gap have raised confidence in the once-booming Brazilian economy, boosting the real.

Although the stronger real has helped inflation drop to single digits by driving down the value of imports, the government remains “very concerned” with the resistance of high inflation.

Despite the recession, which is now in its second year, the annual inflation rate has stayed near 9 percent.

“That is one of our big concerns and we need to study if this phenomenon of persistently high inflation will last longer or if it’s done,” said the official.

At the height of a commodities boom that buoyed the Brazilian economy at the start of the decade, Rousseff had limited foreign capital flows to stop the appreciation of the real, which had strengthened to near parity.

Surprise increases in taxes on local stocks and debt curbed investors’ confidence in the government. That, along with other policy mistakes, led to what could be Brazil’s worst recession ever. (Reporting by Alonso Soto; Editing by Bernadette Baum and David Gregorio)

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