Another yen carry trade -- this one boosts Brazilian economy


Real Making Brazil a Haven for Capital

By Adriana Brasileiro and Alexander Ragir
Bloomberg News Service
Monday, February 5, 2007

Joao de Matos, whose travel agency has been a fixture in Manhattan's Little Brazil neighborhood since the 1970s, stared at a chart showing a surge in Brazil's currency against the dollar and fretted about his business.

"There's nothing I can do," said de Matos, punching numbers into a calculator to determine how much to raise prices on tour packages to Rio de Janeiro. "Brazil used to be a cheap place. It isn't any more."

As de Matos, 59, watched, the real strengthened as much as 1.1 percent on Feb. 1, its biggest rally since September. The gain is the latest spurt in a four-year, 69 percent advance that made it the world's best-performing currency against the dollar. This year, the real has risen against every one of 70 currencies tracked by Bloomberg except Iceland's krona.

A boom in exports of orange juice, sugar, coffee, soybeans, and iron ore, as well as interest rates at 12.9 percent, are luring investors to the real. The currency ended last week at 2.105 per dollar, near its highest level since May.

The gains have hurt profits at manufacturers such as Volkswagen AG, which exports to 30 countries from its Brazilian plants, and made the country increasingly expensive for visitors. A taxi ride to Rio's Copacabana beach from the airport almost doubled to $34 from $18 four years ago.

A penthouse room overlooking the Atlantic Ocean at the Copacabana Palace, a hangout for jetsetters from Frank Sinatra to Mick Jagger, costs $2,480 a night. The rooms went for $1,840 in 2005.

Demand for the currency has risen as international investors buy the country's debt. Yields on two-year benchmark government securities are 7.4 percentage points more than comparable U.S. Treasuries and 8.55 points higher than German bunds.

Brazil's benchmark local-currency, zero-coupon bond due January 2008 returned 18.1 percent during the past 12 months. Converted into dollars, the bonds returned 25.2 percent

The higher yields have made Brazil popular with investors borrowing in Japanese yen -- where the benchmark lending rate is 0.25 percent -- and reinvesting in Brazilian real debt, the so-called carry trade. Foreign investors boosted holdings of real debt more than five-fold last year to 38.4 billion reals ($18 billion).

"The Brazil trade has been one of the best trades over the last two years," said Claudia Calich, who manages $900 million in emerging-market debt for Invesco Inc. in New York. "The biggest gains are behind us, but I don't think it's over yet."

Flows of funds into Brazil have overwhelmed central bank efforts to contain the currency's advance. Banco Central do Brasil has sold reals for dollars every day since July. That has pushed foreign reserves to a record high of $91.6 billion from $56.8 billion a year ago and $32.4 billion in June 2002.

In September, Volkswagen said it would fire 3,600 workers from the 12,000-member workforce at its plant outside of Sao Paulo because the real's rally was cutting into exports. Usinas Siderurgicas de Minas Gerais SA, Brazil's second-largest steelmaker, said third-quarter profit fell 9 percent in part because the currency's gains eroded export earnings.

The stronger real has damped growth in Latin America's biggest economy. The central bank estimates gross domestic product expanded 3 percent in 2006, the slowest pace among the nine biggest countries in the region.

President Luiz Inacio Lula da Silva tries to discourage the gains. "The government doesn't have the commitment to an exchange rate target, but this doesn't mean that the government won't intervene in the exchange rate market and that it's unaware of the currency level," Lula said during an Oct. 23 online interview arranged by British Broadcasting Corp.

Brazilian exports rose 16 percent in 2006 to a record $137 billion, buoyed by the surge in commodity prices. Exports may climb another 11 percent this year to $152 billion, Ivan Ramalho, Brazil's deputy trade minister, said last month.

The steady gains in the currency over such a long period are unusual in Brazil, a country that has had eight currencies since World War II and suffered a 35 percent plunge in the real as recently as 2002. The real is now less volatile than the Japanese yen, Australian dollar and Norwegian krone, based on prices quoted by options traders.

"The currency here is a yo-yo; it's always going up and down," said Michael John Moran, a 72-year-old retired businessman who sits on the board of the U.S.-Brazil Chamber of Commerce. "That's one of the reasons American companies like to send executives here. If you can survive in Brazil, you're ready for bigger responsibilities."

Brazilians are heading overseas in record numbers. They spent $5.8 billion on trips abroad in 2006, the most since the central bank began keeping track in 1947. The previous record was $5.7 billion in 1998, when vacationers took advantage of a policy that pegged the real at almost 1-to-1 with the dollar.

The Tourism Ministry forecasts that 5 million people will travel abroad this year, up from last year's record of 4.5 million. Many are opting for more expensive destinations such as China, India and South Africa, said Virgilio Carvalho, a spokesman for Sao Paulo-based CVC Turismo, Latin America's biggest tour operator.

Wine-tasting trips to France, Italy, Argentina and Chile are rising as well, said Ricardo Farias, vice president of the Sommeliers Association in Rio. Membership in the association, which gives classes on wines, has climbed 20 percent a year for the past three years, he said.

A growing number are also making their way to New York and visiting Little Brazil, according to Regina Silva, who runs the Emporium Restaurant & Bar Brasil.

"It's excellent," said Silva, whose restaurant is located across the street from de Matos's travel agency, on 46th Street in midtown Manhattan. "Business has gone up a lot."

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