Various economic factors influence the exchange rate behavior, and recent indicators suggest that Brazil is in a comfortable position in the international scenario.

Brazil’s commodity exports have been performing remarkably, especially in the soybean, beef, iron ore, and oil sectors. In 2023, this strong export performance resulted in a trade surplus of US$98.8 billion. For 2024, a reduction in this surplus is expected, although it remains at a high level, with a forecast of approximately US$80 billion, as indicated by the Focus Bulletin. This performance demonstrates the country’s ability to sustain positive foreign trade flows.

Foreign Direct Investment (FDI) in Brazil reached a record US$ 64 billion in 2023, consolidating the country as one of the main destinations for foreign capital globally. This figure positions Brazil as the second-largest FDI destination in 2023. For 2024, there is a convergence in direct investment projections for the country, with estimates ranging from US$ 70 billion, according to the Central Bank’s Inflation Report and Broadcast, to US$ 67 billion, according to the Focus Bulletin. Therefore, everything indicates that the scenario should evolve or remain stable.

Concerning current transactions, Brazil posted a deficit of US$30.8 billion in 2023, a decrease of 36% compared to the deficit of US$48.3 billion recorded in 2022. This trend of deficit reduction is also observed in 2024, with the current account deficit reaching 1.46% of GDP in the first quarter of the year. Therefore, there are indications of a gradual improvement in Brazil’s Balance of Payments, contributing to the accumulation of foreign exchange reserves and potentially strengthening the stability of the national currency.

All these Balance of Payments figures led to a substantial increase in international reserves in 2023. In December, Brazilian reserves totaled US$355.0 billion, an increase of US$30.3 billion compared to the US$324.7 billion recorded at the end of 2022. In 2024, they remain stable, and this significant volume of international reserves provides a cushion against external volatilities, giving the country a guarantee for international transactions and contributing strongly to the confidence of global investors.

Finally, the nominal interest rate differential between Brazil and the United States, which was once higher but remains around 5.5 percentage points, makes investing in Brazil extremely attractive to investors looking for higher yields. This differential interest rate and favorable macroeconomic indicators contribute to a continuous flow of capital into the country, sustaining demand for the real and mitigating pressures for an exchange rate devaluation.

Thus, Brazil’s economic fundamentals in 2023, the first figures for 2024, and the outlook for the rest of the year initially suggested stability in the exchange rate of the Real. According to the projections of the Focus Report for January 2024, there was an indicative trend of a greater appreciation of the Real, with an expectation that the exchange rate at the end of 2024 would be R$ 4.92 per dollar. However, this forecast is unlikely to come true in the face of the observed scenario, in which the American currency reached the mark of R$6 at the end of December 2024.

In this context of exchange rate volatility, market dynamics suggest that even with a possible subsequent appreciation of the Real after its initial devaluation, the exchange rate is unlikely to return to previously projected levels. This phenomenon is characteristic of overshooting situations, where the currency no longer returns to its pre-crisis levels after an abrupt adjustment, remaining at a new level adjusted to economic realities and market expectations.

The COPOM meeting

Several factors may have triggered the recent overshooting process. Our hypothesis holds that the voting score during the third Copom meeting in 2024 initiated this phenomenon. However, a broader political context has also played a significant role in this process and deserves detailed analysis.

Since 2023, the president has expressed his discontent with the performance of the Central Bank and its president. On February 2, 2023, the president publicly questioned the usefulness of the Central Bank’s independence, signaling a possible review of this policy at the end of Roberto Campos Neto’s term: “I want to know what [the Central Bank’s] independence was for. I will wait for this citizen [Roberto Campos Neto] to finish his term so we can assess what the independent Central Bank meant.”

This critical stance was maintained in 2024. On June 12, 2024, President Lula highlighted that increasing revenue and reducing the interest rate would make it possible to reduce the fiscal deficit without harming public investment capacity, evidencing a preference for lower interest rates. Additionally, on May 22, 2024, Minister Fernando Haddad questioned the 3% inflation target, considered ambitious for the Brazilian context, and suggested the need to debate this guideline.

On June 20, President Luiz Inácio Lula da Silva made significant statements regarding the policies of the Central Bank, highlighting a clear divergence between the government’s priorities and the monetary authority’s actions. He said, “The Central Bank decided to invest in the financial system, in speculators who make money with interest. And we want to invest in production.” These words reinforce the existence of a continuous clash between the president, his economic team, and the Central Bank, indicating that, so far, there are no signs of resolution to this disagreement.

These statements indicate an interest in policies that, while seeking to stimulate the economy, may lead to a lower commitment to price stability, influencing market expectations and potentially contributing to the exchange rate overshooting phenomenon.

In December 2024, the terms of two directors and the Central Bank of Brazil president will end. Until the Copom mentioned above meeting, the perception prevailed that the Central Bank’s decisions were strictly technical. However, this meeting exposed a significant ideological divide within the body. The directors appointed by the current president, Luiz Inácio Lula da Silva, favored a faster reduction in interest rates. On the other hand, those appointed by former President Jair Bolsonaro showed greater caution, prioritizing price stability and meeting the 3% inflation target set for the coming years.

This revealed division, combined with the president’s criticism of the Central Bank’s independence and the Copom’s decisions and the indications that he will appoint directors aligned with his vision of more expansionary monetary policy, fueled uncertainties in the market. These factors combined contributed heavily to the overshooting in the exchange rate. In other words, the expectation of changes in the leadership of the Central Bank and the prospect of a lower interest rate policy reinforced the volatility of the Real — clear evidence of how political decisions and market perceptions can significantly influence the exchange rate.

The impact of the loss of credibility on the exchange rate

The analysis of the fiscal policies of the Dilma and Lula governments reveals similarities that raise an alert for a possible new economic crisis. The current fiscal situation raises doubts about the government’s ability to honor its commitments. There is a growing risk that the debt will be paid off through the issuance of currency, resulting in inflation. This inflation acts as an “inflationary tax,” which falls mainly on the poorest. This creates pressure on the Central Bank, which is currently independent and forced to increase interest rates to contain inflation expectations, which is reflected in the increase in future interest rates and the devaluation of the exchange rate.

Despite this monetary tightening, the dollar has not reacted as expected, even with the fall in interest rates in the United States. Since December 2023, the dollar has been showing an upward trend, mainly driven by internal problems.

As mentioned, monetary policy is losing credibility due to the fear that, with the change in the Central Bank in 2025, its performance may no longer be politically independent.

Research by Rivool Finance uses an exchange rate model that uses a basket of 13 currencies to build a counterfactual scenario, and that covers the period from the beginning of the Lula government (week 1) to the last week (week 96), suggests that this event is very relevant. Since the COPOM meeting in May, Real has been detached from its fundamentals and has never returned. The exchange rate, which could be around R$4.94, pointed to a value above R$6 in early December 2024. A reflection of the loss of credibility of monetary policy and the government’s inability to maintain fiscal balance.

Economic theory indicates that fiscal and monetary policy must be tightened in a scenario of low credibility to achieve stabilization. Low credibility imposes a significantly higher cost of stabilization. Therefore, in times of uncertainty, announcements alone are not enough. It is crucial to demonstrate a firm commitment to economic stability, and this is only possible with policies that generate a high cost for those who signal.

Whether the government and the Central Bank are willing to assume the cost necessary to regain credibility and avoid a new economic crisis remains to be seen.

The Rivool Finance Market Review for 2024 is available at this link: https://dub.sh/rivool-mr24

 Cristiano Oliveira — Head of Research at Rivool Finance