Brazilian Forward Contracts – A Revolutionary Tool in Exchange Rate Management?

From August 2013, the Brazilian Central Bank (BCB) began a novel strategy of currency intervention. The BCB directly auctioned forward contracts in the shape of currency swaps to market participants. Every week until December 2013, the bank released US$2 billion worth of swaps that were priced in US dollars and paid out in Brazilian Real. The programme was then extended from January 2014 until the 31st March 2015, albeit at a reduced rate of US$100 million a day from the previous rate of US$200 million a day.

These contracts completely contravened orthodox economic recommendations of non-intervention and the traditional methods used by emerging economies to manage exchange rates. The swaps were explicitly built to provide additional foreign exchange hedging opportunities to stimulate participants and provide additional liquidity in the domestic market. Their careful design meant that the BCB did not need to use their valuable foreign exchange reserves nor demand sterilisation. Furthermore, as the auctions were in US dollars, the swaps were actively attracting valuable foreign exchange into Brazil to help smooth the path of the Real during the peak of the “Taper Tantrum”, reversing the pattern of currency outflows away from Brazil.

This piece shall evaluate the performance of Brazil’s experimental intervention tool and contrast it against the traditional tools available to central banks. Whilst undertaking its analysis, the essay will consider the development path of the Brazilian financial sector and whether such foreign exchange swaps offer other emerging economies a revolutionary way to manage their exchange rates.

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