LatinFinance - September/October 2015 - 41

What is being done to mitigate the impact
of this potentially destabilizing measure?
LP: Brazil has been preparing itself for
changes in global monetary conditions that
we knew would come. We are now entering the, hopefully, final phase of the global
financial crisis where we expect episodes of
greater volatility in the wake of normalization of monetary policy rates especially in,
and beginning with, the US.
Whether one anticipates a [US Federal
Reserve] rate-hiking scenario similar to
1994, which was less orderly in terms of
how short-term rates transmitted to longerterm rates, or 2004, which was more
orderly, and irrespective of the important
efforts by the Federal Open Market Committee to communicate its policy stance
and prepare markets as well as it could,
the textbook recipe is to strengthen policies. And our framework is precisely being
strengthened on both the fiscal and the
monetary front. We also have a solid financial system, with an intrusive supervision
with the relevant and timely information
about vulnerabilities so that the regulator
can act preemptively.
Finally, while keeping the floating exchange rate regime as a first line of defense,
it is useful to smooth excessive exchange
rate volatility that can affect financial stability. In Brazil, we have many well-tested
tools, including our strong derivative market to provide hedges to our private sector,
and this will allow us to sail through the
monetary policy normalization period.
LF: How vulnerable is Latin America
to rising US interest rates, the China
slowdown and low commodity prices?
Is there enough regional central bank
policy coordination?
LP: The recent slowdown in China,
together with the growth in global supply
led to the fall in commodity prices in recent
years, a movement that has intensified
since mid-2014 and is also propped by the
rise of the dollar. Lower commodity prices
affect emerging market economies (EMEs)
through different channels, positively and
negatively depending on specific macroeconomics and trade positions, through changes in the terms of trade, capital flows and
fiscal revenues. Currently, commodities
represent on average more than 50% of the
total exports of Latin American countries.
The recent downward movement in commodity prices has been a vector of a temporary slowdown in economic growth, and
revisions of public finance and also external

account positions in Latin America.
Prospects for monetary policy normalization in the US have strengthened the dollar
and weakened Latin America's currencies,
raising financial market volatility since mid2014. From July 2014 to July 2015, the dollar
index appreciated about 18%, while the CRB
Index fell about 20%. Note that from the
standpoint of market expectations, most of
the adjustment in commodity prices and
also on the exchange rate of the dollar have
already happened.
All EMEs and Latin American countries
in particular, had experienced in the past
these swings in market sentiment and forex
rates and therefore, prudently have accumulated high levels of foreign currency reserves that help mitigate the spillover effects
of the normalization of monetary policy by
STRONG RESERVE: Brazil has been
stocking foreign currency ahead of the
US rate hike

the Fed and the deterioration in the terms
of trade due to falling commodity prices.
In Brazil, foreign currency reserves
increased to $370 billion in 2014 from $32.4
billion in 2000; in Mexico, to $190 billion in
2015 from $35 billion in 2000; in Colombia,
to $46 billion in 2015 from $9 billion in 2000.
In addition, most Latin American countries
have relied upon flexible exchange-rate regimes and deeper financial markets, which
allow firms to access hedge mechanisms
more easily in order to mitigate exchangerate risk. In addition, many EMEs, and Brazil
is a case in point, have strengthened their

policy frameworks to sail through these
events. Finally, the Fed has highlighted that
the adjustment of its monetary policy will
likely take place gradually and that will help
contain shocks in financial markets and
avoid excessive capital flow volatility.
LF: Would you say that the current
external environment is a positive or a
negative for Brazil? What are the most
important factors?
LP: All EMEs will have to adapt to what
seems to be the end of the commodity
super-cycle and the beginning of monetary
policy normalization in the US. As I said,
policy-making is a permanent process to
continuously adjust and reform under
evolving constraints. China's growth is
converging to a new "mean" due to a model
shift. But growth in the post-global financial
crisis global economy, new EMEs and other
advanced economies are still in need of com-

modities. So, I expect at some point a
stabilization of commodity prices where Brazil
has still innumerous comparative advantages
even at lower levels for international prices.
Nevertheless, we are also looking to open
up our markets, gain competitiveness in other
exports and increasing total factor productivity in Brazil. Monetary normalization in the
US comes on the back of a growth recovery
there, and the spillover to Brazil would probably outweigh some negative effects from,
say, episodes of financial volatility. LF
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