Brazil: Market nervousness

[Sabri Oncu <soncu@xxxxxxxxxxx>]

Brazil central bank under fire amid rocky markets

Thursday June 6, 4:08 PM EDT

By Carlos A. DeJuana

SAO PAULO, Brazil, June 6 (Reuters) - Brazil's Central Bank came
under fire on Thursday for what observers said were perhaps
ill-timed moves that further agitated debt and currency markets
already roiled by the outlook for October presidential elections.

As Brazil's currency, the real, weakened to its lowest point in
seven months, stocks fell and bond prices plunged, the bank said
it would auction off short-term treasury notes in hopes of easing
some of the pressure on markets.

Economists and pundits faulted a Central Bank usually known for
savvy financial operators for stirring an already turbulent
market by enacting a rule that forces investment funds to mark
the value of their assets according to daily market prices.

Although praised in theory and seen as necessary by analysts, in
practice the rule heightened market tension by bringing to light
sharp losses suffered in the treasury notes market.

"The outlook has deteriorated strongly this week. We have the
political issue, which is the main problem, and the Central
Bank's difficulties in understanding and making itself understood
with the market," said Alexandre Vasarhelyi, head of foreign
exchange at ING Barings in Sao Paulo.

The bank said the "mark-to-market" move was meant to bolster
transparency and help small investors, but the accounting change
caused steep losses for many funds, especially those focused on
treasury notes.

The notes had already slumped due to oversupply and market
worries that leftist candidate Luiz Inacio Lula da Silva will
turn his commanding lead in opinion polls into a victory in
October's elections. Although the former union leader has moved
his positions toward the center, investors are still haunted by
his talk of debt renegotiations in past campaigns.

Luiz Gonzaga Belluzzo, a former government official under the
Sarney administration and economist at the University of
Campinas, lambasted the bank. "The election climate surely helped
a bit, but it was the bank's reckless driving that set this all
off," he told Folha de Sao Paulo newspaper.

Even Central Bank President Arminio Fraga admitted perhaps the
timing was not right.

"If I could go back and do it differently, I would have done the
mark-to-market adjustment earlier," he told Estado de Sao Paulo
newspaper.

WORRIES SPREAD

Concerns over the outlook for the Brazilian elections and their
impact on the country's economic policy spread across the
Atlantic, where stocks for Portuguese and Spanish companies with
big investments in Brazil, such as Portugal Telecom (PTCO) and
Telefonica (TEF), fell.

Because most of Brazil's local debt is tied to currency
fluctuations or re-prices daily with floating interest rates,
when markets get nervous its debt becomes more expensive and
harder to roll over.

This week, the government tried to force banks to buy its
treasury notes by offering banks poor returns on inter-bank
loans, leaving extra liquidity in the market. But banks refused
to buy the notes and opted to buy dollars instead, further
fueling instability and making the rollover more expensive.

Constantin Jancso, an economist at MCM Consultants, said in a
report the bank's recent policy of buying up longer-term treasury
notes in exchange for short-term notes was aimed at easing
turbulence. But at the same time it was worsening the country's
debt profile considerably and undercutting its past policy of
extending the length of its maturities.

Still, most analysts supported the bank's decision to make funds
mark-to-market and many said the market was simply overreacting.
In Washington, the International Monetary Fund reiterated its
support for Brazil's economic policies.

IMF spokesman Tom Dawson told a regular news briefing that market
volatility was "understandable" but underscored that the lender
believes "Brazil has a good policy framework."

Full at:
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