Brazil’s Currency Weakness Defies Notion that “Cheaper Is Better”

The Brazilian real has lost nearly 10% of its value against the U.S. dollar over the past month. The currency has steadied a bit this week, but at a rate of nearly 3.9 reais to $1, the Brazilian currency hasn’t been this weak since October 2002.

What It Means

Such rapid deterioration in a currency’s value is generally seen as a bad sign for an economy. But some outsourcing firms across the region are upbeat that drops will help business. Their logic — “devaluation makes our services lower cost for American buyers” — is sound economic reasoning, as an economist would say, ceteris paribus.

source: tradingeconomics.com

Behind the Data

In Brazil’s case, the gains are hard to find. The weakness of the real is not paired to the currencies of Latin America’s traditional export markets, the United States and Europe. Much of the investment targeting operations in Brazil — the country accounts for over 50% of Latin America’s GAO activity — is oriented around delivery to domestic firms. So, the silver lining of currency weakness won’t boost exports, as might be the case elsewhere.

While the benefits may be negligible, the risks are becoming increasingly apparent. A recent article in The Economist noted that part of Brazil’s problem is its amount of dollar-denominated debt. Since 2010 — back when the “BRIC” economic group was being bandied about as shorthand for the new world order — firms in Brazil took to financing growth by borrowing cheaply in dollars thanks to the Fed’s QE policy. Brazilian firms took on $270 billion in international debt during this era.

The good times, fueled by cheap dollars, have come to an end over the past 18 months, however. As portfolio investment from Brazil and other emerging markets flows back to the United States, the Brazilian real has slumped in value. The effective cost of dollar-denominated debt has spiked. Now those firms with dollar-denominated expenses stand to lose from sustained weakness in the real.

Our Take

In some countries, such as Colombia, the currency slide may turn out to be a net positive for many firms. But Brazil’s travails should help debunk the notion that a weak currency mechanistically brings benefits.

Going forward, outsourcing firms should first consider the well being of domestic clients and partners in weak currency markets before they invoke the mantra about a cheaper currency being better for business. And now is as good a time as any to stop assessing Latin America’s prospects with a rosy eye on its biggest market.