Exchange-rate derivatives, financial fragility and monetary policy in Brazil during the world financial crisis

Abstract

The crisis of subprime mortgages in the United States, started in mid-2007 and intensified in the last months of 2008, after the bankruptcy of Lehman Brothers, put an end to that internationally favorable situation the Brazilian economy seems to have taken advantage of in the last years. Since September 2008, a significant decrease has been witnessed in the international liquidity. Credit lines for exports dramatically shrank, slowing down export expansion, while a generalized increase in risk aversion produced an outflow of liquid capital from Brazil of the order of US$ 11 billions in the months of October to December 2008. Because of capital movements, between July (valley of the exchange rate series) and December (peak of the series) 2008, the Brazilian currency was devalued by 50% against the US dollar; the depreciation in the year was 34%. Panic has spread throughout the country’s banking system as a combined result of all such factors, leading to a further drastic reduction in credit to families as well as to firms. This sort of credit evaporation had as a consequence a strong deceleration in the growth pace of consumption and the otherwise already announced hold on a number of investment projects. As overall result, the Brazilian economy had a 0.2% of fall in its GDP in 2009 compared to 2008.