https://orcid.org/0000-0001-6050-6394
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Abstract
In the 2010s, the Brazilian Central Bank (BCB) intervened massively with domestic non-deliverable forwards (DNDFS) to offset the reversal of the global financial cycle. This article aims to investigate why the BCB used these derivatives instead of selling its international reserves, how they affected the markets, and the limits of these interventions. The main benefit of DNDFs is that they preserve the international reserves of the central bank. Since market makers use these DNDFs to hedge their supply of foreign currencies in the foreign exchange markets, the central bank can affect these markets without spending a dollar. We present evidence that DNDFs were associated with an expansion of market makers’ short dollar positions. DNDFs were also used to limit excessive currency volatility. We identified a subset of interventions aimed at offsetting excessive volatility and present evidence that the BCB could stabilize the markets on these occasions. However, DNDFs are not a panacea. If coupled with deregulated foreign exchange markets, frequent interventions may stimulate speculative activity against the domestic currency. Furthermore, they can be costly, and these costs increase the interest-bearing liabilities of the central bank, constraining the domestic policy space of the monetary authority.
Disclosure statement
No potential conflict of interest was reported by the author.
Notes
1 In May 2017, Joesley Batista, owner of the JBS group (one of the largest meat processing companies globally), recorded the former Brazilian President Michel Temer acknowledging the utilization of bribes to silence witnesses in the ‘Lava-Jato’ corruption scandal. In the day that followed the release of the tape, the BRL had, at one point, lost more than 8% of its value to the U.S. dollar, which triggered extraordinary interventions of the BCB to calm the markets.
2 Following De Paula et al. (Citation2017), we define DEEs in this article as the peripheral countries that have liberalized their financial markets and engaged in the process of financial globalization since the 1990s.
3 According to Bonizzi (Citation2017), in October 2013, 1.85% of institutional investors’ portfolios were allocated to DEEs bonds and equities; nonetheless, these investments were equal to roughly 21.5% of total DEEs' portfolio liabilities.
4 We prefer the term ‘DNDF’ to avoid confusion with the FX swaps in which two parties agree to exchange two currencies spot and reverse the exchange at some agreed point in the future (Borio et al., Citation2017). The literature also refers to these instruments as BCB swaps or Brazilian swaps (Chamon et al., Citation2019; Gonzalez et al., Citation2019).
5 Until 2013, the contracts available in the B3 specified periodical adjustments defined at the beginning of the contract.
7 Borio et al. (Citation2016) argue that the CIP condition has been consistently violated since the Global Financial Crisis. However, as emphasized by these authors, it is not profitable for arbitrageurs to exploit its failure. This apparent paradox is consistent with the argument raised by Moosa (Citation2017) that the effective CIP faced by traders and other market operators may differ from the theoretical CIP based on published data. Therefore, when we say that the CIP holds, we refer to the situation where market makers can move between markets of different maturities, but profitable active arbitrage opportunities are not present.
9 It would also be important to look at the forward (OTC) market to have a complete view of the derivative markets. Unfortunately, the data for this market (CETIP) is not publicly available
10 The removal of the ceiling – through the Circular 3,659 – over the short USD position of the commercial banks that took place before starting the intervention program suggests that policymakers were aware of this channel.
11 The code and datasets used to ran all econometric analyzes and to generate the figures presented in this article are available at https://github.com/joaomacalos/dndf.
12 To calculate the spread between the coupon and the libor rate, we used the maturity of every lot as declared in the announcement. Since data for the libor is only available at two weeks, 1, 2, 3, 6, and 12 months, we utilized the closest lower maturity as a comparison.
13 JP Morgan Emerging Market Bond Index Brazil.
14 We removed the few observations with negative coupon rates. Negative coupon rates may arise with unexpected interventions at the end of the trading day when the PTAX rate was already defined and the future rate moved upwards.
15 The tables containing the estimates are presented in the appendix.
16 The result would be the same regardless of the monetary policy operation.
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João Pedro Scalco Macalós
Joao Pedro Scalco Macalós has a Ph.D. in Economics from the CEPN - Université Sorbonne Paris Nord. He is interested in international macroeconomics, central banking, and exchange rate policies in emerging economies