By Ana Nicolaci da Costa
BRASILIA, March 9 (Reuters) - Recent comments by BrazilianFinance Minister Guido Mantega that Brazil must prepare itscurrency for international circulation revived the debate onhow to reform the country"s foreign exchange regulations.
Central bank president Henrique Meirelles said last weekthe bank had recently resumed work on an overhaul of itscurrency laws, which date back to the 1930s. [ID:nN05188197].
The comments come after speculation last year policymakerscould take further steps to facilitate the outflow of dollars,to help curb a rally in the local currency. Brazil"s real(BRBY) surged about 34 percent in 2009.
Although the local currency has since given up some ground-- it has weakened 2.9 percent so far in 2010 -- Brazil isexpected to remain a magnet for capital inflows as investorsseek higher returns in emerging markets.
Following are some questions and answers on the issue:
WHAT IS BRAZIL"S FOREIGN EXCHANGE LEGISLATION?
Brazil"s foreign exchange legislation includes law 4595,which creates the central bank and gives the national monetarycouncil the authority to formulate currency norms, and law4131, which regulates foreign capital investments in thecountry and capital repatriation out of the country.
Gustavo Loyola, a former central bank president and apartner at Tendencias consultancy, says a key idea behindBrazil"s foreign exchange rules is the principle of "foreignexchange monopoly."
This means the central bank has a monopoly of the purchaseand sales of foreign currency and shares the latter with somecommercial banks.
Another principle is that of "non-compensation." Thisstipulates that if two entities need to pay off debts betweeneach other outside Brazil, they cannot compensate through athird party and must make separate exchange transactions.
Over time these principles have been modified and relaxed.For example, an exporting company can today keep its resourcesabroad and use them to pay commitments there.
WHAT MORE CAN THE CENTRAL BANK DO?
Experts say most of what the central bank can do to free upcurrency regulations through government norms has been done.
The next step would be to overhaul old laws from a timewhen Brazil suffered a scarcity of foreign inflows and thedollar was perceived as a means of self-protection. Norms backthen aimed to restrict capital outflows from Brazil.
Today, Brazil has a relatively stable currency and is a netcreditor, while also enjoying ample foreign inflows.
Analysts see room for simpler foreign exchange rules toimprove efficiency. But some say Brazil has made significantprogress recently and caution against excessive deregulation.
"I am not that in favor of absolute and unrestrictedliberalization. Brazil"s culture and past still don"t allow fora complete debureaucratization," said Cassia Monteiro Cascione,a foreign investment attorney at L.O. Baptista Advogados.
BANK ACCOUNTS IN BRAZIL IN U.S. DOLLARS?
Brazil does not allow domestic bank accounts in U.S.dollars, or any other foreign currency. Some analysts argueallowing dollar accounts would be a step toward making the reala convertible currency that can be bought and sold anywhere.
But some former central bank officials say this would beirrelevant. There are countries with convertible currencieswhere accounts in foreign currencies are not allowed.
Experts say dollar accounts could weaken the role of thenational currency by creating competition. In addition, itcould leave Brazil more vulnerable to external shocks becausethe central bank cannot print dollars and thus cannot be theultimate guarantor of dollar accounts.
END OF LIMITS FOR FUND INVESTMENT ABROAD?
There was talk last year that there could be changes to thepercentage that investment funds can invest abroad, therebyfacilitating the outflow of dollars.
But analysts say such a measure would have little impact.They say funds don"t make use of the full amount they areallowed to invest abroad because there are plenty ofhigh-yielding opportunities in Brazil, where benchmark ratesare among the world"s highest.
ALLOW BANKS TO LEND FUNDS RAISED DOMESTICALLY OVERSEAS?
The central bank may allow commercial banks to lend fundsraised in domestic markets to overseas clients as part of amove to relax restrictions on dollar outflows, a local dailysaid in November. Brazilian banks are barred from using fundsraised in reais for international loans or investment abroad.
Analysts are generally in favor of such a move but saythere might not be a lot of demand for it because funding coststend to be higher in Brazil than in many other countries.
HOW DO FOREIGN INVESTORS CURRENTLY TRADE THE REAL?
Foreign investors trade Brazil"s real through instrumentscalled non-deliverable forwards, or NDFs, which are used when acurrency cannot be used for settlement outside its country oforigin.
NDFs are settled in cash and in dollars by comparing a rateagreed upon by the two parties at the time the contract is madeand the official rate at the settlement date.
In practice, a foreign investor goes to a bank in afinancial center like New York or London, where they get aquote for an NDF. Once that trade is done, the bank"ssubsidiary or its investment vehicles will trade dollar futurescontracts at the BMFBovespa exchange in Sao Paulo -- theworld"s third-largest exchange operator by market value.
The currency futures market is more liquid than the spotmarket in Brazil, with an average daily trading volume of $15billion, according to the BMFBovespa. The futures market isconsidered to drive prices in the spot market.
HOW FAR AWAY IS FULL CONVERTIBILITY OF THE REAL?
Changing Brazil"s foreign exchange rules further would helppave the way to make the real a fully convertible currency. Butwhat ultimately determines whether a currency will become fullyconvertible are the fundamentals of an economy, itsinstitutional development and how well it is viewed by others.
The real would have to be internationally recognized as asolid currency that people and businesses want to hold and usefor transactions and investments.
Experts say market demand will be the key driver forchanges in foreign exchange rules.
"Convertibility, after a certain point, is not a regulatoryissue, but a market issue," said Gustavo Franco, former centralbank president and head of securities firm Rio Bravo.
IS THERE GLOBAL DEMAND FOR THE REAL?
There is growing demand for the real as seen by the steepappreciation of the currency in 2009.
Brazil has also made a push to use its currency in foreigntrade transactions with certain countries such as Argentina,although volumes are still very low.
"We have to prepare ourselves for the real to become acurrency of international circulation," Mantega said inFebruary, when Brazil unveiled new currency bills.
In a further sign that local agents are thinking big forthe real, BMFBovespa, the Brazilian Banking FederationFebraban, and the Brazilian Financial and Capital MarketsAssociation, or Anbima, are working on a project to turn Brazilinto a major international financial center. The project is dueto be unveiled on March 25. (Additional Reporting by Isabel Versiani; Editing by ToddBenson and Chizu Nomiyama)
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