In 2012 Brazil signed a currency swap agreement with China, eliminating the need for US dollars in exchanges, involving Chinese yuan and Brazilian real only. This was a huge step forward for the Brazilian real and for its recognition as a growing currency. Now, the World Cup, along with the Summer Olympic Games 2016 will further throw the spotlight on the Brazilian real. As the World Cup is in full swing currently, we take a look at how businesses can gain access to the Brazilian market and strategise to protect their profit margins and improve their bottom line.
Image: FIFA World Cup 2014 by Crystian Cruz, licensed under CC2.0
The Brazilian market simply cannot be ignored. It is quite simply far too big. Brazil is the world’s sixth largest economy, it is one of the fastest growing economies in the world, and is currently the world’s 20th biggest exporter and 21st biggest importer. Emerging markets are becoming more prominent in the global economy year-on-year. As we head towards 2020, 70% of global GDP’s growth is expected to come from emerging markets. The main players will likely be China and India, followed by Russia and Brazil. If you have identified Brazil as a market for your product or service, you have done all the pre-entry market research, and become educated in local laws, customs and ways of doing business, you are almost ready to go. Something businesses tend to overlook however, is in how to optimise working with the foreign currency. In this case, Brazil’s currency, the real (BRL), is more difficult than many other foreign currencies, as it is what is known as “non-convertible”, or “blocked”. In other words, it is impossible to transfer real out of Brazil. How can a business successfully move profits out of the country then, without impacting their profit margins? In this piece, we look at how to protect your margins when working with the Brazilian real and how to minimise the drawbacks of its blocked currency status.
What is a non-convertible currency?
To fully understand the Brazilian real, you must first understand what “non-convertible” implies. A non-convertible currency is the legal tender of a country that is not traded at all on the international FX market, usually because of government restrictions. It is normally a method of protection as an exotic currency’s economy is usually particularly vulnerable to market movements. If the exotic currency decreases or increases in value sharply, its potential adverse effects could be devastating for a country. The only way to trade a non-convertible is on the black market. The real, therefore, represents challenges for foreign businesses wishing to repatriate profits out of Brazil.
Specifics of the Brazilian real
- Spot trades are non-convertible
- Forwards possible through non-deliverable forwards (explained below) normally with the US dollar, quoted up to 2 years usually
- Value determined by number of reals per US dollar
- 1.1% of global FX market share (on one side of currency pairs)
3 steps to maximise profits with Brazilian real
The main method of moving money in and out of Brazil is through the use of non-deliverable forward contracts (NDFs) after setting prices in Brazilian real. To do this, the counterparty must be prepared to work with a more common international currency, such as US dollar. Euro can be used, but is much less frequent. US dollar is normally used for NDFs with Brazil’s real.
1. Price in Brazilian real
It is much more favourable to price in the local currency, whether you are importing or exporting. Pricing in your own home currency comes with many drawbacks: Suppliers or clients are less likely to do business with you when you use your own currency, and it is necessary to price locally in order to conclude a rate for an NDF.
2. Agree on a common currency
Look to reach agreement with your suppliers in the exotic currency denominated country to complete transactions in a more liquid, less costly major currency first. This may mean bearing the full costs of the FX transaction or if not, the counterparty to the transaction may add a premium to their charge. Ultimately, it is infinitely safer and worth the extra cost.
3. Use NDFs
Non-convertible currencies are not traded in the spot or forward currency markets like the US dollar or euro. To remedy this, non-deliverable forward contracts are used to allow access to a non-convertible currency. NDFs have a similar purpose as a regular forward contract, and they are the principal way to gain access to non-convertible currencies. They are used to hedge against currencies that operate with tight exchange controls in place. In the case of Brazil, with an NDF there is never actually an exchange of the real as the underlying currency, but rather a more common currency, such as the US dollar, is used to settle the trade.
Advantages of NDFs
- Easy implementation
- Provides hedge against currency fluctuation, insulating company from exchange rate
risk exposure - Acts like a regular forward contract to lock in an exchange rate for a future date
- No convertibility risk
- Provides easy access to international markets with non-convertible currencies
Disadvantages of NDFs
- Company is bound to the terms of the NDF – no flexibility
- NDF is another cost for companies and requires an effective FX
risk management strategy to be in place - Limited liquidity in NDFs
- Often there are minimum size requirements on NDF transactions, which is more likely to negatively discriminate against smaller companies