Frustration Mounts as Brazil’s Real Tumbles

Updated May 31, 2013, 3:56 p.m. ET

Frustration Mounts as Brazil’s Real Tumbles

By PAULO WINTERSTEIN

SÃO PAULO—Brazil’s currency tumbled to a four-year low Friday, underscoring investors’ frustration with the world’s sixth-largest economy.

The real dropped as low as 2.1443 reais per dollar, its weakest since May 2009, while stocks slipped to a six-week low. Friday’s selloff capped a week that saw Brazilian markets battered by mounting evidence that a hoped-for economic recovery isn’t materializing, as well as an interest-rate increase that threatens to further reduce growth.

With the economy slowing, inflation pressures rising and the country’s fiscal situation worsening, policy makers are running out of options to steady what was once South America’s rising star.A fall in commodity prices because of China’s slowing growth has weighed down Brazil’s exports, which already struggled to compete globally due to high taxes, underqualified and costly labor, and an overburdened transportation network that elevates the cost of doing business in the country.

Meanwhile, tax cuts and social-spending programs meant to encourage consumer spending have driven up prices and depleted government coffers without providing the payoff of faster growth.

“Despite all the stimulus to consumption created by the government, this model of growth has been exhausted,” said Tony Volpon, head of emerging-markets research at Nomura Securities.

As the U.S. recovery gathers momentum and speculation mounts that the Federal Reserve will reverse its easy-money policies, investor flows to Brazil could slow even further, putting additional downward pressure on the real.

Officials have at times clashed over the best way to right Brazil’s economy, another factor reducing the appeal of the country’s currency, stocks and bonds, investors say.

After keeping the currency trading in a narrow band between 1.95 and 2.05 reais per dollar since the start of this year, Brazil’s government may want the real to weaken further. That would help increase exports and slow imports, improving the country’s deteriorating balance of trade. However, it would potentially lead to higher inflation, which the central bank is attempting to bring down.

Officials aired both sides of the policy debate this past week. On Wednesday, after a weaker-than-expected reading of first-quarter growth, Finance Minister Guido Mantega said the falling real wasn’t a concern. However, as the real slipped to a four-year low on Friday, the central bank announced it would auction dollar-swap contracts, a common tactic to support the currency.

The contradictory message “creates insecurity in a country that needs to draw on foreign savings,” said Nathan Blanche, a partner at the Tendencias consulting firm.

Brazil’s bigger-than-expected interest-rate increase on Wednesday signals a possible turning point. The monetary-policy committee raised the benchmark Selic rate half a point to 8%, more than many economists had expected.

“The central bank and [bank President Alexandre] Tombini gave a very important signal that they won’t tolerate high inflation. We saw in the first quarter that more inflation doesn’t equal more growth,” said Carlos Kawall, a former secretary of Brazil’s treasury and currently chief economist at Banco J Safra in São Paulo.

On Friday, the central bank said the country’s 12-month primary surplus shrank in April to 1.89% of gross domestic product, from 1.99% in the 12 months ended in March. Brazil targets a primary surplus—the amount before interest payments on debt—of 3.1% of GDP. Mr. Mantega has said that to meet that goal, the government may deduct up to 45 billion reais in investments and tax breaks.

The imbalance in the government budget, together with the drop-off in exports, have weakened the currency.

“Now the problem is on the fiscal side,” Mr. Kawall said.