Brazil yesterday lived its darkest day in recent memory when it gave up the fight to save its cherished inflation-busting currency, the real, and let it float freely on the market.
The real fell because, after a controlled devaluation of 9 per cent on Wednesday, it could not cope with speculative pressure. Investors were already trading above the new limit and the central bank was forced early yesterday to withdraw all exchange rate controls. The real fell to a level equivalent to a combined devaluation of 23 per cent.
The devaluation is a massive blow to the credibility of President Fernando Cardoso's government as the main pledge of his rule has been to protect the strength of the real against the dollar at all costs.
However, analysts were yesterday saying that President Cardoso had no choice in floating the real and the immediate consequence was a sharp rise in the stock exchanges in Rio and Sao Paulo as reals became a cheap buy.
Both indices were up more than 20 per cent late yesterday and helped stocks rally all over the world after a jittery period since the real's surprise devaluation two days previously.
Brazilians, who have seen their country lurch towards recession because of the high interest rates, needed to prop up the real will be hoping that interest rates can now be dropped to stimulate the economy.
The main fear is that a rise in the cost of imports will trigger the conditions for inflation, which is already a spectre in the minds of most people who remember the decades of hyperinflation that ended with the creation of the real in 1994.
As soon as the central bank announced that it was abandoning the ceiling of 1.32 reals to the dollar the real hit 1.51 dollars before stabilising at 1.49. Mr Pedro Malan, the Finance Minister and Mr Fransisco Lopes, the new head of the central bank, were last night flying to Washington to talk with officials from the International Monetary Fund (IMF), which last November agreed a $41.5 billion (#35.5 billion) bail-out package.
One positive effect of the devaluation is that it should stop the flood of dollars from the country, which has resulted in its reserves halving from $70 billion to about $35 billion this week, excluding the IMF loans.
The strong real was the cornerstone of Brazil's spectacular economic recovery that made it in four years the second largest destination of foreign investment after China. However, weak economic fundamentals like a huge public deficit have created what became untenable pressures on the currency.
The current crisis was triggered by the confrontational style of former president Itamar Franco, now governor of Minas Gerais state, who declared a temporary moratorium on the state's debt to the federal government and unleashed investor unease that spiralled out of control.
