Brazil has become the centre of financial market turmoil in Latin America

The Brazilian real (BRL) is under escalating negative pressure fuelled by a complex domestic economic and political environment and adverse external factors. After touching 4.25 per US dollar (USD) in what many analysts see a signal of overshooting due to heightened political stress, the real partially recovered, accumulating a 40% loss over the past 12 months. A deep economic recession, exacerbated by a prolonged bearish momentum in emerging market (EM) assets and escalating domestic political uncertainties have been factors compounding an already weak tone in the BRL. 

Unlike Mexico and Colombia, Brazil does not enjoy the "implied" support of an IMF flexible credit line to counteract a negative investor confidence shock. Ironically, China has become both a factor of potential support (through direct financial assistance) and vulnerability (as China is a major bilateral trading partner at a time of economic deceleration). 

Looking ahead, a weaker currency will help inject export sector competitiveness into the Brazilian economy to aid the structural fiscal adjustment under way. On a positive note, high real interest rates (policy rate set at 14.25%) and a strong FX reserve position are positive factors that might help to stabilize financial market conditions. Meanwhile, sovereign debt assets remain vulnerable to further downgrades with two agencies keeping a "negative" outlook on the country's credit ratings.