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brazil currency drop fuels growing hedge demand May 24, 2004 5:31pm ET (Reuters)

By Daniela Machado

BRASILIA, Brazil, May 24 (Reuters) - A slump in Brazil's currency, the real , against the U.S. dollar in recent weeks has prompted a rise in demand for hedged currency positions by companies, experts said.

Such an increase in demand for currency protection has been normal during turbulence in Brazilian markets in recent years. But analysts said that so far the extra demand is not an alarming signal and should not push the Central Bank to change its strategy for reducing currency-pegged debt.

In less than a month, Brazil's currency has fallen from a steady trading level around 2.9 per dollar to trade at about 3.2 per dollar --its lowest in more than a year.

"Yes, there has been a rise in demand for hedging, but for now it is within historic averages," said Eloi Dantas dos Santos Junior, an economist at the Intercam brokerage, which works with about 400 corporate clients.

Still, doubts about where the currency will settle after the current bout of volatility may have prevented some firms from seeking new hedge positions for now, he said.

"Today nobody knows if the currency will settle at 3.10 or 3.20 after finding an equilibrium. It's the same for hedging; many firms have a strategy and wait for the worst moment of the turbulence to pass."

Brazilian markets have been hit in recent weeks by the prospect of higher U.S. interest rates, which would make emerging markets like Brazil a less attractive investment. Higher international oil prices have also weighed.

Jorge Sant'Anna, superintendent at the Central Securities Depositary for Brazilian fixed income and derivatives securities, said data have shown a rise in demand for hedged currency positions.

"What I perceive is that companies will hedge themselves, they are just waiting for a sign that volatility will continue," he said. "I think one thing that is beginning to worry is the persistence of the rise in the oil price."

Demand for currency hedge instruments like swaps and Non-Deliverable Forward (NDF) contracts rose, especially as of the second week of May. The value of outstanding NDF contracts rose to about 13 billion reais at the end of last week compared with 10 billion reais at the beginning of April.

Swap contracts rose to 113 billion reais from 106 billion.

Less than a week ago, Sergio Goldenstein, head of the markets department at the Central Bank, said that demand for currency hedge instruments was low, guaranteeing that the government could continue to redeem currency-linked debt.

The government is trying hard to reduce currency-linked debts in an effort to cut the sensitivity of Brazil's debt load to currency market swings.

Because of large demand for currency hedging in the past, the government has periodically been obliged to increase supply of currency-linked debt. But so far this year it has been able to buy back currency-pegged debt worth $17.6 billion, compared with $19.1 billion during all of last year, indicating low demand for hedging.

Sant'Anna said that even if demand for currency hedging rises further, the government is unlikely to have to be the supplier of such instruments to the market.

Even so, traders said it was difficult to predict where the currency will settle this year.

"I think it is very difficult to know what happens with the exchange rate," said Carlos Antonio Rocca, a partner at the Risk Office consultancy. "It is still risky to predict that the dollar has reached a new trading level."