As I settled down to write this article on Sunday morning, it was still unclear just how the past week's terrorist attacks in United States – and how the U.S. responds to them – will impact the Brazilian economy. Some key issues have to be investigated and monitored from now on, if future effects are to be properly followed:

- The risk aversion, that has reduced portfolio investments in emerging economies since the Asian crisis in 1997, will increase. In other words, the so-called "flight to quality" movement will deepen. This trend was already observed in early trading in the U.S. bond market, which reopened last Thursday. Prices jumped and yields dived, as investors looked for the safe harbor of U.S. Treasury bonds;

- This movement is already being anticipated by traders in Brazil. The Brazilian real's exchange rate against the U.S. dollar skyrocketed, reaching record post-Real Plan (1994) levels, while stocks plunged. In fact, on Friday the São Paulo Stock Exchange Index (IBOVESPA) dropped to levels not seen since prior to the introduction of the Real Plan, when the economy was plagued with hyperinflation, disarray and negligible growth;

- Is the market overreacting to the effects of lower overseas portfolio investments in Brazil? Hard to say so. The exchange rate now floats. This is the first time in history that Brazil faces such a crisis with a floating exchange rate policy in place. The foreign exchange market in Brazil has been totally controlled by federal authorities since Brazil's independence in 1822, and more recently – in the past 40 years – by the Central Bank. Just a few months ago, the Central Bank would intervene heavily in the foreign exchange market to control the exchange rate. Now, Central Bank officials are limiting themselves to small interventions to reduce volatility. They are not trying to prevent the exchange rate from rising;

- The floating exchange rate mechanism controls itself. In other words, if the real-U.S. dollar exchange rate increases too much, imported goods will be more expensive, but Brazil's exports will also become so attractive that the cost of purchasing U.S. dollars will tend to stabilize. Also, Brazilian assets would get so cheap that investors abroad would feel tempted to buy equities and securities in general again. This would stabilize the exchange rate at some point in the near future – in other words, the exchange rate will not rise indefinitely at the pace observed in recent weeks. The question that remains is at what level will the exchange rate reach a new balance? Any speculation at this point would be just that – for now, nobody can answer that question with any degree of certainty.

- New exchange rate parameters mean higher costs for most of the economy. But whether industry, for example, will be able to increase its prices to compensate for higher costs linked to a rising exchange rate, is another matter. This will depend on the monetary policy in place. In the last two months, the Brazilian Central Bank has shown it is committed to a tight monetary policy, to keep inflation from taking off. But a direct consequence of a tighter monetary policy is a reduction of economic growth levels in the coming months;

- More and more respected economists in Brazil are saying the Central Bank should accept higher levels of inflation, so as not to compromise growth. Certainly, the coming week's COPOM (the Central Bank's monetary policy committee) meeting comes too early to offer a clear sign of how the monetary authority will respond to that challenge. The next monthly COPOM meeting gets under way this Tuesday, September 18, with results of the gathering to be announced on Wednesday, September 19. I personally believe the Central Bank cannot afford to accommodate higher levels of inflation. Which means that, sometime soon, monetary policy will have to be tightened further;

- Do higher interest rates in the near future and lower growth expectations down the road make the 2002 elections easy pickings for the opposition? I wouldn't be so sure. In my opinion, and some surveys are already showing this, voters will want to keep their distance from radical changes next year. They're more likely to choose certainty – known territory – as their beliefs about the world and their own lives have been dramatically affected by the past week's events.

Related sites:
Brazilian Central Bank
http://www.bcb.gov.br/defaulti.htm