The Brazilian real this week secured its place as the best performing of the world's 16 most-traded currencies, writes Tom Henniganin São Paulo.

Less than five years ago Brazil's currency, the real, was punch-drunk. It hovered at all-time lows of four reais to the dollar, hammered by predictions from seasoned observers that Latin America's largest economy was headed for history's biggest debt default and financial pariah status.

Since then, the real has undergone a dramatic turnaround to become the best performing of the world's 16 most-traded currencies over the last four years. It capped that performance this week by steaming through the psychologically important two reais to the dollar barrier for the first time since 2001.

All the more remarkable is the fact that overseeing this great bull run is the country's first left-wing government; ironically it was uncertainty over what the Workers Party would do in power that had investors scrambling for the exits throughout 2002.

When President Luiz Inácio Lula da Silva took office in January 2003, the real was still near $4, interest rates were at 25 per cent and fears over Brazil's capacity to service its huge foreign debt meant that spreads on its sovereign bonds over comparable US Treasuries - a measure of investors' aversion to risk - had ballooned to 22 per cent.

Now inflation is a meek 3 per cent, allowing the central bank to halve interest rates to 12.5 per cent. It has twice as many dollars in its reserves as the public sector owes abroad, helping slash spreads over US Treasuries to a tight 1.5 percentage points. A chorus of analysts says it is only a matter of time before the country receives investment grade status from rating agencies.

So what brought about this "perfect storm of good news" as one analyst calls it? Firstly, on taking office the Workers Party earned the respect and trust of the financial community by hiking already stratospheric interest rates to show it would be relentless in battling inflation. It also tightened its belt and set a primary surplus target higher than that demanded by the IMF.

The high commodity prices of recent years have been another crucial factor for this traditional commodity exporter. China has shown a voracious demand for Brazilian iron ore, soy and other commodities with exporters sending home billions of dollars each month, boosting the country's reserves and strengthening the currency.

Brazil has also seen a huge inflow of money as part of the global hunt for yield. Low interest rates in developed economies over recent years have sent many investors around the globe looking for higher returning - if inherently riskier - assets. Despite halving in recent years, Brazil's interest rates of 12.5 per cent are still among the world's highest and very attractive for foreign investors, especially those in the yen carry trade who can borrow yen at rates barely above zero per cent.

This inflow of dollars and consequent build-up of foreign reserves has created a virtuous circle, helping strengthen the real and so put downward pressure on inflation and create an environment for interest rates cuts. This, in turn, has helped spark domestic demand and boost the internal economy.

Not everyone gains from a stronger real. Exporters, particularly those whose margins are dependent on low-cost manual labour, are complaining that they are getting squeezed.

But winners outnumber losers. Though growth remains sluggish compared to other emerging market competitors like China and India, it is accelerating. Lower interest rates have laid the beginnings of a boom in the property market and the stock exchange has seen a rush of IPOs and all-time highs in recent months.

The stronger real has also made it cheaper for industry to re-equip. "It reduces the costs of importing machines which means greater industrial capacity in the future," says Alexandre Lintz, senior economist at BNP Paribas in São Paulo.

All this, say analysts, will better prepare Brazil to make the transition when the current - and hugely benevolent - global cycle comes to an end.

"One day the free lunch that is the glut of global liquidity will end," says Emy Shayo, a Latin America economist with Bear Stearns in São Paulo. "The next problem will be external but Brazil is now without question better placed to deal with it."

Some worry the country has been slow to take advantage of such historically favourable circumstances to implement much- needed structural reform to the country's burdensome tax and pensions systems. "Is Brazil leveraging its upside potential with reform? Not enough," reckons Gray Newman, chief Latin America economist at Morgan Stanley.

But despite this, the consensus is that Brazil has made huge strides since 2002. "Four years ago the debate was about whether the country was going forwards or backwards," says Nuno Camara, Brazil analyst at Dresdner Kleinwort bank.

"The discussion today is about the pace of progress."