By Thierry Ogier
Brazil has finally sorted out its foreign debt problem. All eyes are now on local markets
President Luis Ignacio Lula da Silva and his economic team have won much acclaim from international capital market investors for their deft handling of Brazil’s foreign debt. Having amicably severed ties with the IMF by opting not to renew a loan agreement a year ago, Brazil used a chunk of its burgeoning foreign reserves to pay back $15.5 billion it still owed the Fund. It did the same, on a much smaller scale, with its Paris Club and UN debt ($2.6 billion and $135 million respectively).
As overall foreign debt fell well below $200 billion and against a background of booming exports (close to $120 billion last year), solvency ratios improved significantly. So too did Brazil’s sovereign risk, with the premium over US Treasuries falling towards 200 basis points – an historic low – in early March. Although abundant liquidity in the world capital markets has made things easier, local officials have played their part in promoting investor friendly policies and an active debt management policy.
One of the boldest moves came in February when Brazilian Treasury exempted foreign debt investors from a 15% withholding tax. The measure is expected to attract up to $5 billion in additional investment this year. “We have sorted out the 25-year-old foreign debt problem,” Joaquim Levy, the treasury secretary told Emerging Markets.
Luiz Fernando Figueiredo, Central Bank director in the previous government, agrees: “During the past three years, Brazil cut the exchange rate risk by some $50 billion per year on average, which is huge. In 2002, 40% of the domestic debt was linked to the dollar. Today, it’s the reverse [as the dollar indexed bonds were eliminated] ... I have never seen such a positive situation in 25 years.”
The Treasury started to substitute C-bonds for A-bonds at the end of last year, and ended up announcing the buy-back of all the remaining Brady bonds by mid-April for some $6.6 billion. The anticipation of debt repayments may amount to $20 billion by the end of the year, in order to reduce concentration of reimbursements due between 2007 and 2010.
COVERED
Funding is also well ahead of schedule. After 11 issues of sovereign bonds last year, including one in euros and another in local currency, Brazil has reduced its funding needs to $4.2 billion until the end of 2007; this year’s needs have already been covered. This compares with a $5.5 billion requirement in 2005 and almost $6 billion in 2004, according the Treasury.
“We led the first ever sovereign issue denominated in local currency, and it was quite a success. We had a demand for $7 billion but we sold the equivalent of $1.5 billion in 10-year bonds at 12.75%,” says Jose Antonio Gragnani, who is responsible for debt management at the finance ministry. “It has since been trading over par with a yield of less than 12.5%. Such a success helped us in creating an extension of the interest curve in local currency ... The market has developed an appetite for Real-denominated risk.”
As for the euro issue of the beginning of this year, praise for which has been mixed, Treasury officials are satisfied that the aim for those bonds to be traded on the MTS was successfully reached while the secondary market benefited from greater liquidity.
“Brazil has done everything right during the past two or three years,” says Enrique Bustamante, managing director and head of corporate finance and origination for Latin America at Dresdner Kleinwort Wasserstein. “It has been successful in re-profiling not only the international but also its domestic debt.”
HOME TALK
On the domestic front, the next step is to reduce the proportion of the debt that is corrected by variable rates, government officials say. Indeed, a large proportion of debt in dollar-linked bonds was substituted for others that are indexed on the benchmark Selic rate, which has been raised repeatedly by the Central Bank in 2004 in order to fend off inflationary pressures. As of the beginning of March, the Selic was still at 17.25% per year [TBU to fall further on Wednesday April 8th], which still represents a strong attraction to investors.
Monetary authorities have also managed to cut the share of Selic-corrected bonds to less than 50% of total domestic debt, while the proportion of pre-fixed bonds has been increased from 2% in 2003 to 27% against a background of declining domestic short-term interest rates since the end of 2005.
“We are going to spend less on interest rates to finance the domestic debt,” says Gragnani. Nevertheless, the overall amount of the public debt denominated in local currency has now exceeded the symbolic level of 1 trillion Reais ($475 billion), due to a high level of current public spending and a growing social security deficit (the nominal budget deficit was 3.3% of GDP last year).