Brazil’s Public Sector Finances
Where one stands on this issue is largely determined by one’s assessment of the economic, non-financial benefits relative to the financial losses of both FX reserve accumulation and BNDES lending. It is incontrovertible, however, that this policy causes non-negligible financial costs and may even raise medium-term fiscal risks. The Treasury runs some (admittedly limited) credit risk on its loans. The BNDES loan portfolio is of relatively high credit quality. But in a severe economic scenario, it would nonetheless likely suffer losses, which could indirectly impact the Treasury. While the public sector does not run credit risk on its FX holdings, currency appreciation does lead to accounting losses. On the flipside, of course, currency depreciation results in valuation gains. All told, too narrow a focus on direct financial costs and potential losses overlooks the potential “opportunity costs” of asset accumulation. By preventing a more sustained decline in domestic debt, this policy helps keep domestic interest rates at a level higher than under a scenario where (external) asset accumulation had not taken place.
Again, the stock of federal debt securities held by the public would be closer to 40% of GDP rather than the 53% of GDP, had the central bank stopped accumulating FX reserves in 2007 and the Treasury not extended financing to BNDES. A faster decline in domestic interest rates would not only have created “fiscal space”, enabling the government, if necessary, to respond to an economic slowdown forcefully. It would also have allowed for a decline in gross and net interest payments and, under the assumption that the government had refrained from increasing current expenditure, for higher public investment or more rapid deficit reduction. In addition to narrowing the “carry” differential and thus further reducing opportunity costs, it should also have led to less severe currency appreciation pressure earlier in the year.
Debt structure has improved tangibly
An improving outlook for public sector solvency and lower, but still very high (real) interest rates have also allowed the authorities to improve the debt structure and reduce the risks attached to it. As mentioned above, the vulnerability to exchange rate and interest rate shocks has diminished dramatically.
In 2004, 1/4 of all federal public debt securities outstanding3 was FCY-linked or -denominated, rendering the debt vulnerable to exchange rate shocks. A very considerable 1/2 was linked to the Selic rate. By 2011, the debt structure had improved very dramatically. Today FX debt is only 4% of the total debt stock, while Selic-linked debt amounts to 1/3 of the total. This, as pointed out several times already, renders public debt significantly less susceptible to currency and interest-rate shocks, as the 2008 crisis demonstrated.
Moreover, more than 40% of all domestic debt securities were maturing over the next 12 months in December 2002, or 17% of GDP. Today, less than 23% of all securities will mature over the course of the next 12 months, or less than 11% of GDP. This is still higher than the government’s deposits with the central bank and is high by emerging markets standards. But roll-over risk has un-doubtedly declined over the past decade, even if gross financing requirements remain comparatively high.
In terms of the holders of government debt, a little more than 10% of total government debt securities are held by non-residents, and the vast bulk consists of holdings of LCY-denominated debt, whether domestic or external. This significantly improves the risk features from the creditor’s point of view by transferring FCY-related risks to the investor. Before 2005, there were, admittedly, next to no non-resident holdings of domestic government debt. But given that foreigners are predominantly invested in longer-term and/or fixed-rate instruments, financial risks from the Treasury’s point of view are low. By comparison, non-residents hold 50% of both German and US government debt securities (held by the public) due to their reserve currency status.
The structure of foreign government debt also improved. On the back of FX reserve accumulation, the public sector became a net foreign(-currency) creditor in 2006. Brasilia retired its IMF debt in 2005, repaid its Paris Club debt in 2006 and it pre-paid World Bank debt in 2009. Today the bulk of government debt is owed by the federal government in the form of international bonds. (It is worth mentioning that 10% of international bonds are denominated in BRL.) Starting in 2006, the Treasury has also been repurchasing international bonds.
Long story short. Not only has net public sector and, to a lesser extent, gross GG debt declined in recent years. But the risk profile of the debt has also improved markedly in terms of susceptibility to financial markets shocks. The 2003 fiscal adjustment unambiguous-ly re-established public sector solvency and it subsequently allowed a tangible improvement in the debt structure. Were a financial shock equivalent to 2002 to occur today, the net debt ratio would fall by 3% of GDP rather than increase by 17% of GDP. It is worth pointing out, however, that, by the standards of the more advanced emerging markets, gross government financing requirements remain significant and the maturity of the domestic debt stock is of relatively short duration.