Foreign Investors’ Flight Rises and Pressures Debt in Brazil

RIO DE JANEIRO, BRAZIL – Since 2015, the foreign share of public debt securities dropped from 20.8 to 9 percent. The shift was intensified by Covid-19 and creates greater challenges for the Treasury, as this investor typically seeks longer-term securities.

The Covid-19 pandemic further reduced the share of foreigners in financing the country’s public debt, thereby spurring a trend that had already been occurring since Brazil lost the “seal of good payer” in 2015.

Since then, the share of foreign investors in the national debt has dropped from 20.8 to 9 percent in July this year, further complicating the Treasury’s task of trying to extend debt payment terms.

Although foreigners rank fourth among the main bondholders, behind pension funds, investment funds, and financial institutions, they typically prefer long-term securities, as long as they have confidence in a country’s macroeconomic situation.

Therefore, the outflow is an indication that the outlook on Brazil at this time is one of uncertainty and risk. Recently, the Treasury held the largest auction in history for short-term bonds. The 12-month debt (short term) should close the year at the highest level of GDP since 2005.

Between January and July alone, foreign investors’ flight from their holdings in Brazil exceeded US$30 billion (R$158 billion), according to Central Bank data. Of the total, one-third (US$10.8 billion, or R$57 billion) dropped out of fixed income (where the Treasury bonds are included). The remainder dropped investments in shares in the B3, the São Paulo stock exchange.

The loss of investment grade had already pushed Brazil out of several international fund portfolios, but the uncertainties generated by Covid-19 pushed away part of the non-residents who still gambled on Brazilian securities.

“The pandemic led to a market behavior of preference for liquidity. Investors want money in their hands, not an asset that can take months to dispose of, all the more so in the international market,” says Luis Felipe Vital, general coordinator of public debt operations for the government.

The outflow of foreigners pressures the rate that investors in general have charged the Treasury to buy the bonds sold to finance debt – they want to get more than the government is willing to pay. And the term of the bonds has become shorter. It is now between 2.5 and 2.8 years. One year ago it was 4.06 years.

Trap

Economist Affonso Celso Pastore, former Central Bank President and columnist for Estadão, warns that the National Treasury’s strategy of increasing fixed-rate bond issuances with shorter maturities is short-lived and could turn into a trap if the government fails to balance the accounts. According to him, Brazil’s fiscal problem translates into a steep long-term interest curve and excessive volatility of the real against other emerging currencies.

“The Treasury has an obligation to minimize the cost of debt, so it is forced to sell short-term securities, which have lower interest rates. But if the agency sells only short-term securities, in a year or two it will have to start rolling over the debt on a day-to-day basis, as it did in the 1970s,” he says. “The Treasury could find itself caught in an extremely difficult trap.”

Without reform, not even the end of the pandemic should bring investment

The National Treasury’s assessment is that the end of the pandemic will not guarantee the immediate return of foreigners and that their return hinges on the approval of reforms. For the government’s general coordinator of Public Debt operations, Luis Felipe Vital, there may even be speculative movements at certain times, but the return of institutional investors – who bet on Brazil in the long-term – is conditional on the approval of more reforms and clear indications of an economic rebound.

“We are talking about a reform agenda that is not short-term. The end of the pandemic alone is not a trigger for this return. This flow is fast to drop, and slower to return. It’s a gradual process.”

For economist Affonso Celso Pastore, intensifying the reform agenda to prevent this situation from prolonging is required. He recalls that savings with the pension reform were lower than in the original proposal and that the administrative reform project, which provides for savings in spending on civil servants, does not affect current servants.

“The government’s proposals do not solve the problem. The economic team attempts quick fixes to solve the fiscal problem a year or two ahead. The debt today is unsustainable because there is no credible fiscal system with a guarantee that the debt can be paid.”

Economist Carlos Kawall, director of Asa Investments and ex-secretary of the Treasury, also argues that the crisis is an opportunity for the country to strengthen itself, not to spend more.

“It is one thing to finance the debt in 2020. It is another to think that we will do this forever,” he says. “But it seems that the government – I’m not talking about the economic team – chose to have a picnic on the edge of the volcano.”

Kawall criticizes indications from the Jair Bolsonaro government and Congress that some emergency spending from the pandemic period could continue next year. According to him, in previous crises, Brazil made similar mistakes.

“In 2007 and 2008 we tackled the international crisis very well. We were investment grade and we could spend”, he recalls. “In the following period, we stopped making reforms and started to break the fiscal institutionality”.

Although the debt curtailment dynamic will persist until 2021, the National Treasury’s General Public Debt Strategic Planning Coordinator, Luiz Fernando Alves, assures that the Treasury will return to the strategy of extending bond maturities in 2022 and 2023. “The impact of the pandemic on the fiscal framework will tend to be restricted to 2020, and the reform agenda will favor this change in profile.”

Source: O Estado de S. Paulo