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Reducing Public Sector’s FX Exposure:
The Brazilian Experience
Afonso Bevilaqua
December 2003
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Reducing Public Sector’s FX Exposure:
The Brazilian Experience
I. Background
II. Recent Strategy for Reducing Public Sector’s
FX Exposure
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Reducing Public Sector’s FX Exposure:
The Brazilian Experience
I. Background
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Reducing Public Sector’s FX Exposure:
The Brazilian Experience
 From the 80s to 1994:
 Despite chronic inflation, Brazilian economy has
never dollarized.
 Broad and credible indexation substituted the
dollar as an instrument to mitigate inflationary
losses.
 Demand for domestic debt was preserved through
indexation mechanisms.
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Reducing Public Sector’s FX Exposure:
The Brazilian Experience
 From 1994 to 1998:
 Monetary reform and exchange-rate anchor
succeeded in stopping high inflation;
 Public sector provided dollar-indexed securities,
safeguarding the administered FX regime;
 External crises in mid-90s (Mexico, Southeast
Asia, Russia) gradually increased vulnerability of
the Brazilian economy, with significant losses of
international reserves to sustain FX regime.
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Reducing Public Sector’s FX Exposure:
The Brazilian Experience
 From 1999 to present:
 Provision of dollar-indexed securities helped to
smooth the transition from administered to floating
FX regime, without generalized financial distress or
credit crunch;
 No significant balance sheet mismatches in the
private sector;
 3 major waves of devaluation after the move to
floating regime (1999, 2001 and 2nd half of 2002);
 Main impact of the 3 waves of devaluation on the
public sector’s debt.
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Debt/GDP Ratio (1994/03)
Sep 02
62.5%
65
60
57.7%
50
45
1999-02: FX realignment
40
35
30
Sep 03
Nov 02
Jan 02
Mar 01
May 00
Sep 98
Nov 97
Jan 97
Mar 96
May 95
25
Jul 99
1994-98: lax fiscal policy
+ high real interest rates
Jul 94
% of GDP
55
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Dollar-Indexed Debt /
Total Domestic Debt Ratio (91/03)
40
35
30
%
25
20
15
10
5
0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003*
* October/2003
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Exchange Rate R$/US$ (1994/03)
4.0
3.5
R$/US$
3.0
Nov 27
2.94
2.5
2.0
1.5
1.0
0.5
Jul 94
Jul 95
Jul 96
Jul 97
Jul 98
Jul 99
Jul 00
Jul 01
Jul 02
Jul 03
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Real Effective Exchange Rate (1994/03)
4.00
3.80
3.60
3.40
3.20
R$/US$
3.00
2.80
2.60
2.40
2.20
2.00
1.80
1.60
1.40
Jul 94
Jul 95
Jul 96
Jul 97
Jul 98
Jul 99
Jul 00
Jul 01
Jul 02
Jul 03
10
Net Public Sector Debt vs
Real Exchange Rate (1994/03)
63
4.0
45
Net Debt/GDP
2.5
36
Real Effective Exchange Rate
2.0
Sep 03
Nov 02
Jan 02
Mar 01
May 00
Jul 99
Sep 98
Nov 97
Jan 97
Mar 96
1.5
May 95
27
Jul 94
% of GDP
3.0
R$/US$
3.5
54
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Net Public Sector Debt Increase
Decomposition - % of GDP (1995/98)
1995
1996
1997
1998
95-98
Net debt increase
1.4%
1.9%
1.1%
7.4%
11.7%
1. Primary surplus
-0.3%
0.1%
0.8%
0.0%
0.7%
2. Pure interest on the debt
6.1%
5.4%
4.8%
7.4%
21.2%
3. Depreciation on domestic debt
0.1%
0.1%
0.2%
0.5%
0.8%
4. Depreciation on foreign debt
0.9%
0.1%
0.3%
0.3%
1.2%
5. Skeletons
1.5%
2.0%
0.1%
1.6%
4.5%
6. Privatization proceeds
0.0%
-0.2%
-1.8%
-1.4%
-3.3%
7. Effect of GDP growth
-7.0%
-5.6%
-3.3%
-1.0%
-13.5%
Debt dynamics (1+2+7)
-1.2%
-0.1%
2.4%
6.4%
8.4%
Currency (3+4)
1.0%
0.2%
0.5%
0.7%
2.1%
Net "skeletons" (5+6)
1.5%
1.8%
-1.8%
0.3%
1.2%
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Net Public Sector Debt Increase
Decomposition - % of GDP (1999/03)
1999
2000
2001 2002
2003* 99-03*
Net debt increase
7.0%
0.1%
3.8%
4.0%
1.2%
16.0%
1. Primary surplus
-2.9%
-3.3%
-3.5%
-3.4%
-3.7%
-14.4%
2. Pure interest on the debt
8.2%
6.8%
6.9%
7.3%
7.4%
31.1%
3. Depreciation on domestic debt
3.8%
0.8%
1.5%
4.9%
-1.4%
8.0%
4. Depreciation on foreign debt
2.8%
0.8%
1.5%
4.5%
-2.6%
5.7%
5. Skeletons
1.3%
0.8%
1.5%
0.9%
0.1%
3.7%
6. Privatization proceeds
-0.9%
-1.8%
-0.1%
-0.2%
0.0%
-2.2%
7. Effect of GDP growth
-5.4%
-3.9%
-4.0%
-10.2%
0.6%
-16.7%
Debt dynamics (1+2+7)
0.0%
-0.5%
-0.6%
-6.2%
4.2%
0.0%
Currency (3+4)
6.5%
1.6%
3.0%
9.4%
-4.0%
13.7%
Net "skeletons" (5+6)
0.5%
-1.0%
1.4%
0.7%
0.1%
1.5%
* Data for September/2003
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Reducing Public Sector’s FX Exposure:
The Brazilian Experience
II. Recent Strategy for Reducing Public Sector’s
FX Exposure
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Reducing Public Sector’s FX Exposure:
The Brazilian Experience
 Different features of the 2001 and 2002 depreciation
episodes:
 2001:
“pure external shocks”  increase in demand for hedge.
 2002:
confidence crises  reduction in demand for hedge
(and reduction in FX liabilities of private sector).
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Reducing Public Sector’s FX Exposure:
The Brazilian Experience
 Different responses in the depreciation episodes:
In 2001:
 Net placement of dollar-indexed securities to mitigate impact
of increased demand for hedge on the exchange market;
 Dollar-indexed domestic debt rollover rate reached 137.0%.
In 2002, before the crisis:
 Central Bank introduced FX swaps to replace dollar-indexed
Treasury notes (NTN-D); swaps perceived as having lower
credit risk (daily margin adjustment) than NTN-D.
 2nd Half of 2002:
 Increased risk perception reduced the rollover rate to 45.2%
during August/October, averaging 66.4% for the year.
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Reducing Public Sector’s FX Exposure:
The Brazilian Experience
 2003: rapid improvement in fundamentals enabled the
Central Bank to actively reduce public sector’s FX
exposure;
 Since the end of May, Central Bank announced that it
would not rollover a fixed rate of FX securities or swaps
maturing;
 In July, Central Bank disciplined auction procedures,
establishing a maximum of two auctions to be carried
out for each rollover;
 In September, Central Bank reduced number of
auctions to one.
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FX Instruments Rollover Rate* (2001/03)
140
137.0%
120
100
80
%
66.4%
65.8%
60
40
20
0
2001
2002
* Includes rollover of intermediary and final interests
Jan/Nov
2003
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FX Instruments Rollover Rate* (2003)
Average Jan/May: 87.1%
100
90
80
85.3
88.1
Average Jun/Nov: 41.5%
91.4
85.0
84.5
81.7
70
%
60
56.2
50
42.3
40
33.9
30
20
7.3
10
2.1
0
Jan 03 Feb 03 Mar 03 Apr 03 May 03 Jun 03 Jul 03 Aug 03 Sep 03 Oct 03 Nov 03
* Includes rollover of intermediary and final interests
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FX Domestic Debt:
Total Outstanding in US$ (1999/03)
(Includes Swaps)
2001:
Increase of
US$ 18.8 billion
80
2002:
Reduction of
US$ 8.4 billion
2003 to November:
Reduction of
US$ 6.0 billion
US$ billion
75
70
65
60
55
Dec 99 Apr 00 Set 00
Feb 01 Jul 01 Dec 01 May 02 Oct 02 Mar 03
Nov 03
OBS: This behavior is partly explained by the rise and later fall of the FX
coupon, which affected outstanding marked to market (see next slide).
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FX Coupon (2002/03)
90
Pre-elections
period
80
70
60
%
50
40
30
20
10
0
-10
Jan 02
May 02
Sep 02
90 days
Jan 03
May 03
Sep 03
360 days
21
FX-Indexed Debt/Total Domestic Debt
(2000/03)
(Includes Swaps)
42
peak in Sep/02 (40.7%), especially
due to price-effect (FX depreciation)
40
38
36
%
34
32
30
28
26
Trough in Oct/03 (24.4%) due to
price-effect (FX appreciation)
and quantity-effect
24
22
20
Dec
99
Jun
00
Dec
00
Jun
01
Dec
01
Jun
02
Dec
02
Jun Oct
03
03
22
FX-Indexed Debt/Total Domestic Debt
vs. Exchange Rate (1999/03)
42
4.0
40
38
FX-Indexed Debt/Total Domestic Debt
%
34
3.0
32
30
R$/US$
36
3.5
2.5
28
26
24
Exchange Rate
2.0
22
20
1.5
Dec 99 May 00 Oct 00 Mar 01 Aug 01 Jan 02 Jun 02 Nov 02 Apr 03 Oct 03
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Stock of Hedge at Cetip (2002/03)
41
40,6
40.6
US$ billion
39
37
35
33
31
30.0
29
Jan
02
May
02
Aug
02
Nov
02
Mar
03
Jun
03
Oct
03
Cetip: Private central securities depository for Brazilian fixed-income securities and
derivatives (OTC market). Data excludes intra-market operations.
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Exchange Rate Volatility (2002/03)
 Reduction in demand for hedge partly explained by fall in FX volatility
60%
55%
Pre-elections
period
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
Jan 02
May 02
Sep 02
Jan 03
May 03
Nov 03
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Reducing Public Sector’s FX Exposure:
The Brazilian Experience
 Main Outcomes:
 In 2003, Government actively pursued a strategy
aimed at reducing dollar-indexed debt;
 Rollover rate of FX instruments reduced to 41.5% in
the June/November 2003 period, without any major
effect on the FX market;
 Share of FX debt to total domestic debt fell to 24.4%
in October 2003 from peak of 40.7% in September
2002;
 Reduction in FX hedge provision by the public
sector in 2003 (including early December rollover)
reached US$ 17.6 billion.
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Reducing Public Sector’s FX Exposure:
The Brazilian Experience
Afonso Bevilaqua
December 2003
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