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Afonso Bevilaqua December 2003

Reducing Public Sector’s FX Exposure: The Brazilian Experience. Afonso Bevilaqua December 2003. 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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Afonso Bevilaqua December 2003

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  1. Reducing Public Sector’s FX Exposure: The Brazilian Experience Afonso Bevilaqua December 2003

  2. Reducing Public Sector’s FX Exposure: The Brazilian Experience I. Background II. Recent Strategy for Reducing Public Sector’s FX Exposure

  3. Reducing Public Sector’s FX Exposure: The Brazilian Experience I. Background

  4. 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.

  5. 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.

  6. 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.

  7. Debt/GDP Ratio (1994/03) Sep 02 62.5% 65 60 57.7% 55 50 % ofGDP 45 1999-02: FX realignment 40 35 30 1994-98: lax fiscal policy + high real interest rates 25 Jul 94 Jul 99 Jan 97 Jan 02 Mar 96 Mar 01 Sep 98 Sep 03 Nov 97 Nov 02 May 95 May 00

  8. 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

  9. Exchange Rate R$/US$ (1994/03) 4.0 3.5 3.0 Nov 27 2.94 2.5 R$/US$ 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

  10. Real Effective Exchange Rate (1994/03) 4.00 3.80 3.60 3.40 3.20 3.00 2.80 R$/US$ 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

  11. Net Public Sector Debt vs Real Exchange Rate (1994/03) 63 4.0 3.5 54 3.0 45 % of GDP R$/US$ Net Debt/GDP 2.5 36 2.0 Real Effective Exchange Rate 27 1.5 Jul-94 Jul-99 Jan-97 Jan-02 Mar-96 Mar-01 Sep-98 Sep-03 Nov-97 Nov-02 May-95 May-00

  12. 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%

  13. 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

  14. Reducing Public Sector’s FX Exposure: The Brazilian Experience II. Recent Strategy for Reducing Public Sector’s FX Exposure

  15. 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).

  16. 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;

  17. 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.

  18. FX Instruments Rollover Rate* (2001/03) 137.0% 140 120 100 80 66.4% 65.8% % 60 40 20 0 2001 2002 Jan/Nov 2003 * Includes rollover of intermediary and final interests

  19. 100 91.4 88.1 90 85.3 85.0 84.5 81.7 80 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 FX Instruments Rollover Rate* (2003) Average Jan/May: 87.1% Average Jun/Nov: 41.5% * Includes rollover of intermediary and final interests

  20. FX Domestic Debt: Total Outstanding in US$ (1999/03) (Includes Swaps) 2001: Increase of US$ 18.8 billion 2002: Reduction of US$ 8.4 billion 2003 to November: Reduction of US$ 6.0 billion 80 75 US$ billion US$ billion 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).

  21. FX Coupon (2002/03) Pre-elections period 90 80 70 60 50 % 40 30 20 10 0 -10 jan 02 may 02 set 02 jan 03 may 03 set 03 90 days 360 days

  22. FX-Indexed Debt/Total Domestic Debt (2000/03) (Includes Swaps) 42 peak in Sep/02 (40.7%), specially 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 Jun Dec Jun Dec Jun Dec Jun Oct 99 00 00 01 01 02 02 03 03

  23. FX-Indexed Debt/Total Domestic Debt vs. Exchange Rate (1999/03) 42 4.0 40 38 3.5 FX-Indexed Debt/Total Domestic Debt 36 34 % 3.0 32 R$/US$ 30 2.5 28 26 Exchange Rate 2.0 24 22 20 1.5 Dec 99 May 00 Oct 00 Mar 01 Aug 01 Jan 02 Jun 02 Nov 02 Apr 03 Oct 03

  24. Stock of Hedge at Cetip (2002/03) 41 41 40,6 40.6 39 39 37 37 US$ billion 35 35 33 33 31 31 30.0 29 29 Jan May Aug Nov Mar Jun Oct 02 02 02 02 02 02 02 02 03 03 03 03 03 03 Cetip: Private central securities depository for Brazilian fixed-income securities and derivatives (OTC market). Data excludes intra-market operations.

  25. Exchange Rate Volatility (2002/03) • Reduction in demand for hedge partly explained by fall in FX volatility Pre-elections period 60% 55% 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Jan-02 May-02 Sep-02 Jan-03 May-03 Nov-03

  26. 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.

  27. Reducing Public Sector’s FX Exposure: The Brazilian Experience Afonso Bevilaqua December 2003

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