Brazil’s Public Debt Outlook

By Marcela Ayres

BRASILIA (Reuters) – Brazil’s government anticipates that public debt linked to interest and foreign exchange rates will exceed half of the total debt this year, a level not seen since October 2006, according to a revision of its annual financing plan released on Wednesday.

Known as LFTs, the bonds tied to Brazil’s benchmark interest rate, Selic, typically create unpredictability in debt management. The government aims to reduce its reliance on LFTs in the long term, though these bonds are highly favored by investors during periods of risk aversion, such as this year amid uncertainties surrounding U.S. monetary policy, as noted by the Treasury.

Currently, Brazil’s benchmark interest rate is at 10.5%, and futures indicate a potential hike at the central bank’s upcoming policy meeting on September 17-18.

If confirmed, this increase would raise the Treasury’s costs for servicing these securities. Additionally, exchange rate-linked bonds are more volatile. The Brazilian real has depreciated by about 14% against the U.S. dollar this year, elevating the local currency cost of this debt segment.

The currency has fallen due to monetary uncertainties in the U.S. and fiscal concerns in Brazil.

On Wednesday, the Treasury adjusted expectations for interest rate-linked bonds to comprise 43%-47% of federal public debt, up from the previous 40%-44% range. The expected share of exchange rate-linked bonds remains at 3%-7%.

As of July, these bonds represented 44.95% and 4.44% of total debt, respectively, and the Treasury suggested they may surpass 50% by year-end.

Otavio Ladeira, the deputy secretary for public debt, stated this anticipated rise in exchange rate-linked debt is manageable, given Brazil’s robust international reserves and the low share of debt tied to foreign exchange, unlike the situation 18 years ago.

Regarding LFTs, Ladeira pointed out that rising interest rates affect the entire yield curve, including fixed-rate bonds. “The cost ends up being the same or even higher for fixed-rate bonds depending on how much the market is pricing in interest rate hikes relative to actual outcomes over time,” he explained.

Ladeira emphasized the Treasury’s commitment to improving debt composition, with a goal of reducing the share of interest rate-linked bonds to 23% by 2035, approximately half of the current level.

In this revision, the Treasury also lowered the expected share of inflation-linked bonds to 25%-29% of total public debt from the previous 27%-31%. The expected share of fixed-rate bonds has been reduced to 22%-26% from 24%-28%.

The Treasury still anticipates ending 2024 with public debt between 7 trillion and 7.4 trillion reais ($1.24-1.31 trillion), arguing that the revised debt composition is more aligned with market conditions without exerting additional pressure on bond pricing for the remainder of the year.

($1 = 5.6326 reais)