Brazil's public debt linked to interest rates and FX set to exceed 50%

Brazil's debt surges: Brazil's public debt associated with interest rates and foreign exchange is expected to exceed half of the total debt by the end of this year, a level last recorded in October 2006, according to the Treasury's revised annual financing plan released on Wednesday.

The bonds in question, known as LFTs, are linked to the country's benchmark interest rate, Selic. These bonds introduce a level of unpredictability in debt management due to their sensitivity to interest rate changes. 

LFTs popular again

While the government aims to decrease reliance on LFTs in the long term, their appeal has increased this year due to market uncertainties, particularly related to US monetary policy, the Treasury highlighted.

Currently, Brazil's benchmark interest rate stands at 10.5 per cent, with futures markets indicating a possible increase at the central bank's next meeting scheduled for September 17-18. A rate hike could elevate the cost of servicing these LFTs.

Additionally, bonds linked to the exchange rate are prone to volatility. The Brazilian real has depreciated approximately 14 per cent against the US Dollar this year, raising the cost of these debt instruments in local currency terms. This depreciation has been driven by both US monetary policy uncertainties and fiscal concerns within Brazil.

Debt share adjusted

In its update, the Treasury raised its forecast for the share of interest rate-linked bonds to 43 per cent-47 per cent of federal public debt, up from the previous 40 per cent-44 per cent range. The forecast for exchange rate-linked bonds remains at 3 per cent-7 per cent. As of July, these bonds constituted 44.95 per cent and 4.44 per cent of the total debt, respectively. The revised projections suggest that these figures will surpass 50 per cent by year-end.

Deputy Secretary for Public Debt, Otavio Ladeira, remarked that the anticipated increase in exchange rate-linked debt is manageable due to Brazil's substantial international reserves and the relatively modest share of foreign exchange-linked debt compared to 18 years ago.

Regarding LFTs, Ladeira pointed out that rising interest rates affect the entire yield curve, including fixed-rate bonds. He noted that the cost could be the same or even higher for fixed-rate bonds, depending on market expectations versus actual interest rate changes.

Future debt goals

The Treasury is committed to improving the debt profile, targeting a reduction in the share of interest rate-linked bonds to 23 per cent by 2035, about half of the current level.

Additionally, the revised plan lowers the expected share of inflation-linked bonds to 25 per cent-29 per cent from the previous 27 per cent-31 per cent. It also reduces the expected share of fixed-rate bonds to 22 per cent-26 per cent, down from 24 per cent-28 per cent. 

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

(With Reuters Inputs)