Brazil heads the list of large economies at risk from bond refinancing in 2018, according to a new Risky Finance analysis. A combination of maturing debt, bond coupon payments and a current account deficit means that Brazil must finance 15 per cent of GDP this year.
The risk comes as Brazil attempts to recover from recession and faces significant political milestones over the next 12 months. The data emphasises the importance of bond funds in the US and Europe that have poured money into the country’s debt in recent years, and now will be required to help roll it over.
Using a combination of Markit iBoxx bond data and International Monetary Fund statistics allows us to assess Brazil’s challenge. It has $248 billion in local currency bonds that mature in the next 12 months, $25 billion in coupon interest payments and a current account deficit that the IMF forecasts will be $39 billion1)some definitions of current account balance include coupon interest payments but the IMF definition excludes them.
Adding these together gives what the IMF calls a ‘gross financing need’ of 15 per cent of GDP, and is probably an underestimate given that iBoxx data doesn’t include short-term debt such as treasury bills. Only countries like Egypt or Pakistan have GFNs much bigger than that.
There is a reason why Brazil isn’t bracketed with these countries by lenders. Sidestepping the classic emerging market trap of dollar-based debt, Brazil has developed a deep and liquid market in local currency bonds, issuing debt with maturities as much as 32 years in the future, as shown in our repayment schedule chart below.
Hunting for yields in the QE environment, developed market money managers and pension funds have flocked to buy Brazilian debt. Big pension funds like the Dutch ABP and PFZW have bought billions of euros of it, according to their reports of top holdings. Pimco’s Total Return Fund reported owning $3.5 billion of local currency Brazilian bonds in September 2017, down from $5 billion a year earlier.
Specialist fund managers have built up big portfolios too. Take the GAM Local Emerging Bond fund, which doubled its assets under management in the past two years to $10.5 billion, with 13 per cent denominated in Brazilian currency, according to a December factsheet. Then there are exchange-traded funds such as Blackrock’s IEML local emerging market bond ETF, which has $7.3 billion AUM, with seven per cent invested in Brazil.
A 2017 IMF study put the total foreign holdings of Brazilian debt at $170 billion, illustrating just how comfortable investors have become. Meanwhile the local currency yield curve has dropped sharply at the short end, with bonds maturing next year yielding just five per cent compared with double that a year ago. But have investors become complacent?
Brazil’s political establishment is mired in corruption scandals, and populist outrage is strong. While the country’s government forecasts strong GDP growth this year, that is contingent on deeply unpopular reforms to pensions and social security passing through parliament. At the same time, Brazil’s deficit is increasing, adding to the debt financing requirement.
Markets took encouragement this week when a court upheld a conviction for Brazil’s left wing presidential front-runner Lula, effectively disqualifying him from standing. But October’s election could still spring a surprise. It will be interesting to see whether foreign investors continue to go along for the ride.
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|1.||↑||some definitions of current account balance include coupon interest payments but the IMF definition excludes them|