Brazil’s Public Debt Tied to Interest Rates and FX Set to Exceed Half of Total Debt in 2024 – Reuters

By Marcela Ayres

BRASILIA – The Brazilian government anticipates that public debt associated with interest and foreign exchange rates will exceed 50% of the total debt in 2023, a level not reached since October 2006, according to the Treasury’s updated annual financing plan.

Bonds linked to the country’s benchmark interest rate, known as LFTs, tend to make debt management less predictable. The government is aiming to reduce reliance on LFTs in the long term; however, these bonds tend to gain traction among investors during risk-averse periods, such as this year, due to uncertainties in U.S. monetary policy.

As it stands, Brazil’s benchmark interest rate is at 10.5%, with futures suggesting a potential increase at the central bank’s upcoming meeting on September 17-18. If realized, this hike would raise the Treasury’s costs associated with servicing these securities.

Bonds tied to exchange rates are also seen as more volatile. The Brazilian real has depreciated by approximately 14% against the U.S. dollar this year, raising the costs of this segment of the public debt in local currency. The currency’s decline has been linked to concerns over monetary policy in the U.S. and fiscal stability in Brazil.

In Wednesday’s announcement, the Treasury increased its forecast for the share of interest rate-linked bonds to 43%-47% of federal public debt, up from a previous estimate of 40%-44%. The forecast for exchange rate-linked bonds remains at 3%-7%. As of July, these bonds represented 44.95% and 4.44% of the total debt, respectively, indicating they could exceed 50% by year-end.

Otavio Ladeira, the deputy secretary for public debt, stated that the projected rise in exchange rate-linked debt is manageable, thanks to Brazil’s strong international reserves and the comparatively low portion of debt tied to foreign exchange, particularly when compared to conditions prevailing 18 years ago.

Regarding LFTs, Ladeira commented that expectations of increasing interest rates impact 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 the market prices in the interest rate hike relative to what actually transpires over time," he explained.

He also emphasized the Treasury’s commitment to diversifying the debt portfolio, with goals to reduce the share of interest rate-linked bonds to 23% by 2035, roughly half of the current level.

Additionally, the Treasury revised down its expectations for inflation-linked bonds to 25%-29% of total public debt this year, from an earlier range of 27%-31%. The anticipated share of fixed-rate bonds was also reduced to 22%-26%, down from 24%-28%.

The Treasury projects that public debt will range between 7 trillion and 7.4 trillion reais in 2024. It believes that the adjusted composition of the debt aligns better with market conditions, minimizing pressure on the bond pricing for the remainder of the year.