Lula Real Policy Makes Brazil Borrow Local as Dollar Costs Fall

Brazil’s policy of limiting gains in the real is preventing the government from taking advantage of the cheapest international borrowing costs relative to domestic rates in 16 months.

While Brazilian companies have sold a record $16 billion of bonds in overseas markets this year, the government has held one international issue, raising $788 million in an April offering of notes due 2021 that now yield 4.56 percent. Its real- denominated bonds due 2021 yielded 12.22 percent yesterday, or 766 basis points more than the dollar securities.

Policy makers are avoiding international bonds because foreign reserves have risen 26 percent since March 2009 to a record $255 billion as the central bank purchased dollars every day to prevent the real’s gains from disrupting exports, according to RBS Securities Inc. The real, down 0.7 percent this year, has appreciated 7.2 percent since May 20 and has strengthened more than any other currency against the dollar over the past six years.

“Brazil constantly intervenes to stem the pace of the currency appreciation,” Siobhan Morden, a debt strategist with RBS, said in a telephone interview from Stamford, Connecticut. “There are so many inflows. Why would the Treasury want to add to the problem and bring in more dollars?”

The difference between the government’s average dollar bond yield and the Brazilian overnight interbank target, the benchmark for 34 percent of local Treasury debt, climbed yesterday to 476 basis points, or 4.76 percentage points, the biggest since March 2009, according to data compiled by Bloomberg and JPMorgan Chase & Co.

Two Benchmarks

“Tactically when rates are at this level, it would make more sense for them to borrow abroad, but they have other long- term objectives,” said Pablo Cisilino, who helps manage $14 billion in emerging-market debt, including Brazilian bonds, at Stone Harbor Investment Partners in New York.

In addition to stemming dollar inflows, the government wants to hold down its foreign debt and develop the local bond market, Cisilino said. The government, which is rated the lowest investment-grade ranking at Standard & Poor’s and Moody’s Investors Service, had less than $60 billion of dollar debt as of April, down from about $75 billion in 2001, according to the Treasury.

Jose Franco Morais, public debt operations coordinator at the Treasury, said the government’s international bond strategy is to maintain liquid 10- and 30-year bonds that serve as benchmarks for corporate debt sales.

“The Treasury’s external financing needs are a lot smaller than in the past,” Morais said in a telephone interview from Brasilia yesterday.

Gol Sale

Gol Linhas Aereas Inteligentes SA, Brazil’s largest airline, sold $300 million of 10-year bonds to yield 9.5 percent yesterday, the third corporate international offering in the past three days. The gap between the average Brazilian corporate dollar bond yield and the local overnight rate reached a 16- month high of 388 basis points on June 21, according to data compiled by Bloomberg and JPMorgan. It closed yesterday at 383 basis points.

The government may sell debt abroad in coming weeks, Treasury Secretary Arno Augustin told reporters in Brasilia on June 29. Paulo Valle, the deputy treasury secretary, said in a June 21 interview that the government is considering issuing more of its dollar bonds due in 2021 and 2041.

The difference in Brazilian corporate and government bond issuance this year is the biggest since Bloomberg began tracking the data in 1999.

Default Swaps

The extra yield investors demand to hold Brazilian dollar bonds instead of U.S. securities fell 11 basis point yesterday to 212, according to JPMorgan. The so-called spread has tumbled 36 basis points this month.

The cost of protecting Brazilian debt against non-payment for five years with credit-default swaps dropped five basis points yesterday to 121, according to data compiled by CMA DataVision. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

Yields on Brazil’s overnight interest-rate futures contract due in January fell six basis points to 11.26 percent yesterday. The central bank has raised the benchmark overnight rate to 10.25 percent from a record low of 8.75 percent in April to cool the fastest economic expansion in 15 years.

The real gained 0.2 percent yesterday to 1.7570 per dollar.

‘Sporadic Issuer’

Foreign reserves have jumped more than six-fold from $38 billion when President Luiz Inacio Lula da Silva took office in 2003, bolstered by a rally in the country’s commodity exports.

When the government sells bonds abroad, the central bank buys the dollars raised, adding to its reserves. The increase prompts the bank to sell real bonds in the local market to prevent a surge in the money supply, adding to the country’s financing costs, Valle said.

“We need to coordinate the stretch of this debt with the international reserves,” Valle said in a June 21 interview at Bloomberg Headquarters in New York. “If I sell this in the market, the central bank will have to sterilize it and to pay the interest rate.”

JPMorgan forecasts Brazil may issue $1.2 billion more bonds in overseas markets this year.

“They are a sporadic issuer,” Morden said. “All governments have multiple policy objectives — funding costs, foreign exchange flows. Right now, the primary focus is the domestic market and that does come with a cost.”