By Carlos Pallordet.
Sluggish domestic activity and weak global growth have enabled Brazil’s central bank (BCB) to gradually bring interest rates closer to levels in other major emerging markets. Since August 2011, the BCB has cut the benchmark SELIC rate eight straight times, from 12.5% to an historic low of 8%. In order to make room for lower interest rates, the government changed the rules determining returns on domestic savings accounts in May, removing an obvious stumbling block to a lower SELIC.
The government has also worked to promote a lasting decline in interest rates in other ways. Through better management of the federal public debt (FPD) profile, the government is improving the efficiency of monetary policy. Many studies have shown that Brazil’s monetary policy effectiveness is hindered by the high share of floating-rate bonds (mostly SELIC-linked) in the FPD.
One of the reasons for this is that changes in the policy rate usually affect the value of financial assets and therefore the wealth of debt holders. In the case of Brazil, where financial institutions are major debt holders, this should affect their capacity to lend. This is one of the mechanisms of monetary policy transmission. In Brazil, however, the high share of SELIC-linked debt in their portfolios partially immunises them from changes in the SELIC, thereby limiting monetary policy effectiveness. As a result, changes in the SELIC need to be more dramatic than would otherwise be needed.
Another disadvantage from the prominence of SELIC-linked securities in the FPD is that fighting an adverse inflationary shock would entail high fiscal costs, as the average cost of debt would increases as interest rates rise (Chart 1). Given higher debt servicing costs, the government’s capacity to spend and invest would be more limited.
Chart 1: The cost of debt moves in tandem with the SELIC rate
As a result, public debt re-profiling lies at the heart of the federal government’s debt management strategy. Every year since 2001, the Treasury presents an annual financing plan determining targets with maximum and minimum levels for four main indicators of the FPD: stock, composition, average maturity and maturing debt in the next twelve months. These parameters are determined in accordance with the government’s borrowing needs and the overall macroeconomic scenario for the current year. They are also determined by seven long-term guidelines of FPD management.
The first of these guidelines relates to the gradual replacement of floating-rate securities with fixed-rate and inflation-linked instruments. The shares of each component are meant to gradually converge to a desired long-term debt structure given by an optimal benchmark in terms of public debt cost/risk efficiency. This benchmark was first quantified in last year’s annual financing plan (PAF 2011), which set a target range of 10%-20% for the share of floating-rate bonds in total FPD in the long term.
Progress in this direction was modest until last year. Floating-rate securities accounted for 30.1% of FPD in December 2011, compared to 33.9% in December 2008 (Chart 2). But the Treasury has set a more demanding target this year and is aiming to bring this share down to 22%-26% of total debt. The disinflationary environment has lent a helping hand with expectations of a weakening SELIC rate making floating-rate bonds less attractive compared with fixed-rate securities.
Source: Timetric, National Treasury Secretariat
According to the latest FPD monthly report, the share of floating-rate assets has fallen to 25.8% in May and it is poised to decline further as the Treasury finalised a BRL38 bn exchange deal in June with the Employees’ Severance Fund (FGTS) administered by the government. This accounts for almost 2% of total FPD of BRL1,922 bn (roughly USD950 bn) in May and should help bring the share of floating-rate bonds closer to the lower bound of the 22%-26% target range for the year.
The Treasury has also worked to improve the maturity of outstanding debt, another one of the guidelines set out in the FPD planning strategy. Improvements on this front are not yet visible, with the average maturity of the FPD stock remaining broadly unchanged at 3.6 years in December 2011. In part, this is due to the fact that fixed-rate bonds tend to be of shorter duration than floating-rate bonds so altering the debt composition works against extending average duration.
In May 2012, for example, the average duration of fixed-rate public debt offerings stood at 3.0 years, compared to 5.9 years for floating-rate bonds. The Treasury has partially addressed this concern by issuing inflation-linked bonds, which carry longer maturities. This has resulted in a steady increase in the average monthly duration of public offerings since the second half of 2011 (Chart 3).
Chart 3: Average duration of public offerings is on the rise
Finally, the Treasury has made progress in smoothing the debt maturity profile with special attention given to short-term maturities, another important guideline in the FPD planning strategy. As a result, debt maturing within 12 months has fallen steadily since 2004, down to just over one-fifth of the FDP in December 2011 (Chart 4).
Chart 4: The maturity profile has improved
Source: Timetric, National Treasury Secretariat
At a time when Brazil is under pressure to implement structural reforms, it is important to remember the progress it has made in other areas. The improvement in the public debt profile is a key example.