Frameworks for Monetary Stability
Chapter

19 Debt Management Techniques Under High Inflation: The Brazilian Experience

Editor(s):
Carlo Cottarelli, and Tomás Baliño
Published Date:
December 1994
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CARLOS AUGUSTO DIAS DE CARVALHO

The successive changes in the level of Brazilian inflation since the 1950s nullified all possibilities of government savings and limited to short term all resources raised by private financial intermediaries. With the financial and tributary reforms of 1964, it was possible to renew the Brazilian public sector finance mechanisms, especially with the introduction of indexation of public bonds and taxes. Consequently, it was possible to accomplish these reforms by the absorption of foreign savings, making possible the high growth rates throughout the end of the 1960s and the 1970s.

Simultaneously with this successful phase of the Brazilian economy, it was possible to develop a modern financial market while many monetary innovations were added. These innovations were responsible for the maintenance of the financial mechanisms in the economic crisis present after 1980.

This paper seeks, in its first part, to describe the institutional aspects associated with the evolution of public debt in Brazil and the relative data from 1964 to 1992. In the second part, the controversies over the Brazilian public deficit and its impact on public debt are explained. In the third part, the relationship between public debt and the execution of the monetary policy is discussed. Finally, the way the Central Bank of Brazil and the National Treasury handled public debt in the period from 1986 to 1993 is analyzed. In this period, Brazilian inflation fluctuated a great deal, due to numerous unsuccessful stabilization plans that led to atypical operational practices which were successful. Whereas they allowed the monetary flows of the economy to be kept constant, there was also a constant shortening of their terms.

An Overview

In the period up to 1963, the internal public federal securities debt1 was based on placements of federal bonds and securities of compulsory issue. As examples of these papers, one can cite economic restructuring bonds (Law 1474, dated 11.26.51; Law 1628, dated 06.20.52 and Law 2973, dated 11.26.56) and refundable bonds (Law 4069, dated 06.11.62). Lacking the liquidity required to form a secondary market for its papers and in the absence of mechanisms capable of avoiding negative earnings for borrowers (provoked by worsening inflation), the Government was deprived of an effective instrument for obtaining noninflationary resources and, thus, became dependent on tax inflows and currency issues to meet expenditures.

With the institutional reforms introduced in 1964, the process of recovering public sector credit was initiated, with creation of indexed national treasury bonds (ORTN) and the institution of monetary indexing (Law 4357, dated 07.16.64). The purpose of the latter measure was to protect those holding these papers against variations in the purchasing power of national currency. Though subscription to treasury bonds was initially compulsory or an optional alternative to tax payments, they gradually gained a position of preference with the general public, since their rate of return was more attractive in comparison with other fixed-yield papers then in circulation on Brazil’s still incipient financial market. Aside from this, public acceptance of these papers made it possible to lengthen redemption periods and, consequently, elongate the public debt profile. The period of sharpest public debt growth occurred in the wake of the creation of national treasury bills (LTN) through Decree Law 1079, dated 01.21.70. These papers had preset earnings and were to be used basically in developing open market operations, considered a more flexible and efficient instrument available to the Central Bank in its efforts to regulate financial system liquidity.

It should be noted that, once the Federal Government had created a public debt policy, coupled with more effective placement mechanisms, the states and some municipalities followed suit and expanded their outlays through issues of papers with similar characteristics.

Among the most hotly debated aspects of the Brazilian public debt, the most important always involved the causes of its growth. While some affirmed that the causes were to be found in the public deficit, others defended the position that growth was rooted in the need for adjusting monetary base expansion, which, in turn, was strongly impacted by questions related to the nation’s foreign accounts. Since these discussions were of fundamental importance to elaboration of fiscal and monetary policies, a specific section is devoted to this matter. Here, we present only the public debt figures of greatest importance to Brazil’s objectives and, in a preliminary fashion, tell about the causes of debt growth.

Banco do Brasil, Central Bank, and Treasury Relations2

The financing standard of the development models adopted by Brazil in recent decades depended on credits supplied by the government banking system and the international financial system. In the latter case, up to the final years of the 1960s, the major share of credits originated in international credit institutions. From that point forward, however, the participation of the private banking network took on progressively greater importance.

As regards monetary authority credits granted, it is worth looking back on the evolution of the system up to 1987. Until 1945, Banco do Brasil exercised monetary authority functions, though it did not control decisions on monetary base growth, such as exchange policy implementation and budgetary programming. Creation of the Superintendency of Currency and Credit (SUMOC) in 1945 did not eliminate the monetary structure then in effect since it was founded as a consultative entity, while Banco do Brasil continued financing the cash imbalances generated by treasury deficits.

The 1964 Banking Reform (Law 4595) created the National Monetary Council and the Central Bank of Brazil, while also institutionalizing the capital market (Law 4728/65). The purpose of these measures was to create and develop a financial system suited to recently introduced innovations, including adoption of monetary indexing. From that point forward, monetary budget proposals elaborated by the Central Bank were submitted to the National Monetary Council. However, this procedure generated little practical effect since the central bank “Movement Account” in Banco do Brasil continued generating distortions that demanded automatic Banco do Brasil coverage of treasury deficits. However, with the limited degree of transparency introduced into monetary programming, a new system of monetary policy implementation was gradually adopted, making it possible to introduce open market operations as one of the instruments capable of controlling deviations that had previously occurred in the programmed trajectory of the monetary aggregates.

Monetary budget monitoring demonstrated just how difficult it is to manage monetary policy when the monetary authority is automatically obligated to honor commitments that are characteristically a treasury responsibility, such as formation of buffer stocks and floor price policy in the farm sector. On innumerable occasions, open market operations were incapable of correcting deviations from programmed goals, since the public securities market was often unable to absorb the volume of federal papers required to neutralize monetary base expansion, due either to the inadequate structure of the central bank portfolio or to the magnitude of the monetary base growth generated, for example, by the financing of farm activities and positive trade balances. In the latter case, efforts made to adjust the Brazilian economy in the wake of the balance of payments crisis made it essential that positive trade balances be achieved. In much the same way, on several different occasions, such random events as crop failures or harvest excesses were detrimental to the efficacy of central bank measures.

Over the course of time, innumerable sources of nonmonetary funding were utilized to finance monetary authority investments, including deposits registered in foreign currency and fund and program resources managed by the monetary authorities. For the most part, therefore, the role of regulating monetary base growth fell to central bank federal public security operations. Evidently, this would have been the normal way of doing things were it not for the fact that it generated erratic and unprogrammed public debt growth.

Evidence of the increasing difficulty involved in implementing Brazilian monetary policy is provided by Ferreira (1984), who estimated that, in 1965, growth of 1 percent in monetary authority investments corresponded to a 1.4 percent increase in the monetary base, as compared with the January-July 1984 period, when the same level of growth would have generated an expansion of 6 percent. The same study demonstrates that monetary base instability is also generated by nonmonetary liabilities. Consequently, up to 1987, it was simply impossible to elaborate a public debt policy built upon a transparent definition of its role in the financing of federal government deficits.

Based on estimates made in 1969, inclusion of public debt redemptions and interest payments—both of which had risen considerably in the 1964–68 period—in the federal government budget would have increased the treasury deficit to an excessive degree. At the same time, it was necessary to create the conditions required for a secondary market. This was done by allocating the task of open market operations to the Central Bank, since these are considered the most agile monetary policy instrument available. Complementary Law No. 12 was signed on 11.08.71, with the purpose of providing those responsible for economic policy formulation and execution with greater leeway and freedom of action in the financing of the deficit. According to this law, credit operations involving placements and redemptions of national treasury papers designed for purposes of rolling over the public debt could be made independently of annual budget estimates of revenues and expenditures.

Down through the years, many disbursements characterized as fiscal in origin were made through the monetary authorities. The result was to circumvent the natural decision-making process on public resource allocation and, in this way, neutralize the budgetary authority of the Congress. Examples of such distortions are found in releases of funds through the Central Bank and Banco do Brasil for purposes of buffer stock formation, farm price supports, subsidies to priority areas and activities, and marketing of wheat, sugar, alcohol and other products.

The measures taken by the Central Bank had the objective of neutralizing the causes of monetary base expansion generated not only by its role as the entity responsible for monetary policy implementation, but also by the impact of increased Banco do Brasil investments at the order and on the account of the National Treasury. To the extent that growth in monetary authority assets was not offset by nonmonetary liabilities, disbursements were effected through monetary base growth, which, in turn, resulted in central bank security placements permitted by Complementary Law No. 12 to neutralize the effects of such growth.

When one considers that placements of securities for purposes of financing expenditures occurred after the Government had already made such expenditures, and that the system was further expanded in an erratic manner in the 1970s—since monetary base growth did not occur exclusively by reason of exogenous factors—public debt growth became an almost totally random process. This phenomenon resulted in the measures adopted in 1986, including creation of the Secretariat of the National Treasury (STN) and legislation that attributed to the Congress authority to define ceilings on public debt growth in each fiscal year. A good example of the degree of public debt management bedlam—coupled with the latitude provided by Complementary No. 12—was the Central Bank’s practice of hedging its liabilities in foreign currency through federal security issues, when the original liabilities had been generated by the Government’s assumption of the external debt (Resolution No. 432). This is a clear demonstration of the fragility of public debt growth controls, since Brazilian monetary policy generated practically no impact over such factors as exchange rates and international interest rates.

Public Debt Growth, Structure, and Cost

Recent analyses of the public debt situation have focused on verifying whether it is feasible for the Government to continue managing it in an effective manner or, in other words, in a manner compatible with its debt and payment capacity. Since one of the objectives of this paper is to verify in what way indebtedness in securities can contribute to future financing of the Government in a framework of high inflation, principally now that public debt management has been transferred to the Secretariat of the National Treasury, background information should be provided as a foundation to the proposals and analyses we intend to present. In this way, it should be possible to avoid repetition of the debt management distortions of the past. Therefore, what follows should not be considered as a detailed specification of the process itself, but rather as a record of relevant facets of the development of the nation’s situation of securities indebtedness.

In 1964, the level of government indebtedness was practically nil, due either to the lack of credibility in securities as a value reserve or to the absence of a financial market capable of operating such papers. It should be emphasized that, for the same reasons, there were no feasible options available to the private sector for placements of long-term debt. The period from 1964 to 1970 was marked by recovery of the government’s capacity to assume indebtedness in securities as a means of financing treasury operations. This was achieved both through the reforms introduced after 1964 and by the compulsory nature of the placements made. The change was evident in the growth of the participation of federal public debt securities in total financial assets, as shown in Table 1. Another important aspect in the evolution of the public debt in the period from 1970 to 1992 was its real average growth of approximately 10.5 percent per year.

Table 1.Brazil: Distribution of Financial Assets Among Monetary and Nonmonetary Assets, 1968–92(In billion U.S. dollars)
Monetary Assets (A)Nonmonetary Assets (B)
YearCurrent

Public

Assets
PercentDemand

Deposits
PercentTotalPercentSavings

Deposits
PercentCDB/FAF/LC

/DER/VOB1
PercentPublic Federal

Securities

Debt Held by

Public2
PercentState

Municipal

Debt
PercentTotalPercentFinancial

Assets

(C) = (A) + (B)
Percent
19681.04134.58555.62680.0001.72210.91110.0002.63328.26100
19721.8558.652410.50291.2537.122017.31480.00025.687136.19100
19763.73716.363120.09388.671612.222310.18191.86432.936253.02100
19804.43517.362021.792515.041714.141633.58392.29365.057586.83100
19823.88513.061616.942022.842720.982518.55223.96566.328083.26100
19832.0337.11109.151318.292615.242125.41363.05461.998771.14100
19841.8836.91118.791418.843015.702516.65262.83554.028662.81100
19851.9128.581110.491420.972717.452324.79323.15466.358676.84100
19865.36524.772430.122922.092122.492224.10234.02472.7071102.82100
19873.46410.931114.391530.453214.301531.28335.54681.568595.96100
19882.6136.5369.15933.973413.591339.20395.23591.9991101.14100
19893.5235.2848.80728.172314.621262.605010.578115.9593124.76100
19905.7669.001014.761713.941643.574911.76135.29674.568389.32100
19913.3746.74810.101315.341938.164811.60154.77669.888779.99100
19923.3035.5458.84820.421836.253236.333210.419103.4192112.25100
Sources: Public federal securities debt (DPMF): reports from the Department of Public Debt (DEDIP). Department of Economics of the Central Bank (DEPEC), and Department of Open Market Operations (DEMAB); GDP: Department of Economics of the Central Bank (DEPEC) and Inter-American Development Bank (IDB) concept; rate of exchange at end of period.

Bank certificates of deposit and other bank accounts.

Various securities: treasury obligations (OTN), treasury bonds (BTN), treasury notes (NTN), treasury bills (LTN), treasury financing bills (LFT), central bank bills (LBC), and central bank bonds (BBC).

Sources: Public federal securities debt (DPMF): reports from the Department of Public Debt (DEDIP). Department of Economics of the Central Bank (DEPEC), and Department of Open Market Operations (DEMAB); GDP: Department of Economics of the Central Bank (DEPEC) and Inter-American Development Bank (IDB) concept; rate of exchange at end of period.

Bank certificates of deposit and other bank accounts.

Various securities: treasury obligations (OTN), treasury bonds (BTN), treasury notes (NTN), treasury bills (LTN), treasury financing bills (LFT), central bank bills (LBC), and central bank bonds (BBC).

The ratio of public debt to gross domestic product (GDP) (see Table 2) demonstrates that growth was compatible with the financial market reforms initiated in 1964. In other words, this growth occurred in a manner compatible with that of other nonmonetary financial assets and with the expansion of internal savings (Table 3), while at the same time remaining at a relatively low percentage level. In the period from 1964 to 1970, the medium-term public debt declined steadily. This occurred as a result of its compulsory nature and the fiscal incentives granted at the time of first placement. Later, with the creation of a central bank sector directly involved in public debt management (GEDIP), coupled with the other financial assets generated by the 1964 reforms, average terms declined as voluntary placements surpassed compulsory placements, and open market operations (created in the fourth quarter of 1968) expanded. In the 1964 to 1970 period, the cost of the public debt was impacted fundamentally by the need to create a market for federal public securities. Consequently, in the period in question, the real cost of the debt was increased by the fiscal incentives granted to subscribers and by the earnings paid on compulsory deposits in the Central Bank that were partially transformed into ORTN investments, at that time the only security in circulation and one that produced maximum earnings of as much as 10 percent per year.

Table 2.Brazil: Public Federal Securities Debt Held by the Public in Relation to GDP, 1970–92(In million U.S. dollars)
PeriodPrice Indices

(Percent per year)
Public Federal

Securities Debt

Held by Public
GDPPublic Federal

Securities Debt

Held by Public

(Percent of GDP)
197019.272,00047,2224.24
197119.462,41755,7454.33
197215.703,97765,7416.05
197315.575,33079,5906.70
197434.556,36894,0346.77
197529.358,757108,6988.06
197646.2711,740127,5949.20
197738.7812,622142,9258.83
197840.8414,763161,0579.17
197977.219,238187,2274.93
1980110.249,492223,0884.25
198195.1816,659234,2097.11
198299.7118,556250,3977.41
1983211.029,678251,4293.85
1984223.9017,333274,4366.32
1985235.0024,736305,6268.09
198665.0424,046337,8327.12
1987415.8331,731360,8108.79
19881,037.5641,196371,99911.07
19891,782.9062,214399,64715.57
19901,476.5612,462398,7473.13
1991480.1811,559418,5602.76
19921,157.9438,145423,4139.01
Sources: General index of prices (IGP)—Internal demand (DI): historic series of inflation (ANDIMA, pp. 92–95); public federal securities debt (DPMF): reports from Department of Public Debt (DEOIP). Department of Economics of the Central Bank (DEPEC), and Department of Open Market Operations (DEMAB); GDP: Department of Economics of the Central Bank (DEPEC) and Inter-American Development Bank (IDB) concept; exchange rate at end of period.
Sources: General index of prices (IGP)—Internal demand (DI): historic series of inflation (ANDIMA, pp. 92–95); public federal securities debt (DPMF): reports from Department of Public Debt (DEOIP). Department of Economics of the Central Bank (DEPEC), and Department of Open Market Operations (DEMAB); GDP: Department of Economics of the Central Bank (DEPEC) and Inter-American Development Bank (IDB) concept; exchange rate at end of period.
Table 3.Brazil: Financial Assets in Relation to GDP, 1972–92(In billion U.S. dollars)
PeriodMonetary

Assets

(A)
Nonmonetary

Assets

(B)
Financial

Assets

(C) = (A) + (B)
Monetary

Assets/GDP1

(D)
Nonmonetary

Assets/GDP1

(E)
Financial

Assets/GDP1

(F) = (D) + (E)
197210.5025.6836.1915.9839.0755.04
197620.0932.9353.0215.7425.8141.55
198021.7965.0586.839.7729.1638.92
198216.9466.3283.266.7626.4933.25
19839.1561.9971.143.6424.6628.29
19848.7954.0262.813.2019.6822.89
198510.4966.3576.843.4321.7125.14
198630.1272.70102.828.9221.5230.43
198714.3953.4167.813.9914.8018.79
19889.1591.99101.142.4624.7327.19
19898.80115.95124.762.2029.0131.22
199014.7674.5689.323.7018.7022.40
199110.1069.8879.992.4116.7019.11
19928.84103.41112.252.0924.4226.51
Sources: Monetary and nonmonetary assets: central bank reports for 1984, 1986, and 1968 (pp. 50, 47, 52, respectively); exchange rate at end of period.

Percent.

Sources: Monetary and nonmonetary assets: central bank reports for 1984, 1986, and 1968 (pp. 50, 47, 52, respectively); exchange rate at end of period.

Percent.

As already affirmed, the level of public indebtedness generated a situation in which the cost to the Treasury led to issue of Complementary Law No. 12, which delegated management of public debt rolling over to the Central Bank, at a moment in which absorption of its costs had already become significant to the Treasury. In the period between 1971 and 1979, real growth of the public debt was steady, averaging approximately 15.5 percent per year. This situation was fostered by consolidation of open market operations, which made it possible to place an increasing volume of papers with financial institutions. It should be mentioned that this strategy was made feasible through transformation of maturities, risks, and volumes of capital effected by these companies on obtaining resources from the public for the financing of their portfolios. Such operations are carried out under the terms of the regulations governing operations based on fixed-price repurchases.

Here, one should emphasize the importance of these operations since, prior to them, backing for security placements was supplied by resources saved by economic agents. Following consolidation and regulation, an increasing volume of resources originated in the separation of the reception and payment periods of companies and individuals. In other words, resources with reduced availability in terms of investment periods came to sustain central bank placements. Another factor of importance was the more dynamic nature of the public and private securities market, which, by expanding the liquidity of these assets, made it possible for economic agents to absorb them into their portfolios. The growth of this market was of fundamental importance to open market operations since the increasingly contractive monetary impacts demanded by monetary policy—generated by increased movement of fiscal disbursements through the monetary budget—could then be operative. As a consequence of the enhanced dynamics of the financial market brought about by creation of the LTN and of the excess liquidity that resulted from the inflow of foreign resources, the average debt term oscillated between a minimum of 12 months and 15 days in 1971 and 24 months and 22 days in 1975 (Table 4).

Table 4.Brazil: Average Term of Federal Public Securities Debt, 1970–92
PeriodORTN/

OTN
LFTBTNNTN-BNTN-CNTN-DNTN-HLTNTotal
197017M 05D20D16M 00D
197116M 11D01M 13D12M 15D
197221M 23D02M 20D14M 05D
197327M 22D03M 21D16M 20D
197431M 02D03M 24D22M 140
197537M 29D03M 14D24M 22D
197631M 28D03M 19D19M 04D
197730M 27D03M 11D17M 01D
197827M 12D03M 07D14M 08D
197925M 09D03M 05D13M 270
198034M 02D03M 02D24M 21D
198135M 22D04M 10D24M 16D
198236M 01D03M 12D29M 20D
198331M 17D02M 1lD25M 29D
198420M 06D01M 26D19M 01D
198512M 04D27D10M 11D
198612M 12D02M 16D08M 12D
198713M 13D01M11M 10D
198807M 14D04M 23D11D04M 24D
198905M 01D04M 24D14M 14D04M 29D
199017M 10D18M 04D08M 14D08M 12D
199108M 17D09M 13D17M 00D13M 16D23M 11D16011M 07D
199215M 03D15M 25D17M 07D07M 20D11M 05D01M 20D07M 07D
Sources: Secretariat of the National Treasury, central bank reports, and Department of Open Market Operations (DEMAB).NOTE: ORTN/OTN = treasury securities; LFT = treasury financing bills; BTN = treasury bonds; NTN = treasury notes; and LTN = treasury bills. In body of table, M = months and D = days.
Sources: Secretariat of the National Treasury, central bank reports, and Department of Open Market Operations (DEMAB).NOTE: ORTN/OTN = treasury securities; LFT = treasury financing bills; BTN = treasury bonds; NTN = treasury notes; and LTN = treasury bills. In body of table, M = months and D = days.

Among the most important aspects of that period, emphasis should be given to the stability of the public debt/GDP ratio both from the point of view of the total debt and from that of the percentage held by the public. It should be mentioned that, in the second half of the 1970s, debt growth was strongly determined by central bank actions that imposed interest rate increases with the objective of stimulating the inflow of the foreign resources required to achieve balance of payments equilibrium. And this factor generated the need for neutralizing the monetary growth that followed security placements. This is important since it demonstrates that expansion of the public debt was not always consistent with growth of the government deficit, as the traditional view would have it.

With regard to debt composition (distribution between ORTN and LTN), the period was marked by increased LTN participation since these papers were better suited to short-term operations. Aside from this, one should mention that the inflationary curve was also a factor of importance—low in relation to the subsequent period—thus facilitating operations with preset papers.

Another factor that cannot be ignored was the December 1979 maxidevaluation of exchange, which introduced a period of heated discussion on debt management. This debate centered around utilization of ORTN with exchange indexing at redemption, a factor that, at one and the same time, made it possible to elongate the public debt profile while also generating a perverse speculative process, since it tended to tie expectations of exchange devaluations to financial market rates and, consequently, resulted in strong price oscillations. With this process, the debate on public debt management became quite heated, since the two maxidevaluations (1979 and 1983) increased the cost of the debt, even considering the premium at some auctions. This whole series of events provoked repeated central bank interventions to avoid market degeneration at a time in which the risks faced by institutions were increasing.

In the 1980 to 1987 period, public debt growth was strongly influenced by the condition of Brazil’s foreign accounts following the “bilking” of creditors in 1980 when the rate of exchange was preset and monetary indexing was held to levels below inflation. With the second oil shock in 1979 and the later increase in international interest rates, economic policy turned its attention to external sector adjustment. This, in turn, resulted in a substantial increase in the public debt through net placements of securities aimed at neutralizing purchases of exchange resources by the Central Bank in 1981 and 1982. At the end of 1982, this situation was reversed and, during all of 1983, starting with the Mexican and Argentine defaults, the flow of resources to the debtor nations came to an abrupt halt. In the case of Brazil, this generated a loss of international reserves and a consequent very high level of internal contracting of liquidity. To neutralize this situation, the Central Bank began redeeming a substantial portion of market debt.

On the other hand, one should recall that the foreign sector adjustment generated a lengthening of the debt profile, since it became possible for the Government to place papers on the market with five-year maturity terms and exchange rate indexing at redemption. These securities were avidly sought by the financial market and by nonfinancial companies carrying large foreign currency debts as a means of hedging their liabilities.

With the signing of the first letter of intent with the International Monetary Fund (IMF) in early 1983, expectations of a maxidevaluation diminished, generating a substantial depreciation in financial institution portfolios that were then strongly concentrated in exchange rate ORTN. This fact forced the Central Bank to intervene intensively in the market, so as to avoid plunging the entire financial and nonfinancial system into a crisis. It was also a moment that inaugurated a new stage in the management of the public debt, strongly based on ORTN with monetary indexing redemption clauses. Consequently, the average debt term shortened while the cost to the Treasury increased, since the change in the general level of inflation created expectations of sharper monetary policy restrictions and, consequently, higher costs of carrying such papers.

Between March 1983 and March 1985, the Central Bank operated in such a way that financing rates remained in the range of 1 percent above monthly inflation, thus generating placements with the market at a real cost close to 15 percent per year. Besides this, during this period, the Central Bank was not successful in utilizing LTN as backing for its operations, as already stated above, due to the difficulties inherent to operating with preset papers in a framework of high and unstable inflation. Starting in March 1985 with the switch in the economic team, the debate on the public debt intensified since, in the framework of a rather lenient fiscal policy, those responsible for conducting monetary policy steadily increased overnight financing rates and, consequently, the earnings rates accepted in ORTN auctions.

Here, one should note that, contrary to what many analysts concluded, the increase in rates at that moment was not caused by difficulties rooted in public rejection of federal securities, but by the fact that it was the only way to neutralize the effects of the excess liquidity then in circulation (provoked by the lenient fiscal policy). Evidence of this is found in the fact that real rates of earnings on ORTN in the period from September 1985 to February 1986 were in the range of 15 percent per year, after increasing from 14 percent per year to 23 percent per year in the six previous months, during the administration of different Ministers of Finance. It should be recalled that during the first half of the administration of Dr. Dilson Funaro (August 1985 to April 1987), when the central bank staff refused to accept the possibility of forcing rates on security auctions to levels of less than 15 percent per year, some of the Minister’s own advisors discussed the possibility of forcing them down to a level near 12 percent per year, so as to reflect the cost of the money available on the international financial market for those domiciled in Brazil.

What is stated in the previous paragraph has the purpose of calling attention to the fact that interest rates that involve negotiation of federal public securities cannot be viewed solely as the rates that define the cost of the debt to the Treasury but rather, above all, as a macroeconomic variable of fundamental importance to the policies used in managing aggregate demand.

In the period following the so-called Cruzado Plan, a truly exceptional period of remonetization of the Brazilian economy generated a substantial decline in the cost of the public debt that was consolidated in June 1986 with utilization of central bank bills (LBC), Earnings on these papers were defined by the rate of overnight financing of institutional portfolios and determined by the operations of the central bank dealers’ desk and, consequently, stabilized over the course of time at a level close to that of monthly inflation. At the end of 1987, with the renewed inflationary spiral, criticisms were leveled at monetary policy, stating that utilization of LBC was increasing the difficulty of defining a restrictive policy. According to the critics, the most vulnerable point of central bank monetary policy was found in the fact that the profitability of these papers was tied to rates of inflation, thus making it impossible to define real positive rates of interest as the basic rates of the economy as a whole. We disagree with this position, since the setting of real positive rates of interest by the Central Bank in its operations is possible with operations backed by LBC. Since we will discuss the factors that conditioned growth of the public debt in the final section of this paper, we will leave a more detailed account of our position for later.

What is important to this debate is the position of the Secretariat of the National Treasury, which, as of January 1988, assumed legal responsibility for public debt management and rejected operations with papers other than treasury financing bills (LFT), which are papers that have the same characteristics as LBC. The Secretariat argued—in our opinion mistakenly—that this would avoid undesired growth in the cost of the public debt, one of the major sources of national treasury expenditures.

The average terms of the debt in LTN and ORTN declined steadily over the period from 1980 to 1987, principally due to the fact that investors tended to reject longer-term papers. It is worth mentioning that the ORTN placed on the market in the 1984–86 period had maturity periods of less than six months, since the Central Bank issued papers from its own portfolio or papers with partially lapsed maturities, thus generating—it should be emphasized—a gross distortion in market operation. As a result of this, the average maturity at the end of 1986 was 8 months and 12 days, with some degree of variation in 1987 as a result of the utilization of LBCs of 182 days and 273 days.

With respect to the cost of the debt borne by the Treasury—a subject of the utmost importance to our theme—one should note the conflict between the desire to finance the Treasury at low cost, supported by the Secretariat of the National Treasury, and the Central Bank’s concern with maintaining interest rates at real positive levels. Here, we limit ourselves to simply stating this fact, since our view is that the institutional change that transferred to the Secretariat of the National Treasury and the Congress responsibility for defining the principal parameters of indebtedness was quite correct. This change could, once and for all, avoid the heroic and isolated attempts made by the Central Bank, often through excessive increases in interest rates, to correct the distortions provoked by the lack of fiscal policy control.

Once again, we reiterate our agreement with those who have called attention to the financial nature of the public deficit and its impact on the growth of the public debt, while disagreeing with those who attribute no significance to fiscal disbursements operated through the monetary budget, including commitments generated by the Government’s assumption of the external debts that were honored by the Central Bank and were the elements chiefly responsible for growth in the public debt stock in recent years.3

Finally, we emphasize the need for analyzing the public debt on an item-by-item basis, separating that share placed with the public and subject to competition with other assets available on the financial market from that placed with the central bank portfolio itself, which, as of 1981, registered a volume greater than that required for monetary policy. This situation is easily explained by the Central Bank’s efforts to create hedges for the charges tied to “Deposits Registered in Foreign Currency” and other similar items included in its liabilities. The stability of the federal public debt/GDP ratio was lost in 1981, when it moved from 7.2 to 26.9 under the impact of sharp increases in the central bank portfolio, at the same time in which the federal public debt held by the public/GDP ratio, which was stable up to 1984, registered relatively negligible growth in the following years.

Controversy Over the Public Deficit

Today, the financial imbalance of the public sector is an accepted fact to all currents of Brazilian economic thought, though this certainly does not mean that understanding of the question is a national unanimity. Debates on this theme began in the 1970s and peaked in intensity in the following decade. Initially, the discussion centered on the public deficit and, more recently, shifted to its financial aspects. In light of the repercussions that the theme will have on the question of the public debt in the future, it is worthwhile to go back and look at some of the historical aspects of the question.

In the early 1970s, the Brazilian Government issued the Second National Development Plan with the explicit objective of removing Brazil from the classification of underdeveloped nation. The basic strategy of this ambitious program was to complete the process of import substitution in the sectors of raw materials and capital goods. Since internal resources were considered insufficient to implement the program, the Government induced companies to make investments on the basis of foreign savings. Government companies also participated in this strategy that, based on restrictions on internal credits, led them to demand resources abroad as a means of making balance of payments deficits feasible. Thus, it was in this way that the standard of investment financing that prevailed in the 1970s was defined on the two basic pillars of external indebtedness and government savings. At the same time, aside from investing directly or through state companies, the Government provided intensive subsidies to the private sector.

Since the undertaking was projected as a whole, the Government was unable to count on returns on its capital for the financing of its own investments. In this sense, it was clear that the strategy adopted by the economic authorities was to leverage investments with foreign resources. On the other hand, in the wake of the development program, the Government launched a political campaign against state intervention. One of the implicit objectives of this plan was to avoid substantial increases in the prices of public utilities. With the benefits introduced by these measures, one should certainly not find it strange that private investments followed close behind public sector investments. The campaign lost some of its momentum in 1976, when private investments in the Brazilian economy declined sharply and continued at a rather low level during the remainder of the decade. At the same time, however, the Government made every effort to maintain the nation’s previous investment level.

With the model adopted for the financing of investments, gross tax revenues dropped gradually during the entire period from 1970 to 1980. In the same time period, underlying this model was an increase in transfers from the Government that were disproportionate to its revenues. Despite the drop in government expenditures, it was not sufficient to maintain the level of government savings, which declined from 5.4 percent of GDP in 1970 to 1.2 percent in 1980 (see Table 5). The repercussions on inflation were unmistakably clear. While the 1970s began with inflation in the range of 20 percent per year, the following decade opened at nearly 100 percent.

Table 5.Brazil: Government Savings In Current Account(In percent of GDP)
Item1970197519801985
A.Tax revenues26.026.324.222.2
B.Transfers9.311.814.020.5
Internal debt interest1.41.21.910.9
Assistance and Social Security8.27.07.67.1
Subsidies0.82.83.61.6
Others1–1.1080.90.9
C.Net government revenues
(A–B)16.714.510.21.7
D.Current government expenditures11.310.79.09.7
Wages and charges8.37.56.26.8
Purchases of goods and services3.03.22.82.9
E.Savings in current account
(C–D)5.43.81.2–8.0
Source: Fundaçao Instituto Brasiliero de Geografia e Estatistica (IBGE).

Net result of diverse transfers less other revenues.

Source: Fundaçao Instituto Brasiliero de Geografia e Estatistica (IBGE).

Net result of diverse transfers less other revenues.

In the final years of the 1970s, as the inflationary process intensified, economic authorities began to focus on the public deficit as its fundamental cause. This gave rise to an intense debate that extended throughout the following decade—a debate not restricted only to methodological aspects, but including economic policy itself. At the same time, another current of economic thought came to the fore, defending the position that excess government spending in the traditional concept, and not the component associated with financial charges, was directly responsible for the lack of monetary base control. Thus, the money supply in the economy was equally affected and, in this way, also exerted pressure on inflation.

Among the outlays to which the greatest attention was given were credit subsidies granted by the Government. The public debt was relegated to a secondary position since charges were not being covered by the Federal Government. The fact is that, in the 1970s, a generalized system of subsidies took root in the Brazilian economy. Alongside the traditional instrument of credit incentives, a multiplicity of fiscal incentives were granted to industrial sectors and favored regions, coupled with export subsidies and artificially low prices for the goods and services supplied by state companies. While subsidies represented 0.8 percent of GDP in 1970, they were responsible for 3.6 percent of GDP at the start of the following decade.

As the Government lost its capacity to generate savings, the volume of incentives granted to the private sector was curtailed and, consequently, the volume of these subsidies dropped to 1.6 percent of GDP by 1985.

One of the first economists to attempt to estimate the deficit was Doellinger (1985). In his projections, the author included only the Federal Government and restricted himself to the “operational concept.” At the same time, he included the accounts allocated in the monetary budget, such as the petroleum account, debt charges, and, principally, credit subsidies.

Once the deficit had been defined, the trajectory of economic policy was changed. Previously based on the objective of growth, the new goal adopted was that of reducing inflation. Minister Simonsen attempted to adopt deficit reduction as a means of controlling inflation. However, he was replaced since he did not have the backing required for adoption of a contractive policy.

Delfim Neto’s return to the cabinet in August 1979 clearly represented an option for a growth-oriented policy. However, the financial imbalance of the state companies was already evident at that time. Consequently, it was essential that an instrument capable of evaluating the financial situation of these companies be created. The result was creation of The Secretariat of Budget and Control of State Enterprises (SEST), given responsibility for elaborating the state company budgets and, thus, introducing a new element into the evaluation of the public sector deficit.

The development policy attempted by Delfim Neto was short-lived, since the investment standard based on foreign and state financing deteriorated sharply in the 1980s. Two major factors were responsible for exhaustion of the model: the Government’s loss of capacity to generate savings and the interruption in the flow of foreign resources.

Starting in 1982, government savings became negative, reaching a level of −0.8 percent of GDP in 1985. At the same time, inflation, after opening the decade at 100 percent, climbed to 200 percent in 1984. Economic policy was profoundly altered and became contractive in nature. Initially, Brazil opted for a voluntary adjustment in 1981, before finally coming to agreements with the IMF in 1983. The impact on growth was evident. After registering average annual GDP growth of 8.7 percent from 1971 to 1980, Brazil closed 1981 with negative growth of 3.4 percent, followed by a slight 0.9 percent positive expansion in 1982 and a drop of 2.5 percent in 1983. Following a period of attempted adjustment between 1981 and 1983, the worsening financial imbalance of the public sector became evident and the internal debate on the question of the public deficit took on new urgency.

The methodology adopted by the Fund and accepted by the Government for purposes of calculating the public deficit—i.e., overall public sector borrowing requirements defined on the basis of growth in internal and external public indebtedness—became the target of criticisms. Critics of the concept of public sector borrowing requirements (NFSP) represented a reaction to the tendency to exaggerate the dimensions of the deficit and identify it as the single element most responsible for the distortions and imbalances inherent to the Brazilian economy. According to Batista (1983), this concept could easily lead one to conclude that growth in the deficit could be perfectly understood as an effect and not a cause of inflation. All that would be needed would be upward inflationary movement. Given that the monetary and exchange indexing applied to the balance of the securities debt tended to surpass growth of the implicit deflator of product, since GDP is measured by average prices, the NFSP/GDP ratio would certainly rise, without being the result of an expansionary fiscal policy.

With the deteriorating situation of government financing, marked by successive declines in current account savings, pressures on the private sector increased sharply. The tax load was 24.2 percent of GDP with transfers of 14.0 percent in 1980, compared with a situation five years later in which revenues dropped to 22.2 percent of GDP and transfers climbed to 20.5 percent, with half of the amounts transferred by the Government being represented by interest on the internal debt. Over a period of five years, federal net revenues declined from 10.2 percent to 1.7 percent of GDP, as shown in Table 5.

Many observers of the Brazilian economy came to understand the imbalance in public sector finances as rooted in a predominantly financial deficit. Lundberg and Castro (1987) were some of the authors who came to this conclusion. In their analysis, the nonfinancial public sector was forced to resort to the monetary authorities, due to the measures taken to achieve balance of payments adjustment. In this way, aside from providing the credits required for payment of the external interest of public companies, the Central Bank was forced to seek the resources needed to meet external charges on deposits and obligations in foreign currency for which it was liable. The impact of these payments remitted abroad brought strong pressure to bear on monetary budget implementation. To neutralize these operations, the monetary authorities increased net placements of securities with the public.

However, other authors—though admitting that the public debt was following an explosive trajectory—continued defending reduction of the public deficit. Resende and Neto (1985) can be cited as representatives of this group. In their work on the relation between deficit and debt, Resende and Neto state that, once external financing flows had been interrupted in 1982, the Brazilian economy was submitted to an adjustment unparalleled in its history. With the adjustment policy agreed upon with the Fund, the private sector was forced to reduce investments and rechannel operations to the foreign market. The consequences of this shift were trade balance surpluses of US$6 billion and US$13 billion in 1983 and 1984, respectively.

On the other hand, the public sector held 75 percent of the foreign debt stock. Considering the problems of the trade balance situation, external creditors restricted themselves to refinancing amortizations. With no new money entering the country, the economy was compelled to pay interest and charges on the foreign debt stock through trade balance surpluses. And since these surpluses were being generated exclusively by the private sector, the public sector accumulated increasingly larger financial liabilities with the private sector. According to Resende and Neto, this process represented no more than an exchange of external debt for internal debt mediated by the monetary authorities. The adjustment mechanisms cited above implied an interface between two macroeconomic constraints: the balance of payments constraint, in the context of the question of transfers of resources abroad, and the internal budgetary constraint, in the framework of the internal financing of such transfers. It happens that the external constraint was being resolved, on the basis of the internal constraint, through enormous issues of public securities. Since the two constraints had to be resolved simultaneously, this meant that the public sector had to be capable of generating the internal resources needed to effect foreign debt interest payments. Following this line of thought, Resende and Neto state that curtailment of the public deficit would be the suitable means of obtaining the needed resources.

Castro (1985)4 assumed a firm position in opposition to this therapy. He refused to accept the attempt to combat the public deficit, coupled with a restrictive monetary policy, as the best means of resolving the recessive process that had taken root in the economy. Quite to the contrary, he believed that the practice of attacking the public deficit in these circumstances would only further enhance its magnitude. On the other hand, growth in interest rates provoked by monetary restrictions would hamper deficit growth in the performance of its anticyclical role.

In his analysis, Castro recommended a policy of economic expansion. Adoption of a restrictive monetary policy in the framework of high inflation had the effect of drastically reducing the monetary base, thus making it not feasible to issue currency as a source of public sector financing. With the cutoff of external sources, the only alternatives were massive issues of public securities and a consequent explosion of interest rate levels. In this context, Castro defended reductions in interest rates not only for the purpose of encouraging investments in the economy but also as a way of attenuating public sector financial imbalances by curtailing growth of the securities debt.

Castro’s line of thought was further deepened by Pereira and Dall’Aqua (1987). Their basic premises were founded upon the idea that the impact of fiscal policy on aggregate demand depends on the financial and nonfinancial components of the public deficit. Considering that the recessive policy adopted between 1981 and 1983 consisted of reductions in public expenditures and increases in tax revenues, he came to the conclusion that the nonfinancial deficit had become practically nil. However, parallel to this, he affirmed that the financial deficit was expanding as a result of rising interest rates, thus assuming that the deficit was essentially financial in nature. Since real expenditures were consumed in the act of initial financing, there was no reason to believe that fiscal policy would be able to exert an impact on aggregate demand. In this framework and in the midst of a recession, Pereira and Dall’Aqua concluded that it would be unproductive to reduce the public deficit. It was essential that the nonfinancial deficit be increased to stimulate economic growth. At the same time, the financial deficit would have to be reduced to make it possible to renew the process of investment at a lower level of interest.

Despite agreement between Resende and Neto (1985) and Castro (1985) as to the explosive character of the public debt, they disagreed with respect to the therapy to be applied. It should be mentioned that, in the opinion of Resende and Neto, it was not a question of reducing the public deficit through an anti-inflationary policy as defended by economic authorities during the Simonsen administration (1979) and, later, during the Figueiredo government (1979 to 1985). Since transfers of resources abroad were being made at the cost of public sector imbalances, it was essential that the public deficit be reduced to offset the imbalance. Viewing the situation under a different prism, Castro believed that the question of the deficit had been shifted to interest rates, to the extent that the deficit was being financed heavily through the securities debt. The problem, therefore, had to be coped with through growth. A decline in interest rates would make it possible to increase investments, which, in turn, would reduce the securities debt stock through changes in business portfolios.

Doellinger and Resende (1985) led opposition to the view that public debt management had lost control. In their analysis, the volume of public securities in the economy has been consistent with the stage of the nation’s development. When one considers the two outbreaks of real growth in the securities debt in 1981 and 1984, it has remained at a relatively stable level in the range of 5 percent to 7 percent of GDP. At the same time, participation of the debt held by the public in total nonmonetary assets has held stable at 25 percent.

In another article, Bonelli and Doellinger (1987) focused their analysis on the need for new investments when the cycle of recovery of economic activity at the end of 1986 came to an end. With estimated growth needs in the range of 6 to 7 percent per year, the necessary investments would have to be financed entirely through internal savings, since the flow of external savings to the country was practically nonexistent. Since they did not share the opinion that internal resources could be obtained through compulsory savings, as had been attempted with the National Development Fund (FND) in the Cruzado Plan, the way to make this source of financing feasible would be a greater volume of transfers from the private to the public sector. They concluded that the public sector would have to make a greater effort to generate savings. To achieve this end, they believed that it was essential that a fiscal reform be adopted that would be capable of increasing the funding available to the public sector in a noninflationary manner.

In this discussion, we have attempted to explain the major points of view put forward by Brazilian economic thought as regards the financial imbalances of the public sector.

The Public Debt and Monetary Policy

An analysis of the preceding section leads one to conclude that little thought was given to the possibility of utilizing the public debt as a means available to the Government to finance investments considered essential to renewed economic growth. Our objective, therefore, is to look at the possibilities of the public debt as a fiscal policy instrument—a theme that will be developed further on.

The first step is a brief historical evaluation of Brazilian monetary policy. On this basis, it is possible to explain the reasons that lead us to believe that the public debt has not been perceived as an alternative source of financing. The public debt can serve both as an instrument of fiscal policy and as a support to monetary policy. However, since Complementary Law No. 12 did not define clear norms on the relationship between the Central Bank and the Treasury, coupled with the fact that the deficit was being financed principally with foreign resources, its utilization in economic policy made it difficult to differentiate between its fiscal and monetary aspects. The pressures brought to bear on the money supply by foreign accounts and fiscal accounts allocated in the monetary budget clearly reflect this fact.

Parallel to this, public debt management was extremely penalized. Its stable growth in the 1970s can, to a great extent, be attributed to intense utilization of exchange policy. At that time, the task of regulating the liquidity of the economy was shared by the systems of deposits registered in foreign currencies and public debt management. In the following decade, the accumulation of public sector financial imbalances no longer permitted this, as became evident in the erratic growth of the 1980s. Thus, we believe that this is the reason why the public debt has been relegated to a secondary position in the current economic literature.

In the absence of a well-developed system of financial intermediation, monetary policy up to the 1950s utilized the classic instruments of rediscount and compulsory deposits to regulate liquidity. Currency was for all practical purposes the sole financial asset available in the economy, and was often utilized as a means of financing. The Plan of Goals (1956 to 1960) was a very good example of this. Juscelino Kubitschek utilized massive issues to finance his great national project and, in doing so, the line between monetary policy and fiscal policy became blurred.

The financial reforms implemented after 1964 had the objective of resolving these distortions. Introduction of readjustable national treasury bonds by Law 4357, which also institutionalized monetary indexing in a framework of high inflation, ensured consolidation of public securities on the financial market throughout the 1960s. New financial assets were created as part of the reform. In this context, there was an intense internal transfer of financial assets from monetary assets to nonmonetary assets (see Table 6).

Table 6.Brazil: Ratio of Financial Assets to GDP(In percent)
YearMonetary Financial

Assets/GDP
Nonmonetary

Financial Assets/GDP
Total Financial

Assets/GDP
196027.12.329.4
196521.33.224.5
197017.313.630.8
197517.027.244.2
198010.922.233.1
19857.762.269.9
Source: Central Bank Reports.
Source: Central Bank Reports.

In 1970, national treasury bills (LTN) were created by Decree Law 1079. These papers possessed great operational facility since their financial calculation was based on discounts. Consequently, they became a potentially excellent instrument of monetary policy operation. In this way, readjustable national treasury bonds, which were indexed papers, could be released exclusively for long-term financing and, in this way, economic policy could be made more consistent.

For the reasons already stated above, the relationship imposed by law on the monetary authority and the National Treasury did not allow for this type of public debt management. Consequently, the lack of clarity that was so strongly felt in fiscal and monetary policy implementation up to the time of the financial reforms was resolved only partially. However, innovations introduced by the 1988 Constitutional Reform regarding the manner in which the Treasury could finance its deficit, now stand as a possibility of clearly defining fiscal and monetary policies. Further on, we will dedicate a specific section to this theme.

It was only in the early 1970s that open market operations effectively began as part of the sequence of developments triggered by the financial reforms of the 1964–67 period. Despite permitting voluntary placements of public securities on the market, they are not sufficient to form the necessary foundations for a secondary market. Proof of this is found in Resolution No. 366/76, which instituted repurchase agreements six years after creation of national treasury bills. With this mechanism, the government was able to generate the liquidity needed for its papers and thus make this market feasible, even in a context of persistent inflation. In the same period, the utilization of private papers as backing for repurchase agreements was prohibited or severely restricted by the same resolution in operations with individuals and nonfinancial legal entities.

The consolidation of public securities on the financial market generated degrees of freedom in monetary policy implementation. Through public debt management, the Central Bank was charged with the task of managing the basis interest rates of the economy, which were defined by the overnight rate, corresponding, in turn, to one-day operations with repurchase agreements.

According to some analyses, the blocking of external sources of financing, coupled with spiraling demand for internal public financing and renewed utilization of monetary control measures, moved the Brazilian economy into an unsustainable position in the first half of 1985. These difficulties were clearly evinced in the haphazard growth of the public debt and in the rise in the level of interest on public securities to a real level of 23 percent per year. It was therefore proposed that monetary policy be made less restrictive in order to reduce the basic rate of interest and free the resources required for investments and renewed economic growth.

However, one should recall that the influence exerted by monetary policy on the money market is not the same as it exerts on the credit market (free segment). Though it is true to affirm that a tightening or expansion of liquidity through monetary policy has the capacity to restrict or expand the credit supply in the economy, the same thing cannot be said for credit demand. According to the traditional analysis of the IS-LM curves, an injection of currency into the economy would generate a drop in interest rates and encourage business to invest and this, in turn, would provoke increases in income. With the increased supply of currency, there would be greater demand for transactional and speculative currency, with the consequent balancing of the money market.

For an interest rate reduction to occur simultaneously with an increase in income, one fundamental condition must be met. The expectations of businessmen with respect to the future have to be sufficiently positive for them to invest in the framework of a given level of interest rates. If this condition is not met, balancing of the money market will only be achieved through growth in speculative currency. In this case, there would be a reduction in interest rates without the corresponding increase in income.

Monetary policy does not have the same degree of impact on income as fiscal policy does. It is, therefore, easy to understand why Keynes accorded a privileged position to fiscal policy over monetary policy. Credit demand is determined first by the uncertainties admitted by economic agents. And this uncertainty is closely linked to investor expectations of rates of return, which Keynes defined as “marginal efficiency of capital.” In this framework, businessmen try to compare their curves of marginal efficiency of capital with interest rates in effect. When substantial changes do not occur in this ratio, there is no reason to believe in profound alterations in credit demand. Thus, it is reasonable to foresee that a liquidity squeeze fostered by monetary policy does not necessarily affect interest rates on loans in the economy. Therefore, theoretically, an increase in the basic rate of interest could occur simultaneously with stable rates of interest on loans. In this case, there would be a reduction in spreads and, consequently, a curtailment of banking profits.

With the 1985 advent of the New Republic, following a long period of recessionary adjustment (1981 to 1983) and only marginal growth in the following year impelled by the performance of the foreign sector of the economy, the need for economic growth became the principal theme of the nation’s economic authorities. In that year, the discussion on just how to foster self-sustained growth in the economy was waged basically between two government ministers: on the one hand, Francisco Dornelles, then Minister of Finance; and on the other, João Sayad, Head of the Planning Ministry. The former advocated efforts to reduce inflation as a means of stimulating investment, while the latter supported reductions in interest rates.

When the orthodox approach prevailed, the Minister of Finance managed the public debt by systematically increasing interest rates, until reaching a level of 23 percent per year. The strategy was based on utilization of monetary policy to restrict consumption and, consequently, reduce inflation. The difficulties implicit in sustaining a policy such as this one resulted in the substitution of Dornelles by Dilson Funaro and adoption of a new monetary policy approach. One of the first measures taken by the new Minister was to reduce interest rates to a level of 15 percent.

The measures taken by the New Republic (post-1984), by the next administration that governed up to 1990, and by administrations right up to the present have still not attained self-sustained development of the economy, since the uncertainties inherent to the situation have inhibited the investment required to expand capacity.

The 1986–93 Period

Starting in 1986, the Brazilian economy was subjected to a series of stabilization attempts, all of which ended in failure. Inflation continued moving upward and economic activity declined, with the exception of those periods immediately following price freezes, caused either by increased consumption or by stock rebuilding at the level of commerce and industry.

As regards monetary policy and public debt management, one can identify the 1985 creation of central bank bills (LBC) as a turning point in central bank operational routines. Up to 1985, open market operations were carried out through purchases and sales of ORTN (an indexed security) and LTN (a preset security), both of which were issued by the National Treasury. To the extent that the financial market took exception to the maturities offered on federal securities, the Central Bank attempted to circumvent the problem by issuing the LBC, a paper with earnings defined by the average rate of overnight operations, and central bank bonds (BBC), which were equivalent to the LTN and also issued by the Central Bank. In this way, national treasury expenditures were masked under financial charges. Thus, it was possible to maintain open market operations as the major monetary policy instrument, since the risks to institutions specialized in operating with papers issued by the Central Bank (LBC) were attenuated, though their gains also dropped substantially, in comparison with ORTN and LTN.

As a consequence of the stabilization plan of February 1986 (Cruzado Plan) and those that followed in July 1987, January 1989, and March 1990, monetary policy and public debt management varied widely. Since all these plans were marked by price freezes, monetary policy was operated in a highly volatile manner, with real interest rates ranging between negative and sharply positive. The result was a constant rise in the cost of the public debt, which, at such times, became the most important public deficit component.

During the brief periods in which stabilization plans effectively curtailed inflation, substantial changes occurred in the money supply. These were periods in which quasi-currency (public securities, savings and time deposits) ceded territory to currency (Ml) in its traditional concept (demand deposits and currency held by the public), and the public debt declined as the cost of retaining currency dropped and alterations occurred in the portfolios of financial institutions. Aside from this, in the period after 1986, monetary policy was operated with strongly positive interest rates and, thus, encouraged foreign capital inflows and accelerated exports, generating large surpluses in the balance of trade. The consequences were expansion of the monetary base and, following this, placements of securities with the public for the purpose of regulating the liquidity of the economy, thus transforming public debt growth into an internally generated process.

Simultaneously, despite the institutional changes introduced, the Central Bank of Brazil still had instruments for financing the Treasury, including transfers of its profits and earnings on available treasury resources deposited at the Central Bank. With the successive failures of attempts to adjust the situation of public finances, the Central Bank has operated as the instrument of last resort in attempts to avoid hyperinflation. To achieve this, it has relied increasingly on open market operations, taking advantage of the rapid development of the banking industry and its adaptation to an unstable inflationary environment, while the contribution of compulsory deposits and financial liquidity assistance (rediscount operations) has been negligible. In its open market operations, the Central Bank has frequently made use of papers that the Bank itself issues or of federal papers included in its portfolio, all with quite short maturity terms.

Here, one should mention that, over the course of time, the security portfolio of the Central Bank has been composed of extra-market acquisitions or, in other words, acquisitions directly from the National Treasury. Up to recently, this has operated as a hedge for its exchange liability position assumed in the name of the Treasury. Currently, relations between the Central Bank and the National Treasury have been moving toward elimination of the spurious relations of the past. This should make it possible to reduce the Bank’s federal security portfolio to the level required for monetary policy. Doubts remain, however, with regard to continued authorization for the Central Bank to issue papers and this question is expected to be resolved by the constitutional review now going forward at the Congress.

More recently, it has been possible to carry out open market operations at a high real cost—approximately 17 percent per year in July 1993 and 28 percent per year in December 1993—and with a substantial reduction in the average terms of the papers in circulation. All of this results from the high level of dispersion of inflation projections at the end of the year, thus making it difficult for agents specialized in trading these papers to form the prices of these securities.

Aside from this, one should also mention that the new Stabilization Plan is centered on the pursuit of budgetary equilibrium in 1994, which will depend on votes to be taken at the Congress. The second stage of the plan is complete indexing of the Brazilian economy and, if these two stages are successful, transformation of the indexer—value reference unit—into the nation’s currency. Just as in the past, one can expect that the public debt can be affected through cost reductions—to be achieved by society’s acceptance of the proposed indexing factor—and lengthening of maturities. One should recall that, from 1979 to 1983, papers indexed to the dollar were issued with discounts (though in a situation in which exchange devaluations were expected) and had maturity terms of five years.

Another important factor was the compulsory transformation of terms of 80 percent of the debt in March 1990 (Collor Plan) that resulted in a drop in debt charges from 5.8 percent of GDP in 1989 to just 0.7 percent of GDP, at the same time in which the balance of the debt held by the public dropped from 15.0 percent of GDP in 1989 to 4.4 percent in 1990, and the maturities of papers on the market lengthened to up to 30 months at real interest of 6 percent per year.

At the end of 1993, the public debt held by the market came to US31.7 billion, with preset papers (LTN and BBC), totaling US9.3 billion, while the position of securities held by the Central Bank (all of which are indexed to exchange rates or inflation) totaled US68.0 billion. Of the total held by the market, the portfolios of financial institutions represented US10.1 billion, while those earmarked to specific legal instruments came to US10.0 billion.

In the light of the expectations generated by creation of the reference value unit (URV) and the difficulties involved in forecasting inflation, the Central Bank has encountered difficulties in placing securities through regular auctions, while there has been some degree of acceptance of papers indexed to the rate of exchange, since many believe that the URV will be tied to this variable.

Parallel to this, one should consider that the public debt as a proportion of GDP (9.01 percent in December 1992) is low. Stabilization of the economy would—as occurred in the past—make it possible to increase the volume of papers on the market and, with the monetary issue rules already defined (issues of currency backed by exchange reserves and assets of prestigious state companies), it will be possible to reduce the financial costs of the new issues. It is also important to note that the expected stabilization of the economy will increase the space available for placements of other financial assets, starting with the expected return of Brazilian resources from abroad.

One should conclude that the 1994 federal budget does not call for public debt placements beyond what are needed for rolling over the principal and charges of the debt, while expenditures on real interest are estimated at US$7.7 billion (1.7 percent of GDP) in 1994, as compared to US$9.2 billion (1.9 percent of GDP) in 1993. Finally, one should state that the same budget indicates a primary result of 1.72 percent of GDP and a positive operational result of 0.02 percent of GDP.

Conclusion

The development of public debt in Brazil since 1964 occurred in an environment of increasing inflation, causing a real strain on its administration. Monetary authorities had to operate without parameters for the evaluation of public debt, since the public deficits were not noticeable in the government budget, which did not incorporate numerous and vast items of expenses regularly disbursed through budgets of the monetary authorities. Also, one must note the occurrence of successive crises in the balance of payments in the post-1964 period as a source of monetary expansion and as the cause of the evolution of Brazilian public debt. All of the above-mentioned elements made the task of managing the public debt quite complex because concentration and expansion of the monetary base have occurred randomly. This made it difficult to define the underlying structure of terms and interest rates for market bonds.

Meanwhile, two aspects were essential to the management of the public debt in the post-1964 period. First, let us highlight the freedom the Central Bank of Brazil had in the rolling over of public debt and its charges according to Complementary Law No. 12/71, besides other financing mechanisms of the Central Bank to the National Treasury after 1988. Secondly, we should consider the institution of financial innovations in the Brazilian economy as responsible for the ease with which the Central Bank of Brazil managed public debt. Among these innovations were the monetary indexing, the open market operations in 1969, the incorporation of operations with repurchase agreements in the mid-1970s, and the implementation of the Sistema Especial de Liquidaçāo e Custódia (SELIC) in 1979 that enabled same-day clearing of transactions made with federal public bonds. Therefore, with the use of above-mentioned mechanisms, it has been possible to operate with preset or postset bonds and with long or short terms in operations in primary and secondary markets.

Finally, it should be mentioned that the development of the private bond market since the introduction of the financial innovations described earlier, including that of futures markets, is considered to be one of the reasons that has made possible the coexistence of the Brazilian economy with such high inflation rates and the base for recovery of financial intermediation as an instrument of long-term financing with an expected reduction in inflation.

References

The views expressed in this paper are those of the author and do not represent the views of the Central Bank of Brazil.

The term “public debt” is used throughout the paper.

More detailed information on this question is available in Ferreira (1984) and Silva (1976).

As a reference work, see Dias, Dib, and Silva (1985).

Castro (1985), Part III, Chapters 2 and 3, pp. 203–12.

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