Brazil: Staff Report for the 2017 Article IV Consultation—Debt Sustainability Analysis

2017 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Brazil

Abstract

2017 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Brazil

Debt sustainability risks remain large. Reflecting an additional year of economic contraction and slow progress with fiscal consolidation, gross debt of the nonfinancial public sector (NFPS) increased by 5.8 percentage points of GDP in 2016, reaching 78.3 percent of GDP. Net debt of the public sector rose by 11 percentage points of GDP. The debt maturity profile of the debt stock and composition has changed at the margin since the last Debt Sustainability Analysis (DSA), and foreign holdings of government securities have declined (Box 1). If fully implemented, fiscal consolidation based on the government’s legislated and proposed reforms would restore the sustainability of debt in the baseline scenario. However, debt ratios would stabilize after the end of the 5-year projection period, with gross debt reaching 92.4 percent of GDP in 2022. Primary surpluses of about 1½ percent of GDP (excluding interest revenue) would be needed to keep gross debt from growing as a ratio to GDP beyond the projection horizon. The trajectory of gross debt is highly sensitive to fiscal performance, owing to the adverse dynamics determined by modest GDP growth and high borrowing costs. A delay in implementing fiscal reforms would jeopardize debt sustainability.

Background

1. Definitions and coverage. Brazil’s gross debt statistics cover the NFPS, defined to exclude Petrobras and Eletrobras, and consolidate the Sovereign Wealth Fund. In line with the GFSM 2014 manual, the NFPS debt includes all Treasury securities on the Central Bank’s (BCB) balance sheet, including those not used under repurchase agreements. At end-2016, gross debt amounted to 78.3 percent of GDP.2 As reported by the government, net debt statistics correspond to the public sector, defined to include the BCB. The consolidated public sector has a large stock of assets, amounting to 35.1 percent of GDP in 2016, which include 19.2 percent of GDP in international reserves. Non-financial public sector assets amounted to 29.6 percent of GDP. Brazil’s debt is reported at nominal value.3

2. Debt profile. Federal government (FG) domestic tradable securities account for 91 percent of total NFPS gross debt, of which less than 2/3 is held by the public and the rest is held by the BCB.4 Nearly 17 percent of domestic tradable securities will mature in 2017. Zero-coupon bonds with original maturities over one year constitute slightly more than half of FG domestic tradable securities held by the public. Foreign currency denominated tradeable securities accounted for only 5 percent of the total in 2016, representing 4 percent of GDP. Gross financing needs have tended to be high, above 15 percent of GDP; however, a large fraction of the federal government debt (about 33 percent of total) is held by the BCB, which follows a policy of automatic rollover of its holdings of government securities.

3. Developments. At end-2016, Brazil’s NFPS gross debt amounted to 78.3 percent of GDP, 5.8 percentage points higher than a year before. Public sector net debt amounted to 46.2 percent of GDP. A large primary deficit of 2.5 percent of GDP and net interest payments of 6.5 percent of GDP contributed to much of the increase in the gross debt. Net interest payments were lower than the value recorded in 2015 (8.4 percent of GDP), when the BCB recorded large losses on FX swaps.5 In December 2016, the national development bank (BNDES) repaid R$100 billion in outstanding government securities to the Treasury, which resulted in the proportional decline in NFPS assets of 1.6 percent of GDP and a corresponding fall in the stock of NFPS gross debt of the same amount. The Treasury reconstituted the BCB’s stock of securities used for monetary policy by issuing bonds amounting to 2.7 percent of GDP (at end-2016, the BCB held 24.3 percent of GDP of FG securities, of which 16.7 percent of GDP were in use as collateral in OMOs). The contingent liability risk from Petrobras has been reduced as the company made progress on asset sales and improved management practices affecting cost efficiency and price premiums. The company’s EBITDA margin is at its highest level in several years because of the pricing policy, which targets a premium over import parity. Debt maturing in 2017 and 2018 remains high at over US$20 billion, but the debt amortization schedule has improved.

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Gains and Losses on FX Swaps

(Percent of GDP, cumulated)

Citation: IMF Staff Country Reports 2017, 215; 10.5089/9781484309896.002.A003

Brazil: Changes in the Profile of FG Securities

Debt profile. Reflecting improved risk-perception, the yield curve on government bonds shifted downward, remained below 2015 values during 2016, and was below the Selic for most of the year.1 The decline in the marginal cost of borrowing affected the implicit interest on total debt visibly, which fell from nearly 14 percent at end-2015 to below 13 percent at end-2016.

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Brazil: Sovereign Bond Yields

(Percent)

Citation: IMF Staff Country Reports 2017, 215; 10.5089/9781484309896.002.A003

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Brazil: 5-year Bond Premium over SELIC

(bps)

Citation: IMF Staff Country Reports 2017, 215; 10.5089/9781484309896.002.A003

Non-residents’ holdings of domestic federal government securities shrank in nominal terms by R$70 billion over the year, falling to 14 percent of total debt held by the public. Institutional investors’ (investment and pension funds) share of holdings increased to fill the gap.

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Non-resident Holdings of Domestic FG Securities

Citation: IMF Staff Country Reports 2017, 215; 10.5089/9781484309896.002.A003

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Holders of Domestic Tradeable Securities

(Percent of total)

Citation: IMF Staff Country Reports 2017, 215; 10.5089/9781484309896.002.A003

The average maturity of new placements remained at its 2015 level, somewhat lower than that observed in previous years. The share of SELIC-linked debt in the total increased, against a decline in inflation-linked and fixed-rate securities.

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Maturity of New Issuances

(years, weighted)

Citation: IMF Staff Country Reports 2017, 215; 10.5089/9781484309896.002.A003

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Composition of Domestic Securities Held by the Public

(Percent of total)

Citation: IMF Staff Country Reports 2017, 215; 10.5089/9781484309896.002.A003

1 Interest charged on new issuances declined further in early 2017 and is currently about 600 bps below the end-2015 level.

Baseline Scenario

4. Macroeconomic assumptions. The projections assume real GDP growth of 0.3 percent in 2017, and a gradual return to potential growth of 2 percent by 2019. The fiscal adjustment brings the primary balance to 0.8 percent of GDP by 2022, which implies an improvement of about 3 percentage points of GDP during 2017–22. This is significant, but short of what would be needed to stabilize gross debt by 2022. Nominal interest rates on new borrowing are around 10–10½ percent over 2017–22, bringing the effective interest rate to about 10 percent on average.6 The baseline scenario assumes limited structural reforms and a modest world output recovery. Gross debt remains on an upward path, reaching 92.4 percent of GDP by 2022. Under the assumption that the primary balance path remains consistent with an unchanged expenditure cap until 2027 (when a revision first becomes possible), debt peaks in 2023 and starts falling in 2024. The timing the debt peak is sensitive to variations in the assumptions governing debt dynamics, especially the real interest rate and the rate of potential growth in the medium term. In 2022, the primary balance required to stabilize debt in the baseline scenario is 1.4 percent of GDP (excluding interest revenue).7

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Baseline with Expenditure Rule

(Percent)

Citation: IMF Staff Country Reports 2017, 215; 10.5089/9781484309896.002.A003

Sources: IMF staff estimates.

5. Heat map. The heat map in Figure 1 suggests that the stock of debt and the gross financing needs are high. Gross financing needs remain above the high-risk threshold of 15 percent of GDP on average. This indicator, however, overstates the need for fresh market financing for two reasons. First, the gross financing needs indicator overstates actual rollover risk because of the policy of continuous rollover maintained by the BCB, which holds a significant amount of FG bonds. Gross financing needs would amount to about 13 percent of GDP on average over the medium-term excluding rollover of BCB held bonds, below the threshold level for high risk. Second, the interest on existing FG securities reported in the authorities’ overall fiscal balance (and used in the DSA) corresponds to accrued interest, in line with the reporting of debt at nominal value. Hence, the resulting “gross financing needs” indicator overstates the actual impact of government borrowing on markets, by between 1 and 3 percent of GDP in the next few years relative to what would be obtained using interest on a cash basis.

Figure 1.
Figure 1.

Brazil: Public Debt Sustainability Analysis (DSA)—Risk Assessment

Citation: IMF Staff Country Reports 2017, 215; 10.5089/9781484309896.002.A003

Source: IMF staff.1/ The cell is highlighted in green if debt burden benchmark of 70% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.2/ The cell is highlighted in green if gross financing needs benchmark of 15% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white.200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for the public debt held by non-residents; and 20 and 60 percent for the share of foreign-currency denominated debt.4/ Long-term bond spread over U.S. bonds, an average over the last 3 months, 03-Mar-17 through 01-Jun-17.5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.
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Interest on Extisting Debt (end-2016)

(Percent od GDP)

Citation: IMF Staff Country Reports 2017, 215; 10.5089/9781484309896.002.A003

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Gross Financing Needs

(Percent of GDP)

Citation: IMF Staff Country Reports 2017, 215; 10.5089/9781484309896.002.A003

6. Past forecast errors. There is no evidence of a systematic projection bias in the baseline assumptions that would undermine the assessment of sustainability and the projected fiscal adjustment is in line with other countries’ experiences. Recent forecast errors for GDP growth are larger than those of other surveillance countries reflecting the fact that Brazil experienced its largest recession in a century starting in late 2014.

7. Realism of projections. Brazil’s projected fiscal adjustment (an improvement of about 1½ percentage points in the cyclically-adjusted primary balance/GDP over the medium term) is in line with other countries’ experiences, with a 3-year adjustment in cyclically-adjusted primary balance at the 46 percentile among all surveillance countries.8 Moreover, the projected path for fiscal balances is based on the expenditure rule, which is a constitutional norm supported by provisions for automatic corrective measures in case of breach.

Shocks and Stress Tests

8. Growth shock. The impact on the debt-to-GDP ratio of the 1 standard deviation shock (3.8 percent) to real GDP growth is large. Over 2018–19, real GDP contracts by a cumulative 4 percent while inflation declines by 230 bps in each year. The primary balance worsens before recovering in 2020; interest rates increase by 55 bps for each percentage point decline in output growth. In this scenario, gross debt increases to 112 percent of GDP by 2022 while gross financing needs peak at 31 percent of GDP.

9. Primary balance and real interest rate shocks. In the primary balance shock, consolidation is delayed by one year. In the interest rate shock, borrowing costs increase by 200 bps in the first projection year and remain the same over the medium term. The impact of these shocks on debt and gross financing needs is modest, pushing up debt-to-GDP by 3 and by 4 percentage points above the baseline in 2022, respectively.

10. Combined macro-fiscal shock and contingent liabilities shocks. The macro-fiscal shock combines the growth and interest rates shock and a primary balance shock as in the standard examples above, together with the real exchange rate shock consistent with the maximum movement of the real exchange rate over the past 10 years. The contingent liability shock simulates a loss of 10 percent of banking system assets, in line with the experience with past banking crises in other countries. The latter results in a primary deficit of 7 percent of GDP in 2018 and a 1 standard deviation shock to GDP growth in 2018 and 2019. The effect of these shocks on debt ratios and gross financing needs reflects the sensitivity of debt ratios to growth, which has the largest impact on the debt path. Debt-to-GDP reaches about 112–17 percent by 2022 in the most acute of these shock scenarios.

11. No consolidation. A custom-made scenario assumes that the government’s reform agenda slips, deferring consolidation efforts and abandoning the expenditure cap after 2019. The currency depreciates by 5 percent in 2017 and again in 2018 and 2019, and remains at this level throughout the projection period. Spreads on domestic securities pick up by 300 bps by 2019, and remain elevated thereafter. The growth recovery is delayed further and the pick-up is considerable weaker. Debt reaches 119 percent of GDP by 2022 and continues growing thereafter.

Figure 2.
Figure 2.

Brazil: Public DSA—Realism of Baseline Assumptions

Citation: IMF Staff Country Reports 2017, 215; 10.5089/9781484309896.002.A003

Source: IMF Staff.1/ Plotted distribution includes surveillance countries, percentile rank refers to all countries.2/ Projections made in the spring WEO vintage of the preceding year.3/ Data cover annual obervations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP. Percent of sample on vertical axis.
Figure 3.
Figure 3.

Brazil: Public DSA—Baseline Scenario

(Percent of GDP unless otherwise indicated)

Citation: IMF Staff Country Reports 2017, 215; 10.5089/9781484309896.002.A003

Source: IMF staff.1/ Public sector is defined as non-financial public sector.2/ Based on available data.3/ Long-term bond spread over U.S. bonds.4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.5/ Derived as [(r – π(1+g) – g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).6/ The real interest rate contribution is derived from the numerator in footnote 5 as r – π (1+g) and the real growth contribution as -g.7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).8/ Includes asset changes and interest revenues (if any). For projections, includes exchange rate changes during the projection period.9/ "Interest revenue" is a reconciliation series calculated as a difference between the gross interest of the NFPS and the net interest of the PS. This concept is used to maintain consistency between the fiscal accounts, in which the net interest used to compute the overall balance includes also the net interst bill of the BCB, and gross interest of the NFPS in the DSA.10/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year. Up to 2022, the primary balance is a non-interest balance, with interest income showing in the residual. From 2023 onwards interest income counts toward the required primary balance.
Figure 4.
Figure 4.

Brazil: Public DSA—Composition of Public Debt and Alternative Scenarios

Citation: IMF Staff Country Reports 2017, 215; 10.5089/9781484309896.002.A003

Source: IMF staff.
Figure 5.
Figure 5.

Brazil: Public DSA—Stress Tests

Citation: IMF Staff Country Reports 2017, 215; 10.5089/9781484309896.002.A003

Source: IMF staff.
1

The analysis of public debt sustainability is based on the framework developed for market access countries. See Staff Guidance Note for Public Debt Sustainability Analysis in Market Access Countries, IMF, May 2013.

2

In contrast, the national definition of gross debt includes the stock of Treasury securities used for monetary policy purposes by the BCB (those pledged as security in reverse repo operations), but excludes the rest of the government securities held by the BCB. Thus, per the national definition, gross debt of the general government amounted to 69.9 percent of GDP at end-2016.

3

The nominal value is calculated as the PDV of future interest and principal payments at the security’s contractual interest rate(s), and generally differs from face value.

4

The BCB uses about ¾ of its holdings as security in liquidity-draining operations with the banking system.

5

See 2016 Debt Sustainability Analysis, Box 1.

6

Interest rates on new borrowing are derived by applying the expectation theory to the Brazilian yield curve as of April 2017.

7

The debt stabilizing primary balance shown on the right-most column of the table on “Contributions to changes in public debt” in the Baseline Scenario (2.3 percent of GDP) corresponds to a concept of the primary balance that includes interest revenue. The definition of the primary balance as a non-interest concept is customary in Brazil and corresponds to 1.4 percent of GDP quoted in the main text.

8

The fiscal multipliers and persistence were estimated in the 2015 Article IV Selected Issues Paper at 0.3–0.5 percent.

Brazil: 2017 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Brazil
Author: International Monetary Fund. Western Hemisphere Dept.