Selected Issues

Abstract

Selected Issues

Profitability and Determinants of FX Intervention in Brazil1

It would be little harm for a government agency to speculate in the exchange market provided it held the objective of smoothing out temporary fluctuations […]. And there should be a simple criterion of success—whether the agency makes or loses money. Milton Friedman (1953).

This note examines the profitability of the FX swaps issued the Central Bank of Brazil (BCB) between May 2013 and February 2019 to shed light on the rationale for FX intervention. If FX swaps are used to smooth temporary excessive fluctuations of the exchange rate rather than resisting fundamental movements, they should be profitable in expectation. Indeed, using interest rate and exchange rate forecasts, we find that FX swaps were profitable in expectation, even though actual returns were negative due to unexpected exchange rate depreciations. Moreover, the scale of FX intervention was correlated with the expected profitability of the swaps, further suggesting that the BCB used FX intervention to stem abnormal movements of the exchange rate.

A. Introduction

1. In most emerging markets, central banks intervene in the exchange rate market. This is the case even in countries with flexible exchange rates for which exchange rate fluctuations are an integral part of macroeconomic adjustment. In most cases, central banks argue that they intervene to lean against temporary excessive movements of the exchange rate which are not driven by fundamentals. This is in line with IMF advice which supports FX intervention in case of disorderly market conditions. Nonetheless, there are concerns that in some instances central banks may intervene to resist fundamental movements in the exchange rate which is generally considered inappropriate.2

2. To shed light on the rationale for FX intervention, we analyze its profitability. This idea was first expressed by Friedman (1953). He argued that if FX intervention is used to lean against temporary excessive fluctuations of the exchange rate—reflecting deviations from uncovered interest parity (UIP)—the central bank should make a profit. Indeed, by going long in the domestic currency when the exchange rate is undervalued, the central bank would make money as the exchange rate recovers to its equilibrium level over time.3 Similarly, by shortening the local currency when it is temporarily overvalued, the central bank would make a profit as the currency depreciates over time. If instead the central bank tries to resist fundamental movements in the FX market, for example by going long in the local currency when it is bound to depreciate, it would incur losses.

3. Recent academic literature provides theoretical underpinnings for this argument. Gabaix and Maggiori (2015) present a theory of exchange rate determination where the market can become disconnected from fundamentals. This is because financial frictions constrain the trading operations of financial intermediaries, leading to departures from UIP and generating excessive volatility in the exchange rate market. Central banks can use FX intervention to stabilize markets by going long in the local currency when undervalued and taking a short position when overvalued, thus earning profits in the process. Making money is thus a by-product (not a goal) of a well-managed FX intervention strategy.

4. The Central Bank of Brazil (BCB) intervenes in the FX market using swaps. Brazil has a large amount of FX reserves of about 375 billion USD which in principle allows the central bank to intervene robustly in the spot exchange rate market. However, price discovery takes place mostly in the derivative market since it is more liquid than the spot market. Therefore, the BCB intervenes in the FX derivative market by offering swaps through which it provides insurance against a depreciation of the real, thus propping up its market value.4

5. FX intervention through swaps is well-suited for an analysis of profitability. Measuring the profitability of FX intervention using swaps is relatively straightforward since these instruments have an explicit maturity date. This makes it possible to precisely compute the financial returns on each individual swap, both in realized and expected terms. The latter are computed using market projections for the exchange rate and the Selic at the time of the swap sale. Analyzing the profitability of FX intervention in the spot market is much more challenging since when the central bank buys or sells FX reserves it is not known how long the central bank plans to keep that position for. Therefore, the profitability of a spot-market intervention depends on arbitrary assumptions of when the central bank intends to reverse the position.

6. Besides analyzing the overall profitability of FX intervention, we also test if the scale of intervention varied over time with the swap profitability. This provides a more stringent test of the BCB intentions. A positive correlation between the number of swaps sold and their profitability would imply that the BCB intervened more strongly when the exchange rate was perceived to be more undervalued. To further understand the drivers of FX intervention, we will also consider other possible determinants of FX intervention, among which movements in the exchange rate or the cupom cambial (i.e. the onshore USD interest rate).

B. Average Profitability of FX Swaps

7. The BCB has made considerable use of FX swaps since May 2013. As illustrated in panel 1 of Figure 1, the outstanding stock of FX swaps increased significantly between 2013 and 2015 to almost 120 billion USD. After declining to about 20 billion, swaps increased again in 2018 to almost 70 billion and have remained stable since then. These episodes coincided with periods during which the real came under pressure and were motivated by the BCB with the need to “provide liquidity to the market” and “ensure the smooth operation of the exchange market”.5

Figure 1.
Figure 1.

Outstanding Stock, Auction Size, and Maturity of FX Swaps

Citation: IMF Staff Country Reports 2019, 243; 10.5089/9781513508375.002.A001

8. FX swaps are sold through auctions in different quantities and with variable maturities. We collect information about each FX swap issued between May 31, 2013 and February 28, 2019. The size and maturity of each auction is plotted in panel 2 of Figure 1. The vertical axis shows that the maturity varies from a few days to two years, with an average of about 7 months. The average value of FX swaps sold in a given auction is 200 million USD, but in some instances the auction size reached a few billion USD. The auction size can be negative in which case the BCB reduces the outstanding stock of swaps, thus putting downward pressure on the real.

9. By selling FX swaps, the BCB takes a long position in the real against the US dollar. Swaps provide compensation for exchange rate fluctuations of the BRL against the USD. The BCB pledges the repayment of 50,000 USD at a future maturity date T converted in BRL at the spot exchange rate of the previous day. Through an auction, market participants bid for the swaps by offering a discounted value relative to the 50,000 USD face value, which is paid to the BCB in BRL at the exchange rate of the day before settlement. The discount rate is referred to as the bid cupom cambial. Furthermore, market participants pay the BCB the Selic rate between settlement and maturity, reflecting the fact that the BCB is taking a long position in BRL.

10. Swaps are profitable for the BCB if the real does not depreciate more than the differential between the Selic and the onshore dollar rate. On a given swap, the BCB earns net revenues expressed in USD equal to

Netrevenues=50,000[eS1eT1*Πt=ST1(1+it)12521+ccTS3601](1)

where et is the exchange rate in BRL per USD, the subscripts S and T denote the day of the swap settlement and maturity, and the product operator cumulates the Selic rate it over the working days between settlement and maturity. The variable cc is the bid cupom cambial which reflects the onshore U.S. dollar rate that investors earn using forward exchange rate contracts in Brazil. When issuing a swap, net revenues for the BCB are thus inversely related to the depreciation of the real and positively related to the differential between the Selic rate and the bid cupom cambial The opposite applies when the BCB takes a short position in swaps. Equation (1) calculates realized net revenues (different from expected) since it uses values of the exchange rate and Selic that were not known at the time of the auction.

11. Considering realized returns, the BCB incurred significant losses on FX swaps. The blue line in panel 1 of Figure 2 shows that between May 2013 and September 2018 FX swaps generated cumulative losses of about 7.3 billion USD.6 Losses peaked to 25.6 billion USD in April 2015. Considering realized losses, it appears that the BCB did not react to temporary exchange rate fluctuations, buy tried to lean against fundamental exchange rate movements.

Figure 2.
Figure 2.

Cumulated Net Revenues on FX Swaps for the Central Bank

Citation: IMF Staff Country Reports 2019, 243; 10.5089/9781513508375.002.A001

12. However, it would be improper to assess the BCB’s FX intervention strategy by considering realized returns. This is because realized returns over a relatively short period of time are affected by shocks to the exchange rate and changes in the Selic that were not foreseeable at the time of intervention. These shocks may thus generate arbitrary losses or gains on FX swaps which do not reflect the intentions of the BCB at the time of intervention.

13. We thus focus the analysis on the expected profitability of FX swaps at the time of intervention. This provides a more accurate test of whether the BCB intervened when the exchange rate was perceived to be away from UIP equilibrium conditions and expected to return to its fundamental value over time. To compute expected returns at the time of each auction, we rely on market expectations collected by the BCB through the Market Expectations System. Survey respondents report their end-of-the-month forecasts for the Selic and BRL/USD exchange rate over the 18 months ahead and can update their forecasts every day.7 By linearly interpolating monthly forecasts, we create daily projections over 18 months. To compute expected net revenues, we replace the exchange rate and Selic in equation (1) with their expected values at the time of each swap auction.

14. FX swaps have been profitable in expectation, consistent with the idea that the BCB intervened against temporary excessive movements of the exchange rate. The red dashed line in panel 1 of Figure 2 shows that swaps generated positive cumulative gains in expectation, reaching 19.8 billion USD by the end of February 2019. The average profitability of FX swaps was about 5 percent in annual terms, against an average expected excess return of the BRL over the USD of about 3.5 percent. This suggests that the BCB used FX intervention to lean against temporary deviations from UIP, issuing swaps when the exchange rate was undervalued relative to medium-term expectations and vice versa.

15. Despite being profitable in expectation, swaps incurred realized losses due to unexpected exchange rate depreciations. The gap between realized and expected revenues can be driven by unexpected movements in the Selic or in the exchange rate. To understand which factor is more important, we perform the following exercise. The blue line in panel 2 of Figure 2 shows a hybrid measure of expected revenues obtained by using only expectations for the Selic, while using realized exchange rates. This line tracks closely the realized revenues plotted in panel 1, showing that shocks to the Selic do not explain the difference between realized and expected revenues. The red dashed line in panel 2 repeats the exercise by using expectations only for the exchange rate. This line is very similar to the expected revenues in panel 1. This shows that realized revenues have been negative because of unexpected movements in the exchange rate, notably during the sharp depreciations in 2015 and 2018.

16. A possible concern with the analysis is that the results could be affected by delays in the update of exchange rate forecasts. In principle, survey participants to the Market Expectations System can update their forecasts every day, but they tend to do so only occasionally. This could distort the measurement of the expected profitability of swaps. For example, assume that a depreciation of the exchange rate in the spot market leads to a downward revision of the exchange rate forecast. If this is not timely recorded in the survey, we would overestimate the expected profitability of a swap sale by using an artificially strong expected exchange rate. Note that the same argument would apply in reserve—thus leading to a downward bias in the expected profitability of swap sales—when the exchange rate appreciates.

17. Swaps are profitable in expectation even if we control for delays in survey updates. To ensure that the results are not driven by delays in the update of exchange rate forecasts, we recompute the expected profitability of swaps by using survey forecasts collected several weeks after the auction date. Table 1 shows that the average expected returns on FX swaps using the forecasts recorded on the day of the action is 5.6 percent. If we use the forecasts reported one week later, the expected return declines to 3.3 percent. However, average returns remain positive even if we use the forecasts reported four weeks after the auction dates. This suggests that the finding that swaps were profitable in expectation is not driven by delays in the update of the exchange rate forecasts.

Table 1.

Brazil: Expected Returns on FX Swaps Using Delayed Surveys

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C. Determinants of FX Intervention

18. To further understand the rationale for FX intervention by the BCB, we perform a regression analysis. Up to this point, we have documented that on average FX intervention by the BCB was profitable in expectation. We now perform a more stringent test of whether FX intervention was targeted to temporary excessive movements of the exchange rate. We do so by testing whether the extent of intervention varied over time with the expected profitability of swaps. The idea is that the central bank should issue more swaps when their expected profitability increases, i.e. when the exchange rate is more undervalued.

19. We find that the issuance of swaps is positively correlated with their expected return. We compute the expected return on individual swaps by dividing expected net revenues by the swap face value of 50,000 USD. Annualized returns vary between -61 to 107 percent, with an average level of 5 percent. In Table 2 we regress the face value of swaps in millions of USD issued in a given auction over their expected return. Column (1) shows that the regression coefficient is positive and highly statistically significant. This suggests that the BCB intervened more strongly in the FX market when the exchange rate was perceived to be further away from equilibrium. Despite the tight correlation between swap sales and their expected returns, the regression has a low R-squared.

Table 2.

Brazil: Value of Swaps Sold in a Given Auction over Financial Variables

(In million USD)

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*** p<0.01, ** p<0.05, * p<0.1. Robust standard errors in parentheses

20. The regression fit improves considerably if we drop auctions that were pre-announced or used to rollover maturing swaps. In several instances, the BCB pre-announced a schedule of future auctions.8 Being decided in advance, these auctions should be less responsive to the expected returns on swaps based on the expectations on the day of issuance. Furthermore, the BCB often issued swaps to simply rollover maturing ones, thus keeping constant the outstanding stock of swaps as seen in the flat segments in panel 1 of Figure 1. Column (2) shows that if we exclude pre-announced and rollover swaps, the regression R-squared increases considerably to 19 percent.9

21. Swap issuances were also affected by short-term movements in the exchange rate and in the cupom cambial. Column (3) shows that the BCB increased swaps in response to a depreciation of the exchange rate during the previous ten days. Swap issuance was also inversely related to movements in the 6-month cupom cambial in deviation from the U.S. Fed Fund Rate. The cupom cambial captures the onshore USD rate in Brazil.10 A decline relative to the U.S. Fed Fund Rate reflects pressures in the forward exchange rate market, possibly due to strains in the ability of financial intermediaries to absorb currency risk. Even after controlling for movements in the exchange rate and cupom cambial, the issuance of swaps remains tightly correlated with their expected returns. In terms of magnitudes, a one-standard-deviation shock to the expected return, exchange rate, and cupom cambial affects issuance by 179, 46, and 70 million USD, respectively.

22. The regression results are robust to controlling for additional variables and winsorizing outliers.

  • In column (4) we control for serial correlation in swap auctions by adding among the regressors the sales during the prior ten days. The coefficients (not reported for space considerations) tend to be positive, reflecting autocorrelation in the scale of intervention. The inclusion of lags leads to a further considerable increase in the R-squared and absorbs the effects of exchange rate movements. The statistical significance of swaps returns and the cupom cambial is unchanged.

  • In column (5), we exclude outliers by winsorizing 1 percent of the data with respect to the auction size and swap returns. The regression results are broadly unchanged.

  • In columns (6), (7), and (8), we add other financial variables among the regressors. Swap issuances are positively correlated with sovereign spreads, defined as the difference between the two-year sovereign yields and the Selic. There is instead no association between 2-year CDS on sovereign bonds and the performance of the domestic stock market11

D. Conclusion

23. The analysis suggests that the BCB used FX intervention to lean against temporary excessive movements of the exchange rate. On average, FX swaps were profitable in expectation, implying that the BCB issued swaps when the exchange rate was temporarily undervalued and vice versa. Furthermore, the regression analysis shows that the BCB increased swap sales when the degree of undervaluation was more severe, i.e. when the expected profitability of swaps was higher. FX intervention was also shaped by additional factors, notably movements in the cupom cambial and sovereign spreads, and displayed significant autocorrelation.

24. The expected profitability of FX swaps can be monitored in real time and may thus provide guidance on the appropriate level of intervention. The expected return of swaps can be computed in real time since it depends on expectations at the time of the issuance rather than on future realizations of exchange rates and interest rates over the life of the swap. If the central bank wants to use FX intervention to lean against UIP deviations, it could thus decide on the scale of intervention by openly monitoring the expected returns of swaps.

25. If FX intervention is profitable in expectation, it alleviates concerns regarding the central bank’s balance sheets. Given that FX swaps provide insurance against the depreciation of the real and are issued when the exchange rate is under pressure, there is often a perception that these instruments are prone to incur losses. Therefore, they are financially sustainable only if they are matched by large holdings of FX reserves by the central bank. In this case, the losses incurred on FX swaps when the exchange rate depreciates do not undermine the central bank’s balance sheets since they are compensated by valuation gains on reserves. The analysis suggests that this argument might be overstated. Even though it is true that an unexpected depreciation of the exchange rate generates losses on FX swaps, well-intended FX intervention tends to be profitable in expectation.

References

  • Chamon, Marcos, Márcio Garcia, and Laura Souza, 2017, “FX Intervention in Brazil: A Synthetic Control Approach,”Journal of International Economics, Vol. 108, pp. 15768.

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1

Prepared by Damiano Sandri with outstanding research assistance from Daniel Cunha. The paper benefited from insightful comments by Gustavo Adler, Marcos Chamon, Aasim Husain, Jonathan Ostry, Antonio Spilimbergo, Krishna Srinivasan, and Alejandro Werner.

2

There are cases when FX intervention could be warranted even against fundamental movements of the exchange rate. For example, intervention might be optimal to slow down a fundamental-driven exchange rate depreciation that could otherwise pose financial stability concerns.

3

This argument does not require that FX intervention is successful in boosting the exchange rate. It only relies on the assumption that the currency will return to its fundamental values once temporary shocks dissipate. In fact, if FX intervention is effective in reducing UIP deviations, it would also lower the expected profits for the central bank.

4

Evidence about the impact of FX swaps on the exchange rate is provided in Kohlscheen and Andrade (2014), Chamon et al. (2017), and Nedeljkovic and Saborowski (2019).

5

BCB press release on August 22, 2013 and August 30, 2018 when announcing significant increases in FX swaps.

6

We stop the calculations of realized losses in September 2018 since subsequent swaps will mature in the future relative to the time of this writing.

7

In line with BCB practice, we measure exchange rate expectations using the median of survey participants. For some swaps, the settlement day occurs before the first forecast reported in the Market Expectations System. In this case, to measure the expected exchange rate at the time of the swap settlement, we use a linear interpolation between the spot exchange rate at the time of the auction and the expected exchange rate at the end of the month of settlement. We follow the same procedure to construct the expected Selic. For those swaps whose maturity exceeds the 18-month forecast horizon reported in the Market Expectations System, we assume that expectations are constant after the forecast horizon. We subtract 10 basis points to the Selic forecast to obtain the market Selic rate which is the one contractually paid on the swaps.

8

For example, on August 22, 2013 the BCB announced that “swap auctions will take place every Monday, Tuesday, Wednesday and Thursday, when 500 USD million will be offered for each day” at least until December 2013.

9

We consider “rollover” swaps those for which on settlement date the stock of outstanding swaps differs less than 0.5 billion USD from the previous day.

10

It is the USD-equivalent interest rate that is earned by investing reals at the domestic interest rate and converting the proceeds at the forward USD exchange rate traded in BM&FBOVESPA.

11

For sovereign yields and CDS, we focus on a relatively short-term two-year horizon since swaps have a maturity of less than two years.

Annex I. An Optimal Cash Buffer for the Government

Determining the Benefit Calculation Formula

1. To calculate the benefit for the government of holding cash at the CB, we assume that this benefit derives from the ability of using such cushion to stay out of the market when financial conditions are abnormally tight. Such benefit arises to the extent that the rise in interest rates on government securities is temporary. In the case of permanent or prolonged elevations, the benefit is depleted because, once the fund for rainy days has been used up, the Treasury has to re-access the market and face the same rates it sought to avoid. The benefit is therefore defined as:

B=[(1+ΔACI)M1]*d(1)
  • ΔACI is the change in the average cost of issuance during the period of high volatility;

  • M is the average maturity of debt issuance; and

  • d is debt coming due during the period of high volatility.

2. This definition assumes that there was a moment of volatility in the market where the cost of financing rose. During this period, the Treasury cut off its issuances and ceased to refinance a debt volume of d. After that period, the cost of financing declines and the Treasury resumes its issues. By interrupting its issuances, the Treasury ceased to issue volume d, with an increase AACI in its issuance cost. This potential additional cost, which was no longer incurred, would obviously not be limited to the period of volatility but would extend over a period equivalent to the average issuance maturity.

3. Equation (1), however, is incomplete from the point of view of the consolidated public sector, which includes the CB. The matured volume d that is no longer refinanced increases market liquidity and must be sterilized by the CB. To this end, the CB uses open market operations because they are of short duration, and they have an approximate cost of the policy rate. Thus, the complete formula of the consolidated public-sector benefit obtained by the existence of a buffer becomes:

B=[(1+ΔACI)M(1+PRACI)M]*d(2)
  • M’ is the duration of the period of high volatility; and

  • PR is the policy rate.

4. Equation (2) builds on simplifying assumptions. It assumes that debt maturing in the period of volatility would be fully refinanced. It also considers that, once the period of volatility is over, the Treasury will be able to recompose the TSA immediately. Despite these shortcomings, it is a good approximation for preliminary analyses on the benefits of holding a cash cushion.

Determining the formula for calculating costs

5. In the cash management of private companies, the treasurer is aware of the opportunity cost of keeping the company’s financial resources in the form of cash. If the money is not going to be used right away, it should be invested to maximize profits. In this case the opportunity cost would be the profitability that the treasurer would achieve by applying the surplus of net financial resources in the company’s investment or in financial markets. However, the cash management of a government is more complex. Consequently, the calculation of the opportunity costs is more intricate and depends on the relationship between the Treasury and the CB, as well as the impact of treasury operations on money market liquidity, especially from the viewpoint of the consolidated public sector.

6. The opportunity cost of central government of holding a buffer for rainy days (b) is the Average Cost of its debt (AC). However, consistent with the best practices,1 the CB should remunerate this buffer according to the Market Rate (MR). Hence, we can represent the cost incurred by the Treasury as:

CT=[(1+AC)M1]*b[(1+MR)M1]*b(3)

7. The CB, in turn, suffers the cost of remuneration paid to the Treasury due to b. Moreover, we assume that b was built up via public debt issuance. However, if the Treasury decides to maintain its cash buffer instead of spending it, the monetary authority has an implicit return, as the CB will not have to wipe out liquidity at the cost of PR. Thus, the effective cost of the CB can be represented by:

CCB=[(1+MRM)1]*b[(1+PRM)1]*b(4)

8. Considering an institutional arrangement that establishes that the CB’s profit/loss must be backed by the central government, the underlying cost of holding a fund for rainy days should cover the costs incurred by both the Treasury and the CB. Equation (5) shows that the cost can vary a lot, depending on the evolution of the average cost and policy rate, in such way that it can turn negative if the average cost of debt is lower than the policy rate.

C=CT+CCBC=[(1+AC)M(1+PR)M]*b(5)

9. We can analyze the net benefit (NB) of holding a buffer through a simple maximization exercise, in which b is the control variable and the other ones are exogenous parameters.

NB=BC=[(1+ΔACI)M(1+PRACI)M']*d[(1+AC)M(1+PR)M]*bbenefitfactor=[(1+ΔACI)M(1+PRACI)M']costfactor=[(1+AC)M(1+PR)M]maxb[(1+ΔACI)M(1+PRACI)M']*d[(1+AC)M(1+PR)M]*b(6)

10. As equation (6) represents a linear maximization, it is enough to study the determinants of the signals to find their inclination (positive or negative), aiming to estimate the optimal buffer.

11. In this way, we can find three cases in response to the maximization problem. The first case appears when the spread (AC – PR) is positive. Consequently, the objective function of the maximization exercise becomes negatively sloped. In this situation, the initial response would be that the optimum cushion equals zero. However, a more careful examination, analyzing a neighborhood in which d ≅ b, reveals two different outcomes.

12. First, if the benefit factor is greater than the cost factor, the optimum buffer is equal to the volume that would be refinanced during the period of volatility (b). The economic interpretation of this result speaks to the microeconomic theory of insurance. In this sense, the insurance’s fair value is equal to the expected loss (i.e., the debt coming due). Second, if the benefit factor is lower than the cost factor, then b does not act as a fair insurance. As a result, equation (6) becomes negatively sloped and, consequently, the optimum buffer equals zero.

13. The third case occurs when the spread (AC – PR) is negative. Thus, it is easy to see that equation (6) becomes positive sloped, and therefore, b goes to infinity. However, this situation is temporary because AC typically lags PR in monetary cycle. Considering a debt manager is averse to risk, it is reasonable to include a constraint in (6) that b ≤ d. Therefore, the best response is to hold a buffer that equals d.

Figure 1.
Figure 1.

Optimal Buffer for Precautionary Purposes

Citation: IMF Staff Country Reports 2019, 243; 10.5089/9781513508375.002.A001

Source: Authors’ elaboration.

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  • Stella, Peter, 1997, “Do Central Banks Need Capital?”, IMF Working Paper 97/83 (Washington: International Monetary Fund).

1

Flavia Barbosa, Fabian Bornhorst, Daniel Cunha. Flavia Barbosa (flavia.barbosa@tesouro.gov.br) is an economist in the Brazilian Treasury, Fabian Bornhorst (Fbornhorst@imf.org) a senior economist in Western Hemisphere Department, and Daniel Cunha (DCunha@imf.org) an economist in the IMF’s Brasilia Resident Representative office. The views expressed in this paper are those of the author(s) and do not necessarily represent the views of the Brazilian Treasury, the IMF, its Executive Board, or IMF management.

2

See Robertson (2017), Aamodt and Tafjord (2013), and Nessén, Sellin and Åsberg Sommar (2011). Structural liquidity is defined as the difference of the central bank’s liability to banks (not considering the reserve requirements), and the central bank’s claims on the banking system.

3

The coupon cambial is the surcharge charged in the onshore US$ market.

4

The primary and overall budget balance have the same qualitative effect on liquidity. However, here the focus is on the primary balance as it directly relates to fiscal policy, whereas interest expenditure is also influenced by monetary and exchange rate policies.

5

See IMF (2018a) for a technical discussion of Brazil’s Liquidity Management Framework.

6

In a dynamic context, any replenishment of the FS portfolio will affect the IMF’s gross debt measure.

7

When receiving direct issuances, the BCB obtains a securities portfolio of its choice at prevailing market rates. The BCB does not participate in debt auctions, thus avoiding any price influence.

8

Under the old framework, the supply of securities to the BCB was based on an ordinance from the Minister of Finance (241/2009) which set the lower bound for the free security portfolio to R$ 20bn. Given its low legal hierarchy, the ordinance lacked enforcement options.

9

The IMF’s 2018 Financial System Stability Assessment recommended BCB issued securities as an alternative structural sterilization instrument. Remunerated term deposits are an alternative tool to sterilize liquidity, but they may not fully align within asset managers’ investment mandates (IMF, 2018b).

1

See Yaker and Pattanayak (2010). In Brazil, the cash of the debt is deposited in the single account that is remunerated by the Central Bank at a rate equivalent to the intrinsic income of the Treasury bonds in the Central Bank’s portfolio.

Brazil: Selected Issues
Author: International Monetary Fund. Western Hemisphere Dept.