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OPINION

Why Brazil’s central bank shouldn’t raise rates when inflation rises

M4 money supply growth could fuel inflation more than higher interest rates lower it, causing a predicament for central bank policy should inflation spike.

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I was speaking to a debt capital markets banker about Brazil’s recent international debt transaction – a re-tap of its 2047s. The obvious issue was that it came to market just one week after Standard & Poor’s downgraded the sovereign. But the banks – Citi, HSBC and Morgan Stanley – managed to tighten pricing down to 5.6% (after early guidance of 5.8% for $1 billion) and raise $1.5 billion. 

International investors shrugged off the downgrade just as equity and FX investors had done the previous week. Why? Well, the reason for the downgrade were already known – the slippage of fiscal reform – and neither the banker nor I wanted to go down the path of this pensions conversation again

Besides, he said, as far as international investors are concerned, the level of Brazilian foreign currency debt is dwarfed by its FX reserves, so there is no issue about the government being able to service coupons and maturities whatever mess it makes of the domestic accounts. 

Another related and well-appreciated point, because finance officials regularly brief about it, is that in a stress test (ie depreciating FX), Brazil’s net public debt goes down because the country has large net FX reserves (assets), while liabilities are almost exclusively in local currency, the real.