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Since end-2005, the government of Brazil started to pay part of its external debt ahead of schedule. This operations are really implying an increase in internal debt. The government has made these early payments in order to advertise the fact that brazilian external vulnerability would be over. However, the truth is far away from this announcement.

The recent operations concerning early payment of external debt are really implying an increase in "internal" debt with higher interest rates and shorter maturities.

Since end-2005, the government of Brazil started to pay part of its external debt ahead of schedule. In December 2005, it paid US$15.5 billion to the IMF; early in 2006 it also cancelled the US$1.8 billion debt owed to the Paris Club (association of creditor governments) and also paid US$6.64 billion for the early redemption of “Brady” bonds. Recently, the government announced it will pay more external debt bonds ahead of schedule, totalling these operations the amount of US$20 billion in 2006.

The government has made these early payments in order to advertise the fact that our external vulnerability would be over. However, the truth is far away from this announcement. In the first place, these early payments represent a small part of the external debt.

In the second place, the government continues to issue external debt bonds with higher interest rates than those of bonds paid ahead of schedule. IMF interest rates stood at nearly 4 per cent annually and those of Bradies at 5.7 per cent, while interests for bonds amounting to US$14.3 billion issued since January 2005 were set at an average annual rate of 8.5 per cent.

Aggravating the situation, all new external debt bonds issued as of 2003 include a “Collective Action Clause” (CAC). This clause assigns the resolution of any debt controversy to the courts in New York, which implies a waiver of national sovereignty. Besides, the CAC only allows major creditors (holding 85 per cent of debt) to impose their will in the event of debt renegotiation, thus concentrating power in the hands of a few creditors.

In the third place, these early payments indeed represent a swap of external for “internal” debt, with the world’s highest interest rates and very short maturities. In order to have dollars available to pay off the external debt ahead of schedule, the Central Bank has bought dollars in the market. But when the Central Bank buys dollars, it injects local currency (Brazilian Reais) into the economy, which from the government’s point of view, generates inflation. Thus, in order to withdraw this excess of reais from the economy, the government issues internal debt bonds with the same value. From October 2005 to July 2006, the Central Bank bought US$30 billion, which accounted for the issue of nearly R$66 billion in internal debt bonds (considering an exchange rate of R$2.2 per dollar). This is the reason why the internal debt shows an explosive growth, having risen R$107 billion in just the first seven months of 2006.

Taking into account that these R$66 billion in bonds are paid at a Selic rate, these operations represent an annual amount of nearly R$10 billion, that is to say, two and a half times the total amount spent on the 2005 agrarian reform.

Another onerous device that has been used by the government to advertise a supposed reduction in external vulnerability is the so-called “reverse swap operation”, implemented by the Central Bank. The name of the operation is complicated, but it has quite a simple guiding principle. By means of these operations, the government swaps dollar-indexed internal debt for debt indexed to the world’s highest interest rates. This is all foreign investors want, since if the dollar falls they gain the variation in the dollar value plus interests! Given the fact that the dollar has fallen (as a result of the international financial speculation to gain Brazilian interests) these operations represent a haven for speculators. And who pays?

The answer to this question can be found to the detriment of the Central Bank in the first semester of 2006: nothing less than R$12.5 billion, that is to say, over two times the federal spending on education during the same period! The swap operations currently totalling over R$30 billion will be contributing to this effect. All of the damage being caused to public coffers calls for a comprehensive audit.

In brief: the government’s argument for the reduction of external vulnerability fails to be sustained. And this is due to the fact that the “internal” debt causes even more vulnerability than the external debt. With the daily participation of foreign investors in the “internal” debt market (to obtain easy gains with the world’s highest interest rates), any international crisis involving these investors results in capital flight and major oscillations of exchange rates as it was noticed during the rise in US interest rates in May.

In brief: it is not posible to talk about the "end of external vulnerability" without establishing control over capital flows, concerning either the external or internal debt or any kind of investment.

This article was first published by Citizen Debt Audit (Jubilee South Brazil Network) - Newsletter Nº15 (in portugues)

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