Shortening of the Debt Maturity and Risk of Financial Repression

BRAZIL ECONOMICS - Report 19 Oct 2020 by Affonso Pastore, Cristina Pinotti, Paula Magalhães, Marcelo Gazzano and Bruno Cordeiro

The scare provoked by the information that the debt/GDP ratio will reach 100% at the end of 2020 and continue to grow thereafter is one thing. The foreboding generated by its consequences, which are severe, is another thing, much different. The higher risk is being reflected in asset prices: both in the exchange rate, which is depreciating (by 40% since January); and the positive slope of the yield curve, which has increased significantly since the start of the pandemic. Not only will the Treasury have to finance a primary deficit of 15% in 2020, it will have to roll over the debt with a large concentration of bonds that mature in 2021. If the Treasury decided to sell bonds with longer maturities, it would have to pay a huge debt premium, worsening the debt dynamic even more. For this reason, it has opted to finance the primary deficit for 2020 with shorter term bonds, used also to replace the longer-term instruments when they mature. This will allow it to gain in the cost of the debt, but lose by increasing the concentration of maturity dates, making it harder to roll over the debt and creating a second risk – of financial repression – elevating the positive slope of the yield curve even more, closing a vicious circle. Not only has the slope of the long end of the yield curve been increasing, inducing the authorities to increase the concentration of the debt in instruments with shorter maturities, recently the slope of the short end of the curve (up to one year) has been steepening, sounding an alert about the coming monetary policy movements. In this report, we analyze the relations between the Treasury and Central Bank; how the rising risks have altered the interest rate premiums and the yields on LFTs; and the challenge facing the authorities due to the high concentration of bonds maturing in 2021, a situation that will extend for several more years in the absence of fiscal austerity. We conclude with a strong warning about a looming risk of financial repression.

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