Brazil's Government Bond Market: Liquidity Mechanism or Crowding out Effect?

Brazil’s Government Bond Market:

Liquidity mechanism or crowding out effect?

Lorena Meco

For: Professor Sobol

Financial Globalization, Currency Crisis and Emerging Markets

Fall 2012

Brazil’s Government Bond Market: A liquidity mechanism or crowding-out effect?

It is the country that leads the infamous BRICs, coined by Jim O’Neill, Brazil. The 5th largest country in the world now also boasts an almost corresponding, 6th largest economy in the world, recently overtaking the once economic powerhouse, the UK. As far as Latin America is concerned, Brazil is the flesh and blood proof that success stories can come out of a perpetually hopeless case that is Latin America. As recently as November 2011 Standard & Poor’s upgraded sovereign dollar-denominated foreign debts to BBB from BBB- and government’s local currency debt from BBB+ to A- . Renewed hope in the last decade and a half in Brazil’s strong macroeconomic fundamentals and a commitment by it’s three previous and current governments has signaled with enough longevity to the market that Brazil is a good place to investment. With foreign financial managers constantly in the hunt for higher returns, Brazil is a paradise for high returns with relatively lower risk as far as emerging market countries are concerned.

The confidence in the market for Brazilian securities has allowed the government to galvanize this huge source of funding for their gargantuan financing needs. With a stable level of over $350 billion in foreign currency reserves, a weakening yet stable economy and strong leadership on the monetary and fiscal side of politics, the Brazilian government has been able to issue huge amounts of bonds and even adjust their strategy to change the composition of their debt, whether international or externally, foreign or domestically denominated, fixed or floating rates . This paper looks to inquire further into the depth of such a market and what it represents in the bigger picture. This paper also aims to look at the regulatory aspect that both enhance and impede the type of long-term growth and integration that is necessary in the future. In order to be able to set the stage for this biggest picture, first we must take a look at where Brazil’s market stands as of now.

A current snapshot

The Brazilian government sold over $825 million in long-dated bonds on a single day in early January with demand so unexpectedly high that the yield for the securities came in at 3.449%, a record low with the bond’s coupon yield at par of 4.875% . Given Brazil’s historically high interests,