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Thursday, February 7, 2013

Less of a Brazilian Anomaly


Last month, I did a post looking into a presentation by Citi that showed an anomalously large real yield on Brazil’s local currency denominated debt.  It didn’t add up, in a world where virtually no sovereign is paying more than its inflation rate, and sometimes less, on its debt; on its dollar-denominated debt, Brazil was paying far less, both in nominal and real terms.  I couldn’t find a satisfying explanation; my final thought was that perhaps the official inflation rate was understated, or holders of BRL were simply expecting inflation to be significantly higher than the official rate Citi was using. 

Today, the FT’s “beyondbrics” blog reports, Brazil’s January inflation numbers are out and, indeed, it has gotten much worse.  Inflation for the month was 0.86% sequentially and, but for the government’s acceleration of an 18% reduction in the electric tariff, it would have been 0.99%.  Were one to annualize either of those numbers, the supposed real yield premium Citi presented would completely disappear.  Local currency debt holders who have a currency hedge are probably very happy they do, but the dollar-denominated debt will become a lot more expensive for the issuer.

Their economy appears to be a mess.  Inflation is rising despite price controls on a large sector of the economy.  Despite the jump in inflation, the authorities are pursuing expansionary policies, including trying to weaken the BRL further.  By one measure, the Economist's "Big Mac index", the BRL is one of the most overvalued currencies in the world.  Perhaps that is why real GDP is stagnant at best – in fact, industrial production fell by more than 2% year-over-year.