Latinnews Archive
Latin American Economy & Business - 28 October 1977
BEHIND THE HEADLINES: Distortions limit role of Brazil money markets
The Brazilian money market has recovered from the crisis which rocked the financial system early last year and is at last becoming a useful tool for controlling the money supply. It is limited in this role, however, by distortions in the capital structure of Brazilian companies.
In industrialised economies with sophisticated financial systems, money markets developed over decades. The Brazilian market began in 1971 when the government created short term treasury bills, Letras do Tesouro Nacional (LTN). The volume of trade rapidly built up with peaks of more than US$1,500m a day. It was not limited to the LTN. Almost any interest-bearing paper, ranging from housing bonds to savings deposits, began to be traded.
Excess money
Monetary policy was so badly handled in 1975 that, by flooding the financial system with excess money, the government encouraged market intermediaries to speculate and build up huge portfolios which could not be maintained under normal circumstances. One market operator, for example, had commitments to buy back bonds worth US$54m while its total assets were worth no more than US$125,000. When the central bank began to dry up the surplus funds, several operators were pushed to the brink of bankruptcy.
A chain of failures would have destroyed confidence in Brazil's fledgling financial system and may even have affected the country's ability to borrow abroad. A rescue operation, however, meant losing control of the money supply and fuelling inflation.
The central bank chose the latter course and, with great secrecy, bailed out the hard-pressed firms. The money supply jumped by 9.2% in December 1975, and helped set the stage for 46% inflation in 1976. The size of the bailout has been estimated at more than US$1,000m.
The central bank was roundly criticised for leaving the market in turmoil until April last year, when it brought in reforms under Resolution 366. Limits were placed on the size of portfolios and operations were largely limited to LTNS. Smaller operators, thought to be the most speculative and least conservative, were pushed out of the market in the hope of leaving more sophisticated and stable institutions. Market intermediaries are trimming portfolios to more manageable sizes and weeding out the longer-term cumbersome securities.
According to one of the market's most respected operators, the crisis is now over, but he says that Brazil still has some way to go before the market is as efficient as those in Europe or the United States. The Brazilian market is a conglomeration of financial centres dotted around the country. Money does not flow easily between centres and hence the monetary authorities' control of the money supply is limited.
He also argues that the treasury created a basic imbalance in the system so that too much paper is chasing too little cash. As a result, companies find eager takers for short-term deposits. Gustav Franco, the finance director of Rohm and Haas in Brazil, says: 'You have more flexibility in Brazil to park some money than you might find in the United States. If you are willing to take the risk, you can get a great return on your money, but you have to sleep with one eye open.'
Handsome profits
The profits are enough to lure most large companies. Pirelli says it made profits of about US$4m on the money markets last year. Fiat made a handsome US$2m in Brazil in 1974, some 18 months before its manufacturing plant came on-stream. Most of this profit is believed to have come from the 'open', as the money market is known. Some economists and businessmen argue that high rates of return on the money market are hurting the country. Companies, instead of investing in productive capacity, turn to financial transactions for profits. Large amounts of government-subsidised credit, intended for agriculture or development projects, quickly find their way on the money markets. The press, which keeps a beady eye on the state companies, has highlighted the profits they make up by placing taxpayers' money on the market.
Economists agree that as the market matures, it will settle and cease to be an important investment alternative. They point to the example of the European and United States markets where relatively low rates attract only companies unable to tie up funds for long periods. At present, however, 'open' rates are bouncing between 3% and 4% each month, occasionally soaring to 6% or dropping to 1.5%. Acceptance bills of first-line finance companies pay 2.7% per month and savings accounts (cadernetas de poupanca ) offer 7% to 8%, while inflation was about 1.8% in September.
Rates are high because tight money is one of the government's anti-inflation weapons, and the money market is an important instrument for applying the policy. However, Brazilian companies are too weak financially to withstand a strong monetary attack on prices and so the effectiveness of the 'open' is circumscribed.
Subsidised loans
The government itself built in the limitations. As a development strategy, the government, almost the only domestic source of long-term capital, has offered subsidised loans to stimulate priority sectors. Firms responded to the state's largesse as intended, but with the side effect that they are now heavily indebted.
With high debt-to-capital ratios, interest is an important cost and when tight money pushes interest up, companies respond immediately and perversely with price increases to pass on their higher financing costs. And as credit dries up, even the largest quickly totter towards bankruptcy.
The Banco do Brasil, which is the principal source of Brazil's long-term subsidised credit, is more concerned by the effects of the deflationary policy on the strength of industry than is the central bank, which is charged with controlling the money supply. Banco do Brasil president Karlos Rischbieter has been arguing strongly for a fall in interest rates, but has been opposed by his counterpart at the central bank, Paulo Lira. Rischbieter says that the Banco do Brasil cannot bring its interest rates down until the central bank cuts the coupon on the LTNS, at present the same as finance company acceptance bills.
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