Tuesday, February 26, 2008

Brazil: Net External Creditor and Few Reasons to Celebrate

Last week we learned that Brazil became a ‘net foreign creditor’, something so positive that the authorities in Brazil are confident that this was the last step for the country to achieve investment grade status.

The net total external debt of a country is equal to total external debt minus international reserves minus Brazilian credit abroad minus commercial bank assets. In turn, a country is becomes a net foreign creditor when its assets abroad are greater than its liabilities. In Brazil such fact was primarily due to the 200% increase in international reserves, from 2003 to 2007. One may then asks if the switch from net debtor to net creditor was also due to a decrease in total external debt. The answer is no: the total external debt remained relatively constant during this period, as displayed in table 1.

As correctly explained by Jose Antonio Ocampo, a large share of Latin America’s international reserves derives from portfolio investments and hence are extremely volatile. In turn, when Brazilian markets are victim of a ‘sell-off’, like the one in January one cannot simply affirm that Brazil is better off than other countries due to its high level of reserves. These reserves are borrowed and when capital flies back the same holds for the reserves.

Given that total external debt did not present any important decrease since 2003 (despite the $5.8 billion Brady bond purchase in 2005 and the $6 billion from the 2006 National Treasury debt buyback in 2006) and that ‘hot money’ is the main source of the increase in the international reserves, we don’t understand why the market is praising so much the new status of ‘net foreign creditor’.

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