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Wednesday, 13 December 2017

Brazil Roundtable 2006

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Brazilian capital markets are at an historic turning point. The leading South American economy is the darling of emerging markets investors and an influx of foreign capital is expected to revolutionise the nation's credit profile and local corporate finance.

Since IFR convened leading market participants in February to discuss this issue, significant steps have already been taken by the government to open up the local market. Crucially, Brazil exempted foreign investors from a 15% withholding tax on local government debt, a move that is likely to be hailed as pivotal in its financial history.

The government also unveiled a US$6.64bn call of its remaining Brady bonds, casting off the stigma of past default while saving itself US$3.7bn in interest. The Bradys weighed on the curve and served as a painful reminder of just how poorly the nation was governed in the early 1990s when it was beset by hyperinflation.

This followed the announcement of a medium-term buyback programme for short dated bonds, and Brazil is set to continue a switch from international debt into local currency alternatives. And in late February, S&P upgraded Brazil a notch to BB. Many in the market think the agencies are behind the curve and some predict investment-grade next year.

There may be some froth developing as Single B cross-border deals fly out the gates well oversubscribed, and there is a fear that Asian investors will get a shock if perpetual bonds are not called in year five. But fundamentals look firm enough to weather the storm.

All of this provides a world of opportunity for investors, who are driving the process owing to continued high levels of liquidity. The yield-starved fixed-income buy side worldwide is trying to figure out how to participate in a US$445bn Brazilian debt market promising local currency returns of more than 17.5%.

As this report shows, international banks are also weighing the potential for new business and some are setting up new locally based teams. Together, buy and sell side look set to hasten a maturing of Brazil's fledgling capital markets. Lowering rates overall is a key objective and should help the local market to grow up and better match risk to return.

But as is always the case in emerging markets, it is unlikely to be an entirely smooth ride. A general election looms in the fourth quarter and last time the country went to the polls, the benchmark bond traded in the 40s and analysts screamed default. However, even though Brazilian debt now trades in the 130s, most observers expect minimal turbulence and fear much bigger external risks.

Analysts used to quip that Brazil was the country of the future – and always would be. It has a long way to go before reaching the domestic capital markets maturity of, say, Mexico. But with the help of foreign banks and investors, Brazilian capital markets are poised to realise some of their massive potential.

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