Itaú BBA - Brazil: less vulnerable to shocks

Macro Vision

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Brazil: less vulnerable to shocks

mayo 26, 2017

The country may count on robust buffers and is therefore less vulnerable to both internal and external shocks

Since political uncertainty began to worsen, Brazilian authorities have emphasized that the country may count on robust buffers and is therefore less vulnerable to both internal and external shocks. 

We highlight below some of the buffers, which have in our view indeed made the Brazilian economy less vulnerable to external shocks in recent years: i) high international reserves; ii) a reduced current account deficit, now fully covered by foreign direct investment; and iii) a lower stock of currency swaps, making room for BCB action. 

We have also developed an external vulnerability indicator. Based on a comparison between Brazil and other emerging economies, we concluded that while the country continues to suffer above-average external vulnerability, it has improved in recent years.

On the domestic front, we note the considerable amount of funds deposited by the Treasury with the BCB, which allows the government to meet its commitments without needing to fund itself in the market for approximately one year.

Uncertainties have dominated the scenario in 2017. On the international front, the growth of developed economies has been a positive surprise, but the monetary tightening in the U.S. and the drop in commodity prices may have implications for emerging markets. On the domestic front, the uncertainties surrounding the political situation and the approval of reforms have increased over the past few days.

Some factors, however, indicate that Brazil is currently less vulnerable to potential external and internal shocks. 

What are the main buffers that have made the Brazilian economy less vulnerable to shocks?

High international reserves:

Between 2006 and 2012, Brazil's international reserves rose from approximately USD 60 billion to about USD 370 billion, remaining at this level since then. Successive balance-of-payment surpluses, whether due to the commodity boom or the intense capital flows to emerging economies in the post-crisis period, have allowed Brazil to accumulate a high level of reserves in the period.

Since then, the public sector has become a USD creditor, with reserves outpacing public external debt, putting the country in a relatively comfortable position in terms of solvency in foreign currency. The maintenance of international reserves at this level creates a "liquidity buffer" in USD that allows the BCB to mitigate the undesirable impacts from any eventual volatility in external capital flows on the real economy, and to ensure that price formation is not dysfunctional in moments of stress. 

This is exactly what happened in 2008, when the BCB – facing an international liquidity shock that reduced foreign capital flows to Brazil – sold approximately USD 15 billion in international reserves (about 7% of the total). At that time, the exchange rate went from approximately 1.60 BRL/USD to around 2.50 BRL/USD over a two-month period. Insurance and the BCB’s actions somewhat mitigated the FX movement, reducing its eventual impact on corporate indebtedness, inflation and economic activity – the FX movement subsequently reversed from the beginning of 2009 onward.

Numerous metrics have sought to determine the appropriate level of international reserves for each country, some of which are described below.

The IMF establishes an optimal reserve level rule reflecting the potential shocks that could affect the balance of payments of emerging economies[1]. International reserves will be at a safe level if they remain within a range of 100%-150% of the metric, described below:

Benchmark established by the IMF for countries with floating exchange rate = 30% Short-Term External Debt + 15% Other Liabilities + 5% Broad Money + 5% Exports of Goods & Services

Exports of goods and services capture the potential losses from a drop in external demand or a negative terms-of-trade shock. The broad money (we will use M3 in this case) captures potential residents' capital flights. Short-term external debt reflects debt rollover risks, while other liabilities reflect potential portfolio outflows, which are typically more volatile. According to this metric, Brazil currently has a very comfortable international reserves position.

Other indicators directly compare the size of reserves with GDP, external liabilities (total and short-term external debt) and liquidity indicators (M2, for example).  

The comparison with external debt, particularly in the short term, allows us to assess the risk that a crisis will affect the country’s ability to access international markets (at least on a shorter-time horizon). The reserves should cover at least the entire volume of short-term external debt, anticipating a possible inability to access international markets in that period. Brazil’s reserves are approximately 6.5 times larger than its short-term debt.

The comparison with liquidity indicators (M2[2] in this case) captures the potential risks of residents' capital flight in times of crisis. There is no consensus on what percentage of M2 should be covered by international reserves, but some argue that a level of around 20% would be appropriate. Brazilian reserves cover 50% of M2, a higher percentage than that of peer countries.

Brazil has an overall comfortable situation, with sufficient reserves under the main metrics. 

Reduced stock of currency swaps:

The reduction in the stock of currency swaps also creates an additional buffer, given that the smaller stock allows the BCB to act more intensively during periods of higher volatility. For example, in times of sharper exchange rate depreciation (due to either domestic or international factors), the BCB can sell currency swaps in the market, offering a hedge to agents of the economy.

The BCB's stock of currency swaps reached USD 113 billion in March 2015, and has dropped since mid-2016. The stock is currently close to USD 25 billion, creating a much more comfortable position for the BCB to act in the event of a possible malfunction of the FX market.

Current Account deficit fully covered by foreign direct investment:

The financing pattern of the Brazilian current account deficit has also improved significantly over the past few years. The current account deficit has declined as a result of a more depreciated exchange rate and weaker economic activity, but direct investment in the country (equity participation) has remained resilient.

Foreign direct investment currently accounts for 3.3% of GDP, significantly above the current account deficit (around 1% of GDP). However, the situation was quite different not long ago: in 2013 and 2014, foreign direct investment (equity participation) was not enough to cover the total current account deficit, which reached 4.3% of GDP.

It could therefore be argued that the financing of the balance of payments has become more comfortable and healthier over the past two years. This is because foreign direct investment in the form of equity participation has, for the most part, a longer-term nature and therefore tends to be less volatile and less sensitive to short-term economic and exchange rate fluctuations.

 Determining the degree of external vulnerability

We have developed external vulnerability indicator for different emerging economies[3]. The indicator takes into account the following variables (equally weighted)[4] :

  1. International reserves (% of GDP): the higher this figure, the greater the central bank's "liquidity buffer" to mitigate the impacts of a sharp reduction/interruption in foreign capital flows on the real economy, and the lower the country's external vulnerability.
  2. Current account deficit (% of GDP): the lower the deficit, the lower the dependence on external savings and the lower the vulnerability to external shocks.
  3. External debt[5] to current account revenue (exports of goods and services) ratio: the higher this ratio, the greater a country's commitments in foreign currency relative to its ability to generate revenue (also denominated in foreign currency) – i.e., the higher the external vulnerability.

The analysis of this indicator allows us to draw some interesting conclusions.

The external vulnerability of emerging countries as a whole remains high. On the one hand, the current account balance has increased, reflecting the depreciation suffered by most emerging currencies after the announcement of the beginning of the monetary tightening in the U.S. International reserves have also remained high, despite the impact of the exchange rate depreciation of emerging currencies under the accounting of GDP in USD.  However, the ratio of external debt to current account revenues has increased due to the increase in external debt caused by the exchange rate depreciation and the drop in commodity prices, which has affected export revenues over the past two years.

The external vulnerability indicator for 2016 suggests that Brazil is, on average, more vulnerable than the other countries in the sample for the same year, but it is not in the most vulnerable group. South Africa, Chile, Indonesia, Argentina, Turkey and Colombia have a more delicate external situation. 

Brazil has become less vulnerable in recent years. Thus, external shocks are likely to have a smaller impact on the currency and the economy than before.

Treasury internal reserves

Without reforms (the main one being the pension reform) that will make the fiscal adjustment based on the constitutional amendment of the spending ceiling viable over time, there is no prospect of an improvement in the trend of increasingly negative primary results, and public debt will remain on an unsustainable trajectory. A vicious cycle of high (and growing) debt and economic stagnation will persist. Between 2013 and 2016, this imbalance led the gross debt to increase by an average of 6 pp per year, jumping from 52% to 70% of GDP. The continuity of this trend generates legitimate concerns about the solvency of the public sector in local currency, which affects the financing and management conditions of public debt by the National Treasury.

In times of greater turbulence it is incumbent upon the National Treasury to act for the proper functioning of the public securities market. The traditional mechanism is the announcement of extraordinary auctions, buying and selling securities, in order to restore basic price references and avoid contamination to other markets.

Equally important is the ability of the Treasury to stay out of the market at times of potentially distorted financing costs. The Treasury already follows the policy of detaching an amount from its deposits with the Central Bank enough to pay the service of the public debt for at least 3 months. However, at the limit, this capacity is directly proportional to the total size of its deposits with the Central Bank, against the sum of public debt maturing in the short term and the nominal deficit.

The Treasury would currently be able to subsist approximately one year without being financed by the market. The deposits total BRL 1 trillion (16% of GDP) and are sufficient to roll over a nominal deficit of BRL 580 billion (9.2% of GDP) and BRL 425 billion (6.7% of GDP) of public debt maturing over the next 12 months. This large volume of resources is an important buffer, which guarantees the state's solvency in case of prolonged market stress. In light of the previous discussion regarding the public debt trajectory, while the use of government deposits at the BCB buys time in periods of stress, it obviously does not eliminate the need for reforms.


The indicators show that Brazil is currently in a more comfortable position to absorb eventual external and internal shocks than in recent years. The high volume of international reserves and the smaller stock of currency swaps give the BCB room to mitigate the impact of unanticipated events on the exchange rate and, consequently, on the economy. The more favorable external financing situation (with foreign direct investment covering the current account deficit) also reduces the risks associated with possible liquidity issues. The availability of resources in the Treasury’s account with the BCB enables it to manage debt with more flexibility, although it certainly does not eliminate the need for fiscal reforms.


Julia Gottlieb

Pedro Schneider


[1] Assessing reserve adequacy – specific proposals (IMF, 2015). Available at

[2] Defined by the Brazilian Central Bank as follows: M2 = M1 + savings deposits + time deposits + bills of exchange + mortgage notes + real estate credit bills.

[3] Countries in the sample: China, India, South Korea, Philippines, Thailand, Malaysia, Indonesia, Brazil, Chile, Colombia, Mexico, Peru, Argentina, Czech Republic, Hungary, Poland, Russia, South Africa and Turkey.

[4] We have normalized each of the variables based on the historical average and standard deviation.

[5] We only consider the concept of "traditional" external debt (loans, fixed income bonds issued abroad and commercial credits).



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