Lula Credit Risk Rising to Peru, Panama as Brazil Debt Levels Deteriorate

The risk associated with holding Brazilian bonds relative to Peru climbed to a 20-month high on concern President Luiz Inacio Lula da Silva isn’t taking advantage of the fastest growth in two decades to cut debt.

The cost of protecting Brazil’s debt against non-payment for five years with credit-default swaps compared with Peru rose yesterday to 10 basis points, or 0.10 percentage point, the highest since December 2008, according to CMA DataVision prices. As recently as March, Peru’s swaps were more expensive than Brazil’s. Brazilian swaps are also 10 basis points higher than Panama. All three countries are rated BBB- by Standard & Poor’s.

“The fundamentals of Brazil have been deteriorating whereas the fundamentals of Peru and Panama have improved,” Paulo Vieira da Cunha, a former Brazil central bank director who’s now a partner at Tandem Global Partners LLC in New York, said by telephone. “In Brazil, gross debt to GDP is increasing rapidly. It’s not like an alarm bell. The whole issue is how easily Brazil can get away with.”

Brazil swaps have become more expensive relative to similarly rated Latin American countries after Lula, 64, increased gross debt to 60 percent of gross domestic product, twice as much as Peru and 15 percentage points more than Panama, according to central bank data. Record lending by Brazil’s state development bank, known as BNDES, is adding to the government’s leverage and may hurt chances for a credit upgrade, Fitch Ratings Ltd. said in a June 28 statement.

Borrowing Costs

Brazil’s dollar bonds have also lagged behind smaller nations in the region, returning 9.7 percent this year, compared with 14 percent in Peru and 12 percent in Panama, according to JPMorgan Chase & Co.’s EMBI+ indexes.

The extra yield investors demand to hold Brazilian government dollar bonds instead of U.S. securities rose six basis points this year to 198, according to JPMorgan prices at 5:26 p.m. in New York. The spread declined 17 basis points to 148 in Peru and fell six basis points to 165 in Panama.

While Brazil’s overall credit profile is “very good,” the country “has to move faster on a number of fronts in order to improve the quality and sustainability of growth and the environment of growth prospects,” da Cunha said.

Corporate Credit

The cost of protecting Brazil’s debt against default fell eight basis points this year to 115, according to CMA. Peru’s dropped 19 this year to 105, while Panama’s declined 28 to 105. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to debt agreements.

Brazil, South America’s largest economy, and Peru, the continent’s sixth-largest, were raised to Baa3, the lowest investment grade, by Moody’s Investors Service last year, matching the BBB- rating from S&P and Fitch. Panama was lifted to investment grade by the three rating companies this year.

Brazil’s credit swaps, the most actively traded in the region, are underperforming because investors bought protection to hedge their corporate debt holdings, Gorky Urquieta, who oversees $12 billion of emerging-market assets at ING Investment Management in Atlanta, said in a telephone interview.

Companies in Brazil borrowed $18.8 billion in international markets this year through yesterday, a 235 percent increase from the same period in 2009, according to data compiled by Bloomberg. Peruvian companies borrowed $676 million. No companies in Panama issued dollar debt this year.

More Spending

“In Brazil, there is some pretty vibrant activity in the corporate markets,” Urquieta said. “This can at least explain part of the distortion” in the credit default swaps between Brazil and peers, he said.

Trading of Brazilian credit default swaps rose 28 percent to $74 billion in the first quarter of 2010 from the previous three-month period, compared with $8.38 billion in Peru and $1.2 billion in Panama, according to data from the Emerging Markets Traders Association in New York.

Lula increased spending as he sought to pull the economy out of its first recession since 2003. Brazil’s gross debt jumped to 2.01 trillion reais ($1.1 trillion) in June from 1.34 billion reais in December 2006, when the central bank started compiling the data under a new methodology.

Investors are paying more to protect against a debt default by Brazil even as the country’s $1.6 trillion economy is forecast to expand 7.2 percent this year, after shrinking 0.2 percent in 2009, according to a central bank survey released this week.

Debt Burden

BNDES, based in Rio de Janeiro, increased loans 41 percent in the first five months of this year to 46 billion reais, fueling credit growth.

The gross debt to GDP ratio, a measure of a country’s ability to pay loans, increased to 60.1 percent, from 56.4 percent four years earlier. In Peru, the ratio is 24.8 percent, compared with 44.7 percent in Panama and 37.7 percent in Mexico, the second largest economy after Brazil in Latin America, according to data compiled by Bloomberg.

“The fiscal stance needs to improve to allow for a better monetary-fiscal policy mix,” Fitch analysts including Shelly Shetty in New York wrote in a statement on June 28, when the firm revised its outlook for Brazil to positive from stable. “The continued quasi-fiscal stimulus through the BNDES is contributing to high credit growth” and “preventing a faster reduction in the gross general government debt burden,” the analysts wrote.

Rate Futures

Shetty wasn’t available to comment, said Fitch spokesman Brian Bertsch. Brazil’s Finance Ministry didn’t respond to questions sent by e-mail seeking a comment.

The two candidates leading in polls ahead of Brazil’s October presidential election, former Sao Paulo Governor Jose Serra and ex-Cabinet Chief Dilma Rousseff, say lower spending may help push down borrowing costs. Rousseff told Veja magazine she would aim to reduce the government’s net debt-to-GDP ratio to 28 percent by 2014, from 41 percent in June.

Yields on the interest-rate futures contract due in January rose one basis point to 10.82 percent, indicating traders expected the central bank to raise its benchmark to 11 percent by year-end from 10.75 percent.

The real gained 0.3 percent to 1.7522 per dollar.

Peru’s economy grew 9.2 percent in May from a year earlier, and may post growth of close to 10 percent in June, central bank President Julio Velarde said July 22. In Panama, the government plans to cut public debt to 35 percent of GDP by 2014 as an expansion of the Panama Canal boosts tax revenue and growing investment in the mining industry buoys royalties, Finance Minister Alberto Vallarino said in March.

“The Peru and Panama stories at this stage look more compelling in terms of fundamentals than Brazil,” said Donato Guarino, a strategist at Barclays Capital Inc. in New York. “I don’t think the spreads will reverse any time soon.”

To contact the reporters on this story: Ye Xie in New York at yxie6@bloomberg.net; Tal Barak Harif in New York at tbarak@bloomberg.net

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