Bond Buying Barriers for Foreigners Swell Cost for Rousseff: Brazil Credit

Brazil’s barriers to international bond investors are exacting a growing cost from the Treasury.

The country has the lowest foreign participation in its debt market among major Latin American countries and pays the highest yield on local bonds relative to its overseas securities, according to data compiled by ING Groep NV and Bloomberg. Brazil’s local bonds due in 2017 yield 331 basis points more than its foreign real-denominated notes, up from 217 in mid-July and almost double the 127 gap on neighboring Colombia’s debt.

The differential will climb further, adding to Brazil’s interest rate tab, because President-elect Dilma Rousseff is unlikely to dismantle the deterrents to international investors that her predecessor, Luiz Inacio Lula da Silva, has put up, according to David Beker, head of Latin America strategy at Bank of America Corp. Lula tripled a tax on foreigners’ fixed-income purchases last month to slow a two-year currency rally and rein in a record current-account gap.

“Dilma is seen as continuity,” Beker said in a telephone interview from New York. The yield gap “only will change when the government decides to stop taxing capital flows and they don’t look like they’re willing to do it,” he said.

Rousseff’s staff didn’t respond to an e-mailed message seeking comment. Rousseff, who served as cabinet chief and energy minister under Lula, will take office in January after winning 56 percent of the vote in the Oct. 31 election.

Lula boosted the tax rate on foreign investors twice last month, taking it to 6 percent from 2 percent and extending barriers that include a requirement that they open local accounts to buy bonds.

Real Rises

The government raised the tax after the real touched a two- year high of 1.6442 per dollar on Oct. 14. It’s surged 28 percent in the past two years, curbing exports and helping increase the annual deficit in the current account, the broadest measure of trade, to $47 billion.

International investors seeking alternatives to near-zero key rates in the U.S., Europe and Japan were moving money into Brazil to take advantage of the country’s benchmark 10.75 percent rate. Finance Minister Guido Mantega told reporters in Brasilia on Oct. 25 that the tax increase was working to curb investment in the debt market and stem the real’s gains.

The real fell 0.7 percent in October, the biggest monthly slide since declining 4.5 percent in May.

The tax, which Lula reinstated at 2 percent in 2009 after eliminating it a year earlier, is pushing more foreigners into Brazilian real-linked international bonds.

Overseas Bonds

Yields on the 12.5 percent overseas bonds due in 2016 have climbed 25 basis points, or 0.25 percentage point, to 8.45 percent in the last month, according to data compiled by Bloomberg. Yields on Brazil’s local bonds maturing in 2017 have risen 9 basis points to 11.77 percent over that time, swelling the difference between the two securities to 331 basis points. The gap touched 389, the widest in five months, on Oct. 19, a day after the second tax increase.

Brazil’s 10.7 billion reais of overseas local-currency bonds equal only about 0.7 percent of its 1.5 trillion of domestic debt, according to the Treasury.

“It’s a bad deal,” Tony Volpon, a Latin America strategist in New York at Nomura Securities International Inc., said in a telephone interview. “They’d rather have the tax and lessen the pressure on the currency but they have to pay a higher yield” on the local securities, he said.

The Finance Ministry’s press department didn’t return an e- mailed message seeking comment.

Overseas Investors

Brazil’s local-versus-foreign yield spread compares with 127 basis points on Colombian securities, 138 on Chilean debt and 171 on Philippines notes.

Foreigners hold 14 percent of all Brazilian government bonds, less than half the 29 percent they own of Mexican debt and the 33 percent they hold on average in the region, according to ING, the biggest Dutch financial services company. The percentage in Brazil will double over the next decade since government measures won’t be able to keep capital away over the long term, said David Spegel, head of emerging-market debt strategy at ING in New York.

“The existence of capital controls is a bit of a deterrent, but it’s a very attractive market,” Spegel said.

Brazil’s inflation-adjusted interest rates are the second- highest after Croatia among the 46 countries tracked by Bloomberg.

The extra yield investors demand to own Brazilian government dollar bonds instead of U.S. Treasuries fell two basis points to 173 today at 5:15 p.m. New York time, according to JPMorgan’s EMBI+ index. The spread on emerging-market government dollar debt shrank six basis points to 236.

Credit Default Swaps

The cost of protecting Brazilian bonds against default for five years dropped two basis points to 95, according to CMA DataVision. 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 its debt agreements.

The yield on the overnight interest-rate futures contract due in January 2012 rose one basis point to 11.33 percent. The yield level implies traders expect the central bank to raise the benchmark rate 125 basis points to 12 percent by the end of 2011 to cool the fastest economic expansion since the 1980s.

Sapping Demand

While slowing the real’s rally, the tax increase has sapped demand at the government’s weekly bond auctions. The Treasury rejected all bids on bonds due in 2021, their longest local fixed-rate securities, in the past two auctions.

The flops marked the first back-to-back canceled auctions since June. The government began issuing the securities in February. Treasury Secretary Arno Augustin said in an interview on Oct. 21 that the yield bids were “unreasonable” that day.

“The Treasury has not been willing to sell the longest dated bonds because the yields are too high,” Bank of America’s Beker said. “The implementation of the tax has made the Treasury’s job more complicated.”

To contact the reporter on this story: Veronica Navarro Espinosa in New York at vespinosa@bloomberg.net

To contact the editor responsible for this story: David Papadopoulos at papadopoulos@bloomberg.net

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