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Brazil Capital Flows and the External Debt
Capital Flows and the External Debt
Much of Brazil's economic experience in the past two decades has
been dominated by large capital inflows that attained record levels
in the 1970s, only to collapse after 1983 in the wake of the Mexican
debt crisis. For the rest of the decade, Brazil coped with the consequences
of this collapse, and only in the 1990s did capital again begin
to flow into the Brazilian economy, with a substantial increase
after the Real
Plan.
The enormous inflow of external capital to Brazil that ended in
1982 had its roots in a number of policies and institutional changes
in the preceding two decades. The military government that seized
power in April 1964 quickly reformed existing laws governing direct
foreign investments, including liberalizing restrictions on remittances
of profits and simplifying procedures for reinvestment of profits.
The changes did not address the effects of inflation in the currency
of the lending country, however, so that the real returns on a direct
investment were affected negatively by inflation in dollar prices.
The negative effect of dollar inflation on a direct foreign investment
in Brazil arose because the original investment was registered in
a fixed dollar amount, on which allowances for profits and remittances
were calculated. A million-dollar
investment in 1964, for example, would still be registered as a
million-dollar investment in 1974. Higher nominal dollar profits
in 1974 would then result in a substantially higher nominal profit
rate and a heftier Brazilian tax,
thus lowering the real return.
Financial lending to Brazil was different because the interest
rate on the loan, usually denominated in dollars, incorporated the
market's expectations of inflation. The asymmetrical treatment of
financial capital flows and direct investment was one of the reasons
total capital flows to Brazil in the post-1964 period were dominated
by bank lending, which at times was ten times as great as foreign
direct investment.
Among the other changes that encouraged large financial capital
flows to Brazil was Law 4,131, which allowed final borrowers to
deal directly with foreign lenders after approval by the Central
Bank of Brazil (Banco Central do Brasil--Bacen; see Glossary). Another
vehicle for capital flows was Resolution 63, which permitted Brazilian
banks and authorized subsidiaries of foreign banks to obtain dollar
loans abroad and reloan the proceeds to one or more domestic borrowers.
Finally, the increasing participation of the Brazilian government
as a borrower itself, backed by explicit "full faith and credit"
guarantees and by the implicit assumption that taxes could be levied
to pay for loans to the government, made lending to Brazil an increasingly
attractive option for foreign banks.
Equally important in explaining the sharp rise in financial lending
to Brazil after the mid-1960s were changes in international financial
markets. International banks began to negotiate variable interest
rate loans, in which the borrower and the lender agreed to reset
the loan's interest rate at specified intervals, usually six months,
on the basis of a rate that neither the borrower nor lender controlled
(usually the London Interbank Offered Rate--LIBOR), or the United
States prime rate. Added to this underlying rate was a "spread,"
or premium charged to borrowers like Brazil, based on the market's
assessment of any additional risk compared with the risks associated
with prime borrowers. Finally, the rise in syndicated bank lending,
in which one "lead" bank organized the loan and then sold
portions of it to other international lenders, permitted banks to
expand substantially their loans to borrowers like Brazil.
Together, these innovations cleared the way for lending on a scale
that was unprecedented in Brazil's history and with few parallels
elsewhere in the world. Because the loans were denominated in the
creditor country's currency, they were isolated effectively from
inflation in cruzeiro prices. As long as the value of Brazil's export
revenues grew at rates exceeding the interest rates charged on the
loans, an assumption that appeared valid throughout the 1970s, the
burden of the external debt in relation to Brazil's capacity to
repay it would fall.
Although it is easy from the vantage point of the 1990s to criticize
the volume and terms of much of the bank lending to Brazil, at the
time it appeared to be an extremely attractive option for a borrower
like Brazil. When inflation in the currencies of the lending countries
is subtracted from the rates charged on loans to Brazil, real interest
rates on these loans in the 1970s were negligible and often negative.
The nominal and real interest rates in the markets in which Brazilian
external borrowing occurred do not include the spread paid by Brazil,
which during the 1970s and early 1980s was generally between 1 percent
and 2 percent. Nevertheless, these rates do show clearly why foreign
borrowing appeared to be such an attractive option for Brazil.
The debt crisis that began in Mexico in August 1982 had an almost
immediate impact on the ability of other Latin American borrowers
to maintain capital inflows. Even though Brazil's trade balance
and current account had improved slightly in 1981, loans from international
lenders became increasingly scarce. Interest on new loans increased,
and most lenders refused to roll over on existing loans. New lending
dried up in the second half of 1982, reducing capital inflows, which
had reached a peak in 1981, by more than a third. Private borrowers
in Brazil encountered a total cutoff of loans from foreign lenders,
while official borrowing dropped sharply. By 1984 net capital inflows
(public and private) were negligible by comparison with earlier
years, and by 1986 the country was experiencing a net capital outflow
of US$7.3 billion, a sum nearly equal to Brazil's trade balance.
The principal components of Brazil's balance of payments show this
sharp drop in the net inflow of foreign capital after 1982 (see
table 13, Appendix).
The 1982 crisis interrupted for many years private Brazilian external
borrowing. Private loans contracted under Law 4,131 had leveled
off in the late 1970s, and after 1982 net private borrowing under
this law became negative. The fall in private borrowing under Resolution
63 was even more pronounced. After a rapid rise in such borrowing
between 1979 and the 1982 debt crisis, this source of financing
virtually collapsed, as the level of outstanding Resolution 63 debt
was more than cut in half between 1982 and the end of 1987.
Part, if not all, of the increase in external debt reported by
the Central Bank after 1982 was simply forced lending to finance
interest payments. It did not have a real counterpart in the form
of new resources entering the country through the capital account.
As a result, Brazil's ability to tap external saving to finance
either public-sector borrowing or private-sector investment collapsed
after 1982.
A number of Brazilian economists have made the point that before
1982 net capital inflows more than covered service payments (net
interest, profits and dividends, and reinvested profits). After
1982 interest payments alone far exceeded net capital inflows, which
turned negative after 1985. Although 1982 is usually viewed as the
turning point, the net capital transfer from the rest of the world
actually began to decline in the mid-1970s. Brazil was only able
to avoid an external payments crisis in the late 1970s because lenders
were willing to finance debt service through further lending. After
the Mexican debt crisis in 1982, Brazil's own crisis could no longer
be postponed.
The 1986 Cruzado Plan exacerbated capital outflows. Real exchange-rate
overvaluation, with increasing expectations of a future adjustment,
was one factor. A second factor was the increase in uncertainty
about future fiscal and monetary policy, as the shortages and informal
markets produced by the price controls undercut the euphoria of
the first few months.
During the rest of the 1980s, net capital outflow continued, further
reducing Brazil's capacity to finance investments needed for future
economic growth. In real terms, however, the external debt began
to decline in the late 1980s, both as a result of debt renegotiation
and a marking down of some of the debt by public and private lenders.
Despite temporary interruptions in debt servicing, domestic political
pressures in Brazil for a permanent repudiation of the external
debt were rejected. As interest rates in international financial
markets declined substantially in the early 1990s, the costs of
servicing the remaining external debt were reduced further.
Although the debt crisis that exploded in Brazil in the early 1980s
had not disappeared a decade later, it was no longer regarded as
Brazil's central economic problem. Its effects, however, lingered
on in several forms. First, the steep fall in the availability of
international reserves (see Glossary) after 1982 sharply curtailed
Brazilian investment. The resulting decline in capital formation
was evident a decade later, as Brazilians faced the consequence
of lower levels of investment in plant, equipment, and essential
infrastructure. Second, international confidence in the financial
soundness of external lending to Brazil remained low. When foreign
capital began to return to Brazil in the early 1990s, it took a
rather different form from the capital inflows of the 1970s. Foreign
capital inflows to Brazil in the early 1990s were smaller and were
no longer dominated by loans from international banks. Instead,
foreign lenders sought equity investments in Brazilian enterprises.
Foreign firms with the capacity to manage direct investments in
Brazil began to replace commercial banks as the primary source of
foreign capital.
Data as of April 1997
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