Brazil is one of the main players in the global sovereign credit markets mainly because of its status as a prominent emerging market. This translates to a permanent place in the portfolios of international investors. How attractive a country’s debt is usually dependent on its risk of defaulting. Credit defaults are undoubtedly very harmful to the defaulting countries. Some of the negative effects include trade exclusion, political costs, economic costs, and loss of reputation. Creditors are exposed to these effects because of the significant monetary losses usually attached with credit defaults. This discussion covers Brazil’s probability of default, the main reasons that make it a likely occurrence, and the effects it will have on the country.
Brazil has one of the highest default risks today that can be traced to various factors and conditions prevailing in its internal environment. Yahoo Finance reports that the country’s treasury stated it expected public debt to increase to around $1.03 trillion, a 14% increase from last year (Ayres, 2022). This report is in line with Cbonds’ estimates that the country’s likelihood of a default over the next five years lies at 14.12% (Cbond, 2022). This means the country’s bonds are B-rated, barely passing the criteria for a good investment. Brazil has a large economy but it is very likely to default on its external debts, begging the question of what could be possible transpiring. The answers to this question can be found by considering the country-level balance sheet framework’s three main indicators of default risk including global commodity prices, the level of its external debt s and the composition of its external debts (Feyen et al., 2017). This discussion incorporates political stability as one of the reasons that increase Brazil’s default probability.
Global commodity prices can have a significant impact on the revenue generated by any country, especially if it is export-oriented like Brazil. Sudden falls in prices drastically reduce these countries’ taxable revenue, increasing their likelihood of succumbing to trade balance pressures. Further, engagement in the production of goods with volatile global prices increases the probability of default when the prices are low (Hu, 2021). Brazil’s vulnerability to global trade and export revenue was shown by its defaults in 1983 and 2001 (Hu, 2021). The country defaulted in these two occasions after succumbing to the combination of weak global trade, falling commodity prices, and decreased exports. The price of Brazil’s commodities saw a decline in the period leading up to the 2015-2016 recession (Hu, 2021). Prices have recovered since, especially over the 2020 global pandemic but there is a high likelihood of the trend halting or regressing. One reason is the fact that commodities have highly volatile prices. Secondly, price increases have always preceded major price shocks, like the one in 2014 (Hu, 2021). Therefore we can expect a significant shock in the near future.
The composition of external debt is another crucial factor predisposing a given country’s probability of a default. It is always preferable to have more long-term debt compared to short-term debt as the latter is much riskier. Short term debt made up around 14% of Brazil’s external debts as of the early part of 2021compared to 10.5% in 2016, signifying a 33% increase (Hu, 2021). Short-term debt is expected to increase as time goes by. High amounts of short-term debt have increased the country’s trial balance as it has less time to generate the money owed in the event that investors refuse to roll over loans afforded. This results in a stressed economy and export revenue streams. The increase in Brazil’s short-term debt is most probably due to a decline in the purchase of 10-year plus government bonds (Hu, 2021). The pandemic made the situation worse as the country was forced to almost exclusively sell short-term debts because the crisis made investors have a negative outlook. The country’s central bank increased interest rates for short-term bonds, making them highly attractive to external investors (Hu, 2021). This sharp increase in short-term debt increases Brazil’s risk of default especially as it is continued to accelerate.
External debt is a good indicator of a country’s burden of debt when it is expressed as a percentage of the Gross Domestic Product. External debt accounted for around 38% of Brazil’s GDP at the start of 2021, up from around 30% in 2016 (Hu, 2021). High levels of external debt are directly related to a high default risk. Therefore, increases in external debts are associated with increased borrowing needs because of increases in the trial balance. The 8% increase from 2016 means that Brazil’s assets are increasingly less able to handle this pressure and that is why the country is at a high risk of defaulting. Besides, the amount of external debt has been on a sharp incline since 2017, increasing the country’s default risk further (O’Neill, 2021). This high level of external debt puts pressure on commodity prices, exports, consumption, and investment.
Political stability is another crucial determinant of the likelihood of a default. For instance, a significant likelihood of coups or violence deters investors as they associate the economy with a high probability of crashing. The country’s leaders pulled a move over the last days of 2021 that have put it in a worse standing with external investors. Brazil’s Congress put in place a motion that will allow the government to refrain from paying up its court-ordered payments, also known as precatórios, on time (Nóbrega, 2021). The motive touted as the main reason behind this move is this year’s election that is expected to be highly-competitive. This political situation has increased Brazil’s probability of defaulting on its credit.
A default by Brazil will definitely have far-reaching ramifications. One of the most significant effects of a default is a higher cost of borrowing on future loans. The effect of paying more for credit could result into inflation, which will especially hurt the country’s poorest. The country will generally have a hard time accessing capital markets. Perhaps one of the most visible effects of credit defaults is a fall in the local currency’s exchange rates. This is because investors will sell local currency holdings in preference for stable foreign currencies. Brazil is in a precarious position because it has a significant dependency on international investments. The listed effects combine to cause significant economic degradation, which undermines the stock market. This crash then starts a perpetual cycle that continually degrades outcomes for all stakeholders.
Brazil is one of the countries most likely to default on their foreign credits in the near future. Financial sources place the likelihood at around 14%, which is a concerning number. The current position the country finds itself in can be traced to prevailing political conditions, global commodity prices, the level of its external debt s and the composition of its external debts. A default will see the country lose on multiple fronts and undermine the livelihood of its citizens, especially the underprivileged ones.
References
Ayres, M. (2022). Brazil sees 2022 public debt as high as 6.4 trillion reais. Finance.yahoo.com. Web.
Cbond. (2022). Index page 5Y Default Probability Brazil. Cbonds.com. Web.
Feyen, E., Fiess, N. M., Zuccardi Huertas, I. E., & Lambert, L. A. V. (2017). Which emerging markets and developing economies face corporate balance sheet vulnerabilities?: a novel monitoring framework. A Novel Monitoring Framework (September 19, 2017). World Bank Policy Research Working Paper, (8198).
Hu, K. (2021). Brazil’s Sovereign Credit Risk: Changes from 2016 to 2021. Available at SSRN 3930982.
Nóbrega, M. da. (2021). Opinion | Brazil’s Lawmakers Embrace Default. Wall Street Journal. Web.
O’Neill, A. (2021). Brazil – National debt in relation to gross domestic product (GDP) 2024. Statista. Web.