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I'm not seeing it. The balance sheet is (assuming the BCB has the "wrong" side of the swaps, so the S stocks have to opposite sign from the body of the diary):

Balance SheetBRA (BRL)BCB (BRL)RoW (USD)
BRA $ Liabilities-λL$φ+λL$
BCB $ Reserves+ρR$φ-ρR$
BRA BRL Debt-βBR+βBR
Cash+CR+C$φ-CR-C$
Swaps $ Leg+σS$φ-σS$φ
Swaps BRL Leg-σ'SR+σ'SR

Suppose the domestic sector's $ liabilities of -λL$φ come suddenly due. Because the external stability condition ρR$ > λL$ is being maintained, the BCB can settle the liability with the external creditors in exchange for domestic BRL debt. The result is

Balance SheetBRA (BRL)BCB (BRL)RoW (USD)
BRA $ Liabilities00
BCB $ Reserves(+ρR$-λL$)φ+λL$-ρR$
BRA BRL Debt-βBR-λL$φT+βBR+λL$φT
Cash+CR+C$φ-CR-C$
Swaps $ Leg+σS$φ-σS$φ
Swaps BRL Leg-σ'SR+σ'SR

The subscript T is in case we want to be generous to the domestic sector and not index the new debt to the dollar exchange rate but just vaue it at the exchange rate at the time of the rescue. In that case, the stock of new debt might well be written as
β[BR+(λL$φ/β)T]

But, in any case, to be able to rescue the domestic economy from its foreign entanglements, the swaps position is irrelevant. It is true that the swap legs indexed to the dollar are a potentially domestically destabilising after a "successful" external rescue.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Carrie (migeru at eurotrib dot com) on Sat Jan 18th, 2014 at 12:51:48 PM EST
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