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That's precisely the point: the swaps have one leg denominated in dollars, but they are settled in reals.

FT.com: Brazil: net debtor to the world

When the bank uses such a swap to limit the depreciation of the real, it offers to pay the difference between the initial exchange rate and the final exchange rate during the period of the contract, plus a dollar-linked rate of interest (known to traders as the cupom cambial). In return, it receives the cumulative interbank interest rate (currently about 10 per cent a year) on the amount of the contract in Brazilian reals. Crucially, the contracts are settled entirely in reals. No dollars exchange hands and there is no obvious impact on the country's ability to pay its foreign debts.


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 Migeru (migeru at eurotrib dot com) on Sat Jan 18th, 2014 at 10:12:48 AM EST
[ Parent ]
That's still a dollar liability for the purpose of the internal stability condition (which is external stability plus no index-linked gov't obligations).

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Jan 18th, 2014 at 11:16:22 AM EST
[ Parent ]
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 Migeru (migeru at eurotrib dot com) on Sat Jan 18th, 2014 at 12:51:48 PM EST
[ Parent ]
You're right that they don't by themselves trigger a hyperinflationary debt-devaluation spiral. But if someone were to engage in unfriendly currency movements aimed at Reals depreciation, then they would adversely affect the ability of the BCB to maintain domestic stability.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Jan 18th, 2014 at 12:57:25 PM EST
[ Parent ]
Well, the fact that the BCB is attempting to prop up its exchange rate with derivatives is an indication that it's more interested in preserving the comprador class' access to foreign consumer goods than in domestic stability. If the Real is sliding it should let it slide, precisely because it needs to preserve its reserve buffer. It is possible that this all has something to do with the 2014 football world cup and the 2016 olympics. After that, all hell might break loose in the domestic market and the swaps might explode in the BCB's face.

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 Migeru (migeru at eurotrib dot com) on Sat Jan 18th, 2014 at 01:09:24 PM EST
[ Parent ]
I suppose that's the point the FT article is trying to make:
... Gersztein and Alday at BNP Paribas think a reasonable indication of the cost is to net out the central bank's short dollar position through currency swaps from its foreign reserves. After all, it is not only the stock of reserves but also the broader health of the Brazilian economy that affects its ability to pay its debts.
(my emphasis)
That is something investors may wish to keep a close eye on if, as widely predicted, the real continues to weaken and Brazil's fiscal position continues to deteriorate during 2014 and 2015.


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 Migeru (migeru at eurotrib dot com) on Sat Jan 18th, 2014 at 02:14:18 PM EST
[ Parent ]
I suppose that's the point the FT article is trying to make.

Clumsily and without focus.  It appears the BCB is attempting to manage currency by playing with financial markets (which it can do) instead of dealing with the actual foundation of the currency, the domestic economy (which it can't), and is doing so with the acquiescence of the government, which doesn't want to deal with the economy either.  Which supports your conclusion that they are simply manipulating money for the benefit of the moneyed.

by rifek on Thu Jan 30th, 2014 at 11:59:31 AM EST
[ Parent ]

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