VZCZCXRO9830
RR RUEHRG
DE RUEHBR #0902/01 1301242
ZNR UUUUU ZZH
R 101242Z MAY 06
FM AMEMBASSY BRASILIA
TO RUEHC/SECSTATE WASHDC 5326
INFO RUEHRG/AMCONSUL RECIFE 4728
RUEHRI/AMCONSUL RIO DE JANEIRO 2023
RUEHSO/AMCONSUL SAO PAULO 6903
RUEHAC/AMEMBASSY ASUNCION 5403
RUEHBU/AMEMBASSY BUENOS AIRES 3987
RUEHMN/AMEMBASSY MONTEVIDEO 6221
RUEHSG/AMEMBASSY SANTIAGO 5477
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDO/USDOC WASHDC
RHEHNSC/NSC WASHDC

UNCLAS SECTION 01 OF 02 BRASILIA 000902 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
NSC FOR CRONIN 
TREASURY FOR OASIA - DAS LEE, FPARODI 
STATE PASS TO FED BOARD OF GOVERNORS FOR ROBITAILLE 
USDOC FOR 4332/ITA/MAC/WH/OLAC/JANDERSEN/ADRISCOLL/MWAR D 
USDOC FOR 3134/ITA/USCS/OIO/WH/RD/SHUPKA 
STATE PASS USAID FOR LAC 
 
E.O. 12958: N/A 
TAGS: EFIN ECON PGOV BR
SUBJECT: BRAZIL BUYS BACK BRADY BONDS 
 
REF: A) BRASILIA 0366    B) BRASILIA 0790 
 
¶1. (U) Summary: The GOB exercised its option to buy back its Brady 
bonds on April 18.  The operation involved bonds with a total face 
value of US$6.63 billion, and was part of Brazil's broader effort, 
taking advantage of the appreciated Real, to put behind it the 
legacy of its 1980's default.  Brazil also has prepaid most of its 
rescheduled Paris Club debt.  In a separate effort to improve its 
debt profile, the GoB bought back US$3.7 billion of its Global 
bonds, which were to mature in 2010.  Repurchases of external debt 
since January have totaled US$10.2 billion.  The GoB hopes the 
moves, which improve its external debt profile, will help it make 
its case for an eventual investment-grade sovereign credit risk 
rating.  End Summary. 
 
Legacy of 1980's Default 
------------------------ 
 
¶2. (U) The appreciated Real, the product of high dollar inflows over 
the last two years (ref A), has created opportunities for the GoB to 
improve its external debt profile and to wipe from the books the 
legacy of its late 1980's default.  This effort, which will extend 
the repayment profile of Brazil's debt and reduce near-term 
payments, also is designed to enhance Brazil's bid for an 
investment-grade sovereign credit rating.  The GOB has been aided in 
this effort by the record low spreads (as of May 9, 219 basis 
points) at which it has been able to borrow overseas.  To buy back 
the Brady bonds, the GOB used US$5.7 billion of its international 
reserves, which stood at US$58.9 billion on May 8 (up from 18 
billion in 2003).  The GoB in late 2005 also prepaid its $15.5 
billion debt to the IMF. According to the Finance Ministry, external 
government debt has now been reduced to US$65 billion, or 52.4% of 
expected 2006 exports.  However, with stagnant GDP growth in 2005 
and increased levels of domestic debt, after marked improvement in 
2003/2004, the overall public sector net-debt-to-GDP ratio (both 
domestic and external) barely budged last year, down from 51.7% in 
2004 to 51.6% in 2005. 
 
Finance Minister: "Erases a Stain" 
---------------------------------- 
 
¶3. (U) Finance Minister Guido Mantega described the buyback as 
erasing a stain from Brazil's record, declaring that "We are free 
from ... the debt repayment moratorium in the 80s".  Local analysts 
tend to agree. By eliminating a reminder of Brazil's past failure to 
honor its repayment obligations, the Brady Bond repurchase should 
improve the perception of Brazil risk on international markets. 
 
New focus: Domestic Debt and Investment Grade 
--------------------------------------------- 
 
¶4. (SBU) The GOB's recently-appointed Treasury Secretary, Carlos 
Kawall, said that the Treasury's focus will switch ever more to 
managing the domestic debt, with the particular goal of extending 
its maturity and moving away from floating rate notes to fixed rate 
and inflation-indexed bonds.  In an aside directed at some local 
critics of the government's Brady buyback, Kawall remarked that the 
GOB expects that some of this US$6.63 billion used to repurchase 
this external debt will return to the Brazil in the form of 
investments in domestically-issued bonds.  However, former Assistant 
Secretary of the Treasury, Jose Antonio Gragnani, has admitted it 
 
SIPDIS 
would be hard to calculate how much of this money would return to 
Brazil.  Kawall stated the Treasury will now focus on the reducing 
the proportion of floating rate domestic debt which is indexed to 
the overnight benchmark rate (the SELIC) as well taking other steps 
to move Brazil from the necessary two notches up to investment 
grade.  A Fitch-IBCA report noted that while the recent external 
debt repurchases were positive, the action does not justify an 
upgrade in and of itself. "There needs to be more clarity on the 
structural reforms and fiscal programs, this would be essential for 
an upgrade on Brazil" the report stated.  (Note: Fitch's most recent 
upgrade of Brazil's sovereign rating was based primarily on the 
improvement in external solvency, based on Brazil's surprising 
export/current account performance.) 
 
 
BRASILIA 00000902  002 OF 002 
 
 
¶5. (SBU) Comment:  As there will be no progress on the 
structural/microeconomic agenda until after this presidential 
election year, the GoB is limited to steps such as the Brady Bond 
buyback and its other debt repurchases to build its case for an 
investment grade credit rating.  But there is only so much that 
clever debt management can do.  Overall debt levels remain high as 
the GoB's external debt repurchases have, essentially, been financed 
with additional domestic debt.  The fiscal picture remains 
complicated by constitutional spending earmarks and mandated 
transfers to states and municipalities.  And with previous strong 
revenue growth beginning to falter (ref B), that leaves cutting 
current expenditures beyond what is necessary to meet the 4.25% of 
GDP primary surplus target as perhaps the only substantive step left 
for this GoB to take to build its case for investment grade.  But 
with presidential elections looming, political scandals and a crisis 
with Bolivia brewing, we do no expect the current government to 
undertake such politically unpalatable choices.  Instead, look for 
the GoB to kick the fiscal can down the road a year, postponing the 
investment grade rating along with it. 
 
CHICOLA