2. Monetary Policy in an Adverse Environment: Brazil 2002 Luiz Fernando Figueiredo Ciudad de Mexico October 2002 1

3. 2 I.Public Debt Management II.Is There a “Flight-to-quality” from the Real ? I.Public Debt Management II.Is There a “Flight-to-quality” from the Real ?

4. 3 I. Public Debt Management

5. 4 0.0% 0.2% 0.4% 0.6% 0.8% 1.0% 1.2% 1.4% 1.6% 1.8% Dec-01 Jan-02 Feb-02 Mar-02 Apr-02 May-02 Jun-02 Jul-02 Aug-02 Sep-02 Dec 2003 Dec 2004 Aug 2007 LFT – Yield above Selic rate (% p. y.) F April/May 2002: “elections concern” affected public bonds premium. Public Bonds Yield

6. 5 F Also, concentration of maturities of FX-indexed bonds enhanced the “political risk” and elevated risk premiums. 0 2 4 6 8 10 Apr-02 May-02 Jun-02 Jul-02 Aug-02 Sep-02 Oct-02 Nov-02 Dec-02 Jan-03 Feb-03 Mar-03 US$ billion Structure of Maturities Dollar-indexed bonds – position in March Concentration of FX Bonds

7. 6 FCentral Bank´s strategy to deal with adverse environment in the April/July period included:  Introduction of FX swaps (first coupled with LFTs, then “single” swaps) in substitution for FX bonds;  Enforcement for mutual funds to mark to market (May 31 st );  Increase in reserve requirements for time deposits and saving accounts (June);  Direct sales of US$ 1.6 billion in the spot market and US$ 1.9 billion through FX repo operations, to foster liquidity;  Guarantee of liquidity to the market in the transition to the new Brazilian Payment System (April 22th); Policy Responses

8. 7 FAlso important were the Government´s initiatives linked to the IMF agreement and to the inflation targeting framework:  Approval for Brazil to draw up to US$ 10 billion from the IMF (June);  Reduction from US$ 20 billion to US$ 15 billion of floor for net international reserves (June);  Buy-back program of external bonds (up to US$ 3 billion);  Revision of 2003 inflation target (from 3.25% +/- 2% to 4% +/- 2.5%) and set up of 2004 target (3.5% +/- 2.5% target); Policy Responses

9. 8 F Withdrawals from mutual funds were fuelled by domestic bonds price falls and enforcement to mark to market. Mutual Funds Source: ANBID 320 330 340 350 360 370 Jan-02 Feb-02 Mar-02 Apr-02 May-02 Jun-02 Jul-02 Aug-02 Sep-02 R$ billion 321.9 361.0 355.7 Withdrawals reached R$ 53.9 billion in the June-September period (about 20% of funds net worth).

10. 9 Brazil Risk Premium FHowever, concern about the “political risk” aggravated in the second semester, also affected by deteriorated external scenario and larger risk aversion. EMBI+ Brazil Basis Points 500 1000 1500 2000 Jan-99 May-99 Sep-99 Jan-00 May-00 Sep-00 Jan-01 May-01 Sep-01 Jan-02 May-02 Sep-02

11. 10 Credit Lines – Bank to Bank 15 16 17 18 19 20 21 22 23 US$ billion Jan/01Fev/01 Mar/01 Abr/01 May/01 Jun/01 Jul/01 Aug/01 Sep/01 Oct/01 Nov/01 Dec/01 Jan/02Fev/02 Mar/02 Apr/02 May/02 Jun/02 Jul/02 Aug/02 Sep/02 External Lines to Brazil: Bank to Bank FThe “election concern” and the worsened external scenario were accompanied by a external credit crunch.

12. 11 FX Indexed Debt 50 55 60 65 70 75 80 Dec/00 Mar/01 Mar/01 Jun/01 Jun/01 Sept/01 Dec/01 Mar/02 Mar/02 Jun/02 Jun/02 Sep/02 2001: Increase of US$ 18.8 billion FX Indexed Debt (Including Swaps) (total outstanding in US$) US$ billion 2002: Reduction of US$ 8.4 billion F Demand for dollar-linked bonds diminished.

13. 12 F That was due to falling demand for hedge by the non-financial sector, associated with lower FX liabilities (buy-back of external debt). 32 36 40 44 48 52 Jan-01 Feb-01 Mar-01 May-01 Jun-01 Aug-01 Sep-01 Nov-01 Dec-01 Feb-02 Mar-02 May-02 Jun-02 Jul-02 Sep-02 Demand for Hedge - Open FX Swap Contracts at CETIP - US$ billion Demand for Hedge Source: Cetip (Central for Custody and Financial Settlement of Securities)

14. 13 FAdditional measures by the Government to cope with aggravated scenario in the August/October period included:  IMF agreement in September (US$ 30 billion for 2002 and 2003), including compromise by all main presidential candidates;  Reduction of floor for net reserves to US$ 5 billion;  Increase in primary fiscal target for 2002 to 3.88% of GDP;  FX auctions to exporters (US$ 1.4 from August to date);  Continuous intervention in the FX spot market to foster market liquidity (limited to US$ 3 billion in 30 day-period); Additional Policy Responses

15. 14 FMonetary measures adopted by the Central Bank:  Program of buy-backs of LFT to support prices and interrupt withdrawals from mutual funds, backed by R$ 11 billion increase in reserve requirements (August);  Shortening of debt tenure, with swap of maturities;  Increase of Selic rate to 21% from 18% a.a. (October);  Additional increase (October) in reserve requirements on demand deposits, time deposits and saving accounts to reduce liquidity, totalling R$ 14.2 billion;  Increase in capital requirements for FX exposure;  Intervention in the money market to tight liquidity; Additional Policy Responses

16. 15 Domestic Debt F Average maturity of debt fell. However, the Treasury, preemptively, managed to lengthen in the 2000 / 2001 period. 26 28 30 32 34 36 38 Jan-00Apr-00 Jul-00 Oct-00 Jan-01Apr-01 Jul-01 Oct-01 Jan-02Apr-02 Jul-02 Sep-02 Outstanding domestic public debt Average maturity in months % 31.9 36.2 32.2 35.1

17. 16 Domestic Debt F As a side effect, share of domestic debt maturing in the next 12 months increased. 0 10 20 30 40 50 60 Dec/99Dec/00Sep/01 Oct/01 Nov/01 Dec/01 Jan/02 Feb/02 Mar/02 Apr/02 May/02 Jun/02 Jul/02 Aug/02 Sep/02 41.1 % Share of Debt Maturing in next 12 months (%) 53.0 25.3 27.0 25.9 36.6

18. 17 II. Is There a “Flight-to-quality” from the Real ? II. Is There a “Flight-to-quality” from the Real ?

19. 18 Where has gone the Money of M. Funds ? Saving Accounts Time Deposits Demand Deposits Currency Net FX Outflow June/02-21.25.32.84.61.34.3 July/02-17.54.12.12.50.64.1 August/02-9.04.07.90.01.45.5 September/02 - 6.5 1.03.12.71.23.4 Total-53.914.315.99.94.517.2 Mutual Funds Net Financial Flows (R$ billion)

20. 19 “CC5 Accounts” US$ million Total (a+b) 5 208 Deposits (a) 3 071 Corporate Corporate 2 056 Individuals Individuals 1 015 Other operations (b) 2 137 Brazilian Investment Abroad Brazilian Investment Abroad 1 031 Brazilian Loans Abroad Brazilian Loans Abroad 660 660 Other Other 446 446 International Transfers CC5 Accounts Jan to Aug 2002

21. 20 “Black” Market Spread (10) (5) - 5 10 15 Jan-95 Jul-95 Jan-96 Jul-96 Jan-97 Jul-97 Jan-98 Jul-98 Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Sep-02 Spread in the US$ Black Market Historical Trend (1995 / 2002) (6.3)