Brazil’s central bank governor Gabriel Galipolo said on Tuesday that when the government issues debt in local currency it gains flexibility as the borrower, but the risks associated with that debt are borne by investors.
Speaking at an event in Sao Paulo, Galipolo underscored the dynamic between borrower and lender, saying "the lender sets the interest rate, not the borrower." He noted that because Brazil conducts most of its borrowing in Brazilian reais, investors who finance that debt still face opportunity costs despite the sovereign borrowing in local currency.
Galipolo also emphasized the scale and liquidity of the Brazilian foreign exchange market. He said the real ranks among the most liquid and most traded currencies in the world, with a daily turnover of $110 billion. According to the governor, Brazil’s FX market exhibits particularities and idiosyncrasies that differentiate it from other emerging markets.
The governor addressed the composition of Brazil’s debt and the role of international reserves, saying that the country’s reserves are more than sufficient to cover the share of debt that is indexed to currencies other than the real. He framed reserves as a buffer for the portion of liabilities denominated in foreign currency.
Galipolo cautioned that holding long-term Brazilian securities implies simultaneous exposure to movements in the exchange rate and shifts along the yield curve. That combined exposure, he said, is a feature investors face when taking positions in long-dated local-currency debt.
The governor also discussed how currency shocks can arise. He stated that shocks may follow events that involve a loss of credibility, and that the resulting perception of risk can persist for many years. Galipolo linked a perception of risk to a sequence of events related to the transmission of shocks and to issues of credibility.
In summary, Galipolo portrayed local-currency issuance as a tool that provides sovereign flexibility while making investors responsible for the interest-rate and exchange-rate risks embedded in those instruments.
Summary
Gabriel Galipolo said local-currency debt gives the Brazilian government flexibility but shifts important risks to investors, highlighted the real’s high liquidity with $110 billion in daily turnover, noted that international reserves are sufficient to cover debt indexed to other currencies, and warned that long-term holders face exposure to both exchange-rate and yield-curve movements. He also cautioned that currency shocks tied to losses of credibility can generate long-lasting risk perceptions.
Key points
- Issuing debt in Brazilian reais grants sovereign flexibility while transferring interest-rate and exchange-rate risks to investors - impacting domestic bond markets and fixed-income investors.
- The Brazilian real is highly liquid, with a daily turnover of $110 billion, underscoring the depth of FX activity - relevant to currency traders and institutional investors active in emerging markets.
- Brazil’s international reserves are sufficient to cover the portion of debt denominated in currencies other than the real, which bears on sovereign external vulnerability and reserve management policies.
Risks and uncertainties
- Currency shocks can originate from events that cause a loss of credibility; such shocks may affect foreign-exchange markets and financial institutions that are sensitive to sudden moves.
- Perceived risk tied to credibility episodes can persist for many years, creating prolonged market volatility for bondholders and FX participants.
- Holding long-term local-currency securities creates simultaneous exposure to both the exchange rate and the yield curve, increasing sensitivity for long-duration investors and pension funds.