Provision of FX hedge by the public sector: the Brazilian experience

Abstract

A singular experience with forex intervention in Brazil over the past ten years has been the use of foreign exchange linked debt instruments denominated in domestic currency. The country started to use them with the goal of safeguarding the administered FX regime in 1994-98. Later, those instruments were useful to smooth the transition to the floating rate regime in 1999, and to mitigate the impact on the economy of two further major devaluation waves in 2001 and 2002. While such a strategy was successful in avoiding generalised financial distress or a credit crunch in the private sector during that period, the accumulation of a large stock of such instruments increased the vulnerability of the public sector balance sheet to adverse external shocks. As a result, the main impact of the three large devaluations was felt in the public sector’s debt.