TNAG-1942-FCO40-2768-Internal-economic-situation-in-Hong-Kong-1989 — Page 98

314u

Brazil:

Unofficial swaps

=

$1 and

The profitability of these transactions depends on the secondary market discount on the debt being greater than the discount on the parallel exchange rate in relation to the official exchange rate. Suppose the official exchange rate is Crl the parallel market rate is Cr 1.65 = $1 (a discount of about 40%). In the secondary market a Brazilian public enterprise's external debt is discounted at 60%. The Brazilian borrower is due to repay $100 to a foreign bank. Normally it would pay the cruzado equivalent into the Central Bank which would assume responsibility for paying the lender under the terms of a rescheduling agreement. The payment of cruzados to the Central Bank would tend to depress the domestic money supply.

Instead the borrower effectively repurchases its debt through an intermediary (a local bank) using the parallel exchange market. It provides, say, Cr 90 to the intermediary which uses the proceeds to buy (roughly) $55 in the parallel market. The intermediary retains $4 as commission and buys the debt from the foreign bank for $50. The bank is happy to sell at this price which is well above that in secondary market, the buyer of cruzados gets them at the cheap parallel rate, the agent gets a commission, and the cost to the borrower of the repayment is reduced by 10%.

From the Brazilian authorities' standpoint, the transaction has a number of undesirable features. The transaction leaves the money supply unchanged rather than reducing it. (In effect cruzado deposits pass from the state company to the seller of dollars for cruzados in the parallel market.) Downward pressure is also exerted on the parallel rate. The Central Bank loses the opportunity to put the

debt up for auction under the official scheme and realising the profit on any discount offered. While the cruzado counterpart of such official debt conversions will tend to boost the money supply, the effect will only exceed that arising in the case of unofficial swaps if the discount at the official auction is narrower than the margin (in the example 10%) earned by the borrower in undertaking the unofficial swap.