Brazil’s Plan May Work Too Well : Success of Debt Conversion Could Spark Hyper-Inflation

While coming to terms with private banks and resuming foreign debt payments, Brazil has also been whittling billions of dollars from its debt principal by encouraging the conversion of loans into investment equity.

The debt-for-equity swaps have surged so rapidly that some economists say the money being pumped into the Brazilian economy could help trigger hyper-inflation. According to central bank figures, more than $6.5 billion of Brazil’s $120-billion foreign debt has been traded for investment equity since the beginning of the year.

Many loans to developing countries end up on secondary markets, where Brazilian loan paper has been bought and sold at discounts of up to 50%. An investor who buys a Brazilian loan can trade it at Brazil’s central bank for local currency to finance an officially approved investment.

The transaction allows Brazil to buy back a foreign loan at a discount, without paying in dollars or other hard currency, while raising investment capital.

Since March, the government has sponsored six “auctions” in which brokers have used foreign loan paper with a face value of more than $1 billion to buy equity in Brazilian industry. Other officially regulated or “formal” conversion operations, many by multinational corporations already operating in Brazil, have trimmed $1.6 billion from Brazil’s foreign debt.

‘Absolute Success’

“Informal” conversions of $1.9 billion in foreign debt have been negotiated outside official channels but registered with the central bank. The bank estimates that informal conversion of an additional $2 billion in debt has not been registered. In informal conversions, foreign creditors are often paid off at a discount with dollars bought on the Brazilian black market.

Elmo Camoes, president of the central bank, told a Sao Paulo seminar this month that debt conversion could reach a total of $8.5 billion this year. “Our conversion project is an absolute success,” Camoes said.

But Edmar Bacha, a leading Brazilian economist, warned that the monetary expansion involved in so much debt conversion will sharply increase inflationary pressure. The present rate of inflation is more than 20% a month.

“We are on the verge of hyper-inflation,” Bacha wrote in a recent article. To prevent it, he recommended that the central bank suspend formal debt conversion and “combat informal conversion without quarter.”

On Wednesday, the financial newspaper Gazeta Mercantal quoted Finance Minister Mailson Nobrega as saying that the government will soon prohibit government-owned companies from making informal debt conversions. The government-owned companies are responsible for about three-quarters of the informal conversions, according to the newspaper.

In New York last week, Nobrega signed a long-awaited agreement with private banks for refinancing $62.1 billion in loans to Brazil that had been scheduled to fall due by 1993. The agreement provides $5.2 billion in new loans to finance interest payments, lowers interest rates and spreads principal repayment over a 10-year period that will not begin until 1995.

The day before the signing, President Jose Sarney announced the official end of a foreign debt embargo that was declared by Brazil in February, 1986. Since late last year, however, Brazil had been making interest payments provided for under preliminary agreements with the banks.