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Brazilian Infrastructures Rethink | The New BNDES Benchmark Lending Rate

Lastly, on 21 September 2017, the Government of Brazil enacted Executive Act No. 777/2017 creating the new market-based interest rate (TLP), which will substitute the long-term enterprise loan rate (TJLP) as the yardstick for loans provided by the Bank of Brazil Development (BNDES). BNDES is using this action to try to reduce subsidised credit, impose more stringent funding requirements and significantly raise the key interest rate that has long been used.

BNDES's new paradigm presents a challenge for upcoming Brazilian infrastructural developments. BNDES' mission. The BNDES was founded on 20 June 1952 under Law No. 1.628 as a governmental body with the primary objective of establishing and implementing domestic policies for commercial growth. BNDES has been transformed into a public limited liability vehicle in accordance with Law No 5.662/1971.

BNDES has since its inception been instrumental in promoting the growth of industrial and infrastructural development in Brazil, providing multiple funding opportunities for businesses of all size, as well as government agencies, to enable investment in all economic sector. It is no accident that BNDES became the main long-term funding resource in Brazil, mainly because of the low interest rates associated with such funding (e.g. TJLP).

TJLP what is it? The TJLP (Long Term Interest Rate) was established in 1994 by Executive Act No 684 (later transformed into Act No 9.365/1996) as the reference interest rate for long-term funding, which includes that of BNDES. When the TJLP was founded, the aim was to transfer the long-term interest rate conditions prevalent in foreign countries to the Brazil area.

Against this background, the National Monetary Council (Conselho Monetário Nacional) should introduce the TJLP on a quarterly base, taking into account the long-term rate of return on capital, internal rate inflation and Brazil's sovereign exposure. However, over the years, the absence of tough benchmarks for the creation of the TJLP opened the way to a high level of confidentiality.

The TJLP was normally set over the years at a lower rate than initially forecast by the Ordinance, leading to a widening divide between the TJLP and the Selic rate (the Brazilian Central Bank's principal tool for controlling formal Inflation, the so-called SP and Escrow System, which constitutes the mean interest rate weighting by the amount of one-day transactions backed by German Government securities).

In response to such a shortfall, the Government of Brazil identified the need to enhance investment through more favourable long-term loan arrangements (in particular investment in infrastructure). BNDES' loan book in Brazil has grown at an exponential rate in recent years as a consequence of the introduction of the TJLP. This, however, necessarily created problems, as the low interest rate of BNDES severely affected the brazilian loan markets.

Firstly, the separation between the Selic rate and the TJLP constituted an implied subsidisation of the operations carried out by BNDES, the costs of which are borne by the Treasury. Importantly, BNDES can only calculate such low interest charges because its financial costs are very low also thanks to special financial resources, such as the National Ministry of Finance.

Over the last few years, the National Treasury has not only been transferring funds to increase the equity of GNDES, but also to recover the tax costs of lending operations, as the National Treasury itself has financing costs near the Selic rate that are well above the TJLP. Secondly, the effectiveness of the Brazil monetar y policies was also severely hampered by the large number of loans at very low interest rates provided by GNDES.

If almost all the long-term funding is provided by BNDES, the Selic rate fluctuations policies, with which the Brazil authorities monitor the loan and the business sector, do not fulfil their part. Therefore, if it is necessary to raise the Selic rate to decelerate the economies and contain inflation, but a large part of the loan is not affected, the rise must be higher to offset this inefficiency.

After all, the large amount of subsidised BNDES funding was detrimental to the domestic long-term lending markets (through either retail bank or equity markets transactions). BNDES (reseller) distributors, the retail financial institutions, had a much narrower spreads and therefore tried to offset this by widening their spreads on other financial operations.

BNDES' lower interest rate did not allow the banking sector to rival BNDES' lower interest rate, so the long-term BNDES dominant position was fully in the long-term one. It is a montly calculation of the Central Bank of Brazil's TLP: a) IPCA (National Consumer Price Index) index; and b) a spreads rate derived from the yield on inflation-protected five-year sovereign debt known as NTN-B (National Treasury Notes - Series B).

Obviously, at first glance, TLP and TJLP may have similar parameter values. Firstly, while the TJLP was prepared taking into account the long-term interest rate prevalent on foreign stock exchanges and adjusting for country-specific risks, the TJLP is computed on the base of a forecast internal interest rate for a longer horizon. Secondly, while the TJLP is determined by the National Monetary Council on a quaterly base, the Brazilian Central Bank calculates the TJLP on a pro rata base, taking into account actual Brazilian economic developments.

Taken together, such issues give a much more transparency and market-oriented benchmark to TSP. However, it is important to bear in mind that the TJLP will not enter into force until January 2018 - which means that all loans extended by BNDES until 31 December 2017 will remain rated by TJLP.

What impact will TSP have on the credit markets in Brazil? While it is still too early to gauge the impact of the TLP's successor to the TJLP, the changes are hoped to promote a deep and more competetive funding of projects in the following ways: - Brazil's monetar y policies. Given that the MLP will (at least theoretically) be much nearer to the Selic interest rate, the effectiveness of Brazil's monetar y policies will trend to improve, both stimulate and tighten the economies and reduce the interest rate structural instability in Brazil.

For some time now, as already stated, the National Ministry of Finance has been paying the tax costs of BNDES loans (the differential between the financing of the National Ministry of Finance and the TJLP levied by BNDES). Since TLP is approaching the financing costs of the national Ministry of Finance, the so-called'implicit subsidy' in BNDES financing will finally vanish at the end of the five-year transitional time.

Since BNDES loans are becoming more costly, different funding tends to emerge, especially from commercial banking or equity markets, which strengthens the domestic Brazil economy. With the withdrawal, BNDES is trying to create room for privately funded investments that are seen as keys to long-term sustained economic development, and businesses need to look for alternative resources for new project development.

This is a new stage in the Brazilian long-term lending process in a much more challenging business climate.

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