Brazil Faces Default Risk After Missing Venezuela Loan Alert

(Bloomberg) -- Brazil’s government needs swift congressional action to avoid defaulting on loan guarantees it has made to Venezuela and Mozambique.

Legislators must approve the use of up to 1.5 billion reais ($424 million) to honor loans that banks made as part of a policy to finance exports. Brasilia itself is on the hook because Caracas is poised to miss a May 8 deadline for a $275 million debt installment. Wary that legislators may not return to work after Tuesday’s Labor Day holiday, President Michel Temer canceled a trip to Asia this week to supervise the episode his office said could cause "immense damage to Brazil’s economy."

The imbroglio is the result of a series of missteps by Brazilian policy makers, from a cumbersome arrangement for export loan guarantees to a gross underestimation of the credit risk. Only days before Venezuela missed a previous loan payment to Brazil last August, top budget ministry officials in Brasilia flatly dismissed the chance that their Caribbean neighbor could default, thereby failing to account for the risk in this year’s budget.

Now Brazil faces an unlikely but possible default, which in turn would have a series of domino effects, including problems with multilateral institutions such as the Paris Club.

"We expect Brazil to service the guaranteed debt owed by Venezuela and Mozambique. However, in an unlikely event, where Brazil were unable to service guaranteed debt, this would constitute a sovereign default. In this remote possibility, we would consider the impact of this credit event on Brazil’s sovereign risk,” said Samar Maziad, a senior analyst at Moody’s Investors Service responsible for Brazil’s sovereign credit.

The loans guaranteed by the government were made by the state development bank BNDES and Credit Suisse, according to the finance ministry. The credits were granted during the left-wing administrations of Luiz Inacio Lula da Silva and Dilma Rousseff and used to finance major construction works executed by Brazilian companies in Venezuela.

Credit Suisse declined to comment for this story.

To provide such guarantees, the government set up a fund known as FGE with billions of reais in assets. While the bulk is made up of fixed assets, the fund generated nearly $1.3 billion in cash that is stored in miscellaneous accounts. The use of any of these funds requires congressional authorization and must be earmarked in the budget, raising questions about its effectiveness and continuity beyond a change in government.

Last year Venezuela made a last-minute payment to Brazil from its reserves with the International Monetary Fund. This time, however, those reserves are depleted and Caracas is running short of alternatives. If it doesn’t come up with the money by next Tuesday, Brazil will have 30 days to honor its guarantee.

Some opposition lawmakers on Wednesday threatened to obstruct the voting process. In a sign of how delicate the situation is, Temer told reporters also on Wednesday that congressional leaders are working to guarantee a minimum quorum in order to vote.

Critics say the government could have avoided this situation had it set aside the money.

“The government has mishandled the situation,” said Luiz Carlos Hauly, deputy-leader of the PSDB, a party that has so far supported the ruling coalition. “The government can’t allow this type of thing to spin out of its control and into Congress, where it becomes an insult to the population that is suffering with all sorts of problems, from floods to public security.”

--With assistance from Simone Iglesias Gabriel Shinohara and Aline Oyamada

To contact the reporters on this story: Rachel Gamarski in Brasilia at rgamarski@bloomberg.net, Samy Adghirni in Brasilia Newsroom at sadghirni@bloomberg.net.

To contact the editors responsible for this story: Vivianne Rodrigues at vrodrigues3@bloomberg.net, Raymond Colitt at rcolitt@bloomberg.net, Matthew Malinowski, Walter Brandimarte

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