The power of the markets? The international bond markets and the 2002 elections in Brazil

This study uses an investment bank's fixed income research reports to analyse in unusual detail the investment activities and attitudes of international emerging bond market investors during the extreme market volatility over the Brazilian presidential elections of 2002. In examining these investors' reaction to the prospect and subsequent policies of the left-wing Lula government, the article considers Mosley's (2003, Global Capital and National Governments, Cambridge, New York, Melbourne: Cambridge University Press) conclusions regarding the strength and breadth of the bond market's influence on emerging market governments. The data show that international bond market investors did not exit Brazil before the elections, putting in question whether they were the source of the rise in the cost of government borrowing that Mosley and others see as indicative of the market's strength. This suggests that our understanding of the actors responsible for market movements remains incomplete. The article, therefore, challenges the idea, common within international political economy, of 'the market' as a single entity, with common actions and policy preferences. The data presented strongly suggest 'the market' is in reality made up of multiple, heterogeneous actors, often lacking any unity of opinion or purpose. After Lula's election victory, market prices recovered and the data show that international investors increased their investments in Brazil, despite slower policy implementation than market practitioners desired and the new government's social agenda. This supports a questioning of the true breadth of investors' policy interests and, therefore, influence. KEYWORDS: Brazilbond marketselectionsemerging marketsgovernment autonomy. ACKNOWLEDGEMENTS I would like to acknowledge the helpful comments and suggestions of Mark Aspinwall, Eric Fine, David Howarth, Donald MacKenzie, John Ravenhill, and two anonymous reviewers. Notes 1. Investors, fund managers, insurance companies and pension funds, who do not borrow to increase the size of their investments relative to the funds they manage. 2. Investors, usually in this case hedge funds, who borrow to increase the size of their investment. 3. The author worked for Morgan Stanley, and between 1997 and 2003 arranged international bond issues for Brazil and other emerging market countries, usually in partnership with the other leading banks. It was unusual for one bank to have an investor unknown to other banks. I therefore conclude that Morgan Stanley is able to survey the leading investors in emerging market debt. 4. See Santiso, 2003, p. 178 for a discussion of 'EMBI-constrained' investors being 'forced to maintain sizeable positions in Argentine bonds' before the Argentine default, and Santiso, 2004 for a more general discussion of emerging market bond indices. 5. Repo. rates are effectively the rates, which are charged for borrowing bonds. To run a short position in a bond (sell a bond one does not own), it is necessary to borrow bonds to deliver to the purchaser. Since the repo. market is driven by supply and demand, if it expensive to borrow a bond, it may indicate many investors have taken short positions, expecting prices to fall. 6. The effective interest rate payable to borrow bonds is low. 7. If a borrower, or institution acting on its behalf, buys substantial volumes of bonds, and does not lend those bonds in the repo. market, the supply of bonds available to borrow is reduced. This increases the cost of such borrowing. 8. The primary surplus is frequently a central market concern. As the government's surplus before the payment of interest and principal, it effectively represents the amount available for debt service. 9. Turkey was also experiencing pre-election uncertainty. 10. Martinez and Santiso (2003, p. 376) note a JP Morgan investor survey at the end of September in which the majority of investors surveyed expected Brazil to default. 11. De Faria demonstrates the reification of the market common among market participants. 12. Pension reform was important because of the cost of state pensions to the budget. 13. In 2000, 90% of emerging market funds was equity, only 10% debt (CitationSantiso, 2003, p. 65). 14. Santiso (2003, p. 184) notes an estimate by investment bank JP Morgan that by the end of 2001 hedge funds accounted for less than 20% of the market. 15. MSFIR, 20 September 2002 found a high correlation between the Brazilian Real (in US$) and C bond prices during 2002, although this clearly does not demonstrate causality. 16. Maxfield was discussing capital flows. 17. Erb, CitationHarvey and Viskanta (1999) find the S&P500 to be an important influence on investment returns on emerging market bonds in the 1990s, and at certain times the most important influence. 18. If Brazil is 17% of an investor's index, for every US$100 million they buy or sell for overall market reasons, US$7 million will be Brazil. The greater liquidity of Brazilian debt (since percentage in an index is a function of outstanding debt) will mitigate the impact, but only partially, particularly at the time of dramatic market moves, up or down.