Brazil’s debt costs seen rising as tax bill favors private bonds

There is growing concern that government bonds, especially those with longer maturities, may lose appeal relative to tax-exempt securities, forcing the Treasury to offer higher premiums to attract investors.

“MP [provisional presidential decree] 1303 started off trying to address the lack of tax parity between incentivized and taxed instruments, but in its current form, it worsens the distortion,” said Gustavo Pessoa, partner and fixed-income portfolio manager at Legacy Capital. “It raises taxes on products that already pay them, while those that don’t remain exempt. This widens the gap in the market.”

The measure maintains tax exemptions for several financial products, including infrastructure debentures, Agribusiness Credit Bills (LCA), Real Estate Credit Bills (LCI), and Certificates of Real Estate and Agribusiness Receivables (CRI and CRA). At the same time, it raises taxes on long-term government bonds, one of the changes most criticized by investors.

From an investor’s point of view, Mr. Pessoa argued, the new flat 18% tax reduces long-term visibility. “You’re eliminating the stepped tax scale that went from 22.5% to 15% and replacing it with a flat 18%. This raises taxes for long-term investors and lowers them for short-term ones. It’s terrible for attracting long-term capital and drives buyers away from long-dated government debt,” he said.

Pessoa noted that this makes the National Treasury itself a primary victim of the proposal, which faces a final deadline for approval in Congress this Wednesday (8).

Concerns inside and outside the Treasury

Speaking on condition of anonymity, some market participants told Valor they had voiced their concerns directly to Treasury officials, who reportedly shared similar worries about the implications for debt management.

Mr. Pessoa pointed out that the Treasury is already struggling to roll over debt as it competes with tax-exempt securities. “To give an idea, last year the issuance of incentivized bonds (debentures, CRIs, and CRAs) exceeded that of NTN-Bs [Brazil’s inflation-linked Treasury bonds]. The Treasury is already unable to roll over debt the way it wants to.”

Although NTN-B issuance has increased significantly this year, the market has seen growing distortions. In September, strong demand for tax-exempt securities pushed infrastructure debenture yields below those of NTN-Bs in the secondary market. The Idex-Infra index compiled by JGP ended September with a negative spread of 22.5 basis points compared to inflation-linked Treasury bonds.

On Tuesday, there was visible stress in the real interest rate market, with yields on NTN-Bs rising across the curve. “The market is already pricing in a higher cost of borrowing for the Treasury, since the measure further increases the distortion between tax-exempt instruments and government bonds, making incentivized assets more attractive to hold,” said a trader at a major Brazilian bank’s treasury desk.

Yields on medium-term NTN-Bs maturing in 2029 rose from 8.11% to 8.17%, while those maturing in 2035 climbed from 7.66% to 7.70%. Longer-dated bonds also saw significant increases, with 2050 bonds rising from 7.27% to 7.32%.

“The Treasury can’t finance itself as it would like due to these distortions. And since this bill exacerbates them, we expect the Treasury’s situation to worsen, with investors demanding even higher premiums for long-term securities,” Mr. Pessoa said, noting that Brazil’s domestic federal debt already has a short average maturity, just 3.98 years, based on August data from the Treasury’s Monthly Debt Report.

Mr. Pessoa’s concerns are shared by Gabriel Leal de Barros, chief economist at ARX Investimentos, who warned that the measure will further distort the market. “It’s going to get worse. Despite what the government and the economic team are saying—that the measure is meant to correct distortions—it will actually amplify them. The Treasury will have to pay much higher premiums,” he said.

Mr. Barros believes the financial market has downplayed the potential impact on asset prices, because the MP is expected to boost federal revenue in the short term. “In that sense, concern over the extra premium the Treasury will need to pay to issue debt may have taken a back seat,” he said.

“This creates a major problem in the medium and long term and affects the rollover premium for government bonds. But for the government, it seems to be a lesser concern due to the short-term focus, which could also delay the debate on changing the fiscal target,” Mt. Barros added.

Fabio Landi, partner and portfolio manager at Adam Capital, said the proposed changes in MP 1303 only deepen distortions in Brazil’s public and private debt markets. “No doubt about it, once you exempt certain instruments and tax others, the market remains distorted,” he said.

Mr. Landi also highlighted the fiscal impact of the measure, which has been weakened since discussions began. In addition to maintaining exemptions for incentivized securities (LCIs, LCAs, debentures, CRIs, and CRAs), the provision to increase taxes on sports betting companies was removed.

Finance Minister Fernando Haddad has projected that the current version of the measure, as presented by rapporteur Carlos Zarattini (Workers’ Party, São Paulo), would raise R$17 billion in 2026.

“This is a disappointing measure in terms of revenue and it does worsen the fiscal outlook,” said Mr. Landi, noting the already fragile state of Brazil’s public accounts. “The MP has been watered down in a context where government spending remains strong, fueled by the current high approval ratings of President Lula,” he added.