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Summary Brazil’s government bond yields are at 14.8% – one of the highest among emerging markets. The Brazilian real has depreciated over 38% against the dollar due to capital flight. High interest rates may deter future capital flight. Brazil’s economy is contracting while its dollar-denominated debt is appreciating vis-a-vis its local currency. Brazil’s interest rates are higher than Venezuela (10.5%), though Venezuela’s debt is at junk levels. Brazil’s bond yields scream “default” and I believe them. Emerging markets are in the doldrums. Their currencies are falling, capital flight has taken hold and commodities — the main source of revenue for many — are in free fall. China’s recent currency devaluation amplified the situation. China is one of the biggest importers of everything from copper to steel to oil to iron ore; those products are now more expensive in China. Secondly, the devaluation was a de facto admission that the country’s economic growth is slowing — a bad omen for its trading partners. Selected Bond Yields In attempting to find the emerging country with the most risk, I looked at bond yields of selected countries – China, India, South Africa, Venezuela, Russia and Brazil. Brazil has the highest interest rates at 14.8% followed by Russia (11.9%) and Venezuela (10.5%). China has the lowest yields at 3.3%. Brazil is heavily dependent upon iron ore and oil in order to generate revenues. Oil is off 60% from its Q2 2014 peak and iron ore prices are 70% off their 2013 peak. Brazil’s economy contracted 1.9% in Q2 and the government is forecasting a budget deficit for the year. The country’s debt-to-GDP is about 65%, but could rise rapidly given its penchant for issuing debt in dollar-denominated currencies. According to the Wall Street Journal , Brazil has borrowed about $188 billion in dollar-denominated debt since 2008; it is second only to China’s $214 billion. Since Brazil’s currency is depreciating against the dollar, its debt-to-GDP could become untenable. Moody’s recently downgraded Brazil’s debt to Baa3 from Baa2 — one level above junk status. Another downgrade could be coming if its debt-to-GDP ratio amps up. Given 14.8% bond yields, that downgrade may already be priced in. Russia is heavily dependent upon oil and has been hard hit by economic sanctions from the U.S. and the EC. It has also engaged in conflicts to re-unify parts of the old Soviet Union, which has been costly. Like Brazil, Venezuela is heavily-dependent upon iron ore and oil to generate revenue. Declining commodity prices caused Venezuela to record a current account deficit in 2015 — the first time in nearly two decades. Currency Depreciation Currency depreciation against the U.S. dollar could be one measure of the amount of capital flight a country is experiencing. Russia’s currency depreciated 45% over the past year. Brazil’s is next at 39%. Given economic sanctions against Russia, the fact that it is at war Ukraine and is expected to make further incursions into Europe, it is almost foolhardy to maintain capital there. The depreciation of the real has been caused by capital flight to more stable currencies. At 3.76 against the U.S. dollar, the real is now at its lowest level since September 2002: (click to enlarge) I believe Brazil’s bond yields and currency depreciation are linked for the following reasons: Brazil Is In A Recession Brazil’s economy is contracting which may hurt its ability to repay its debt. Bond investors demand a higher premium for the risk of default — thus the high bond yields. Investors are also becoming more risk averse, thus capital is leaving Brazil and other emerging markets for the U.S. Higher Interest Rates Needed To Deter More Capital Flight 10 Year treasuries in the U.S. yield 2.14%. The Brazilian government may need to pay the 1,261 basis point differential between Brazilian bonds and U.S. treasuries in order to deter more capital flight. Brazil’s foreign currency reserves declined from $337 billion in August 2014 to $368 billion in July 2015. This will be a much-watched figure going forward. For instance, Venezuela only has about $17 billion in foreign exchange reserves so it is considered to have a higher default risk than Brazil. Dollar-Denominated Debt Payments Could Drain FX Reserves The more the real declines against the U.S. dollar, the more currency Brazil will need in order to pay interest and principal on its dollar-denominated debt. Those payments could be further strain on Brazil’s economy and budget deficit. If the U.S. raises interest rates, it will [i] drive more capital flight from emerging markets to the U.S. and [ii] force Brazil to pay more interest on its government bonds to keep capital at home. At some point it may become pure folly for Brazil to pay back dollar-denominated debt which is growing at double digits simply due to a depreciating real. It may behoove Brazil to default , thus its interest rates are so high. Brazil pays higher interest rates than Venezuela (10.5%), despite the fact that Venezuela’s bonds are rated at junk levels (Caa3) by Moody’s. Conclusion Brazil’s bond yields are screaming “default!” I believe them. I am short the ETF (NYSEARCA: EWZ ). I am also short Brazilian oil giant Petrobras (NYSE: PBR ) which has been hurt by a corruption scandal and lower oil prices, and is also exposed to dollar-denominated debt. This article may also impact the following securities: (NYSEARCA: BRZU ), (NYSEARCA: BZF ), (NYSEARCA: BZQ ), (NYSEARCA: BRAQ ), (NASDAQ: FBZ ) and (NYSEARCA: UBR ). Disclosure: I am/we are short EWZ, PBR. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.