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Brazil’s New Legal Rate - Here’s What You Need to Know

The new Legal Rate (in Portuguese “Taxa Legal” or “TL”) was implemented to be applied when there is no rate agreed upon by the parties, serving as a benchmark for late payment interest on contractual obligations and legal claims. The TL has standardized the parameters for value adjustments by defining that (i) monetary correction should consider the Brazilian consumer inflation (IPCA-15) as a benchmark; and (ii) the real interest rate should be calculated based on the Brazilian basic interest rate (“Selic”) minus the IPCA-15; eliminating doubts regarding different interpretations on how and which parameters to apply.

The Legal Rate has the benefit of adapting to changes in the country’s macroeconomic environment, which was not the case with the most commonly used parameter prior to Law 14.905: a fixed “1% per month” interest rate.¹

A historical comparison over the last decade, shown in the graph below, indicates that an adjustment based on “IPCA + 1% per month” would exceed “IPCA + TL” by more than 80%, showing that, in recent history, the Legal Rate has almost always been considerably lower than 1% per month.

Comparison of adjustment parameters (“IPCA + 1% p.m.” vs. “IPCA + Legal Rate”)

1: Equivalent to 12% per year, as this is a simple interest calculation.

On the other hand, the Legal Rate is based on the Selic rate, a monetary policy tool used to control inflation, which is expected to affect inflation in a 6 to 9 months period.² Thus, there is often a mismatch between the Selic rate (which change has a lag effect on inflation) and the inflation rate of one specific month or months immediately following a change in the Selic rate. For example: the Selic rate for the 12 months prior to January 2021 was 2.64%, significantly lower than the accumulated IPCA in the same period (4.56%). Therefore, despite being a nominal rate, in practice, the Selic rate does not necessarily account for short-term inflation.

In its methodology, the Legal Rate does not consider negative real interest rates (i.e., when inflation in a month exceeds the Selic rate of that same month). Although this seems like an occasional effect, the occurrence of months with negative real interest rates - which should be rare - has increased 5 times in the past decade compared to previous decades in Brazil. In such an environment, adjustments based on the Legal Rate diverge significantly from Selic-based adjustments in real terms. For example: (i) in 2020, the Legal Rate would have been +1.7%, while the real Selic rate was negative at -1.4%; and (ii) in 2021, the Legal Rate would have been zero, while the real interest rate was negative at -5.4%. In both cases, the creditor would be favored.

Also due to its methodology, the “IPCA + TL” adjustment is equal to the IPCA in months with negative real interest rates; and is equal to the Selic rate in the remaining months, including when there is deflation. Therefore, while historically much lower than “IPCA + 1% p.m.” the “IPCA + TL” adjustment is always equal to or higher than the Selic rate on a monthly basis.

Between June 2020 and March 2021, when there were many months with negative real interest rates, the use of “IPCA + TL” would represent an adjustment 278% higher than an adjustment using the Selic rate, as shown in the graph below. Over a longer period, from June 2020 to December 2022, it would have been 62% higher.

Comparison of ‘IPCA + Legal Rate’ vs. Selic (accumulated)

brazil new legal rate graph 2

2: Source: https://www.bcb.gov.br/controleinflacao/transmissaopoliticamonetaria

In summary, when compared to the Selic rate, the “IPCA + TL” adjustment benefits the creditor in periods with negative real interest rates, which have not been rare in Brazilian recent history.

To verify how the adoption of the Legal Rate could influence the behavior of market agents, we compared “IPCA + TL” with the average cost of funding for companies and individuals in Brazil. We observed that, while the historical variations of “IPCA + TL” are similar to the variations in funding costs for legal entities and individuals over the years (reflecting the macroeconomic scenario), the “IPCA + TL” sum results in a rate significantly lower than the funding cost for legal entities (43% lower) and even more so for individuals (69% lower).³

Lastly, since the Legal Rate uses a simple interest calculation method, it underestimates the returns when compared to a bond linked to the Selic rate or bank loans (for example), which in Brazil use compound interest. To illustrate this effect, over a three-year period without deflation or negative real interest rates, the “IPCA + TL” adjustment would be 5% lower than the Selic rate calculated with compound interest (as commonly applied in Brazil).

Thus, a debtor with several liabilities adjusted to market interest rates, in addition to lawsuits, will almost always find the liability adjusted by “IPCA + TL” to be the “cheapest” one, except in months with negative real interest rates or subsidized interest. Excluding other effects (such as reputational damage or litigation costs), it may become more common for a debtor to opt to payoff liabilities with higher costs instead of making settling liabilities adjusted by “IPCA + TL”. In other words, there may be a disincentive to make settlements and/or an incentive to litigate or use delay tactics. Market agents should consider these effects when drafting their contracts, mainly by pre-defining the most appropriate parameters for monetary and interest adjustment (compensatory and potentially default interest), rather than being exposed to the application of the Legal Rate.

Footnotes:

1: Equivalent to 12% per year, as this is a simple interest calculation.

2: Source: https://www.bcb.gov.br/controleinflacao/transmissaopoliticamonetaria

3: Analysis presented in the full version of this article.