Brazil: the line in the sand
September 24, 1998
BY PAUL BLUSTEIN WASHINGTON POST
''The Rubicon'' is what William R. Rhodes, Citicorp's vice chairman, calls
Brazil.
It's a metaphor that dramatizes an intensive effort under way to keep the
global financial crisis from inundating the Brazilian economy--which has
suffered an alarming outflow of funds this month--and rampaging through
Latin America.
For officials of the Clinton administration and the International Monetary
Fund, who are leading the defensive stand, what's at stake is whether the
crisis can be beaten back--or whether it will explode with more destructive
fury than ever.
Few stops are being left unpulled by the forces seeking to shield the Latin
economies from the selling panics that have overwhelmed stock and currency
markets in Asia and Russia.
The IMF, despite being financially strapped after committing tens of billions of
dollars for bailouts in Asia, has declared its willingness to support deserving
Latin governments with its available cash reserves, which the fund puts at
about $9 billion. The Clinton administration and other governments said last
week they stand ready to provide $15 billion more to the IMF through an
emergency line of credit.
The World Bank, which normally lends only for specific purposes, such as
road construction or health care, has pledged to be a ''significant contributor
in any international package'' for Brazil. A major organization of international
banks said that many of its members would lend vast sums to Brazil if asked.
But it is uncertain that all these gauzy promises will help calm markets
unnerved by Russia's default on its debt last month and worries about Brazil's
own looming debt obligations. About $70 billion in short-term debt comes
due this month and next.
The offers of aid had gone unaccepted by Brazilian President Fernando
Henrique Cardoso until Wednesday, when the Inter-American Development
Bank approved a $1.1 billion loan to Brazil.
Cardoso is running in an Oct. 4 election and is trying to show that his
government can turn around the country's fortunes with its own policy
moves--such as jacking up interest rates to 50 percent--to make Brazilian
investments more attractive.
But he said for the first time Wednesday that he'd support a financial aid
package from international lenders.
Many market analysts fret that investor confidence in Brazil could evaporate
quickly without an infusion of aid. The country's stock market has swung
wildly in recent days as hope for international loans soars and ebbs.
What nobody questions is that a financial debacle in Brazil could have a
disastrous impact far beyond the country's borders. It is not just that the
country is an important purchaser of U.S. goods and borrower from U.S.
banks. Among administration and IMF officials, the much bigger fear is that a
collapse in Brazil's currency, the real, could trigger a financial ''contagion'' that
would dwarf almost everything that has come before.
Argentina, which sells about one-third of its exports to Brazil, would be
vulnerable to a massive flight of capital should its giant neighbor falter. Strange
as it might seem, those two tumbling dominoes could deal a crowning blow to
Hong Kong, because the Hong Kong dollar is rigidly linked to the U.S. dollar
in the same manner the Argentine peso is--and the result would almost
certainly be a new downward spiral in Asian markets. Meanwhile, Mexico's
peso crisis could erupt anew--with considerably adverse consequences for
the U.S. economy, given Mexico's status as America's No. 3 export market.
Such a nightmare scenario ''is on people's minds. It has to be,'' said John
Boorman, director of the IMF's policy development and review department.
The effort to stave off that possibility has become daunting in recent weeks.
About $13 billion has flowed out of Brazil this month, though the pace
diminished late last week to a couple of hundred million dollars a day.
Ecuador and Colombia have devalued their currencies.
Fueling those developments was a general stampede from emerging markets
after the Russian default and an announcement by Malaysia earlier this month
that it was slapping controls over the flow of capital across its borders.
To indicate just how severe the sell-off has been, average interest rates on
emerging-market bonds have soared to about 15 percentage points above
U.S. Treasury bonds; as recently as July, the spread was about 6 percentage
points.
''These unilateral actions [by Russia and Malaysia] raised fundamental
questions in the eyes of many lenders and investors about what the rules are
internationally,'' said Charles Dallara, managing director of the Institute of
International Finance, an organization of banks and other financial institutions
that invest in emerging markets. ''We have a new generation of fund
managers who pull money in from institutional investors and retail
investors--and they're saying, 'If this is what emerging markets are about, why
do I need it?' ''
The United States has sought to convince the markets that the Latin
Americans, with their broad commitment to market-oriented economic
reform, should not be lumped in with the likes of Russia. At a special IMF
conference of Latin finance ministers earlier this month, fund officials lauded
the region for its economic accomplishments: Mexico's budgetary austerity,
Argentina's rock-solid currency, and Brazil's industrial restructuring and low
inflation.
But the trouble is, Brazil in particular shares some of the fiscal problems that
got Moscow into trouble, even though it also enjoys many strengths--such as
a relatively strong banking system--that set it well apart from Russia. Brazil's
budget deficit totals more than 7 percent of gross domestic product, and the
government has huge short-term debts.
With its markets under selling pressure and the government forced to raise
interest rates, Brazil faces the same sort of vicious cycle Russia
did--borrowing at ever-higher rates to pay off debt coming due.
''It's a question of confidence,'' said Citicorp's Rhodes. If Brazil can swiftly
convince investors it is not going to go the way of, say, Indonesia or Thailand,
it can reap the advantages of a virtuous cycle as interest rates come down and
the fiscal outlook improves. All that might happen after the election, if
Cardoso is returned to office and, with the support of the IMF, begins
implementing a major budget-pruning.
Even if Brazil and its neighbors escape a full-blown crisis, the recent turmoil is
sure to cause economies to slow in most of the region's countries.
At the IMF and at the U.S. Treasury, there will be sighs of relief all around if
the damage is that limited.
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