Brazil: Currency defence crucial to region
By Alex Bellos in Rio de Janeiro
Tuesday August 25, 1998
Brazil used to be a country of dictatorship, hyper-inflation and political mismanagement on a grand scale. Then it became the world's third largest democracy, the second largest destination of foreign investment after China, and built a stable new currency, the real.
Now it stands once again on the brink of economic meltdown.
The stakes could not be higher. Brazil is the largest economy in Latin America, amounting for about 50 per cent of its GDP, and the battle to defend the real is seen as a crucial test in stopping the whole region from descending into a full-blown crisis.
Shares at the Sao Paulo stock exchange fell more than 10 per cent at one point on Friday, triggering a halt in trading and unleashing fears that Brazil might be forced to devalue the real. In the past month, Brazilian shares have fallen by 25 per cent.
"All the markets in Latin America are looking bad. This is about Russia and Asia, and Venezuela definitely brought it home. People are starting to get scared over Latin America," said Gabriel Ruiz, a fund manager at Banco Quilmes.
With $70 billion (œ43 billion) in reserves Brazil could avert devaluation in the short term. But the country's achilles' heel is an unsustainable budget deficit of 7 per cent of GDP. And there is doubt that the real could withstand repeated speculative assaults.
Amaury de Souza, a political scientist at Techne in Rio de Janeiro, said: "High deficits force governments to go out and borrow money. And because Russia has defaulted on some of its foreign debt, emerging nations must now pay more for those loans, a cost that only adds to the red ink."
A devaluation will in one fell swoop reverse Brazil's four-year-old campaign to stabilise the economy, which ended inflation of more than 1,000 per cent and created a positive environment for external investment. It transformed the lives of millions of Brazilians, who for the first time were able to hold on to their money without it becoming worthless.
To stop runs on the currency in the past, Brazil has sharply raised interest rates to discourage speculators and attract foreign capital. In the heat of the Asian crisis last October, President Fernando Henrique Cardoso raised interest rates to 43 per cent - successfully defending the currency but causing hardship for many Brazilians.
The interest rate has since been lowered to 19.75 per cent, but it has been blamed for a slump in spending and the highest levels of unemployment in Brazil for more than a decade.
"The big risk is that these emerging markets will have to again tighten their belts both fiscally and monetarily to restore confidence," said Jim Barrineau, an equity strategist at Salomon Smith Barney.
Despite the hardship President Cardoso remains the runaway leader in polls for October's general election - mostly due to his reputation for having transformed the economy during his four-year term. Commentators say Mr Cardoso will not risk putting up interest rates before the election because it would lose him popularity. But a devaluation - even through circumstances beyond his control - would throw the presidential race wide open.
Analysts point to Brazil's well developed programme of privatisations as a reason why the economy might have the strength to hold its own. When the government sold off the state telecommunications business Telebras last month for $15 billion - the largest privatisation in Latin America - the mostly foreign winning bidders paid more than 60 per cent above the asking price.
If Brazil were forced to devalue, Argentina, its main partner in the Mercosur trading bloc, might have to follow suit because the two economies are closely intertwined. One-third of Argentina's exports go to Brazil, its largest trading partner.
reports.guardian.co.uk |
