In Brazil, Fighting a Tide of Turmoil
U.S., IMF Fear That Panic in Latin Economies Could Have a Disastrous Ripple Effect
By Paul Blustein
Washington Post Staff Writer
Sunday, September 20, 1998; Page H01
"The Rubicon" is what William R. Rhodes, Citicorp's vice chairman, calls Brazil.
It's a metaphor that dramatizes an intensive effort underway to keep the global financial crisis from inundating the Brazilian economy -- which has suffered an alarming outflow of funds this month -- and rampaging through the rest of 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 finally 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. To pack additional punch behind that offer, the Clinton administration and other governments said last week that 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 Wednesday that many of its members would lend vast sums to Brazil if asked.
But it is unclear whether 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 have gone unaccepted by Brazilian President Fernando Henrique Cardoso, who is running in an Oct. 4 election and is trying to demonstrate 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.
Many market analysts fret that investor confidence in Brazil could evaporate quickly without a formal IMF package; 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, especially now, could produce 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 bout of 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 that 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 was forced to devalue its currency last Monday, and Colombia did the same less than two weeks before.
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?' "
Alarmed by the seemingly indiscriminate dumping of emerging-market stocks and bonds, Washington has sought to convince the markets that the Latin Americans, with their broad commitment to market-oriented economic reform, have no business being 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, for example; Argentina's rock-solid currency; 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 coming due.
With its markets under selling pressure and the government forced to raise interest rates, Brazil now faces the same sort of vicious cycle Russia did -- borrowing at ever-higher rates to pay off debt coming due. The higher borrowing costs only add to the deficit and make investors even more unwilling to keep their money in the country.
"It's a question of confidence," said Citicorp's Rhodes. If Brazil can swiftly convince investors that 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 may happen after the election, if Cardoso -- who enjoys a big lead in the polls -- is returned to office and, with the support of the IMF, begins implementing a major pruning of the budget that he has been hinting at. But the markets, which have seen Brazil's Congress thwart one budgetary initiative after another, are skeptical.
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 -- and some economists foresee Brazil heading into recession next year.
"They are going to have to adjust to a world of lower external financing, which translates into lower deficits, and higher interest rates, which translates into lower growth," said Paolo Leme, head of emerging-markets research at Goldman Sachs & Co. in New York.
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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