January 6, 1999
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Amid Soaring Interest Rates,
Brazilians Fall Deep Into Debt
By MATT MOFFETT
Staff Reporter of THE WALL STREET JOURNAL
SAO PAULO, Brazil -- The old woman covered with burns and pleading for help in the federal Justice Ministry wasn't a victim of accident or arson. Facing constant pressure to pay back a black-market loan taken at the crushing rate of 10% a month, she had finally cracked, poured alcohol on her body and set herself on fire.
Brazil's latest drive to preserve economic stability has brought a punishing interest-rate policy. Monthly charges of 6% on bank loans and 10% on credit cards have produced a rate shock that is spreading fast and claiming many victims.
With credit so dear, manufacturers have been forced to stint on capital spending, and that has helped raise unemployment. While some businesses are profiting from the tough rate regime -- especially debt-collectors and loan sharks -- few individuals are so lucky. Many fail to read the fine print and suddenly find themselves trapped in a maelstrom of spiraling debt. One consolation: Support for debtors' rights is on the rise. On the macro side, high interest rates are taking a bite out of the national coffers without really sheltering the embattled currency, the real -- the root of all these evils.
For Brazilian policy makers, sky-high interest rates are the price the country must pay to avoid the currency collapse and high inflation that have devastated Asia and Russia. So when financial speculators took aim at Brazil this past September, the central bank pushed the country's already lofty rates higher still, offering big yields to tempt investors to keep their savings in the real. Eager to rein in the ever-widening emerging-markets crisis, the International Monetary Fund and other lenders who assembled $41.5 billion in emergency loans to Brazil last year also backed the government's strategy.
In their zeal to face down speculators, however, policy makers may be strangling the economy. The government's benchmark interest rate is a hefty 29% a year. But after banks, retailers and credit-card companies slap on their stupefying spreads -- partly to fatten profits but also to compensate for a record number of defaults -- the final rate for consumers can reach 150% to 250% a year. And the blow to the consumer isn't cushioned by high inflation and devaluation; stable consumer prices are the major triumph of the currency policy.
Sign of the Times
Brazilian manufacturers, finding financing prohibitively expensive, have slashed capital spending to half its level of the 1980s. That has helped drive unemployment in greater Sao Paulo, the country's industrial center, to more than 17%. A lawyer here who placed a help-wanted ad for a $300-a-month clerical worker was amazed to receive 130 applications.
It's a sign of the times that one of the few growth industries in Brazil today is debt collection. The main player is a huge but secretive company called Grupo Union, which has averaged 35% annual revenue growth over the past three years. The company attributes its success to a sophisticated computer system to track debtors and an amicable attitude once it finds them.
"We believe in a friendly collection," says Julio Shinohara, a Grupo Union director. You can't afford to be too friendly in the high-anxiety world of Brazil's high-interest economy, however. Mr. Shinohara refuses to reveal the names of the company's ownership group for fear they will fall victim to the country's increasingly active kidnapping gangs.
Joblessness and towering consumer interest rates also have driven many desperate Brazilians into the hands of loan sharks, who are thriving on their distress. Police in Rio de Janeiro recently uncovered a vast money-lending ring headed by a lawyer who employed vicious pressure tactics against hundreds of debtors -- before he turned against his financial backers and absconded with $20 million.
Clogging the Courts
Debtors are trying to fight back. Brazil's rapidly growing debtors-rights movement got started 18 months ago when clothing-shop owner Marcelo Salvato contracted a $5,000 debt that tripled within only a matter of months. Rebuffed when he tried to renegotiate with his bank, an indignant Mr. Salvato took to the streets to recruit other debtors interested in clogging the courts with suits against creditors.
"We want to use guerrilla tactics," he says. In almost no time, Mr. Salvato says, the ranks of his National Debtors Association have grown to 10,000 in two dozen cities throughout Brazil.
Amid all this ferment, the high interest rates are failing to achieve their primary purpose: assuring investors of the soundness of the real. Brazil lost about $5 billion in hard-currency reserves in December, partly for seasonal reasons, but also because investors are increasingly worried that scorching rates could push the government itself into insolvency. Currency reserves now stand at about $37 billion, not including the $41.5 billion the IMF and other lenders are making available to Brazil.
Higher rates are triggering an explosion in the public sector's internal debt, which ballooned by almost 20% last year to around $300 billion. Meanwhile, interest payments on treasury bills and other government debt instruments are now the overwhelming contributor to the mammoth public deficit of 8% of gross domestic product.
"The interest rates are a classic case of a government shooting itself in the foot," says Luiz Carlos Delben Leite, president of a manufacturers' association.
President Fernando Henrique Cardoso's government is betting rates will come down if -- and it's a big if -- Brazil's Congress approves a pending package of widely unpopular proposals to cut the budget and raise taxes. These harsh measures are designed to give investors confidence that the real will be anchored in solid fiscal policy, rather than on the more shaky foundation of inflated interest rates and a dollar-pegged currency.
But even assuming a government triumph in Congress, an increasing number of industrialists don't believe rates will fall far enough, fast enough. "Until about five months ago, nine out of 10 economists in Brazil supported the government economic policy unconditionally," says Paulo Mallmann, an economist at Banco Industrial e Comercial SA, a middle-market Sao Paulo bank. "Today more and more people are saying it's time to begin thinking about a new set of policies."
An Unlikely Alliance
Last month, Sao Paulo industrialists, largely heads of struggling family-owned companies, formed an unlikely alliance with labor unions to demand that the government shift directions by lowering interest rates and providing more protection against foreign imports. A radically different prescription came from a top conservative politician in the governing coalition. He urged President Cardoso to shore up market confidence with bolder market reform, including the privatization of a sacred nationalist symbol, the state-run oil company, Petroleo Brasileiro SA.
In the meantime, high rates, which have been employed with varying degrees of intensity throughout the 4 1/2 years of the real's existence, are beginning to erode the benefits wrought by the currency. The real, which reduced annual inflation to 1.5% last year from 2,700% in 1993, had fostered productive investment and growth after decades in which Brazil had been a speculator's paradise.
But as banks once again shift assets toward investments in high-yield government debt, the share of loans as a percentage of assets, around 25%, has fallen to a lower level than it was when the real was launched. Interest payments on the government debt are crowding out public investment in critical areas such as health and education. The federal university of Rio has struggled even to pay its utilities.
Since the local market is constricted, Brazilian corporations are trying to compensate with fancy financial footwork. Betting astutely on higher rates during the middle of last year, Souza Cruz ON, Brazil's major cigarette producer, sped up its tobacco harvest, obtained advanced export credits, and invested the proceeds at lip-smacking rates in the money market. Thus, in the third quarter of 1998, Souza posted a whopping $44 million in gains from financial arbitrage, helping to offset a sharp drop in cigarette sales.
Expansion of Credit
In some ways, it's miraculous that any productive activity can take place in a country where credit is so costly. One reason is that cash is still preferred and used, whenever possible -- a legacy of Brazil's long history of economic instability. Credit has expanded significantly only since the real created a more predictable climate, and credit is still less widely available than in developed economies.
In the real's first three years, there was a doubling in both the total value of personal loans outstanding and the number of credit cards in circulation. Brazilian banks even launched a special credit card for workers earning less than $500 a month and at what was called a "bargain" interest rate of 7.5% a month. "We may be running out of poor people to give credit cards to," jokes Manoel de Oliveira Franco, president of a financial executives' group.
As Brazilian consumers uncorked a gaudy shopping spree with the onset of stability -- the number of shopping malls in the country grew by 30% in the first three years of the real -- peculiarities of the financial system facilitated excesses. Most Brazilian banks offer checking clients a high-interest overdraft account. Postdated checks are legal.
Inexperienced consumers taking on debt at soaring interest rates was a recipe for problems. Soon after receiving a credit card in 1996, public-relations executive Elaine Aparecida Rocha rang up $6,700 in charges. It took less than a year for the debt to ascend to $25,500, due to interest and penalties. Meanwhile, she lost her job, so now her only hope is to negotiate a debt reduction. In a mistake common among Brazilian consumers, Ms. Rocha never found out the interest rate she was being charged on the card, more than 200% annually, before she used it.
Benedito Guidolon, an economist by training, found out how fast disaster can strike when he took a $100,000 bank loan, at annual interest of more than 150%, to support his auto-parts company a little over a year ago. Caught short when the loan came due, Mr. Guidolon was forced to contract another credit from a finance company at even steeper interest. The finance company confiscated his two apartments and his imported cars, yet the total amount due on the loan still mushroomed to $300,000. Abandoned by his wife in the midst of his crisis, Mr. Guidolon now rents a tiny apartment owned by the finance company.
New Service Niche
So many middle-class Brazilians have gotten in over their heads that a new service niche is evolving: the personal financial consultant. Marcos Silvestre, a fresh-faced 31-year-old economist, started his consultancy, Forex, 18 months ago, and already has more customers than he can handle, not to mention two walls plastered with write-ups from the Brazilian press.
Mr. Silvestre's clients are sorely in need of advice: About 20% of their total income is consumed by interest payments. One client had a high-interest bank debt of $5,000 and only one significant asset, a car worth $10,000. Mr. Silvestre's advice: sell the car quickly, and use the proceeds to liquidate the debt and buy a cheaper car. When the client resisted, Mr. Silvestre pointed out that it would take only six months for the debt to swell to $10,000, wiping out the total value of the automobile.
Mr. Silvestre notes that Brazilian debtors do have one point in their favor: Creditors often prefer debt rescheduling or partial debt forgiveness to a lawsuit, which can drag on for years due to the inefficiency of the Brazilian courts. Negotiating lesson No. 1: "If you want a reduction in principal, and not just lower interest," Mr. Silvestre says, "you have to be prepared to cry in the presence of the lending officer."
Creditors think that someone ought to shed a tear or two for them. Owing to a record surge in consumer delinquencies and bad checks, some prominent retailers have faced financial crises. On top of that, retail executives have been singled out as prime targets of kidnappers. That's partly because of the perception that eye-popping interest charges have made them fabulously wealthy, but also because kidnappers seem to regard them as more accessible than bankers or other types of lenders.
Last year, Girsz Aronson, owner of a large Sao Paulo appliance retailer, G. Aronson, endured double trouble: His company filed for protection from creditors and, not long after, he was kidnapped and forced to pay a $100,000 ransom. Mobbed by reporters upon gaining his liberty, Mr. Aronson could hardly afford to pass up some free publicity: "I'm making another appeal to the public to purchase at G. Aronson," he said, "because I'm broke."
Bearing Up Well
But overall, the Brazilian retail sector seems to be bearing up well -- better than many consumers, at least. An analysis of retailers by the Austin Asis consultancy found that sales were off slightly in 1998, but tighter cost control had led to a 10% increase in profits.
Typical of the successful retailers is Globex SA, which sells appliances and electronic products and has seen sales nearly triple to $1.6 billion since the introduction of the real in 1994. Globex has cut costs to the bone and has also been opportunistic in its credit policy: When the government raised rates last fall, Globex followed suit, hiking its average charge to 7.5% a month. But Globex has lagged in following the government's example of dropping rates since then. "We have to cover ourselves for an increase in defaults," explains Romolo Isaia, Globex's planning director.
After a big shakeout a few years ago, Brazilian banks have also navigated smoothly enough through the high-interest storm. Return on equity was slightly higher in 1998 than in the previous year in a sample of key banks tracked by consultant Carlos Daniel Coradi. He grumps: "Any bank that fails in a country where it can earn 29% a year investing in government paper deserves to go out of business."
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