'Real' Problem or Brazil overblown!
Hi Satish:
Here is a brief look at the Brazilian 'situation' in case you are interested in this sort of thing.
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(Source:Forbes)
January 15, 1999
Brazil: Overblown?
By Marius Meland
EW YORK. 4:40PM EST—
Is the market overreacting to Brazil's economic difficulties? It certainly seems so.
Consider this: On Wednesday, when Brazil devalued its real the first time, U.S. stocks lost about 3% in the few first hours of trading before the market began to recover. Traders cited worries about the impact of the Brazilian debacle on the U.S. economy as the main cause of the selloff.
But the drop in the value of the U.S. stock market, at about $45 billion, was more than double the total value of U.S. exports to Brazil last year.
Today, the market reacted in the opposite fashion, putting a positive spin on Brazil's decision to allow the real to float freely.
Sure, it's difficult to pinpoint the reason why stock prices move on a day-to-day basis, but worries about Brazil's problems seem blown out of proportion.
In the media, Brazil is portrayed as a major trading partner for the U.S. But in fact, only about 2.2% of U.S. exports go to Brazil, according to the latest figures from the Commerce Department. That's about one tenth of U.S. exports to Latin America, which overall account for 21% of total exports.
So what's all the fuss about?
The market's biggest fear is that a Brazilian meltdown would spill over to the rest of Latin America, much as the "Asian contagion" brought down seemingly invincible tigers in Southeast Asia last year.
But Ethan Harris, an economist at Lehman Bros., says the effect on the U.S. economy is likely to be muted, even if turmoil were to spread throughout Latin America.
First of all, he points out, about 5 percentage points of the 21% export figure is part of the Mexican border trade with the U.S. and as such is well shielded against a regional meltdown.
Second, the spillover from Brazil isn't likely to be as significant as, say, the widespread effects of Thailand's decision to devaluate its baht last year. The Asian crisis revealed structural weak spots that markets had ignored in their enthusiasm for the tiger economies. The revelations of suspect bookkeeping, cronyism and weak banking systems shocked financial institutions as the crisis unfolded last year. In Latin America, earlier periods of distress such as the "tequila crisis" of 1994 in Mexico have already exposed such weaknesses, according to Harris.
And finally, he says, the fixed-income market is likely to react less harshly to economic woes in Latin America. At the time of the Asian crisis, the spread between Treasurys and lower-quality bonds was extremely narrow. The crisis sent shudders down Wall Street and froze up fixed-income markets, triggering the "credit crunch" that forced the Federal Reserve to lower interest rates. Today the spread between high- and low-quality bonds remains relatively wide, but the market is confident the Fed would react swiftly if the market were to freeze up again.
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