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Strategies & Market Trends : Telebras (TBH) & Brazil -- Ignore unavailable to you. Want to Upgrade?

To: posjim who wrote (7685)	9/9/1998 5:19:00 PM
From: Steve Fancy	Read Replies (1) \| Respond to of 22640

Merrill Lynch Bulletin 8 September 1998 Francis Freisinger Manager, Latin American Economics Latin America Economics: Brazil's Fiscal Measures Not enough to offset interest expenses ú The spending measures announced today are insufficient to offset the additional interest expenses likely this year even under a relatively positive interest rate scenario in the coming months. Broadly, the finance ministry has reaffirmed existing budget targets for the Central Government accounts in 1998 and 1999. But they have issued a decree that will give extra powers to cut spending to meet these targets if revenues are inadequate. For 1999, there will be bimonthly targets to ensure steady progress. For 1998, the Central Government is now targeting a surplus of R$5bn. This compares with a budgeted surplus of R$4.3bn and our pre-announcement forecast of R$2bn. Spending cuts of R$4bn from the "Other Current & Capital Spending" line in the treasury accounts have been announced to reinforce the target. These cuts are exactly what we suggested were likely in the bulletin we released earlier today ("Brazil Hikes Rates"). Overall, our forecast for the consolidated primary balance in Brazil moves from a deficit of 0.4% of GDP to a zero balance, on the assumption the government meets this target. The consolidated fiscal deficit for the year we now expect to reach 7.4% of GDP, assuming that overnight interest rates begin to fall in October and reach 23% by year-end. This compares with our previous forecast for the fiscal deficit of 6.9% of GDP. In other words, after the additional primary spending cuts, the deficit will still have worsened by 0.5% of GDP as a result of additional interest expenditure in a fairly optimistic interest rate scenario. For 1999, the government has simply restated the Central Government budget announced last week of a surplus of R$8.7bn. Based again on a gradual fall in interest rates in 1999 to 18% by year end, our forecast for the consolidated fiscal deficit would be 5.7% of GDP, with a consolidated primary surplus of 0.5% of GDP. The 1999 target in particular looks unambitious at first sight. The Central Government surplus is only programmed to increase by R$3.9bn (from R$5bn to R$8.9bn), or just 0.4% of GDP. But the 1999 budget is based on optimistic growth assumptions of 4% real GDP growth and 3.5% inflation. This gives nominal GDP growth of 7.5%, whereas Merrill Lynch expects real GDP growth of just 0.4% and inflation of 2%. So significant spending cuts will be required to ensure compliance with the new target. The limited nature of the announcement highlights the fiscal constraints facing the government. Unwilling to cut health and education, and unable to cut social security, 75%-80% of all primary expenses are beyond reach. If further interest rate increases are necessary, the government's narrow fiscal options will be highlighted still further. Tax increases could be the only way to improve the primary result further.

To: posjim who wrote (7685)	9/9/1998 5:23:00 PM
From: Steve Fancy	Respond to of 22640

Merrill Lynch Bulletin 2 of 2 8 September 1998 Francis Freisinger Manager, Latin American Economics Latin America Economics: Brazil Hikes Rates But Can It Deliver On the Fiscal Side? ú As we expected, accelerating capital outflows have forced the Brazilian Central Bank to raise interest rates. The overnight rate (Selic rate) will rise from 19% to 29.75%, with effect from September 8. The move will buy the government time by temporarily slowing down capital outflows. But without additional measures the increase is probably not enough to generate net capital inflows. ú Whether this time is measured in days or weeks depends on two factors: First, can the government send sufficiently strong and clear signals about fiscal measures given the political constraints of the elections on October 3, and second, the state of the global financial markets. ú Preliminary reports suggest that outflows on Friday September 4 were around $3bn. That would imply that international reserves currently stand in the $55-57bn range, compared to $70bn at the end of July. Reserves will continue to fall even without capital flight by domestic Brazilian investors. Reserves could easily fall below $50bn in October even in a good scenario. ú New fiscal measures should do more than offset the extra debt service costs of the rate hike-we estimate these at around 0.22% of GDP per month. They ideally would have to make progress towards reducing the deficit to below the level expected before the interest rate hike. Unfortunately, we find it difficult to see where such dramatic fiscal measures could come from in the short run. The risk of disappointment is thus real in our view. ú If there is disappointment, or if world capital markets deteriorate further, it is possible that capital outflows will accelerate once again, and at that point it will be difficult to avoid floating the exchange rate. ú Despite recent market speculation, we do not believe the government will adopt additional administrative controls on capital outflows. Apart from strong denials this weekend by Central Bank authorities, we believe that the costs of such measures would significantly outweigh any benefits. ú At best, if the fiscal package is adequate and the world markets are more favorable, interest rates should begin to fall after the election. However, we do not expect rates to fall back to their previous levels until well into 1999. ú Last week we revised our annual GDP growth forecast down to 1.0% for 1998 and 0.4% for 1999. These forecasts incorporate a monetary tightening and assume that the government can produce sufficient fiscal measures to stabilize expectations. They imply a contraction in GDP in Q4 1998 and Q1 1999 of around 0.4% quarter-on-quarter, seasonally adjusted. This is roughly twice the contraction that occurred following the last period of monetary tightening, when rates were raised to 43%. 1) The Central Bank has raised rates by suspending rediscount operations at the 19% TBC rate with effect from Tuesday October 8. It will force the SELIC overnight rate up to the 29.75% TBAN level as a minimum. But rates could easily rise further if the authorities desire. 2) The move demonstrates that official commitment to the current exchange rate policy remains strong, after several weeks of apparent denial about the seriousness of the global situation. But the interest rate hike on its own will not be sufficient to stabilize the situation. 3) The interest rate hike will tend to discourage speculation against the Real, by increasing the carrying cost of short positions. But a comparison with the interest rate hike of October 1997 suggests that the increase may be insufficient to attract inflows. Then, the government raised the TBC and the SELIC rate to 43%. At that time, the implied annualized currency depreciation in the non-deliverable forward (NDF) market was then trading in 18-25% range (compared to 7% suggested by the exchange rate mini-band). But in recent days, the implied depreciation has been much higher, in the 32-39% range. In other words, from the perspective of an offshore investor, an overnight interest rate of 30% will still be highly unattractive until the risk premium in the NDF market has come down dramatically. The temporary exemption on the 15% withholding tax granted this August to foreigners makes the current overnight rate comparable to just 34.5% last October. 4) We believe that interest rates are going to stay at current levels or higher at least until November. Note that it was only in February 1998, three months after the onset of the previous crisis, that large-scale capital inflows arrived. This time round, given the deteriorating world environment, the political uncertainties generated by the election and the inevitable delay in implementing a fiscal package, it seems likely that it will be at least as long before the government can count on capital inflows. Meantime, reserves will continue to fall. 5) The fiscal impact of higher interest rates will be much more rapid than last October because of the structure of domestic debt. We estimate that 70% of the outstanding R$310bn of domestic debt is floating linked to domestic interest rates. That implies an extra R$2bn monthly spending. To put that in perspective, the entire monthly federal payroll is only R$3.5bn. 6) We believe Brazil's fiscal deficit was not acceptable even before the interest rate hike. So ideally a fiscal package would have be big. It ought to go well beyond simply offsetting this interest rate expense. Moreover, it should focus on reducing expenditure, although further tax increases are also going to be necessary. 7) The problem is that spending remains extremely rigid downwards in Brazil, since key constitutional reforms are still not fully in place. The only obvious short-term measure we can see would be drastic cuts in the "other" spending line at the federal level, which has risen rapidly in recent years. This spending line could relatively easily be cut by R$3-4bn in 1998. 8) Unfortunately, such a spending reduction would be far from sufficient. Yet big reductions in payroll spending will only be possible with the completion of enabling legislation for the administrative reform, which has been delayed until after the election. In the longer term, the social security reform offers the other key to fiscal savings. 9) Moreover, Brazil has a credibility problem as a result of the failure of the fiscal package announced last November to produce any improvement in the primary balance. Indeed the primary balance deteriorated by nearly 1.5% of GDP after November. In order to make any future package credible, binding fiscal targets are going to be crucial. That will require congressional approval, as will any tax increase. In other words, we cannot expect key fiscal measures to be implemented until after the election. Our big concern is that they will disappoint the market.

To: posjim who wrote (7685)	9/9/1998 5:33:00 PM
From: Steve Fancy	Respond to of 22640

Brazil shrs end down on worries of capital flight Reuters, Wednesday, September 09, 1998 at 17:25 SAO PAULO, Sept 9 (Reuters) - Brazilian shares ended down for the fifth straight session on Wednesday as local and foreign investors in local assets continued to be vexed by the huge outflow of dollars recorded in recent days, brokers said. The 57-share Bovespa index (INDEX:$BVSP.X) ended down 2.78 percent at 5,655 points in weak volume of about $381 million. "Things remain the same. We just have to wait until world markets calm down a bit and investors start regaining confidence in Brazil," said one Banco Santander trader. Forex dealers have speculated about $850 million fled Brazil's forex markets on Wednesday. On Tuesday, Brazil's commercial and floating forex markets had posted a $885 million net outflow. The figure, while robust, remained well below a $2.925 billion drainage recorded last Friday--the biggest single day outflow of the U.S. currency since late last year's when the Asian crisis began. Outflows had declined somewhat after the government decided to virtually raise basic interest rates by 50 percent to nearly 30 percent late on Friday. The government also showed its determination to tackle its dire fiscal problems on Tuesday by announcing spending cuts, though investors were not too encouraged, brokers said. Copyright 1998, Reuters News Service