Brazil Strives to Steady Its Foundering Markets
BY MATT MOFFETT and PETER FRITSCH
Staff Reporters of THE WALL STREET JOURNAL
SAO PAULO, Brazil -- The financial tempest that has ravaged emerging
economies from East Asia to Russia is now billowing closer to U.S.
shores, threatening its biggest target yet: Brazil.
Since last month's collapse of the Russian ruble, Brazil, the world's
ninth-largest economy, has endured its worst swoon in nearly a decade.
Sao Paulo stocks have lost half of their value. Interest rates have surged to
nearly 40%, provoking such concern about economic growth that
temporary auto-plant shutdowns have been imposed by Ford Motor Co.
and Fiat SpA.
And as confidence in Brazil's ability to support its currency has waned,
$23 billion in hard-currency reserves has poured out of the country -- a
financial drain exceeding the government's entire take from the recent
privatization of the national telephone network, the largest divestiture in
Latin American history.
This mess is unfolding just three weeks before national elections in which
President Fernando Henrique Cardoso, a freemarket leader whose
hallmark has been economic stability, is seeking a second term. Now his
leftist challenger is trying to come from behind in the polls by turning the
vote into a referendum on whether Brazil should impose currency and
import controls to try to insulate itself from today's hair-trigger global
markets.
Brazil still has about $51 billion in dollar reserves with which to defend its
currency, the real. And on Friday the International Monetary Fund
pledged that it, too, would support Brazil, if necessary. That word spurred
the volatile Brazilian stock market, which had fallen 16% Thursday, to a
13% rebound Friday. Yet on the same day, less-sanguine investors
shipped $1.6 billion out of the country. Markets simply aren't sure how
much Brazil can count on international assistance at a time when the IMF's
own coffers are far from flush.
In all, "it is the most serious crisis of confidence Brazil has seen in years,
and somebody has to step up, either here or outside the country, to
restore it," says Igor Cornelsen, a Sao Paulo investment banker.
The alarms in Brazil, which is by far the largest economy in Latin America,
have helped ignite sharp retreats in stock markets from Mexico City to
Buenos Aires and raised fears of a region-wide recession. And U.S.
corporations have more riding on Brazil than on most other countries
caught up in the past year's financial tumult.
This isn't Malaysia, a flyspeck market harnessed to an outsized export
engine, or Russia, the hulk of an empire stumbling out of a long socialist
slumber. Brazil's population of 160 million is a vast pool of consumers, the
world's second-largest market for blue jeans and third-largest market for
television sets. Brazil is Whirlpool Corp.'s leading foreign market for
kitchen appliances and McDonald's Corp.'s seventh-largest market for
fast food. A survey by A.T. Kearney ranked Brazil as second only to the
U.S. as a favored investment destination for multinational corporations.
Yet despite its burgeoning consumer culture, Brazil is saddled with an
old-style, patronage-ridden political system that has failed to rein in a
budget deficit equal to a whopping 7% of total output. The curious result is
a big-spending government that ranks low in international creditworthiness,
yet keeps its currency mighty vis-a-vis the U.S. dollar. The real is so
strong that in New York, Brazilians are the top spenders among foreign
tourists.
In what is called a "crawling peg," Brazil links the value of its real to the
dollar within a band, which moves each year to let the real's value slip
about 7%. But now, amid a global climate of doubt about emerging
markets, skepticism that Brazil can keep supporting the real at what is
widely considered an unrealistically high value has stirred an assault on the
currency.
Policy makers have few options to deal with it. Mr. Cardoso rejects out of
hand a devaluation, which could revive Brazil's nightmarish inflationary past
and might well scuttle his re-election. He has also repudiated exchange
controls. So sharply raising interest rates, to tempt investors with high
yields if they hold reals, is about the only viable policy weapon remaining in
Brazil's arsenal.
But when trouble first arose last month, shellshocked Brazilian policy
makers dithered in deploying this weapon. Indeed, as recently as 10 days
ago, while money was flowing out of the country at the rate of about $750
million a day, Brazil's central bank was aggressively squeezing rates
downward, in order to perk up the pre-election economy.
When authorities finally bumped up rates, capital outflows continued
unabated. President Cardoso, citing the risk that high rates pose to
economic growth, vowed that the monetary vise would be clamped no
tighter. "I'm not going to sacrifice the country," he said. Yet hours later,
monetary authorities lifted rates still further.
Some analysts are scathing about the country's fumbling crisis
management. "It looks like the last days of Pompeii," says Riordan Roett,
a Brazil expert at the Johns Hopkins School of Advanced International
Studies.
But Fernao Carlos Bracher, president of Banco BBA Creditanstalt SA
here, says the interest-rate shock may be just the remedy to calm currency
markets and get investors to reflect on some of Brazil's overlooked
strengths: low inflation, a banking system that is sound by emerging market
standards and an aggressive government privatization program. "You are
dealing here with a crowd reaction," he contends. "Those who are going
out now are going to lose money."
In the best-case scenario, Brazil toughs it out through the Oct. 4 election,
defending the currency with its tight monetary policy and its cache of
reserves. Assuming Mr. Cardoso maintains his lead in the polls and is
re-elected, supporters say he would use the first 100 days of his second
term to ram through a series of long-stalled reforms to shrink the bloated
public sector. Then, with the government finally on a sound fiscal footing,
Brazil could begin to increase the rate of the real's gradual devaluation
against the dollar, and thus remove the constant threat of a speculative
attack.
Economic Drag
But such a nimble escape from the crisis seems a long way off for a
country whose characteristic self-confidence has been badly shaken.
"People aren't buying anything because they fear they'll soon be out of
work," says Valdemir Colleone, operations supervisor for Lojas Sem, a
big retail chain. At the Restaurante Sancho Panza, a smorgasbord-style
eatery that charges diners by the weight of their plates, cashier Helio
Gomes notes that customers are serving themselves smaller portions.
The squeeze is crimping blue-chip companies like Grupo Odebrecht SA, a
huge civil-engineering firm that has just announced postponement of $115
million in investments. The reason: its inability to tap sinking markets for
fresh capital. "The market for Latin American stocks has disappeared,"
says Rodolfo Maluf, Odebrecht's capital-markets manager.
Brazilians of all ages are worried about the state of the currency. An
anesthesiologist at one Sao Paulo hospital last week began factoring in a
15% devaluation when billing American clients. And in the race for
president at the Escola Coruja school in a middle-class neighborhood,
six-year-old Daniel Llanes is suddenly losing ground to chief rival
Marcello, whose main economic plank is beginning to resonate: "I would
change everything to dollars."
Mr. Cardoso's political fortunes have been tied to a stable real ever since
he introduced the currency in 1994 -- the last in a long succession of
Brazilian currencies -- while he was serving as finance minister. Its success
in restraining the country's chronic inflation and igniting a roaring
consumption boom helped elevate him to the presidency that same year.
Deficit Spending
But tying the currency to the dollar suppressed inflation without eradicating
its underlying cause: deficit spending that was deeply woven into the
structure of Brazil's governing institutions. Throughout his term, Mr.
Cardoso has introduced a series of constitutional amendments aimed at
scaling back profligate state spending, such as a pension system that
begins paying retirees even in their 30s. But the budget initiatives were
either watered down or blocked completely in Brazil's fractious Congress.
"In practical reality," observes former U.S. ambassador Langhorne A.
Motley, "the Congress he has to work with makes the U.S. Congress look
like a Swiss watch." But Mr. Cardoso also draws blame for squandering
precious political capital on less-crucial measures, such as an amendment
allowing him to run for re-election.
Unable to balance the budget, Mr. Cardoso had to continue relying on the
currency peg to restrain inflation. But the longer Brazil went without
devaluing the real, the more its value became distorted.
The government got a foretaste of the risks of overdependence on the
strength of its currency last October, when the first tremors from the Asian
currency crisis reached its shores. Facing a speculative attack that drained
$10 billion from its reserves, the government held the real's value by
boosting interest rates and announcing an emergency plan to slash the
budget.
Poor Follow-Through
But rather than taking this narrow escape as a warning to finally tackle its
chronic fiscal imbalance, the government simply papered the problem
over. Many proposed budget cuts were never carried out. Mr. Cardoso
did move to speed up Brazil's huge privatization program, bringing some
one-shot gains into public coffers. But when that still wasn't enough to halt
the widening of the budget deficit, the government this year simply stopped
releasing unfavorable fiscal data.
After Russia's ruble devaluation and default put investors on edge about all
emerging markets, Brazil found it could no longer sweep its problems
under the rug. Foreign investors in stocks and bonds were the first to flee.
Now, for the first time in the four-year history of the real, Brazilians, too,
have begun to seek the haven of dollars. "The number of Brazilian
businesses looking to protect themselves from a devaluation has increased
with each passing day," says Paulo Mallmann, an economist at Banco
Industrial e Comercial SA in Sao Paulo.
The government's strategy of raising interest rates to back the real is a
double-edged sword. The only way Brazil can place public debt these
days is by linking it to fluctuations in domestic interest rates. The rate boost
raises Brazil's debt-service payments by $3.4 billion a month, placing
further strain on the budget.
Nonetheless, with their painful history of devaluation and hyperinflation,
most Brazilians defend the stable-real policy. "Look at what happened to
Russia and the Asian economies that followed the advice of the market
wizards who told them one small devaluation would fix everything," says
Paulo Ferraz, president of Banco Bozano, Simonsen SA, Brazil's largest
investment bank. "In practical terms, no one has gotten away with a
devaluation."
Rather than even considering a devaluation, Luis Inacio Lula da Silva, the
leftist candidate who opposes Mr. Cardoso in the October election,
advocates exchange controls like those recently imposed by Malaysia. So
far, his proposal has failed to strike a chord with the masses. Polls have
shown that Mr. Cardoso has actually gained support amid the economic
fear as voters cling to the candidate they already know.
In the meantime, Brazil will continue trying to muddle through, much as it
has for the past four years. A crucial test of investor confidence in Mr.
Cardoso's administration comes Tuesday when the government tries to
privatize the electric company, Gerasul SA, seeking a bid of at least $800
million.
A successful sale could be a boost both to Brazilian markets and to Mr.
Cardoso's presidential campaign. Ana Maria de Souza, manager of
Paranoya, a cut-rate women's clothing store on Sao Paulo's vast
downtown pedestrian mall, says she is sticking by Mr. Cardoso even
though sales are already plummeting. "It's not his fault -- it's the Russians,"
she says. "And besides, there is no other choice." |
