WSJ Editorial on danger of devaluation in Brazil:
Devaluation Won't Solve
Brazil's Problems
By MARY ANASTASIA O'GRADY
On Sunday, Brazilians will go to the polls to choose a new president. For the first time in the country's modern democracy, an incumbent will be on the ballot; this made possible by a 1997 constitutional amendment that allows a second presidential term.
After a volatile campaign period, election day looks to be a bit anticlimactic. President Fernando Henrique Cardoso--who between lobbying for the re-election amendment and running for a second term has been de facto campaigning for nearly three years--is leading his closest opponent by at least 15 points in the polls. He is predicted to win with more than 50% of the popular vote, thereby avoiding a second round.
And yet, like in any good Brazilian soap opera, there is still suspense. In this case, thanks to the fragility of the Brazilian real, the drama will play in the days and weeks immediately after the outcome is decided. Mr. Cardoso may prevail on Sunday but his government will still be a long way from victory.
Currencies with weak underlying fundamentals are under attack world-wide. In Brazil, an unsustainable public sector borrowing requirement of 7.5% of gross domestic product is making the popular 1994 Real Plan--which ended hyperinflation by pegging the Brazilian real to the U.S. dollar with a crawling depreciation--a potential casualty.
Mr. Cardoso has pledged to defend the real. If, after the election, he decides he should devalue, the country might well spiral into economic chaos, and all of what he has achieved over the past four years would go with it. For a man known as much for his integrity and concern for the poor as for his statesmanship, it would be a devastating defeat. For Brazilians it would be catastrophic.
Brazil's fiscal position has been steadily declining since last October, but the pressure was exacerbated in August when investors learned that Russian government debt would not be backed by the full faith and credit of the International Monetary Fund. This combined with a deteriorating Brazilian fiscal picture caused a rush out of the real. Since late August the drain on international reserves has been merciless; the reserve position is now about $45 billion, down from $70 billion just two months ago. The outflow has slowed but the crisis is far from over.
The market has been buoyed recently by rumors of financial assistance from the International Monetary Fund; a $30 billion package is one number floating around. But this is merely a calm in the storm; the IMF cannot save the real anymore than it was able to save the peso, the ruble, the baht, the ringgit, the rupiah or the won.
While an IMF loan package might minimize the immediate panic, re-establishing confidence in Brazilian fiscal reform is now the hurdle that the Cardoso government must clear on its own. The market will be looking for a measurable, transparent, Brazilian-built fiscal adjustment package; serious, draconian in scope and fully implemented. If Brazil is not able to convince investors that it has the political will to fix what ails it, the market is likely to use IMF funding solely as a means to exit the real in a more orderly fashion, saving some on Wall Street but leaving the largely poor Brazilian population in even greater poverty.
Brazil has a serious lack of credibility. Its budgetary difficulties vis-à-vis the real go back at least to 1995, when the end of hyperinflation revealed the country's spending chaos. But in a 1996 interview, Central Bank President Gustavo Franco--then the bank's director of international affairs--insisted that the spending trend was in the right direction and predicted that by the end of 1997 the fiscal deficit would be close to 4%.
That goal was never reached and many subsequent promises to cut spending have been followed by increases. Fresh in the minds of investors is last October's crisis, when Mr. Cardoso's government committed to deliver some $9 billion in government spending cuts. Despite revenue increases of 1% of GDP since then, the noninterest portion of the fiscal deficit has expanded by 1.1% of GDP. Rightfully, critics of IMF bailouts are asking why anyone should believe that this time will be different. They fear the Brazilian Congress and the states will follow the same old line of thinking: get the money, delay the reform.
And so, one critical question now is whether reform would proceed more quickly if Brazil did not have IMF funding--especially given the public's traditional antipathy toward the Fund. As important is the question of whether IMF funding to Brazil might have destructive conditionality attached--most notably a requirement to float the real or punitive antigrowth measures like tax increases. It is by no means clear that the IMF has abandoned that kind of medicine, despite its devastating impact in Asia.
Even if the IMF package is properly crafted--1995 assistance to Argentina helped defend the Argentine peso--the fact remains that only the Cardoso government, through serious, and likely unpopular, public sector cuts, can save the real. Moreover, even if some kind of immediate fiscal adjustment materializes, Brazil will still be short of what it really needs to be a world-class player. As Paulo Rabello de Castro, chairman of SR Rating, a Duff & Phelps affiliate in Rio de Janiero, has written: "Curbing the deficit in 1999 . . . may not be enough in the long run." Noting that Brazil has several times in the past reduced the deficit, only to see it eventually expanded again, Mr. Rabello de Castro echoes the concerns of many observers when he says that the country needs a "new fiscal regime . . . a public sector debt bill, a funded social security system and a new tax system that will foster production and savings."
Institutional change that will minimize the political class's capacity for discretionary public spending is a tall order but not too tall for the powerful Mr. Cardoso. If he is elected with a majority he will have the mandate to go to Congress and enact meaningful institutional change. It will be his last chance to save the real and his legacy as a hero to disenfranchised Brazilians.
The Real Plan has exposed the dishonesty of the state. For years, hyperinflation hid a power-hungry compulsion to spend without regard to the costs and added to the general dishonesty in the political economy. It would be a pity if the IMF enabled Brazilian politicians to delay facing that truth and in doing so destroyed the gains of the last four years.
After his re-election, Mr. Cardoso will be under a heavy moral obligation to keep his word. He very well may still be able to save his country if, and it's a big if, he is able to re-establish confidence in his commitment to reform by acting decisively.
|
