Steve-- What pisses me off in this stock(s) is that everything we predicted have come true, and the stock price has dramatically declined. With great anticipation, we waited for the auctions. They went better than expected; we wait for news of telephone income-- it goes well; we wait for the elections -- they go well; we wait for the reform package -- it seems to go well; we now wait for the big loan -- it's happenning. Yet the stock goes down. The enclosed may be the reason; we have not considered currency devaluation as inhibiting big investors.
fred
Brazil: The Virtues and Vices of Devaluation
Ernest W. Brown (New York)
I had a conversation recently with another economist, who will only be identified here as a friend
following Brazil (FFB). The conversation went something like this:
FFB: "I think there's going to be a 15% devaluation in Brazil sometime in early 1999, after things calm
down."
EWB: "You're wacko. There's no way on God's green earth that these guys will devalue."
FFB: "Brazil faces the prospect of years of low or negative growth. I'm not sure that we can stand
this. I think GDP will be close to zero this year and next year, and might not be any better in 2000. A
one-shot devaluation of, say 15%, if successful, would really clear the way for interest rates to come
down in 1999."
EWB: "I think you're right about the bad growth numbers. We see GDP declining 2% in 1999 and
only growing 1% in 2000, which isn't a whole lot better than your 0%. I'm not so sure I agree with
you on the interest rate scenario post devaluation. Won't rates stay high as the market braces for the
possibility of further devaluation?"
FFB: "Maybe for a while. But if they devalue 15% right away, they can slow the rate of
minidevaluation. That means the coupon (the dollar-equivalent rate) can be higher at a lower rate in
reais. That means interest rates can come down sooner."
EWB: "That's true, if the devaluation is successful. How many successful one-shot devaluations have
there been? The currency, with all the deflation, has been devaluing at a 9% real rate. If the current
pace continues, it will devalue at 9% in 1999 as well. That's over 18% compounded in two years. Isn't
that enough?"
FFB: "Well, it isn't as good as a one-shot devaluation of 15%, up front, with all of the adjustment
front-loaded."
EWB: "What about the impact of a 15% devaluation on Brazilian firms levered in US dollars? That
will be really difficult for those guys!"
FFB: "Well, how much easier is it to have the 18% over two years? It'll still be pretty painful."
EWB: "Well...I just don't buy it. I don't think there's anyone in Brasilia or at the IMF or the U.S.
Treasury who's ready to take a step down that slippery slope. The Washington guys are going to
worry about further devaluation elsewhere, Mexico, Asia, and the Brasilia guys are going to worry
about how to stop the devaluation cycle once it begins. Besides, how much is devaluation going to
help Brazil's balance of payments?"
FFB: "Well, I don't know about those people in Washington, but I think you might have a point about
our own technocrats in Brazil being cautious. You're right about trade: it won't make much of a
difference how they devalue."
At the end of the conversation, my friend acknowledged that he had some misgivings about his call.
He remains concerned about the repercussions for the Brazilian economy of a gradual devaluation
scenario and, short of a sharp devaluation, doesn't see any other quick way back for economic growth.
We agree that purely from the economist's point of view, the shortest distance to strong new
economic growth in Brazil is through a successful one-shot real devaluation that permits financial
sector players to assume future devaluation risk is near-zero, allows interest rates to quickly fall and
lending to recommence.
His concern about current growth in Brazil isn't misplaced either. According to press reports,
industrial production declined in September by 2.4%, seasonally adjusted, and capital goods
production took a big hit, no surprise given sky-high interest rates. I certainly agree that growth is
going to be compressed by a continuation of gradual devaluation in Brazil. We're assuming that GDP
declines by 2% in 1999, all of it in the first half of the year. We assume growth of -2% this quarter,
-7.5% in 1Q99 and -4% in 2Q99, followed by 1% growth in the third quarter and 2% in 4Q99. We
look for growth of 1% in 2000. I'm not as pessimistic as my friend about the political impact of
negative growth, in part because I think the recession is going to be front-loaded and, as they say,
"short and sharp." If there's a risk of being wrong in our forecast, it is likely that the recession is
happening sooner than we thought. This should minimize the political risk.
The devaluation question, our dialogue suggests, hinges on the willingness of Brazilian authorities to
shoulder the risk that the cascading effects of a one-shot devaluation will destabilize the Plano Real. It
also depends, but to a lesser degree, on the willingness of the Washington-based lenders to push
devaluation as an issue in their support of Brazil.
It may seem paradoxical, but the willingness of Brazilian authorities to devalue would seem to depend
to a large degree on how successful they are in selling their austerity program in Congress and to the
Brazilian financial sector. The ease with which Washington tries to push devaluation on the Brazilians
will depend on how fragile they believe the global system. The farther away we get from the
precipice, it seems, the more likely we are to hear the word "jump."
For the record, despite all the above, we think the odds of devaluation had been 30% since
mid-August, and think that the recent progress in the Brazilian Congress should be seen as
diminishing the odds significantly, possibly to 20%. This means 80% odds that the real will be at
R$1.20 at the end of 1998, and R$1.30 at end-1999. Our friend "FFB" isn't helping us to sleep any
better, however. |
