The Coming Year: Will Brazil Come Crashing Down?
By Peter Eavis
Senior Writer
1/6/99 3:27 PM ET
Recent troubling developments suggest that Brazil will not make it
through this year without another globe-quaking crisis, which will
probably involve an uncontrolled devaluation of the real.
And that awful fate appears to await the country even though the
International Monetary Fund last year made more than $40
billion available for protecting the currency.
The downward spiral has already begun. Congress late last year voted against important
elements of the fiscal reform package put together by Brazil in return for the IMF cash.
Other crucial budget-cutting measures are getting held up in the machinery of Brasilia. Just
this week, one high-profile governor threatened to withhold payment on his state's debt to
the federal government. Others may follow.
As a result, it's now almost inevitable that the government of President Fernando
Henrique Cardoso will fail to significantly trim its out-of-control budget deficit, which
stands at a burdensome 8% of GDP. High interest rates will continue to strangle the
economy, causing a recession in which GDP may shrink by more than 3% in 1999,
according to some economists.
What does this mean? Government debt will continue to soar. The IMF will likely become
frustrated with the lack of fiscal improvement and -- after much hand-wringing -- slam shut
its coffers, according to some Brazil analysts. If that happens, panic-selling of the real
would force the currency out of its dollar-pegged regime. And Cardoso's gallant but
tactically deficient effort to bring low inflation growth to Latin America's largest economy
would collapse.
Overly pessimistic? Well, consider what's happened since the IMF signed off on its $41.5
billion credit line for Brazil in November last year.
Blame It on Brasilia
In mid-December, the uncooperative lower house of Congress voted down two critical
proposals for increasing taxes on social security payments. These defeats show how
dangerously out of touch Congress really is. The social security system's debts alone add
up to 4.7% of GDP, according to Flemings. The politicians did not have the courage to
grasp this huge nettle -- even though the next House elections are four years away. The
government has said it intends to reintroduce these social security measures this month.
In addition, what was going to be the biggest single measure of the fiscal package -- an
increase in the financial-transactions tax -- will probably not be implemented until the
second part of this year. This could result in a loss of up to $5.8 billion from the $23 billion
that the fiscal package aims to raise.
To make up for this possible shortfall, Cardoso last week introduced a range of new
measures that aim to save $5.6 billion, only a third of which must be approved by Congress.
Tax, Tax and Tax Again
So far, Cardoso's team has fought back from every defeat -- something that should give
confidence to investors. But there's a big problem with its approach. Walter Molano,
economist at BCP Securities, says Cardoso's team is relying too much on tax increases
for its savings, which will hit businesses and therefore exacerbate the recession. "It
would've been much better to announce additional spending cuts," he says.
Molano surmises that Cardoso is reluctant to slash public-sector wages and jobs. He
points out that in 1990 President Fernando Collor faced a ferocious backlash after
announcing big layoffs.
Socialist Nostalgia
But it may be that, at heart, Cardoso is ideologically opposed to such measures. For many
years, he was a New Left guru. The market assumes that he left all that baggage behind
when he entered government earlier this decade. But, as economic hardship and
unemployment grow, he may be rethinking his commitment to free-market ideals. Indeed,
there are already signs that Cardoso is revisiting some of his old theories.
In a speech to visiting South American heads of state Monday, Cardoso railed against what
he calls an "asymmetrical globalization" that only benefits some countries, by which he
presumably means the First World. This sounds suspiciously like Cardoso's old
dependency theory, which, very crudely, says that the interests of developed countries will
override those of the developing world.
Plus, from a technical point of view, it seems odd to favor tax hikes over spending cuts. The
fiscal savings package is based on a 1% decline in GDP this year. But most economists
expect a shrinkage of 2% to 3%. And Goldman Sachs estimates that for every 1% fall in
GDP, tax revenues drop by 0.25% of GDP.
The Hidden Debt Mountain
There's another threat to fiscal targets that the press and most analysts have failed to pick
up on: hidden losses in government accounts.
ING Barings' eagle-eyed economist Arturo Porzecanski points out that the IMF's loan
agreement with Brazil refers to $21 billion of hitherto unrecognized debts from
now-privatized companies, euphemistically termed "unregistered liabilities."
As a result, the government now has to spend all this year's expected privatization revenues
in filling this black hole. But the big issue now is how much more debt is hidden in the
system, according to Porzecanski. "The government faces huge unfunded pension and
other liabilities that make one wonder just how big the iceberg of debt is that the Brazilian
ship of state is running toward," he says.
IMF End Game
Brazil will almost certainly fail to meet the IMF's fiscal requirements this year. The big
question is how the IMF and, more important, the U.S. Treasury will react to this likely
failure.
The IMF wants Brazil to have a fiscal surplus of 2.6% of GDP in 1999 (excluding interest
payments) and an overall deficit, or public-sector borrowing requirement (PSBR), of 4.7%
(including interest payments). However, ING Barings is expecting a PSBR of 7.5% for this
year.
Brazil has already drawn $9.3 billion from the $42 billion IMF package. It can probably get
another $10 billion or so before the IMF starts to balk at giving more money.
But the conditions under which Brazil can make additional drawdowns virtually ensure that
Brazil-IMF relations will become strained in the second and third quarters of this year. In
each quarter, the IMF says that the PSBR must be lower than the same quarter in the
previous two years. Porzecanski thinks it will be the third-quarter target that will be the
hardest for the Brazilians to meet.
If it's missed only slightly, the IMF would be prepared to disburse more cash (assuming
Brazil wants or needs it). But if the numbers are way off, then don't expect the IMF to cough
up. After all, it walked away from Russia in the end, despite all the talk about the country
turning into a nuke-laden Weimar republic.
Many opinions exist as to what would happen if the IMF got tough. The optimists say the
Brazilians would make massive efforts to cut spending -- and fiscal accounts would quickly
look better. Others say that the IMF will demand some sort of controlled devaluation of 10%
to 15%. A weaker currency, it is argued, would allow interest rates to come down and the
economy would get an extra boost from higher exports.
But Latin American countries with their backs against the wall rarely engineer such orderly
escapes. And, regrettably, the evidence available at this stage overwhelmingly suggests a
much nastier outcome. |
