Brazil: IMF prescribes restraint
to avoid real fallout
By Joanne Gray, Washington
The International Monetary Fund has scrambled to calm
markets and pressure Brazil to meet its fiscal reform
promises in the wake of the resignation of Brazilian
central bank governor, Mr Gustavo Franco, and the
effective 8 per cent devaluation of the real.
Brazil's currency devaluation threatens the IMF's most
recent attempt to stop the spread of the emerging
markets economic crisis, and increases the risk of
recession throughout Latin America.
The devaluation of the real, although long-expected,
initially rocked financial markets around the world
because of concern that the global economy could be hit
by another bout of the financial contagion that has
devastated Asian economies and Russia in the past 18
months.Investors feared it would set off further
devaluations in the region, and economists warned that a
further decline in the value of the real would be hard to
avoid, as an estimated $2 billion left the Brazilian
economy in the hours after the devaluation.
The early, panicked reaction to the events in Brazil,
however, had subsided by the opening of Australian and
Asian markets yesterday.
The All Ordinaries Index fell 17.2 points, or 0.6 per cent,
on the day to 2804.8. The Hang Seng lost 1 per cent
while the Nikkei gained 2.5 per cent.
The Australian dollar fell, weighed by commodity prices,
but was underpinned by further signs of strong domestic
growth after the unemployment rate fell to an eight-year
low. The $A closed at US63.11¢ from US63.53¢.
And the IMF plans to discuss the impact of the Brazilian
devaluation for its $US41.5 billion loan package with
Brazilian officials in coming days, the IMF managing
director, Mr Michel Camdessus, said. He urged the
Brazilian Government to meet its promises on spending
cuts and structural reform.
The Brazil package, announced last November, was the
international community's first use of a new tactic to avert
the spread of financial crises. The IMF was given new
powers to give quick access to funds to countries
threatened by massive capital outflows.
Brazil has already received $US5.3 billion in IMF loans,
and in coming weeks can draw on a further $US4.5
billion if it meets the conditions on the package, which
include promises to cut spending.
In a letter of intent to the IMF when signing the
agreement, it described the currency exchange rate, a
soft peg, as "essential to keeping inflation down".
A further devaluation could unleash inflation and
destabilise already jittery world markets.
Chase senior US economist Mr Jim Glassman said: "The
threat of a new currency disorder, that's what we worry
about. It poses a risk to financial markets more generally.
If we are in the midst of a [stockmarket] bubble, what
happens when it bursts?"
The director of the Economic Strategy Institute in
Washington, Mr Greg Mastel, said: "This will be watched
very closely by other countries around the world,
especially China, which could use the Brazilian
devaluation as a pretext or a reason to start its own
devaluation."
The Dow Jones Industrial Average fell as much as 3 per
cent on the news before rebounding to close down 1.32
per cent, or 125 points, at 9,349.56. The US dollar also
fell on concern that Brazil might face a large devaluation.
Latin American currencies and equity and debt markets
fell as investors cut their exposure to the region. Mexico
used an intervention tool to reduce the volatility of the
peso and also drained liquidity from the banking system.
In Chile, the central bank sold dollars. Other countries in
the region raised interest rates.
The Latin America analyst for the G7 Group of economic
consultants, Ms Rowena Dasgupta, said the IMF was
under serious pressure to avert another crisis.
"The IMF has been burned so many times," she said. "It
has lost a lot of credibility and it is under enormous
pressure from the Administration -- the White House and
the Treasury -- to make sure this thing goes off without a
hitch."
Economists said the onus was on Brazilian lawmakers to
grasp the seriousness of the crisis and pass government
spending cuts.
A senior fellow at the Institute of International
Economics, Professor Jeff Schott, said: "If I was a
member of Brazil's congress I'd be scared to death of not
accelerating the reforms for fear of what the markets
might do next."
The Brazilian Congress has baulked at spending cuts and
taxing measures in the face of high interest rates and with
the economy forecast to shrink some 5 per cent this year.
President Clinton said he had consulted with Brazil's
leaders, Group of Seven countries and the IMF on the
situation, and all had an interest in seeing Brazil's reforms
succeed.
The US Treasury Secretary, Mr Robert Rubin, who has
orchestrated the Clinton Administration's response to the
world financial crisis, said that Brazil's decision was an
attempt to "enhance the flexibility of its exchange rate
system".
It was important that Brazil "carry forward the
implementation of a strong, credible economic program".
Economists said they were not surprised by the
devaluation.
"The only surprise here is why it has taken so long," said
Columbia University economics professor Charles
Calomiris. "The plan orchestrated by the IMF was
unlikely to succeed and the execution was never serious."
But he said the couple of months of respite since the
package was agreed in November had given investors
time to hedge positions and spread risk. That could
reduce the chances that this episode will spark market
panics like those that caused massive devaluations in Asia
in 1997 and 1998 and the bond market crisis which
erupted after Russia defaulted on its debt in August last
year.
"That's the silver lining on an otherwise disastrous set of
policies," Professor Calomiris said.
But he said the onus was now on Brazil to deliver. Until
the Brazilian Congress "decides it wants to get its fiscal
house in order, the IMF will be ineffective".
Markets will be sceptical of an attempt at controlled
devaluation if they believe fiscal discipline is lacking.
Brazil may also consider using capital controls to stem the
capital outflow. The Central Bank is estimated to have
between $35 billion to $37 billion in foreign exchange
reserves available to defend the currency, Ms Dasgupta
says.
afr.com.au
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