Brazil Appears Likely to Allow Currency to Continue Floating
By MICHAEL M. PHILLIPS
Staff Reporter of THE WALL STREET JOURNAL
WASHINGTON -- Brazilian officials are expected to announce Monday
that they will continue allowing their nation's currency, the real, to float
against the dollar, a risky move that would ease the global financial crisis
only if markets are convinced Brazil is willing to adopt the tough spending
cuts it has long resisted.
Brazil's finance minister hinted Saturday that he
will ask the International Monetary Fund and
the Group of Seven major industrialized
nations to speed delivery of a $9 billion loan.
That would be the second drawing on a $41.5 billion international credit
line set up in November, when financial officials around the world thought
keeping the real in a set range around the dollar was the best way to
contain global financial panic.
Brazil junked that approach last week, first devaluing the real by 8% on
Wednesday, then letting the currency float on Friday.
This weekend, Brazil's finance minister, Pedro Malan, and central-bank
president, Francisco Lopes, traveled to Washington seeking the blessing of
the U.S. and IMF for a new strategy, a necessity if Brazil has any hope of
restoring the confidence of jittery investors. Brazil irritated its patrons with
its clumsy two-step devaluation, but the U.S. and IMF can ill afford to risk
renewed global instability by rejecting Brazilian appeals, and they are likely
to endorse the new currency plan.
Under that plan, the real would be allowed to move freely against foreign
currencies, although the central bank might intervene if officials feel that its
value sinks too low.
Reflecting the urgency of the Brazilian situation, IMF Managing Director
Michel Camdessus canceled a visit to Africa and Deputy Treasury
Secretary Lawrence Summers abruptly returned from long-scheduled G-7
consultations in Frankfurt to meet Mr. Malan. G-7 nations include the
U.S., Japan, Britain, Germany, France, Italy and Canada.
While financial markets reacted favorably Friday to the decision to float
the real, the move carries huge risks for Brazil, the world's ninth-largest
economy, and most other nations. A falling currency could reignite Brazil's
inflation, deepen its budget deficit and spur further investor flight. Or, it
could give Brazil the time it needs to cut spending, cut interest rates and
restore investors' confidence.
Should Brazil fail to do so, a financial meltdown could spread to Argentina,
Mexico, Ecuador and other Latin American countries, shaking currencies,
forcing up interest rates and deepening recessions. Pessimists fear Latin
America's instability could double back on Asia, where countries are just
starting to climb out of the crisis that began there 18 months ago. Under
the worst scenario, China would devalue its currency to protect its
exports, launching another round of competitive depreciations around Asia
and freezing foreign capital flows.
Facing such prospects, the IMF last week quickly reassured Argentina
and Mexico that fresh financing would be available, if needed, to stop the
contagion.
Brazil's turmoil also threatens to weaken the relative immunity that most of
the U.S. economy has shown toward the global crisis. Brazil is the
11th-largest market for U.S. exports, and 450 of the top 500 U.S.
corporations do business there. Latin America, anchored by the huge
Brazilian economy, bought $118 billion in U.S. products during the first 10
months of last year -- 20% of all U.S. exports.
"Americans five years ago wouldn't have cared what goes on in the
Brazilian Congress," said Robert Hormats, vice chairman of Goldman
Sachs International. "Now their portfolios and their jobs are affected by it."
Goldman Sachs predicts that a complete Brazilian meltdown could lop 0.5
percentage point off U.S. economic growth this year.
Brazil's choices in the currency crisis, however, were limited: a free float, a
new trading band that would further strain the government's credibility, or
an Argentine-style currency board, a major undertaking that would tightly
fix the money supply to the number of dollars held by the central bank.
It is "very brave and probably foolhardy to do anything other than let the
rate float," said C. Fred Bergsten, director of the Institute for International
Economics, a Washington think tank.
Indeed, Mr. Malan praised the float as "a positive step" when he arrived in
Washington on Saturday.
Perhaps, but both IMF and U.S. officials repeated warnings that Brazil's
Congress must adopt painful budget-cutting steps if the country has any
hope of calming investor nerves. "Whatever judgment one makes on
exchange-rate regimes and the rest, it always comes back to one
thing-having sound policies at home," Treasury Secretary Robert Rubin
said Friday.
The old Brazilian policy -- defending the real's trading range with high
interest rates and government spending cuts -- didn't restore investors'
confidence for long. Clinton administration officials still believe it was a
good approach and blame Brazil's failure to cut the budget deficit.
But IMF critics wasted no time in issuing their I-told-you-so's. "We put
Brazil through two years of unnecessary hell on the basis of terrible
recommendations," said Jeffrey Sachs, director of the Harvard Institute for
International Development. Prof. Sachs has been especially critical of the
decision to jack up interest rates to levels that made it hard for Brazilian
businesses to afford credit.
In a sense, however, the plan did the trick during the crucial months after
Russia shook global capital markets in August by devaluing the ruble and
essentially defaulting on domestic debt. A Brazilian collapse back then,
economists agree, could have spooked investors and bankers so much that
they might have refused to lend to all but the most secure borrowers.
Today, the world is somewhat better able to absorb Brazil's troubles.
Many banks already have shored up their balance sheets to insure
themselves against losses overseas, and the U.S. Federal Reserve has
lowered rates three times since September to keep the U.S. economy -- a
critical engine for the rest of the world -- churning away.
That said, the worst-case scenario remains grim. Argentina and Brazil have
close commercial ties in the Mercosur free-trade area, and the
depreciation of the real will put pressure on Argentina to abandon its
currency board, which keeps the value of the peso on par with the dollar.
Such an abandonment, though perhaps unlikely, might make investors
wonder whether Hong Kong's currency board is secure.
China might then feel obliged to devalue, setting off another round of
competitive depreciations around Asia.
"You could have a domino row from Brazil to Argentina to Hong Kong to
China," Mr. Bergsten said. "You'd have reverse contagion from Latin
America back to Asia and you'd have a whole new round of world-wide
crisis."
That is a risk the IMF and the U.S. feel they can't afford to take. |
