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ECONOMY-BRAZIL: Crisis Delays Threat of ‘Venezuelan Disease’

Mario Osava

RIO DE JANEIRO, Nov 4 2008 (IPS) - The global financial crisis has corrected the extreme overvaluation of Brazil’s local currency, caused by the policies of its Central Bank, thus temporarily chasing away fears of “Dutch disease”, which in the developing world could well be called “Venezuelan disease”.

The change of name for this particular “economic ailment” in the countries of the developing South is based on the work of the late Celso Furtado (1920-2004), who in 1957 identified the phenomenon of “underdevelopment with abundant foreign exchange” in Venezuela, a unique case in Latin America at a time when the region’s main complaint was the lack of capital for industrial development.

The study by the economist who was the top authority on Brazilian political economy, carried out for the Economic Commission for Latin America and the Caribbean (ECLAC), was just now published by the International Celso Furtado Centre for Development Policies, as part of the first volume of a series based on his personal archives, that includes another essay on Venezuela, written in 1974, and commentaries from other experts.

Furtado’s analysis of the “peculiarities” of the Venezuelan economy identified problems that would only be labeled “Dutch disease” two decades later, said Carlos Aguiar de Medeiros, a professor at the Federal University of Rio de Janeiro, who commented on the two studies by the late economist.

The large amount of foreign exchange generated from exports of a non-renewable natural resource like oil, the price of which is unrelated to production costs, leads to “external overvaluation of local currency” which “tends to disorganise important productive sectors” in a country with a low level of economic activity apart from the fossil fuel sector, Furtado wrote.

Dutch disease, also known as “the curse of oil,” refers to damaging effects on the economy caused by the export of natural resources, which leads to increased inflows of revenues that drive up the exchange rate. This in turn makes the manufacturing sector less competitive.

Luiz Carlos Bresser-Pereira, a former minister of finance and state reform, has been warning since last year that in Brazil, agricultural exports, which have given the country a large trade surplus, are playing the same role as oil in Venezuela and natural gas in the Netherlands.

Brazil posted a trade surplus of 46.5 billion dollars in 2006, which fell to 40 billion dollars in 2007. The surplus was due to agricultural and mineral exports, which compensated for trade deficits in several industrial sectors, such as electronics and petrochemicals.

The consequent overvaluation of the real, the national currency, may be “deindustrialising” Brazil, by reducing the competitiveness of the industrial sector, forcing it increasingly to import components and transforming it into a “maquiladora” – a term for companies in duty free zones that import components on preferential terms and assemble products for export, using cheap labour, without adding value or technology.

This was the apparent trend, but a serious situation of “Dutch disease” will only come about towards the end of this decade if the exchange rate is maintained at the level it stood at three months ago, at just over 1.50 reals to the dollar, Julio Gomes de Almeida, a professor at the University of Campinas and a consultant for the Institute of Industrial Development Studies (IEDI, founded by industrialists in 1989), told IPS.

From 2006 until the first half of this year, “the expanding internal market reduced the impact of the appreciated exchange rate” on the manufacturing sector, he said.

Appreciation of the national currency is “the mechanism through which the disease is transmitted,” but strong growth in domestic consumption “to a large extent compensated” for the overvalued real, he said.

The real stood at around three to the dollar in 2003, but the exchange rate fell to 1.56 reals per dollar in early August this year. If this exchange rate continues, it will cause “severe damage” to industry, according to the economist.

But capital flight, triggered by the international financial crisis that originated in the United States, has led to a sharp depreciation of the real since September. Two weeks ago the real stood at 2.30 to the dollar in Brazil, reaching a value of 2.52 on Oct. 23.

The Central Bank intervened, selling dollars after being authorised to use up to 50 billion dollars of the country’s foreign reserves, which totalled 207 billion dollars in early October.

This had the effect of strengthening the real to nearly 2.10 to the dollar, thanks also to the anti-crisis measures taken in the United States and Europe.

Brazil has had one of the most volatile exchange rates in the world in the past three months, if not the most volatile, with sharp rises and falls in the value of the real within the space of a single day.

These are “devastating blows” that damage business and cause losses at a moment’s notice, since “all the big companies have debts in dollars,” and the benefits of the devaluation of the real for exporters “will only be felt in the long term,” Almeida said.

Many Brazilian companies have speculated on future exchange rates, wagering on a continued overvaluation of the real. This could cause huge losses and aggravate the impact of the crisis in Brazil.

In any event, Almeida said the crisis brought about a “correction” in monetary policy, which seemed “to actually be wishing for Dutch disease” by allowing speculative capital to enter and exit the country freely, something that is not permitted in other emerging economies. When the present turmoil has been overcome, some restrictions, however temporary, will have to be imposed, he said.

Now “a new international and national economy has been born,” and the excessive overvaluation of the real has been left behind, although it remains to be seen what the exchange rate will be when the crisis is over, the economist said.

His concern now, he added, is that at some future time, which the financial crisis has possibly delayed for several more years, Brazil might become a major oil power, exporting the large reserves that were discovered this year thousands of metres below the surface of the Atlantic ocean, under a salt layer, some 250 kilometres off its southeastern coast.

The creation of a fund similar to Norway’s is being discussed, to convert oil riches into benefits for the entire population, especially future generations, by investing in education and so avoiding “the curse of oil” and “Dutch disease”.

But “Brazil is not Norway, and it will be more difficult here” to develop the capability to “make oil a source of development,” Almeida concluded, suggesting that Brazil is closer to Venezuela, and not just in geographical terms.

In the 1980s, Furtado took many by surprise when he said that it was lucky that Brazil lacked abundant fossil fuels. At that time the country was experiencing, as well as a return to democracy, the “lost decade” caused by foreign debt that was largely due to the increase in oil prices in the 1970s.

Brazil was then importing three-quarters of the oil it consumed, but people had not read Furtado’s studies on Venezuela.

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