WEEKLY SELECTION: Brazil, the Right Decision or Attempted Suicide?

By Mario Osava Reprint | | Print |

Mario Osava

RIO DE JANEIRO, Jan 16 1999 (IPS) - By widening the band in which the real (the local currency) traded, Brazil’s Central Bank made the correct decision Wednesday, according to some analysts – or took one more step toward the abyss according to others.

The psychological torture to which Brazil is submitting the rest of the world was comprised of two blows Wednesday morning.

The first was the resignation of Gustavo Franco, Central Bank president since July 1997 and a staunch defender of monetary stability. The second was the announcement of the new band, an attempt at a controlled devaluation of the real of up to nine percent now, and 12 to 15 percent for the year as a whole.

The first announcement led to stock market losses all over the world, a plunge in the value of foreign debt bonds in developing countries, especially in Latin America, and currency crashes in several countries, like Mexico.

But the measures announced by the new president of the Central Bank, Francisco Lopes, and assurances by President Fernando Henrique Cardoso and Finance Minister Pedro Malan that Brazil’s economic policy would not be modified, cushioned the effects of the catastrophe.

Apocalyptic predictions were not slow in coming. Eduardo Cabrera, chief economist of the Merril Lynch investment firm in Brazil, predicted “the total collapse of Brazil’s economic programme” due to the modification of the exchange rate band in the midst of a financial crisis.

In three or four days, Brazil’s reserves could dwindle down to nothing, said Cabrera, who argued that the country was facing fiscal, not exchange rate, problems. He pointed to the late 1994 meltdown in Mexico and the more recent ones in Asia and Russia, when those countries tried to follow a similar route.

In a similar vein, the leftist Workers Party (PT) forecast the “Mexicanisation” of Brazil.

The party argued that the flexibilisation of Brazil’s exchange rate came too late, and that the serious political and economic crisis would force a major devaluation in the near future, which would once again drive up inflation.

But government officials and supporters of the Cardoso administration were confident that the measure would give fruit, and even some of the government’s critics saw a light at the end of the tunnel, saying the devaluation could lead to a drop in Brazil’s notoriously high interest rates.

The measure is “healthy,” said the president of the Federation of Industries of Sao Paulo, Horacio Lafer Piva, who launched a movement last month, with union support, against the government’s economic policy, arguing that it kept interest rates too high while curbing growth.

Industry would grant the government a 100-day “truce,” announced Sinesio Baptista da Costa, the head of the Brazilian Association of Toymakers.

Antonio Porto Gonzalves, director of the Getulio Vargas Foundation’s Brazilian Institute of Economy, an influential Rio de Janeiro-based research centre, maintained that the devaluation was too small, however.

According to Gonzalves, the exchange rate band should be even wider, from 1.25 to 1.50 reals against the dollar, rather than the new 1.20 to 1.32 reals set by the Central Bank. He cited the reaction by the market, whose demand for dollars had already pushed the rate up to the cap of 1.32 reals.

The Central Bank will have trouble keeping the band within the announced limits, at the cost of a major outflow of reserves and high interest rates. On the futures market, bank interest rates stood at upwards of 60 percent in March and 42 percent in February.

But Lopes is banking on Brazil’s foreign currency reserves, which he estimated at “between 44 and 45 billion dollars,” to sustain the new policy.

The new president of the Central Bank can also count on the 32 billion dollars that Brazil has yet to receive from the International Monetary Fund, development banks and governments of industrialised countries over the next 18 months, 28 billion of which is to be disbursed this year.

Accompanying jitters in the market was a sense of relief, according to economic commentator George Vidor, writing in the daily ‘O Globo’. The widening of the exchange band was seen as indispensable by many authorities and economists, who only had doubts as to the best timing for the move.

The ongoing flight of capital, a persistently high trade deficit, unrenewed foreign credits and political opposition to the fiscal adjustment plan currently being implemented had created an untenable climate, in which it would have been impossible to ward off speculative attacks with a new rise in interest rates, said Vidor.

The moratorium on debt payments to the central government declared last week by the state governor of Minas Gerais, Itamar Franco, aggravated the pessisism worldwide, and helped trigger the decision, according to parliamentary deputy and industrialist Emerson Kapaz.

Tuesday’s meeting of the 18 (of a total of 27) state governors who back President Cardoso, who demanded an urgent slashing of interest rates in order to bolster economic growth and ease the financial troubles of their state governments, provided further pressure toward the modification of the exchange rate band.

The reaction by the market and the evolution of Brazil’s financial situation over the next few weeks will indicate whether Wednesday’s decision was the right solution – or a suicide attempt entailing grave consequences for the global economy.