By Emad Mekay
WASHINGTON, Jul 8 2002 (IPS)

Brazil faces a high chance of defaulting on its debts by the end of 2003, a threat that could turn Latin America’s largest economy into anther crisis-ridden Argentina, say analysts.

International concern that Brazil could see a financial crisis, defaulting on its debt and sending big portions of its population below the poverty line, has grown recently as the country looks poised to elect a leftist president, Luiz Inacio Lula da Silva, who is the frontrunner for the Oct. 6 elections.

Economists monitoring the Latin American country here say that political turmoil is not the only problem Brazil faces.

“There is something I think to be concerned about in Brazil behind political uncertainty,” said Morris Goldstein, a senior fellow at the Washington-based Institute for International Economics (IIE). “The chances of Brazil having to do a comprehensive debt rescheduling by end 2003 is 70 percent. It’s probably higher if Lula wins.”

Goldstein, who is also devising an early warning system of global crises, says that the recent salvo of statements from the International Monetary Fund (IMF) and officials from the seven most industrialised countries (G7) supporting Brazil, hides a growing anxiety over the country’s performance.

“Until very recently the G7 attitude to Brazil’s difficulty seemed to be ‘never let them see you sweat’. In the last few days, in contrast, there have been several statements of support from the IMF and U.S. Treasury and other sources. If they are not sweating they are at least breathing a little heavier,” said Goldstein, who was one of few economists to predict Argentina’s financial crisis.

IEE’s director C. Fred Bergsten, said he backs the economist’s predictions, because in the last few months Brazil has witnessed a large increase in the interest rate spread on its bonds.

The country’s external debt is at 400 percent of exports while the net public debt is at 45 percent to gross domestic product (GDP), figures reminiscent of Argentina’s on the eve of its declaration of debt default late last year.

In 2000, the Brazilian economy grew 4.5 percent while this year it is forecast to increase only two percent. “Growth slowdowns are bad for debt sustainability, said Goldstein, whose early warning system will evaluate information including: the macroeconomic environment facing banks in a country; its current-account deficit; accounting and legal frameworks; financial liberalisation, and official safety nets.

Although Brazil will maintain a current account deficit of about four percent of GDP in 2002 – the same as in 2000 – the country will receive only about half of the nearly 33 billion dollars in foreign direct investment it got in 2000, said Goldstein.

While Brazil’s volume of exports has increased over the past few years, dropping prices have kept their value low, which hampers the country’s ability to repay dollar-denominated debts. Furthermore, exports remain at only about 10 or 11 percent of GDP, a low level.

But more seriously, according to Goldstein, Brazil needs 45 to 50 billion dollars to finance its external debt in 2003-4. “It’s far from clear where the financing will come from,” he said.

Brazil’s currency, the real – created in 1994 to put an end to three decades of high inflation – is now 20 percent below its 2001 level. The nation’s equity market is also 21 percent lower this year.

The IMF says Brazil is living in the same trouble-infested area as other Latin American countries suffering from contagion of the Argentinean crisis – Paraguay, Uruguay and Chile. Venezuela and Ecuador are also in various degrees of trouble.

A telling measure of looming troubles, according to some observers, was the news late last month that Brazil activated almost all of its existing credit line from the IMF, getting a 10 billion dollar loan.

The situation seems so volatile that even Lula, a staunch leftist, publicly dropped some of his policies and pledged to respect the country’s foreign obligations and stick to terms reached with the IMF.

He said he will also adhere to strict fiscal targets set by the administration of the incumbent president, Fernando Henrique Cardoso.

William Cline, anther economist at the IIE, does not agree with Goldstein’s pessimistic scenario. He says there are major differences between Brazil and Argentina.

Brazil’s floating exchange rate gives it considerable economic strength compared to the previously fixed system in Argentina, argued Cline.

Cardoso has also been following a sensible monetary regime of inflation targeting that makes the prospect of runaway inflation highly unlikely, unlike the previous administration in Buenos Aires, he added.

Another Brazil expert, Riordan Roet of the School of Advanced International Studies (SAIS), said that investors were unduly anxious over the possibility of Lula winning, since he ran four times before without success.

“People are overweighing the possibility of the victory of Lula and under weighing the coalition that (government-supported presidential candidate Jose) Serra represents to come from behind and win the elections,” said the author of several books on Brazil.

Goldstein admits that Brazil has maintained a stable monetary policy that has till now resulted in no signs of significant capital flight or bankruptcies.

“They have been pragmatic policy makers and very capable, who played the cards they are dealt very well,” he said. “Brazil has performed very well under the Fund’s programme. This enhances their credibility.”

Yet, he argues that international economic conditions are not working in Brazil’s favour.

“There may not be G7 investors who may want to cross over into emerging economies,” Goldstein said. “Those may prefer going to China, Mexico, South Korea and, yes, Russian where crisis probability is lower for now.”

Goldstein said that Brazil needs to reduce electoral concerns by getting candidates to further commit to a set of actions, including not defaulting on debt and maintaining a primary surplus for a number of years.

“The debt is sitting there and it’s both external and domestic,” he said. “It’s not that there’s a course of action or events coming in a week or two weeks. It’s more like you’ve got problems that unless you make progress on soon, you can just get down into a crisis ¡ a big one.”

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