Brazil: the real roots of the crisis

Like Uruguay, Brazil has become the recipient of an IMF bailout after a dramatic US policy reversal. While the crisis facing this Latin American giant has been fuelled by the Argentinian crisis and political uncertainty arising from the market’s fears of the election into office of a left-wing president, the roots of the country’s crisis go deeper.

Adhemar S Mineiro

THE financial crisis in Brazil seems to be only a new - and maybe a more dramatic - chapter of a longer story called the ‘Plano Real’1, which began eight years ago, within a framework of a balanced budget, external trade surplus (‘superavit’) and economic growth. On 1 July 1994, when the new currency called the real was created, R$1.00 was valued at US$1.00. One month after the creation, US$1 fetched R$0.80, approximately. On 1 July 2002, the value of the Brazilian currency was estimated at R$2.90 per each US$1, and on 24 July, it reached R$3.00!

Just what is happening to the Brazilian economy? Will Brazil follow in the steps of Argentina? And, with impending elections this year in Brazil, what economic scenario awaits the next government?

Structural fragilities

The indicators for the Brazilian economy in the seven years from 1995 to 2001 show an economy that has stagnated and been subjected to turbulences due to structural fragilities in public finance and the external sector (see Table 1 on p.26). The indicators show also a remarkable difference between the period from 1994-1998, and the following period, from the middle of 1998 on. In the second quarter of 1998, a huge capital outflow and a new set of agreements with the IMF and the World Bank, together with the hard devaluation of the national currency in the beginning of 1999 (in spite of the agreements with the international financial institutions), revealed clearly, for the first time, the fragilities of an economic model of price stabilisation, financial and trade liberalisation, combined with explosive increases in internal and external debt.

At the beginning of July 2002, the internal debt reached about 60% of the GDP, with one-third of this debt in the form of public bonds indexed to the North-American currency. This means that the faster the real devalues the higher the public debt increases. And about one-third has to be paid or rolled over in the next 10 months (or, in less than a year, Brazil has to pay or roll over about 20% of its GDP in public bonds). This is no easy task, and the financial fund managers know it.

On the other hand, the macroeconomic management model adopted since 1994 presupposes persistent inflows of capital to balance the current account deficit of about 4% to 5% of the GDP. This is not so easily realised even in normal conditions and can become extremely complicated in a situation of international financial uncertainty and the default of Argentina, Brazil’s main trade and geopolitical partner - a fact well known to those who manage the international flows of capital.

The situation today is even more difficult than it was four years ago, when Brazil suffered a speculative attack and lost in six months US$35 billion. In June 1998, Brazil had about US$70 billion in reserves, and this stabilised to about US$35 billion in the first three months of 1999. At this moment, Brazil’s total level of international reserves is equivalent to the US$35 billion that went out in the second quarter of 1998 (in May, the international reserves were equivalent to US$32.9 billion, according to the Brazilian Central Bank). This indicates an increased fragility in dealing with a new speculative attack - and, unfortunately, those who can profit from this fragility are very watchful of the situation.

Going the way of Argentina?

As elections are forthcoming which could alter the political scenario, the question posed is if Brazil could go the way of Argentina. There are, in essence, enormous similarities between both countries in their recent economic choices - trade and financial liberalisation, increased privatisation processes, increased dependence on international inflows of capital, high internal interest rates, agreements with the IMF, budget cuts, high unemployment rates and increasing social crisis.

But, on the other hand, the management of the same policies has been different in each country. Argentina seems to have gone too far with those policies, and that was the reason why the country was the enfant gatŽ of the international financial institutions until the economic crisis reared its ugly head. For example, Argentina maintained for 10 years a rigid system of convertibility between the Argentine peso and the US dollar at a parity rate of one to one. Brazil has never gone so far.

Argentina lost an opportunity to legitimise an option to the former economic model which led to its default, when the main political parties and the main candidates in the last presidential and congressional elections all sang the same tune, promising not to change the main pillars of the adopted economic model. In Brazil, which is at this moment facing presidential and congressional elections, all candidates are promising changes in the macroeconomic management and most of them are defending changes in the general economic direction - but it is also true that, due to very strong pressure exerted by the financial markets, the main candidates are also compromising themselves to respect the former rules and to lead the changes in negotiations with the financial representatives and capital market concerns, in a kind of transitional period - whatever this transition means2.

Market interests

Some vested interests representing the financial markets have been insisting since the beginning of this year that the economic turmoil Brazil is facing is largely due to the intention of the main opposition candidates to change the model. These interests are therefore using the crisis to negotiate conditions which are more favourable to their interests or a longer transition. They have in the past often insisted on maintaining the ruling president of the Brazilian Central Bank, or the conditions of the actual agreements with the IMF, in order to guarantee a more peaceful transition.

But it is obviously forgotten that, four years ago, when Brazil’s current president Cardoso was re-elected, he was the candidate who had gained the confidence of the financial markets; and yet there were huge turbulences, and the country lost US$35 billion in six months. He won the election only to implement two decisions he had during his campaign denied he would implement - a new agreement with the IMF and the devaluation of the national currency. In fact, as in 1998, the turbulences the Brazilian economy is now facing are due to its own fragilities and vulnerabilities, and the future president has, in this campaign period, the opportunity to legitimise an alternative path for the country.

Path to growth and distribution

While this alternative cannot avoid the crisis, which is already going on, it can distinguish the Brazilian case from that of its southern neighbour Argentina. Specifically, the three main opposition candidates at this moment, Mr Luis In‡cio Lula da Silva, Mr Ciro Gomes and Mr Anthony Garotinho3, face the challenge of confronting the short-term economic crisis and the pressures emanating from the financial interests and constructing a different economic model, one which deals with the social crisis by retaking the path towards economic growth and redistributing income and properties.

This is not easy as it entails a confrontation with entrenched powerful interests, but it can represent a democratic perspective of tiding over the turbulences. Otherwise, Brazil could face the same fate as Argentina, or the end of the democratic path - or both.               

Endnotes

1 ‘Plano Real’- the Real Plan -which name is attached to the new Brazilian currency, the real, created in July 1994, is  a Brazilian stabilisation plan launched in 1993-1994 which consists of a combination of trade and financial liberalisation, simultaneously with the determination of an overvalued exchange rate, making use of ‘cheap imports’ to force a quick movement backwards of prices; at the same time capital inflows are used as a resource to deal with the current account deficit provoked by the combined measures.

2 The cases of South Africa, when former president Nelson Mandela rose to power, and South Korea, with the entrance to office of President Kim Dae Jung, are frequently evoked to illustrate the idea of economic transition.

3 Mr Luis In‡cio Lula da Silva is a member of the Workers’ Party (PT), and the candidate of a coalition including two communist parties (the Communist Party of Brazil - PCdoB - and the Brazilian Communist Party - PCB), the Liberal Party (PL) and the National Mobilisation Party (PMN). Mr Ciro Gomes is a member of the People’s Socialist Party (PPS) and the candidate of a coalition called the Labor Front, which also includes the Democratic Labor Party (PDT) and Brazilian Labor Party (PTB). Mr Anthony Garotinho is the candidate of the Brazilian Socialist  Party (PSB).                                            

Adhemar Mineiro is a Brazilian economist.