New York Times, September 27, 1998
By Louis Uchitelle
With the Clinton administration and the International Monetary Fund taking the lead, a package of loans for Brazil, likely to total more than $30 billion, is gradually being put together to limit the damage from the Asian crisis to Latin America's biggest economy. But the bailout plan is a calculated risk: Rather than save Brazil, it could sink the country into deep recession.
The stakes for Americans are considerable. The huge Brazilian economy dominates Latin America, which in turn purchases nearly 20 percent of America's exports and is host to thousands of American-owned factories, whose sales and profits contribute significantly to corporate America's bottom line. A sharp cutback in the flow of all this income, coming on top of a similar blow from the Asian crisis, might reduce economic growth in the United States to a crawl.
Now that Asia and Russia have been flattened, Brazil is suddenly the new front line in the struggle to halt the spreading financial crisis, with its power to pull down markets and plunge countries into recession. If Brazil goes down, then Europe or the United States would become the next battlegrounds.
"It is very clear from the statements being made by top officials in the Clinton administration that Brazil is fundamental to the system," said Desmond Lachman, an economist at Salomon Smith Barney, a Wall Street firm with money at risk in Brazil. "There is just no way they can allow Brazil to fail."
The whole purpose of the proposed loan package is to preserve the present value of the Brazilian currency -- the real -- avoiding the steep devaluations that have been so ruinous in Asia. Because Brazil spends much more on imports and other overseas purchases than it earns from exports, it must finance these overseas purchases by continually borrowing money abroad. That is not easy, given that foreign lenders are increasingly nervous about putting money into any country showing signs of difficulty. Since mid-summer, these lenders have gradually withdrawn money from Brazil.
The hope is that the huge loan package will reverse these withdrawals, particularly if it is combined with austerity measures already initiated by Brazil's president, Fernando Henrique Cardoso. Confidence in the Brazilian economy would revive and fresh foreign money would enter the country.
But obstacles are looming. The U.S. government, for example, might participate in the proposed loan package. But rather than ask Congress for the money, the Clinton administration might ask the Federal Reserve to make the loan from its resources, or it might tap the same emergency fund that it used in 1994 to help Mexico through its crisis. Both possibilities are reported to have arisen in the preliminary loan discussions. And both are likely to draw the ire of Republicans in Congress, who challenged the administration in 1994 for risking taxpayer money without congressional approval.
Private sector lenders are also being asked to participate, and some are clearly reluctant. "Anything that boosts confidence in emerging markets we would regard as positive," said Andrew Tuck, a Chase Manhattan spokesman. "But as far as stepping up to the plate and putting up more money, we have $4.3 billion outstanding in Brazil already, and we cannot dig into our pockets every time someone asks for a handout."
The proposed loan package would be openly negotiated only after next Sunday's presidential election in Brazil, and only if -- as expected -- Cardoso is re-elected. Nevertheless, a senior Clinton administration official acknowledged on Friday that active discussions are already in progress with the Brazilians, the IMF, other governments and private sector lenders. He added, however, that "the speculation about the contents of a package are way ahead of reality."
The preliminary loan package, according to interviews with people involved in the talks, has taken this form: The IMF would put up $10 billion or so, borrowing the money itself if its existing reserve is inadequate. The World Bank and the Inter-American Development Bank would add roughly $5 billion apiece. The governments of the largest industrial countries, or some of them, would each contribute sizable, but so far unspecified amounts. And when these loans were in place, the private sector lenders, as a demonstration of their confidence in Brazil, would agree to roll over existing loans, and add roughly $10 billion.
Still, a giant loan package may not be sufficient to save the Brazilian economy, even if it is combined with the sort of cutbacks in government spending that Cardoso has already initiated. The Brazilian real must also be devalued, this argument goes, by 15 percent or more.
The reason is that the real is overvalued. An American-made toothbrush that sells in the United States for perhaps $1, sells in Brazil for the equivalent of 75 cents, while a Brazilian-made toothbrush sells in both Brazil and the United States for more than $1. No wonder foreign goods flood into Brazil, swamping Brazilian exports. No wonder there is so much demand for foreign loans to finance the resulting trade deficit.
No one is more outspoken on this issue than Jeffrey Sachs, director of the Harvard Institute for International Development, and a persistent critic of IMF practices. The proposed loan package is fine, he says. So are Cardoso's austerity measures. But neither will work without a 25 percent devaluation of the real. Many economists agree with Sachs in principle, but favor a smaller devaluation, say 15 percent.
"The Brazilians are suffering today from slow economic growth," Sachs said, "in part because they have been trying for months to defend an over-valued currency."
The issue is interest rates. In the midst of a worldwide financial crisis, foreign banks and other foreign lenders have grown increasingly reluctant to put money in a country that might soon have to devalue its currency. Brazil's hard currency reserves have dwindled to $50 billion from $75 billion in recent months as foreign money is withdrawn from the country. And part of the $50 billion could soon depart, as repayment for $49 billion in loans from foreign banks that have come due this year.
To keep the money in the country -- and also discourage Brazilians from converting their reales to dollars and depositing billions abroad -- Cardoso has doubled interest rates since midsummer, to more than 40 percent. At so high a level, Sachs argues, economic activity is discouraged and the already sluggish Brazilian economy will soon find itself in a severe recession. Devalue the currency, he says, and interest rates can be lowered.
The IMF and the Clinton administration are counting on the giant loan package, along with Cardoso's spending cutbacks and the high Brazilian interest rates to restore the confidence of foreign lenders before a recession can take hold. They resist devaluation on two other counts. It would end Brazil's fixed exchange rate, and that could frighten Argentina, and even Hong Kong -- two other countries still keeping to fixed rates.
And, they say, while the real may indeed be overvalued, any attempt at a limited devaluation could get out of hand in the current panicky environment. The real would then plunge in value, bringing the Asian crisis full-force to Latin America.
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