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Brazil's Ill Winds


News: Analysis & Commentary: GLOBAL ECONOMY

BRAZIL'S ILL WINDS

A recession could spread throughout Latin America

Pedro Malan's image on the TV screen perfectly reflected the somber mood of a country battered by global financial markets. Dark-suited and weary-looking, Brazil's Finance Minister announced $10.8 billion in painful budget cuts on Sept. 8. Four days earlier, the Central Bank had raised interest rates by 10 points. That's not exactly voter-friendly news with national elections looming on Oct. 4. But the economy in Brazil is facing desperate times once again. And President Fernando Henrique Cardoso had to do something substantial to stem the exodus of money and convince investors he is committed to defending Brazil's currency, the real.

As the region's biggest economy, Brazil is the Latin lightning rod for the financial storm triggered by Russia's default and the bankruptcy of much of Asia. If fleeing capital forces Cardoso to devalue the real, other Latin countries--starting with Argentina--will come under intense pressure to follow suit. The result could be economic turmoil throughout the region, wiping out much of the progress toward economic stability achieved in recent years. Multinationals would reconsider their ambitious investment plans for Latin America. And U.S. hopes of forging a prosperous hemispheric free-trade partnership would dim, possibly for years to come.CATCH-22. Even if Cardoso manages to keep the real afloat, the cost will be a sharp economic slowdown, very possibly a recession. Brazil's downturn would stifle the economies of such trading partners as Argentina. That, in turn, could transform the emerging-market crisis into a palpable drag on the U.S.

Brazil is already slowing. High interest costs, now 30% for the Central Bank's key lending rate, and proposed deep cuts in government outlays are depressing corporate investment and consumer spending. Marcelo Carvalho, economist for J.P. Morgan & Co. in Sao Paulo, forecasts a 2% shrinkage of Brazil's gross domestic product in 1999, down from previous projections of 2% growth. For all of Latin America, Morgan is now predicting 0.8% next year, revised downward from 3.4%

The catch-22 in Cardoso's game plan is the sharp increase in the cost of financing Brazil's $260 billion domestic debt. Proposed spending cuts to rein in the government's huge budget deficit, equal to 7% of GDP, are "palliative steps that it hopes will hold until the elections," says Carl Weaver, Sao Paulo-based head of Brazil research for Banque Paribas. "But it's not clear whether it will be enough." Growing worries over Brazil's shaky finances have sent capital fleeing, cutting Brazil's currency reserves to an estimated $59 billion in early September, from a peak of $75 billion last April.

What's clear is that Brazilian business is already headed for the bunkers. Auto makers, a key sector, have already toughened credit terms. General Motors Corp.'s Brazil unit, which exports 20% of its output, has cut back production because of reduced demand in such markets as Venezuela and Russia. Brazil Realty, a real estate developer partly owned by U.S. financier George Soros, has postponed construction of four apartment projects, fearing that higher interest rates will hurt demand. The harsher economy will eliminate scores of companies, from steelmakers to electronics stores. "Only the best will stay around," says Zeke Wimert, chairman of the American Chamber of Commerce in Sao Paulo.

The impact of Brazil's slowdown is already spreading. In Argentina, which sends 30% of its exports to Brazil, forecasts of 6.5% GDP growth this year and 5% in 1999 have been cut to 4.5% and 3.7%. Fiat's Argentine unit, which has 200,000 cars sitting in Brazilian ports, will halt production for seven days this month as Brazilian demand dries up.

Now, looming beyond Brazil's slowdown, is the specter of deflation in a country notorious, not long ago, for hyperinflation. Supermarket prices dropped a head-turning 1.4% in just the last week of August. Overall, consumer prices fell 1% for the month, the lowest in the 45 years in which records have been kept. Price deflation and rising financing costs could quickly lead to layoffs and more economic strife.

Until recently, a major strength of Brazil has been its attraction for foreign direct investment. But economists are already predicting that this year's $20 billion inflow will not be matched in 1999, despite recent commitments by companies such as Dell Computer Corp. and Caterpillar Inc. to expand in Brazil.

Can Brazil right itself and save the other dominoes? Cardoso will have to persuade a reluctant Brazilian Congress to accept his cuts and enact reforms of Brazil's bloated public payrolls, social security system, and inefficient tax structure. And for that, he'll need a strong popular mandate in October. Unfortunately, high interest rates and increased unemployment have never been a great recipe for political popularity.By Ian Katz in Sao PauloReturn to top


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