Businessweek Archives

Brazil: It's Getting Worse


International Business: Brazil

Brazil: It's Getting Worse

Can Cardoso find a way out of the crisis?

In a one-room plaster and wood home in a slum in Recife, a city 1,500 miles north of Sao Paulo, Expedita Monteiro frowns as she discusses her fears about Brazil's growing economic turmoil. Monteiro makes less than $100 a month as a maid for two local doctors, and she washes laundry on the side. With the economy slowing and prices rising, she's worried that she won't be able to afford the beans and rice to feed herself and her three children. "I remember from the past what can happen," she says.

From poor neighborhoods to giant multinationals, Brazilians are hunkering down for what could be their most painful economic period since the debt crisis of the 1980s. Five years after President Fernando Henrique Cardoso conquered hyperinflation with a new currency, the real, Brazil's great economic experiment looks close to unraveling.

Nearly all the country's economic indicators are going haywire. The real has fallen 35% since Cardoso allowed it to float freely on foreign exchange markets in January. Prices rose 3.6% in February alone, making hyperinflation a real danger once again. To shore up the currency, the government has been hiking interest rates sharply. That is plunging the country into deep recession, with the economy expected to shrink by 3% to 6% this year. Soaring rates also mean that Brazil even runs the risk of eventually defaulting on its ballooning $170 billion in domestic debt. And although the International Monetary Fund announced a $4.9 billion loan for Brazil on Mar. 8--the latest tranche of a $41.5 billion package agreed to last November--the funds are unlikely to reverse for long the flagging confidence in Brazil's currency and economy.

At stake is nothing less than the hard-fought gains Brazil has made since it began to open its economy in the early 1990s. Cardoso's anti-inflation drive had allowed an estimated 30 million impoverished Brazilians to save money to buy consumer goods. Economic stability spurred multinationals from General Motors Corp. to Wal-Mart Stores Inc. to invest $53 billion from 1996 to 1998, giving them a stake in the country's success. Long-protected Brazilian businesses whipped themselves into shape to compete with cheap imports. And Cardoso privatized scores of state-controlled companies, from banks to the phone system.

Now, inflation threatens to turn back the clock. If Cardoso cannot control prices, Brazil will find itself "going back to a very different kind of economic model," says Albert Fishlow, a Latin America expert at the Council on Foreign Relations in New York. Inflation rates of 50% or more could again become the norm. That would spur workers to demand wage indexation--a tool used in the early 1990s to keep salaries in line with inflation. Local companies would be tempted to play speculative financial games, rather than bolster competitiveness. And inflation would dash the aspirations of lower-income Brazilians to join the middle class.HARD HIT. The tumult in Brazil could cause tremors far beyond its own borders. J.P. Morgan is already predicting that Latin America's economy this year will slump by 2.3%, compared with growth of 2.3% in 1998. The downturn deals a blow not only to local companies but to U.S. and other foreign corporations that have invested heavily in the region. Moreover, if Brazil's economy spins out of control, forcing the government to default on domestic or foreign debt, foreign banks active in the country--such as Citigroup--could take a hit.

Cardoso and his new Central Bank chief, Arminio Fraga, will do all they can to prevent such a profound reversal. The government says it has no intention of defaulting. Fraga and Cardoso are also betting that weak domestic demand will discourage Brazilian companies from raising prices. Moreover, on his first day on the job on Mar. 4, Fraga increased overnight interest rates by six points, to 45%. The real strengthened 4% the next day. But every one-percentage-point hike in rates lifts the cost of servicing the government's debt by $2 billion a year. Some $31 billion in domestic debt matures in March and April.

Brazilian companies and people are increasingly feeling the pain. Unemployment in Brazil is running at 8%--a 15-year high--and in Sao Paulo it has soared to close to 20%. As he battles inflation, the best Cardoso can hope for is a short--albeit deep--recession. If Cardoso makes all the right moves, economists say, Brazil could come out of its crisis much as Mexico emerged from the aftermath of its 1994 peso devaluation. By the end of this year, in this optimistic scenario, Brazil could be enjoying renewed growth with a stabilized real.

But to do that, Cardoso must take tough decisions now, and the markets must back him every step of the way. He must convince his unruly Congress and Brazil's 27 states, many of which are run by his political opponents, that severe measures are necessary to keep a deep recession from turning into economic chaos. Cardoso is toeing the IMF line, embracing its prescription of higher interest rates and budget cuts. So far, Congress has approved key tax increases and spending cuts, and by the end of March, it is expected to vote on a financial-transactions tax. But many believe that Cardoso will have to go much further to restore credibility to the real.

Business leaders criticize Cardoso for not taking radical moves to fix the country's deeper economic problems earlier. A year ago, Brazil had $75 billion in reserves. A record $26 billion in foreign investment poured into the country in 1998. But instead of pushing ahead with reforms, Cardoso turned his attention to getting reelected. "Brazil missed a window of opportunity to move forward, and now it's paying the price," says Hermann H. Wever, president of the Brazilian unit of Germany's Siemens.

Faced with continued uncertainty about the real, companies are delaying investments and strategic decisions. Others are boosting prices. Sadia Concordia, Brazil's largest producer of processed foods, says it will raise prices by up to 18% because of the higher cost of imported raw materials. Brazil's airlines, including national carrier Varig, plan to hike fares by 20% or more. Meanwhile, soaring rates are slamming the auto industry, which represents 12% of Brazil's $500 billion gross domestic product. Auto sales crashed by 50% in February. Ford Motor Co. wants to slash 2,000 jobs through voluntary retirement.

The one good bit of news on Brazil's horizon is its growing trade surplus. Exports are expected to rise about 7% this year, to $55 billion, while imports could plummet by 22%, to $45 billion. Last year, the country had a trade deficit estimated at $6.5 billion. But the surplus would be higher if Cardoso could regain the credibility of commercial banks that have largely cut off trade financing recently.

However Cardoso plays his cards in the weeks ahead, the big losers will be millions of ordinary Brazilians. Many will feel the pressure both of rising prices and joblessness. Like Expedita Monteiro and her family, they are watching and waiting to see if Cardoso can steer Brazil through the storm.By Ian Katz, with John Kolodziejski, in Sao Paulo and Kelly Candaele in RecifeReturn to top


Too Cool for Crisis Management
LIMITED-TIME OFFER SUBSCRIBE NOW
 
blog comments powered by Disqus