The Economy
of Chaos

On January 15, Brazil's Central Bank lifted its foreign exchange trading band and allowed the country's currency, the real, to float freely in the market. The abrupt decision triggered a 50 percent devaluation of the currency, signaling the end of the Real Plan, credited with bringing a four-year period of unprecedented stability to the often turbulent Brazilian economy. Aimed primarily at taming the hyperinflation that plagued Brazil for decades, the plan's mentors had adopted, among other measures, a strong currency and strict exchange rate policies, and thus succeeded in bringing inflation down to historical low levels.

However, from the beginning of the plan's implementation, financial analysts had criticized the real's artificial strength, and had consistently advocated a currency devaluation. Although President Fernando Henrique Cardoso's economic team conceded that the currency was overvalued, government officials pledged not to devalue the real until the much expected fiscal reforms had been approved by Congress. By reneging on its pledge without a warning, or even a single explanation to the nation and to the international community, not only did the government lose its credibility, but it also sparked a new wave of speculation and rumors, which in turn fueled an upsurge in capital flights from Brazil. In the first three weeks of January alone, $8 billion had fled the country.

The government's lack of definition as to the future of its economic policies led, among other things, to a collective hysteria on January 29. Amidst rumors of an imminent bank holiday, which might result in the confiscation and freezing of the populace's assets, Brazilians rushed en masse to the banks, and frantically withdrew their savings from their financial institutions. Although the rumors proved to be unfounded, the threat seemed too real to the alarmed Brazilians, whose memories of the unexpected asset freeze imposed by former President Fernando Collor de Mello in 1990 are still vivid in their minds.

As a result, the Black Friday, as it was dubbed by the local media, left the nations' banks with a shortage of money never seen before. Bank of Boston's two branches in the city of São Paulo ran out of money before day's end, while banks across the country faced a similar scenario. Banco Itaú, Brazil's second largest private bank behind Bradesco, had an average shortage of $R13 thousand at each of its 992 branches.

Adding to the chaos, the Central Bank raised interest rates from 32.5 percent to 37 percent, hoping to prevent a rebound of inflation and, at the same time, to try to reverse the trend of increasing capital flights. Instead, the hike on interest rates, in addition to the currency devaluation, only fueled speculations among investors and international agencies as to the government's ability to repay Brazil's dollar-denominated debt—approximately $90 billion in foreign debt and $177 billion in domestic debt.

Eventually, the cantankerous and often self-serving Brazilian Congress approved unpopular, albeit necessary, measures aimed at slashing the budget deficit by means of cuts in social security pensions and benefits for both retired and current civil servants. The measures, which had been defeated in four earlier attempts, were only one of the steps of a broader fiscal reform that aims to cut Brazil's deficit almost in half this year.

Unfortunately, the approval of the social security reform was too late to avoid the drastic currency devaluation. The real's devaluation was supposed to happen in an orderly manner only after the whole fiscal reform package had been successfully implemented. Nevertheless, President Cardoso scored good marks with the international community by showing that his political skills are in good shape as he managed to convince Congress to approve the much needed social security reform. Opposition leaders, however, have continually accused Cardoso of selling out Brazil to the International Monetary Fund (IMF), U.S. banks and foreign investors.

The Soros
Connection

Criticism grew stronger when on February 2, Armínio Fraga Neto, a top aide of billionaire investor George Soros, was suddenly appointed as the new Central Bank president. Fraga, 41, Carioca (a Rio de Janeiro native) and a Princeton University graduate, replaced Francisco Lopes just a week after the latter had been confirmed in the job. His nomination drew praise from investors both at home and abroad while outraging Cardoso's opponents. Itamar Franco, a former Brazilian president and currently the governor of Minas Gerais state, expressed his opinion on Fraga's appointment by declaring to the local media: "Brazil has a new Finance Minister - Fischer - and a new Central Bank president - Soros. Now it will be much easier to renegotiate our foreign debt. All we have to do is perfect our English."

The reference to Fischer (Stanley Fischer, first deputy managing director of the IMF) was due to the timing of his visit to Brazil for talks with government officials about the $41.5 billion rescue package signed last November with the IMF. Fraga's nomination came shortly after Fischer's visit, which left the government open to criticism that the IMF had played a role in his appointment.

On the other hand, Franco himself has been accused of precipitating the current crisis when in the beginning of January he decided to halt Minas Gerais' debt payment to the federal government, sending shock waves to the financial markets, which in turn forced the devaluation of Brazil's currency. The standoff between Franco and the federal government remains, with the addition of seven other state governors who have joined forces with Franco.

Unfazed by all the reshuffling at the Central Bank—Fraga has become the bank's third president since January 15—and by the tug of war between governor Franco and president Cardoso, the average Brazilian is nonetheless wary, as a return to inflation seems to be inevitable. Analysts have already predicted an inflation of roughly 12 percent for this year, while last year Brazil posted deflation of 1.8 percent. Just to have an idea, car manufacturers have raised their prices twice since the real's devaluation in spite of sluggish sales.

Better to
Export

The electronic industry has increased prices by 30%, leading retailers to postpone new orders—subsequently, consumers are already having problems finding some brands of VCRs, TVs and sound systems. The same problem can be found in other areas, such as construction supplies and raw materials. Manufacturers argue that, unless retailers and consumers are willing to accept price adjustments of at least 20%, they might as well export their goods and profit 40% to 50% more, as the new exchange rate has turned exports into a favorable business again. Worse yet, the price of the basic food basket has increased in at least thirteen state capitals.

Following the implementation of the Real Plan in 1994, the government lifted barriers on imports, a strategy that proved successful in holding the prices of local products down. Now, with the currency devaluation, imported commodities, such as meat, wheat, dairy and others, which have flooded Brazil's supermarkets in the past five years, had their prices in dollar readjusted by nearly 50 percent.

Not surprisingly, President Cardoso has suffered a serious loss of credibility and his popularity has reached an all-time low. According to a nationwide poll conducted by polling institute Datafolha for the daily Folha de São Paulo, 61 percent of respondents believe Cardoso deceived voters during his reelection campaign. The survey also found that 36 percent of Brazilians rate the president's performance as bad, compared to 21 percent who think he is doing a good job, and another 39 percent who consider his performance average. The poll, conducted on February 3 and 4, questioned 2,076 people aged 16 and over, and had a margin of error of plus or minus 2 percentage points.

The question now is: "What's next for Brazil?" At this time, there are no sure answers. In the short run, recession and growing unemployment seem inevitable. However, those same factors could be the deterrent to Brazilians' inflationary instincts, as they would force retailers to keep prices down.

The government faces yet another dilemma: how to lower the sky-high interest rates without jeopardizing the currency stabilization and without a return to inflation? While high interest rates may help restrain inflation, the domestic debt—65 percent of which is linked to floating market interest rates—has ballooned to 8 percent of gross domestic product since the latest hikes on rates. Conversely, the current account deficit—approximately 4.4 percent of GDP—is expected to narrow, as the currency devaluation will boost exports and lower demand for imports, which have become more expensive.

All told, Brazil's current crisis may have been best described by assemblyman Roberto Campos in his farewell speech to the Chamber of Deputies (Brazil's Lower House). Former Brazilian ambassador to the United States, former senator, and one of Brazil's most respected economists, Campos complained about the mesmice (tedious repetition) of the country's problems. He reminded that in 1983, when he was elected to Congress, the crucial issues debated then were default and recession. "Sixteen years later", he said, "the pressing issues are once again recession and currency crisis."

"Brazil has a past of having a great future", he added, leaving Brazilians to wonder if that great future will ever materialize.

Marta Alvim is a Brazilian journalist, freelance translator and interpreter. You can reach her at mltdalvim@yahoo.com  

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