The Globe and Mail Monday, February 1, 1999

Brazil: a test of IMF's new tactics
ANOTHER FAILURE?

HEATHER SCOFFIELD
Although the multibillion-dollar bailout was supposed to be pre-emptive, some say it has only benefited speculators, and has failed to stabilize the economy or help Brazilians.

Brasilia -- When the International Monetary Fund put together a $41.5-billion (U.S.) bailout for Brazil last November, it was supposed to be the new and improved IMF at work -- an IMF that was flexible, realistic in its demands, socially conscious and sensitive to national politics. But Brazil's markets are now trading on panic. Almost $9-billion has fled the country since the beginning of the year. The currency has lost almost 40 per cent of its value. Interest rates have been hiked three times in a week. The treasury's reserves are slipping away and an inevitable recession is now expected to be deeper and longer than first thought.

IMF and Brazilian officials met during the weekend to assess the crisis, but the country was quickly running out of options.

Analysts say a rescheduling of the country's debt seems just around the corner, unless the volatility stops of its own accord.

It's clear Brazil will not be able to meet its IMF commitments.

"It's obvious that we have to revisit the targets and the numbers that we reached with the IMF in November of last year," said Marcos Caramuru, the secretary for international affairs in Brazil's Ministry of Finance.

Is this another IMF failure?

Definitely, says Giorgio Shutte, an analyst for a large chemical workers' union in the heavily industrialized area around Sao Paulo.

"It just didn't work. The money is still going out of Brazil," he said in a recent interview. "This plan didn't do anything for us."

All the IMF injection has done is give more profit to speculators, rather than stabilize the Brazilian economy or help regular Brazilians, said Itamar Franco, a former Brazilian president who is now the governor of the state of Minas Gerais.

Mr. Franco brought the Brazilian currency tumbling down after he announced a 90-day moratorium on his state's debts to the federal government.

"I don't have good thoughts about the IMF," Mr. Franco said in an interview last week in Belo Horizonte. "They have regressive policies, and I'm very sad to see that Brazil has to look to them to solve our problems."

Brazil's crisis will no doubt continue to fuel some critics of the IMF, who have blamed the fund for political unrest in Indonesia, chaos in Russia and volatility in Asia. International financier George Soros has already weighed in with criticism of the Brazil package, too.

But many analysts say Brazil's growing turmoil cannot be blamed on the IMF. In fact, they say, the IMF was more flexible this time around, and Brazil's crisis has more to do with its own domestic policies -- coupled with an utter lack of confidence in foreign investment -- than it does with the IMF.

For the IMF, the Brazil bailout was a break from the past because it was designed last November to be pre-emptive, rather than disaster relief, said political science professor Jose Augusto Guilhon Albuqueque, director of the international relations centre at the University of Sao Paulo.

And Brazil, not IMF officials, designed the content of the program, he said.

"They self-imposed their own policies. The government didn't accept anything it wasn't prepared to accept," he said. "Their [the IMF's] policies were consistent with the government's policies. What they're demanding of the government is to be more consistent with its own policies. To be stringent."

The Brazilian package was far from the strict restructuring of financial institutions and monetary policy that the IMF demanded of Asia and Russia.

Brazil committed to macro-eco nomic stability and to maintaining monetary discipline, including a fixed trading range for the currency. It also pledged to continue opening its economy, and to reduce its deficit from a current 8 per cent of gross domestic product to 4.7 per cent of GDP.

Brazil also agreed to try to keep its treasury reserves above $20-billion; if reserves fell below that level, Brazil would restrict domestic credit and inform the IMF about the level of reserves on a daily basis.

Brazil also set out voluntary targets for key economic indicators such as inflation and current account deficit.

Of the $41.5-billion package, Brazil already has access to $9.4-billion. The next tranche of about $9-billion can be made available by the end of February, if Brazil can show the IMF that it is keeping its commitments.

As far as sticking to its fiscal targets, the Brazilian government believes it should have no problem convincing the IMF it's on track.

"We've delivered," Mr. Caramuru said. "We have all the elements to produce the program that we envisaged with the IMF."

Indeed, Brazil's Congress has passed key budget-cutting measures recently, and is on schedule to meet the IMF fiscal plan.

The monetary policy front is another matter entirely. Brazil insisted on designing the package around a fixed trading range for the Brazilian currency, the real.

Then, within nine weeks of receiving the first instalment, Brazil suddenly allowed the currency to float -- or sink, in this case -- freely. Brazil is now in a monetary policy vacuum.

The IMF was not impressed. While analysts had been warning for months that Brazil's currency regime was unsustainable, the IMF and Brazil had agreed to bring the currency's value down very gradually over the years.

Brazil's top officials rushed to Washington, and emerged with a silent approval from the IMF, but no advance on the next instalment of funding as they had hoped, said political scientist David Fleischer at the University of Brasilia.

And while Brazil may have been calling the shots in November with the IMF, it seems now that the tables have turned.

The IMF has indicated to Brazil's central bank that it should raise interest rates, even though the Brazilian government had publicly justified its abandonment of currency supports by saying interest rates would fall.

"The problem is, the outcome is not what they thought," Mr. Fleischer said. Instead of stopping the outflow of cash and stabilizing the currency with higher interest rates, the country's coffers have continued to bleed profusely.

Every time rates climb, the currency weakens further as investors see the country's debt burden growing, and its ability to service the debt shrinking.

The higher rates get, the more of a quandary the central bank creates, leaving few ways out except imposing controls on capital, exchange rates, or inflation; or rescheduling its debt completely.

The government has repeatedly rejected the first three options. As for rescheduling -- a move that would no doubt destroy investor confidence in markets across Latin America and Asia, and ripple through North America and Europe as well -- "We don't see much need now for rescheduling," Mr. Caramuru said.

For Mr. Caramuru's government, the roots of the Brazilian crisis are a lack of international liquidity and a lack of investor confidence stemming from turmoil in emerging markets everywhere. "I have no doubt that for a certain period of time, this movement of [investors] staying away from emerging markets is going to be there," Mr. Caramuru said.

But with more cash coming in from the IMF package, he said, Brazil will have an easier time coping with the volatility. Still, he subtly indicated a disagreement with the IMF's reasons for higher interest rates.

A rate hike sends a signal to markets that Brazil will fight inflation, but investors are no longer responding traditionally by sinking their money into emerging markets with high rates, he said. "We only believe that this program will work if we have a strong sense of ownership."

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