Just a week ago economists were hailing the rand’s recovery. Brazil this week dashed their hopes, writes Donna Block
The nightmare scenario world economic leaders have struggled to avoid has begun. Brazil has hit the slippery slopes of destitution. China, Mexico, Venezuela, Chile and South Korea may follow.
The world economy looks set to head into a new tailspin, possibly dragging the entire world into recession.
The trouble started on Wednesday when the governor of Brazil’s central bank resigned and his successor abandoned the country’s strict exchange rate policy in favour of a more flexible one, effectively devaluing Brazil’s currency, the real, by 8%.
The move rocked the world’s already neurotic financial centres, susceptible to the slightest sign of instability in emerging markets. The tremors then turned into a tidal wave of emerging market fear and slammed those countries with weak current account balances like South Africa, Chile and Turkey.
Economists who just a week ago were hailing the rand’s recovery have once again learned the hard lesson that what happens in an economy thousands of kilometres away has an impact over here.
Already at risk are the recent interest rate cuts as the rand comes under renewed pressure from foreign speculators looking for a fast buck. South Africa’s climb out of a recession will be long and hard.
“This is not good for South Africa,” concluded Mike Schussler, economist with FBC Fidelity. “We’re hoping against hope that we’ll survive. This is going to make it more difficult to decrease interest rates, which will be a problem for everyone.”
The crisis really started a few days before the Brazilian bank governor’s resignation when Itmar Franco, the governor of Brazil’s second most populous state Minas Gerais, announced a 90-day moratorium on payments of its $13,5- billion in debt to the federal government.
This action sparked fears that other states might follow suit and that the country would be unable to comply with the terms of the $41,5-billion rescue package from the International Monetary Fund (IMF). The markets were already worried about Brazil and when the devaluation hit, investors ran scared.
Many analysts and fund managers say the Brazilian devaluation was not unexpected but its timing was horrendous. Uncertainty over what will happen next in Brazil is likely to hang over world financial markets for some time.
An estimated $3,2-billion flowed out of Brazil after Tuesday as investors ran for cover. Brazil relies on foreign dollars to keep up its foreign reserves and protect itself against speculative attacks on its currency.
Unless the country can bring the crisis under control and restore some semblance of confidence quickly, economists say, world markets will continue to rock. But few economists have much faith now in the Brazilians’ ability to stem the rot.
“There’s really little the government can do now,” said one Brazil specialist in New York. “All they can do is try to manage expectations, stick to their [austerity] plan and cross their fingers.”
But Rudi Dornbusch, a professor of economics at the Massachusetts Institute of Technology, doesn’t even believe Brazil can do that, calling the Brazilian government “incompetent” and saying the country’s leadership is “not fit even to be interior decorators”.
He added that the devaluation of the real is the “opening shot for what is going to be a really big crisis”.
Fund managers are now worried Brazil’s devaluation may give rise to the possibility of China devaluing its currency, which could then spread further – possibly even to North America and Europe.
This is exactly what the IMF and 20 of the world’s richest nations were hoping to avoid last November when they scrambled to put together a $41,5- billion loan package to keep Brazil from sinking during the fallout of the Russian debt crisis.
In return, the Brazilians committed to end their spendthrift ways. The government said it was “fully committed” to maintaining the value of its currency – a commitment that was vital if there were any hope of keeping the rest of Latin America from descending into a nasty recession.
In the end, Brazil’s legislature baulked at the tougher reforms, money left the country faster than vegetarians at McDonald’s and Brazilians could only sit back and watch their currency fall like the proverbial lead balloon.
United States officials in particular are angry at Brazil’s leadership for its inaction which will almost certainly drag down all of Latin America – the fastest- growing market for US goods and services. “It’s hard to overestimate the anger around here about how the Brazilians wasted time when they needed to deal with their problems,” said a White House official.
The dilemma now confronting US President Bill Clinton and his Secretary of the Treasury, Robert Rubin, as well as the IMF, is whether to continue pumping aid into a country that seems reluctant to reform or to stand back, even if that means watching currencies around the world plummet and risking reigniting the economic turmoil that followed Russia’s economic crisis last August.
In carefully worded statements on Wednesday, neither Clinton nor Rubin tipped their hand – or promised much more help. “It is important that Brazil carry forward the implementation of a strong, credible economic programme,” Rubin said.
However, privately, some administration officials predicted Brazil’s problems would not trigger another sell-off around the world, the way panicked investors and lenders fled from developing nations five months ago. The world economy is less brittle now, they argue, and investors are a lot better prepared and more savvy than they were five months ago.
But the reality, as one senior administration official said, is “none of us really know”.
In the immediate aftermath, the US stock market shrugged off Brazil’s bad news and contained its losses at respectable levels. But the ability of the US market to weather these kinds of storms will be compromised if Brazil spreads its contagion to the rest of Latin America and China.
Against this kind of devastating backdrop, the US would have to look to the Federal Reserve Bank and its high priest, Alan Greeenspan, once again to come to the rescue of the economy with further interest rate cuts. Whether the bank is able or even willing to become the saviour of the world once more remains to be seen.