ITAMAR FRANCO, THE FORMER president of Brazil, has never been one to shrink from a brawl–especially when his archrival and successor, Fernando Henrique Cardoso, is involved. A flamboyant figure with a windswept coiffure, Franco is known for his brazen acts. When he was president, the TV cameras once caught him cavorting with a pantyless pageant queen at carnival. So what’s a little tussle with global financial markets? On Jan. 6 Franco, the newly elected governor of Minas Gerais, abruptly stopped payment on his state’s $15 billion debt to Cardoso’s government. Never mind that Brazil was on the verge of financial collapse, with the whole world watching and waiting. Or that Cardoso was desperate to get the nation’s fragile fiscal house in order; or that the success of a $41.5 billion rescue plan, announced by the International Monetary Fund last month, required Franco and Brazil’s 26 other state governors to pay up their debt. Franco said his state didn’t have the money, he needed a 90-day moratorium and he didn’t care about world markets. ““I am very worried,’’ he sneered, ““about my shares in Hong Kong, New York and Tokyo.''
For Brazil, that may have been one embarrassment too many. Last week Franco’s defiance proved to be the final break in the market’s tenuous confidence in Brazil. Investors had already been jarred in early December by the Brazilian Congress’s refusal to enact pension-payment increases by public workers. Now ““creditors [began] wondering how many Itamar Francos were out there,’’ said a senior Brazilian economist. Convinced that Brazil’s sky-high budget deficit would soar further–making it ever more difficult to defend its overvalued currency, the real–investors, traders and high-stakes speculators scrambled to cash out of the country. By last Thursday $1.8 billion a day was fleeing, companies trading on the Bovespa stock exchange had already lost a third of their value and speculators bid big time against the real. The capital flight finally forced Cardoso’s hand. Last Wednesday he abruptly announced he was doing what he once said he’d never do: devaluing the currency. But only by a little–a few percentage points more than last year’s 7.5 percent decline against the dollar.
No big deal, right? But this is the era of global contagion, when for developing economies devaluation is like surrendering one’s national treasury to barbarian hordes –er, currency traders. In New York the Dow, fearing a ““samba effect’’ similar to last year’s serial market collapses in Asia and Russia, promptly dropped more than 350 points in two days. Europe’s markets also swooned. And Washington’s crisis managers, who had been getting a good night’s sleep for the first time in months, went back to being financial firemen. Angered by Cardoso’s unilateral, surprise move, IMF and U.S. Treasury officials privately criticized the Brazilians for devaluing ahead of a rigorous fiscal fix that would prop up the real. Even so, they advised Cardoso and Finance Minister Pedro Malan that the currency, having been devalued partially, would never hold against speculators. They also hinted that the second tranche of Brazil’s rescue package–at least $4.5 billion scheduled for March–might take longer to gain approval, NEWSWEEK has learned.
Finally, after two days of intense discussions that went late into the night, the Brazilians conceded. At the IMF’s urging, Cardoso last Friday announced a ““float.’’ He would let the market determine the real’s value, supported only by high interest rates. At least now he wouldn’t have to spend his last $36 billion in reserves in a quixotic defense of the currency’s dollar link. This was, at best, a policy of prayer, built on the hope that investors wouldn’t panic as they had over Indonesia’s rupiah, Russia’s ruble and, three years before, Mexico’s peso, all of which spiraled out of control.
By late Friday things seemed to be holding. The Bovespa soared by 33.4 percent, and the real finished the week down a mere 17.3 percent against the dollar. Brazilian Brady bonds were up as well. On Wall Street the Dow rebounded by 220 points, giving buoyancy to markets around the world. No one was quite sure why the markets were suddenly so sanguine: it might have been genuine confidence in Brazil’s prospects or just short-covering by currency traders–a breather before the final onslaught. ““It’s a big gamble,’’ said Amaury de Souza, a political scientist in Rio de Janeiro. ““Either it works or it will be a meltdown.''
There is, however, another possibility. If the calm lasts, the global panic over emerging markets may be petering out. If so, the IMF, the chief whipping boy of the one-and-a-half-year crisis, finally deserves some credit. The fund, criticized for being too harsh in its fiscal demands on Asia in 1997, was blasted last fall for the opposite reason: throwing money at the Brazilians without demanding enough reform in return. Its ballyhooed ““firewall’’ against further contagion in Brazil was a mere Band-Aid, critics said. But that may have been all the world really needed–a period for healing. ““The IMF program bought valuable time for the markets to reduce their leverage, which helps to avoid some kind of post-Russia contagion,’’ says Robert Hormats of Goldman Sachs International. U.S. and European banks’ exposure to Brazil and other potential hot spots has been slashed as well. Hence the lack of panic last week. ““You don’t have people who have to cover positions quickly and therefore having to pull out of other markets,’’ said a senior U.S. administration official. People believe that ““the likelihood of runaway contagion is a lot less this time.''
Plenty of danger spots in the world economy remain: principally neighboring Argentina, which may find its ““currency board’’ link to the dollar under attack; the barely recovering economies of Asia, and weakened emerging markets like South Africa and Turkey. Yet by Friday the other major Latin American markets, Mexico and Argentina, had suffered strikingly little from the devaluation (though smaller ones like Ecuador took a big hit). And Argentina, after all, is not just another Asian currency domino: it is zealously committed to its currency board, under which every peso issued by its central bank is backed by a dollar. Many Brazilians are looking to see whether the Argentine peso now holds–mainly as a test for whether they should adopt a currency board themselves.
One indication of the changing mood is that few economists are predicting that the Brazilian crisis will knock ““supertanker America’’–Wall Street seer Abby Joseph Cohen’s term–off course. That was the fear last fall as Brazil seemed yet another teetering domino after Russia’s collapse in August. ““We are still bullish on the U.S. stock market,’’ Cohen said Friday. Chris Varvares, president of Macroeconomic Advisers in St. Louis, says a 30 percent drop in Latin American trade will mean at most a few tenths of a percentage point off U.S. growth, a drop of perhaps $100 billion in trade over the next three years (the Asia crisis, by comparison, dropped net exports by $100 billion in just the first half of 1998).
Brazil, however, remains in deep trouble. Much depends now on Cardoso’s fiscal program, and the depth of a recession that will almost certainly worsen as long as he maintains 40 percent-plus interest rates to curtail further capital flight. Brazil’s public deficit is currently 8.4 percent of GDP, largely thanks to overspending by state governments like Franco’s. U.S. and IMF officials have been careful to characterize their discussions with the proud Brazilians, who only reluctantly took IMF help in December, as mere strategizing, not marching orders. But U.S. Deputy Treasury Secretary Lawrence Summers planned to meet over the weekend in Washington with Finance Minister Malan and the new central-bank president, Francisco Lopes (the previous one, Gustavo Franco, resigned in disagreement), to push for fiscal reform and tight monetary policy. And late last week Cardoso quickly delivered some of what the U.S. and the IMF wanted, ramming a new $5 billion tax on financial transactions through Congress. He also vowed to come through with a new pension-reform plan.
The rivalry between Franco and Cardoso really began, ironically enough, over taking credit for the real. Until last week Brazil’s firm, dollar-linked currency was a source of great pride–and political capital–in a country that once suffered 2,400 percent hyperinflation. Indeed, it was Franco, as president, who laid the groundwork four years ago for the successful renegotiation of the country’s massive internal debt, making a hard currency possible. But it was Cardoso, then Franco’s Finance minister, who got many of the kudos. And now other state governors have begun to support him. In fact, 18 of them drafted a letter of support for the president last week. Franco, needless to say, was not among them.
