September 25, 2003
Argentina's defiance of its creditors has not eased Brazil's financial dilemmas
Néstor Kirchner, Argentina's pugnacious president, is making life awkward for his opposite number in Brazil. Earlier this month, he briefly stopped repaying a loan from the International Monetary Fund and was rewarded with a new credit on easy terms. This week he demanded that private creditors swallow a 75% write-down in the value of debt on which Argentina defaulted in 2001. That would be the biggest "haircut" in the recent history of debt restructuring.
All of this puts pressure on Brazil's left-wing president, Luiz Inácio Lula da Silva. Brazil's $30 billion IMF agreement expires in December. Should he follow Argentina's bold example, by demanding more flexibility from the Fund, or even forswear an agreement altogether? Brazil's recession and Mr da Silva's own history of IMF bashing make either of those options tempting. But the odds are that he will resist.
Mr Kirchner's priorities are political legitimacy and economic growth. He won the presidency last April with just a fifth of the vote. His tough line has made him popular without, so far, hindering the economy's recovery from a catastrophic slump. Argentina's latest proposal would still leave it with a colossal debt: the full 75% write-down on bonds worth $87 billion would cut the public debt from 140% of GDP to a mere 90%. Yet, predictably, it has infuriated creditors ("scandalous" said the head of an Italian bondholders' group). But the bondholders were already mad, and Mr Kirchner reckons that the recovery does not depend on their early return. Some Argentines have begun investing (though investment stands at half its peak level of 1998). Officials believe that domestic consumption can drive the economy for a year or two, and that investor-friendly reform can come later.
Argentina has already paid a high price for its financial irresponsibility. In contrast, Mr da Silva, a popular president with a strong mandate, has staked Brazil's economic recovery on credibility. Mr Kirchner makes this look uncool, but it seems to be working. Since taking office in January, Lula has convinced the markets that he will not default on, or recklessly add to, Brazil's $285 billion public debt. The currency has strengthened, allowing inflation and interest rates to fall, reducing the debt burden and making an economic recovery possible. Loss of credibility would throw this virtuous cycle into reverse. The trouble is that the recovery has not yet appeared. Brazil's economy shrank in the first half of 2003. Growth is forecast at 3% next year, not enough to create many jobs. "Lula can have one year of recession," says Paulo Nogueira Batista, an economist at Fundaí§í£o Gétulio Vargas, a business school. "Two years, and the government's over."
The answer, many people think, is "flexibility". Brazil has promised the IMF that it will run a primary fiscal surplus (before interest payments) of 4¼% of GDP. That stops the government from spending its way out of recession, limits help for the poor and restricts public investment. Argentina convinced the IMF that its fragile economy could bear a primary surplus of no more than 3% of GDP next year. Perhaps the new leniency will apply to Brazil.
Francisco Pires de Souza, an economist at Rio de Janeiro's Federal University, argues that Brazil should disengage from the IMF in order to be free to reduce the primary surplus when it sees fit. With lower interest rates, Mr de Souza argues, this could be done without raising debt as a share of GDP, the variable that matters most for stability in the long run. No one is suggesting that Brazil play Kirchner-style hardball. Mr Batista predicts "a cautious shift from emphasis on credibility to emphasis on growth, which will be endorsed by the IMF, with or without an agreement."
Such a shift, however cautious, would be risky. "The markets would react badly" to tinkering with the fiscal target, such as by unleashing spending by state owned companies, says Marcelo Carvalho of Itaú Corretora, a brokerage firm. The government looks likely to reject this course. Brazil must improve "its real accounts, not its accounting techniques," declared the finance minister, Antí´nio Palocci, at the IMF meeting in Dubai this week.
But credibility may not require an IMF deal. For the first time Brazil is negotiating without the compulsion of a financial crisis. It remains vulnerable to the markets' whims: 75% of federal domestic debt is linked either to interest rates or the dollar, and it must roll over some $30 billion of external debt next year alone. But the IMF's cash is no longer the only form of reassurance the markets will accept. Armínio Fraga, a former central-bank president, argues that Brazil can add to its stock of credibility more quickly if it breaks free of the IMF. He thinks that investment will take off when investors believe "that Brazil has embraced sound macroeconomic policies out of its own understanding" that they are the way to promote growth. "Not renewing the [IMF] agreement would be a signal of that."
Against that, a new deal would keep foreign-exchange reserves high, allay lingering investor mistrust and shield Brazil from unexpected shocks. "Cosmetic changes" in the terms, such as inserting targets for social spending, could make an IMF deal more palatable politically, says Maílson da Nóbrega, a former finance minister who now runs Tendíªncias, a consultancy. He expects Brazil to sign a new one-year agreement for less than the IMF lent last year. "A year from now we won't need it any more." Either way, if Brazil sticks to its economic plan, it will not be an IMF customer for much longer. Then it will be Mr Kirchner's turn to squirm.
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