- The Washington Times - Thursday, June 20, 2002

SAO PAULO, Brazil — Could Brazil be the next Argentina? . That's the question that's spooking currency, stock and bond markets as South America's largest economy appears to be lurching toward a potentially explosive debt crisis.

Unnerved by the likelihood of a victory for the left in elections in October and fearful of a default on an internal public debt worth more than 70 percent of the country's economic output of $370 billion, its currency, the real, has slid to near-record lows, and the benchmark C-bond has slumped.

The risk has soared to levels last seen just before Argentina collapsed late last year. Traders, analysts and even presidential candidates are warning that Brazilians could be headed for a meltdown like their southern neighbor's.

Mired in a four-year recession, Argentina has defaulted on its foreign debt, and seen its currency lose more than two-thirds its value and more than half its population slip below the poverty line. It is cut off from international markets.

Could Brazil be next?

According to J.P. Morgan's Emerging Markets Bond Index, Brazil must pay more than 13 percentage points over U.S. Treasuries on capital markets, making the country the riskiest investment proposition other than Argentina and Nigeria.

According to Celso Pinto, chief editor of business daily Valor, "Whoever was saying that Brazil had escaped unharmed from fallout from the Argentine crisis is reviewing their position."

"All attention is now on Brazil, the presidential elections and the internal debt," he said.

With Luiz Inacio Lula da Silva, the three-time failed presidential candidate of the left-wing Workers Party, way ahead in opinion polls for the October vote, investors have been increasingly reluctant to take on long-term Brazilian paper.

Mr. Lula has openly flirted with the idea of renegotiating Brazil's $54 billion foreign public debt, something more conservative investors fear really means a default. Although the Workers Party has moved toward the center, many investors are still wary of buying longer-term Brazilian debt.

The central bank has had to issue more and more short-term paper, increasing the roll-over burden for the first quarter of 2003, when the new government takes over, to more than $6.3 billion.

Leading commentator Clovis Rossi of the Folha de Sao Paulo daily has called the debt "a time bomb ready to explode in the lap of the next government."

Mr. Pinto wrote that the next government "could be engulfed by a huge crisis."

Only 18 months ago, Brazil's economy was robust, but the global economic slowdown, a home-grown energy crisis, the collapse of neighboring Argentina a principal export market and a credit squeeze on Wall Street have helped strangle growth, expected to reach 1.5 percent at best this year.

In addition, the central bank's concern some say obsession with keeping interest rates high, at 18.5 percent, to meet ambitious inflation targets is further stymieing recovery.

Central Bank Governor Arminio Fraga and Finance Minister Pedro Malan introduced last Thursday a package of economic measures including freeing up an extra $10 billion in funds from the International Monetary Fund (IMF), boosting budget-surplus targets and lowering foreign-reserve levels to soothe the markets' nerves.

But the markets hardly reacted. The real was trading yesterday at 2.7 to the U.S. dollar. Still, most people say likening Brazil with Argentina is like comparing apples with oranges.

"Brazil has all the elements to avoid being the next Argentina," said Marcelo Carvalho, chief economist at Bank of America in Sao Paulo.

"Argentina's debt was mostly external, Brazil's is mostly internal. Brazil has a flexible, floating currency, unlike Argentina's fixed-rate regime, and Brazil has built up a credible monetary policy over recent years," he said.

IMF and U.S. Treasury officials had words of support for Brazil in recent days.

"I think the market reaction has been somewhat exaggerated," said Mr. Carvalho. "But, despite yesterday's measures, there is still a sense of doubt in the markets."

Mr. Malan and Mr. Fraga have called upon the Workers Party to clarify its commitment to market-friendly policies and fiscal discipline, but the party has not laid down hard and fast rules for its economic program.

Perhaps the main element that will prevent a Brazilian meltdown is the country's size and its 170 million population, by far Latin America's biggest.

"I don't believe Brazil will become the next Argentina," said Eduardo Rocha Azevedo, former president of Sao Paulo's stock exchange.

"Where would Ford or General Motors go? You close those factories down and take them where?" he asked.

"There are more interests at stake here than in Argentina, and Brazil's potential as a consumer market is much greater than any other Latin American country."


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