Brazil survived financial fray but forecast is reserved

By Jean-Louis Doublet

NEW YORK (AFP): Brazil appears to have weathered last week's financial storm, but the long-term forecast by U.S. economists for Brazil and Latin America is reserved.

"If the fiscal (reform) effort is not implemented very quickly, the pressure on the (Brazilian) currency won't be relieved," said Jose Maria Barrionuevo, Lehman Brothers' Director of Global Markets Strategy.

"Over the next weeks, the changes in the regime are going to test the capacities of the government," which was elected partly on its promise to defend the national currency, he added.

Michael Moskow, president of the Federal Reserve Bank of Chicago, agrees: "It is still too early to know how this situation will turn out, but it's very important that Brazil make progress in addressing its fiscal deficit problems".

So far, the market has reacted positively to Brazil's decision to float the real, said Federal Reserve Chairman Alan Greenspan.

"But follow-through in reducing budget imbalances and in containing the effects on inflation of the drop in the value of the currency will be needed to limit the potential for contagion to the economies of Brazil's important trading partners, including the Unites States," he added.

"If political reforms go well, it can be the catalyst for a best case scenario," said David Chon, chief Latin America equity strategist for Bear Stearns.

"Real interest rates were supposed to decline after the fiscal plan. Now the likelihood is that lowering interest rates will trigger inflation," noted Barrionuevo.

If a lower real, which now floats freely, is an advantage for Brazilian exports, it also entails higher interest rates, the only mechanism left Brazil to avoid renewed hyperinflation.

The Brazilian economy is also in the throes of a recession which will cause a drop in internal consumption.

"It will come a point where (because of) denied access to income and capital, companies and banks won't be able to meet their obligations on a timely basis," said Arturo Porzecanski, chief economist at New York's ING Barings.

Porzecanski recalled that several Latin American economies, such as Venezuela and Chile, depend heavily on their exports in raw materials like metals and oil, "which are in some case at their all time lows."

The devaluation of the Brazilian currency also threatens its chief economic partner and neighbor, Argentina.

"Argentinean companies competing with Brazilian ones with a 30 percent weaker currency are going to have a difficult time," said David Chon.

The Argentine peso is linked to the U.S. dollar through a monetary council. Under such a system, any drop in financial reserves, which leads to lower liquidity, causes an immediate rise in interest rates.

According to Barrionuevo, Buenos Aires has enough reserves to defend its currency, but "the last thing you have to believe from a government is that it is not going to devaluate," said David Rothkopf, president of The Newmarket Company, which specializes in emerging markets.

If Brazil has the advantage of a new government, several Latin American countries are facing elections by 2000.

"Social issues are going to dominate but what we don't know is are we going to have sensible solutions," said Porzecanski.

"Political leaders may realize that what is perfect for Wall Street is not going to get them re-elected. So they will have to find some kind of balance," Rothkopf said.