Brazil Relief Rests on Hopefuls’ IMF Stances

Just a week ago Brazil was rejoicing in its $30bn loan package from the International Monetary Fund. But it is already clear that the operation has done little to boost international investor confidence and many observers are now asking how long and at what cost Latin America's largest economy can hold out.

With access to international capital markets severely restricted, investment is being slowed and the currency put under stress because of corporate demand for dollars.

Relief from this credit crunch in the coming months will depend to a large extent on the ability of the leading candidates in October's presidential election to allay uncertainty over their economic policies.

The surge of Brazil's risk premium this week to its levels before the massive IMF rescue plan has made clear it is not so much a lack of money but as of confidence in the next administration that underlies Brazil's woes.

"Looking at the raw numbers, they look OK through the end of the year," says Neil Dougall, an economist with Dresdner Bank in London. "The question is what happens then."

The IMF resources and Brazil's international reserves are "more than enough to over-finance the balance of payments, not only in 2002 but also in 2003, if the new government maintains the policies agreed with the IMF", Goldman Sachs, the investment bank, said this week.

Next year's $24bn (€24.4bn) IMF aid hinges on the maintenance of a primary budget surplus target (excluding interest payments) of 3.75 per cent of gross domestic product through 2005.

Much hope has been pinned on the retiring president, Fernando Henrique Cardoso, who on Monday will seek to obtain more explicit undertakings from presidential candidates that they would adhere to such targets if elected.

Yet the opposition will be hesitant to endorse the accord further, in an election marked by widespread disenchantment with past IMF policies. It will also seek to avoid being seen as responsible for the current crisis.

The leftwing Workers' party said it recognised the severity of the crisis and was ready to talk but warned the government not to use the meeting with Mr Cardoso to its advantage. "Don't count on us [to participate] in a spectacle to hide from the Brazilian people the need for fundamental change in the course of Brazil," it said.

Some investors have not given up hope that José Serra, the government candidate and market favourite, can bounce back in opinion polls once free television election commercials begin on August 20. According to a new Ibope opinion survey on Tuesday, he rose 1 point to 12 per cent of voter intention. Luiz Inácio Lula da Silva of the PT, and Ciro Gomes of the centre-left Workers' Front, now lead with 34 and 27 per cent, respectively.

How foreign banks respond to Brazil's public-relations efforts to achieve an easing of the credit crunch in coming weeks will be equally crucial.

In the wake of the 1998 Russian financial crisis, Brazil won agreement from banks to renew short-term commercial lines of credit. Such a move "makes sense collectively" but not individually, argues Albert Fishlow, head of the Brazil Centre at Columbia University in New York. Given their exposure to Brazil, "it is not in their interest to cut off credit".

Government plans to offer short-term commercial credit and export financing using international reserves and foreign aid could go a long way in easing the credit crunch. Unlike cash injections into the dollar spot market, such loans provide a lower risk of capital flight.

"It will certainly help reduce pressure on the currency," says Carlos Langoni, economist with the Getulio Vargas foundation, a national think-tank.

Under the current IMF agreement, the central bank has an additional $16bn it can use to intervene in the markets. That compares with an estimated $14bn balance of payment gap through October.

In addition, the Inter-American Development Bank and the World Bank have promised new loans of $7bn until the end of next year, of which $2bn could be disbursed this year.

"Even with pessimistic assumptions, they are safe through the end of the year," says Paulo Leme, director of emerging markets economic research at Goldman Sachs in New York. "With strong leadership and solid management, they can still turn things around. It is now up to the presidential candidates to assume their responsibility."