The formidable changes Brazil was experiencing with urbanization, greater political participation, and wider access to education and to the media and technology were simultaneously giving a voice to increasingly larger sectors of the Brazilian population. And as new voices emerged in the more pluralistic environment of the mid1980s and 1990s, the political game became even more complicated and more ideological, with newly independent unions, religious groups, indigenous movements, women’s organizations, environmental activists, a powerful and more critical press, and a formidable movement of landless rural workers all energizing civil society and challenging the old oligarchic style of decision making and political representation.
Thus, the crisis that hit at the beginning of 1999 resulted from the convergence of three developments: the burden of the state apparatus and its rigidities; the imperatives of the political calendar; and a dangerous vulnerability to external conditions. The 1988 Constitution, because it had incorporated such a high degree of specificity on social as well as political rights, made policy questions, which in other political systems could be resolved by legislation, weighty matters of constitutional amendment, thereby placing very high barriers to governmental reform by requiring a cumbersome process of constitutional revision. This involved attaining two consecutive 60 percent votes in each house of Congress, virtually ensuring delays in the enactment of any measures for which timeliness was essential, and making any such measures extremely costly for the government in terms of the horse trading needed to accumulate sufficient votes to pass the amendments.
The unwieldy process led inevitably to the use of “provisional measures,” mechanisms retained in the 1988 Constitution’s Article 62 at the insistence of the military and its allies during the transition from authoritarian rule. Under this article, the president could impose measures with the force of law for a 30-day period. The real plan itself was implemented by these means.
In theory, provisional measures could be rejected if Congress did not pass enabling legislation within 30 days. In practice, presidents simply reissued them. The ending in 1995 of “indexation,” by which salaries had been adjusted at the end of each month to the inflation index of the previous month and which contributed mightily to Brazil’s hyperinflation, was also achieved by means of a “provisional measure” reissued 47 times. In his first three years in office, in fact, President Cardoso issued 1,800 provisional measures, including 1,698 reissued decrees. Only 90 were transformed into law. This made Congress increasingly determined to strip the president of such powers in any rewriting of the constitution itself. This means that the trade-off for simplifying the constitution, which all agree is essential to make the system function more efficiently, will be inevitably marked by efforts to strip the Brazilian president of the very constitutional mechanisms that had made possible any forward progress at all over the past decade.
The intractability of social security reform encapsulates the problems of expenditures and special interest mandates. To give but two sensitive and politically explosive examples: The military contributes R$100 million to social security annually, while military benefits cost R$7.2 billion. In the city of Sao Paulo, pensions absorb two-fifths of the public safety budget. The military police of the city alone have 35,000 pensioners, one for every two men on active duty. With 53 serving colonels, the city supports 100 retired colonels collecting pensions.
Chronic Insecurity and Public Order
But to cut expenditures such as this, in a situation where most Brazilians already face chronic insecurity, can be very dangerous to public order. In late 1997, sometimes violent police strikes erupted in several Brazilian states, including in Alagoas, where the police had been unpaid for over seven months by the bankrupt local administration. The average government pension is eight times higher than private-sector pensions. And those received by sitting congressmen are 30 times higher on average than what the average pensioner receives.
Pensioners, in fact, form the largest lobby in Congress. Thus, the power to paralyze the administration of government lies fully in the hands of those who most benefit from this situation and have the most to lose by its reform. Federal civil servants, who contribute R$3.3 billion annually, cost the system R$12.8 billion a year. The situation at the state level is little better. The states spend on average 30 percent of their payrolls on inactive and retired workers and surviving spouses. Not surprisingly, the cutbacks in pension payments promised to the IMF-a mere R$3 billion in 1999-are derisory in face of the level of debt and unfunded obligations in the social security system. As if these rigidities were not enough, the timetable of politics also made reform hostage to the electoral calendar. President Cardoso had succeeded in changing the constitution so that he could run for a second consecutive term-a tradition even the military rulers had never attempted to alterbut this mortgaged reform to political ambition.
Cardoso’s argument was that reform could await the second mandate when it would be his primary objective. The problem was that any delay in stanching the fiscal hemorrhaging of the state became extremely expensive once the need to retain “investor confidence” became paramount. This required that Brazil pay astronomical interest rates to restrain capital flight in the paradoxical belief that this would sustain the conviction among foreigners that it retained the ability to service its debts, something the excessive interest rates made increasingly unlikely. This critical factor was masked not only in the IMF program itself but also in the reporting on the business pages, which spoke about shifting primary deficits into surpluses without quantifying what this entailed or calculating what the interest on these government borrowings involved.
But interest, more than percentages, was a key to the escalating crisis. The burden of debt quickly attained unsustainable levels. Yet because of the global crisis of liquidity and the risks it posed, the fiction that all was well in Brazil needed to be sustained, and it was-at least until the global system could be inoculated against the potential impact of a Brazilian crash and President Cardoso was safely reelected.
Time magazine put Alan Greenspan, Robert Rubin, and Lawrence Summers on its January 27, 1999 cover, proclaiming these “Three Marketeers” as the men who “had saved the world.” Perhaps the editors meant Wall Street. Certainly the U.S. edition of Time contained not a word of reporting from most of the world south and east of Manhattan, where that message of deliverance might have seemed hollow at best.
The Fiction Is Over
What are the risks now that the fiction is over? The segment of the population that is most threatened by a return of inflation and recession are the 19 million people who during the mid-1990s, gaining from the stability brought about by the real plan, had moved into the emerging lower middle class. As voters, many of these people provided solid support for President Cardoso’s reelection. But they too had became hooked on credit, much of it linked in the small print to the dollar. They are the most vulnerable to the new situation, and the most volatile.
An acute struggle over land and property has been developing on the rural frontiers for over a decade. Here, the landless rural workers movement comprises the most organized and radicalized segments of the Brazilian population. Rural workers have long claimed that Cardoso’s policies were unsustainable. Industrial workers have been under pressure since 1995, the flood of imports and the consolidation of the manufacturing sector having forced many out of stable employment into the informal sector. The unions, fearful of provoking more job losses in the face of declining opportunities have preferred negotiation over confrontation, but this too could change.
Brazil is also a country where over a million people seek to enter the workforce each year-they will have minimal prospects in the foreseeable future-a serious long-term problem for an economy that needs rapid growth if it is to both absorb workers and compete in an increasingly competitive world market. On all these counts, Brazil will fall behind in the new global economy, not leap forward as many had hoped.
At the end of 1998, unemployment in greater Sao Paulo stood at an all-time high of 18.3 percent. It can only get worse in the face of a contraction of the economy and the deepening recession. Bankruptcies and defaults will be unavoidable in both the public and private sectors. It is difficult to see where the federal government in particular can cut further, since its ability to use fiscal means is limited by political and social constraints, and its monetary policy is hostage to the domestic debt burden.
The secondary market in state and municipal securities, valued at some R$9 billion, came to a virtual halt in February, as an increasing number of governments in all areas of Brazil failed to pay their obligations on maturity. The reduction of the stock of dollars in the commercial bank coffers threatens Brazilian importers and companies with overseas commitments, which are estimated to be $13.5 billion for the first quarter of 1999 alone.
The current account deficit reached almost $35 billion for 1998 despite the $9.32 billion initial payment from the IMF package. Brazil’s external financing needs in 1999 are estimated to be in the region of $52 billion. With the second tranche of $9 billion due in March 1999, this will mean that almost 44 percent of the IMF package has already been committed.
The country’s total foreign debt meanwhile stands at over $230 billion, and its domestic public debt, as of this writing, in March 1999, exceeds R$500 billionroughly equal to the total purchasing power of the 28 million families that make up the Brazilian middle and lower middle classesand is rising quickly due to the expensive interest that must be paid. Almost 20 percent of this debt is dollar linked, and 70 percent must pay overnight rates. This vicious cycle means that a one percentage point rise in the interest rate-and the IMF wanted the interest rates to rise to 70 percent-forces the government to assume an extra R$ 1-2 billion in debt servicing costs.
It is not difficult to see the cracks already visible at the state level quickly turning into canyons. If “smoke and mirrors” had enveloped the IMF package in the first place, the same applies two-fold to its failure. As an official of the Group of Seven industrialized economies told Stephen Fidler of the Financial Times in October 1998, “There is one thing worse than failure and that’s failure that takes a lot of your money and credibility with it.”
So it was hardly surprising that the IMF declared quickly in January 1999, after the value of the real had collapsed, that the “float” of the real was the best policy for Brazil, even though the “maintenance of the current exchange rate regime” had been a central plank of its bailout package announced the previous November. Or that the R$28 billion Brazil eventually cut from expenditures under pressure of the currency crisis was hailed in Washington as evidence of compliance with IMF directives, despite the fact that these figures had been predicated on “maintenance” of the real’s value. But once again, no one wanted to look too closely in the interests of reestablishing “confidence,” much less talk about it. The reality was that the old figures were shot. U.S. Treasury secretary Robert Rubin had said of the bailout package in November, “This should do it.” It had not.
George Soros told the annual gathering of worthies at the World Economic Forum in Davos, Switzerland, in February 1999 that what Brazil needed from the international financial community was a “wall of money”-in addition, presumably to the $41.5 billion already committed by the IMFled package. On March 8, in Washington the IMF announced yet another memorandum of agreement with the Brazilian government. Cardoso, it said, promised to reduce Brazil’s public debt ratio to GDP; increase surpluses; increase prices of domestic energy; reduce federal expenditures; “retrench” with respect to state employees; privatize more state companies and state banks; encourage the “voluntary commitments of foreign banks”; and issue more bonds.
On the same day in Rio de Janeiro, Cardoso, speaking at the Superior War College, was more ambiguous, especially about the privatization of Petrobras, the state petroleum company, and other key state enterprises. “If this is useful to excite the markets, so be it. But it does no good for Brazil to fantasize about routes that are not needed,” he told the generals whose social security contributions he had just promised the IMF he would increase. Perhaps he assumed the generals did not read English-or Wall Street traders Portuguese-a dangerous presumption in the age of the internet.
But looking at Brazil’s bleak prospects, Soros knows of what he speaks. With interest rates at 45 percent, inflation in the month of February reaching 7.65 percent, and 2 million unemployed between the ages of 15 and 24 in Greater Sao Paulo, his former asset manager, Arminio Fraga, now Brazil’s Central Bank president, to whom the country’s economic policy has been largely ceded, will have his hands full. So too will the “Three Marketeers” if Brazil fails to convince skittish investors that it is back on track, if it is forced to resort to capital controls, or even defaults, as the year progresses, and Western taxpayers eventually wake up to the way their taxes have been gambled on a mission impossible.