Brazil 2 Essay, Research Paper
On January 12, 1999, over a billion dollars fled Brazil. Three days later, the Central Bank attempted to bring about a limited devaluation of the Brazilian currency, the real, but it failed to prevent a free fall. Over the next two days, another $3 billion was pulled out, and by the end of the month, the real had lost over 40 percent of its value. The Central Bank president resigned, his successor lasted a week, and as speculative attacks continued, President Fernando Henrique Cardoso, in some desperation, sought out one of international financier George Soros’s closest associates, Arminio Fraga, for the job. Fraga used to manage a fund that took bets on macroeconomic changes, such as currency devaluations in places like Brazil. It was, as the Brazilian press pointed out, a case of putting the fox among the chickens.
The outlook for 1999 is grim. Brazil is facing a deep recession and a return of inflation; continuing volatility in the value of its currency; a political cat fight over fiscal reform legislation in Congress; acute stress in the relationship between the federal government and the states; the risk of defaults on state and federal government debt as well as in the private sector; and astronomic and unsustainable interest rates.
For Brazil’s partners in Mercosurthe common market that joins Argentina, Paraguay, Uruguay, and Brazil-its plunge into recession and the quantum leap in the price of their own exports in the Brazilian market (especially for Argentina, which has locked its own currency into a one-to-one relationship with the U.S. dollar by means of a currency board) has put enormous strains on the fledgling trade bloc. Other Latin American governments worried that investors would not differentiate between Brazil and the rest of the region, slowing down access to the foreign capital needed to meet their own borrowing requirements. The rest of the world grew fearful of “contagion.” For the International Monetary Fund (IMF) and the U.S. Treasury (and ultimately the American taxpayer), which gambled in November 1998 that a huge $41.5 billion package of multilateral assistance for Brazil would sustain the value of the real, the realization began to sink in that, as with Russia, good money might well have been dropped once again into yet another bottomless pit.
The Fall from Grace
How did Brazil get into this sorry state? Who or what was to blame? The fall from grace was dramatic, to say the least. Only a year before, this vast South American nation of 167 million people, with the world’s eighth largest economy, had seemed firmly set on the path to a more prosperous, modern, and even equitable future. It was led by a polyglot, internationally minded leader of high intelligence who was hailed in European capitals and in Washington as the archetype of the new Latin American leader who would pull the region firmly into the new world envisioned by the “Washington consensus”-a world of free trade, open markets, privatized state corporations, and flourishing democracies. Beginning in late 1994, Brazil had broken the old pattern of hyperinflation by the skillful introduction of a new currency-the real-which was tied to the U.S. dollar but allowed to fluctuate within a narrow band. The immediate positive effects were quickly felt by the Brazilian population, especially those who lived precariously on the edge of destitution. For the first time in decades poor people had cash in their pockets that retained its value, and could not only buy more food but also consumer goods.
The flip side of this rosy picture was heavy borrowing on the international financial markets-”external savings” as the economists put it with Orwellian obfuscation. Brazil was not alone in this game, since it was an integral part of the new equation whereby the liquidity of global capital flows made such deficit financing highly profitable. Brazil was, after all, now an “emerging market,” and a very big one at that. It was no longer “third world” or “underdeveloped” or even “developing,” much less a country with a history, institutions, and a young democracy shaking off the legacy of two decades of authoritarian rule. To money managers in New York, London, and Frankfurt, and increasingly Madrid and Lisbon, it was a place where speculative investment promised double-digit returns. Financing deficits of one type or another, and at all levels of the domestic economy, as well as sustaining the imbalance in external payments was what everyone did with the foreign capital thrown at them-Brazilians no less than Indonesians.
But in the real economy itself, a strong Brazilian currency made Brazilian exports expensive and beguiled the Brazilian government into complacency in the one area in which it needed to get its house in order quickly if the country was to sustain the new economic model over the long haul: its chronic inability to collect sufficient revenues to cover expenditures at the federal, state, and municipal levels, and its equally striking inability to contain expenditures on personnel, pensions, and politically inspired pork.
So long as the world did not look too closely at the details all was well, but when the Asian crisis hit, and Russia defaulted, the flow of easy money dried up overnight. In the immediate aftermath of the Russian crisis, Brazil spoke tough words about fiscal reform, and for a time Wall Street and the U.S. Treasury were tranquilized. But Brazil did not deliver. In fact, it did the opposite. President Cardoso had changed the constitution in 1997 so that he could seek an unprecedented second term. And with elections in the offing, deficits escalated as politicians at all levels made sure that if a president could be reelected, so could they.
Deferring the Crisis
The U.S. Treasury-to which policy with respect to Latin America had been largely ceded by the State Department-unsurprisingly saw the suave Cardoso, and not the gruff union leader Luiz Inacio Lula da Silva, as its presidential candidate of preference in Brazil. And with the financial markets spooked by renewed fears about the health of the international financial system, it took the lead in crafting a mega-package of IMF support just as the electoral campaign in Brazil reached its climax last October. The U.S. Congress was at the time preoccupied with Iraq and the impending impeachment of President Clinton, something an anonymous U.S. Treasury official noted with some relief at the time.
But the crisis was postponed, not eliminated. In order to restrain capital flight after the Russian debacle in August 1998, Brazil had raised interest rates to 40 percent a year. With deficits continuing, this served to balloon obligations at all levels, public and private. Legislation was already on the books to oblige the state governors and mayors to live within their means, but it had not been enforced. The colossal obligations accumulated by the end of 1998 included interest on public debt that was three times higher than total direct foreign investment for that year. Social security payments in 1998 amounted to more than twice the sum the government received from privatizations. And the $25 billion that disappeared from its reserves between August and October 1998 were three times what Brazil earned in exports over the same period.
There is another bit of history the IMF seems to have neglected to notice: Brazil’s record of compliance with IMF agreements is abysmal. Six Brazilian presidents have signed six IMF agreements since the late 1950s. Not one of them was fulfilled. In the Mexican bailout of 1994, the IMF money was collateralized with petroleum receipts. The recent Brazilian bailout was collateralized with promises. This was not just a “moral hazard.” It was plain dumb.
The consequences of the loss of key operatives on whom President Cardoso had relied for political clout and economic expertise also became painfully apparent as the year ended. The unexpected deaths over the previous months of both his prime confidant and political fixer, Sergio Motta, the communications minister (a key position in the government because of the megaprivatization of the telecommunications sector in 1998), and of Luiz Eduardo Magalhaes, the government’s whip in the lower house of Congress, robbed Cardoso of his eyes and ears, as well as two very big sticks. Luiz Eduardo was the favorite son of the powerful president of the Senate, Antonio Carlos Magalhaes, and increasingly was seen as Cardoso’s heir apparent. (The younger Magalhaes had the support of his ambitious, doting, and, if need be, ruthless father, a factor that would have contained the challenges from other politicians looking toward the presidential election in 2002.) The economic team had blown apart as old friends in and outside the government were caught on tape in a bugging scandal swapping inside gossip about privatization bids.
In mid-January 1999, two weeks after Cardoso’s second inauguration, the speculators returned with a vengeance and the long-feared crisis erupted with catastrophic effects. By the end of the month, Brazil had lost in capital flight more than it had gained in promised budget cuts. The first tranche of the IMF disbursement of $9.32 billion released in December equaled the amount of exposure to Brazil the big U.S. money center banks had cut back since the plan was announced, and Brazil, not surprisingly, was back at the trough seeking more money with a new set of promises.
But with confusion reigning in Brasilia, this time President Cardoso found very few who would accept his words at face value. Worried teams of IMF technocrats arrived to pore over the books and seek more budget cuts and higher interest rates: the old formula that had helped deepen the crisis in the first place. Cardoso put the challenge bluntly in private comments to his advisors: “If this package of austerity measures is not approved, the government, I, you, and the Congress will be in the trash bin within six months.”
All Was Ashes
During the height of the panic in January, President Cardoso, borrowing from Winston Churchill’s famous wartime exhortation, spoke of the need for “blood, sweat, and tears.” Later, it became apparent that Brazilian banks had made more profit in January than had the whole Brazilian banking system over the previous year. Elio Gaspari, the Brazilian political columnist, pointed out that not only had President Cardoso forgotten to add Sir Winston’s call to “hard work,” but that he could also have evoked another Churchillianism to explain what had happened that month in Brazil: never before had so much been given by so many to so few in so short a time.
The Brazilian population’s anger that the real plan had collapsed is not difficult to explain. Brazil’s recent history is littered with failed economic programs and abandoned currencies. Brazilians had hoped against all hope that this time the real was for real. Even its name was now an affront. And Brazil had had more than its fair share of political disappointments as well.
Tancredo Neves, Brazil’s first civilian president since the military coup of 1964, indirectly elected by Congress in 1985, was a stalwart figure of the opposition to the military regime. But he died of heart failure before he was inaugurated and was succeeded by his vice president, Jose Sarney, a politician who had long supported the military regime in Congress. The first directly elected president, Fernando Collor de Mello, who was elected in 1990 with high hopes of modernizing Brazil, was tripped up by the ingrained habits of the small backward state he came from. He was impeached in a corruption scandal and succeeded in 1992 by his vice president, the erratic Itamar Franco.
Fernando Henrique Cardoso, who was first elected to the presidency in October 1994, had sought his second term on the basis of the real plan’s success. Now all was ashes. Having been reelected to the presidency only three months before with over 50 percent of the vote, Cardoso saw his approval rating in the polls drop below 22 percent by the end of January 1999.
Many observers have been quick to attribute the Brazilian crisis to “politics.” Certainly there is a large share of politics involved, as in any democracy. But to attribute the failure to politics alone conveniently avoids the more difficult questions about the sustainability of the economic model itself.
Nor did the obstacles Brazil faces in implementing reform begin with the January moratorium on debt payments by the state of Minas Gerais declared by its governor, Itamar Franco, the former Brazilian president. It was as Franco’s finance minister that Cardoso had introduced the real plan in 1994. Franco had long been irritated that Cardoso got all the credit, some of which he felt he deserved. The personal antagonism was real, but on taking office, Franco found that 80 percent of his revenues were needed for state salaries, 33.8 percent for active and retired pensions, and 12.5 percent on debt payments -for a total of over 126 percent of expected income. At least 13 other states were in similar straits, including several of the most important ones under opposition governors. Minas Gerais, Brazil’s third most important state in terms of its economy and one of the most important in terms of its politics, thus faced a crisis in its accounts that many other major Brazilian states also faced.
The difference was that Itamar Franco put a very confrontational spin on his default because he resented President Cardoso and had been humiliated by him, and saw nothing to gain by accommodation when confrontation would propel him back into the limelight. Ironically, Franco was nominally a member of the coalition of parties that purportedly supported Cardoso’s administration.
More quietly, Olivio Dutra, the governor of Rio Grande do Sul, Brazil’s second largest state in economic terms, who is a member of the opposition Worker’s Party, obtained an injunction from the Supreme Court allowing him to place his debt to the federal government in escrow and avoid being declared “in arrears,” which would trigger the impoundment of federal transfers to his state. Thus, when all the governors except Franco met with Cardoso at the end of February, the president was obliged to recognize that their situation was precarious and needed federal support.
Federal-state tensions were in fact bound to erupt in early 1999, given the chronic condition of state government finances. But this is also an old story that resurrects a potentially dangerous conflict. The flux between central and regional power has marked Brazilian history since the early nineteenth century, and it is a critical component of the current crisis. Brazilian central governments have often been required to conciliate the formidable interests of the regions, and policymaking in Brazil, even at the best of times, is at its core a complicated negotiation over the distribution of resources between the center and the powerful state bosses.
Brazil is a complex nation, larger than the contiguous United States, with strong regional power centers, an entrenched bureaucracy, and legal and administrative systems with a formidable tradition of corporative self-protection. Party affiliation has been less important at the national level than the access to the power and resources that a congressional or senatorial seat brings with it. Brazilian political parties lack discipline and loyalty, and the special interest groups-whether they be bankers, rural landowners, pensioners, evangelicals, or civil servants-tend to support individual senators and congressmen rather than parties, which are weakly organized at the national level and heavily dependent on patronage at the state level.
This situation is further aggravated by the huge dimensions of electoral districts -covering entire states-which makes campaigns very expensive, even by U.S. standards. By the late 1980s, for instance, successful congressional candidates in Sao Paulo were spending on average $600,000 per seat. In that same period in the United States, successful congressional candidates were spending $393,000. Given this reality, the popularity of Brazil’s president is critical to his ability to obtain results in Congress. An unpopular president, or a lame duck president, quickly loses authority. President Cardoso is both a lame duck and deeply unpopular. Not a healthy situation in a time of crisis.
The Transition Game
In the past decade and a half, Brazil moved away from one of Latin America’s longest periods of military rule; but its transition from military to civilian rule came about through a process of negotiation rather than rupture. Many of the civilian politicians who cooperated with the military during their 21 years of rule moved seamlessly into the more pluralistic system established after 1985 and were key participants in the writing of Brazil’s 1988 Constitution. While the 1988 Constitution enshrined many social and political rights, it also retained, at the insistence of the military and powerful regional oligarchs who had benefited from military rule, a fundamental imbalance in which the more traditional, more rural states of the north and northeast were overrepresented to the detriment of the more developed industrialized states of the south and southeast, where the main political opposition to the military governments had always existed.
The 1988 Constitution also provided protections to bureaucrats and the organized or corporative sectors of society, making administrative reform difficult and providing extraordinary benefits to those entrenched within the government apparatus in a country where millions still lived in abject poverty and the distribution of income was among the worst in the world. The postmilitary constitution became a Christmas tree of entitlements. It also mandated the distribution of tax revenues away from the center to the states. The states, because they could use their delegations in Congress to block attempts to control excess expenditures and oblige the federal government to absorb the costs of rolling over their debts, faced few obstacles to a massive escalation of expenditures with little regard for their ability to cover these expenditures from their own resources.