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What’s Real with the Real?

What's Real
      with the Real?

The first cases of AIDS in Brazil were diagnosed in São Paulo and
Rio de Janeiro in 1983. Today the country has one of the highest numbers of AIDS cases in
the world and more than twice as many AIDS cases than any other South American country.
Today there is an increasing number of women, adolescents, and people with a low income,
low level of education becoming infected with HIV. One way of reaching out is through
community-based HIV prevention programs and the distribution of condoms.
By Brazzil Magazine

When Russia devalued its ruble, world markets—the ones not affected yet by the
Asian contagion that is, started unraveling under the fear that the Asian flu could not be
contained in the Pacific Rim. However, every sophisticated investor knew that Russia’s
importance was greatly exaggerated given the size and impact of its economy to the world
economies.

When Brazil’s Real came under attack by currency speculators in early fall, investors
came to believe that world economies were in trouble. Default on Brazil’s $200 billion
debt would have incited a domino effect that would bring down Latin economies (20% of
Brazil’s trade), Europe (24% of Brazil’s trade is with the European Union) and eventually
US (17% of Brazil’s trade).

For the first time there was a clear and present scenario explaining the end of this
unprecedented bull market that even less sophisticated investors could comprehend. The Dow
Jones promptly dropped 20% from its high within a month and every financial guru worth his
bonus was predicting the end of the world.

Almost six months since then, Brazil has secured a $42 billion loan from the IMF and
both Dow and Nasdaq are flirting with all new time highs. Well, that was all? Now, Brazil
is on track again, Russia was put in its place (financially speaking) and let the bygones
be bygones? What really happened in Brazil since hell broke loose?

President Cardoso managed to amend the Constitution so that he was qualified to run for
re-election. As expected, he successfully defended the presidency in the subsequent
elections in October, and his victory, in a sense, calmed financial markets since he is
widely respected for his determination to modernize Brazil. In his previous career as
Finance Minister, he implemented the Real Plan that reduced inflation within months from
3,000% to less than 10%.

In the middle of November, Brazil secured a $42 billion credit line from the IMF. The
package was larger that expected by about $10 billion under the reasoning that Brazil
should have some margin to defend the Real in case that speculators attempt another
battery of attacks.

Brazilian economy retracted by 1.5% in the third quarter of 1998 versus a 1.4%
expansion of the second quarter. The shrinkage is expected to be even higher in the fourth
quarter while most credible analysts predict a recession year for 1999. The consensus
estimate is that GDP will decrease by at least 1% GDP in 1999.

Central Banks’ Monetary Policy Committee lowered interest rates to 42.25% from 49.75%.
It is expected that Brazil’s Central Bank will gradually lower the rates even more and
this was only the first step toward that direction.

In late November, the Minister of Telecommunications and two senior officials resigned
after allegations that were trying to influence the privatization of $20 billion Telebrás
in July in favor of certain candidates. In early December, Brazil’s lower house of
Congress (Chamber of Deputies) rejected a pension reform bill that would have cut spending
by $2.5 billion and narrowed the deficit gap. In reality, this has been a clear
requirement for the IMF package. Although relatively small in size, it is a blow to the
government’s confidence. The government will try to introduce the bill again in early next
year.

In middle December, Brazil’s legislators proposed a 59% increase of their own salaries
and other senior public servants. The salary proposal will be sent to Congress in February
1999 and is expected to pass with minimal opposition. The cost is estimated to be about
$500 million.

Moody’s Investors Service has downgraded Brazil’s foreign currency debt to B2 from B1
in September, while Standard & Poor’s has maintained its slightly better BB-minus
rating.

Brazil’s Central Bank announces that as of the end of November, foreign reserves
dropped to $41.2 billion, a $1.2 increase in the month of November. This is the lowest
amount of foreign reserves since 1994 and is sufficient to fund imports for only eight
months. Also in November, Brazil’s foreign debt reached $230.5 billion, versus $199.99
billion at the end of the year. Foreign Direct Investment (FDI) in November was $1.857
billion, the lowest monthly figure since April 1998. The total FDI for the first ten
months in 1998 was $23.437 billion versus the government’s target of $22. Finally, the
year-to-date current account deficit was 4.29% of GDP versus a 4% from a year earlier.

On December 23, Cardoso appoints a new Cabinet. Actually, he re-appoints most of his
previous ministers with a direct word of advise that "if they do not vote (for the
government’s agenda), they do not support the government; if they do not support the
government, then they can’t be in the government".

It is clear that things have been exiguously changing toward a more secure future in
Brazil in the last months. With the exception of the re-election of President Cardoso and
a $42 billion credit line from the IMF, all other factors have deteriorated. Do these
events justify the complacency of equity markets around the world and especially in the
US? Probably not. Shouldn’t the Brazilian President and Congress be working more
aggressively to put their house in order? Definitely yes.

Basil M. Karatzas is graduating in May 1999 with an MBA degree in
international Business from Rice University, in Houston, TX. Basil also serves as
President for Platinum Holdings International, an international management and capital
consulting firm, and can be reached at karatzas@rice.edu
 

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