What’s Real with the Real?


What's Real
with the Real?

What really happened in Brazil since the Real came under attack by
currency speculators in early fall?
President Cardoso was re-elected for a second term. He then re-appointed most
of his previous ministers with a 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". Things have
been exiguously changing toward a more secure future in Brazil in the last
months though.

By
Basil M Karatzas

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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