Brazil: Latin America's Largest Economy in Trouble

Print Text Size



SummaryThe economy of South America's largest nation, Brazil, will slow sharply in 2001-2002 due to a domestic energy shortage and the impacts of Argentina's financial crisis. Government-mandated cuts in power consumption will have a disproportionate impact on Brazil's industrial sector. Slower growth, shrinking foreign investment and growing debt will converge in a financial crisis, most likely early next year. Analysis President Fernando Henrique Cardoso will enact measures June 1 to reduce Brazil's electricity consumption by 20 percent this year in order to limit the risk of widespread blackouts in 2002. Cardoso is sacrificing economic growth for political leverage in 2002, when Brazilians will elect a new president. Cardoso cannot be re-elected, but he wants to be a kingmaker and keep the coalition he leads in power. Cardoso, however, is gambling dangerously with Brazil's economic stability. Power rationing will shave up to 1.5 percent off the economy's growth this year, according to the Getulio Vargas Foundation in Sao Paulo. The Argentine financial crisis may reduce Brazil's economic growth by an additional 1 percent. As a result, Brazilian economists have scaled back their growth forecasts for this year, from 4.5 percent to about 2.5 percent. However, even this revised forecast may prove overly optimistic. The impact of the government-mandated reductions will fall disproportionately on Brazil's industrial sector, which must cut consumption by 15 percent. The government will aggravate the impact by not disclosing the dates, times, and locations of rolling blackouts in order to guard against looting and rioting by poor Brazilians. As a result, industrial firms will not be able to plan production around the scheduled power outages, and many will have to shut down and lay off thousands of workers. Exports will fall as power-intensive industries, such as automobile manufacturing and aluminum smelting, are forced to reduce production. Fiat Brazil, which exports 90,000 autos annually to Europe, has already announced lower exports this year. Less industrial production also means lower tax revenues, higher inflation, rising unemployment and a bigger current account deficit as exports drop and imports rise to offset declines in local production. Complicating matters, foreign direct investment this year will slow to about $20 billion, compared with nearly $30 billion in 2000. Brazil's net foreign debt, which is its overseas dollar debt minus assets abroad, was $405 billion in December 2000, according to the Brazilian society for studies of Transnational Business and Economic Globalization in Sao Paulo. This amount included $231 billion of foreign debt, $147 billion of FDI stock in Brazil and $27 billion of portfolio investment stock. According to Fitch, an international rating agency, the Brazilian government's consolidated foreign debt in 2000 represented over 60 percent of gross domestic product. Moreover, 51 percent of the government's consolidated foreign debt was tied to overnight interest rates, 24 percent to the U.S. dollar/Brazilian Real exchange rate, and 40 percent was due within one year. The combination of lower export and tax revenues, falling FDI and a bigger current account deficit could have ominous implications for Brazil's ability to service its foreign debts this year. Brazil has an external debt-servicing requirement of $55 billion this year and will have to borrow what it cannot raise through exports and taxes. Borrowing costs will be high due to increased worries about the financial and political stability of both Brazil and Argentina. Investors watching Brazil have several concerns. The first is the Cardoso government's political stability and the continuity of its free-market policies after next year's presidential election. No clear candidates have yet emerged, but meanwhile a $2 billion embezzlement scandal in which several of Cardoso's closest aides have been implicated has damaged his credibility. Two Cabinet ministers have resigned, and Congress has created a committee to investigate 19 corruption cases. The political opposition in Congress is already exploiting Cardoso's weakening political base to demand that the government restructure Brazil's foreign debt to free up funds for increased social spending. A second concern investors have is the duration and severity of Brazil's electricity shortage. The Cardoso government blames the shortage on insufficient rainfall over the last three years. Rainfall levels are running 30 percent below normal in the Southeast and 50 percent below normal in Northeast Brazil. As a result, reservoir levels are well below 50 percent of capacity for this time a year. Brazil derives over 80 percent of its electricity needs from hydroelectricity. Since 1995, however, the Cardoso government has not done enough to encourage private investment in new power generating capacity. Industrial demand for electricity has grown 10 percent annually since 1995. Overall national demand for electricity during this period grew by 4.4 percent a year, but generating capacity increased only 3.4 percent annually. Growth in new generating capacity has lagged the rest of the Brazilian economy, because the government refused to sell state-owned generating companies and delayed needed tax and regulatory reforms. Now Brazil is paying the price with a structural power shortage that could last until 2003 or 2004. A third concern investors have with regard to Brazil is Argentina. A default by Argentina will trigger a financial crisis in Brazil. Fears of an imminent default have eased temporarily as Argentina's Economy Minister Domingo Cavallo pushes forward with plans to swap up to $30 billion of short-term debt for up to 30 years. Argentina, however, has merely postponed the moment when it will have to seek a forced debt restructuring. If Argentina's economy does not start growing again in the next three to six months, it will default and drag down Brazil.