Brazil is not Argentina but still risky

The Times of Malta



Following the shock of Argentina`s default on its domestic and international financial obligations, investors, including local ones, were shocked by the sharp fall in market value of Brazilian bonds.` Yields rose to strong double digits normally associated with borrowers with very strong risk of defaulting.

Benchmark EUR bond 9.5% due in 2011 touched a low of 36 yielding around 30% p.a. till maturity. Even on the morrow of IMF stand by credit line bailout announced on 7th August, the bond was trading at 53 with a yield to maturity of over 23% p.a.

So while the pressure on Brazil has been eased by the IMF re-assuring intervention in this run-up` period for the Brazilian Presidential elections, it is by no means assured that Brazil will avoid a default or that Brazilian bond prices will return anytime soon to their healthy start of year price levels. `As for us it is worth noting that whilst we are far from knocking on IMF doors, and whilst our foreign exposure position is stable, in many other economic indicators (public deficit, economic growth, ratio of public debt to GDP) we are performing worse.`

Yet Brazil should not present the same risks as Argentina. Whilst its economy has seen the growth rate decline form 4.4% in 2000 to 1.5% in 2001 it did not contract for three successive years as experienced by the implosion of Argentina`s economy.

Whilst Argentina was having problems reigning in public expenditure and cutting public deficit to avoid the need for its government to continue borrowing, Brazil has been running a public account surplus. The only reason why the public debt increased in relationship to the GDP was because of the downward floatation of the Brazilian Real.` Public sector debt is still below the 60% of GDP generally accepted for good-housekeeping by EMU standards, and only 20% of this is held abroad although a further 20% is held locally but linked to the US currency.

Furthermore Brazil`s economy has not been living with a totally artificial rate of exchange as was Argentina`s experience prior to its implosion, whilst following totally unrealistic attempt to keep parity between the Argentine peso and the US dollar.

Consequently Brazil is much more worthy of IMF support than Argentina. It is therefore heartening to see that IMF brushed aside calls from moral-hazard fanatics and signified it is ready to continue supporting Brazil with its macro-economic adjustment project.

The newly elected Brazilian president ought to show commitment to sound adjustment policies, without which IMF support will vanish leading to the certainty of default on the substantial accruing obligations of its maturing debt. `It is only the savings culture bequeathed to us by our forefathers and the deep tradition of faith and confidence in our financial system that makes financing the deficit and the debt much less painful than Brazil.`

This is not the same thing as saying that IMF policies are a perfect solution or that they are socially fair or just. Only that without IMF support under whatever conditions they think appropriate, Brazil will go the Argentina route.

It is this uncertainty which will keep Brazil bond prices soft until there is an elected president that makes a credible commitment which will secure the continued support of the IMF for the economy to regain its competitiveness, moving to higher growth rate and addressing the 4.4% current account deficit on its balance of payments.

Failing this Brazil will default on its debt obligations sooner rather than later.` It is a risk not worth taking not only for Brazil, but for the world economy.

The IMF has shown its commitment to avoid the risk. It is hoped that newly elected Brazilian President will do the same so that Brazil will take the road to Mexico rather than to Argentina.

As for us it is worth noting that whilst we are far from knocking on IMF doors, and whilst our foreign exposure position is stable, in many other economic indicators (public deficit, economic growth, ratio of public debt to GDP) we are performing worse.` It is only the savings culture bequeathed to us by our forefathers and the deep tradition of faith and confidence in our financial system that makes financing the deficit and the debt much less painful than Brazil. But this should not be abused or stretched, as what took centuries to build will strap in an instant.

Alfred Mifsud