Plunge in Latin Stocks Threatens to Clip Economies : South America: Scandal in Brazil and price swings in Mexico revive old fears and stereotypes toward the region. Worse, it could shake investor confidence.

Tumbling Latin American stock markets are endangering the region’s ability to raise badly needed foreign capital, threatening to disrupt economic programs that had counted on foreign funds.

Stock markets that only a month ago seemed the best source of funding for Latin America’s capital-hungry economies are plummeting because of scandal in Brazil and stock price instability in Mexico. The Mexican, Brazilian and Argentine stock markets have suffered dramatic sell-offs in the past month.

“People are being reminded that there is an inherent instability in these markets,” said Ernest Brown, chief economist for Latin America at the investment house of Salomon Bros.

As a result, countries may have difficulty obtaining the foreign exchange to pay for badly needed imports. Smaller Mexican financial groups could find themselves hard-pressed to raise the capital they must have to meet regulatory requirements and to keep their share of a more competitive market.

Argentina’s treasury could receive less than expected for the 15 companies the government plans to privatize this year, and the new owners may not be able to invest as much as is needed to modernize those companies, many of which are crucial to the country’s infrastructure.

“It is clear that a good deal of the optimism that generated the upward movement will be curtailed for some time,” said Seymour Goodman, an economist at Tulane University. “Things could have been a lot better than they will be now.”

“As we saw in the 1982 debt crisis, when one country sneezes, the rest caught cold,” said Andreas Gil, partner in charge of Latin America at Davis Polk, an international law firm. “Both Brazil and Mexico are significant players and they have effects on other markets in the region.”

The decline in Latin markets represents a stark turnaround from their dramatic rises of recent months.

In the past year, foreign investment in Mexican stocks had nearly tripled to $29 billion, about three-fourths of it in the 29 companies listed on international markets.

The success of those issues had been expected to attract foreign financing for modernizing factories and automating services--expensive changes that are essential to the region’s transformation from protectionism to free market economics.

Instead, the wild swings produced in Mexico’s Bolsa exchange by rumors that a large block of the country’s top stock--Telefonos de Mexico--would be placed on the market and worries that the proposed North American free trade agreement will not become a reality have revived old fears about the instability of Latin American markets.

Meanwhile, accusations of bribery reaching to the Brazilian presidency have renewed stereotypes of corruption. Those allegations, which Brazilian President Fernando Collor de Mello denied in a speech Tuesday night, caused the Sao Paulo stock market to fall 15% Monday, although it rallied Tuesday for a 7% gain.

Mexico’s Bolsa index fell 15% in two weeks in roller-coaster trading that included drops of 10% in a matter of hours and slight recoveries at the end of some trading days.

When investors saw the setback in Mexico--where stocks were fetching prices of 11 to 12 times their earnings per share--Argentine stocks priced at 30 times earnings looked expensive, said Terence Mahoney, vice president at Baring American Asset Management Co. Those stocks were sold, sending that market downward also. Even Chile’s market, which has relatively little foreign money, dipped.

“Three weeks ago nobody would have thought about shifts in these markets,” lawyer Gil said.

Now he worries that spillover effects will shake investor confidence in the region. “There is a general perception that all these countries are alike,” he said.

Thus, even though Argentina has avoided the strikes and protests that have accompanied Brazil’s privatization and economic reform efforts--and managed to isolate its economy from politics--investors may not note the differences.

Many of those interviewed emphasized that the fundamentals that led to market booms in the region have not changed. Latin American countries are still putting their federal budgets in order, privatizing government-owned industries, tearing down trade barriers and developing exports.

What has changed are investors’ perceptions.

Mexico’s largest financial group, Banamex-Accival, has already been forced to postpone an offering on international markets. Banamex-Accival did not actually need the money, which was earmarked for expansion, but smaller financial groups that had counted on being able to go to the market for capital may find themselves in difficulties if capital requirements are raised as anticipated later this year.

Governments may need to find other ways to retain foreign money, such as paying high interest rates on bonds, or seek other sources of funds, such as more foreign direct investment.

Mexico’s short-term interest rates (measured by 28-day Mexican Treasury bills), which had dipped to 11%, are back up to the year-end rate of 16%. Manuel Robleda, stock exchange president, said that increase has provided an option for investors who wanted out of the equity market, while keeping funds from leaving the country altogether.

“Debt returns have improved, so particularly for investors taking a wait-and-see attitude, this is an attractive place to park your money,” Gil said.

However, higher interest rates are not a long-term solution, said Patricia Linton, a consultant on international finance and capital markets.

“Latin America knows it cannot compete with Germany,” she said. “Besides, when you fight with interest rates, you begin to have problems with the currency.” Foreign exchange markets sense a problem and drive down the value of futures contracts for currencies, she said.

In the long run, Latin American countries must attract direct foreign and domestic investment for manufacturing and consumer products, Linton said. Foreign capital was disproportionately being invested into Latin stock markets--instead of directly into manufacturing and consumer products--and balance needs to be restored, she said.

In fact, many analysts believe, the events of the past month may later be looked upon as a healthy correction.

“Although a lot of people have been badly shaken, the long-term story is still intact,” Mahoney said.

Meanwhile, Latin American markets can expect some support from investment funds that raised money earlier in the year and that still have some cash to spend on stocks.

Another point working in Latin markets’ favor is that emerging markets in other parts of the world are lackluster, providing investors with fewer alternatives.