Latin Markets Crash on Fears of Recession

Latin America has finally been engulfed in an economic crisis potentially as serious as those devastating Asia and Russia, a realization that prompted financial markets across Latin America to crash Thursday.

The region’s linchpin--Brazil--saw its main stock index tumble nearly 16% as investors concluded that its economy might not avoid a recession and a devaluation of its currency. That drop was followed by declines of 13.3% in Argentina, nearly 10% in Mexico, 7.4% in Chile and 4.5% in Venezuela.

In recognition of the gravity of the situation, the U.S. Treasury Department said Thursday it was prepared to help in unspecified economic aid efforts in Brazil and other Latin American countries. Economists suggested that industrialized nations could unite to lower interest rates or create some kind of massive “standby” fund to help countries defend their currencies.

The region’s growing problems and the negative implications for the American economy weighed on U.S. stocks, helping push the Dow Jones industrial average down 249 points to 7,615.

“This is serious. This is a crisis of confidence,” said Lacey Gallagher, Standard & Poor’s Latin America debt expert, adding that Brazil’s situation has been in crisis status since the start of this month. Thursday’s crash marked the sixth straight decline for Brazil’s stocks.

Late Thursday night, Brazil took drastic action by raising interest rates to 50% from the previous 29.75%, the second major rate hike in less than week in a bid to stem the massive flow of foreign capital out of Brazil’s markets, which has totaled $22 billion since Aug. 1.

Financial analysts and policymakers regard Brazil, the hemisphere’s largest economy and locus of billions of dollars of investment by U.S. companies, as a bulwark in the ongoing fight to stabilize global markets and prevent economic turmoil from reaching the U.S.

But the ongoing effects of Asia’s turmoil and Russia’s sudden currency devaluation and bond default last month have caused global investors to lose their appetite for emerging markets.

Earlier this week, Brazil raised interest rates and imposed budget cuts to try to restore investor confidence, but those measures failed to persuade the international financial community that the country is adequately addressing its economic problems. Those problems include mounting budget and trade deficits and increasingly onerous debt load.

Thursday night’s rate hike followed Standard & Poor’s credit rating service downgrading its outlook for Brazil’s debt to “negative” earlier in the day. While the rate hike should lure foreign capital back, it will also raise to crushing levels the cost of servicing about $260 billion of internal debt, 70% of which is linked to prevailing interest rates. This hike also will add more than $2 billion to its monthly debt payment.

In Mexico, the collateral damage was only slightly less serious--and all the more painful because Mexico’s economic fundamentals are widely regarded as healthy.

But even Mexico’s top economic leaders conceded that the global financial community’s crisis of confidence in emerging markets could taint even sound economies.

“We have never seen so much volatility of such intensity in so many important countries at the same time,” Mexico’s finance minister, Jose Angel Gurria, said at a news conference with Central Bank Gov. Guillermo Ortiz. “This is causing enormous surprise in international financial centers.”

In reaction to regional turmoil, the peso plummeted Thursday from 10.32 to 10.60 to the dollar, prompting the Central Bank to intervene directly in the market for the first time in three years, selling $278 million. The Mexican peso floats relatively freely based on market demand, making it more vulnerable to shifts in sentiment.

“We are speaking not of questions that have to do with the fundamentals of our economy, but rather of a dissolution of confidence at international levels for reasons that are beyond the reach of the Mexican economy,” Gurria said.

Still, Gurria rejected suggestions by opposition parties that Mexico should control capital flows or impose currency restrictions. He said the government still projected economic growth this year of between 4.5% to 5%, though both he and Ortiz said that if interest rates remained so high for long, economic growth would suffer.

The situation is more urgent in Brazil, where government efforts to contain the damage have so far failed. The specter of a currency devaluation is serious because it would almost certainly throw the economy into a recession, reintroduce the high inflation seen in the 1970s and 1980s, and could jeopardize the free market reforms championed by President Fernando Henrique Cardoso. Cardoso is seeking reelection Oct. 4.

A crisis in Brazil would also be bad news for the United States because Brazil is one of the few major trading countries with which the U.S. enjoys a trade surplus, which last year totaled $6.3 billion. A devaluation, if it happens, would hurt U.S. exporters because Brazilian consumers and businesses would have less spending power to purchase U.S. goods.

Prospects of a growing consumer-based Brazilian economy are what have prompted U.S. and other foreign firms to invest $17 billion in Brazil last year, the highest direct foreign investment in any country except China. That investment flow would almost certainly be reduced with a devaluation.

* DOW DROPS: The Dow slumped 249 points, wiping out what remained of Tuesday’s record gain. D1