U.S. Voices Support for Brazil

The stakes are high for the United States if Brazil, Latin America’s biggest economy, falls into recession, or worse, devalues its currency, a fact underscored by an unusual telephone call of support to Brazil’s president Friday by U.S. Treasury Secretary Robert E. Rubin.

In a statement to reporters, Rubin said he called President Fernando Henrique Cardoso to “express U.S. support for Brazil’s actions” in response to its current economic crisis, commending its ongoing market reforms and saying that Brazil is “of vital importance to the United States and to the global economy more generally.”

Brazil is the U.S.’ 11th-largest export market with $16 billion in sales last year and one of the few major trading partners with which the U.S. is running a trade surplus. U.S. companies’ exports to Brazil grew 25% last year and are now roughly five times the value of Russia’s before its crash last month.

A deeper crisis in Brazil’s economy would spell big trouble for the scores of U.S. companies that have invested there in recent years. Companies such as General Motors, Whirlpool, Eastman Kodak and Procter & Gamble have come to rely on Brazil for sales and profit growth. California high-tech companies have been building a presence in Brazil and a consumer class has taken shape.

Rubin’s call, made public after Brazil’s markets closed Friday, amounted to an unusual show of support that analysts said should bolster Brazil’s efforts to avoid economic disaster. Although Rubin did not specify what form the U.S. support might take, analysts said the gesture alone was significant.

“For weeks, Rubin has maintained an icy silence as countries around the world self-destructed. Calling Cardoso to say that Brazil is vitally important, just the fact that he said it, should have an effect on the confidence of investors,” said David Malpass, chief international economist at Bear, Stearns & Co. in New York.

Brazil’s embattled government was given a further boost Friday by the International Monetary Fund, which announced it is ready to make available special funds to Latin American countries trying to shore up their economies, an overture it did not make to Russia.

Without disclosing specific details, the IMF said it was ready to tap a line of credit with major industrial nations, known as the General Agreement to Borrow, to meet Latin American requests for aid.

The gestures come as Brazil is desperately trying to avoid an economic meltdown. Chances of that seemed to ease Friday as markets reacted favorably to the government’s raising of interest rates late Thursday to nearly 50% from the previous 29.75%.

The rate hike, designed to reverse an exodus of foreign capital, also sent Brazilian stocks up 13% Friday, its biggest rise since March 1995, nearly wiping out Thursday’s 16% loss after a day of panic selling. Brazilian stocks have lost 40% of their value in a month.

Foreign capital outflow fell off sharply Friday, declining to about $730 million, down from $2.2 billion on Thursday and off the $1 billion per day average so far in September. Disenchanted with emerging markets and fearing that Brazil might devalue its currency or slip into recession, investors have been dashing for the exits.

The drastic hike in interest rates “demonstrated the serious commitment” of the Brazilian government to defend its currency at all costs, said Albert Fishlow of the Council on Foreign Relations in New York. The higher rates will attract foreign investors but could cause an economic slowdown, even a recession, if prolonged.

Higher interest rates are sure to hurt auto sales in Brazil, which are already running at half the rate they were a year ago, according to Marc Forest, general manager of Detroit Diesel’s plant in Curitiba, Brazil. His company supplies motors to Chrysler. The rate hike, the second in a week, comes at a severe cost, adding about $5 billion per month to Brazil’s annual carrying costs on its $340 billion in domestic debt, said Lacey Gallagher, Latin America debt expert at Standard & Poor’s, the credit rating agency that lowered its outlook on Brazil to negative Thursday.

Gallagher and other analysts applauded the measure but cautioned that it’s a stopgap that must be accompanied by serious budget cutbacks.

“This is triage, not a rehabilitation,” Gallagher said, adding that rates will need to be lowered soon to avoid a recession.

Faced with a similar currency run last October, Brazil doubled interest rates to 43%, which stopped the capital outflow, but also induced a five-month period of negligible economic growth.

An economic slowdown is vastly preferable to a currency devaluation, particularly to the U.S. companies that have invested in Brazilian plants and personnel since 1993, when the government began to embrace free-market reforms and liberalize trade laws. More than one-third of the $17 billion direct foreign investment last year came from U.S. companies making long-term bets that the country can escape its hyper-inflationary past.

A devaluation is to be avoided at all costs because Asian and Russian devaluations have shown they breed high inflation and compound the monetary crisis they are meant to alleviate, Fishlow said.

“Those countries have shown it’s impossible to have a devaluation as a matter of policy,” Fishlow said. “A devaluation turns out to be cumulative and would generate a great deal of domestic inflation.”