Brazilian Stocks Drop, Capital Flees Amid Fresh Fears

Renewed fears of a Brazilian economic crisis sent stocks plummeting, interest rates rising and foreign capital fleeing Thursday after a large Brazilian state ordered a 90-day freeze on payments toward its $15-billion debt to the federal government.

Nervousness about the moratorium declared by the governor of Minas Gerais--dismissed by some as political grandstanding--raised fresh doubts about Brazil’s fiscal future and sent chills throughout the hemisphere.

As Brazilian stocks tumbled 5.1%, other Latin American markets were hammered too. Mexico’s leading index lost 2.1% and Argentina’s Merval index skidded 1.2%.

The commotion was also blamed for the decline of the dollar against the yen and the euro, reflecting Brazil’s importance to the U.S. economy. It also extended the headlong flight of foreign capital from the country.

Groaning under a huge budget deficit, Brazil is desperately trying to cut spending and raise revenues to meet the terms of November’s $41.5-billion rescue package from the International Monetary Fund. It needs the cooperation of its states in cutting bloated payrolls and in paying down debt.

In November, Brazil received the first $9.3-billion installment of the IMF package, which is designed to bolster the nation’s currency reserves and stop a run on the currency. But December and the first week of January have seen the loss of some $6 billion in foreign capital, a sign of waning confidence.

Thursday’s move by Gov. Itamar Franco alarmed investors because it underscored doubts about Brazil’s ability to pull off a complex series of fiscal reforms against a backdrop of oncoming recession and growing resistance to the IMF-imposed austerity.

This month, Brazil’s National Congress is meeting in a special session to consider fiscal adjustments.

Governors of two other large Brazilian states also said Thursday they wanted to renegotiate their federal debt but stopped short of halting payments until they meet later this month with President Fernando Henrique Cardoso and other governors. The overwhelming majority of Brazil’s governors, however, back Cardoso’s programs.

As a practical matter, Brazil’s federal government controls much more money in the cash transfers it pays out to Minas Gerais and other states than it takes in from the states. So threats like Franco’s are not likely to jeopardize Cardoso’s plans, said Arturo Porzecanski, emerging-markets economist at ING Barings in New York.

Nevertheless, Franco’s action is a wake-up call to international investors that Brazil’s fiscal adjustment program faces severe obstacles, said Desmond Lachman, chief emerging-markets economist at Salomon Smith Barney in New York.

“While this particular incident is overblown, the markets are correctly interpreting it as a sign that the federal government needs the cooperation of the states and that they will be on a collision course every step of the way,” Lachman said.

The news sent Brazil’s largest stock index, Sao Paulo’s Bovespa, down 377 points, or 5.1%, to 6,954 on Thursday. Brazilian bond yields--which already were 11.5 percentage points above yields on comparable U.S. Treasury bonds--rose further.

Brazil’s finance ministry took the unusual step Thursday of announcing that Minas Gerais would pay as scheduled a $100-million Eurobond that matures next month, despite the state’s claims of insolvency. The bond payment is in a secure account and can be used for nothing else, a ministry spokesman said.

Another positive sign for Brazil is that the World Bank delivered on schedule Thursday a $1-billion installment toward its share of the IMF bailout.

Meanwhile, capital outflows totaled an estimated $250 million Thursday, on top of the $200 million that departed Wednesday, according to Citibank in Sao Paulo.

Franco’s move was described as an act of political theater. President of Brazil from 1992 to 1995, he reportedly resents Cardoso because Cardoso has received credit for the success of Brazil’s battle against inflation in the 1990s, the so-called Real Plan.