Brazilian Devaluation Delivers Global Jolt

Brazil opened a new chapter Wednesday in the world’s 18-month saga of financial turmoil by abruptly devaluing its currency, driving down markets across the Western Hemisphere and raising fresh worries about potential damage to the U.S. economy.

Brazil’s action is the latest and potentially one of the most damaging in a string of devaluations that began in Thailand in July 1997 and has since undermined developing economies throughout Asia, Russia and Latin America.

The government acted despite a promised $41.5-billion bailout from the International Monetary Fund and more than a year of pledges that it would protect its currency, the real.

But pressure on the currency accelerated in recent days amid signs that Brazil faced insurmountable political obstacles to the fiscal reforms demanded by the IMF and international investment community.

Even so, analysts warned that the real was overvalued by as much as 30%, and said that Wednesday’s action--which let the currency weaken by only about 8%--would not be enough.

Far from restoring confidence on the currency markets, the devaluation failed to halt the flight of foreign capital out of the country. An estimated $1 billion left Brazil on Wednesday, on top of the $1.2-billion drainage Tuesday, according to Citibank of Sao Paulo.

In losing 8.1% of its value against the dollar Wednesday, the real lost more ground than in all of last year. The shock sent Brazil’s leading stock index, the Bovespa, down 5.1% to 5,617 points, on top of Tuesday’s 7.6% slide. Brazilian stocks have now lost half their value since April 15.

The fallout hit other Latin American markets as well. Argentina, Brazil’s partner in the Mercosur trading bloc, plunged 10.2%. Mexico’s leading index lost 4.6%, and Peru fell 5.5%. Mexico’s peso initially plunged 10% against the dollar, but it recovered two-thirds of that ground by day’s end.

On Wall Street, the Dow Jones industrials plunged more than 260 points before recovering about half the loss after an appearance by President Clinton that was intended to voice support for Brazil.

After a briefing by Treasury Secretary Robert E. Rubin, Clinton appealed to Brazil to stick to the pledges of financial reform, including reduced public pension benefits, that Brazilian lawmakers have increasingly resisted.

“We have a strong interest in seeing Brazil, with whom we have worked on so many important things around the world, carry forward with its economic reform plan and succeed,” Clinton told reporters.

Brazil is by far Latin America’s largest economy, and its troubles spell immediate danger for Argentina, Mexico and other neighbors. As a region, those countries buy fully 20% of U.S. exports.

The devaluation came immediately after Gustavo Franco resigned as president of the Central Bank, where he was a hard-line defender of orthodox monetary policy and high interest rates that were welcomed by foreign investors but criticized at home.

Franco’s replacement and former deputy, Francisco Lopes, promptly widened the exchange rate margin, or “band,” in which the Brazilian real “floats,” causing an effective devaluation of about 8%.

Brazilian authorities have used the currency trading band to enact periodic mini-devaluations before, but Wednesday’s action exceeded the total of about 7% that the real’s value decreased all of last year.

“The resignation of Gustavo Franco represents the end of a Brazilian exchange policy that resulted in the weakening of the economy, an economic policy that is collapsing,” said Antonio Alves, an economics professor at the Federal University of Rio de Janeiro. “The naming of Lopes is not a revolution. He is part of the same team. The important event is the change in the government’s exchange policy.”

The new policy, combined with fiscal austerity, aims at warding off speculative attacks on the currency, according to Lopes.

Currency values have become much more volatile in recent years as they have been left to float in the free-market world economy. Currencies tend to lose value when an economy is seen as being in trouble, such as Brazil’s, which runs a huge budget deficit.

The stronger a nation’s currency, the greater its purchasing power. At the same time, a weak currency makes a nation’s exports cheaper and more competitive overseas.

Brazil’s foreign reserves stand at about $41 billion, including the $9.3-billion first installment of the IMF aid package. Brazil is scheduled to get an additional $10 billion in IMF money Feb. 28. The acid test of Wednesday’s devaluation will be whether or not capital flight slows. If capital continues to rush out, another devaluation may be necessary.

But analysts and investors fear that the attempt at a moderate devaluation could spiral out of control, as occurred during Mexico’s crisis in 1995, and spread to other developing economies and the United States.

Concern was greatest about Argentina, which depends on Brazil as a market for nearly one-third of its exports of products such as beef, cars and textiles.

A major Brazilian devaluation would hurt the Argentine economy, which has weathered global turbulence with a strict monetary regime that ties the Argentine peso to the dollar and rules out devaluation.

“If Brazil goes down, the consequences could have similar effects in Argentina as occurred with the ‘tequila effect’ [in Mexico in 1995]: increasing recession, increasing unemployment,” said Carlos Perez, director of the Fundacion Capital think tank in Buenos Aires.

Projecting a hands-on image, Brazilian President Fernando Henrique Cardoso abandoned a brief seaside vacation and appeared on national television Wednesday afternoon. He reiterated the achievements so far of his austerity package, saying most of it had already become law.

And in a well-timed victory later Wednesday, the Brazilian Congress’ lower house approved four vital new taxes that, according to the president, will bring in an estimated $3.3 billion. Brazil is trying to overcome a budget deficit that represents 8% of its gross national product. Its once-robust foreign reserves have plummeted about $40 billion in recent months to about $41 billion today.

The latest economic tribulations intertwine with political difficulties impeding the passage in Congress of the sweeping reform of the tax, pension and social security systems. Problems flared up last week when newly elected Gov. Itamar Franco of Minas Gerais state declared a moratorium on repayment of his state’s debts.

A former head of Brazil’s National Development Bank praised Wednesday’s initiatives.

“Everyone thought the [real} was overvalued, and I thought they made a significant correction,” said Edmar Bacha, chief executive of BBA Securities in New York. “I think they made two important moves in widening the exchange rate and showing they could make the Congress move.”

Dissenting was Arturo Porzecanski, an economist with ING Barings in New York, who said the move has not restored confidence.

The devaluation puts Cardoso, whose second term began Jan. 1, on risky terrain. The president’s ironclad popularity rests on his image as the professorial leader who vanquished rampant inflation. Some Brazilians are raising the specter of a return to the bad old days.

Times staff researchers Paula Gobbi in Rio De Janeiro and Vanessa Petit in Buenos Aires contributed to this report.

* RISK FOR U.S.: Brazil’s financial ills hold considerable risks for the U.S. C1

* MARKETS TAKE HIT: World stock markets fell on news of the devaluation. C1