Brazil Crisis Unlikely to Be a Replay of Asia Meltdown

The financial thunderstorm that erupted over Brazil last week instantly sparked fears that a new wave of economic chaos would spread widely, this time rolling into America’s own backyard.

Yet for all the dangers Brazil’s problems pose for its neighbors and the global economy overall, economists argue that the latest crisis might prove less damaging than last year’s Asian turmoil, which set off the worst global fiscal instability since the 1930s.

There is little question that today’s global economic landscape remains extremely fragile, with countries such as Russia and Indonesia teetering on the edge of economic and political anarchy and the U.S. and Europe heading into a period of slower growth and increased trade tensions.

But it is a better-prepared world than that of July 1997, when the collapse of the Thai baht sparked a round of devastating currency and stock market meltdowns and threw a damper on the capitalist euphoria that followed the collapse of the Soviet Union in 1991.

And Latin America today is a different place from the Asia of mid-1997. Its countries don’t compete as directly with one another, its financial systems are more open and accountable, its overall trade with the United States is smaller, and so much foreign money has already left that the region doesn’t have as far to fall.

“We’re unlikely to see a round of dominoes in Latin America like we saw in Asia,” declared William R. Cline, chief economist at the Institute of International Finance in Washington.

While the Asia crisis impoverished millions and toppled governments, it also has triggered changes at all levels of the fiscal food chain and a much greater recognition of the ties that link the problems of a Brazilian banker to a steelworker in Seoul or a farmer in Iowa.

“Asian people recognize we are no longer living in an insulated world, and that’s why if you see the Asian newspapers today, this Brazilian crisis is on the front page,” said Cho Dong Sung, president of Seoul’s Institute of Industrial Policy Studies. “This is a new phenomenon.”

Brazil’s Problems Were No Secret

That global awareness makes a huge difference in the intangible yet vital matter of investor psychology. Brazil’s problems, unlike those in Asia’s once-celebrated economies, have long been recognized from Wall Street to Main Street.

“People have been waiting for a Brazilian crisis--even the optimists,” said David D. Hale, chief global economist with the Zurich Group in Chicago.

To be sure, few analysts--including Hale--are ready to discount the seriousness of the Brazilian situation and its potential to spread financial chaos worldwide.

It will still have important ramifications in a world already suffering from a collapse of Asian consumption and from overcapacity in everything from oil to automobiles.

Countries heavily dependent on commodities, such as Canada, Mexico and South Africa, are certain to feel more downward pressure on their currencies. And with 400 of the 500 largest U.S. companies operating in Brazil, the potential impact of a deep recession there on American corporate profits--which are already growing weaker--is worrisome.

More so than in Asia, analysts say, the severity of the Brazil crisis will be determined by its people themselves. Their leaders are battling over politically distasteful reforms that are being demanded by the international community.

“The outcome will really depend on whether this leads to an acceleration of the reform program in Brazil, so Brazil is not so vulnerable to similar outside forces at the same time next year,” said David Hirschmann, executive vice president of the Brazil-U.S. Business Council in Washington.

There were good signs last week: World stock markets rallied on Brazil’s decision to quit defending its currency, the real, a move that will save billions of dollars the country was spending each week to prop it up. And the muted reaction of currency traders in Asia and elsewhere eased fears about an Asia-style contagion.

In some ways, Latin America is better equipped to withstand the latest upheaval, thanks to economic reforms that accelerated after Mexico’s 1994 peso crisis spread its “tequila effect” across the region.

Since then, Mexico has stepped up privatization of its state-owned companies and banks and opened the doors to foreign ownership in sensitive sectors including finance. That has sped the adoption of modern accounting and debt management systems, and Brazil, Argentina and Chile took similar steps.

While Asia’s governments had encouraged export-oriented investment, they had also maintained high barriers to foreign involvement, particularly in banking and professional services.

In Thailand, Indonesia and South Korea, the banks did the government’s bidding, which led to widespread corruption and misallocation of funds. Foreign lenders flush with capital lent extravagantly to Asian banks and private companies, fueling the stock market and real estate bubble that burst when investors began fleeing the region in 1997.

Meanwhile, the danger of a punishing round of competitive devaluations appears less likely in Latin America, whose countries don’t compete as directly with one another on exports as Asian nations do.

When a country’s currency weakens, its exports become cheaper, and that puts pressure on competitors to let their currencies fall. Asian nations are fiercely competitive in key industries such as steel, semiconductors and electronics.

“Latins don’t compete in as many of the same types of products as the Asians did,” said James Glassman, senior U.S. economist for Chase Manhattan Bank in New York. “That’s why the contagion was so fierce and quick in Asia.”

Another major difference is the world’s readiness.

In stark contrast to the fall of 1997, when President Clinton dismissed Asia’s woes as “a few glitches,” Brazil’s financial struggle--and its implications for global stability--has been widely known.

That gave investors who wanted to reduce their risks in Brazil or viewed its currency as overvalued ample opportunity to bail out before last week.

Latin America Was Already in Slowdown

Indeed, most investors have avoided emerging markets since Asia’s meltdown.

Moreover, Asia was at the peak of a decade of dramatic expansion when its markets came under attack, which made its fall particularly steep and abrupt. Brazil and its Latin American neighbors were already slowing down when the latest trouble erupted.

“The reason one would be a little less pessimistic about Brazil is that most of the large institutions have moved the funds they wanted to move--so the sort of unwinding you saw in Indonesia and Thailand is probably going to be less important,” said Jan Kregel, a scholar with the Jerome Levy Economics Institute in New York.

Kregel added: “For many people, Asia came as a bolt out of the blue. In this case, people have had sufficient time to adjust themselves.”

The past 18 months also have put international financial authorities, including U.S. Treasury and Federal Reserve officials and the International Monetary Fund, on high alert.

In Asia, the IMF and other agencies were unprepared for the virulent market contagion. By the time rescue funds were funneled to Thailand, South Korea and Indonesia, the governments were virtually out of money.

With that experience under its belt, the IMF, prodded by the Clinton administration, worked out with Brazil a $41.5-billion support package in an effort to ward off the crisis.

U.S. Had Begun to Fine-Tune Policies

To be sure, the IMF’s failure to prevent last week’s turmoil has called into question the effectiveness of its approach, which typically requires financial austerity to placate investors even though local economic growth is often one of the casualties.

But in addition, by the time Brazil’s dike burst, U.S. and European officials had already begun fine-tuning their monetary policies in conjunction with a series of interest rate reductions imposed by U.S. Federal Reserve Chairman Alan Greenspan.

And two of Asia’s hardest-hit countries, Thailand and South Korea, appear to be rounding the corner, with strengthening stock markets and stable currencies, growing foreign reserves and governments making reforms. Recently, the South Korean government even began repaying its IMF loans.

While Latin America’s proximity and growing trade ties bolster its strategic importance to the U.S., it occupies a much smaller economic niche than Asia. Latin America buys 20% of all U.S. exports, but its two-way trade is still just one-third of the U.S.-Asia trade relationship.

All these factors will help cushion the world from Brazil’s fall, analysts say.

“I think we can live with this,” economist Hale said. “I think it’s a problem, but I’m not in the camp that thinks it’s out of control.”

* CURRENCY DEVALUATION

Brazilians are feeling the impact of real’s devaluation. C1

* FORD PLANT

Ford temporarily closes its Brazil plant after backlash. C2