Another Plunge in Brazil’s Currency Fans Default Fears

Brazil’s currency continued its chaotic ride Tuesday, tumbling to nearly 2 reals to the dollar before regaining some ground, as worries spread that the government may be buried under an avalanche of debt that gathers force as the currency slides.

The currency has now lost about 52% of its value against the dollar, significantly more than predicted, since Jan. 12 when it stood at 1.21 to the dollar. It closed Tuesday at 1.84, off another 4.5%.

The weaker currency increases Brazil’s cost of paying its billions of dollar-linked or dollar-denominated debt, while higher interest rates at home are increasing the burden of its domestic real-based debt as well. The result: spiraling waves of the budgetary red ink that has been the source of investor disenchantment with Brazil all along.

Brazil risks being sucked into “an unmanageable debt spiral,” said Lacey Gallagher, a Latin American debt specialist with Standard & Poor’s of New York. The real’s ongoing devaluation reflects market doubts about how Brazil will resolve the crisis, she said.

Although Brazil’s debt picture darkens by the day, the news wasn’t all bad out of Brazil on Tuesday. The largest stock market, Sao Paulo’s Bovespa, soared 6.33% to close at 7,645 points, reflecting the added purchasing power of investors with dollars and perhaps a sense that Brazil’s rocky situation will soon stabilize.

In the face of massive capital flight, Brazil abandoned its defense of the real on Jan. 13 after President Fernando Henrique Cardoso suffered stinging legislative defeats in his efforts to cut Brazil’s massive deficit nearly in half.

Cardoso has since enjoyed some success with the Congress, including Tuesday’s final approval of a critical pension-reform package that will reduce payments to tens of thousands of government retirees.

But concern increasingly focused on whether Brazil can avoid defaulting on its debt.

“Brazil’s current difficulties are more likely than not to be resolved without a default on either its domestic or sovereign debt. . . . Nevertheless, the risk of an adverse outcome has clearly increased,” said Fitch Investors Service, which Tuesday became the third debt-rating agency to downgrade Brazil’s sovereign debt to below investment grade.

But others were less measured, and said Brazil will probably have to seek a restructuring of its debt on easier terms.

Joseph Petry, a Salomon Smith Barney economist in New York, said that unless the real stabilizes soon, Brazil is “going to have trouble paying its debt . . . and will have to begin speaking to its creditors about making it more sustainable.” Petry is among those who expect the real to weaken further, to as many as 2.25 reals to the dollar.

“The Brazilian government has lost control of the situation. To a large extent, they are being acted upon by the market, instead of acting,” Petry said.

A prominent local economist says Brazil should already be renegotiating its crushing debt.

“Brazilian public opinion is drunk on false information, but the country is right on the edge,” Celso Furtado, a respected economist and former Brazilian planning minister, told Folha de Sao Paulo newspaper.

Brazil’s debt includes $90 billion in public foreign debt, and about $150 billion in real-denominated domestic debt, based on Tuesday’s exchange rate. One-fifth of the domestic debt is dollar-indexed, Petry said, meaning bondholders must be compensated for the real’s loss in value against the dollar.

At his confirmation hearing Tuesday in Brasilia, Francisco Lopes, the new central bank president, assured senators that Brazil will “meet its obligations” this year, partly by continuing to attract foreign capital that in the last few years has helped it finance its large budgetary and trade deficits.

With $36 billion in foreign currency reserves, Brazil still is in a strong position to withstand capital flight, Lopes said. But that is nearly $40 billion less than it had on hand as recently as August, despite infusions of some $16 billion from an International Monetary Fund bailout and the sale of the government phone company, among other properties.

Separately, Finance Minister Pedro Malan sought to downplay the gravity of the currency crisis, saying there is “no sense in staying glued, watching the exchange rate that has to find a point of equilibrium.”