Prague, 14 January 1999 (RFE/RL) -- International financial institutions, world leaders and private investors have been rattled by Brazil's decision yesterday to effectively devalue its currency.
Stocks on world exchanges plunged on news of the devaluation and of the resignation of the country's head central banker, Gustavo Franco. Franco is credited with pulling the country out of an inflationary spiral earlier in the decade by establishing a new currency, the real, and then convincing investors the currency would hold its value. There are fears his departure may spark a return to hyperinflation.
Brazil is the world's eighth-largest economy, and banks in Europe, the U.S. and Japan have committed thousands of millions of dollars in loans to the country. The devaluation has heightened concern over whether they'll get that money back.
But the devaluation may be more damaging in psychological terms, coming at a time when investors had just started to regain confidence after last year's economic crises in Asia and Russia. Many had hoped the global economy was poised to recover. Brazil was widely seen as a test of the international community's ability to manage crises.
The devaluation also raises renewed skepticism about the International Monetary Fund (IMF) and its policy of encouraging countries to keep currencies strong and -- as a consequence -- interest rates high. Philip Poole, an analyst for ING Barings in London, spoke today with RFE/RL:
"The IMF's credibility is certainly on the line as it has been in fact since the Asian contagion started. So it's been a very difficult period for the IMF."
The IMF's goal is to tame inflation in order to lure foreign investment, but the number of success stories is low, while the casualty list continues to grow.
The IMF in November approved a financial package of more than $40 billion for Brazil designed to protect the real from speculators and to give policymakers room to lower interest rates.
The bail-out was not enough. Speculators, believing the real to be overvalued, continued to attack the currency. A devaluation proved inevitable.
Shock devaluations, however, rarely work. Russia tried something similar last August when the government realized it couldn't keep the ruble pegged at a rate of six to the dollar. Facing a similar situation as that in Brazil -- falling foreign-currency reserves and high interest rates -- Russian policymakers were forced to allow the ruble to float.
The consequences are well known. The move inspired panic -- not confidence. Investors fled the country and the ruble fell to more than 20 to the dollar. Russia is still trying to devise a policy to cope with the aftermath.
Investors were no doubt thinking about Central Europe yesterday as they were watching events in Brazil. While stock exchanges in Europe and the U.S. fell yesterday by one to four percent, stocks in Central Europe dropped as much as 10 percent. The Budapest Stock Exchange had its worst day of trading yesterday since the ruble devaluation.
World attention will now focus on other emerging economies that are pinning their hopes on a pegged currency. Argentina and Hong Kong, two large regional economies, both tie their currencies to the U.S. dollar. China artificially props up its currency too. If those pegs fall, the effect on global finances would be considerable.
Analysts say Brazil may yet solve its problems and the fallout need not be as severe as with the Asian and Russian crises. Brazil, for example, didn't exhaust its currency reserves before deciding to devalue. The country's debt schedule, as well, is not as heavily weighted toward short-term repayments as in Russia and some Asian nations. Although some regions and companies in Brazil may not be able to meet debt payments, the country as a whole is not in immediate danger of default.
Much now depends on whether policymakers can convince investors that the devaluation is a one-time event and the country is committed to a policy of low inflation and a stable currency. An eight percent currency devaluation should allow for some easing of interest rates which in turn should stimulate the local economy.
But ING Barings' Poole is not optimistic. He says the currency may still be overvalued and that further devaluations -- and severe fluctuations for world stock markets -- may be down the road.