RIO DE JANEIRO, Brazil -- Brazil has announced it will take decisive action to cut its chronic public deficit to avoid becoming the next casualty of the global economic crisis.
Although President Fernando Henrique Cardoso's recent message was the latest in a string of similar -- but unfulfilled -- promises since the global market turmoil began a year ago, it also was his toughest and most decisive statement.
The message followed Brazil's loss of more than $20 billion in reserves in recent weeks due to investor fears that the country's unhealthy economy (a public deficit that is 7% of the gross national product, a current account deficit that is 4% of the GNP) makes it a candidate to be the next emerging-market domino to drop.
Mr. Cardoso criticized municipal and state governments for spending too much and promised a fiscal adjustment package that would quickly cut spending and reduce the unwieldy public deficit by 1999.
Such spending cuts would boost dwindling investor confidence and stem continued massive capital outflows. Mr. Cardoso said the government might increase taxes as part of the package.
Polls gave Mr. Cardoso a 23 percentage point lead over his main opposition 10 days before the Oct. 4 election, and he probably felt confident that he had a big enough cushion to allow him to talk straight.
"Cardoso is seen as the candidate most capable of combating economic ills and voters hesitate before changing leaders in the middle of a crisis," said economist Rogerio Studart, who teaches at Rio de Janeiro's Federal University.
Many agreed that the announcement was frank enough. "Cardoso's warning the voters of tough times ahead before the election will keep them from claiming he betrayed them and thus make belt-tightening measures more palatable," said Rio de Janeiro-based political scientist Jairo Nicolau.
The market, which felt Mr. Cardoso squandered his credibility when he failed to implement an $18 billion budget cut in November, will take a wait-and-see attitude about plans to cut spending and raise taxes. Another reason for skepticism: fiscal adjustment takes time and is hard to implement.
By year's end Mr. Cardoso plans to get Congress to pass his much-delayed social security reform package, which would cut government payouts to reduce the deficit-running program, and to pass laws making it easier to lay off civil servants, a move called for in his administrative reform plan.
The Oct. 4 elections -- which also elected the entire Chamber of Deputies and one-third of the Senate -- were expected to allow parties that support the government to maintain their more than two-thirds majority in both houses. If that is indeed the outcome, the social security reform plan is more likely to get the three-fifths vote it needs to pass in the chamber. However, politicians routinely cross party lines, making approval less than certain.
Social security reform could save the government $3 billion per year.
"If Cardoso, after the elections, maintains his two-thirds majority in the Chamber of Deputies as is expected, there's a good chance social security reform will be passed by the end of the year," said Creston Portilho, press spokesman for ABRAPP, the national association of Brazilian pension funds.
The Central Bank recently raised the discount rate -- the interest rate at which it lends money to local banks -- by almost 30 percentage points to 49.75% to curb massive capital outflows, which went from an average $3 billion per day at the end of August to $1.5 billion per day by the end of the second week in September, to a current $300 million per day.
Those rates will further affect the public deficit by increasing the cost of servicing Brazil's high domestic debt. With 60% of the federal debt indexed to interest rates, this is dangerous. Still, the Central Bank plans to keep rates high until it is convinced markets have stabilized. This could likely lead to negative growth in 1999, increased bankruptcies and an increase in the already high 18% unemployment rate, analysts said.
Perhaps the biggest feathers in Brazil's economic cap are its still high -- but falling -- $48 billion in reserves and plans by the IMF to provide a standby credit rescue package estimated at $25 billion if Brazil needs it. Undoubtedly, the IMF will condition aid on a credible plan to shrink the deficit. Having the IMF as a lender of last resort has already persuaded investors that Brazil has a safety net to keep it from becoming another emerging-market casualty. News of a possible IMF bailout has apparently helped slow capital outflows.
If Brazil's economic situation again gets bleak and reserves suffer another big drop, either due to continued fallout from world economic turmoil or its being unable to put its fiscal house in order, the government could consider alternatives such as devaluation or foreign exchange controls -- taxes, fees, delays and other barriers to capital outflows.
But the government has ruled out both measures and is particularly averse to a devaluation because it believes economic stability depends on low inflation.
Because 30% of the federal debt is dollar-linked (although not maturing for 19 to 26 months), a devaluation would be costly.