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Government reacts to deterioration in markets
In a bid to re-instil market confidence and to stem the currency
deterioration, the government has adopted a number of measures since 13
June, including:
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Drawing on IMF funds to buy back foreign debt. The
government has decided to draw US$ 10 billion from its contingency loan
with the International Monetary Fund (IMF), US$ 3 billion of which will be
used to purchase bonds maturing in 2003 and 2004 to ease the country’s
short-term debt burden with the balance to be made available to defend the
currency. Also the IMF permitted monetary authorities to lower the floor
of international reserves that the Central Bank had committed to from US$
20 billion to US$ 15 billion.
-
Tightening public finances. The government raised the
primary surplus target for this year from 3.5% to 3.75% of GDP.
- Raise
bank reserve requirements. On 14 June, the Central Bank
decided to raise bank reserve requirements from 10% to 15%, in an effort
to reduce cash available to buy US$.
-
Adopting tax measures. On 12 June, the Senate approved
the extension until December 2004 of the temporary tax on financial
transactions.
Public
sector debt concerns rising
The government measures were not sufficient to stem further currency
deterioration. The weakening currency has raised concerns about the
country’s debt burden as some 28% of total public debt is linked to the
US$ and another 51% is tied to overnight interest rates. Brazil's total
public debt in April reached US$ 290 billion -- including US$ 233 billion
of domestic debt and US$ 56 billion in foreign debt. The current worry in
international markets is the pace at which the public debt to gross
domestic product (GDP) ratio has grown in recent years. In April the ratio
reached 54.5% of GDP, which is up from 41.7% of GDP just four years ago.
The rising debt ratio is only sustainable if growth remains healthy and
interest rates remain low, as financing requirements rise. The current
economic scenario does not provide these conditions. The Central Bank
lowered its growth forecast for this year at the end of June to a modest
2% from 2.5% earlier and interest rates remain high. The current risk is
that the deteriorating currency could force the Central Bank to maintain
high interest rates or to even raise them, which would require the
government to generate ever larger fiscal surpluses to service debt. If
the current Brazilian risk perceptions persist or deteriorate further the
fiscal deficit could slide as debt servicing rises. According to Central
Bank data, the primary consolidated public sector deficit (public sector
borrowing requirement with exchange rate devaluation) reached 3.7% of GDP
in 2001 but has risen further to 5.1% of GDP in the first four months of
this year. Investors worry that the Cardoso administration could turn to a
political business cycle spending pattern to bolster popularity or that an
incoming administration, committed to a strong social agenda, could raise
spending beyond sustainable levels, triggering default or debt
renegotiation.
Note:
The above text is an abridged version of the LatinFocus Consensus Forecast
briefing on Brazil. For more details please click here.
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