Default is a reasonable option

Adherence to the IMF’s policy prescription of meeting debt service payments and allowing unrestricted capital outflows is crippling Brazil. The rational solution is to call for a debt moratorium and establish capital controls.

Chandra Hardy

A country’s income is divided between consumption and savings. The amount of savings determines how much is available for investment. Good investments raise GDP growth rates and the future levels of consumption and savings.

Payments to foreigners in the form of profit remittances and debt service payments reduce the amount of income that is available for consumption and investment. If the payments to foreigners exceed the level of savings, there will be no GDP growth, and there will be reduced consumption and growing poverty.

Brazil is in the midst of a financial crisis that has largely been brought on by speculators that are withdrawing capital from the country in anticipation of a left-leaning candidate coming to power in the next elections.

The Bush administration and the IMF are trying to stem the outflow by publicly committing to lending Brazil $30 billion over the next two years. This pledge comes on top of a recent loan of $15 billion which did nothing to ease the pace of capital flight, the fall in the exchange rate, and the decline in stock and bond prices.

We have been this way before. After Mexico declared a moratorium on its debt service payments in 1982, several other Latin American countries, including Brazil and Argentina, experienced heavy capital outflows, credit restrictions and debt service difficulties. Most of their debt was owed by the private sector to the major international banks.

The US Treasury, the IMF, the World Bank and the Inter-American Development Bank rushed to the rescue of the banks. In exchange for new loans, governments were forced to assume the obligations of their private sectors. This was known as the ‘fiscalisation’ of the private debt, and it placed heavy burdens on the budget and reduced the ability of governments to increase needed social sector spending.

The borrowers were also required to maintain austerity budgets, open their markets to foreign goods and capital, and privatise their state enterprises.

The promise was that these measures would lead to high rates of economic growth. But since 1980, the growth of GDP in Brazil has averaged 1.5% per annum, which is slightly higher than the average rate of growth of the population at 1.3% per annum. Twenty years later, the average per capita income is about the same, the distribution of income has worsened, more than half of the population is living in poverty and Brazil is unable to provide jobs for the 3.5 million young adults entering the job market each year. In the meantime, the total debt of Brazil has increased from $72 billion in 1980 to about $250 billion today.

[According to the data of the Banco Central do Brasil, Brazil’s gross external debt was $210.8 billion in 2001. This figure excluded $16.2 billion of inter-company loans that was previously treated as part of foreign debt. But in 2001, retroactive to 2000, the Central Bank adopted a new method, treating such inter-company loans as foreign direct investment. The external debt of Brazil in 2000, including the inter-company loans, stood at $236.8 billion, according to the Central Bank data reported before the new method of treatment of such loans was announced.

[Also excluded from the Central Bank data of the gross external debt is an estimated $14.1 billion, pertaining to the debt already paid by the private sector through the CC5 accounts (bank accounts for non-residents with free access to floating exchange rates). During the 1997-98 financial crisis, when Brazil felt the effects of the Asian financial crisis, the CC5 bank accounts are estimated to have facilitated capital outflows by international and domestic investors - $17.5 billion in 1997 and $31.2 billion in 1998.

[In 2001, the interest paid on the foreign debt was $14.8 billion, profits and remittances abroad was $4.9 billion, and amortisation $35.2 billion.]

The US Treasury and the multilateral institutions are back again offering new loans to bail out the international banks and they are once again demanding austerity and more reforms. Brazil is being asked to agree to run a quarterly primary budget surplus of 3.75% of GDP before accounting for debt service payments from 2003-2005. This means that Brazil must give priority to debt repayment and building reserves over social sector spending and investment for the next three years!

[In a comment in the Financial Times, George Soros has said that the IMF would have liked to insist on a higher primary surplus but that would have been politically unacceptable. Soros has estimated that with a 20% interest rate and a 4% growth, Brazil would have needed a primary budget surplus of 4.8% in order to keep the debt/GDP ratios from rising, an obvious impossibility. The right question would have been what interest rates could be reconciled with the 3.75% primary surplus, says Soros, who suggests as a solution the ‘discount windows’ of the central banks of the G-10 countries being opened for Brazilian government debt, and the rescinding of the US steel safeguard duties to enable export-led growth in Brazil.]

The policy prescription of the multilateral institutions does not fit into any kind of poverty reduction strategy. Meeting debt service payments and allowing unrestricted capital outflows are crippling Brazil. The rational decision to make is to call a debt moratorium and to establish capital controls. This will force the creditor banks to observe the rules of the market instead of being bailed out by their governments and the multilateral institutions. The banks would have to negotiate more sensible loan terms at a future date.

The impact on the economy cannot be worse than the current offer. As the rich take their money out of the country, the government and the poor are being made responsible for an even higher debt burden. The next government will have no money available for poverty reduction, job creation or growth. The mechanics of growth and debt indicate that Brazil has a clear choice to make: growth and poverty reduction, or further debt accumulation and no growth.                              

Chandra Hardy, an economist, was formerly on the staff of the World Bank and subsequently a consultant for the Bank. She contributed this comment to the South-North Development Monitor (SUNS), in which it first appeared (issue no. 5181).