The Brazilian swindle

The $30 billion IMF loan made to Brazil last year constitutes a form of blackmail designed to constrain the freedom of the Lula government to institute any fundamental policy change.

James K Galbraith

THE International Monetary Fund has made Brazil a $30 billion loan, on condition that the country continue to run a large primary surplus in the government budget.   Any significant move toward fiscal expansion would trigger revocation of the promised loan. In this way the Fund maintains a strong arm over Brazil’s new government, whose officials are adamant that they will pursue a rigidly orthodox policy.

Right now, Brazil has a trade surplus - due mainly to low demand for imports in an environment of recession and devaluation. It has, nevertheless, a substantial deficit on the current account, most of which must be payment of interest due on external debts. Until recently this was offset by capital inflows, which were not, however, mainly new investments - low, owing to the depressed state of internal demand - but operating loans to existing business and the sale of existing national assets to foreigners.   In short, Brazil’s external balance has been a matter of mortgaging or selling property to pay interest, meanwhile hoping that things will somehow get better.

The IMF’s  requirement that Brazil maintain a primary budget surplus amounts to a prohibition against fighting recession by increasing domestic demand, an action that would raise domestic investment and move the trade balance back into deficit (and the current account even more so), which in turn would require that foreign investors be found who are actually willing to bankroll new activity.  Of course, such investors do not exist.  If they did, the IMF would not be in the picture.

Conversely, the pressure to maintain a trade surplus is a device for balancing the existing willingness of foreigners to buy Brazilian assets against the existing burden of debt service. In part because of the political climate, that willingness has been eroding more rapidly than Brazil can manage by shrinking real activity and curtailing imports. The short-run purpose of the loan was merely to shift the timing of panic so that it would occur under the new government instead of the old.   A report in the New York Times on 21 August 2002 made this clear:

‘American and European banks have all been scaling back their lending to Brazilian exporters and manufacturers in the last six months. Most are refusing to comment on their willingness to jump back into that market on the heels of the fund’s big loan deal.’

In the medium term, if the new government respects the conditions of the loan, the effect must be to finance a continuing reduction in private capital inflows, substituting debt to the IMF for exposure to private external investors while maintaining external debt payments to satisfy older creditors. It is probably not accidental that the net IMF loan for this year is roughly the same size as the present surplus on the capital account.

Bleak prospects

Nothing here holds out hope that Brazil’s high indebtedness and interest obligations can be reduced. At best, optimistic observers calculate that if all goes extremely well, if there is steady growth and low inflation, the debt may prove manageable for a short while. The chances even of such a reprieve, however, are not high.  Therefore, unless something does turn up (for instance, the large US tariff reductions on orange juice proposed by President Lula da Silva, which would occur over the dead body of the Florida Republican Party), the outlook is for another IMF loan, and another, and another, until the private foreign sector is safely divested of its Brazilian holdings and the game ends.

There is also nothing in the loan that holds out the prospect for sustained economic progress in Brazil itself. To be sure, the loan buys valuable time during which Lula’s government can demonstrate its bona fides, and indeed make some progress on the important initiative against hunger already announced.  But neither increased public spending nor increased imports can be financed from it.  Hence the loan represents no new money for the benefit of Brazilians, except to the extent that wealthy Brazilian nationals also transfer their assets abroad, and that locals purchase durable imports while they can.  It is a standstill, not a progressive package, whose purpose is to keep the wheels of finance spinning, aimlessly, on the Brazilian beach.

Who benefits?  In the first place, private holders of Brazilian assets, who have an opportunity to escape before an even more severe devaluation. In the second place, foreign bankers, whose loans will receive interest longer than would otherwise be the case.  And in the third place, domestic political forces inside Brazil who oppose growth in public services and social reform.

What is not clear is why a Brazilian government of the Left, elected with a mandate to rule in the interest of the working population, should sacrifice its freedom of manoeuvre indefinitely to these interests.  It would be one thing if the loan held out a prospect of an early return to net new borrowing in support of state policy and private activity, but this is not the case.  Instead, the loan is more properly thought of as a form of blackmail.  The IMF promises, in effect, to help maintain an illusion of business as usual, during which interval the new government can occupy its offices and enjoy the perquisites of power, and perhaps make some progress on carefully chosen issues. But the condition is that  few large changes of policy may be  made.  The threatened alternative, if the terms are broken, is financial chaos no doubt accompanied by concerted efforts to destabilise the new regime.

But has Lula  worked for so many decades to build the Workers’ Party, only to govern on such diminished terms?  Or is he prepared seriously to consider an alternative strategy?  And if so, of what should it consist?

Myth of ‘sound policies’

Brazil is a large, resource-rich, industrialised developing country with a history of interventionist policies in several industrial areas, including aerospace, computers and energy.  It is the economic centre of gravity in Latin America.  The country’s notorious flaw lies in income and wealth inequalities higher than almost anywhere on earth, and a ruling elite aligned to the sectarian interests of the wealthy.  A weak regulatory regime persists, particularly with respect to newly privatised sectors. Taxes have never been raised sufficiently to finance a satisfactory mass urbanisation, and the country’s vast national resources have not been protected or developed in sustainable fashion. Capital, moreover, has been free to take flight whenever policy threatened to move in these directions.

A case could once have been made for capital market openness in Brazil on the ground that the country was short of capital resources, and these could only be acquired abroad.  But that case was valid for at most the extremely short period between 1973, when the old Bretton Woods institutions were dismantled, and 1982, when the resulting explosion of private debts culminated in economic collapse. During the oil shocks, Brazil did manage to finance growth and its import bill from abroad - but of course it could not do so on a sustainable basis.  Ever since then, Brazil and the rest of Latin America have laboured under the dead hand of past debts, unpayable except by selling off existing capital assets. There is no serious case that airlines, roads, power grids and telecommunications networks actually function better under private foreign ownership; the record of privatisation is largely one of a return to the exercise of private monopoly power. At present the entire case for privatisation is financial: it raises resources to permit the continued servicing of past debts.

For what purpose?  The rationalising argument behind current IMF programmes is that countries which follow ‘sound’ financial policies - balanced budgets, tight money, deregulation and privatisation of capital assets - will be rewarded by a stamp of creditworthiness.  They should then benefit by being able to borrow from private capital markets on favourable terms, relative to their own histories and the record of countries who are less responsible. In principle this should mean that they can run deficits on their trade accounts, loan-financing the purchase of capital good imports to support development, and maintaining high levels of economic growth and job creation.  They should be able to do all of this  and still attract inflows of direct foreign capital investment.

It has been clear for several decades, however, that this argument is a myth, that the promised land it envisions is a mirage. If it were not, what would Brazil be able to complain about?  The country has a trade surplus and a primary surplus on the government budget. Foreign money should be coming in now, except for the debt problem.  The source of deficits in both budget and foreign accounts relates to the payment of interest on past debts. And one cannot be helped without hurting the other.  To run a surplus on the current account - reducing imports by another $20 billion or so - would require massive further deflation of the real Brazilian economy. This would destroy the tax base and greatly worsen the public budget. Thus, there is no way to improve Brazil’s accounts from their current position, short of an export boom - which depends on external demand over which Brazil has no control - or else a write-down of the past debt. But of course the very purpose of Wall Street’s interest in Brazil is to get paid, as much as possible, for the past loans.

The Brazilian particulars illustrate a general point. The running of ‘sound policies’ does not translate to favourable treatment on Wall Street. Instead, private investor judgements are driven largely by considerations over  which  national  policies  in developing countries have no influence at all. These include most notably conditions in other developing countries, and conditions in the United States. 

Conditions in other developing countries periodically affect Brazil through contagion in financial markets. Upheaval and financial crisis in Russia, in 1998, directly affected the risk exposure of many ‘emerging markets’ funds.  Forced to account for the rising risk in Russia, they reacted by reducing exposure in other ‘risky’ markets, such as Brazil, even though there was no connection between the Brazilian and Russian economies at that time.  Similarly, contagion from Argentina - itself only recently a ‘model country’ from the standpoint of the IMF - was affecting Brazil in late 2002. Brazil was being punished by the financial markets because of the failure of the IMF’s sound-money prescriptions as they were applied in Argentina, even though Brazil did not follow the Argentine road of full acquiescence in the IMF’s neoliberal schemes.

US policies and internal conditions affect Brazil through their influence on relative rates of return facing investors.  In the late 1990s, with a ‘flight to quality’ compounded by the bubble mentality of the technology sectors, capital flowed into the United States and away from developing economies such as Brazil.  Now that the bubble has collapsed, so has the appetite for emerging country risk, and perhaps also the capacity to purchase Brazilian assets. This too is beyond Brazilian control.

Debt reduction

It follows that the best and perhaps the only route available to Brazilian policymakers acting on their own to restore growth and expand public goods and services in a serious way must, sooner or later, involve a reduction of external debt payments (the question is not, as it was in Russia in 1998, one of an internal default). The easiest way to achieve this is, simply,  to reduce payments, meanwhile imposing strict controls over capital flight and asking for a full renegotiation of financial terms. Alongside these measures, the national currency, the real, would be devalued, and interest rates reduced to accommodate both exporters and import-substitution. This is along the lines followed by Russia after the 1998 crisis, and the result was, in fact, a modest revival of domestic production after a terrible crash.   Since that time, the crisis in Russia has eased, even though the vast damage done since the advent of shock therapy has not been overcome.

If this analysis is correct, then the key issue facing Brazil’s new government is one of timing.  There is a case for starting as they have done, by pressing for free trade agreements that they will not get, and by expressing fealty to a financial orthodoxy that cannot be sustained.  There is the possibility that, in the time so purchased, the political position of the government may grow stronger, for a while. It is possible that, in response to repeated reassurances, the pressure of higher interest rates may abate for a time.  But, at some point, these advantages will come to a peak.  It will then become advisable - and eventually it will become necessary - to face the implacable arithmetic of an escalating and unpayable external debt.

Under these circumstances, the remaining case against a policy of debt reduction comes in two parts, one of which is specious, but the other must be taken more seriously.  The specious argument holds that the capital market will punish Brazil for its defiance.  The difficulty with this argument is straightforward:  Brazil presently enjoys no benefit from its participation in world capital markets.  Even the IMF package serves, from the standpoint of ordinary Brazilians, merely to keep up appearances. It is self-evident that to interrupt the recycling of IMF loans into debt service would change nothing in real  terms,  while  the  effective  imposition of capital controls - if technically possible in Brazil’s case - would slow the exit of private investors and so the decline of domestic asset prices.  It does no harm, nor is it dishonourable, to acknowledge a bankruptcy that exists.  The main effect is to put an end to the outflow of inside money trying to escape beforehand. Although affected investors obviously do not welcome this sudden loss of freedom, there is no moral or ethical basis on which they can claim a greater ‘right to escape’ than that of ordinary workers and other citizens to whom the market grants no such opportunities.

The more serious objection is that Brazil’s internal political stability may be threatened by a policy undertaken in the national interest.  This is the danger of subversion from the outside.  The interests of international finance protect themselves by the means at their disposition. There is a long history of this in Latin America, extending to present-day Venezuela, where the complicity of the US administration in recent and continuing efforts to subvert the government is clear.  In the Russian case, such risks are much smaller, because the government rests on the bedrock of its security services, whose defects are well-known but whose national loyalties do not seem to be in question.  How well a new Brazilian government may be able to meet this danger is a matter of internal politics on which a distant observer cannot speak with any authority. But it is there - in the ‘crisis of confidence’ -  and not in the supposed power of a market, that the true danger lies.                             

The author is Lloyd M Bentsen, Jr Professor of Government/Business Relations at the Lyndon B Johnson School of Public Affairs, the University of Texas at Austin, and Senior Scholar at the Levy Economics Institute. This article is adapted and updated from a Levy Institute Policy Note.  The author wishes to thank Dean Baker, Luiz Carlos Bresser Pereira, Paul Davidson, Tom Ferguson, Wynne Godley, Steve Magee and Robert Wilson for widely divergent but very helpful comments on earlier drafts.