Headline: Brazil Braces for Argentine Default

Source: Associated Press, 24 July 2001

URL: http://www.nytimes.com/aponline/business/AP-Brazil-Argentina-Tango-Effect.html

SAO PAULO, Brazil -- At his dance school on one of Sao Paulo's more Bohemian streets, Andrei Udiloff already knows what it means to be hit by what economists call the ``Tango Effect.''

``For me the Tango Effect means I can't afford to bring in any teachers from Buenos Aires,'' said Udiloff. The 28-year-old has cut tango workshops with Argentine experts because Brazil's real -- battered by fears of an Argentine meltdown -- has crumbled to new lows against the dollar.

The specter of an Argentine default on $125 billion of foreign debt or a devaluation of its peso is stalking emerging markets across the globe from Chile to Korea.

Hardest hit so far is Brazil, Latin America's biggest economy. Dependent on foreign investment -- worth nearly $30 billion in 2000 -- to keep its finances buoyant, Brazil is worried that an Argentine collapse could slow inflows or even reverse them. The government is building defenses by hiking interest rates, mulling spending cuts and considering seeking help from the International Monetary Fund.

On Wednesday, the central bank raised its key Selic rate three-quarters of a point to 19 percent, the fifth increase in as many months. But that didn't stop the real from weakening more, opening lower Thursday at 2.53 to the greenback. Once worth roughly the same as an Argentine peso, the real was drastically devalued in 1999 and has shed another 22 percent of its value since January.

``We are about to see a three-component policy response -- a substantial rise in interest rates, fiscal tightening and some sort of IMF support,'' said Marcelo Carvalho, chief economist at J.P. Morgan Chase in Sao Paulo. He predicted that, should Argentina collapse, Brazilian rates could spike as high as 30 percent and the government could chop 3 percent to 4 percent off federal spending.

After huddling with his Finance Minister Pedro Malan and Central Bank Governor Arminio Fraga on Tuesday, President Fernando Henrique Cardoso told O Estado de Sao Paulo that Brazil was open to seeking IMF assistance. ``Certainly, if necessary, we would ask for more resources,'' Cardoso told the paper. Brazil's $41.5 billion IMF loan runs out Dec. 1. According to Carvalho, fresh support from the Fund would be ``a gesture that the IMF is on board and is keen on containing contagion.''

That doesn't bring much cheer to Udiloff. ``We obviously still haven't hit the bottom of the well,'' he said. ``Things are going to get worse before they get better.''

As Argentina, Brazil and Mexico make up the bulk of J.P. Morgan's Emerging Market Bond Index, their economies' performance strongly influences other emerging markets be they Turkey or Malaysia.

It is still not clear how hard more distant countries will be hit by Argentina's woes. Some analysts argue that emerging markets' financial systems are in much better shape now than during previous crises in 1994 and 1998. Others say that, with the world economy in a slowdown, the effects could be worse.

In Brazil, business leaders have urged Argentina to devalue its peso, currently pegged one-to-one to the dollar. After Brazil's 1999 devaluation, the economy stopped in its tracks, but then recovered and was more competitive than ever -- until the Argentine crisis hit. ``Better a horrible end than endless horror,'' said Horacio Lafer Piva, president of Sao Paulo's Federation of Industries. ``The Argentines will have to pass through a deep process of impoverishment, but afterwards the scenario will be better.''

Argentina's Economy Minister Domingo Cavallo -- a figure now despised by many Brazilians -- is reluctant to unhook the dollar peg he introduced a decade ago. And with less than a third of Argentines' bank deposits in pesos and the rest in dollars, a devaluation could threaten the stability of the banking system.

Argentina's other neighbors -- Bolivia, Chile, Uruguay and Paraguay -- might disagree. Chile's peso and Paraguay's Guarani have hit all-time lows against the dollar, while Uruguay's leftist opposition has presented President Jorge Batlle an ``emergency plan'' to kick start the economy.

Chile has spent $1 billion on propping up the peso so far this year and Vitorio Corbo, economist at Santiago's Universidad Catolica says an Argentine collapse could slash growth by a quarter to 3 percent.

In Mexico, the peso, while holding at around 9.2. to the dollar, has been more volatile.

``All attention is focused upon Argentina,'' said a report by New York-based financial consultants IDEAglobal. ``The sentiment in the market is that the peso could go anywhere.''

-- Andre Weltman (aweltman@state.pa.us), July 24, 2001

Answers

Nothing said about the influence of the big drought and energy cutback in Brazil influencing this situation, which is supposed to have dropped that country's industrial output a great deal.

It must be raining in Brazil.

-- RogerT (rogerT@c-zone.net), July 24, 2001.