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Investors Concerned Over Brazil's Ability to Meet Debt Obligations - 2002-08-16

Foreign investors continue to view Brazil's economic future with apprehension, despite a huge loan from the International Monetary Fund, announced earlier this month. Investor nervousness stems not just from the uncertainty surrounding the October presidential election, but also concern that Brazil may be unable to meet its debt obligations.

Brazil's risk assessment by foreign brokerage companies remains high, and the value of the Brazilian currency against the dollar continues to fall. Meanwhile, many foreign banks are restricting short-term credit lines to Brazilian companies. All these are signals of the growing crisis of confidence in Brazil's economic future.

The $30 billion IMF loan unveiled earlier this month was aimed at alleviating market concerns. But most of the IMF money will only be disbursed next year, if the new government that is elected in October maintains the current economic stabilization policies.

Foreign investors apparently consider this a big question mark, given the possibility that Brazil's next president may be a candidate of the left. Two left-wing candidates, Luiz Inacio "Lula" da Silva of the Workers Party and Ciro Gomes of a Workers Front coalition, are ahead in opinion polls. Both have strongly criticized the economic policies of President Fernando Henrique Cardoso, who will leave office at the end of this year, after eight years in power.

Market hopes had been centered on the government party's presidential candidate, Jose Serra, as the man most likely to continue the stabilization policies favored by investors. But these hopes have dimmed, as Mr. Serra remains a distant third in the surveys.

Political analyst David Fleischer said he tells foreign investors there seem to be few prospects that Mr. Serra can recover. He compares the Serra campaign to the 1968 presidential election in the United States.

"A lot of people are saying 'cut the umbilical cord, cut loose from Fernando Hernando Cardoso and begin showing your own program and your own ideas with some criticism of what's happened over the last 7.5 years.' It's very similar to Hubert Humphrey who was so loyal to [former US President] Lyndon Baines Johnsonin 1968, that he only cut loose in October, too late to really win the election and beat Richard Nixon," Mr. Fleischer said.

But investor apprehension over the outcome of the election is not the only factor affecting the markets. There is growing concern that Brazil may not be able to meet its debt obligations, especially as the cost of borrowing new money rises. Brazil's interest rate spread over U.S. Treasury Bonds has risen to almost 23 percentage points because of market uncertainty. If that level persists, a Financial Times editorial warned this week, Brazil will be "insolvent and will default."

This gloomy view is becoming widespread. Mike Conelius, who manages the Emerging Market Bond Fund for the T.Rowe Price investment company, said Brazil and other Latin American countries simply have too much debt.

"Brazil has a debt problem, and the IMF loan is debt, and debt has never solved problems. These countries have just far too much debt, and they have not done enough to try to reduce that debt stock or ease that burden over the years, and they're paying the price for it," Mr. Conelius said.

Brazil's debt is $250 billion, of which the government owes $75 billion to foreign private sector creditors.

President Cardoso maintains Brazil's economy is fundamentally sound, and that the current crisis is the result of market speculation, fueled by uncertainty over the October election. Mr. Cardoso told TV Globo this week that, if the new government continues his economic stabilization policies, there will be, as he put it, "nothing to fear."

But the continuing market pessimism over Brazil's prospects seems increasingly hard to shake off. As the world's tenth largest economy, a financial collapse of the South American giant would be devastating internationally, something market analysts are very well aware of.