Brazil Pulls Reins on Runaway Deficit

Rocked by the turmoil in Asian markets, Brazil on Monday took harsh steps to cut spending, raise taxes and reduce its vulnerability to the whims of currency speculators.

The moves, decreed by President Fernando Henrique Cardoso, will trim about $18 billion from the public sector deficit, which had threatened to grow by $1.8 billion a month after the central bank nearly doubled interest rates in an effort to staunch an outflow of dollars from the nation’s economy.

“We are not a country that puts its head in the sand,” Planning Minister Antonio Kandir said. “We have to face this crisis.”

He acknowledged that the measures were drawn up in response to investors’ fears that Brazil could face the same kind of economic pressures that have forced devaluation in several Asian currencies.

Brazil has been hard hit by the ripple effects of the financial crisis that began last summer in Southeast Asia.

The Bovespa index of the Sao Paulo stock exchange--Latin America’s largest--plunged more than 30% in two weeks, and the Central Bank in Brasilia sold billions of dollars of its reserves to protect Brazil’s currency, the real. Speculators were betting the government would be forced to devalue the real.

On Monday, the Bovespa index closed up 2%, although trading was extremely light.

The package of 50 measures is expected to save about $18 billion next year, making Brazil less dependent on foreign capital.

But it almost surely will bring higher unemployment and economic stagnation as well. It’s a grim scenario for Cardoso as 1998 elections approach, but he had little choice.

“I’m not worried about popularity, but about Brazil,” Cardoso said in a televised address Monday from Brasilia. “I authorized these measures because we can’t have doubts at a moment when other countries are devaluing their currencies.”

Brazil’s Senate and Chamber of Deputies must vote on 23 of the 50 measures issued by the president. All the measures are now in effect by decree. The leaders of the government coalition in Congress said they will support them.

Some supporters of the plan said they believe the government needs to go further.

“The government must keep looking for bigger cuts,” said Ian Campbell, chief Latin American economist with ABN Amro Bank in Amsterdam.

If it doesn’t, and fails to reduce interest rates as planned by early 1998, Brazil faces recession, he said.

After nearly doubling interest rates to 3.05% a month, Cardoso’s economic team met over the weekend to decide how to reassure investors and keep the real strong. A devaluation of the real would reignite inflation, which the government has brought under control in recent years.

The plan calls for budget cuts next year of $4.7 billion, and the government will lay off 33,000 workers and eliminate 70,000 jobs.

Brazil also will speed up its program to sell off government companies and properties, from energy and phone companies to interstate highways.

The only sector to escape the crunch was exports. Industries geared to exports will get increased incentives.

“The measures go far beyond what we expected,” said economist Jose Carlos de Faria with the ING Barings bank in Sao Paulo. “It’s a good sign that the government is willing to pay a high price to protect the real.”

But others were not so happy.

With tight money and higher taxes, the economy could swing dangerously toward recession. Unemployment--now around 16%, by some estimates--is bound to rise, and the leftist labor group Workers Central promptly called for a protest caravan.

Although no one said how long the squeeze will last, Finance Minister Pedro Malan said interest rates will come down if there is a decline in the current-account deficit, the broadest measure of foreign trade.

Brazil’s deficit now is around $33 billion, or 4.3% of gross domestic product, well above the target of 3%. The bigger the deficit, the more Brazil depends on foreign capital for financing.

Michel Camdessus, managing director of the International Monetary Fund, applauded the proposals.

“We welcome this package, which attests to the government’s determination to safeguard the gains made with the Real Plan in disinflation and improved living standards for the Brazilian people,” he said in a statement.

He added that the measures, along with swift approval of pension and administrative reform bills now before Congress, “will create conditions for a rapid improvement in the balance of payments and for an early and sustainable decline in interest rates.”