Brazil's Debt Menaces U.S. Markets By Charles Penty & James L. Tyson
Sao Paulo, Sept. 30 (Bloomberg) -- In August, as a financial panic convulsed Brazil, the International Monetary Fund moved to quell the crisis by pledging to lend the nation a record $30 billion. Now, the markets say that might not be enough. On Sept. 27, Brazil's currency, the real, sank to a record low of 3.8750 to the U.S. dollar, down 28 percent since the IMF disclosed its plan on Aug. 7. Brazil's benchmark 8 percent bond due 2014 slid to 48.44 cents on the dollar, down 17.6 percent since Aug. 7, for a yield of 25 percent. Brazil's problem is debt -- $335 billion of it. That's twice the $174 billion that Argentina's federal and provincial governments had in 2001, when that nation was racked by default and deepening recession. Brazil's net public debt equals 62 percent of its gross domestic product compared with 54 percent for Argentina last year. About 45 percent of Brazil's debt is tied to the U.S. dollar. As the real weakens -- the currency has plunged 44 percent this year -- the debt burden grows. The economic fate of Latin America's largest country -- and the future of many other emerging markets -- may hinge on presidential elections set for Oct. 6. Leading voter opinion polls is Luiz Inacio Lula da Silva, whose Workers' Party has long supported the idea of renegotiating some of Brazil's debt. A Sept. 17 Vox Populi poll put Lula's support at 42 percent; his nearest rival, Jose Serra of the current coalition government, registered 17 percent. "Up to the Politicians" Lula has said his government wouldn't renege on Brazil's debt. Even so, some analysts have begun tallying the potential losses for bondholders and international banks should Lula win and Brazil then default. "Now it's up to the politicians," says Mark Dow, a former IMF economist who now helps manage $400 million in emerging-market debt at MFS Investment Management. The turmoil in Brazil threatens to hurt countries like Colombia and the Philippines, according to the IMF. "Confidence in emerging-market investments has been shaken," the IMF said in a Sept. 12 report. "Developments in Brazil are critical." As of March, international banks -- including Citigroup Inc. and J.P. Morgan Chase & Co. -- had $66 billion in claims outstanding in Brazil, and U.S. banks' claims totaled $15 billion, according to the Bank for International Settlements. On June 30, Citigroup had $9.3 billion of outstanding cross-border claims in Brazil, including loans financed by deposits outside the country, according to the bank's second-quarter filing with the U.S. Securities and Exchange Commission. At Stake A default by Brazil -- the 13th-largest trading partner of the U.S., with $40 billion a year in two-way commerce -- would undercut profit prospects for scores of U.S. companies, says Robert Mangles, chairman of the American Chamber of Commerce in Sao Paulo. On average, the 100 largest U.S. companies derive about 3 percent of their annual sales from Brazil, says Mark Smith, executive vice president of the Brazil-U.S. Business Council. Alcoa Inc. and Coca-Cola Co. generate about 5 percent of their sales in Brazil. For Whirlpool Corp., that figure is 6 percent. After the U.S., Brazil, with 174 million people, is the largest consumer market in the Western Hemisphere. Foreign companies have as much as $420 billion of investments there, according to CreditSights Inc., a New York-based market analysis company. "There are plenty of bumps on the road ahead for Brazil," says Mohamed El-Erian, who helps manage $8 billion in emerging- market bonds at Pacific Investment Management Co. in Newport Beach, California. "The question is: Does the whole cart have to fall apart?" U.S. Treasury Secretary Paul O'Neill initially disparaged the idea of helping Brazil with IMF loans. In July, O'Neill said such IMF money -- which ultimately comes from taxpayers in the fund's member nations -- might end up in "Swiss bank accounts." O'Neill's Turnabout At an Aug. 5 breakfast meeting in Rio de Janeiro, executives from such U.S. companies as Cargill Inc., Caterpillar Inc., Colgate-Palmolive Co. and General Motors Corp. told the Treasury chief that an economic collapse in Brazil would hammer U.S. banks, U.S. corporate profits and U.S. stocks, says Mangles, who attended the meeting. O'Neill eventually threw his weight behind the IMF's rescue effort, saying, "The U.S. stands ready to support Brazil." "The Brazil package is fundamentally opposed to some of Paul O'Neill's beliefs about Treasury's policies toward emerging markets," says Kristin Forbes, an associate professor at the MIT Sloan School of Management and a former deputy assistant Treasury secretary who advised O'Neill on Latin America. Alan Larson, U.S. undersecretary of state for economic affairs, says restoring prosperity to Brazil is vital to safeguarding open markets and democracy in Latin America. Brazil also plays a role in fighting drug trafficking and terrorism in the region, he says. Brazil Beachhead "We are at a moment when it is important to reinforce those trends," Larson says. Adam Lerrick, an economic adviser to Dick Armey, the Texas Republican who's House majority leader, says O'Neill's about-face also shows how important Brazil is to corporate America and the U.S. economy. "You're the secretary of the Treasury, and bankers are saying at the top of their lungs, 'Brazil will go down, the Dow will plummet and this will be the great meltdown of the new millennium,'" Lerrick says. "It becomes a U.S. domestic policy issue." Dozens of U.S. companies have made Brazil a beachhead for the planned launch of the Free Trade Area of the Americas in 2005. The accord would remove trade barriers in the hemisphere's $13 trillion market of 800 million consumers. The stakes are high for U.S. companies, which ranked No. 1 among direct investors in Brazil, with $54 billion in assets in 2000, according to Brazil's central bank. "Growth could be meteoric if the economy can stabilize and improve," says Alcides Amaral, former president of Citigroup's Brazilian unit. "That is the great motivator that drew all these companies here." And that's why they want to keep Brazil from going the way of its neighbor to the south. (Published in the October issue of Bloomberg Markets.)
