September 25, 2002
Center for Economic and Policy Research Paying the Bills in Brazil: Does the IMF's Math Add Up? By Mark Weisbrot and Dean Baker Executive Summary (full paper is at www.cepr.net) The IMF has recently approved a $30 billion loan to Brazil, with the idea that the government should eventually be able to stabilize its growing public debt burden at a sustainable level. This paper looks at the trajectory of the country's debt to assess whether such an outcome is likely. The evidence indicates that Brazil is extremely unlikely to reach a sustainable level of debt service, and return to a normal growth path, until a partial default has allowed the country to write off some of its debt. Brazil's public debt rose from 29.2 percent of GDP in 1994 to nearly 62 percent of GDP at present. (See Figure 1). The budget deficit is currently running at about 6 percent of GDP for 2002. The real interest rate on Brazil's debt has averaged 16.1 percent over the last eight years (1994-2001). With interest rates at this level, deficits quickly grow through time; as this year's deficit increases next year's interest burden, the debt burden becomes explosive. The paper examines several possible scenarios for Brazil's debt (see Figure 2): · Assuming a 16.1 percent annual real interest rate for the future, the same as its average over the last eight years: This scenario is explosive, with the debt-to-GDP ratio quickly reaching implausible levels.[2] By 2009, the debt is projected to exceed 100 percent of GDP. It would be more than 188 percent of GDP by 2016. Of course these levels would not be reached; along this path, financial markets would demand ever higher risk premiums, which would raise the interest rate to higher levels yet, and default would cut short the process of accelerating debt accumulation. · The implicit real interest on the public debt for the first six months of 2002 was 15.5 percent, or 33.5 percent at an annual rate. If we take an extremely conservative estimate for the 2nd half of the year, and project an annual rate of 21.0 percent for the year 2002, the debt is rapidly explosive. If we assume annual interest rates at the (underestimated) 21.0 percent rate for 2002, the ratio of debt-to-GDP would reach more than 100 percent in 2007. By 2012, the ratio of debt-to-GDP would pass 200 percent. On this path, which may best represent Brazil's current situation, the financial markets will very quickly give up hope that Brazil will be able to repay its debt in full. · Assuming, as an optimistic scenario, that the real interest rate falls to 10 percent over the next two and a half years and stays at this level (real rates this low were achieved only once in the last eight years): the debt-to-GDP ratio will still rise to extremely high levels. By the end of 2010 it would reach almost 80 percent of GDP. By 2016, it would have grown to almost 90 percent of GDP. As in the other scenarios, these projections assume that the interest rate does not rise, even though the debt-to-GDP ratio grows substantially. This is almost impossibly optimistic, as investors would surely become increasingly concerned about the probability of default as the debt-to-GDP ratio continued to rise. The paper also considers the possibility of stabilizing the debt-to-GDP ratio by running larger primary budget surpluses (see Figure 3). This would require such huge primary budget surpluses that it would not be potentially achievable. There is also the possibility that the central bank could switch to a much lower short-term interest rate policy -- the nominal rate is currently still high at 18 percent -- and thereby eventually lower the interest burden of the debt. This would be difficult for a number of reasons, including the exchange rate risk, and the risk of default -- which is difficult to reverse now that the debt-to-GDP ratio is so high. But in any case, a trajectory that includes a new central bank policy with much lower short-term interest rates is not on the agenda, and is definitely not part of the IMF's current loan agreement. Therefore the projections included in this paper would cover the range of possibilities that could be expected if Brazil continues its current policies. On the basis of current policies, as well as past and present economic data, a scenario under which Brazil's debt burden stabilizes at a sustainable level would have to be regarded as an extremely low-probability event. It would depend on Brazil's economic and fiscal policy meeting targets that could not be regarded as plausible, and/or a world in which international financial markets behaved very differently than they have in the past. If the IMF cannot produce a credible intermediate or long-range projection under which Brazil could stabilize its debt service at a sustainable level, then the purpose of this $30 billion loan agreement is questionable.
