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January 14, 1999, Thursday, Late Edition - Final

SECTION: Section C; Page 5; Column 1; Business/Financial Desk

LENGTH: 747 words

HEADLINE: TURMOIL IN BRAZIL: THE HISTORY;
It Started From a Spark Set Off in the Political Powder Room

BYLINE: By DIANA JEAN SCHEMO

BODY:
The unraveling of Brazil's economic plan yesterday began with the political equivalent of a lover's quarrel last spring. On one side is a spurned and humiliated former President, Itamar Franco, and on the other, Fernando Henrique Cardoso, the onetime underling to Mr. Franco who had outshone him by becoming President himself.

It was Mr. Franco, the President of Brazil in 1993 and 1994 and now the Governor of Minas Gerais state, who set the Brazilian devaluation in motion by announcing last week that his state would suspend payments on its $15.4 billion debt for 90 days.

Although Minas, as the state is called, had been behind on debt payments for four months, the Governor's declaration drew investors' attention away from the progress the Brazilian Congress was making toward passing parts of a $23.5 billion package of income tax increases and spending cuts.

Instead, it highlighted the financial travails of state governments and raised doubts about Brazil's underlying solvency as word spread that nearly a dozen states were behind on their payments to the federal Government.

The stock market has nose-dived 23 percent in the last five trading days, and today the Brazilian central bank did what it had sworn it would never do: devalued the currency by a steep 8 percent.

The anger that moved Mr. Franco, most analysts agree, began last spring when he tried to win the nomination of his Brazilian Democratic Movement Party, one of six partners in Mr. Cardoso's ruling coalition, to run against the President in elections scheduled for October. Mr. Cardoso, who had pushed through a constitutional amendment to allow his own re-election bid, lobbied Mr. Franco's party hard to prevent the Franco candidacy.

The former President, when he spoke to his party's convention, was ridiculed and jeered by politicians who had courted him just a few years earlier. Even before the party convention began, Mr. Franco competed with Mr. Cardoso, who had served under him as Finance Minister, over credit for the anti-inflationary economic policy on which Mr. Cardoso built his path to the nation's top job.

After these bitter and scalding experiences, Mr. Franco instead ran for and was elected Governor of Minas Gerais in the first round of balloting in October.

Within days of his swearing in on Jan. 1, Mr. Franco announced the moratorium, throwing in a threat, later rescinded, to delay a $108 million Eurobond payment coming due on Feb. 10. With investors already skittish over Brazil, Mr. Franco's mention of a possible moratorium shook the walls of Brazil's fiscal house, raising questions of its possible collapse.

One political analyst, David Fleischer of the University of Brasilia, called the former President's decision "a spark in the powder room," and said, "He's been waiting around the corner for Fernando Henrique and the others who tried to ditch him in the party convention, and this is what he decided to do as soon as he got into office."

Mr. Franco's salvo not only had large consequences on the economic front. It also fanned fears of a political rebellion, pitting state governors coming into office, many inheriting the overspent budgets of previous administrations, against a federal Government bent on austerity.

So far, Brazil's 26 other governors have not defied the central Government as openly as Mr. Franco has. In a meeting in Sao Luis last night, however, 11 governors demanded that the Government postpone debt payments for 90 to 120 days and that it reduce interest rates.

"There are 26 governors working to make a compromise solution,," said Walder de Goes, president of the Brazilian Institute of Political Studies. "Itamar Franco is crazy," Mr. de Goes added. "He decided to break the system."

The states, Mr. de Goes said, owe the federal Government about $40 billion in payments due this year.

The federal Government could force the states to pay up by withholding state shares of Government revenue and seizing the receipts from sales taxes. A state in default also risks seeing its interest rate jump to 29 percent from 7 percent.

With his currency plan's survival at stake, and Brazil's credibility among international investors on the line, President Cardoso appears intent on projecting a stern image. He has warned the governors that Brazil, at both the state and federal levels, must meet its debt obligations. "Rules are made to be followed," the President said at a news conference in Brasilia yesterday.

LANGUAGE: ENGLISH

LOAD-DATE: January 14, 1999