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January 14, 1999, Thursday, Final Edition

SECTION: A SECTION; Pg. A01

LENGTH: 1635 words

HEADLINE: Brazil Devalues Currency; Wider Crisis Feared; Global Markets Fall

BYLINE: Paul Blustein, Washington Post Staff Writer

BODY:

The global financial crisis flared anew yesterday as Brazil was forced to allow its currency to slide, shaking markets worldwide amid fears that a fresh bout of instability could threaten the economic health of Latin America and, ultimately, the rest of the world.

Major European stock markets fell by more than 3 percent, Latin markets swooned and the Dow Jones industrial average plummeted as much as 261 points in the morning following the Brazilian government's announcement that it would let the nation's currency, the real, decline considerably below previous official targets.

That decision, which came after jittery investors shipped billions of dollars out of the country in recent weeks, stunned markets mainly because it suggested that Brazil's government -- having long resisted a devaluation -- was losing its grip on the economy.

The Dow Jones industrial average partly recovered through the day to close down 125.12 points, at 9349.56. But the turmoil shattered a period of relative calm in global markets that had prevailed since late October, when the United States and other major nations cut interest rates and took a series of other measures aimed at quelling a panicky sell-off in stocks and bonds that threatened worldwide growth. Stock markets in Southeast Asia, where the crisis began in mid-1997, have enjoyed handsome gains in recent weeks.

That recovery suddenly seemed in jeopardy yesterday because of mounting doubts about whether international efforts to shelter Brazil from the crisis were working. In November, after investors grew nervous about Brazil's ability to pay its debts, the International Monetary Fund and the Clinton administration marshaled a $ 41.5 billion loan package for Brazil that was touted as a major initiative to keep Latin America from succumbing as Asia and Russia had.

"We've been through a whole series of financial crises now, and the package for Brazil seemed to hold promise for stabilizing matters," said William Cline, chief economist at the Institute of International Finance, an organization of major banks and investment firms. "And now, with that promise being severely called into question, it's another time of testing."

The problem, many analysts said, is that Brazil's move yesterday -- which was accompanied by a resignation of its central bank president, Gustavo Franco -- may fail to halt a severe erosion in investor confidence in the country's economy. Franco's replacement, Francisco Lopes, maintained that the government was still determined to keep the real from falling too far, and that it was merely lowering and widening the "band," or range of values in which the real is allowed to fluctuate. The real ended the day about 8 percent lower at 1.32 per dollar.

But experts noted that other countries stricken by crisis, such as Indonesia and Russia, had tried similar, limited devaluations only to see their currencies crash as investors, convinced more devaluations were on the way, headed for the exits.

"Right now, what you're seeing is that the markets don't think this is the solution," said Desmond Lachman, head of emerging markets research at Salomon Smith Barney Inc. in New York, noting that money continued to pour out of Brazil yesterday as the nation's main stock index fell 5 percent.

Brazil is Latin America's largest economy by far, and the eighth largest in the world, so the IMF and the U.S. Treasury believe that staving off financial collapse there is crucial to ensuring continued economic expansion in the United States and Europe. It is not just that Brazil is an important market for U.S. exports or that U.S. banks have lent the country $ 25 billion; the $ 8 trillion American economy is big enough to withstand major losses in its business and financial ties with Brazil.

Of much greater concern for policymakers is the potential for Brazil to drag a host of other countries into the financial maelstrom, as Russia did when it defaulted on its debts and devalued the ruble in August. Such a turn of events would pose much greater problems for the U.S. economy, which despite its robust health is already suffering from a decline in exports to crisis-stricken countries.

A massive flight of capital from Brazil, and a collapse in the value of the real, would generate enormous selling pressure on the stocks and currencies of neighboring nations such as Argentina. That is partly because those countries' economies would suffer from lost sales to Brazilian customers, and partly because their exporters would lose out to Brazilian competitors, which could sell their goods more cheaply with a cheaper real.

Accordingly, yesterday's developments sent administration officials scrambling in a series of high-level meetings and conferences with the IMF, Brazilian ministries and counterparts in other industrialized countries. Lawrence H. Summers, the deputy treasury secretary, canceled a planned trip to New York, and President Clinton went out of his way to express U.S. concern at the start of a White House meeting with U.S. labor leaders.

"Latin America is our fastest-growing market for American goods and services, and Brazil is the largest country in Latin America. So obviously, we hope that the situation will be resolved in a satisfactory way," Clinton said.

Yesterday's developments could deal a fresh blow to the credibility of the IMF and the administration, which have already drawn harsh criticism for the failure of multibillion-dollar rescue efforts in Russia and Indonesia. The IMF may deflect some of the blame because, according to some accounts, the agency urged the Brazilians last fall -- in vain -- to consider devaluing the real. Even so, the turbulence in Brazil marks a setback to the fund's efforts.

"Local reports are indicating that there's an outflow of $ 2 billion from the country today, and if that's right, then all of the money the Brazilians got from the IMF in the first disbursement is already gone," said Raul Elizalde, head of fixed income research at Santander Investment in New York. The Brazilians have drawn about $ 9 billion from the $ 41.5 billion package of credits, and that is roughly equal to the amount that the Brazilian central bank has had to provide to people cashing in their reals for dollars.

Allowing a depreciation in the real was a bitter pill for the government of President Fernando Henrique Cardoso. The stability of the currency has played a major role in helping Brazil end years of triple-digit inflation that eroded purchasing power and worsened the nation's crushing poverty. A real that maintains its value against the dollar means that imports are cheaper, and the government's unswerving determination to pursue currency stability -- dubbed the "real plan" -- has forced it to avoid potentially inflationary growth in the money supply.

But Brazil is still in trouble because of investor worries that it is, in effect, living beyond its means. The nation imports considerably more than it exports, and the government runs a budget deficit estimated at more than $ 60 billion, which economists contend must be cut if the country is to be able to continue paying its obligations.

To protect the currency and attract foreign investors, Cardoso's government has driven interest rates as high as 50 percent and, in agreement with the IMF, promised to slash the budget deficit. But the plan has encountered rising skepticism because of political resistance to such austerity in the Brazilian congress. Last week, doubts intensified about Cardoso's political clout when the governor of one of Brazil's largest states, in an act of defiance against Cardoso, declared a moratorium on payments to the federal government.

In a conference call with investors, Lopes, the new central bank president, maintained that Brazil could weather the latest crisis and keep the real within the new, wider trading bands. "We've been under attack at least three times before during the real plan," he said. We're in a much better position with this new system."

Lopes said the central bank's reserves of foreign currencies are still at a "very comfortable" $ 40 billion, "and we still have some $ 30 billion" left in the international loan package that could be used, "ultimately, to defend our currency."

Some experts agreed that for such reasons, Brazil's prospects for avoiding disaster are considerably better than Indonesia's or Russia's. "Their external indebtedness is not that great, they have world-class industry, and they have a strong government," said one former IMF official. "They won't have a big depression and collapse like you had with the other countries."

But analysts warned that a favorable outcome depends largely on whether Brazil presses forward with measures to put its fiscal house in order.

"A lot is going to depend on the devaluation serving as a real wake-up call to the Brazilian congressmen that they are on the edge of the abyss, and they had better pass those fiscal reforms immediately," said Cline of the Institute of International Finance. "If that happens, things could look a lot calmer soon. If congress does not pass the measures, then all bets are off."

IMF Managing Director Michel Camdessus issued a statement late in the day that urged Brazil to pursue further budget-cutting efforts. He said he "welcomed" reaffirmation by Cardoso's government of its "strong determination to put in place, with the cooperation of the congress and in the shortest possible time," the deficit-reduction plan announced in November.

But notably absent from Camdessus's statement was any endorsement of Brazil's new currency policy. He said only that "the Brazilian authorities have notified the IMF of the modifications of the exchange rate system adopted today."

LANGUAGE: ENGLISH

LOAD-DATE: January 14, 1999