đź”’ Lessons for SA: Brazil set for new type of currency crisis

EDINBURGH — Brazil is in a corruption-induced mess that has been compounded by policy errors. Sounds a lot like South Africa, where Zuma-instituted graft has eaten away the gains of the Mandela-led years and self-interest has distracted leaders from the task of fixing the economy. The Economist outlines how government decision-making and politics play into different types of currency crises. Brazil can prevent the worst if its leaders take action now, it notes. – Jackie Cameron

By Thulasizwe Sithole

There are three types of currency crises, observes The Economist. The pre-1990s kind is slow, starting with an overvalued exchange rate, which gives rise to a trade deficit. Foreign-exchange reserves are gradually run down to pay for it and, when they are gone, the game is up.
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“The currency drops. The finance minister loses his job. But life goes on much as before. The world does not collapse,” it comments.

The second is the first sort on steroids, says The Economist.

“A country that might once have blown some World Bank loans on bad policies is able to tap global capital markets for billions of dollars to misuse. Domestic banks join the party. The economy booms. When the flow of capital suddenly reverses, the currency collapses. Bankruptcy is widespread. The damage is big enough to affect others.”

Brazil, reckons The Economist analysts, would seem to demand a third category. “Elections this month will decide its next president and the character of its congress. They will thus shape the response to a slow-motion financial crisis. The drama is likely to be played out in the currency market. The impact might be far-reaching,” the magazine cautions.

“But Brazil displays no symptoms of an old-fashioned balance-of-payments crisis. Nor is it at the mercy of global capital. Brazil’s crisis is, in essence, a battle with itself.

“Compare Brazil with Argentina and Turkey, both in the eye of market storms this year. They fit the template for a currency crisis. Both had run large deficits on the current account, a broad measure of the trade balance,” it notes.

“These were financed by foreign borrowing, much of it in dollars. Both suffer high inflation. Both had skimpy foreign-exchange reserves. Brazil is different. Its current account is broadly in balance. Inflation is close to a record low. Its plentiful currency reserves dwarf its dollar debts.”

Brazil’s problem is that its government finances are on a dangerous path, with public debt up from 60% to 84% of GDP in just four years.

Spending cuts are needed to fix the public finances. The government wage bill has grown rapidly and over-generous pensions are a far bigger problem.

“They already account for 55% of non-interest public spending. The cost will go on rising as Brazil ages. Things might be worse were it not for a constitutional amendment in 2016, which caps the rise in public spending.”

The crunch point might be next August, if not before, Arthur Carvalho of Morgan Stanley is reported as saying. “A budget for 2020 must be submitted then. If pension reform is not in place, a big squeeze will be needed elsewhere to stay below the spending cap, he says. Or the cap itself will have to be lifted.”

Bondholders would take fright, predicts The Economist. “Though foreigners hold little of Brazil’s debt, there would still be capital flight, a falling currency and rising bond yields. As Brazilian savers anticipate the inflation and economic chaos that will result from soaring public debt, they will seek to escape it.”

The symptoms of Brazil’s past crises were high inflation and external deficits. Below the surface, the underlying problem was lax fiscal policy, according to Armínio Fraga of Gávea Investimentos, a hedge fund, and a former governor of Brazil’s central bank.

“In the slow-burning sort of crisis, said Dornbusch, a mid-course correction can prevent the worst. Brazil might yet manage that. If it cannot, events are likely to speed up dramatically,” it says.

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