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Friday, 28 June, 2002, 14:34 GMT 15:34 UK
Will Brazil follow Argentina?
President Fernando Henrique Cardoso
President Cardoso "is in charge of the Titanic"

In their latest move to sort out the Brazilian economy, the country's policy makers have relaxed their determination to fight inflation.

Their softer target of 4% for the year - up from a previous target of 3.25% - sent shares higher on the Sao Paolo Stock Exchange as investors welcomed the prospect of lower interest rates.

A move to cut rates ahead of the autumn's presidential election might earn the government candidate, Jose Serra, a few votes.

But lower interest rates alone would not provide a quick fix to Brazil's fundamental economic problems, sceptics argue.

Burdensome liabilities

Like its crisis-hit neighbour Argentina, Brazil is burdened by a massive debt mountain of $274bn (179m).

This has raised fears that Brazil, too, could be facing an economic crisis.

Only this time, the consequences would be much more severe.

"When Argentina defaulted on its debt earlier this year, global capital markets emerged relatively unscathed," observed WestLB Research.

The situation would be far different if Brazil followed suit.

The reasons are there for all to see:

  • Investors tend to view Brazil as synonymous with Latin America
  • Brazil's economy is twice the size of Argentina
  • The US, Europe and Japan all export about three times as much to Brazil as to Argentina

"For better or for worse, events unfolding in Brazil will have a much sharper impact on the global economy than those in Argentina had earlier this year," WestLB Research said.

Spooked investors

Analysts still see a debt default by Brazil as an unlikely event.

But growing numbers of investors are beginning to see it as a real possibility, not least because two leading credit rating agencies recently said they were increasingly wary about Brazil's creditworthiness.

For months, such concerns have sent investors scurrying for cover.

"We have now seen three straight months of decline in investor exposure to Brazil," a recent survey by JP Morgan observed.

In order to bolster investor confidence, Brazil's central bank has stepped in with a $3bn cash injection to buy back bonds from investors who want out.

"We have been buying back debt in the secondary market bit by bit," central bank president Arminio Fraga told investors in London earlier this week.

Sinking ship

Though not making international headlines just yet, Brazil's economic woes have come to dominate the nation's political agenda.

Much of the debate has focused on who should be blamed and on how it should be sorted out.

Presidential challenger Luiz Inacio Lula da Silva recently called for his opponent, President Fernando Henrique Cardoso, to take a lead and "sail in the open sea of economic and social development".

But while doing so, he should be wary about the risks, Lula, as he is widely known, said.

"Fernando Henrique is in command of the Titanic. He should stop taking part in those elite parties, he should see the iceberg ahead of him and stop acting like Captain Smith."

Market turmoil

Lula, who has been consistently critical of the government, has gained great popularity among the Brazilian people.

Burdened by the highest level of unemployment in two years and a rising gap between rich and poor, disgruntled Brazilians are clearly prepared to blame their government.

But the financial markets' reaction to Lula's political ascent has been measured.

In recent weeks, the prospect of him beating the markets' favourite - the free-market advocate Mr Serra - in the autumn election has caused sharp falls in share prices.

It has also pushed the country's currency, the real, to its lowest level yet.

Earlier this week, Brazil's central bank received an additional $10bn from the country's loan facility with the International Monetary Fund to back its intervention in the currency market.

Few believe the financial market turmoil is nearing an end.

"I think we are going to continue to see a lot of uncertainty and weakness," said IDEAGlobal Latin America analyst Aryam Vazquez.

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