JOHN GEDDES October 19 1998


JOHN GEDDES October 19 1998

The next dominoes?

The IMF tries to buy time for Latin America



As some of the world’s most powerful politicians fretted over how to engineer a $46-billion bailout for Brazil last week, Domingos Carneiro was worrying about a much smaller investment. After years of scrimping, the 39-year-old father of three, who operates a small business in Rio de Janeiro, was finally able to purchase a modest home for $65,000. But in the wake of financial collapses in Asia and Russia, nervous international investors began pulling their money out of Brazil, fearing yet another meltdown. To stanch the hemorrhage, which at one point in September surged to $1.5 billion a day, President Fernando Henrique Cardoso jacked up the country’s prime interest rate to 50 per cent. Unable to afford his payments, Carneiro stopped making them. Now, like thousands of Brazilians, he expects to lose his house. “The increase in rates,” he says, “put an end to my lifelong dream to own a home.”

Dreams are rapidly turning into nightmares across Latin America as governments from Mexico to Argentina struggle to contain the fallout from the Asian meltdown. Layoffs are mounting, interest rates are soaring, currencies and stock markets have collapsed. The

fear of a looming financial catastrophe in the region has become almost palatable. Many officials of the International Monetary Fund and the world’s largest industrial powers, who met in Washington last week, believe that rescuing Brazil’s economy may be all that stands between a recession and a global depression. Nearly a quarter of the countries of the world are already in recession, and if Brazil, the region’s largest economy, falls, experts fear it will take the rest of Latin America down with it. Robbed of key markets, the U.S. and Canadian economies would be badly hurt. “Compared with Asia there is a greater sense of urgency on the part of the Americans,” says Josh Mendelsohn, chief economist at the Canadian Imperial Bank of Commerce in Toronto. “They have seen the contagion spread from Asia and Russia. Now, it’s closer to home.”

The storm roiling financial markets around the world began in Asia in July, 1997, when the once-vaunted Asian tigers, including South Korea, Indonesia and Thailand, were no longer able to meet the payments on their foreign debts. The IMF responded by pumping more than $150 billion into the region in an attempt to contain the damage. But Asia’s conditions worsened, and in August the val-

ue of the Russian ruble plummeted when the country effectively defaulted on more than $24 billion in foreign debts. Battered international investors, who can move billions of dollars worth of so-called hot money in and out of markets with the touch of a computer key, began pulling their cash out of South America with a vengeance. Although the outflows have slowed, Brazil is still losing more than $750 million a day in foreign investments.

With a gross domestic product of $830 billion, Brazil is the region’s linchpin economy.

Its industrial output is twice that of Russia, and accounts for nearly half of Latin America’s total. Many analysts believe that before the crisis has passed, the IMF will be forced to pour more than $150 billion into Latin America—and even then there is no guarantee that North America will escape without a severe recession.

To head off a crash, the IMF is readying its $46 billion for Brazil. As well, the country’s finance minister, Pedro Malan, met with representatives of major world banks in Washington in an attempt to put together a private loans package totalling as much as $40 billion. Putting the deal together and making it work is seen as a major challenge for the IMF. “This is right in our headlights,” said Jim Peterson, Canada’s secretary of state for financial institutions. “This will be a test of the effectiveness and the credibility of the IMF and the World Bank to respond to something we know about.”

The money would allow Brazil to make payments on some debts while replenishing its foreign reserves, which were run down when the country was forced to defend its falling currency. The rescue package would buy Brazil time as it attempts to reform its economy. And it would buy time for its neighbors. President Bill Clinton desperately wants to save a region that consumes 20 per cent of U.S. exports.

The pain on the streets of Latin America is mounting daily. Stock markets have crashed across the continent. With prime rates skyrocketing, annual interest on credit-card debt now runs as high as 211 per cent. At the same time, some of the region’s leading currencies have slumped by 20 per cent or more in value, making it all but impossible to buy expensive imports. And as unemployment soars—Brazil’s rate is now the highest in 10 years—many people

TROUBLED LANDS $462 $0.39 $0.33 El BRAZIL MEXICO ARGENTINA COLOMBIA VENEZUELA CHILE The fall in world commodity prices has left many Latin American countries struggling to pay their foreign debts. Key figures for the top six economies (in billions): SIZE OF FOREIGN DEBT IMPORTS EXPORTS TO ECONOMY (GDP) (% OF GDP) FROM CANADA CANADA . $344 (41%) $1.67 $1.31 $312 (50%) $132 $6.99 $170 (37%) 1 $0.41 $0.23 $136 $39 (29%) $043 $03 $136 I $62 (46%) $0.95 $0.97 $119 $43 (36%)

who just a few years ago had fought their way into the middle class now find themselves tumbling back into poverty.

Even two months ago, it was almost impossible to find a seat for an early morning coffee at the Suco Loco, a street bar popular with manual laborers working in a middle-class area of Rio de Janeiro. But now there is always a free stool. ‘We used to serve 60 people every morning,” says manager Jose Luiz. “But since September, it is only half that amount. It’s because all the people who own apartments around here are cancelling their building work. No one wants to spend more than they have to.”

With consumer confidence collapsing, everything seems to be on sale in Rio’s shopping markets and stores. “The market is shrinking in anticipation of what will happen,” says Eduardo Candeias, manager of an electronic goods store in Rio. “The consumer is being a lot more cautious.” And with a possible devaluation looming of the Brazilian currency, the real, shoppers are even more reluctant to spend. “There will be full devaluation,” says Amilton Motta Filho, a „ Rio publicist who bought a car priced in dol£ lars. “If the real falls by 20 per cent against £ the dollar, my monthly car payment will go I up by 20 per cent. My family will really start £ to feel the pinch.”

§ Like many Asian countries, Brazil’s trou5 bles began with easy credit. As long as its economy kept growing and it could meet its foreign debt payments, major banks continued to loan Brazil money. President Cardoso was originally elected on a reform platform that included promises to cut government spending. But he was unable to ram the changes through the Brazilian Congress, which is dominated by regional politicians who were elected to protect the status quo, including a bloated bureaucracy.

As a result, the country’s deficit continued to grow along with foreign borrowing. Now, analysts are divided over whether Cardoso, who was re-elected easily last week despite the crisis, can bring in the necessary fiscal reforms. David Fleischer, a political scientist at the University of Brasilia, says conservative reforms will only create unrest and further slow the economy. But Amoury de Souza, a political analyst in Rio, expects the IMF to insist that Cardoso steamroller forward. “Regardless of the social unrest that the reforms will produce, and it will be an enormous amount,” says de Souza, “the fact is we either carry out the process or we will not resume growth.” Brazil’s economic problems have spread to neighboring Argentina, Latin America’s third-largest economy (Mexico is number 2). With Brazil, Argentina is a key member of the Mercosur trade bloc, and it exports nearly 30 per cent of its industrial and agricultural output to its neighbor. Argentina will also require help from the IMF. The exact amount of that aid has yet to be determined, but last week, the

IMF’s sister organization, the World Bank, was forced to loan Argentina $6 billion to meet debts coming due over the next three weeks.

As the crisis has intensified, many of South America’s stock markets, including those of Brazil and Colombia, have lost almost half their value. Venezuela, faced with a run on its currency when oil prices slumped, has increased interest rates to 80 per cent. Ecuador and Colombia have also devalued their money.

Even Mexico, which has been integrated with the U.S. and Canadian economies under the North American Free Trade Agreement, is staggering. The peso has lost 25 per cent of its value since the beginning of the year.

And Clinton, says Jorge Nef, a political scientist and emerging markets specialist at the University of Guelph, is determined not to let Mexico fall into a deep recession. The country, which consumes about 10 per cent of U.S. exports, is now America’s third-largest trading partner after Canada and Japan. Unlike its Latin neighbors, Mexico has been the beneficiary of massive capital investments by large U.S. corporations as its economy merges into North America. In 1997 alone, U.S. and Canadian direct investment in Mexico reached a record $13.4 billion. Nef says Washington has another strategic reason for protecting its southern neighbor: it does not want millions of unemployed Mexican workers flooding north. “If Mexico goes,” he says, “there would be a security threat on America’s border.”

The massive bailout of the South American economy is also needed to protect U.S. financial markets. American banks have loaned about $123 billion to governments and corporations across the region. A widespread default on those loans would be very damaging. “If the financial markets don’t stabilize,” says Mendelsohn, “it will seriously weaken the U.S. economy.”

Canadian banks are also heavily exposed in the region, with almost $13 billion in loans to corporations and governments. Throughout the 1990s, the Torontobased Bank of Nova Scotia has been the most aggressive Canadian bank in the region, and currently has close to 700 retail outlets operated by subsidiaries across Latin America. Among others, it owns 10 per cent of Mexico’s giant Banco Inverlat, 100 per cent of Argentina’s Banco Quilmes and 53 per cent of El Salvador’s Ahorromet-Scotia Bank.

Despite such massive investment,

John Crean, Scotia’s senior executive vice-president of credit and risk management, insists that the bank has positioned itself to withstand a sharp downturn in the region. Most of its $3.9-billion loan portfolio is backed by government guarantees, he says, and it has attempted to control risk by picking as borrowers financially sound multinationals operating in the region. As well, the Latin retail banks that it controls deal primarily in local currencies—if funds are devalued, loans do not have to be repaid in more expensive foreign currencies. “It’s going to be a tough period for a while,” admits Crean, who does not expect Latin countries to default on their loans the way they did in 1982 during a similar crisis. “There is enormous political will to avoid the problems they went through the last time around.”

The economic tremors also come just as Canadian corporations are trying to close a number of major deals in South America. The upheaval will likely make it more expensive to borrow money. In

September, a consortium of Canadian mining companies—Rio Algom Ltd., Noranda Inc., both of Toronto, and Vancouver-based Teck Corp.—finalized an agreement with the Peruvian government to develop and operate what would be one of the largest copper and zinc mines in the world.

The Antamina project will cost $3.4 billion to complete. According to Noranda executive vice-president of corporate development David Bumstead, the partners are now meeting with a consortium of 12 banks to lock up financing. The banks want to be assured that the project will succeed in a depressed economic environment and to offset the risk, they are demanding a higher interest rate. “The impact of uncertainty,” says Bumstead, “is that the appetite for longterm lenders is less. They perceive the risk as higher.”

But even with the region’s economy sliding into recession, there may yet be a bright spot for Canada in the debacle. Ottawa has pushed for a broadening of NAFTA to include South America. And with the need for investments in the region becoming acute, says John Keale, Canada’s ambassador to Ecuador, Canadian companies will be welcomed if they increase their presence in South America.


Total outstanding loans by major Canadian banks to Latin American borrowers:

Bank of Nova Scotia $3.9 billion

Royal Bank $2.9 billion

Bank of Montreal $2.7 billion

Toronto Dominion $2.2 billion

CIBC $925 million

In fact, Chile, which, until two months ago, had currency controls in place that forced investors to keep their money in the country for a year, dropped the measure in the hope of attracting new investments. (Ironically, international financial officials have lately begun citing Chilean-style controls as a way to curb currency volatility.) ‘The pressure on Latin America’s currencies is slowing down public sector investment,” says Keale. “But it’s definitely opening up opportunities for Canadian companies to establish joint ventures in the region.”

Still, Bumstead says that no one really knows when the economy will bottom out. With so many countries dependent on resource exports, world commodity prices will have to rebound before widespread prosperity returns. That, in turn, depends heavily on conditions in Asia, one of Latin America’s major customers. Domingos Carneiro will have to follow events far beyond his borders to find out whether he can ever again hope to own a home.

With ANDREW PHILLIPS in Washington, WILSON RUIZ in Quito and ALEX BELLOS in Rio de Janeiro