[stop-imf] FT: Soros on Brazil
Thu, 15 Aug 2002 11:31:46 -0700
Financial Times; Aug 13, 2002
COMMENT & ANALYSIS: Don't blame Brazil
By George Soros
The International Monetary Fund's $30bn (ż20bn) rescue package for Brazil
was larger than expected, and should have brought relief to the markets.
But it did not. After an initial rally, bond interest rates have settled
at levels incompatible with long-term solvency.
The country's benchmark C bonds yield about 22 per cent in dollar terms.
Brazil's debt equals 60 per cent of gross domestic product, of which 35
per cent falls due within one year. A primary surplus of 3.75 per cent,
required by the IMF programme, is not sufficient to prevent a significant
further deterioration in the ratio of debt to GDP, especially as high
interest rates are pushing Brazil into recession.
The IMF would have liked to insist on a higher primary surplus but that
would have been politically unacceptable. The difference was eventually
papered over by a communiquż that put the burden of proof on Brazil. The
size of the package was meant to compensate for the gaffe by Paul O'Neill,
US Treasury secretary, about Swiss bank accounts; and to provide a vote of
confidence in a star pupil.
Its failure to bring the required relief indicates that there is something
fundamentally wrong with the international financial system as currently
constituted. Brazil's problems cannot be blamed on anything Brazil has
done; the responsibility falls squarely on the international financial
Admittedly, Brazil is going to elect a president who the financial markets
do not like; but if international financial markets take precedence over
the democratic process, there is something wrong with the system. Under
the influence of market fundamentalism, the IMF does not provide enough
benefit for its members.
In recent years, the so-called Washington consensus has put its faith in
the self-correcting nature of financial markets. That faith has been
misplaced. Ever since capital was allowed to move around freely, one
crisis has followed another and the IMF has been called on to put together
ever-larger rescue packages.
Market fundamentalists blame the moral hazard created by the IMF bailouts.
In the aftermath of the Asian crisis, the IMF switched from bailouts to
bail-ins. The true risks of investing in emerging markets were revealed,
and there has been a reverse flow of capital from the periphery to the
centre ever since.
The fact is that financial markets require a lender of last resort to
preserve stability, and there can be no lender of last resort without a
modicum of moral hazard. Every developed country has learned this lesson
domestically but we have yet to learn it internationally. The current
system is lopsided. It is designed to preserve the international financial
markets, not the stability of periphery countries. It has rendered the
risk/reward ratio of investing in emerging markets unfavourable.
The Washington consensus starts by asking how big a budget surplus is
needed to keep indebtedness within bounds - the higher the interest rates,
the bigger the required surplus. In the case of Brazil, with 20 per cent
interest and 4 per cent growth, the primary surplus would have to be 4.8
per cent to keep the debt/GDP ratio from rising - an obvious
The right question to ask is what interest rates could be reconciled with
reasonable growth. A primary surplus of 3.75 per cent would be the maximum
required, rather than the minimum, and could support real interest rates
of no more than 10 per cent.
The challenge would be how to bring interest rates down to that level.
That might require some international credit enhancements or guarantees,
and the task would be to find the right instruments to keep the real risks
- as distinct from moral hazard - within tolerable bounds.
Before the bailout, I suggested that instead of a traditional IMF package,
the central banks of developed countries should open their discount
windows for Brazilian government debt. Brazilian bonds would rally and
confidence would return at the sight of a lender of last resort.
The risk would be minimised by not raising the amount the central banks
were willing to lend in line with the rise in market prices. Commercial
banks would reinstate their credit lines and export-led growth could
resume, especially if the US completely rescinded its steel tariffs. The
crisis would dissolve into thin air.
My proposal would do the trick that the recently announced package did
not, and would cost no more. It is not too late to adopt it. Once it was
in place, the incoming president would have no reason to contemplate any
interference with the normal servicing of debt. As it is, he would be
justified in demanding some international support, rather than allowing
his country to bleed to death as Argentina did.
Financial markets are right to factor in a significant risk of debt
reorganisation or default, and once they do so it is liable to become a
self- fulfilling prophecy. That is why the markets cannot be left to their