SUNS  4319 Monday 7 November 1998

Rio de Janeiro, Nov 5 (IPS/Mario Osava) -- Interest rates, not inflation, is the new bogeyman tormenting Brazilians, and exorcising the latest demon is the main focus of economic and political debates here today.

A wave of criticism of "extortionist" interest rates has brought together members of parliament, business leaders and state governors, from pro-government as well as opposition parties.

President Fernando Henrique Cardoso has shown that he feels the pressure, berating the "demagogues" and "Cassandras" (doomsayers), while rejecting criticism and negative predictions by foreign economists.

Those demanding a swift reduction of interest rates include the governors of Brazil's four most powerful states, among them Sao Paulo Mayor Mario Covas, a member of Cardoso's Brazilian Social Democracy Party (PSDB). The other three governors belong to opposition parties.

The Sao Paulo federation of industrialists, headed by the group's president Horacio Lafer Piva, is calling for an immediate cut in interest rates to 20% (or half of the interest rate applied by the
Central Bank since Sep. 11 to curb the flight of foreign capital) in order to prevent even greater production losses.

Brazil, which began to feel a major impact from the ongoing global financial crisis when Russia declared a debt moratorium in August, forced the Central Bank to raise its base interest rate, which then stood at 19 percent.

Brazilian interest rates have been among the highest in the world since 1994, when the country was finally successful in reining in its chronically high inflation. The high interest rates were justified by
the need to stabilise the local currency and attract the foreign capital needed by a country with a limited capacity for domestic savings.

The gradual reduction in interest rates undertaken by the government was abruptly interrupted in 1995 due to the Mexican peso crisis. Then, when the financial turbulence began to spread through Asia in October last year, the Central Bank raised its base rate to 43 percent, before lowering it little by little to August's 19 percent.

That strategy, designed to defend the real, tipped the country into economic stagnation this year.

The Russian crash and the worsening of the Asian crisis drove the Central Bank rate back up to above 40 percent, which pushed up the annual interest paid to commercial banks by companies in need of credit up to nearly 100 percent, and the interest paid by consumers who dare to buy on credit to twice that.

As a result, the economy will be plunged into recession next year, according to the economists whose predictions have been refuted by Cardoso.

And in its Fiscal Stability Programme announced last week, the government itself admitted that gross domestic product would shrink by one percent next year.

The tough adjustment measures announced last Wednesday, many of which are pending ratification by Congress, are aimed at reducing the public deficit by $23 billion next year through spending cuts and tax hikes which will aggravate the economic recession.

Pressuring Congress to quickly approve measures such as the government's proposed reform of the social security system, Cardoso and Finance Minister Pedro Malan argued that only such a tough fiscal adjustment programme would allow interest rates to be lowered.

They argue that it is the state, whose expenditure exceeds its revenues, that forces a rise in interest rates, especially when foreign capital is as scarce as it is today. To finance its deficit and high
debt, the public sector concentrates internal savings, making credit scarce and expensive.

But a loose group of Brazilian and foreign economists from varying schools of thought reject that diagnosis, and see the exchange rate as the key problem.

In their view, today's high interest rates are due to Brazil's dependence on foreign capital, which is in turn the product of a $35 billion a year current accounts deficit. With its overvalued currency,
the country's imports rose twofold in the past three years, while exports grew less than 25 percent. They argue that sooner or later it will be necessary to devalue the real or allow it to float freely - a
measure that would immediately allow interest rates to fall and thus boost economic growth.

The government's mistaken insistence on keeping the real overvalued with respect to the dollar, thus driving up interest rates, is destroying the national economy, especially industry and agriculture, according to parliamentary Deputy Antonio Delfim Netto. Netto, who served as minister of planning and finance in the 1970s and 1980s, is today a parliamentarian of the conservative Brazilian Progressive Party, which is in the coalition that backs Cardoso. Opposition leftist economists echo his criticism of the government's economic policy.