SUNS4370 Tuesday 9 February 1999

Brazil: IMF targets put squeeze on economy



Rio de Janeiro, Feb 7 (IPS/Mario Osava) -- Increased efforts at financial reform in Brazil and higher interest rates, recommended by the International Monetary Fund (IMF) in the past week appear to have condemned the world's 8th largest economy to recession this year.

The primary fiscal deficit of three to 3.5% of gross domestic product (GDP), the target agreed in the latest review with the IMF, will have to be obtained through additional spending cuts, because society and Congress will not accept additional tax hikes.

"The budget will have to be modified once again," said Arnaldo Madeira, a key ruling alliance lawmaker.

The target set by the accord signed with the IMF three weeks ago provided for a primary fiscal deficit of 2.6% of Gross Domectic Product (GDP) this year, 2.8% in the year 2000, and 3.0% in 2001.

As a result of the devaluation of the Brazilian currency, the Real, which began to slide on Jan 13, made necessary an additional effort of 0.4 to 0.9%, according to IMF officials and local economic authorities
who met all week to discuss how to adapt the agreement to the new conditions created by the free flotation of the real.

In order to meet the initial target, Congress has yet to approve two new taxes, the revenues from which have already been figured into the budget. The first measure would set a 0.38% tax on bank withdrawals, checks and other operations, and the second is to tax fuel consumption. Approval of the two unpopular taxes has been held up, and will not bring in revenues until June or July at the earliest, said Deputy Pauderney Avelino, the sponsor of the bill for the tax on bank operations, a constitutional amendment.

Levying any other new taxes would be "intolerable" for the country, he added.

But the hardest-hitting social effects, such as a sharp rise in unemployment, will be caused by the recession to be generated by the high interest rates, considered the central weapon against an upsurge in inflation.

Curbing the rise in prices is currently "the critical problem" in Brazil, said IMF deputy managing director Stanley Fischer, who took part in the negotiations from Tuesday to Thursday in Brasilia. Interest rates should only be reduced once inflation is under control, he added.

The interest rate set by the Central Bank has already risen from 29 to 39% since the real started to crash, when Brazil was already the country with the highest financial costs in the world.
IMF critics like prominent US economist Jeffrey Sachs and international investor George Soros, blame the formula of high interest rates to defend national currencies as the key factor in the financial crises shaking the world.

In the case of Brazil, a major effort is being made to balance government accounts, while the fiscal deficit is being fed by the high interest rates that swell the public debt and make it more expensive to service. Failure is inevitable, according to Sachs. Moreover, economic activity is slowing down, reducing fiscal revenues and aggravating unemployment. The unemployment rate is expected to double, to 12 or 13% in the next few months, according to university researchers.

It was against that policy that seven state governors belonging to opposition parties rebelled. The governors met for the second time Friday in Porto Alegre, in southern Brazil, demanding an end to the "unfair economic model" which has made the country "hostage to international speculators."

The fiscal adjustment, promised by the central government to restore market confidence, includes a major contribution by states and municipalities, whose resistance could make it difficult to meet the targets agreed with the IMF.

The seven dissident governors represent a small minority of Brazil's 27 state governors. But their rebellion threatens the credibility of the central administration's fiscal programme. The moratorium on payments
on its debt to the central government decreed by the governor of Minas Gerais last month was the last in a chain of events that triggered the devaluation.

At Friday's meeting, the seven goernors demanded a "grace period" for
paying their debts to the central government, and said they could only earmark five percent of their fiscal revenues to servicing the debt, compared to the 11 to 15% agreed on by their predecessors.

The seven governors inheritedstates with serious insolvency problems, which require a restructuring of their debts, they argue. Many of their ruling alliance colleagues are facing a similar situation.

The prospect of a major recession, with high interest rates, tax hikes and a drop in public spending, as well as inflation expected to soar above 10% this year, should generate even heavier resistance to a government weakened by the loss of its chief banner, the stability of the local currency.