Brazilian Domino Effect?

$30 billion bailout is for US bank exposure, not regional protection

By

Brazil is widely regarded as the latest pressure point in the ongoing global financial turmoil.

Conventional wisdom suggests that if the fiscal adjustments recently announced by President Cardoso become bogged down in the Brazilian congress, investor confidence would erode, and reserves dwindle - eventually compelling Brazilian authorities to devalue the real. The result would be further stress for Brazil's already contracting economy, and a return of inflation. A Brazilian crisis might make Argentina the next domino, as Argentina's fixed exchange rate and heavy trade dependence on Brazil are often cited as key vulnerabilities.

If Brazil and Argentina go, then could Mexico and the rest of Latin America be far behind?

Recommended: Could you pass a US citizenship test?

And would a crisis in that region render the US economy increasingly vulnerable to an extension of the Asian collapse?

The domino-style argument is the rationale behind the sizable assistance package for Brazil currently being cobbled together by the International Monetary Fund, the World Bank, and the US Treasury, among other international actors.

Most analysts foresee a package of at least $30 billion.

How could a crisis in Brazil affect the United States?

US-Latin American trade links are often cited as a potential channel of contagion.

Indeed, Latin America accounts for nearly 20 percent of US export earnings, and Brazil is the largest economy in Latin America, accounting for more than 40 percent of regional economic activity.

But it is erroneous to conclude that Brazil is therefore a significant trading partner for the US.

Department of Commerce data shows that the US exported $134.4 billion to Latin America in 1997. Of this total, Mexico purchased $71.4 billion, or 53 percent.

Brazil, meanwhile, accounted for only $15.9 billion, merely 12 percent of total exports to Latin America, and only 2.3 percent of total US exports worldwide.

Indeed, strong trade ties between the US and Mexico provided a more meaningful - though still controversial - justification for the 1995 bailout of Mexico, when the US Treasury circumvented Congress and provided a $20 billion credit line to Mexico. Commercial relations with Brazil are not by themselves nearly significant enough to merit such assistance.

Moreover, it is not at all clear that a downturn in Brazil should necessarily result in deteriorating long-term prospects for the rest of Latin America.

Even in Argentina - normally considered the economy with the greatest Brazil-related risk - the evidence is mixed.

While Brazil accounts for about 30 percent of Argentina's export earnings, the export sector as a whole represents less than 10 percent of the Argentine economy. And even though Brazilian Gross Domestic Product is forecast to contract by at least 1 percent in 1999, Argentina is still expected to grow by 2 percent to 3 percent next year.

Meanwhile Mexico, which sells more than 80 percent of its exports to the US, is much too linked to its northern neighbor to be significantly affected by Brazil's fiscal woes.

If neither trade nor regional contagion is an overriding concern, then why is Brazil such a worrisome issue for US economic officials?

The less-publicized answer lies in the loan exposure of US banks in Brazil. US banks held $25.6 billion in outstanding loans to Brazilian borrowers as of June 30, 1998.

This is by far the largest exposure by US banks to any developing economy, dwarfing the highly-touted $6.2 billion exposure to Russia, and more than one-and-a-half times the total loan exposure to Mexico.

Should capital keep fleeing Brazil, which it did at a pace of $500 million per day last month, the risk of loan default would grow. Hence the multibillion-dollar assistance package.

Indeed, it is little coincidence that a $30 billion bailout would neatly cover the US banks' outstanding loans in Brazil.

The need to "restore investor confidence" is the prevailing mantra in today's international financial circles, and is a common justification for massive assistance packages such as the one being prepared for Brazil.

But increasing confidence should not be confused with eliminating risks to lenders by creating the perception that the US and the multilateral agencies will open the spigot at the first signs of trouble, bailouts may promote risky or reckless lending.

Mexico already carries an implicit US government guarantee. Should Brazil, and perhaps other economies in the future, come to enjoy the same?

* Carlos Lozada, formerly a consultant to the Inter-American Development Bank, in Washington, D.C., is an economic analyst in Atlanta.

Share this story:

We want to hear, did we miss an angle we should have covered? Should we come back to this topic? Or just give us a rating for this story. We want to hear from you.

Loading...

Loading...

Loading...