Brazil devaluation roils global markets

Latin American pillar sparks fear of collapse similar to Asia, Russia

January 14, 1999|By Shanon D. Murray | Shanon D. Murray,SUN STAFF

The world's financial markets were sent into a tailspin yesterday when Brazil's top financial official resigned unexpectedly and his successor devalued the country's currency by 7.6 percent.

Economists feared that the latest troubles of Latin America's largest economy could spread to other countries in the region -- and to the United States, which has substantial export and financial interests in Brazil.

The Dow Jones industrial average fell more than 260 points in the first half-hour of trading after the announcement that Brazilian Central Bank chief Gustavo Franco had stepped down, and his replacement, Francisco Lopes, would allow the Brazilian currency, the real, to trade in a wider band against the dollar.

The Dow recovered to close at 9,349.56, down 125.12 points. Markets in Mexico, Europe and elsewhere also fell sharply.

The Sao Paulo Stock Exchange, Latin America's largest, opened an hour late because of Franco's resignation and plunged 10 percent within minutes. It closed down 5 percent yesterday. The smaller Rio de Janeiro exchange lost 5.6 percent.

On its own, it is unlikely Brazil's worsening recession will affect America because only 2.5 percent of U.S. exports go to the country, said Alan Levenson, chief economist for T. Rowe Price in Baltimore.

But all of Latin America receives nearly 20 percent of U.S. exports, he said.

"By itself it doesn't mean much," said David Wyss, chief economist at Standard & Poor's DRI in Lexington, Mass. "The question is: Is this the first of a new row of dominoes?

"For the U.S. economy, it could be bad news. We sell to Latin America, and it hurts us when they are not buying."

Within minutes of the real's tumble, currencies throughout Latin America fell. The Mexican peso, for example, slid 3.4 percent to 10.5 to the dollar.

"What you are worried about is investors saying `Forget this' and walking away from the region for years," said Christian Stracke, a Latin American economist with Bankers Trust in New York. "It could be a serious blow to investor confidence in Latin America."

President Clinton tried to ease investors' concerns, saying that the United States has worked hard to keep Asia's financial crisis from spreading to Brazil, the fastest-growing market for U.S. goods and services.

"We have a strong interest in seeing Brazil, with whom we have worked on so many important things around the world, carry forward with its economic reform plan and succeed," Clinton said. "We certainly hope that they will."

Tuesday, Treasury Secretary Robert E. Rubin listed Brazil -- the world's eighth-largest economy -- as among his chief concerns, along with the financial mess in Russia and Japan's continuing struggles to right its economy.

In November, the U.S. Treasury secured a $41.5 billion rescue deal for Brazil, officially led by the International Monetary Fund.

Despite its resilience, it's unclear if the United States can continue to shield itself from the global financial crisis that has ensnared Asia and Russia, economists said.

In a worst-case scenario, the situation in Brazil could cause a major stock market correction in the United States, said Sung Won Sohn, senior vice president and chief economist for Wells Fargo & Co. in Minneapolis.

"There are a lot of pension funds and retirement money invested in Brazil," Sohn said. "When you take risks, sometimes you have to pay for them. Clearly Brazil has been a very risky market for quite some time.

"One of the reasons the U.S. is the largest lender in Brazil is because a lot of American investors have been chasing yields, thinking that the situation in Brazil would work out, and it has not."

An estimated 2,000 U.S. businesses operate in Brazil, including such giants as IBM, Coca Cola, Ford and General Motors, and weak operations overseas could tighten profit back home. Appliance maker Whirlpool Corp., which was expected to get 10 percent of its revenue in 1998 from Brazil, saw its shares fall $1.125 yesterday to $52.75.

Additionally, U.S. banks have a $27 billion stake in Brazil. Shares in Citigroup Inc. sank $3.5625 to $52.1875; Chase Manhattan Corp. shares fell $2.25 to close at $71.625.

But not all economists and experts are convinced the United States will suffer as a result of the economic chaos in Brazil.

Gurdip Bakshi, an associate professor of finance at the University of Maryland, College Park, said he expects some ripple effects, but no long-term impact on the stock market.

"The good news is the U.S. market has distinguished itself as a safe haven for foreign investors," he said. "Our economy is very stable."

Brazil's currency stability has anchored a four-year economic recovery after decades of high inflation. Markets have long considered the real overvalued but feared a devaluation might spark the kind of crisis of confidence among investors that plunged Russia and much of Asia into chaos after they bungled devaluations last year.

Lopes, Brazil's new Central Bank chief, devalued the real in hopes of stemming his country's financial crisis.

He said Brazil would widen the band within which the real trades against the dollar. The new band is 1.20 to 1.32 reals, compared to 1.12-1.22 on Tuesday.

More important, the bank will allow the dollar to float within the band, instead of keeping it within a much smaller "mini-band." Yesterday, the real rose to 1.32 to the dollar, up from 1.2114 a day earlier.

The change means a dollar will buy more reals and make Brazilian goods cheaper, possibly reducing a $6.3 billion trade deficit as well as interest rates.

Investors have pulled more than $40 billion from Brazil since July.

Wire services contributed to this article.

Pub Date: 1/14/99

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