Features unique to the Brazilian crisis in 1998-1999
It isn’t easy to find a country in the world with such an explosive potential – the gap between the rich and the poor is among the widest globally. Having peacefully liquidated the military dictatorship in late 1980s, Brazil, a federation by state structure, opted for the path of liberal and democratic (by Latin American standards) development. However, inflation which reached hundreds and even thousands of percent a year remained its primary obstacle to normalization of the economic situation. In 1994, a financial stabilization was carried out upon the initiative and under the supervision of Finance Minister Cardoso to become the first success in many decades. Inflation was lowered to a level of several percent a year. Furthermore, this Brazilian-style shock therapy didn’t put an end to industrial growth. These achievements made such a strong impression on the nation that soon Cardoso was elected President and reelected for the second term in 1998.
Nevertheless, weaknesses of the Brazilian economy remained obvious to the global financial community. The Russian shock of 17 August 1998 had gravest repercussions in Latin America, primarily, in Brazil. This was not because of the country’s close economic ties with Russia (these ties aren’t very significant). The reason was that Brazil became the center of mistrust and suspicion of financiers that manage global capital flows. In fall 1998 when the crisis whirlpool sucked in up to a dozen countries of medium levels of development and the banking crisis broke out in Japan, many observers in the world felt that this series of regional crises could well grow into a global economic crisis. It seemed events in Brazil supported these concerns.
Despite all differences between tropical Brazil and cold Russia, problems of our countries have quite a few things in common: traditional extravagance of willful states that are part of the federation; feebleness of the banking and loan system with a substantial share of bad, non-repayable loans; dependence on inflow of foreign capital, mainly short-term resources.
In the 1990s the Brazilian authorities chose the exchange rate of the national currency (real) as the stability anchor supporting it within the fixed sloping corridor, i.e. allowing slow depreciation, roughly reflecting inflation rates. The real rate gradually went down but it turned out it remained overpriced. As usual, this made exports difficult, stimulated imports and created a feeling of inevitable devaluation in the markets.
In summer 1998, especially after 17 August, all these weaknesses of Brazilian economy and finance surfaced big time. The first signal was sent by the falling figures of the stock exchange – indexes about halved in July and August. Foreign capital invested in Brazilian bonds, bank deposits and loans of foreign banks to Brazilian borrowers turned to panic flight from Brazil. As usual, national capital followed. To maintain the exchange rate of the real that everybody was trying to get rid of ASAP, the central bank sold almost a half of its foreign currency reserves in three months worth a staggering 70 billion dollars by the time the crisis began. In an attempt to stop capital flight, the central bank increased the refinancing rate to over 30% per annum. Banks’ market interest rates went up to 40-50% making bank loans virtually unaffordable for most enterprises. A situation typical of many countries in recent years ensued: protecting the currency’s stability at the expense of economic decline. A strong echo of the Brazilian crisis reverberated across entire Latin America in the guise of depreciating stocks, foreign capital flight, currency devaluation.
Brazil’s financial collapse is as dangerous for Washington as Mexican collapse a few years before. It decided not to wait for the worst and act preemptively. As early as in November 1998 the International Monetary Fund, in conjunction with the US government and a few other creditors, put together an aid package for Brazil worth 41.5 billion dollars, including 18.1 billions of the Fund’s resources. This money was to be paid in installments as soon as the country implemented the stabilization program approved by the IMF. They also counted that the very huge amount of credit support would add trust to Brazilian economy and currency.
Brazil had the Fund approve a program of steps intended for economic readjustment: cutting the budget deficit, improving tax collection, limiting bank credit to poorly performing enterprises, holding down growth of money supply, readjusting banks and other financial institutions. The Brazilian government promised to continue privatization of the state sector which was rather successful since early 1990s. This was a standard set of requirements that sometimes borrowing countries vehemently oppose. However, for Cardoso’s government this course was quite limited and the government allegedly didn't try to cheat the Fund assuming burdensome liabilities. Rather, this strengthened its positions in relations with the parliament and influential governors. However, this ‘first aid’ failed to save the real from devaluation and prevent an acute phase of the crisis. In January 1999 Brazil was forced to abandon a fixed (to be more precise, almost fixed) exchange rate and allow market devaluation of the real. Instead of the 10-15 percent of rate weakening prescribed by financial ‘doctors’, the real’s rate vis-à-vis the dollar dropped by about 40 percent within a few weeks. The situation appeared so alarming in March 1999 that the government forecasted unfavorable figures for this year in its memorandum to the Fund: GDP to fall 3.5-4% and CPI annual inflation up to 10% in first half and up to 15-17% a year.
Having turned down the ‘manual’ exchange rate of the national currency and opted for a floating regime, the government started focusing on another key indicator – maximum inflation rates. This policy typical of many countries was named ‘inflation targeting’. The government is allegedly capable of influencing main factors that determine price growth rates in order to keep them within pre-defined limits. Judging by all things, Brazil managed to do so in 1999-2000 to a great extent. The main achievement of post-crisis development was that they managed to avoid resumption of high inflation. As compared to Russia and Indonesia where the inflationary wave powerfully rose after the crisis and devaluation, Brazilian price growth figures looked relatively fine and didn't reach the government’s forecasts referred to above. Unlike in the Asian countries, economic decline reflected itself not in falling production (measured by the GDP or the industrial product index) but only in stagnation of these figures in 1998-1999. By late 1999 stock prices regained their pre-crisis positions in dollar terms.
Experts have a difference of opinion about why Brazil emerged from the financial crisis so safely. IMF management and economists close to them naturally point to the fact that the government was wise in not succumbing to pressures of rather influential forces that opposed tough financial policies recommended by the Fund. This strengthened the global community’s trust to Brazil and stopped capital flight.
There must be a substantial grain of truth in this. Nevertheless, it is clear that the condition of the entire global economy was very important as it managed to overcome decline symptoms and generally continued growing in 1999-2000 at a rather fast pace. Brazil also benefited from a number of features which are peculiar to its economy and prevented intensification of the crisis. Foreign investments in Brazil are mainly made as direct investments. This capital is more stable by nature and independent from temporary factors even of the character and scale that Brazil experienced in 1998-1999. Direct foreign investments grew even in crisis years because medium- and long-term outlook of Brazilian economy is believed to be positive in the principle. Brazil’s banking system had little to do with the crisis. No bankruptcies of large banks and panic withdrawals of deposits were witnessed. Of course, this fact needs to be explained but so far it will suffice only to state it. Brazilian imports have only an insignificant share of foods higher costs of which during a devaluation are almost immediately included in retail prices, i.e. put on the consumer. This weakened the inflationary wave and helped prolong the devaluation effect in time.
Asian model of financial crises
Eastern and South-Eastern Asia has invariably been a region with highest economic growth rates over the past couple of decades. Japan has long been the second largest industrial nation of the world after the US. Asian tigers – Taiwan, South Korea, Singapore, Hong Kong – turned into leaders of modern industry and technical progress. Indonesia, Thailand, the Philippines, Malaysia also made decent progress in economy. Finally, China won a worthy place among leading industrial powers during the epoch of Deng Xiaoping and his successors.Production growth in these countries was accompanied by formation of modern financial systems integrated in the global financial market. Asian markets are close at the heels of US and West European markets in terms of securities turnover. Performance of stock exchanges in Tokyo and Hong Kong are equally important for global economy as stock indexes of New York and London. These markets draw not only domestic savings but also capitals from all regions of the world. Large Japanese banks aren’t inferior to their American counterparts in terms of the size of assets and transactions. Bank loans used by Korean concerns whose names are very well-known in Russia are worth dozens and even hundreds of billions of dollars. Quite logically, a prolonged boom created factors characteristic of a financial crisis. The Mexican crisis of 1994-1995 gave birth to a wave of debate among financial politicians and experts on the subject of whether anything of the kind could occur in Asia. The answer came before it was expected: starting in mid 1997 economies of several Asian countries were hit. Japan avoided a full-scale crisis but a deteriorating situation in this major country had a strong effect on other countries.
Asian nations quickly went though the economic cycle typical of capitalism for almost two centuries. However, in late 20th century both the boom and the collapse had a new scale and forms. These new forms are, in particular, determined by the fact that the Asian region has peculiar features that make it different from the west. According to many experts who tried to explain the crisis, the financial and banking system of the region’s countries didn’t correspond to that level and rates of economic growth they had reached through hard work, organization and order in their societies and external factors favorable for them. Roughly speaking, it was a crisis of growth caused by that the financial infrastructure was lagging behind economy in general. The burden of globalization appeared unbearable for the region’s countries. Entry of the global system with its dynamics, primarily, with staggering capital flows across borders of countries and regions that could undermine the previously impeccable financial status of a country within a short period of time. In the second half of 1997 one country after another ended up under the pressure of forfeited trust from global financial markets, international creditors and stockholders. Financial panics occurred when foreigners were trying to take their capital out of the affected country.
Words characteristic of this financial earthquake were found in 1998 by the investment expert who was working in Hong Kong: “This total economic collapse and huge destruction of wealth which occurred in Asia over the past six months exceed anything I have seen before”. Of course, he thinks in his customary categories of paper wealth – fictitious capital. However, destruction of paper wealth in crisis conditions becomes a very important factor.
Economic disaster in Indonesia
Indonesia was a desperately poor and backward country in early 1960s. Jakarta looked like a large village with a few buildings of European architecture left by colonizers and one modern hotel and stadium built by the Japanese. Two years later saw an unsuccessful attempt by leaders of the Communist Party to take over power. As a result, hundreds of thousands of communists and their sympathizers were slaughtered.
Suharto played an important role in the country’s development. He ruled with a firm hand to create social and political stability and conditions for economic growth. Indonesia was transfigured 25-30 years later. “The Green Revolution mainly provided the country with its own rice and other main foods. Indonesia became a major petroleum producer, many sectors of industry emerged. The country was open to foreign capital, investments gushed into Indonesian economy. Average GDP growth rates during thirty years up to 1997 were about 1% a year. These were the origins and evolution of this ‘economic miracle’. It is in the context of economic progress that negative factors came together to make Indonesia a victim of an acute crisis in 1997-1998. Unlike other crisis-struck countries of South-Eastern Asia where prices were mainly stable, Indonesia experienced a strong spike of inflation caused by a substantial fall of the Indonesian rupee and ‘the inflationary tradition’ in this country. It took the official consumer price index half a year of the crisis to grow almost by 50% and one year to double as compared to what it was before the crisis (staple goods appreciated especially).
Overpopulated Indonesian cities always have social fuel such as the unemployed and half-timers, half-criminal and criminal elements. Higher prices of foods accompanied by unemployment rates growth gave a spark. In early January 1998 when the dollar jumped to 11,000 rupees in Jakarta (being about 2,000-3,000 before the crisis) people panicked and started buying up food which created lines and throngs in shops. The mob’s wrath turned against the ethnic Chinese who had long controlled a substantial part of retail trade. Chinese massacres similar to Jewish pogroms in old Russia occurred before but this time they were of such a scale that the authorities were powerless to bring back order.
A more severe wave of street violence surged in May 1998. However, this time the crowd’s resentment of economic difficulties coincided with political turmoil that reflected the people’s long-lasting hate of the repressive and corrupt regime. After several people were killed and wounded during an anti-governmental demonstration of students, real street fights broke out, and according to statistics, about 1,200 people died in Jakarta alone. The political crisis became irreversible; international organizations and foreign embassies started evacuating their personnel. Thousands of wealthy Chinese families also fled from Indonesia. The Chairman of the Parliament that elected Suharto for the seventh presidential term only two months ago demanded his resignation. The command of armed forces whose support the President used to invariably rely on decided to wait and see. A few thousands of students seized the Parliament’s building and held it for three days. The Parliament and leaders of the student movement issued an ultimatum to Suharto requesting that he immediately leave. After 32 years of dictatorship, the 77-year-old President announced his resignation. The regime that seemed unconquerable not long ago tumbled down virtually in no time.
Sacrificing the aged leader and hastily getting rid of his family members and the clan who held top official positions, the junta kept power. Top military commanders kept their previous positions. Their leader announced that the former President and his family members were given guarantees of personal security. Interim President Habibi, a long-standing employee and assistant of Suharto, urgently announced that democratic elections would be held in 1999. Authorities feverishly did whatever they could to calm down the IMF and the World Bank, governments of western countries and creditors of Indonesia. They had certain progress: the political crisis subsided, advisors from the IMF, the Asian Development Bank, the US and Germany started putting economic affairs in order, in June 1998 the Committee of Creditor Banks agreed to put off repayment of Indonesian debt.
The fall of Suharto’s rule opened new vistas before the country. This was a time of enthusiasm and hopes. Parliamentary elections in June 1999 cleared the path for new social forces and people to the political arena. The new multi-party Parliament bargained for a long time and reached difficult compromises to elect A. Wahid the President – an Islamist known for his stubborn opposition to Suharto’s rule. Politicians of different wings agreed on him as a favorite of the people. Sukarno, daughter of the national hero and founder of the Republic of Indonesia, became Vice-President. First measures taken by the new administration included limitation of power of the military elite inherited from the previous regime. Indonesia’s economy managed to take advantage of certain factors such as growth of global petroleum prices and devaluation of the national currency. Growth resumed in 1998 after a slump even though it lasted another couple of long years.
To be continued…
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