[OPE-L:5683] Real under attack

Wed, 5 Nov 1997 16:07:31 -0500 (EST)

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Dear all,

I would like to make a few comments on Claus's recent post about the
vulnerability of the Real plan in Brazil. I agree with most of what he says,
especially his note about the structural instability of the stabilisation
plan. The Real plan is based on the indexation of prices and revenues, and
the stabilisation of the exchange rate, as the means to eliminate a serious,
underlying, distributive conflict (or at least prevent its manifestation
through inflation).

It has been possible to obtain the necessary foreign capital inflows, and
dampen the expansion in demand which tends to accompany such stabilisation
plans, through high interest rate policies. The cost is high unemployment, as
experienced in Argentina.

This strategy has been criticised as being unstable because it implies the
overvaluation of the currency and persistent industrial depression. Even
though the current account deficit is around 50f GDP, the government
expects the plan to be sustainable because of the inflows of foreign capital
that should accompany the privatisation programme. Large state enterprises
are being prepared for sale, most notably the telecommunications monopoly.

This may no longer be feasible. The risk premium on Brazilian bonds has shot
up over the past few days, while domestic interest rates have risen very
substantially in an attempt to maintain the foreign capital inflows. It is
possible that, because of moral hazard and adverse selection, this will fail
to attract foreign direct investment and may only induce very volatile
capital flows into the country. This would be the beginning of the end for
the Real plan. The end would come when, for whatever reason (another crash, a
sustained rise in US interest rates, etc), the inevitable stampede came. A
sustained outflow of speculative capital would drain the reserves of the
central bank but, before they were exhausted, the accompanying political
instability would force the government to call in the receivers, the IMF. The
anti-democratic character of the current economic policies would increase
even further as a result. This can happen in the near future, or in a few
months, or even in a couple of years. I think the scenario is pretty clear,
and will not change substantially with time.

The challenge for the left in Brazil, and elsewhere, is to design
sustainable, democratic, alternative economic policies. Brazil is one of the
few countries inthe world where the left is active, and has a substantive
political expression. Unless they can come up with such policies before next
year's parliamentary elections, the left may be condemned to observe the
disaster without having much of substance to say. This would be unacceptable
for the majority of the population, and may contribute to the further erosion
of the left in Brazil, and in other countries.