Brazil abandons currency defence as IMF talks begin

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The Independent Online
BRAZIL'S GOVERNMENT gave up its defence of the indefensible and allowed its currency to float yesterday.

The real fell to 1.58 to the dollar before stabilising as Pedro Malan, the Brazilian finance minister, and Francisco Lopes, the new central bank governor, flew to Washington for talks with the US Treasury and IMF. Fernando Henrique Cardoso, the President, was forced to break his holiday for the second time this week.

European finance ministers, meeting Asian counterparts in Frankfurt, signalled a calm response to the crisis in Brazil. "This crisis is manageable," said Yves-Thibault de Silguy, the EU's monetary commissioner.

But in the light of events this week, they will today discuss proposals put forward by Britain late last year for reforms to the international financial system.

The world's stock markets gave a huge sigh of relief at the end of a tense week. Brazil's Bovespa index surged 29 per cent at one stage.

In London the FTSE 100 index ended nearly 121 points higher at 5,941.0 after a day of ups and downs. It had earlier fallen as low as 5,736.8. The Dow Jones index had jumped more than 135 points to 9,256.36 by mid- morning.

The moves reflected the assumption that Brazil would be able to cut its 29 per cent interest rates, boosting economic prospects. Michael Hughes, head of emerging markets at Robert Fleming, said: "Now they have given up the defence of the currency, interest rates should be able to come down in the medium term."

However, many analysts remain uncertain about prospects. Brazil's central bank said it would make an announcement about new foreign exchange arrangements on Monday.

Joaquin Cottani, an economist at Lehman Brothers in New York, said: "There will be a period of uncertainty, and interest rates cannot come down as long as the instability lasts."

A bigger fear was that the recession and turmoil in Brazil would spill over into Argentina and Mexico, both far more important for the US. Ford said it would be cutting 4,600 jobs across Latin America as a result of the crisis.

The IMF and US, which pushed through the $41.5bn rescue package for Brazil over the objections of other G7 governments, were not consulted in advance about this week's developments. They are likely to demand fresh tax rises or spending cuts to counter the inflationary effects of the 25 per cent devaluation of the real this week.

The markets expect the package to be renegotiated. "Brazil needs the IMF, but the IMF also needs Brazil. It cannot afford a repeat of Russia," said Neil Dougall, Latin American economist at Dresdner Bank.

But there was scepticism about prospects for a tougher counter-inflationary budget. Chris Huhne of Fitch-IBCA, the ratings agency, said: "The question is whether the political system can actually deliver on the necessary timescale."

Investors are also concerned about the increased risk of either defaults on debt by the Brazilian government and corporate sector, or the possibility of exchange controls to halt the massive flight of capital out of the country that has reached $7bn so far this month.