Research On Brazil's Currency Crisis example essay topic

Introduction - History The Spanish navigator Vicente Y'a~nez Pink " on was the first known European in the region now constituting Brazil. Landing near the site of present-day Recife on January 26, 1500, he subsequently drifted northward as far as the mouth of the Orinoco River. In April 1500, the Portuguese navigator Pedro 'A lvares Cabral also reached the coast of present-day Brazil and formally claimed the surrounding region in the name of Portugal. The territory was named Terra da Vera Cruz (Brazil Historical Setting). About a year later in 1501, an expedition under the command of the Italian navigator Ameri go Vespucci was sent to Terra da Vera Cruz by the Portuguese government. In the course of his explorations Vespucci named many capes and bays, including a bay, which he called Rio de Janeiro.

He returned to Portugal with a cargo of brazil wood, and from that time forward Terra da Vera Cruz bore the name of the valuable wood Brazil (Brazil Historical Setting). In 1530 the Portuguese king John initiated a program of systematic Brazilian colonization. As a first step the king divided Brazil into 15 districts and granted each of the districts, in eternity, to a person prominent at the Portuguese court. The grantees, known as " ", were vested with extraordinary powers over their domains. Because of the dangers implied in the French depredations along the Brazilian coast, King John revoked most of the powers held by the and placed Brazil under the rule of a governor-general. The first governor-general, Thom'e de Souza, arrived in Brazil in 1549, organized a central government, with the newly founded city of Salvador, or Bahia, as his capital, instituted across-the-board administrative and judicial reforms, and established a coastal defense system (Brazil Historical Setting).

Large numbers of slaves were brought into the region from Africa to overcome the shortage of laborers. S~ao Paulo, in the south, was founded in 1554. In 1555 the French founded a colony on the shores of Rio de Janeiro Bay. The Portuguese destroyed the French colony in 1560, and in 1567 they established on its site the city of Rio de Janeiro. Natural Resources Brazil is the largest country in South America.

Approximately 2.3 million square kilometers, 27 percent of Brazil's total area of 8.5 million square kilometers can be considered forest. Brazil's forests comprise 17 percent of the world's remaining frontiers, making it the third highest ranked country in terms of remaining frontier forest. Brazil has the third largest block of remaining frontier forest in the world and ranks first in plant biodiversity among frontier forest nations. The Brazilian Amazon provides more timber than any other tropical forest on the planet. Over 28 million m 3/year come principally from Par'a, Mato Grosso and Rond^on ia states.

The majority of the wood stays in Brazil (86 percent), and 20 percent of that supplies the markets in S~ao Paulo state (Brazil's Forests in Brief). Among Brazil's other gifts of nature are find mineral resources such as quartz, diamonds, chromium, iron ore, phosphates, petroleum, mica, graphite, titanium, copper, gold, oil, bauxite, zinc, tin, and mercury, manganese, nickel, platinum, uranium, hydropower Politics (past / present ) In 1961 Jan io da Silva Quadro's became President. He believed that Brazil had to trade with all nations and worked to increase trade with communist countries such as Cuba. Pres. Joao Goulart succeeded him after seven months, when military leaders feared that Silva would open the doors for a communist take over. In 1964 troops forced Goulart out of office and Gen. Castel Branco took over.

Branco was given many powers by the military including the right to suspend the rights of citizens and he was succeeded by three other Generals until 1978. During the late 1960's and early 1970's Brazil's economy flourished after the military banned political as well as trade union activities (Brazil Government). In 1985 military rule ended and Brazil returned to democratic civilian government after more than two decades of military rule. The October 5, 1988 constitution reenacted / revised, establishes presidential system made up of executive, legislative, and judicial branches. The president holds office for 4 years, with the right to re-election for an additional 4-year term, and appoints his own cabinet. There are 81 senators, three for each state and the Federal District, and 513 deputies.

Senate terms are for eight years, with election staggered so that two-thirds of the upper house is up for election at one time and one-third four years later. Chamber terms are for four years, with elections based on a complex system of proportional representation by states. The seats are allotted proportionally to each state's population, but each state is eligible for a minimum of eight seats and a maximum of 70 seats. The result is a system weighted in favor of smaller states (Brazil Government). The first directly elected president in twenty-nine years was President Fernando Collor de Mello elected in November 1989 and took office on March 15, 1990. President Collor was impeached in September 1992 on corruption charges, and he was removed from office.

His vice president, I tamar Franco, then assumed presidency. In October 1994, Brazil held elections for presidency, state governorships, Chamber of Deputies, and two-thirds of Senate. Fernando Henrique Cardoso held reign for two consecutive terms 1994-2002 while current President Luiz Ignacio Lula da Silva's period in office is scheduled to end in 2006. There are fifteen political parties that are represented in Congress.

Since it is common for politicians to switch parties, the proportion of congressional seats held by particular parties' changes regularly. The following are the major political parties: o PFL - Party of the Liberal Front o PMDB - Party of the Brazilian Democratic Movement o PSDB - Party of the Brazilian Social Democracy o PP - Progressist Party o PT - Workers' Party o PDT - Democratic Labour Party o PTB - Brazilian Labor Party o PSB - Brazilian Socialist Party o PST - United Socialist Workers' Party o PC doB - Communist Party of Brazil o PL - Liberal Party Brazil Economic Status Fiscal issues were at the heart of the financial turmoil that overwhelmed Brazil prior to the collapse of the currency. Brazil had endured seven years of hyperinflation before the Real Plan, experiencing rates exceeding 1000% annually in the early 1990's. In 1993 the Real Plan was introduced in Brazil as a stabilization package. The plan controlled existing hyperinflation conditions, balanced the fiscal budge, and reduced federal expenditures.

Most importantly, the plan introduced a new currency, The Real. Their new currency was pegged to the US dollar, in an attempt to maintain a fixed exchange rate. At this point Brazil had used up most of their foreign reserves of other currencies. The Brazilian central bank had been spending its reserves to purchase excess supplies of Reals. Brazil began to sell even more of its Reals, draining still more of Brazil's reserves. Between April 1998 and January 1999, Brazil's reserves dwindled from $51.9 billion to $34.2 billion.

The introduction of the Real Plan was successful in calming inflation, it was not however enough to reconcile the inconsistency between Brazilian and U.S. Inflation rates. As a result the Real became overvalued this made imports cheaper to buy and exports harder to sell. Collapse of Currency In January 1999, Brazil abandoned its dollar-pegging and devalued its currency, setting off the Brazilian Real Crisis. According to an article by BBC News dated July 31, 2002, Brazil's leading opposition party accused the central bank for the currency collapse. Brazil's chief economic strategist (PT-workers party) Giu do Mantega, accused the central bank governor Armindo Frag a and President Fernando Henrique Cordosoa of a terrorist election strategy.

Mr. Mantega added the US Treasury Secretary Paul O'Neill had added to the fire by suggesting that financial aid to Brazil, Argentina, and Uruguay might disappear into Swiss bank accounts. However, according to the Forex Education Website, the triggers that led to the Real devaluation were Financial Contagion, Dollar-Peg and Fiscal Problems. Financial Contagion occurs when a financial crisis in one country motivates investors to remove their funds from other countries with similar weaknesses. Financial crisis hit Asia in 1997 and Russia in 1998. Investors were pulling their investments out of those countries also began to withdraw them from Brazil. "The Asian Currency crisis, Russian crisis and the Mexican Peso Crisis were events that preceded the collapse of the Real.

As investors liquidated their capital out of these countries, they also repatriated their funds from Brazil. One month before the crisis, funds were repatriated at an estimated $350 billion per day" (Forex Education). Brazil's growing interest rates were frightening investors. Paulo Lee, one of the many leading figures from the international investment community gathering at the Royal Sonesta Hotel in Cambridge to discuss the Brazilian crisis, believed there was a good fiscal adjustment initially. However, by the fourth quarter of 1997 fiscal problems had emerged. He believed that there was a good opportunity to push for fiscal adjustment at that time.

Unfortunately, the opposite happened and the fiscal situation got worse. Continuing on the fiscal theme Gustavo Franco concurred, saying that the deficit needed to be kept at 3 1/2 percent of GDP. But the fiscal balance went the other way despite the large number of tightening measures that were undertaken. The central bank was surprised by the inability to meet the target, he confided. And added that the markets were not impressed when Brazil tried to put together a further fiscal package after Russia (NBER).

Governments peg currencies to the dollar to stabilize their value. To maintain a peg, the central bank attempts to control the dollar price of its currency by intervening in currency markets. According to the Forex Education Website, "Brazil's reserves fell from a high of 70 billion in the beginning of 1998 to half its value by year-end in order to maintain the value of the peg". Government Prevention Governmental prevention of Brazil's recent currency devaluation has been an ongoing effort over the past few decades. Notwithstanding, with all political entities there can be separate and, at times, opposing agendas (both personal and political). According to an article written entitled, "Southwest Economy", Brazil's devaluation could have been triggered by a particular event.

"It was the announcement by the new governor of the Brazilian state of Minas Gerais that he would suspend his state's debt payment to Brazil's national government for three months" (1999, p 3). It would be inconceivable to think that a single announcement, such as the one made by Minas Gerias, would impact a nation the size of Brazil. But, due to Brazil's fragile economic status over the past few decades and the more recent political setbacks, Minas Gerias's tate ment may have been the spark needed to ignite Brazil's currency explosion. Recent history shows Brazil's failed attempts to get a handle on their hyperinflation rates of, at times, 1000 percent. In 1987 the Cruzado Plan failed. In 1988 the Besser Plan failed.

In 1989 the summer plan failed. And in 1991 and 1992 the Collar Plans failed. Success was finally expressed in the implementation of Cardoso's Real Plan (Plano Real) in July of 1994. Brazil's annual inflation rate was reduced to 20 percent, which would have been a triumph for their monthly rate a few years earlier. President Fernando Cardoso's Real Plan linked the value of Brazil's currency to the United States dollar. The Real Plan was the economic boost Brazil and its people had been hoping for.

With the support of the people, the Brazilian Congress became more receptive to the president's plan and Cardoso had more time to address the root causes of Brazil's fiscal imbalance, which spurred their hyperinflation in the first place. Surprisingly, in the first few months of the plan's inception, the Real actually appreciated against the U.S. dollar. For years the Brazilian people had hoped for economic growth and a lessening of poverty and inequality. With Cardoso's Real Plan their hopes were, seemingly, turning into a reality. President Cardoso's background included a previous appointment as a finance minister. His goals for office were to end Brazil's hyperinflation and stabilize the value of the Real.

Additionally, he wanted to re-establish political democracy in Brazil. By the end of his first term in 1988 he was on his way to achieving his goals. His accomplishments to that date earned him a reelection to his second term in office in 1998. In the second half of his eight-year tenure as president of Brazil, Cardoso and his Real Plan suffered many economic blows. The first came after his reelection in 1998 and 1999 when Russia and Asia experienced financial crisis. World investment became skittish, not only in Russian and Asia but also in other foreign markets, including Brazil.

In 1999 Cardoso allowed the Real to float against the U.S. dollar. These economic pressures forced the devaluation of the Real. Although there was fear of regression and stagnation Brazil emerged from the setbacks without a return to hyperinflation. Could the Brazilian government have foreseen or projected the effects of the Russian and Asian financial crisis? If crystal balls were 100 percent accurate than the answer to this question would be, yes. They were, more than likely, more concerned with Brazil's finances and controlling Brazil's inflation issues.

Was the government doing enough to preempt their recent currency devaluation? This is the Catch-22 effect. By concerning themselves with Brazil's issues, world economic events, consequently, became an important factor in their currency's devaluation. Currently, the Brazilian government has begun processes to approve fiscal reform and has encouraged congressional action in addressing the central government's fiscal deficit. Additionally, Brazil and the International Monetary Fund (IMF) have forged an agreement to negotiate debt between state governors and the national government. The Brazilian government is continuing their ongoing efforts to restore and control the value of the Real.

Affect on Private Business Inflation, currency devaluation and world economics has a profound effect on all businesses, both private and governmental. Brazil is not exempt from these external forces. The creation of President Cardoso's Real Plan to stop Brazil's hyperinflation was successful for the country, the people, and their businesses. Since then the 1999 devaluation of the Real has become, merely, a slight downturn for Brazil in comparison to the hyperinflation experienced 10 years earlier. Brazil and its people have a history of surviving financial hardships and are experienced enough to know that their best financial times are ahead of them. In 1994, Cardoso's Real Plan went into effect.

Rapid economic growth was experienced and consumer enthusiasm, over lowered inflation rates, was similar to a child in a candy shop. This was especially true for lower income families who have been restricted from spending due to Brazil's history of hyperinflation. Spending increased, and private businesses were the happy recipients of the benefits created by the Real Plan. The Brazilian government, concerned by the increase in spending attempted, in 1995, to restrict consumption and reward consumer saving. Although the Real Plan increased the feeling of consumer buying power and reduced poverty, prior history dictated restraint and caution. Over the next several years President Cardoso urged Congress to raise taxes and cut spending in an attempt to spur restraint and reserve caution.

Many state employees suffered from the effects of cost-cutting and governmental downsizing. Unemployment increased with, not only, unskilled workers but with highly skilled former governmental employees as well. Private businesses became target employment opportunities for these skilled workers. In 1999, following the devaluation of the Real consumer spending was reduced. Brazil's currency fell 40 percent, which also resulted in lower wages and cheaper exports. World economic recession and the economic fallout effects of 9-11, coupled with their own domestic energy crisis and the grave economic situation with MERCOSUR (Brazil's Latin American regional block) indicates that Brazil has tough times ahead of them.

Private businesses, once again, are beginning to feel the economic pinch. Adapting their business practices to conform to the currency devaluation is their survival technique. The Brazilian people are experienced in economic survival. They have been there before, but they hope they will not be there many more times in the future. At the end of President Cardoso's eight-year term he wrote a report to Congress entitled, "Eight Years of Stability, Development, and Social Conquest". This was his report to the nation on how Brazil has changed over his two terms and office.

The title alone speaks volumes for his efforts and the resiliency of the Brazilian people to survive. Trading Infrastructure Trade agreements developed after World War II have helped to reduce high tariffs. Over the years, the many negotiating rounds of the General Agreement on Trade and Tariffs (GATT), culminated in the founding of the World Trade Organization (WTO). The WTO has established a comprehensive framework facilitating free trade among most nations. These trade agreements recognize the benefits of increased trade.

Trade agreements tend to focus on smaller geographic areas therefore regional trade alliances enable countries to develop closer relations. Often overlooked are the ongoing trade agreements in the Americas and the opportunities they provide for expanding business operations. The drive to promote free trade and create a common market in the Americas is being spearheaded by Mercosur. Unfortunately many U.S. businesses are unaware of the opportunities presented by Mercosur. However, the US is still the biggest trading partner to Brazil (web). Brazil is one of the world's major producers and exporters of agricultural goods.

Government intervention for agricultural development has decreased. The support programs that exist are targeted to assist low-income farmers in disadvantaged areas. Assistance to agriculture is still very modest. Especially, in the context of market distortions introduced by the support provided to agriculture in other countries, a problem that remains of major concern for Brazil. Natural trading partners to Brazil are considered to be countries that are geographically near and accessible both in transportation and politically. Countries that are at political discord to compromise relationships are not considered natural trading partner.

Brazils natural trading partners are therefore Argentina, Bolivia, Colombia French Guiana, Guyana, Paraguay, Peru, Uruguay, and Venezuela. Mercosur was established in March 26, 1991. Argentina, Brazil, Paraguay and Uruguay signed the framework treaty that forms the Southern Cone Common Market. Mercosur is the Spanish and Mercosur the Portuguese for the Southern Cone Common Market. Mercosur has been a successful agreement for all countries involved. Brazils great strengths in the import and exports areas is the fact that they possess large and well-developed agricultural, mining, manufacturing, and service sectors, Brazil's economy outweighs that of all other South American countries and is expanding its presence in world markets.

However the maintenance of large current account deficits via capital account surpluses became problematic as investors became more reluctant to emerging markets as a consequence of the Asian financial crisis in 1997 and the Russian bond default in August 1998. The industries that help provide a strong and successful export market to Brazil are the following industries; textiles, shoes, chemicals, cement, lumber, iron ore, tin, steel, aircraft, motor vehicles and parts, other machinery and equipment. Due to the vastness of the territory and the geographical location Brazil also has many natural resources. Land in considered one of its major natural resources.

Only 40% of the land is used to as farmland to grow crops and livestock. Mineral resources are important for export. The most important are iron, ore and gold. Copper, zinc, bauxite manganese and tin are also important. Limestone, sea salt, diamonds and phosphates are the leading non-metallic minerals web).

The climate is mostly tropical which is an advantage to many varieties of crops. The terrain is mostly flat to rolling lowlands in north; some plains, hills, mountains to be advantageous to raising livestock. Government Intervention In the early 1990's Brazil took the approach for economic reform. Therefore within the last ten years the country has accrued more open trade and investment. The reform has led to a more market-driven decentralized and flexible economic environment. By having deregulated state monopolies and prices, investment liberalization and privatization has greatly surged.

At this point the main trading partners for Brazil export business are the United States (US), the Mercosur countries and the European Union (EU). In the import of goods, the main suppliers are the EU, the US and Argentina. The Brazilian government had placed high tariffs on agricultural exports then gradually reduced them as the economic reform took a lead. In doing so the government developed programs to help the farmers grow more crops for internal consumption as well as for exports. Some agricultural products that were under the government support group were categorized as receiving production and marketing credit (web). Source: CO NAB and Ministry of Agriculture.

Note: Minimum prices are regional. The minimum prices quoted here are the highest minimum prices quoted. Transportation costs are still extremely high representing a large portion of the export price. Brazil's transportation infrastructure is still very deficient in comparison to the United States.

The transportation factors incorporate railways, ports, highways, waterways, pipelines and airports. The government is presently in the process of developing and improving the efficiency to reduce the cost involved in transportation for producers. At this point it hampers the export prices. Brazil's energy has also slowly been deregulated. In 1997 a new policy was instated, by limiting the government to only 23 percent of the holdings. The balance was to be sold in a public offering.

In 1999, Brazil was the second largest producer of hydroelectric power in the world. However, the government did intervene in 2001 by instituting the energy-rationing program to avoid blackouts. The government is responsible for developing and planning the growth of the electricity sector. Brazil has significant petroleum resources. In December 1999, measured reserves of petroleum totaled 8.15 billion barrels.

Average crude oil production in 1999 was 1.1 million barrels per day (b / d ). Petroleum consumption for 1999 was up 1.7 percent from 1998, to 1.95 million b / d. Imports of crude and refined products in 1996-averaged approximately 829,000 b / d while exports averaged approximately 81,000 b / d. Despite its significant domestic production, Brazil must import more than 40 percent of the petroleum it consumes at an estimated cost of $6 billion in 1997. Argentina, Saudi Arabia, and Venezuela are its main suppliers of petroleum (web). Role of Financial Institutions Although, most of the research on Brazil's currency crisis is outdated, it is evident that the financial institutions, such as IMF, the Central Bank, BNDES, and IDB, played an integral role in strengthening Brazil's currency.

For instance, "in 1998, the International Monetary Fund (IMF) approved a three-year financial rescue package of $41.5 billion to Brazil, which was designed to stop global financial turmoil from spreading to Latin America" (c sf. Colorado. edu). The package was backed by the Inter-Americas Development Bank, the World Bank, the US, Japan, Germany, Britain, France, Spain, Italy and other nations not mentioned. The funds granted to Brazil were added onto the country's existing IMF debt, which was estimated to be around $305 billion or 35 percent of GDP" (c sf. Colorado. edu). The IMF continued to support Brazil even after Brazil reneged on its commitment to halt the devaluation efforts so that the Real was not devalued more than 7.5 percent a year.

In spite of the commitment, the Real was devalued. The IMF recommended Brazil implement fiscal policy (reduce government spending, increase taxes). While the effort was to slow down the currency crisis, "Brazil's primary macroeconomic objective was to re-establish the creditability of the country" (c sf. Colorado. edu). The fiscal targets that were agreed upon included the following schedule. Brazil's Fiscal target for 1999, measured in R$ billion Budget deficit Primary surplus Privatization External debt of the non-financial public sector 1998 total 72.879 5.025 1.246 85.7651999 I 17.145 2.982 1.246 91.2151999 II 28.565 5.907 15.917 93.2351999 32.127 12.604 18.563 94.611999 IV 42.561 1.344 25.713 97.675 Target at the end of 1999 3.5% of GDP 2.6% of GDP Source: Ministry of Finance of BrazilIn addition to the implementation of fiscal policy, monetary policy was also factored in the process, which targeted the interest rates.

The Central Bank of Brazil (BCB) spearheaded this strategy, even though BCB no longer defended the Real. The Central Bank increased the official lending rate from 22 percent to 41 percent. The monetary policy was designed to alleviate the currency crisis, combat inflation, and stabilize prices (c sf. Colorado. edu).

Another key player in Brazil's crisis was the Brazilian National Economic and Social Development Bank (BNDES). BONES is a "publicly owned institution and occupies a central position in the Brazilian financial system". As cited by Dr. Edmund A mann, St. Antony's College, Oxford, BNDES made "increasing contributions to Brazil's government's stated policy objectives of reducing interest rates spreads, extending average maturities, and increasing total credit as a proportion of GDP" (2000). The Inter-Americas Development Bank (IDB)'s primary role was geared towards "the promotion of market opening, poverty reduction and good government; participation consisted of financing of environmental improvement, and long-term financing of crucial infrastructural projects" (Oliveira, D., Dr., June 2000) Brazil Economic Impact The economic impact Brazil experienced during their crisis was two-fold, on the country and on its citizens. First and foremost was the impact on Brazil's economy, the rescue package from IMF failed as a result "exports fell (they were too expensive) and imports rose (they were cheap). The Brazilian economy was in recession by the third quarter of 1998 when the GDP declined by 0.1 percent" (web).

Part of the impact on the country was the changes that surfaced in the financial system due to the decline in inflation. For example, there was an influx of mergers and takeovers, which were initiated by foreign banks. In other words, foreign banks began spouting up in Brazil in the banking sector providing services to their international clients. The other aspect was the impact on the citizens, in terms of the severe social security deficit. Working in concert with IMF, Brazil developed a strategy to increase the revenue by increasing taxes.

The tax increases applied to checking accounts, pension contributions, retirement pensions, capital gains, and investments. The tax increases ranged from. 35 percent on checking accounts to fifteen percent on retiree's pensions. The challenge Brazil faced was the realization that there was mal-distribution of social classes. There was no middle class and the majority of the lower class was mostly under poverty (c sf. Colorado. edu).

This measure seemed to be most difficult on its citizens as they were already working "many more hours to purchase goods and services from other countries" (web). Conclusion - Current Status In closing, the analysis of the events, pre and post the currency crisis, indicate that Brazil was provided the resources and support to assist them in regaining stability in its economy; however, the bottom line rested on the value of its currency and the interest rate. Perhaps Brazil did not have a choice in their decision to devalue the currency as often and as rapid as they did in order to sustain what little purchasing power they had at the time. In a recent news article dated June, 2003, Brazil's Real shows significant gains in the market. According to the article, "the Real has gained 23 percent in 2003, the best performance of the sixteen most traded currencies" (adam. ant ville. org).

Although some investors are betting that the Real will weaken, the statistics indicate otherwise. As cited in the article "capital flows to the country continue, boosting demand for the Real and helping it rise. More than $8 billion of bonds and loans have been contracted aboard in 2003. The real outperformed all the world's major currencies". It was also noted that the inflation rate for the prior twelve months was expected to fall to 10.8 percent, which would promote a reduction in the cost of imports and commodities.

It appears Brazil may be on their way to a stronger more robust economy and can now perhaps revisit their benchmark targets in order to sustain a feasible monetary policy program. This would not only benefit Brazil as a country but more important, improve the quality of life for its citizens.

Bibliography

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Available at: web america / brazil /politics index. php National Bureau of Economic Research. Brazil in the 1997-1999 Financial Turmoil.
McHale, John. 14-15 April, 2000.
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