OGJ Editorial: Turbulence in Brazil

July 1, 2002
With Brazil under financial siege, there's talk of contagion in South America-a regional economic slump like the one that cascaded through Asia in 1997 and threw the oil market into reverse.

With Brazil under financial siege, there's talk of contagion in South America-a regional economic slump like the one that cascaded through Asia in 1997 and threw the oil market into reverse. If economic malaise is indeed spreading like illness in South America, two questions arise: Will there be global effects comparable to those that followed Asia's swoon? And what, exactly, is the nature of the disease?

The first question is the easier to answer. Global effects won't be great. In terms of its shares of worldwide economic output and the oil market, South America is no Asia. Nor is it the oil market's growth area, as Asia was when it slumped. This, of course, is small consolation to Brazilians and other South Americans facing new hardship. But the piece of the continent's 5% share of world oil consumption likely to be shaved by extra economic travail won't rock markets elsewhere in the world.

The contagion

Of greater consequence is the hardship itself-in Brazil and South America, suffered by Brazilians and South Americans-and the contagion that allegedly caused it. Oil and gas companies operating in the region, or interested in doing so, should wonder what happened.

According to the standard contagion view, Brazil has been infected by Argentina's distress. The latter country's financial system collapsed last year under the weight of a recessionary economy locked to a strong US dollar. Argentina in February let its currency float against the dollar but warns of possible default on international debt unless the International Monetary Fund lends it at least $20 billion more. Because the government hasn't implemented all recommended reforms, the IMF is reluctant. The idea of contagion gained credence last month when a major bank failed in Uruguay, where rising demand for dollars forced the government to dismantle its currency board and float the peso.

Why should those problems spread to Brazil, which has an economy more than twice the size of Argentina's and 40 times that of Uruguay? Brazil's economy-largest in South America and 10th largest in the world-had continued to grow in 1998-2000 as most other South American economies sagged and despite devaluation of the real in 1999. Currency crisis aside, Brazil seemed to be flourishing after privatization of state monopolies and liberalization of the economy. It was on most lists-and all of them were short-of South American countries presumed to be immune from what plagued Argentina.

Yet now the Brazilian economy is barely growing, the real has plunged to an all-time low against the dollar, doubts are growing about Brazilian credit-worthiness, and the country's cost of international borrowing has zoomed. Proximity to Argentina and Uruguay surely doesn't help Brazil where the confidence of already wary international investors is concerned.

Another contagion, however, is at work. This one involves Venezuela, where a mercurial, populist president has frightened away international capital. Brazil's economic sniffles turned chronic when polls in May began showing support for a presidential candidate whose politics resemble those of Venezuelan President Hugo Chavez.

The Brazilian candidate, Luiz Inacio Luna da Silva, recently tried to assuage financial markets by naming a well-known businessman as his running mate. But his leadership of the left-wing Workers Party, which resists Brazil's opening of markets and has factions opposed to capitalism, makes that move look hollow.

Market freedom

Why shouldn't financial markets worry, even though those concerns conflict with wishes so far evident of Brazilian voters? In Venezuela, Chavez promised to solve the plight of his country's poor just before steering the economy to the brink of ruin. Venezuela's experiment with state preemption of markets wasn't the first such fiasco in history, of course. And Brazil's, if it comes to pass, won't be the last.

Internationally minded oil and gas companies have experience with developments like these. To them, the turbulence means Brazil might join Venezuela on the list of countries where political risks are high. It won't preclude investment altogether. Of greatest concern must be the chance that progress toward market freedom will stall. Such a setback would needlessly prolong poverty and the despair that goes with it. That's how political squalls turn into tempests, especially in countries that start out poor.