Brazil: Real Fears Of Devaluation

Brazil's financial markets are battling concerns that the country's currency, the real, could become another baht. Even though the economy is recovering nicely, a growing current-account deficit is pointing to an overvalued currency and a possible devaluation.

Real gross domestic product grew at a larger-than-expected 5.1% in the year ended in the second quarter (chart). The industrial and agricultural sectors boosted output, but domestic demand was a bit weaker than hoped. President Fernando Henrique Cardoso has said that growth will slow a bit in the second half, and private economists expect real GDP will expand between 3.5% and 4% for the year. Consumer inflation, meanwhile, will likely slow from 10% in 1996 to 5.5% in 1997. That's the result of Cardoso's inflation-fighting plan centered around softly pegging the real to the U.S. dollar.

This link, though, is lifting the real as the dollar strengthens. Imports are surging, and the current-account deficit is widening. The second-quarter deficit was double its total in the same period of 1996. And the July gap was 54% larger than a year ago. The deficit could hit 4.9% of GDP this year, from 2% in 1996.

The International Monetary Fund warned on Aug. 21 that Brazil should shore up its current-account position. And the rising deficit and strong currency are scaring investors who see similarities in Brazil and Thailand, which had to devalue its baht in early July. Brazil's stock market has fallen some 16% since then.


For now, a devaluation is a remote, but not ignorable, scenario. What helps Brazil is its ongoing privatization. Sales of the government's electric utilities alone are expected to bring in more than $45 billion over the next few years. The inflow of foreign funds will help the trade picture and add to Brasilia's coffers. In fact, as a result of the rise in badly needed revenues, the public deficit will likely fall to less than 3.5% of GDP this year, from 3.9% in 1996. However, Mexico tried the same gambit to cut its twin deficits--and still had to devalue its peso.

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