Remember Tequila Shock? Well, Here Comes Samba Shock

Brazil's slump is crimping growth in Argentina

Two years ago, having Brazil as a neighbor and trade-bloc partner was a boon to Argentina. Battered by the financial shock wave from Mexico's 1994 peso collapse, Argentine companies stepped up sales to Brazil, Latin America's biggest market, of everything from autos to food products. The export surge helped pull Argentina out of a deep recession.

Now the shoe is on the other foot. Contagion from the turbulence in Asia has forced Brazil to brake its economy sharply to protect its currency, the real. And while Argentina's financial reserves and banking system are better able to withstand the global market turmoil than they were after Mexico's devaluation, the falloff in exports to Brazil is slowing its economy. Analysts are lowering their 1998 forecasts of 5.8% gross domestic product growth. "Four percent would be more realistic," says Ronald Ratcliffe, economist at Societe Generale in New York.

TRADE PARTNER. The downturn brings home to Argentine businesses just how dependent many have become on their giant neighboring market--which now takes 30% of all Argentine exports--and how vulnerable they are to the spillover from economic troubles in Brazil. Some executives warn that the setback should spur greater efforts to diversify foreign trade. Argentina and Brazil are leaders of the Mercosur trade bloc, which includes Paraguay and Uruguay. That linkage has led many Argentine industries to take the easy export route by targeting Brazil as "their unique trade destination," says Arnaldo Musich, a director at Siderca, the steelmaking arm of Argentine conglomerate Techint. Now, it's time for Argentines to look beyond Brazil to the bigger world market, he says.

That won't be easy, particularly for auto makers, who are part of an increasingly integrated Brazilian-Argentine industry. Half the cars made in Argentina have been exported to Brazil, duty free, in recent years. But car sales in Brazil have dropped an estimated 20% to 30%. As a result, Ford Motor Co. announced that it would suspend production in Argentina of its Escort for two weeks, affecting some 2,000 workers. Italy's Fiat, which has invested nearly $1 billion in Argentina, will cap production at 400 cars a day instead of the 550 planned by the end of the year and close its plant for three weeks in addition to a two-week Christmas break.

The ripple effects will also hit parts makers, which estimate a 30% falloff in sales. And Techint's Siderar, a flat-steel supplier to the auto industry, expects a 10% sales drop. Siderar, which is spending $900 million to expand capacity to compete in Brazil, recently had to hold off a $150 million peso-denominated debt issue for lack of buyers.

"HOLD." As Argentine banks follow the rise in international rates, costlier credit is also expected to dampen this year's recovery in domestic spending. Construction, which has racked up growth of 27% this year, will be a likely victim. As a result, blue-chip steelmaker Acindar, with more than 50% of its sales to the construction sector, has had its stock downgraded from "buy" to "hold" by investment house Deutsche Morgan Grenfell. The gradual easing of the unemployment rate, from 18% in 1995 to 16.1% in August, may also stall.

In a move to bolster trade within Mercosur, Argentina and Brazil agreed to hike Mercosur's common external tariff from an average 14% to 17%. But all told, Argentina could lose as much as a third of its exports to Brazil.

To ease its dependence on the Brazilian market, Argentina's best bet would be to try to narrow its $10 billion trade deficit with the U.S. But exporters point to U.S. barriers against agricultural imports and competition in textiles from low-priced Asian products.

Brazil hurt Argentina's textile makers with curbs on import financing last March to narrow its trade deficit--a move that has cut textile sales to Brazil by 40%. Still, Brazil is the country's biggest market. "Thank God Brazil has been there for us," says Alejandro Sampayo, president of the Federation of Argentine Textile Industries. "If they didn't buy from us, who would?" Setbacks aside, Argentina's ties with Brazil will likely survive, and get stronger.

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