SUNS 4502 Friday 3 September 1999

Brazil: The Real Plan and its Crisis

Geneva, 1 Sep (Chakravarthi Raghavan) -- A large public sector deficit and high interest rates are limiting the recovery of the Brazilian economy in the short-term, although "numerous factors exist in the medium-term that should ease a return to growth rapidly, or even faster than in the cases of Argentina and Mexico after the 1995 crisis," says a study published by the UN Economic Commission for Latin America and the Caribbean (ECLAC).

In the study, "The Brazilian Economy, the Real Plan and its Crisis," economists Pedro Sainz and Alfredo Calcagno argue that devaluation of the Real at the beginning of 1999 brought an end to a stage in the Brazilian economy that began with the launch of Plan Real in 1994.

The stabilization programme of that plan was part of a broader process of deep macro-economic and institutional reforms, and was intended to introduce changes into the economy and society which, it was hoped, would allow intensive and sustainable growth within the new international economic context.

Reviewing the Real Plan in the period between 1994 and 1998, the economists conclude that the first two years were "extraordinarily successful."

Economic growth accelerated, living conditions improved for vast numbers of the population and the fiscal accounts showed a primary surplus and reduced operational deficits.

The balance-of-payments situation firmed up, reserves grew, and the effects of the Mexican crisis were held at bay. Above all, one of the highest inflation rates in the world was controlled without recession.

However, the first signs of difficulty emerged in 1996.

With hindsight, say Sainz and Calcagno, "the growing vulnerability faced by developing countries in current
international circumstances seems to have been under-estimated, while the likely effects of the reforms and the price system were over-estimated, and too little attention was paid to the simultaneous growth of the fiscal deficit and the balance of payments."

At the same time, the reform process, while strengthening competitive capacity and the efficiency of some sectors, had political and economic costs that were also under-estimated. Rising external and internal public sector debt -- from some 100 billion Reals in 1994 to 400 billion Reals in 1998 -- had a particular impact.

Five years of excessively high interest rates not only stimulated this debt increase, but provoked macro-economic imbalances and were one of the factors preventing any dynamic process of investment from taking off.

The ECLAC study concludes: "Keeping up this economic policy, and accentuating the use of monetary policy, ended up by holding back thorough-going changes in the true economy, exacerbating external
imbalances and preventing public debt being reduced despite income from privatization.

"The result was economic stagnation and more open unemployment.
The final complication came with the Russian crisis, by which time doubts about progress in the macroeconomy and production were already established, and it became evident that high interest rates are not enough to fend off the assault on the exchange rate."