QUERETARO, Mexico, Aug. 8 (UPI) -- Two weeks ago the U.S. Treasury Secretary Paul O'Neill argued that there was no "magic bullet" to solve Latin America's problems. Ten days ago he warned, too, that he would need to be reassured if he were to back the sending of more money to Latin America. Reassurance appears to have been swift. Two magic bullets have since been fired: $1.5 billion from the U.S. Treasury for Uruguay and now a colossal International Monetary Fund package for Brazil of $30 billion.
The $30 billion package for Brazil is remarkable in numerous respects. It marks in the first place a quite astonishing turnaround by O'Neill, from bailout skeptic to bailout believer. O'Neill had been very critical of the IMF's willingness to make loans to Russia, which defaulted in August 1998. In 2001, as Argentina began to lose its fight for survival, his influence was felt: the IMF did not ride to the rescue. A big country and big debtor was allowed to fail. That failure came in December 2001. Eight months later O'Neill is involved in one of the biggest bailouts of all time -- though not as large as the $41 billion extended to the self-same country, Brazil, in 1998.
To be a party to it O'Neill must surely have been convinced that the money would not go to waste. His doubts about the quality of Brazil's governance must have been assuaged. He must have been convinced that there would be policy continuity. Bizarrely, none of these things can be the case. In a matter of months neither O'Neill nor anyone else can know who will be running Brazil.
A presidential election will be held in October. Of the three candidates with a good chance of victory only one, Jose Serra, can be expected to continue with the policies of the current administration of President Fernando Henrique Cardoso. Luis Inacio da Silva, the left-wing candidate, and Ciro Gomes, leader of a hodge-podge of a coalition that brings together the former communist left and some traditional power brokers of the right, may well seek to restructure debt. And as we argued in "Brazil at a turning point" on August 5, the burden of the debt is so heavy that it takes utter determination to carry it. The half-hearted will not do it.
The questions go further. "Brazil has the right economic policies in place to maintain stability so that the economy can continue to grow," wrote the U.S. Treasury Wednesday in a statement. But does it? If Brazil has the right policies in place why does it need help now less than four years after its previous bailout?
It can be said that the crisis is all about nerves and confidence, and of course they always play a role. The neighbor, Argentina, went under and now the neighborhood is suspect. Emerging markets are out of favor. The U.S. and global economy is wobbly. But to characterize Brazil's crisis as mere "contagion" is ridiculous.
Brazil is vulnerable because, contrary to the Treasury's analysis, its economic policies have not been working. Brazil has had quite modest inflation rates since the Real Plan of 1994, drawn up when Cardoso was finance minister, but growth in Gross Domestic Product and in exports has been disappointingly low. Debt has risen. The capacity to service it has not.
The reason is that reforms to the Brazilian economy have not gone far enough. That can in part be blamed on the Congress which has stalled on Cardoso's reforms, particularly those that sought to cut public spending on pensions and to reform taxes. But it may be that even if these reforms had been implemented, the program drawn up by Brazil and the IMF would not have been enough.
There is much wrong with Brazil. This is an economy in which the tax take is about a third of GDP and state spending still higher yet public education is terrible, the police are corrupt and provision of health care is poor. Where does the tax money go? What good does it do?
Yet the burden the taxes impose is all too apparent. Increasing them in recent years, under the IMF program, has helped to narrow Brazil's fiscal deficit but has also made its companies less competitive. Brazil's battle with its fiscal deficit has left it stagnant, undynamic, vulnerable -- just as was the case with its neighbor, Argentina.
Sweeping reform is needed. The tax burden on Brazil's companies must be alleviated. Public spending, little of which helps the army of poor people, must be cut drastically and reformed so that taxes do something to improve the education and health of the poor majority.
Who would carry out such policies? Serra might chip away, just as Cardoso has done. Lula would be more likely to raise public spending. Gomes is an unknown quantity. He has been more strident than Lula on debt, saying that restructuring is needed. Investors should face the truth: he may be right. The build-up of debt has gone on for too long. Brazil's banks feed well off the high rates the government must pay. But those interest payments do no one else any good.
A Serra victory in October would reassure investors but it is far from clear that the policies he implements will be adequate to make Brazil grow and become more creditworthy. Gomes and Lula are more likely to default or to pay debt with money the Central Bank, rather than taxes, provides so that inflation rises again and the real value of the domestic debt falls. As for foreign dollar debt, in these circumstances default would be likely.
It is in this uncertain battle-ground that the IMF bail-out lands, like a huge bundle of emergency supplies dropped between warring forces. The aim of the package is to get Brazil to and through the election without the currency collapsing and the country defaulting, dragging down U.S. banks and the U.S. stock market with it.
The bailout is a short-term fix, nothing more, and for the shortest of terms. It represents a colossal act of faith, faith that perhaps reflects growing desperation. Who would have thought it? O'Neill has a magic bullet, after all.
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