TCS Daily


Brazil Should Stay with the IMF

By Desmond Lachman - November 15, 2004 12:00 AM

As storm clouds gather over the international economy, Brazil's government is giving serious consideration to the idea of "graduating" from the IMF when its present IMF program expires. While politically attractive, at least in the short term, such a course of action is likely to prove to be a costly mistake for Brazil. For when the international going gets rough, markets will again want to be reassured by the external macro-economic discipline normally associated with IMF programs, particularly given Brazil's many unresolved financial market vulnerabilities.

To many seasoned international observers, the global economic outlook has not looked so fraught with risk in many years. Fred Bergsten, for example, has identified five major risks to the global economy that go well beyond the obvious geopolitical threats. These risks include the possibility that oil prices could rise to $60-70 a barrel even without a major political or terrorist disruption; the risk that the renewed sharp increase in the US external current account deficit could lead to a crash of the US dollar; the risk that a US budget profile that is out of control could lead to significantly higher global interest rates; and the risk that China would have a hard economic landing as a result of its present overheating.

The seriousness of these risks is perhaps best exemplified by the recent sharp run up in international oil prices from below $35 a barrel at the start of the year to around $55 a barrel at present. Our past sad experience with international oil price shocks during the 1970s and early 1990s suggest that these shocks do have a major impact on the global economy. Indeed, the IMF estimates that, despite the considerable progress made in reducing the industrialized economies' energy dependence, a sustained $5 a barrel increase in oil prices still reduces global GDP growth by 0.3 percentage points. On that basis, were oil prices to stay above $50 a barrel in 2005, we would be lucky to have global GDP growth much above 3 percent and US GDP growth much above an anemic 2 percent in 2005.

In assessing Brazil's economic outlook, Brazilian policy makers would do well to reflect upon how much of Brazil's adjustment effort over the past two years has been supported by the highly favorable global environment for the emerging markets. In particular, they would do well to recall how the rapidly growing US-and Chinese-economies not only supported international commodity prices but also provided a ready market for Brazil's major export drive. Similarly, they might remember how an environment of historically low global international interest rates and the increased appetite for spread products, allowed Brazil's government to meet its still sizeable borrowing needs at more reasonable interest rates than in the past.

In looking to the future, Brazilian policy makers should be mindful of Brazil's remaining financial market vulnerabilities. For while the Lula government can justifiably take pride in its many triumphs in stabilizing the Brazilian economy over the past two years, the fact remains that Brazil's public debt ratios are still uncomfortably high. At around 74 percent of GDP on a gross basis and 55 percent on a net basis, these ratios are high by international standards. Even more troubling is the fact that still over half of this debt either floats with the overnight interest rate or else is indexed to the dollar.

Against the background of remaining financial market vulnerability and a troubling international economic outlook, one must ask what is the hurry for Brazil to graduate from its IMF program? Might not the extension of the IMF program provide both domestic and international investors with the needed assurance of continued responsible macro-economic policies in more turbulent times? One might also ask whether the current Brazilian government really wants to repeat the mistake of Pedro Malan, Brazil's erstwhile finance minister, of prepaying the IMF in August 2002 as an act of independence only to have to go back to the IMF for major support ahead of the October 2002 elections?


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