The Heritage Foundation

Executive Memorandum #151 on Latin America

March 5, 1987

March 5, 1987 | Executive Memorandum on Latin America

Brazil's Debt Crisis: The Blame Is Widely Shared

(Archived document, may contain errors)

3/5/87 151


For the second time in four years Brazil has unilaterally told its foreign creditors that it will not pay interest on its debts. As Brazil is the largest of ail Third World debtors" with outstanding loans of'$108 billion, this understandably has shocked the, international financial markets. What-is more shocking is that the world's leading capital management,agencies, such as the World Bank, International Monetary Fund, U.S. Federal Reserve System, and the U.S. Treasury, have contributed to Brazil's economic difficulties. For years, these institutions have des@gned, approved, and supervised numerous financial aid and policy reform packages for Brazil--and other Third World states--ostensibly to achieve self-sustaining growth. Instead, these efforts,have, i n many cases, extended harmful public sector control over economic affairs. Only months ago Brazil was hailed as the-model for-Third World economic performance and debt management .. In reality, however,.the Brazilian,government in the past year has.been m a nipulating its economy for reasons. Just prior to the November.1986 elections, for example, massive stimulus was applied to induce short-term growth. The current economic-collapse followed. After this, the IMF, U.S. Treasury, and.0thers were fo r give their grudging stamp of approval to'Brazills-supposedly revised policies in order to keep foreign loans forthcoming. Indeed, the IMF.sent a formal letter last December to Brazil's foreign government creditors; validating the nation's most rece n t economic plan. That Brazil is again on the brink of default attests not only to its-own, internal mismanagement, but also to the hollow rhetoric and failed missions of leading international financial institutions. What went wrong in trazil? In February 1 986,' the new civilian government launched the Cruzado Plan, ostensibly to deal with 400 percent inflation. Prices were frozen while the indexation of,wages to inflation was curtailed. This plan was meant to promote economic growth and to avoid IMF auster ity measures. Fiscal and. monetary rationality, however, were ignored.

During 1986, the budget deficit continued to grow and the monetary base rose by over@200 percent between March and the November -parliamentary elections. Increased wages under a price freeze caused consumption to explode. Goods usually exported were drawn into the domestic market, swiftly eroding Brazil's trade surplus.' Then when price controls were eased in late November, inflation soared to 800 percent. To make matters worse, the g o vernmefit of President.Sarney has failed to cut back Brazil's massive public sector. Government spending totil's' half of Brazil's annual gross domestic product. Some 80 percent of the external debt is owned by the public sector, and-60 percent is account e d for by state enterprises,.many of which are funded by the World Bank and the Ifiter-American Development Bank., Contributing significantly to Brazills,problem has been the ease with which foreign politicians obtain international loans and then misuse th e m. Many of the proceeds have gone into ineffidient state-owned enterprises. Example: the World Bank app .roved a $,400 million loan in FY 1985 for the recapitalization of Brazil's bankrupt state power companies-. Other foreign loans have disappeared throu g h corruption, graft and capital flight. official loans .supposedly were made conditionalon proper policy reforms to ensure sustained economic growth. Brazil's financial. predicament attests that such conditionality has failed. What-can be done? First, U.S . banks should make arrangements to write off existing loan mistakes' in an orderly manner over a number of years. This will avoid disruptions and inso 'lvencies in the U.Si. banking system. Second, Third World political leaders.and governments should not b e let off the hook too easily for past spending indiscretions. Very-few of these debtor'nations are insolvint; they just do not want to use their substantial resources to;honor their debts. Third, the international financial poh2i scheme that allows for r e payment of loans only if new lending exceeds the current installments due must-ehd. Finally,, a hard reevaluation is long overdue of the political and financ.ial institutiona-whose leaders helped create Brazil's problem and those'of other Third World debt o rs. Decades of evidence reveals the harm caused'by artificially skewing capital flows'toward Third World governments. Yet such lending persists-and expands, spurred by such official institutions as the U.S. Treasury. Politics, not markets, still directs f ar too much international lending.- Until these fundamental flaws are corrected and more reliance is given to market'forces to produce growth, there will be'more Brazils and more severe debt m4oritoria and crises.

Morris B.'Goldman, Ph.D. John M. Olin Fellow


About the Author

Related Issues: Latin America