BRAZIL: CRITICAL IMF NEGOTIATIONS

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85M00363R001403100004-3
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 5
• Document Creation Date: December 21, 2016
• Document Release Date: May 12, 2008
• Sequence Number: 4
• Publication Date: July 8, 1983
• Content Type: REPORT

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Brazil: Critical IMF Negotiations
Brazil's financial rescue package, hastily put to-
gether by the IMF and foreign banks in December,
has stalled. Since April, the liquidity position has
weakened considerably because of shortfalls in
export earnings and the failure of foreign banks to
provide expected amounts of short-term financing,
thus forcing a run up of arrears. Brazil's cash-flow
problem grew acute in June when more than $1
billion in IMF and foreign bank loan disbursements
due to Brazil on 31 May were postponed because
Brazil failed to meet the terms of its agreement
with the IMF. To deal with this unanticipated
foreign exchange deficiency, Brasilia is resorting so
far to stopgap measures until it is able to resolve its
differences with the IMF.
Although we believe Brazil will ultimately recon-
cile differences with the IMF, the negotiations will
be difficult. The IMF, supported by foreign credi-
tor banks, is insisting that Brasilia adopt much
tougher austerity measures than those implemented
thus far. President Figueiredo, however, wants to
avoid harsh steps that could provoke social unrest
during the ongoing process of political liberaliza-
tion. If a new agreement cannot be worked out
soon, Brazil will have little choice but to declare at
least a temporary moratorium on its debt servicing.
Problems With the IMF
Brazil's IMF stabilization program was in trouble
almost from the beginning because of unrealistic
goals, the unwillingness of banks to fulfill financial
pledges, and a lack of government aggressiveness in
pushing austerity. By February, it became obvious
that Brazil's current account deficit could not be
squeezed even close to the $7 billion goal because of
the slow world recovery and overvalued cruzeiro.
To get the program back on track, the government
carried out a large cruzeiro devaluation that
month. This action boosted exports but fueled
inflationary pressures. Accelerating inflation-to
well over 100 percent-automatically pushed pub-
lic-sector spending higher via the indexation sys-
tem, eroding Brazil's ability to stay within IMF
limits. Meanwhile, the reluctance of West Europe-
an and US regional banks to restore interbank
credit lines was largely to blame for Brazil's inter-
national reserve deterioration and an accumulation
of payments arrearages.
Brasilia subsequently demonstrated reluctance to
tighten fiscal and monetary policies to deal with
resurgent inflation. In early May, the IMF suspect-
ed that Brazil had fallen appreciably short on its
commitments. Later in the month, a technical team
found that Brasilia failed to meet major first-
quarter performance targets-particularly public-
sector spending and borrowing, domestic credit,
and international reserves. On the basis of its
findings, the IMF judged that Brazil did not
qualify for a second loan installment scheduled for
the end of the month.
The IMF's decision to suspend further loan pay-
ments to Brazil intensified the country's cash-flow
problem. Not only did the Fund defer payment of
its $410 million installment but foreign banks
postponed a planned 1 June transfer of $640 mil-
lion in medium-term commercial loans tied to the
IMF agreement. Brazil has been able temporarily
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DI IEEW 83-027
8 July 1983
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to absorb this loss of funds by rolling over payments
on bridge loans due to the Bank for International
Settlements and other banks.
Since May, banker confidence in Brazil's ability
and determination to manage its economy has
dwindled. This has led to some erosion in short-
term financing support.
enterprise investment and made some cuts in public
employee benefits and cost-of-living adjustments.
While the IMF talks have proceeded, a new 14-
member bank advisory committee has been laying
the groundwork for steps to overcome Brazil's
growing financial problems.
Brazil's major creditors have
Renegotiations Under Way
With its loans cut, Brasilia recognized the need to
implement some midcourse corrections. In prepara-
tion for an impending visit by an IMF negotiating
team, the government's National Monetary Coun-
cil on 9 June announced part of a new austerity
package designed to raise government revenues and
reduce public-sector spending. Among the meas-
ures disclosed were trimmed subsidies for agricul-
ture and exports, higher prices for petroleum prod-
ucts, and increased taxes in the financial sector.
The package, however, omitted Planning Minister
Delfim's proposals for heavy cuts in state enterprise
budgets and changes in Brazil's wage and price
indexation system.
Since arriving in Brazil on 11 June, the IMF team
has stressed that Brazil must take stronger steps.
Particularly, the Brazilian Government has been
urged to slash public-sector spending. The team is
also pressing for deindexing wages
Some progress has been made in the talks. Brasilia
reportedly pledged a quicker phaseout of subsidies
for wheat and sugar. The government cut public
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8 July 1983
indicated that they probably will arrange a new $3
billion medium-term commercial loan to see the
country through the end of 1983. A loan of this
size would compen-
sate Brazil for shortfalls both in interbank deposits
and in export earnings. The committee reportedly is
prepared to begin consideration of Brazil's 1984
financing and debt rescheduling needs
concrete actions must
await IMF approval of a new Brazilian austerity
program.
We believe major differences between Brazil and
the IMF remain:
? The announced public spending cuts appear inad-
equate for Brazil to reach its public deficit target
under the original IMF agreement. Recent large
protest demonstrations and strike threats are
likely to discourage Brasilia from making sharp
cuts in public employee compensation, and the
new investment controls will have little immedi-
ate impact on spending.
? The other sticking point in the negotiations is
Brazil's complex indexing system. Fearful of the
social consequences of dismantling the system,
Brasilia has proposed manipulating the index to
provide less than 100-percent linkage. The IMF,
however, wants a break in the automatic wage-
price adjustment mechanism.
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We believe that Brazil will reach a settlement with
the IMF, but negotiations will most likely be
difficult. Both Brasilia and the IMF have consider-
able stakes in a successful outcome and both want
to avoid the consequences of a collapse. Still, the
Brazilian Government has become worried about
the political fallout of the deepening recession and
is resisting tougher steps.
If the IMF renegotations are not settled by the end
of July, the Brazilian Government probably will
declare a limited debt moratorium. By this time,
foreign payments arrears very likely will have shot
up sharply, perhaps to more than $2 billion. More-
over, growing uncertainty and diminishing confi-
dence would prompt bankers to withdraw more of
their short-term trade financing and interbank
deposit support, further aggravating Brazil's des-
perate foreign exchange reserve position.
Brasilia has been devising a contingency moratori-
um plan. Such an action probably would be applied
only to principal payments and would be intended
only for a short period of time. We believe that
Brazil would hope that this type of a moratorium
would provide opportunities for a new debt resched-
uling plan-perhaps with substantial extensions of
repayments terms and a reduction of interest rates.
Economic Performance Scenarios
for the Rest of the Year
gencies.
The direction that Brasilia chooses and foreign
banker reactions will influence the depth of the
country's recession. A decision by the government
to stay with an IMF program and accede to the
required conditions should net Brazil several billion
dollars of additional foreign funds to support cru-
cial import and investment activities. By contrast, if
the government opts for a moratorium, no net
inflows of foreign private loans would be forthcom-
ing until a new financial package is arranged. The
Brazilian Government undoubtedly will balance
these considerations against its own political exi-
The IMF Route. A revised stabilization agreement
would not only free disbursement of withheld IMF
and bank funds but would clear the way for Brazil
to solicit new funds. Despite sharp import cuts, we
estimate that Brazil would require at least an
additional $2.5 billion in new money to cover its
projected $7 billion current account deficit. Exports
almost certainly will not attain Brasilia's original
projected level of $23 billion because of slumping
demand for its manufactures and raw materials
such as iron ore. By putting its IMF program back
on track, we believe creditor banks will raise
another large loan to enable Brazil to fill its
financing gap. A few large money center banks are
recommending Brasilia seek $3-3.5 billion in new
funds, but the cautious positions of a number of
European and small US regional banks could re-
duce this amount.
Continuing foreign exchange constraints and more
austerity will lead to as much as a 5-percent decline
in Brazil's GDP this year. Brasilia will have to
continue squeezing imports through the remainder
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of the year, forcing manufacturers to scale back
production because of inadequate supplies of criti-
cal imported industrial materials. Furthermore,
large cuts in state enterprise spending and continu-
ing high real interest rates will assure declining
investment activity for some months to come. Fall-
ing national output will probably boost unemploy-
With IMF With ment rates close to double digits and heighten the
Agreement Moratorium a risk of more wildcat strikes and cost-of-living dem-
Current account balance -14.5 -7.5 -6.0 onstrations.
Trade balance 0.8 5.5 7.0
Exports
20.2
21.5
20.0
Imports
19.4
16.0
13.0
Net service balance -15.3
-13.0
-13.0
Interest pay-
ments
11.0
9.0
9.0
Debt repayments
20.8
22.2
18.6
Long-term maturi-
ties
7.8
7.2
3.6
Short-term maturi-
ties
13.0
15.0
15.0
Financed by:
Net direct investment
1.0
0.5
0.4
Official and supplier
credits
5.2
4.0
3.0
Loans
27.0
27.8
23.8
Bridge operations
4.0
-3.6
-2.5 b
Short-term rollovers
10.0
15.0
15.0
Short-term borrow-
ings
0.5
1.0
1.5
Long-term credits
12.5
15.4 c
9.8 d
Other
2.0
-2.6
-2.6
a Assumes Brazil declares a moratorium on amortization payments
at the end of July.
b Assumes Brazil suspends repayment of bridge loans to foreign
banks.
Includes $2.5 billion from the IMF and an anticipated new $2.0 bil-
lion foreign bank loan.
d Excludes not only new loan but also currently deferred IMF and
foreign bank payments on existing loans.
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8 July 1983
The Moratorium Route. Brazil's choice of a debt
moratorium would very likely entail a freeze of
short-term funds-including trade financing and
interbank deposits-and a temporary deferral of
amortization payments on medium- and long-term
debt. Although a few large US money center banks
might favor a moratorium of this type, we believe
most banks would discontinue new lending activity
until new austerity measures and debt rescheduling
agreements can be arranged.
Denied access to its principal source of funds
through yearend, Brazil, we believe, would have to
slash imports by 40 percent in the second half.
Sharply reduced availability of imported oil and
raw materials would cause industrial and commer-
cial output to plummet, and GDP could drop more
than 10 percent for the year. Commodity shortages
would very likely send inflation rates into the 150-
to 200-percent range. Unemployment rates would
climb-probably to the flashpoint for major social
and political turmoil. The government's ability to
deal with the resulting unrest could be sorely
strained, and further movement toward political
liberalization could be threatened.
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Implications of a Moratorium
A decision to break off talks with the IMF and to
temporarily suspend amortization payments to for-
eign banks would most likely be accompanied by a
shakeup within President Figueiredo's three-man
economic policy team.
foreign banks have lost considerable confi-
dence in the economic management abilities of
Planning Minister Delfim and Finance Minister
Galveas. Central Bank President Langoni also is
vulnerable because of his past staunch defense of
IMF austerity policies.
We believe that even a limited
moratorium would imply past economic policy fail-
ures and would likely augur the emergence of a
new economic team.
The successors to Delfim and other economic poli-
cymakers would face two unattractive policy op-
tions. They could-as we believe likely-seek a
compromise with the IMF and a return to the
suspended stabilization program. Brasilia would
have to push harder to achieve important economic
adjustments than it has up to now. The political
price that the ruling government party would have
to pay could be heavy. Alternatively, Brasilia's
preoccupation with social discontent during the
early weeks of a moratorium could lead Brazil's
new economic leaders to adopt more growth-orient-
ed policies. Such policies probably would exacer-
bate existing distortions in the economy, drive up
inflation rates substantially, and enlarge the al-
ready major role of the public sector.
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