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V. Anantha-Nageswaran

With Latin America in a turmoil, it is important that the biggest nation in the region, Brazil, is not allowed to go under. This will have ramifications far beyond the region. In this, the IMF has a role to play. Indeed, how it handles Brazil in 2003 in the event of a global economic and market turmoil would largely reflect if the institution has constructively responded to its critics, says V. Anantha-Nageswaran.

THE first trading day of the year on Wall Street began with a bang. US stocks surged. The putative cause was an outsized increase in the index of purchasing managers. This index is deemed to be a barometer of the prospects for US manufacturing in the months ahead. The hunger with which this news was greeted was understandable, partially.

Investors have begun to feel concerned about the prospect for consumers shouldering the US economic growth burden this year as they did in the previous two years. If they have to do so, it would only be at the cost of their long-term financial health. Hence, any sign that the burden would begin to be shared by the industrial/corporate sector is a welcome relief for markets. Having said that, it is difficult to see much room for sustained optimism in the report.

A particular reason for the cheerful reaction on Wall Street was the spectacular jump in the index for new orders, which is considered a leading indicator of a turnaround in industrial production. However, the Institute of Supply and Management (ISM) that releases this survey every month admitted that it was difficult to explain the big jump in new orders. In fact, one of the survey respondents attributed it to the need to stock up given the mid-week holiday break for the New Year.

Third, the book-to-bill ratio of semiconductor equipment manufacturers for December barely budged from its level in November. Thus, the surge in new orders is likely to be short-lived rather than sustained. That is why it is also telling that the foreign exchange market could not maintain the surge in the US dollar that followed the release of the ISM Survey. The EUR dropped a cent against the dollar only to reclaim almost all of it back on Friday.

Bullish consensus for US economy in 2003

What this brief episode tells us is that irrational optimism has not died on Wall Street. That investors are willing to shrug off any doubt about good news and rush to buy on headlines reveals a different mindset. Thus, gains would be hard to come by in an environment where optimism is the default option.

Further, consensus forecasts on Wall Street (as revealed in the Business Week survey) are on the optimistic side. For 2003, GDP growth is estimated at around 3.2 per cent, unemployment rate is estimated to drop to around 5.7 per cent and Dow Jones is expected to end the year with a 16 per cent appreciation.

Also, the federal funds rate is expected to end the year at 2 per cent. Hence, risks are more to the downside. Only two of the nearly 60 forecasters surveyed predict a lower federal funds rate than the present 1.25 per cent. This author, who was not surveyed, is another voice that predicts a drop in the federal funds rate below 1 per cent in the first quarter.

High energy price to hurt fragile prospects in developed world

The continuing paralysis in the oil sector in Venezuela as part of the ongoing civil war in the country has pushed oil prices higher. Consensus forecasts, as detailed above, have obviously not factored this into account. Since early November, West Texas Intermediate Crude Oil price has risen by about 40 per cent to $33.08 per barrel. Higher petrol prices at the pump are likely to rein in consumer spending. Hence, by and large, chances are high that growth expectations for the US this year could go unfulfilled.

Nor are the chances particularly bright in Europe. The German Chancellor, Mr Gerhard Schroeder, appears paralysed and comparisons with Japan are already being made. Japan boasted of a strong manufacturing sector and a weak financial system with many opaque linkages to the industrial sector. Germany is in a similar predicament. The only saving grace is that Germany's real estate sector is not inflated as was the case in Japan in the early 1990s. Rest of the European heavyweight economies such as France and Italy do not have a spring in their steps either. While the fate of structural reforms hangs in balance in Japan, its economic growth prospects are not given much of a chance by many.

Global growth burden to be borne by developing world

Thus, once again, global growth will have to be sustained by emerging giants such as India and China. With Latin America in a turmoil, it is important that the biggest nation in the region, Brazil, is not allowed to go under. It will have ramifications far beyond the region. The onus is thus on the developed world to ensure that the Brazilian President, Mr Lula da Silva, meets his promises of increasing social spending without sacrificing them at the altar of fiscal austerity. Developed country shareholders at the IMF should do well to remember the macroeconomic lessons that they are applying on their own economies to revive growth: Low interest rates and fiscal expansion.

The US is embarked on fiscal expansion, although in the long term it too faces deficits in its social security budget. Europe faces the demographic problems of an aging society. Aging problem and the burden it poses on the fiscal situation is more acute in Japan.

Yet, all of them are trying to counter their present economic stagnation by boosting government spending and cutting interest rates where feasible. Such a recourse is often not available to emerging economies that rely on borrowings from the IMF to continue with their external account adjustment.

IMF is satisfied with Brazil

Brazil has a $30-billion Stand-By Arrangement (SBA) with the IMF, signed in September 2002. The IMF completed the first review under the arrangement on December 19 and declared full satisfaction with the progress achieved by Brazil in meeting the performance criteria and structural benchmarks.

However, in a display of rare sensitivity, the IMF also pointedly mentioned that "timely progress on the authorities plans for pending structural fiscal reforms, including the pension and tax reforms will facilitate the achievement of the requisite surpluses and allow a reorientation of expenditure in line with the new government's priorities to fight poverty and social inequality, which the Fund strongly supports".

Critical test of this support will only come if debt servicing comes under fresh strain in the New Year under the new administration and financial markets once again begin to question Brazil's ability to service its debt. At the time of announcing the SBA in September, the IMF Managing Director, Mr Horst Koehler, had suggested that "given the sensitivity of the debt dynamics to the real exchange rate, real GDP growth, and real interest rates, the fiscal targets will be reassessed during quarterly program reviews."

It has to show flexibility too

The onus for showing such flexibility falls more on the IMF than on the government in honouring the terms of the SBA with the IMF. The reason is that the IMF is not in a position to influence the factors that could affect Brazil's ability to deliver on macro-economic indicators such as the price of crude oil, the health of global financial markets and trade policies of the developed world.

Mr James Galbraith, of the Levy Economics Institute correctly points out that "neither increased public spending nor increased imports can be financed from it (the IMF loan facility). Nor can the IMF guarantee Brazil a fair price for coffee and oranges — two principal export items. To the extent that these factors could reasonably be judged to have contributed to any possible slippage, flexibility would be called for, from the IMF."

To be sure, it is not the fault of the IMF that Brazil finds itself with a foreign debt burden that is onerous. Therefore, it is incumbent on Brazil to take steps to ensure that it does not assume debt that it cannot service. Where the IMF should adopt an open-minded stance is in the imposition of liberal economic orthodoxy when it does not have any influence over the practice of such orthodoxy by its major shareholders and where such deviance on the part of rich countries impinges on the ability of developing economies to grow up to their fullest potential.

Indeed, how the IMF handles Brazil in 2003 in the event of a global economic and market turmoil would largely reflect whether the institution has constructively responded to its critics.

Else, debt repudiation, capital controls come into play

Given the absence of growth-enhancing mechanisms and assurances in the IMF SBA, Mr James K. Galbraith goes on to argue that the only way Brazil could extricate itself out of the borrowing from the IMF, privatising national assets and allowing foreign ownership just to pay off past debt, is to work on a debt reduction plan together with capital controls.

While he dismisses the possible objections of the well-heeled Brazilians to such capital controls with the argument that their moral right to leave the country is no more than that of ordinary workers and other citizens, he fears the danger of subversion from outside.

Indeed, behind these macro-economic concerns and calls for flexibility on the part of the IMF lies the political concern that major global powers, particularly the US, should not engineer a `crisis of confidence' on a new regime in Brazil that does not swear by free-market dogma. Should such a concern be realised, consequences would not be contained within the borders of Brazil.

However, power and hubris might come in the way of governments thinking through the consequences for their own countries.

It would then be up to enlightened public opinion in the developed world to ensure that the primary purpose of economic adjustment support from multilateral institution is one of economic development of a borrowing nation with the honouring of its past debt obligations being a secondary goal rather than the other way around. Such an advocacy, in the post-9/11 world, would be in their self-interest.

(The author is the Regional Head for Global Economy and Asset Allocation in Credit Suisse, Asia-Pacific. His views are personal. Feedback can be sent to anantha@nageswaran.com)

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