No More Blood in the Stone

By Gavin Scott/Rio de Janeiro

The tone of the speech was neither defiant nor belligerent, but the words were fraught with danger for bankers around the world. As the television camera zoomed in and a concerned nation watched, a somber Brazilian President Jose Sarney dispensed with niceties and got right to the point: "I want to announce that the country is suspending payments of interest on its foreign debt." The action was necessary, he said, to prevent Brazil from running out of money. Still, he continued, "it was not easy to make a decision of this magnitude."

Indeed, its magnitude can hardly be overstated. Brazil is supposed to pay about $800 million in interest every month on its staggering $108 billion foreign debt. If the suspension of those payments goes on for long, it would be a direct hit on the earnings of dozens of major banks in the U.S. and Western Europe. It could set a perilous precedent for other major Latin American debtors, including Mexico ($105 billion owed) and Argentina ($52.3 billion). But as disturbing as Sarney's decision was, Brazil's deepening economic woes and dwindling currency reserves made it almost inevitable.

While not saying when Brazil might resume payments, Sarney expressed willingness to negotiate an interest formula that his country could meet without risking "recession and social crisis." He never used the word default and insisted his aim was not confrontation: "Brazil does not wish to be an autarkic economy outside the world community."

Bankers reacted calmly to the speech, perhaps only because they had seen it coming. Said Rimmer De Vries, chief international economist of New York City's Morgan Guaranty Trust: "The suspension of payments is not a surprise to the banks. What is difficult to understand, however, is how things could have deteriorated so quickly. Brazil has gone completely over the cliff."

The most obvious sign of the country's economic troubles is the return of runaway inflation. After being frozen by the government for much of last year, prices are rising at a 545% annual rate in Brazil, the highest level ever for a country that was notorious for its triple-digit inflation earlier in the 1980s. As prices have leaped, interest rates have surged to more than 700%, dealing a devastating blow to business. Economists predict that Brazil's real growth rate will be cut in half this year, to less than 4%. The trade surplus, which provides the only cash the country has for paying interest, has dwindled from an average of $1 billion a month throughout much of last year to $129 million in January.

Brazil's labor unions and the business community put much of the blame for the economic turmoil on Sarney and his Finance Minister, Dilson Funaro. Ironically, only a year ago Sarney was hailed for imposing the freeze on prices. But the artificial restraints generated an intense consumer demand that put renewed pressure on the economy. Before long, production capacity that was needed to turn out exports was being diverted to satisfy domestic demand. Even so, shortages of meat, milk, eggs and many other products developed. Ignoring the ill effects of the freeze, Sarney persisted with the controls until after congressional and state elections last November. Following his party's sweeping victory, the government almost immediately proclaimed price hikes of 50% to 100% on new cars, gasoline and electricity. Earlier this month Sarney finally decontrolled all prices except those of 61 staples, including milk, bread and rice.

As inflation exploded, the government faced a barrage of protests. In response, Sarney decided to oust the president of Brazil's central bank, Fernando Bracher, who was under criticism for letting interest rates rise too high. His replacement was Francisco Gros, an economist trained at Columbia University and a friend of Finance Minister Funaro's. The appointment of Gros strengthened Funaro's grip on financial policy, but the minister has yet to convince foreign bankers that he has a viable program for straightening out the economy.

In the meantime, distress has generated disorder. Last week in Rio de Janeiro thousands of truck drivers who haul food to warehouses went on strike for higher pay, and supermarket shelves began to empty. Some truckers who tried to deliver produce got their windshields smashed as they drove through gauntlets of rock-throwing pickets. After 48 hours of disruption, the strike ended when drivers received a hefty 72% raise.

As prices and wages spiral out of control, business strategy is virtually paralyzed. Says Thomas Michael Lanz, director of a Sao Paulo electronic-tools company: "We are all lost. We can't plan, we can't set prices, we can't decide whether to hire or fire." Senhor, the widely read Sao Paulo-based business magazine, put an upside-down map of Brazil on its cover last week with the headline GENERAL CONFUSION.

Against that backdrop of uncertainty, Brazil faces what are sure to be difficult negotiations on rescheduling its debt payments. Sarney will be under political pressure to take a tough line. Says Brazilian Labor Leader Jair Meneguelli: "You can't fill the bankers' bellies and the people's bellies at the same time." On their side, the creditors may be sympathetic, and if the talks go well, will consider giving Brazil new loans. But their patience will not last indefinitely. Says a U.S. banker based in Sao Paulo: "The banks want Brazil to admit it has problems, show a feasible plan for dealing with them, and stop throwing sand in the faces of creditors."