BRAZILIAN DEBT MORATORIUM: POTENTIAL INTERNATIONAL FINANCIAL REPERCUSSIONS.

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP90T00114R000100080001-9
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 7
• Document Creation Date: December 27, 2016
• Document Release Date: February 14, 2012
• Sequence Number: 1
• Publication Date: February 26, 1987
• Content Type: MISC

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26 February 1987
Brazilian Debt Moratorium: Potential International Financial
Repercussions.
Summary
Brazil's decision to suspend interest payments
indefinitely on its medium and long-term debt is fraught
with risks. Given its potential repercussions, we have
analyzed the likely impact of this move on Brazil, on the
other key debtors, and on their creditors. Our analysis has
been developed by using the experience of our country
analysts, international financial experts, and the
Directorate's most-seasoned economists. We are projecting
the consequences of the Brazilian move during a six month
time horizon. We have also identified the key factors that
could condition the outcome.
This typescript was prepared by
the Offices of African and Latin
American Analysis, East Asian Analysis, Global Issues, and Near
Eastern and South Asian Analysis. Comments and queries are
welcome and may be directed to the Chief, South America Division,
ALA
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Following Brazil's unilateral moratorium on interest
payments, we believe:
-- Brazil's economy will continue to grow for several months
despite higher inflation and more difficulties in
conducting trade;
-- This action will shock financial markets--it immediately
drove down bank stock prices--but probably not lead to
destabilizing financial panic.
-- Other key Third World debtors will not initially follow
the Brazilian move, despite rhetoric to the contrary, nor
band together to answer a call for multilateral debtor
action.
Rather, the debtors will carefully monitor creditor
response--particularly ones showing retaliation against
Brazil and willingness to negotiate--for signals that
they should reevaluate their debt management strategies.
International cooperation in resolving debt problems
could be derailed by a series of swing factors--sudden
shifts in economic teams, volatile domestic political
events, imitative behavior, sudden economic
deterioration, and a hostile creditor response.
Successive debt payments suspensions by other key Third
World debtors could occur if debt rescheduling and new
money negotiations break down.
The Motives
On 20 February, President Sarney announced that the country
would suspend interest payments on Brazil's $65 billion medium-
and-long term debt to commercial bankers for an unspecified
period. He indicated that the suspension was necessary to
preserve Brazil's foreign exchange reserves, which have plunged
$3 9 billio
Moreover, we concur with a recent Embassy
assessment that an overvalued cruzado and shortages of key
components for exports will mean the trade surplus will not
likely
recover from its recent monthly level of $100 million
before
April. In addition, we know of no significant capital
inflows
programmed for Brazil through March. In addition, we
believe
Sarney was unable or unwilling to fend off intense
since September and are currently reported to be from $1.5 to
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inflows programmed for Brazil through March. In addition, we
believe Sarney was unable or unwilling to fend off intense
political pressure from several groups within Brazil--including
the left, labor, and some influential members of the ruling
coalition--to suspend payments.
Impact on Brazil
According to initial US Embassy reports, the unilateral
action against creditors has met with general public approval,
although it has drawn some critical response from the
conservative press in Brazil. According to the Central Bank,
interest payments will be held in a blocked account in Brazil
while the suspension remains in effect. Initially, we believe,
Brasilia will accumulate these payments as a war chest of
additional reserves. Consequently, the suspension of payments
would add some $800 million per month to the Central Bank's
We also believe that Brasilia will soon be tempted to use
this cash windfall to support growth-oriented policies--the major
economic priority of the populist Sarney government. With the
funds saved by suspending payments, Brasilia will probably seek
to increase imports in an attempt to alleviate domestic shortages
of key foreign intermediate and producer goods and sustain
growth. Within a month or two, we anticipate Brazil will
encounter increased difficulty in conducting trade, except on a
cash-and-carry basis. Because trade will become more expensive,
inflation will begin accelerating in the subsequent six-month
period.
Immediate Financial Impacts-The System Holds
The unilateral Brazilian moratorium on interest payments
hits world financial markets at a time when several other Latin
American debtors are in the process of negotiating new financial
packages. A review indicates that:
-- Mexico has yet to complete its $7.7 billion new money
package from commercial banks.
-- Argentina has begun negotiations for $2 billion in new
bank loans.
-- Venezuela is in the midst of negotiations for lower
interest rate spreads, a reduction in scheduled principal
payments and $400-600 million in new financing.
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-- Ecuador is bargaining for an immediate loan to cover its
cash-flow difficulties.
In cases where negotiations are nearing agreement on
rescheduling and new money, we anticipate talks will proceed.
For example, Chile agreed with bankers on 23 February to
reschedule $12 billion of extensive debt and retime its interest
payments to save $535 million. Given stronger institutional
arrangements than were in place in 1982, creditors are unlikely
to "cut-and-run" or retract short-term credit facilities.
Nevertheless, with $25 billion in US loans at risk, Wall Street
was shaken by the Brazilian announcement, with bank stocks
declining on 23 February. Prior to Sarney's announcement, press
reports indicated that bank stocks dropped slightly in West
Germany and Japan.
Banker Reaction
The scanty public reaction so far from international banks
indicates they are hopeful that new negotiations can lead to an
agreement to lift the moratorium on interest payments. According
to a press report, Brazil's Bank Advisory Committee will request
that Brasilia obtain an IMF program in return for financial
assistance. Other press commentary indicates that Brasilia is
preparing to table proposals for major financial concessions, but
we cannot confirm or deny these reports. Brazil's bank advisory
committee (BAC) has already set a date in early March for
financial negotiations. Some banks, especially smaller US and
foreign banks, are likely to try to cut trade and interbank
lines, but Brasilia has contingency plans in place to freeze
these facilities to prevent a major runoff. Full scale banker
retaliation, however, would occur only if Brazil completely stops
servicing its debt for an extended period.
Spillover Effects
Mexico stated it will continue to service its debt and not
follow Brazil in declaring a debt moratorium. We believe
President de la Madrid will continue to adhere to the rules of
the game in order to get promised credits needed to expand the
economy as the 1988 elections approach.
Argentina indicated it would suspend interest payments on
its debt if western banks refuse to provide new loans, but we
believe it will not initially follow suit. We judge that
President Alfonsin would not jeopardize recent progress on
inflation, structural reform and World Bank and IMF loans.
Nevertheless, we interpret the Argentine statement as exerting
maximum pressure on commercial banks for $2 billion in new money,
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a risky gambit. We believe Alfonsin will continue to
rhetorically support Brazil, but will stand firm in the face of
political pressure for radical action on its debt for the
immediate future.
Although Brasilia claims that Caracas has cabled its private
support, Venezuela's President Lusinchi will be slow to react
publicly, seeking consensus before making any moves and assessing
creditor response to Brazil's action.
In the Philippines, Finance Minister Ongpin is likely to
advocate continued negotiations with creditors to avoid
jeopardizing financial packages now in place and nascent economic
recovery.
Egypt is unlikely to experience any near term adverse
impact. The Mubarak government recently moved closer to reaching
an agreement with the IMF over the terms of a standby agreement.
Moreover, with most of Egypt's external debt in the form of
public and publicly guaranteed obligations, the major portion of
the debt rescheduling exercise will take place within the
relatively congenial confines of the Paris Club.
Creditors' Unfolding Response
Because Brazil's move is unlikely to create an immediate
bandwagon effect with other debtors, creditors will most likely
focus their energies on Brazil. Last year, for example, Mexico's
financial predicament caused creditors to postpone other
negotiations. If discussions became protracted, negotiations
with other debtors could be pushed aside for many months.
Brasilia must tackle its basic economic problems before new funds
will be forthcoming, we anticipate most major banks will
initially take a hard line.
-- The BAC will continue to demand an IMF-supported program
to obtain new bank credits and a restructuring agreement
even if Brasilia initially refuses to cooperate with the
Fund.
-- The BAC will closely scrutinize and contest Brazil's
economic and financial data.
-- The BAC will resist agreeing to concessions similar to
those Mexico received.
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The BAC will insist that raising new medium-term credit
will be extremely difficult, in part because smaller
banks will refuse to participate.
European and Japanese creditors will be unwilling to put
up substantial new funds for Brazil; they can resist
Brazil's demands because of reserves against troubled
loans.
Swing Factors-The Signs to Watch
Events could unfold in a very different manner if the debtor
governments' and private creditors' assumptions were different
from those we postulated. In the event pivotal swing factors
came into play, the world financial system could be rocked by
successive debt payment suspensions.
Shifts in Economic Teams. We have identified at least one
instance where a ministerial shift could result in a policy
change adverse to US interest. According to our Philippine
analysts, if current negotiations with the banks break down and
confidence in the economy falls, Ongpin may lose President
Aquino's confidence and a harder line might prevail. In that
event, Manila will be more likely to look to the other debtors
for support in forging a new financial deal. If an agreement
with the commercial banks does not appear likely and Brazil calls
on debtors to join together and press the banks for a better deal
as a group, then Manila might join.
Internal Political Pressure. Several analysts spotlighted
internal politics as a crucial and volatile swing factor. For
example, our Ecuadorean analysts observe that Febres-Cordero has
swung from one of the most financially responsible nations in
South America in honoring its foreign debt obligations into
technical default. He has been on the defensive since his
temporary abduction by Air Force paratroopers last month and he
does not want to be seen slashing reserves to satisfy foreign
economic interests. According to US Embassy reporting, he has
been angered by bank demands for assurances that Ecuador will not
seek recourse to new money to meet February debt service
repayments. He feels Ecuador deserves special consideration,
given his administration's responsible debt payment record.
In another assessment, the analyst for Venezuela speculates
that strong public opinion against debt repayment could cause
Lusinchi to change Venezuela's course. Lusinchi's political
opponents have already capitalized on the administration's
relations with creditors, claiming the president is bowing to
foreign interests in the current negotiations.
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Imitative Behavior. The situation could be made worse if
other debtors imitated Brazil. According to our experts,
elements within both the Egyptian government and the political
opposition who are opposed to what they see as intervention by
the IMF, may be emboldened by a Brazilian debt moratorium. They
could attempt to block final approval of the standby program,
which could force a de facto payments suspension.
Creditor Response. We judge this is potentially the most
important factor. Bankers are growing weary over the many
protracted negotiations and are divided over how to handle
debtors. If bankers continue their hardline with Brazil and it
spills over to other debtors, these factors could lead to long
delays in reaching agreements for new money and rescheduling. If
other key debtors then experienced financial crises, these
governments would reconsider their strategies. For example,
according to our country expert, Mexico's stance over the longer
term likely would be affected by the way creditors responded to
Brazil. The strategy of de la Madrid or his successor almost
certainly would change if creditors failed to retaliate against a
Brazilian moratorium of if Brasilia appeared to gain by its
actions.
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