The Impact of the Global Financial Crisis on Brazil

Until quite recently I was among those who doubted whether we faced a major crisis in the real economy. When people said that we were in the middle of the greatest financial crisis since the great depression I did not contradict them, but I found one of the interesting aspects of this crisis to be the striking contrast between the gloom and doom prevalent in the financial sector and the buoyancy still in evidence elsewhere. This was especially evident among exporters in the US manufacturing sector, whose historic markets had been largely restored by the correction of the dollar overvaluation except versus some Asian countries, but it was a much more general characteristic. Through the first half of 2008, i.e. for about a year after the financial crisis broke, growth rates continued at historically high levels except among some of the advanced countries. To take an example close to the interests of many here this morning, Brazil reported year-on-year growth of 6.1 percent in the second quarter of 2008. There was much talk of reverse-coupling.

Not only did it seem that the spillovers from financial markets to the real economy were proving blessedly limited, but one could reasonably argue that the emerging markets were unlikely to be severely affected. There were of course a few countries that had given precedence to policies of growth during the preceding boom years—many countries in Eastern Europe plus most conspicuously Turkey and Pakistan—but most countries seemed to have taken to heart the lessons that had been repeated ad nauseum after the crises of the 1990s. Such as: that countries needed to respond to capital inflows or current account surpluses by building up reserves, moving into fiscal surplus, paying off debt, eliminating the use of foreign currencies in denominating assets, cutting the debt/income ratio, and reducing inflation, rather than by splurging. Many of us were happy to emphasize that this was conspicuously true of Brazil.

In the course of September 2008 this optimism, or maybe one should call it complacency, vanished. As the month wore on it became apparent that the financial crisis was deepening to a point where it would inescapably have major spillovers on the real economy. Housing values continued their decline, but meanwhile stock markets fell precipitously worldwide and credit markets virtually dried up, resulting in many who relied on borrowing suffering from acute illiquidity. Everyone had known from the start that a slowdown in the core of the world economy was bound to suppress demand everywhere, but until this point it seemed that the slowdown was to be welcomed rather than something that was going too far. Quite suddenly it seemed that the world was facing a real danger of a depression rather than a welcome alleviation of inflationary pressure.

Moreover, the markets decided that while many of the emerging economies might no longer have any need for an inflow of loans, many (like Brazil) are still significant net debtors to the rest of the world and therefore still vulnerable to a sudden withdrawal of foreign credit. Compounding this is the fact that one may have a balanced overall position and still be vulnerable because debts are concentrated 2 at short maturities. Hence one read, for example, of the Bovespa index falling by over 10 percent in a day (it has cumulatively halved in value since the peak in May). Likewise, the real has fallen by a cumulative 32 percent in the past month. The markets clearly do not believe that Brazil has been made invulnerable by the record cited above.