In a recent article (Acque & Terre no. 6, 1998) we described the situation in Brazil to the background of the international financial crisis. Although stressing the structural weaknesses – still present – in the Brazilian economy and society, our analysis concluded that the enormous progress made by Brazil in the 1990s (a more open market, financial stabilisation, modernisation of the productive system, and regional integration in the framework of MERCOSUR) had created a basically positive overall situation both in terms of the economic development of the country and its growing international role.
We now have to ask to what extent these conclusions have been invalidated by the turbulent events after 13 January 1999, when the greatly feared devaluation of the real actually took place. Under the weight of market speculation Brazil was dragged into a downward spiral that looked set to undermine in only a few weeks the economic stabilisation process of the previous four and a half years (the Real Plan).
In this article we will briefly analyse the evolution of the Brazilian financial crisis (the so-called ‘samba effect’) as the starting point for an examination of the repercussions on MERCOSUR, the economic integration block comprising Argentina, Brazil, Paraguay and Uruguay, now going through its first really deep crisis after years of success.
But why chose this perspective? MERCOSUR iS notonly a regional block with its own specific weight (the fourth in the world in terms of population and trade volume after NAFTA, the European Union and ASEAN). It also represents a particularly successful example of an economic integration process involving emerging countries. Its potential in terms of trade partnerships and capacity to attract investments was so great that in the 1990s, all the big international players turned to this market.
Both the European Union and the United States have set up or are setting up negotiations with the aim of signing intra-regional trade agreements with MERCOSUR. In the case of the European Union a possible agreement with Mercosur would be the first example of an accord between two regional blocks, while all of the countries in the American hemisphere are beginning negotiations for the Free Trade Area of the Americas (FTAA), in which MERCOSUr has taken on a key role.
The rapid success of MERCOSUR also strongly influenced trade and economic balances in
Latin America (see ‘Latin America: from the Pact to the Andean Community, Acque &
Terre no. 2, 1997).
If we consider the overall situation of international trade on the eve of the Millennium Round of the World Trade Organisation (Wro) and the more general consequences of globalisation and the integration of financial markets, highlighted on several occasions by the Brazilian crisis itself, we may conclude that the fate of MERCOSUR is not simply a regional problem but a question of global interest for international trade.
Why did the Brazilian financial crisis occur? The close binding of the real to the dollar, with devaluation controlled by Brazil’s Central Bank at an annual rate of 7.5 per cent, held during Cardoso’s first term of office. The effects were very positive both in terms of keeping inflation down (a kind of endemic disease in Brazil. where it has always been used to finance constantly expanding public spending) and in terms of Brazil’s growing international credibility.
On this basis, the four years before the crisis were characterised by a considerable strengthening of purchasing power for the middle-classes and significant growth rates in the GDP.
But towards the end of Cardoso’s first term of office, his economic policy began to be criticised, mainly by industrialists, because of the tight jacket on and the economy due
to the pegging of the real to the dollar. In particular, after the Asian and Russian crisis, it had become increasingly difficult to defend the real, sending interest rates soaring to very high levels (an almost fifty per cent rise).
In defending its monetary model at all costs, Brazil burnt up more than half its reserves in 1998. Despite the injection of confidence and capital provided by the coordinated IMF aid programme of October 1998, delays in approving pension and tax reforms by congress, and the moratorium announced by the state of Minas Gerais, triggered off a wave of speculation in
January 1999, making it impossible to further defend the real.
The first attempt at reform (the introduction of a wide fluctuation band, from 1.22 to 1.32 reais per dollar) lasted no more than twenty-four hours. Market pressure forced the Central Bank to abandon its defence of the real. In only a few weeks the Brazilian currency plunged towards values considered far too extreme by all analysts, and by the end of February the exchange rate was 2.2 real per dollar (a devaluation of eighty per cent in six weeks compared to the overall devaluation of thirty per cent in the four previous years).
The crisis shock waves also hit the bosses of the Central Bank. The orthodox monetarist Gustavo Franco,who had opposed any slackening in monetary policy, was replaced on 13 January by his deputy Francisco Lopes.
He, in turn, held out no more than eighteen days against the samba effect and was replaced in early February by Arminio Fraga, a man close to George Soros. This appointment led to a great deal of controversy in the Brazilian political classes, loath to accept an exponent of ‘international speculation’ at the helm of the country’s monetary policy.
But initial allegations of possible irregularities committed by Fraga to the benefit of Soros in the period between the appointment and taking office turned out to be unfounded and the first two months of Fraga’s management proved to be extremely positive. The effect desired by Cardoso in appointing an expert of international financial markets to gain credibility was achieved and the real made up ground much quicker than had been expected.
By late April the wave of speculation had been halted, and the real is now back up to values between 1.6 to 1.7 dollars – a figure already unanimously indicated by the experts as being realistic.
This rapid stabilisation, which counterbalanced the speculative peaks in January and February, means that much more optimistic macroeconomic forecasts can be made compared to the fears of a deep recession in the first few weeks after the crisis. Although 1999 will end in recession (-1 per cent), the plunge towards negative values around 4-5 per cent seems to have been averted.
As regards the other great unknown, inflation, which rocketed in the first weeks, hinting at a catastrophic scenario of 30 to 40 per cent for 1999, it has now calmed down, thanks to some successful government measures and a responsible response from traders and, more importantly consumers, who changed their purchasing habits and so refused to follow the escalation of the crisis. Today the most reasonable forecasts suggest that inflation will be nearer 10 than 15 per cent by the end of the year.
Another factor which has contributed to improving the situation is political in nature. Cardoso has managed to strike a deal with the state governors, who without going as far as the moratorium announced by Itamar Franco (Minas Gerais), stressed the need for easier conditions in paying back state debts to the central administration because of the crisis. A general extension of the moratorium would have had dramatic consequences on the international credibility of Brazil. Cardoso granted the states some alternative concessions without either forgiving debts or allowing payments by instalment. The only rebel state is still Minas Gerais, but more for political reasons (Franco’s rivalry with Cardoso and his presidential aspirations) than forfinancial reasons (the situation in Minas Gerais is much less dramatic than in some other states).
That partial recovery from devaluation has, however, aggravated the problem of public debt, making it impossible to reach the objectives established in October with the IMF. A revision of this agreement was signed on 8 March, on the basis of new economic forecasts, which are partly coming good in the framework of a moderately positive scenario.
The agreement is no longer anchored to maintaining the exchange rate but to controlling inflation. In this context, interest rates have begun to fall (the agreement is for a 28.8 per cent rate by the end of the year).
This is the Brazilian financial situation in late April, but what have the repercussions of the crisis been for MERCOSUR?
The first Argentinean reactions were of concern: the spiralling devaluation of the real from January to March led to Argentinean businessmen fearing a major loss of competitiveness for their products compared to Brazilian goods, given that the Argentinean peso is linked to the dollar through the currency board system. We must point out that when MERCOSUR was created, Argentina had always had positive trade balances with Brazil. The business lobby thus
put pressure on the government to obtain compensatory measures.
On the other hand, President Menem had proposed settling MERCOSUR’s monetary problems for good by adopting the dollar as a single currency, following the Argentinean example. In the past Menem had already discussed the possibility of MERCOSUR monetary union following the example of EMU.
But this change in direction towards the dollar meets with little support in Brazil, a country very reluctant to lose any sovereignty. The authorities are well aware how unpopular the adoption of the dollar would be with public opinion, mostly already sceptical about the IMF agreement, seen as a case of external interference. The Brazilian authorities thus announced that adopting a regional single currency would ‘take decades’ At the height of the crisis the MERCOSUR presidents gathered on several occasions to make a show of MERCOSUR strength. The meetings included the bilateral MenemCardoso summit in São José de Campos on 17 February and the meetings between Cardoso and Sanguinetti of Uruguay and Cubas Grau of Paraguay, they too evidently concerned about the consequences of the Brazilian crisis on their economies and keen to keep the block together. These meetings built up solidarity between the countries in the group, and stalled any protective measures by Brazil’s partners. They also confirmed the principle of joint decisionmaking and introduced the concept of macroeconomic coordination within MERCOSUR.
The decision concerning macroeconomic coordination was particularly significant, since Mercosur had always previously been viewed only as a commercial agreement, without any clear prospects concerning deeper integration. The first simultaneously exogenous and endogenous shock demonstrated to the countries in the block the need to gradually move towards macroеcоnomic and monetary integration in order to create a true regional economic area. In this sense, the European experience was often cited by MERCOSUR as a significant reference point.
After the bilateral meetings, the MERCOSUR presidents met for the first Eu-MERCOsur Enterprise Forum in Rio di Janeiro (late February). Two months after the presidential statements, however, there was growing tension between the two main MERCOSUR partners,
Brazil and Argentina. Despite the measures adopted to alleviate the effects of the crisis (the withdrawal by Brazil of subsidies for exports within the MERCOSUR and the Argentinean withdrawal of measures announced for the automatic paying back of negative balances in bilateral trade credits) the introduction of protective measures by Argentina (phyto-sanitary and anti-dumping measures and partial clawback of VAT on exports) created tension in relations between the two governments on trade matters. It must be stressed that in December Argentina had already complained about discriminatory measures introduced by Brazil. Now there is a possibility of Brazilian action against Argentina in the Wro, which would be a negative signal for the health of MERCOSUR.
Other serious differences of opinion concern negotiating strategies of MERCOSUR with other Latin America countries. Although Brazil viewed dimly the renewal of the bilateral agreement between Argentina and Mexico (late 1998), on the grounds that only MERCOSUR as a block should make this kind of agreement, Brazil itself has now decided to abandon negotiations for creating a freetrade area between MERCOSUR and the Andean Community to make its own unilateral preferential agreements with the countries concerned.
In fact Brazil is much more deeply affected than Argentina by this technically very complex negotiation due to the existence of a detailed network of pre-existing bilateral accords between the countries in the framework of the Latin American Integration Association (ALADI). Brazil is interested in strengthening its trade, especially with Venezuela. The newly elected President Chavez has already visited Brasilia twice and has asked for Venezuela to be allowed
to join MERCOSUR.
Lastly, the climate inside the block is worsening, and some Argentinean ministerial statements have casts shadows on the future viability of MERCOSUR. Bearing in mind the European example, however, we must stress that the integration project is a blueprint for the long term, often subject to transitory crises and problems. In this sense the presidential statements tend towards the deepening of integration as a way of responding to the crisis. This attitude still seems to prevail over that of rupture.
As we have stressed, the proposed deepening of integration would extend the range of MERCOSUR action to macroeconomic coordination. Thought is now gradually been given to two themes which until recently were taboo, at least in the two major MERCOSUR countries: the creation of supranational mechanisms for settling controversies and the definition of an institutional structure for MERCOSUR to integrate the intergovernmental dimension.
Although the Brazilian financial crisis rocked MERCOSUR, the Paraguay political crisis has given some positive signals about the block’s democratic solidity.
We cannot go into the details of the recent political events in Paraguay here, although they are extremely interesting, at times verging on the picaresque. The upheavals in Paraguay were the outcome of the imperfect transition from the Stroessner dictatorship to the current democracy, in which pоwer has remained in the hands of Stroessner’s old party (the Partido Colorado).
Divisions and hatred between the various factions of ‘Coloradism’ have given rise to prolonged instability, already undermined in 1996 by General Oviedo’s failed coup to oust President Wasmossy.
On that occasion MERCOSUR already demonstrated its democratic strength (the MERCOSUR
members informed Paraguay that a coup in Asunción would lead to the country being expelled from the group), and a similar stance was made following the assassination of vice-president Argaña. In fact Brazilian and Argentinean diplomatic efforts were of great help in averting an escalation of violence between factions linked to president Cubas Grau and Oviedo and to the followers of the Argaña. The MERCOSUR factor played an important role in thwarting a coup, following the threatened impeachment of Cubas Grau and the intervention of Paraguay’s
neighbours smoothed the way to the resignation of Cubas Grau, which put an end to
the crisis.
The Paraguay crisis has proved that democratisation in the region is irreversible and highlighted the strategic importance of belonging to MERCOSUR.
MERCOSUR is thus experiencing a crisis of maturity. Its early years saw extraordinary results in terms of stepping up trade, a highly significant factor in a region where it had hitherto been very limited. The success of MERCOSUr has also made a crucial contribution to increasing the international credibility of member countries.
The current difficulties due to the economic crisis are useful in raising questions about which path the block should follow: various signals suggest that the deepening of integration could be the response to the crisis.
MERCOSUR has become the focus for South American economic integration: MERCOSUR extended to all South American countries (the so-called AMERCOSUR) is no longer a utopia, although it will certainly be a long and difficult process.
This South American dimension is part of the FTAA negotiations, in which MERCOSUR has assumed the role of Latin American leader to offset the influence of the United States.
Moreover, MERCOSUR is very keen to strengthen its links with the European Union through the creation of a free-trade area between the two regional blocks (the European Union is already MERCOSUR’s biggest trade partner): асcess for MERCOSUR agricultural products on the European market is the key to the question, but the negotiation formula has not yet been defined.
The coming years should thus see a gradual consolidation of MERCOSUR as the tool for economic integration in Latin America and its growing trade diplomacy with the major world trade blocks (European Union and NAFTA).