03/23 07:33 Argentina Crisis Threatening to Erode Brazil's Economic Growth By David Papadopoulos

Sao Paulo, March 23 (Bloomberg) -- Andre Echeverria, Sun Microsystems Inc.'s marketing director in Brazil, has a recommendation for companies that distribute his products: Hedge your U.S. dollar liabilities to guard against a plunging real.

``At times of greater currency fluctuation, like now, it's important to prepare yourself,'' Echeverria said.

Companies such as Sun are sinking money into hedging contracts to guard against the tumble in the real, which closed at its lowest level ever yesterday.

The decline in the real is just one of the ways that the financial crisis in neighboring Argentina is sapping steam from Brazil's 18-month-old economic expansion.

The plunging real is driving up interest rates and the cost for companies to pay back dollar debts, eating into corporate profits. It's widening the government's budget deficit and threatens to cause an inflation surge, which would erode people's purchasing power as prices on imports rise.

The result: The benchmark Sao Paulo stock index yesterday suffered its biggest one-day loss in 14 months and the price on the government's most widely traded foreign bond, the ``C'' bond, tumbled to a three-month low. The bond rose 1.6 percent in early trading, pushing its yield down to 12.96 percent.

``If this continues, you're clearly going to have slower domestic demand and slower output in Brazil,'' said Michael Gavin, head Latin America economist with UBS Warburg LLC in Stamford, Connecticut.

Gavin plans to cut his 4.3 percent economic growth forecast for Brazil this year. The economy grew 4.2 percent last year.

Region

In a region that is being hammered by the Argentina crisis, no country is being harder hit than the biggest of them all. That's partly because the neighboring countries are major trade partners. More than one-tenth of Brazil's trade is with Argentina.

More importantly, analysts said, Brazil is susceptible to selloffs when another country in the region struggles because some of its economic fundamentals worry investors. Its budget deficit is one of the biggest in the region at 4.6 percent of gross domestic product. So is its deficit in the current account, the broadest measure of a country's trade in goods and services, which stands at 4.5 percent of GDP.

``Brazil is quite vulnerable,'' Gavin said. ``It's vulnerable on the fiscal side and vulnerable on the external accounts.''

The real has tumbled for weeks as investor concern has grown that recession-plagued Argentina won't be able to pay back its debts. The currency is down 10 percent this year after falling 1.8 percent yesterday to 2.161 reais to the dollar, the lowest level since it was created in 1994. It's the third worst performing currency this year of the 55 currencies tracked by Bloomberg.

That's trouble for the central bank, which is trying to lower the inflation rate to 4 percent this year from 6 percent in 2000. Policymakers calculate that each 10 percent slide in the currency could translate into as much as a 1.5 percent rise in the consumer price index.

Rate Increase

The bank reacted by unexpectedly raising the benchmark overnight interest rate by 50 basis points to 15.75 percent Wednesday, the first rate rise in two years, to try to keep money in the country and curb the real's slide. More rises may come, analysts said, if Argentina's crisis deepens and Brazil's foreign debt yields keep rising.

``If foreign spreads increase by, let's say, 300 basis points, then the central bank will have to raise domestic rates by at least that much,'' said Rodrigo Azevedo, head Brazil economist with CSFB Garantia investment bank in Sao Paulo.

The economy may slow even if the bank doesn't raise rates again. Soaring one-day future loan rates, which in many ways act as more of a benchmark for bank lending rates than the central bank rate, already stand to sap demand for loans. The rate on the one-day loan contract for Oct. 1 delivery, the most actively traded, has surged 594 basis points since Jan. 31 to 21.1 percent.

``Historically, we've seen that consumers take a while to react to an interest rate cut,'' said Carlos Pontinha Pereira, sales director at paper maker Cia. Suzano de Papel e Celulose. ``But they react real fast when there's a rate rise.'' http://quote.bloomberg.com/fgcgi.cgi?ptitle=Top%20Financial%20News&s1=blk&tp=ad_topright_topfin&T=markets_bfgcgi_content99.ht&s2=blk&bt=ad_position1_topfin&middle=ad_frame2_topfin&s=AOrtCpBbXQXJnZW50

-- Carl Jenkins (somewherepress@aol.com), March 23, 2001