Profligate government spending, service of the public debt, and exchange rate devaluations of austerity programs bring further increases to inflation and, consequently, prices. After Mexico's debt crisis in 1982, Brazil is cut off from international supplies of capital, and turns toward domestic borrowing.
Brazil's domestic debt equals its foreign debt. Four austerity shock plans and three consecutive currencies (the existing cruzeiro, the cruzado in 1986, and the cruzado novo in 1989) aim at reducing inflation. The Cruzado Plan, with its price and wage freezes, brings inflation close to zero, but real exchange rate overvaluation and uncertainty bring capital flight and new inflationary pressures.
The cruzado novo is again named the cruzeiro, without a devaluation. Debt renegotiation and falling international financial market interest rates reduce the external debt burden. The combination of slow growth, accelerating inflation, price freezes, and high domestic interest rates causes investment to slump. The public sector is virtually bankrupt. Brazil plunges into recession.
Finance Minister Cardoso executes his Real Plan with the introduction of an equilibrium budget; general indexation of prices, wages, and taxes; and the introduction of a new currency, the real, worth 1,000 cruzeiros and pegged to the dollar. Inflation falls from 45 percent to 1 percent within the year. Capital flows back into the economy in the form of equity investments in Brazilian enterprises.
The U.S. dollar strengthens, and the real begins to be overvalued. Brazil is highly dependent on short-term capital flows and vulnerable to external shocks. The Russian financial crisis of 1998 heightens fears among investors concerning returns in emerging markets. The Minas Gerais state governor's declared moratorium on debt payments to the Central Bank sparks massive capital flight from Brazil.
The cumulative effects of the Asian and Russian crises and the worsening of the current account deficit demand drastic measures. Brazil abandons the defense of its currency and devalues the real in January, allowing the exchange rate to float freely. Within a month, the real falls 32 percent against the dollar. To reduce the devaluation's inflationary impact, interest rates are raised dramatically.
High interest rates and fiscal austerity hold down inflation and sustain the Real Plan, but in 2002 the real comes under heavy pressure and loses more than a quarter of its value. The election of populist president Lula da Silva rattles world markets, but he earns trust by appointing a well-known investment banker to be head of the Central Bank. To fend off inflation, interest rates reach 25 percent.
back to top