The International Monetary Fund stared into the abyss and drew back from the precipice. By agreeing to lend Brazil $30 billion it has probably ensured a smooth presidential election in October, for which the Brazilians and their hysterical creditors should be very thankful. The immediate threat of default and its potentially devastating consequences for the world financial system has receded. However, the Fund has sent some mixed signals to the outside world.
It has quite rightly withheld support from Argentina because the government of President Eduardo Duhalde has failed to design a rational economic plan. The Fund refused to keep supporting Argentina last year because of its ruinous policies and because it was afraid of rewarding moral hazard. But why is Brazil any different? The government of President Fernando Henrique Cardoso has tried but failed to put a lid on the country’s public finances. Indeed, his first 1994-1998 administration was responsible for running up a big chunk of the country’s $335 billion debts. Luckily, Cardoso’s economic team is sufficiently skilled to avoid blundering in the way their Argentine colleagues have. But does this deserve a $30 billion reward?
Investors have got the message, although not the one the Fund intended to send. Instead of combating moral hazard, its actions in Latin America and around the world indicate that there are indeed some countries that are too big to fail. Brazil is big, with lots of US and European investments. Argentina is of little consequence to the rest of the world. There is one difficulty with this approach: simply lending Brazil’s bust government more money does not restore it to health. The Fund’s $30 billion package may calm down a panic-stricken market for now, but the country’s debt and the latest IMF loan will only be repaid if the next government gets real about stopping the public sector’s fiscal incontinence. I wouldn’t bet a C-Bond on that ever happening.