TNAG-1942-FCO40-2768-Internal-economic-situation-in-Hong-Kong-1989 — Page 96

CONFIDENTIAL

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reduction in the face value of the debt*. However, for most debtors the financing

of buybacks on a significant scale would require the injection of additional

official funds or at least the diversion of money from more traditional forms of

lending.

Further details on individual countries are given below.

LATIN AMERICA AND CARIBBEAN

Brazil

25

A strong trade and current account performance has been overshadowed by a

deteriorating fiscal position and near hyperinflation. With domestic activity

weak, maintenance of a competitive exchange rate has led to a trade surplus of

$16 bn in the first 10 months of the year. Although recent figures suggest a

slowing of export growth and a pick-up of imports (partly reflecting liberalisation),

the surplus for 1988 as a whole should exceed IMF projections of $13 bn by a wide

margin and should put the current account into a respectable surplus. The strength

of manufactured exports has led to some recovery in industrial output since the

early summer but, overall, GDP is likely to remain unchanged.

26 The domestic financial position has continued to deteriorate, with the 12 month

rate of inflation rising to 812% in November after 5 successive monthly increases in

excess of 20%. Inflation is being accommodated by a loose monetary policy and

further fuelled by a growing PSBR (which itself largely reflects a sharp,

inflation-related increase in debt service payments). Fears that the economy is

heading towards hyperinflation triggered a flight from domestic currency in early

October. The government has responded by negotiating a 60-day pact with business

and labour to limit price and wage rises. To have any lasting impact, however, the

pact will need to be bolstered by tougher fiscal and monetary measures. Mailson da

Nobrega continues to battle against stiff political opposition to his plans for

reducing the fiscal deficit. So far he has retained Sarney's support, not least

because there is no obvious replacement.

*

It has to be acknowledged, however, that debt reduction could weaken adjustment incentives. The fact that Chile's self-financed buyback left the market price unchanged indicates a high degree of uncertainty as to which direction the balance of these opposing incentive effects could go.