The recent economic turmoil in Brazil, triggered by the devaluation in January of the "real" (Brazil's currency), has understandably created concern about how the United States will be affected. This article looks at the possible impacts in the Tenth District and finds that, at least for now, there is little need for concern. The article is divided into three sections: an explanation of the crisis and its overall potential for harm, a brief discussion of the direct impact on district producers, and a more thorough analysis of the indirect ways a spread of the crisis could affect manufacturing and agriculture in the region.Brazil

Chad R. Wilkerson

Ricardo C. Gazel

English

Research Papers in Economics

The Impact of the Brazilian
Crisis in the Tenth District
By Ricardo C. Gazel and Chad R. Wilkerson
T
he recent economic turmoil in Brazil, triggered
by the devaluation in January of the real (Bra-
zil’s currency), has understandably created concern
about how the United States will be affected. This
article looks at the possible impacts in the Tenth
District and finds that, at least for now, there is
little need for concern. The article is divided into
three sections: an explanation of the crisis and its
overall potential for harm, a brief discussion of the
direct impact on district producers, and a more
thorough analysis of the indirect ways a spread of
the crisis could affect manufacturing and agricul-
ture in the region.
The crisis and its potential for harm
After spending more than half of its interna-
tional reserves defending its currency since the
Russian debt crisis last summer, Brazil attempted a
small, controlled devaluation of the real on January
13.
1 Similar to the situation in Indonesia in 1997,
the limited devaluation resulted in additional pres-
sures on the currency as the market overreacted to
the move, and Brazil experienced further losses of
foreign reserves. The Brazilian government was
forced to allow the currency to float freely and, by
the end of January, the exchange rate had fallen
from 1.22 reals per dollar to over 2 reals per dollar,
a devaluation of around 40 percent.
2
In the hope of avoiding a massive outflow of
dollars and an even steeper fall of the real and
higher inflation, the Brazilian Central Bank raised
interest rates after the float, with overnight rates
shooting to 39 percent. The higher rates worsened
the fiscal position of the Brazilian government,
which has a high level of internal debt. Meanwhile,
fiscal reforms aimed at cutting spending and
increasing tax revenues continued to drag in the
Brazilian Congress.
3 Under these circumstances,
most analysts in late January and early February
adjusted substantially downward their forecasts of
Brazilian economic activity in 1999, with most
anticipating somewhere between a 3 and 5 percent
decline in real GDP.
Given the magnitude of the crisis in Brazil,
how significantly could it affect the Tenth District
economy? The impact in the district will depend
largely on how the overall U.S. economy reacts to
the crisis. For example, the U.S. stock market could
have difficulties if the profit margins of American
companies that invested in Brazil and other Latin
American countries begin to fall. Paine Webber
estimates that around 7 percent of the corporate
earnings of S&P 500 companies come from Latin
America, with even higher proportions for some
companies. Another risk is the possibility of a Bra-
zilian debt default. If Brazil reneges on its financial
obligations either at home or abroad, there could be
a ripple effect felt around the world.
These potential threats to financial markets are
important, and would certainly affect the district
economy if they occurred. But there are more direct
ways the Brazilian crisis—and its possible spread—
could have an impact on producers in the Tenth
District.
11
1 Brazilian foreign reserves declined from a peak of $74.7 billion
in April 1998 to around $36 billion after the devaluation of the real,
and have stayed around that level since then.
2 The real appreciated somewhat at the beginning of February but
by the end of that month the exchange rate was again over 2 reals per
dollar.
3 It is important to note that the Brazilian Congress has now passed
most of the fiscal measures aimed at achieving a primary fiscal sur-
plus.  However, debt service has increased substantially due to the high
interest rates and also due to the devaluation, since part of the Brazilian
internal debt is denominated in dollars.Direct impacts on district producers
There are three ways the troubles in Brazil
could affect the district economy in the short run.
First, a Brazilian recession would result in lower
aggregate demand for goods and services in Brazil,
including goods imported from the Tenth District.
Second, the large devaluation of the real with
respect to the dollar makes American goods rela-
tively more expensive to Brazilian consumers, fur-
ther reducing their demand for goods produced in
the Tenth District. Finally, Brazilian goods after the
devaluation are cheaper in comparison to their
American counterparts not only in Brazil, but also
in all markets where Brazilian and American pro-
ducers compete, including the United States. In
other words, district producers will face stiffer
competition from Brazilian producers in Brazil,
within the United States, and in other international
markets, especially Latin America.
These direct effects of the Brazilian crisis on
the district economy are likely to be quite small.
Brazil accounted for just 1.6 percent of all district
manufacturing exports in 1997 (Table 1). And
manufacturing exports to Brazil represented only a
tiny fraction of total factory output in the district
(less than two-tenths of one percent). Agricultural
exports to Brazil were also quite insignificant in
1997, comprising around one percent of total farm
exports. In addition, imports from Brazil repre-
sented just over one percent of all imports.
The direct impact in the nation as a whole will
be slightly larger than in the district, since a higher
percentage of national exports go to Brazil and a
bigger share of national manufacturing output is
exported. Nevertheless, given the small percentages
involved, the direct impact on the national economy
will likely be minimal.
The possibility of a spread
If the Brazilian crisis spreads to other Latin
American countries, the impact would obviously
become larger in both the district and the nation,
since Latin America as a whole is a much bigger
trade partner and an important competitor in several
industries. How far the crisis spreads will depend
on several factors, most of which would be difficult
to predict with any degree of certainty: how far the
real falls; the extent of Brazil’s recession in 1999;
whether other countries devalue their currencies;
whether Brazil defaults on its internal and/or inter-
national debts; and how other Latin American
countries, and especially Mexico, are affected by
reduced Brazilian demand and increased competi-
tion from Brazilian producers.
12
Table 1
Destination of U.S. and District Manufacturing Exports
(Percent, 1997)
Brazil
Other
South America
Central America
and  Caribbean Mexico
Total
Latin America
United States 2.4 4.3 2.6 10.6 20
Tenth District 1.6 3.1 1.2 5.3 11
Wyoming 4.2 11.4 0.9 10.6 27
Oklahoma 1.1 5.7 1.3 5.8 14
Kansas 2.5 4.0 1.9 5.2 14
Missouri 1.7 2.9 1.2 6.0 12
Colorado 1.4 1.5 0.8 4.6 8
Nebraska 0.9 1.7 0.9 3.6 7
New Mexico 0.1 0.9 1.3 4.6 7
Source: MISER.While the final extent of the spillover in Latin
America is unknown, a few countries will almost
certainly be affected by the Brazilian crisis in the
near term. These include the other members of
Mercosur, a free trade area in South America that
joins Brazil and neighboring countries Argentina,
Paraguay, and Uruguay. Argentina, for example, is
likely to experience a recession in 1999 as exports
to Brazil fall and imports from Brazil rise. Exports
represent around 10 percent of GDP in Argentina,
and Brazil accounts for one third of them. Thus, a
recession in Brazil and the large devaluation of the
real could significantly reduce Argentina’s net
exports. Many Argentinean car makers, in fact,
have already cut production and are planning fur-
ther labor suspensions in the near future. Argentina
has also raised interest rates to protect its own cur-
rency, and many analysts expect a fall in foreign
direct investment this year since recent investment
has been heavily concentrated in export-oriented
manufacturing activity.
The Mercosur group of countries will probably
suffer the most from the Brazilian crisis, but other
countries in Latin America are also likely to experi-
ence difficulties. Nearly all Latin American coun-
tries, for example, trade more heavily with Brazil
than the United States does. So the direct impact of
lower export flows to Brazil, higher levels of
imports from Brazil, and tougher competition from
Brazilian producers in international markets will
likely be greater in these countries, and could lead
to acute economic difficulties.
Indirect impacts on manufacturing
Given that some spillover to other countries is
likely to occur, how important is Latin America as
a whole to the district manufacturing sector? In
1997, Latin America accounted for slightly more
than 11 percent of the district’s manufacturing
exports, with half of those going to Mexico (Table
1). But since exports account for just a small share
(approximately one-twelfth) of total production in
the district, exports to Latin America represented
less than 1 percent of district manufacturing output
(Table 2).
In contrast, 20 percent of U.S. manufacturing
exports went to Latin America in 1997, and the
share of manufactured goods that are exported is
almost twice as high in the nation as in the district.
Thus, exports to Latin America comprise around 3
percent of the country’s factory output. The impact
of a Latin American meltdown would therefore be
somewhat larger in the nation than in the district
but, given the still limited exposure of the domestic
manufacturing sector, the impact would be rather
small.
While the overall effects of the crisis on district
manufacturing will likely be light, some states will
be more negatively affected than others. Among
district states, Wyoming has the highest share of its
manufacturing exports going to Latin America, 27
percent in 1997 and more than 30 percent in the
first three quarters of 1998. The state’s exports to
the region, which are highly concentrated in the
chemical sector, represent slightly less than 5 per-
cent of Wyoming’s total factory output, a fairly
large amount. Oklahoma, Kansas, and Missouri
each send more than 10 percent of their exports to
Latin America. But exports in these states represent
a smaller fraction of total manufacturing output
than in Wyoming, so Latin America receives
roughly just 1 percent of their manufactured goods.
Latin America accounts for less than 10 percent of
the manufacturing exports of Colorado, New Mex-
ico, and Nebraska. Given the importance of exports
in Colorado, its exports to Latin America represent
slightly more than 1 percent of total factory output
13
Table 2
Share of Manufacturing Output
Exported to Latin America
(Percent, 1997)
United States 3.0
Tenth District 0.9
Wyoming 4.6
Kansas 1.1
Colorado 1.1
Oklahoma 1.0
Missouri 0.8
Nebraska 0.5
New Mexico 0.4
Sources: MISER, U.S. Department of Commerce.in the state. In Nebraska and New Mexico, the
share is less than one-half of one percent.
There also will be differing degrees of impact
among sectors. Tenth District manufacturing
exports to Latin America are fairly concentrated in
a few sectors. For example, Latin America accounts
for almost half of the district’s apparel exports, and
over 40 percent of its textile exports. However,
given the importance of exports as a share of total
output, district leather producers have the highest
exposure to Latin America. Nearly 5 percent of the
sector’s output went to the region in 1997, with
exports consisting primarily of finished hides and
soles (Chart 1). Exports to Latin America also
account for close to 2.5 percent of the output of
chemicals and machinery in the district. But overall
district manufacturing exports to Latin America
account for less than one percent of total output,
meaning that even a considerable spread of the Bra-
zilian crisis is unlikely to have much immediate
impact on district manufacturers.
Indirect impacts on agriculture
The agricultural sector in both the district and
the nation could also potentially be affected by a
downturn in the overall Latin American economy.
Agricultural export data at the state level is not very
reliable, but since agricultural commodities pro-
duced in different areas can be considered close
substitutes, the district’s share of total U.S. produc-
tion can help give an idea of the impact in the dis-
trict.
4 In 1997, the seven district states produced
more than a third of the country’s wheat and cattle,
more than a fifth of the corn and hogs, and roughly
a sixth of the soybeans. Latin America accounted
for between 14 and 20 percent of the exports of
these commodities.
14
Chart 1
Share of District Manufacturing Output Exported to Latin America by Sector, 1997
1
0
Percent
4
2
1
0
Percent
4
2
5 5
Mexico
South
America
Leather Chemicals Machinery Apparel Primary
metals
ALL
SECTORS
4 For a comprehensive analysis of export data at the state level, see
Cronovich and Gazel, “How reliable are the MISER foreign trade
data?” (1999).
Central America
and Caribbean
3 3
Sources: MISER, U.S. Department of Commerce.After taking into consideration exports as a
share of total output, Latin America received about
7 percent of the total U.S. production of wheat,
6 percent of the soybeans, 4 percent of the corn,
and close to 1 percent of the red meats in 1997
(Chart 2). Given these proportions, the agriculture
sector, and especially grain producers, could feel a
moderate impact if the Brazilian crisis spreads to
other countries in South America. Problems would
become even larger if the crisis hits Mexico, since
that country receives more than half of Latin
America’s share of some exported commodities.
In addition, more than a third of U.S. agricul-
tural imports (which include grains and meats as
well as such items as coffee, nuts, fruits, and
vegetables) come from Latin America. While
Brazil accounts for only a small part of this overall
share, it produces and exports a large amount of
soybeans. A weaker real could therefore lead to a
fairly sizable inflow of Brazilian soybeans to the
United States.
Conclusions
The direct impact of the Brazilian crisis on the
district economy is likely to be quite small. Exports
to Brazil account for only a tiny fraction of total
manufacturing and agricultural production in the
district. The indirect effects of a spread of the crisis
to other Latin American countries would obviously
be somewhat larger, especially for agriculture, but
still relatively small since exports to Latin America
as a whole represent just a minor share of overall
district production. In order for the district econ-
omy to be significantly affected by the crisis, some-
thing on a larger scale, such as a Brazilian debt
default or a profit squeeze on U.S. companies that
have invested heavily in Brazil, would have to
occur to weaken the overall U.S. economy. Until
and if that happens, the district economy should be
able to weather the current economic storm in Brazil.
15
Ricardo C. Gazel is a senior economist in the Federal Reserve Bank of
Kansas City. Chad R. Wilkerson is a research associate at the bank.
Chart 2
Share of U.S. Agricultural Commodities Exported to Latin America, 1997
2
0
Percent
6
4
2
0
Percent
6
4
8 8
Wheat Soybeans Corn Red meats
Mexico
South America
Central America
and Caribbean
Source: U.S. Department of Agriculture.

The impact of the Brazilian crisis in the Tenth District

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The impact of the Brazilian crisis in the Tenth District

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