Brazil is hurtling toward an economic crisis that has little to do with whether a leftist gets elected president in October or the size of its standby credit announced Aug. 7 with the International Monetary Fund.

Except in the most implausible of positive economic circumstances, Brazil’s foreign debt is simply unsustainable in the years ahead. The debt must be restructured, stretching out the repayment schedule to ease the burden on the Brazilian economy. The IMF deal and the political leanings of the man who becomes Brazil’s next president may affect the timing of the coming crack-up and the policy nuances of dealing with it, but he can’t avoid the train wreck.

U.S. Treasury Secretary Paul O’Neill’s soothing comments during his recent visit to Brazil were a long overdue U.S. effort to calm skittish international financial markets. But now it’s time for O’Neill to turn his tough-love rhetoric on Wall Street. Never one to mince his words with improvident borrowers, O’Neill now needs to be equally tough on improvident lenders.

The Bush administration should lean on Wall Street lenders to make an upfront commitment to renegotiate the terms of their Brazilian loans as part of a “share-the-pain” effort to rescue the faltering Brazilian economy once the election is over.

Brazil’s public debt is equal to 57 percent of the economy and could grow to 92 percent by the end of 2007, according to estimates by New York investment firm Morgan Stanley. The prospects of Brazil sustaining that debt are not good. Economic growth slowed from 4.4 percent in 2000 to possibly no better than 1 percent this year.

The recent stock market slump in New York foreshadows a contraction in foreign investment in emerging markets, such as Brazil. Exports have slowed, thanks to reduced foreign demand. The interest rate the government is paying on its debt is 17 percentage points over what the U.S. Treasury pays on its debt, an unprecedented spread. And the portion of the foreign debt tied to a variable interest rate has grown substantially compared to that having a fixed interest rate, making debt servicing much more sensitive to the volatility of both the cost of money and the exchange rate.

For Brazil to climb out of this hole, its economic growth rate would have to rebound to more than 4 percent, generating more revenues to service the debt; interest rates would have to fall substantially and the Brazilian real would have to strengthen, to lower the cost of servicing the debt; and the new government would have to cut spending, to reduce the need for new borrowed money. That perfect alignment of financial stars is less likely than a transit of Venus.

So what to do? The new IMF agreement should help avoid a financial meltdown before the Brazilian election. But the long-term challenge facing the Bush administration is how to help lay the groundwork for an economically successful new government in Brazil.

O’Neill should avoid the temptation for any further lecturing of the Brazilians on belt-tightening. The United States will only get blamed for the ensuing pain. The most important contribution Washington could make would be to broker an upfront agreement with Wall Street to renegotiate its loans to Brazil. That should give the new president incentive and political cover to do what needs to be done.

Admittedly, there are no good examples of such foresightful debt restructuring before a crisis. But lack of precedent shouldn’t let O’Neill and company off the hook. It wouldn’t be easy and it wouldn’t be popular. But it’s the right policy. It just requires leadership and a willingness on the part of the Bush administration to spend some of their jealously guarded political capital.

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