**2.4 The 1998/99 Brazilian crisis4**

In 1994, after years of failed price stabilization and high inflation, Brazil initiated a stabilization plan named after its currency—the real. Under the Real Plan, the federal government took steps to correct a large budget deficit by reducing transfers to states and municipalities and increasing federal taxes. Monetary policy was tightened, and the real was pegged to the dollar with gradual adjustments through a crawling peg. During 1998, the plan practically eliminated inflation that had reached hyperinflationary dimensions, but balance-of-payments problems persisted.

Brazil's fundamentals on the eve of the crisis taken alone would not have necessarily deteriorated into a financial crisis. But it was affected by financial contagion from the 1997 crisis and the 1998 Russian crisis. As described above, those two crises substantially reduced international liquidity. International investors withdrew funds not only from the affected countries but also from economies with a poor past record of economic management, such as Brazil. To discourage the consequent outflow of dollars, the CB of Brazil raised interest rates sharply losing in the process half of its forex reserves. High-interest rates dramatically increased Brazil's overall budget deficit through the debt service component.5 In addition, debt maturity was shortened, making this burden more immediate. This obviously spooked investors even more.

The IMF made a commitment to provide funds designed to soften forex hemorrhage, and the Brazilian government was supposed to pass legislation designed to reduce the budget deficit. When this legislation was rejected by Congress and the governor of Minas Gerais announced that he would suspend his state's debt payments to Brazil's national government for 3 months' attacks against the currency intensified.

By mid-January 1999, Brazil announced that pegging was over and its exchange rate would be allowed to float.
