ÃO PAULO, Brazil
WHEN a giant falls, the noise is loud and the collateral damage wide. Fear of such a prospect is gripping Latin America.
For months, Brazil's financial markets have been in turmoil, and unless there is emphatic international financial support soon, the country, South America's largest economy, could well face mass corporate defaults.
Brazil's currency, the real, has lost 23 percent of its value against the dollar this year most of it in July alone. Brazilian companies cannot borrow money, especially from foreign banks, which are even pulling money out of the country. Last week, Brazil sent an emergency delegation to negotiate aid from the International Monetary Fund. In Brazil's presidential campaign, meanwhile, the growing appeal of two opposition party candidates is making international lenders and multinational investors even more nervous. And many economists expect Brazil to renegotiate its $250 billion public debt no matter who wins the election in October.
When neighboring Argentina plunged into recession four years ago, the international damage was largely contained. But Brazil is different. Its economic tentacles reach into every country on the continent and beyond.
"There is no doubt that a Brazilian collapse would contribute to the drag on the global economy," said Christian Stracke, head of emerging-markets debt strategy at CreditSights, a Wall Street firm that analyzes credit risk. "The question is whether a greater cascade effect would develop from losses at large companies and banks working their way through the larger economy."
Treasury Secretary Paul H. O'Neill, whose off-the-cuff remarks last Sunday questioning the financial honesty of Latin American governments set off an uproar here, arrives in Brazil tonight, the first stop in a visit that also includes Argentina and Uruguay. Last Thursday, Mr. O'Neill tried to temper his earlier remarks, saying "the economic team in Brazil has done a remarkable job." But aside from reassuring words, Mr. O'Neill is not expected to offer much help. At least not now.
Trying to calm the waters, Brazil's central bank president, Arminio Fraga, tells an altogether different story.
Mr. Fraga, a former fund manager for the billionaire financier George Soros, insists that Brazil's fundamentals are fine. Whoever wins the election, he said, will not topple the pillars of low inflation, fiscal discipline and punctual debt payments that have been the foundation of eight years of relative stability under President Fernando Henrique Cardoso.
"The market reaction is exaggerated," Mr. Fraga said in an interview. "There is more and more commitment to do the right thing. Though we can't relax, I'm convinced we will have a happy ending."
BRAZIL'S Latin trading partners, as well as the multinational companies that have poured money into the country at a torrid pace in recent years, can only hope that he is right. The central bank estimates that American companies had about 170.5 billion reals in assets, or about $55.3 billion at current exchange rates, tied up in Brazil as of 2000, far more than any other country's corporate investors, with General Motors, the troubled telecommunications company WorldCom and the electric utility AES among the most heavily exposed.
In some ways, Brazil's faltering economy has already been contagious. In neighboring Uruguay, stung earlier by Argentina's problems, the government closed all banks last week for the first time in 60 years, fearing a capital flight as Brazil's financial markets gyrated. On Friday, the government dispatched police to quell looting in Montevideo, the capital. Meanwhile, bond yields in emerging markets as far as away as Poland have shot up recently.
Behind many of the tremors in Brazil are polls showing that Mr. Cardoso's hand-picked candidate, the former health minister José Serra of the president's centrist Social Democracy Party, is steadily losing ground to his main rivals: the leftist Workers' Party candidate, Luiz Inácio Lula da Silva, a former metalworker who used to talk loudly about renegotiating Brazil's debt, and the dark horse candidate, Ciro Gomes of the Labor Front coalition, who still talks about it.
Since May, when Lula, as Mr. Silva is known here, started extending his lead over Mr. Serra, investors have been punishing Brazil. Then, as Mr. Gomes also overtook Mr. Serra in the polls, they started to panic.
Brazil's overall risk, as measured by the J. P. Morgan emerging-markets bond index, has surged to levels that make the country a riskier bet, at least on paper, than any other nations except Argentina and Nigeria. The value of the benchmark C-bond, an inverse barometer of investor fear, has fallen 30 percent this year.
The looming economic chaos in Brazil is confounding partly because the country has been one of the I.M.F.'s star pupils under Mr. Cardoso's watch.
While Mr. Fraga acknowledged that "the horizon remains cloudy," he expressed confidence that whoever wins the election would do nothing to upset hard-earned price stability. Just a decade ago, monthly inflation was running at 80 percent and supermarket price tags eventually became too short to accommodate all the zeros.
"Whether or not to stick with these key policies is a no-brainer," Mr. Fraga said. "I'm confident they will be maintained and that Brazil will continue to enjoy the support of the international community."
CERTAINLY, a reversal in Brazil would help doom free-market reforms elsewhere in South America, which is already tired of waiting for such changes to deliver prosperity for all. Moderate politicians would undoubtedly suffer.
Some economists agree with Mr. Fraga that anxiety over a Brazilian default is misguided and overblown. But they are concerned that international banks and large multinational companies, many of them stung by losses in Argentina and the bankruptcies of companies like Enron and WorldCom, are limiting the availability of credit to Brazilian corporations.
That stinginess has reduced an important source of foreign currency in Brazil and prompted much of the real's decline, putting many Brazilian companies at the risk of default on their debts denominated in dollars. Brazil's government has only $1.2 billion of sovereign debt maturing in the second half of this year, compared with $9 billion of corporate debt coming due in international markets in the same period, said Eduardo Freitas, the chief economist at Unibanco, one of Brazil's largest banks.
Even so, Brazil has not found any strong signals of international support.
Mr. O'Neill's remarks on Thursday eased some concern, and at least temporarily strengthened the value of the real and raised hope that the I.M.F. would grant more aid to Brazil. But the I.M.F. negotiations are still expected to be difficult, and Mr. O'Neill said there were no "magic bullets."
Gustavo Loyola, a former central bank president and now a partner at Tendências, a consulting firm based in São Paulo, said, "Despite all the successes of recent years, in which the country has been the I.M.F.'s best pupil, Brazil is still on probation."
In recent weeks, credit rating agencies have downgraded the country's debt, and one, Fitch, has downgraded its ratings of the foreign-currency-denominated debt of 16 Brazilian companies, effectively making it more difficult for them to borrow money abroad.
Besides worsening the indebtedness of Brazilian companies with foreign loans, the real's decline has deeply hurt Brazilian companies that must import raw materials. Lawrence Pih, president of Moinho Pacifico, a large Brazilian flour mill, said the cost of producing flour has doubled for him because of higher prices for imported wheat. And if he needs to borrow money, domestic banks will lend at 42 percent interest.
Even the country's big corporate names, like the paper giant Klabin, the clothing manufacturer Hering and the top industrial conglomerate, Votorantim Participações, are having to negotiate shorter-term financing at higher rates than in the past.
"It's very difficult to get investors interested in Brazil at this moment," said Luís Soares, a director of and partner in Eurovest, a brokerage firm in Rio de Janeiro.
In the presidential campaign, the most recent polls show Mr. Serra, 60, dropping to third place from second. His support has fallen to 14 percent, from 21 percent in June. Mr. da Silva's rating also fell, to 35 percent from 38 percent, while Mr. Gomes's surged, to 27 percent from 9 percent.
Mr. Gomes, a young-looking 44, became Brazil's youngest-ever governor 11 years ago, in the northeastern state of Ceará, then briefly followed Mr. Cardoso as finance minister in 1994 when Mr. Cardoso quit to campaign for president. Mr. Gomes later defected to the opposition. He has successfully positioned himself as the pro-business but antigovernment candidate, stealing the middle ground from Mr. Serra.
Mr. Serra may have also made a tactical mistake by warning voters that a failure to elect him would court an economic collapse like Argentina's. Instead of turning voters away from his rivals, the comment only further roiled Brazil's markets.
Clóvis Rossi, a respected columnist at the daily Folha de São Paulo, said: "The government people who lit the bonfire of `Argentinization,' thinking they would scorch the opposition, ended up looking like a poor excuse for Nero. Brazil is on fire, and nobody has a fiddle to play."
BUT while much of the world, including Wall Street, tends to regard Brazil and Argentina as Siamese twins, their economies have fundamental differences.
Like Argentina, Brazil was considered a model of free-market change in Latin America and an I.M.F. favorite in its decade of reforms, opening up to foreign investment and honoring its financial obligations.
But unlike Argentina, which maintained a fixed exchange rate that ultimately forced it to default on its $141 billion debt early this year, Brazil caved in to market pressure and floated its currency in January 1999. That increased its ability to resist market volatility.
Brazil has also preserved a strong industrial base and a robust, domestically owned banking system that serves its huge market of 175 million people. Underlining the differences, Brazilian companies have been among the few active investors in Argentina since its collapse, buying the largest brewery and the main energy company at bargain prices.
"Will Brazil go Argentina's way? The answer is no," said José Barrionuevo, chief Latin American economist at Barclays Capital in New York. "The differences between Brazil and Argentina are striking."
He cited Brazil's flexible exchange rate, the country's commitment to continue reforms during past crises and the sheer size of the Brazilian economy.
"A favorable resolution of Brazil's political uncertainties will lead Brazil to outperform markedly after the election," he said.
Even some of Brazil's top business executives say the opposition candidates do not pose a serious threat to economic modernization. Some say a leftist government under Mr. da Silva might even be more combative at forums like the World Trade Organization, which could help increase Brazil's meager 0.9 percent share of global trade.
"I'm watching with caution, but I believe Brazil is mature enough for a political transition," said Luiz F. Furlan, the chief executive of Sadia, a producer of poultry, pork and processed foods and one of the country's top exporters. "There's no chance of anybody forming a government that is not based on some sort of broader coalition, and that implies negotiation and compromise."
MOST analysts and politicians agree that the serious campaigning starts this month, with the beginning of free political broadcasts on television. As the candidate of the government coalition of two major parties, Mr. Serra is entitled to twice the air time of his competitors and could still recover.
All eyes, meanwhile, are on the programs of Mr. da Silva and Mr. Gomes.
The Workers' Party acknowledges that Mr. Fraga's "golden trinity" low inflation, fiscal responsibility and honoring debts and contracts with foreign investors provides the foundation for growth. But it says those goals are more suitable for rich, industrialized nations and have spawned a ruinous combination of high interest rates, low economic growth and spiraling debt.
Mr. da Silva, who now wears a suit and tie instead of his old favorite checked worker's shirt, has distanced himself from his previous radical rhetoric and pledges to honor Brazil's debt payments.
Mr. Gomes, who has tempered his own political leftist leanings by allying himself with conservatives, talks about "voluntary" debt renegotiation and has publicly spurned putting too high a priority on fighting inflation.
Business executives who attended a recent dinner with Mr. Gomes said they were impressed by his fiery style. Some were worried, however, about his alliances with old-style, oligarchic politicians like António Carlos Magalhães, a former Senate president who resigned last year before he could be impeached on accusations of vote-tampering, and the family of former President José Sarney, as well as about ties to the mercurial Fernando Collor de Mello, the former president who opened Brazil's economy in the early 1990's only to plunge it into chaos when he resigned after charges of corruption.
Alexandre Schwartsman, chief economist at the BBA brokerage firm in São Paulo, said the markets were still holding out for a last-minute comeback by Mr. Serra to overcome the opposition candidates.
"If either of these guys wins, I personally will be taking some of my money out," Mr. Schwartsman said. "Maybe I'm not typical of the Brazilian middle-class saver, but I know I am typical of a good number of financial directors of Brazilian companies."