Emerging market debt slides on Brazilian worries; Ecuador down on oil stoppage

By Reshmi Basu and Paul A. Harris

New York, Aug. 19 - Emerging market debt suffered big losses Friday, as a new development in the Brazilian corruption scandal shook investor sentiment.

Late Friday morning, Brazilian local wires reported that finance minister Antonio Palocci allegedly was paid off when he was the mayor of Ribeirao Preto City.

Rogerio Buratti, an aide to Palocci in the 1990s, said Palocci received R$50,000 from local construction companies, according to news reports. Buratti himself is accused of receiving bribes from company that serviced the municipality when he was Palocci's secretary.

Palocci was reported as strongly denying the accusations.

But the claims that Palocci may be involved in the corruption scandal prompted Brazil's financial markets to tank, said sources.

The Bovespa sank by 2.24%. The real jumped to 2.4150 from 2.35. The Brazil bond due 2040 was down 1¾% to 116½ bid.

"There was a rumor in the morning hours that that one of the collaborators of Mr. Palocci, who is in jail, wanted to cooperate with the justice and bring new evidence of wrong-doings," according to a Latin America debt strategist at Refco EM.

"Then the rumor took a different turn," said the Refco strategist.

"This individual was not the one who tried to cooperate with the investigation. It was someone else."

"They just wanted to implicate [Palocci] him in the investigation. If such is the case... he probably has to leave."

The strategist said that locals had told him that there was no evidence that "this was the individual who was going to cooperate. It was someone else."

"On that news, the market bounced back a little bit," remarked the strategist.

"There's still a lot of uncertainty. I can imagine there are a lot of shorts. The market is probably taking some precaution. And the local market, I'm sure there are a lot of players going to short the market just to play a possible implication of the minister," he added.

If the allegations prove true, Palocci will have to step down, said sources. And that would be a major blow to the administration of president Luiz Inácio Lula da Silva. His party has been battling charges of corruption. And the story will not disappear.

Palocci is credited with steering Brazil's economy in the right direction, said sources.

"If he leaves, then he's going to have to be replaced by someone," said the strategist.

From an economic point of view, his replacement will have to share the same vision and same skills to send the market a strong message that the problem is politics and corruption," he said.

"And it doesn't have to do with the improvements in the fundamentals of the country," noted the strategist.

Since the onset of the bribes for vote scandal, locals in the Brazilian markets have made a tradition of selling paper on Friday in order to be insulated from any negative news that may arise over the weekend. There are always rumors that one of the big glossies will feature a breaking story.

"On Friday, the market gets really nervous waiting for the news on Saturday," said the strategist.

Furthermore, the corruption story has many legs, as headlines come and go. One source said that one of the problems stemming from this three-month-old political story is that the media is trying to implicate the highest individual in government because, after all, it is a good story.

If the media can implicate Palocci, it comes one step closer to implicating Lula, but the source noted that they are doing their job.

"It started in the lower ranks and has moved dramatically to the upper ranks," noted the Refco strategist.

"And now we are very close. We are talking about the minister of finance. He's extremely close to Lula."

In June, Lula's chief of staff Jose Dirceu resigned as the first major casualty for the Lula government. He is currently serving as a federal deputy. Four ruling party leaders have also resigned.

Spreads wider

Meanwhile, emerging market spreads overall widened by as much as 10 basis points, according to a trader.

"Colombia is down. Argentina is also down. Mexico is a little lower. Venezuela is lower," remarked the strategist.

Ecuador down on oil production stoppage

Oil exports were stopped Thursday in Ecuador, according to another market source. The government called force majeure (a contractual clause called up in case of events beyond the company's control) because the protests brought state-run Petroecuador's oil production to a halt.

"No oil today [Friday]," said the Refco strategist.

On Thursday, Ecuador declared a state of emergency for the oil provinces of Orellana and Sucumbio in order to allow the armed forced to control the protests.

"The Ecuador defense minister [Solon Espinoza] retook the provinces," noted the strategist. "Then he quit."

"I don't think this is uncommon when a country takes profits due to the good performance of one of the sectors, in this case oil. Then the labor force is trying to obtain benefits from that and the government doesn't want to concede," he commented.

The stoppage slammed Ecuador's debt. Its bond due 2030 was down 2½ points.

Meanwhile, president Alfredo Palacios said that losses could amount to $125 million if production is not resumed in August. That would amount to 0.4% of gross domestic product, according to the second market source. The country would register a $336 million loss if output does not resume until September and $443 million if the delay runs to October.

The source estimated daily losses to be around $18 million in exports and $4 million to $6 million in fiscal revenues.

If the protests do continues, it will be unlikely that Ecuador will be able to tap the capital markets in the coming weeks.

The funds are necessary if Ecuador is to avoid a cash problem in October since some of its domestic debt comes due.

Funds see $109.9 million inflow

Separately, emerging market bond funds saw $109.9 million come into the market for the week ending Aug. 17, according to EmergingPortifolio.com Fund Research. This is the eighth straight week of inflows.

Total inflows to date stand at $4.74 billion.

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