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S&P Cuts Brazil’s Debt Rating to Junk

PAUL KIERNAN and PAULO TREVISANI

The Wall Street Journal – 09/09/2015

RIO DE JANEIRO – Brazil lost its coveted investment-grade credit standard in the eyes of a major ratings firm on Wednesday, dealing a blow to the government’s credibility with investors and threatening to aggravate the country’s worst economic downturn in 25 years.

Standard & Poor’s Ratings Services downgraded Brazil’s sovereign debt by one notch to BB+, placing it in junk territory for the first time since 2008. Citing political challenges to the Brazilian government’s efforts to balance its budget, S&P also maintained a negative outlook, indicating at least a 1-in-3 chance of further downgrades.

The move came sooner than expected, reflecting the speed with which Brazil’s economic and fiscal conditions have deteriorated in recent weeks. If matched by another credit-ratings firm, the downgrade could trigger an outflow of cash from Brazilian financial markets, as big international pension funds often invest only in assets rated as investment class by at least two of three major firms.

Moody’s Investors Service downgraded Brazil last month to its lowest investment-grade rating but gave it a stable outlook. Fitch Ratings has Brazil two notches into the investment-grade category with a negative outlook.
The downgrade by S&P represents a significant setback for President Dilma Rousseff,who has sacrificed her popularity by pushing an agenda largely aimed at saving Brazil’s hard-won status as a trustworthy debtor. Since winning re-election last year, the left-leaning Ms. Rousseff has disappointed core supporters by raising taxes and cutting discretionary spending during a deep economic downturn. Her approval ratings have plummeted into the single digits.

“It’s a major defeat for the government, a major stigma for the Rousseff administration that puts the government even more on the defensive,” said Thiago de Aragão, an analyst at political consulting firm Arko Advice.

“The government understands that the fiscal effort is essential to balance the economy in a global environment of uncertainty and…to increase productivity and create conditions to resume growth in the wake of [the] commodity boom’s end,” Brazilian Finance Minister Joaquim Levy said in an email.

Analysts questioned whether the downgrade will light a fire under opposition lawmakers who, for most of this year, have sought to undermine Ms. Rousseff’s fiscal efforts. Some said the loss of investment-grade status, won only after years of solid economic growth and responsible fiscal management, could instead give Ms. Rousseff’s opponents more ammunition.

“It attests to the bankruptcy of the current government,” said Brazilian Sen. Ronaldo Caiado, an opposition leader who has called for Ms. Rousseff to be impeached.

S&P’s move also reflects the massive fallout from a corruption investigation surrounding state-run energy firm Petróleo Brasileiro SA. The probe has ensnared scores of businessmen and lawmakers, paralyzing key sectors of the economy and undoing Ms. Rousseff’s governing coalition.

“The continuing investigations of corruption allegations against high-profile individuals and companies—in both the private and public sectors and across political parties—have led to increased near-term political uncertainty,” S&P said in a report Wednesday. “Stressed coalition dynamics…augur poorly for approval of needed fiscal adjustment measures.”

In a surprise to many economists, the downgrade came barely six weeks after S&P revised Brazil’s outlook to negative from stable.

“The downgrade came earlier than I expected,” said Alberto Ramos, an economist at Goldman Sachs. “It reflects the tremendous difficulty Brazil is having to make the fiscal adjustment.”

But the past few weeks have been tumultuous in Brazil. Official data showed the economy contracted sharply in the first half of this year, entering a technical recession that most economists expect to last into 2016. Brazil’s currency has entered a tailspin against the dollar, closing last week at a nearly 13-year low. Signs of friction in Ms. Rousseff’s cabinet—in particular, rumors that her well-respected finance minister was growing weary of his job—made things worse.

“We believe Brazil’s credit profile has weakened further since July 28, when we revised the outlook on Brazil to negative,” S&P said. “We now perceive less conviction within the president’s cabinet on fiscal policy.”
Central to the firm’s rationale is Brazil’s so-called “primary” budget balance, which excludes interest payments on the public debt. To reduce the public debt, economists say, Brazil’s public sector needs to post primary surpluses of about 3% of gross domestic product every year. But the country is running a deficit during the current downturn, and the government submitted a budget proposal on Aug. 31 that forecasts an additional 0.5% deficit in 2016.

S&P highlighted the budget proposal as evidence of mounting political challenges that are “weighing on the government’s ability and willingness” to correct its fiscal situation.