Publish in Perspectives - Wednesday, November 4, 2015
Many of the citizens who rose into the lower-middle class during the boom years are falling back into poverty as the economy slows and jobs are cut. (Photo: Steve Evans)
Is Brazil about to lose investment-grade status?
BY LATIN AMERICA ADVISOR
Citing a worsening political and economic situation in Brazil, Fitch Ratings on Oct. 15 downgraded its sovereign credit rating for the country to the lowest investment-grade status, maintaining its negative outlook. Moody’s credit rating for Brazil is also one notch away from junk, and Standard & Poor’s in September lowered its rating for Brazil into junk territory. What are the repercussions for Latin America’s largest economy if a second ratings agency slaps a junk status rating on Brazil? What must Brazil’s leaders do in order to prevent that from happening? What is the likelihood that Brazil’s Congress will pass measures that proponents say are needed to get the economy back on track?
Marcos Casarin, senior economist for Latin America at Oxford Economics in London: Even though markets believe that a second ratings downgrade to ‘junk’ status is already priced in, there will always be a ‘surprise factor’ following such an announcement. This is largely because several institutional investors, including pension funds, cannot (by mandate) hold positions in government bonds that are not rated investment grade in at least two out of the three main rating agencies. As such, we expect a sizeable outflow of capital from Brazil when the country is downgraded to junk status again in the next six months. As a result, the Brazilian real would suffer another sharp sell-off, closing 2016 at around 4.60 per dollar (from 3.95 at the time of writing). Market interest rates are also expected to increase, raising the cost of servicing public debt. To us, the task of averting the downgrade is almost an impossible one. Had the government met the fiscal targets set at the start of the year, perhaps the disaster could have been avoided. But it seems that Brazilian authorities and legislators preferred to kick the can down the road as all the measures announced so far look too little, too late. Finally, what Brazil needs to get the economy back on track is structural reforms. Although we see very limited chances of them being approved (some of them are not yet even being discussed in Congress!), such measures should be aimed at changing the rules of readjusting the minimum salary with nominal GDP growth and breaking the link between increases in the minimum salary and social security benefits and pension disbursements. Without those measures Brazil’s public debt will remain in explosive territory, triggering further downgrades, currency depreciation and higher long-term interest rates, ultimately hampering the recovery.
Margaret Daly Hayes, principal at Evidence Based Research Inc. in Vienna, Va., and professor of security studies at Georgetown University: It can’t get much worse for Brazil. Even with two of three credit agencies still holding the country at the cusp of junk, markets are viewing the country’s prospects in the near and medium term with a negative eye. Brazil’s inflation is now the worst it has experienced since the 1930s. Many of the citizens who rose into the lower-middle class during the boom years are falling back into poverty as the economy slows and jobs are cut. A further downgrade would only reinforce the already dim-to-negative outlook. For the most part, investors are waiting and hoping to see the Brazilian political establishment—both the president and the Congress—begin to tackle the country’s problems in a serious and realistic way. Finance Minister Joaquim Levy has said that he is staying, a confidence building measure, but President Rousseff and her party need to take a leadership stance and call firmly for reductions in government spending while, at the same time, explaining to the public why the country is in such a mess and pursing a credible way out of it. Congress, which voted itself a fat pay raise after the last election, can’t be counted on to do what’s needed. Securing necessary votes will require cajoling, arm twisting and a strong message for the voting public. More importantly, Brazil needs to engage in some profound political reforms that include reducing trade restrictions, bureaucratic inefficiencies, and addressing the stalemates that result from the fractured representation of 32 political parties in its Congress. Political reforms may be the most important measures Brazil can take to strengthen its long-term governance capacity and its credibility before the international investor community.
Joel Korn, president of WKI Brasil and senior international partner at UPITE Consulting Services: A second downgrade in Brazil’s credit rating, whether by Fitch or Moody’s, will trigger the loss of investment grade, a hard-earned accomplishment. Even though investors and the financial markets have already factored in the likelihood of such a potential downgrade, the implications will be quite negative for the country. It will prompt the withdrawal of financial investments that are conditioned on investment-grade countries and worsen further the negative perception of the business community toward Brazil. The current difficult political climate has been a constraint for the Congress’ long overdue approval of critical fiscal measures to address the large and growing public-sector deficit. The constant budget reviews, compounded now by the mandatory requirement to include the allegedly illegal financial actions taken by the executive in 2014, as reported by the Federal Accounting Board, have contributed significantly to the imperative need to promote severe fiscal adjustment actions on the revenue and expenditures fronts. Congress will demand sharp reductions in spending in exchange for further tax hikes. Against this background, the outlook for 2016 is one of continued recession, rising unemployment and above-target inflation, albeit at lower level than in 2015. Notwithstanding the difficult negotiations that it will entail between the president and Congress, it is expected that the crucial approval for the minimum fiscal measures imposed by such an economic scenario will be ultimately obtained.