on the government’s ability and willingness to submit a 2016 budget to
Congress consistent with the significant policy correction signaled
during the first part of President Dilma Rousseff’s second term.
The government’s 2016 budget proposal envisions yet another change to the
primary fiscal target less than six weeks after the previous downward
revision, which would mean three consecutive years of a primary deficit
and net general debt continuing to rise if subsequent revenue or
expenditure measures are not taken.
We are lowering the long-term foreign and local currency sovereign
ratings on Brazil to ‘BB+’ and ‘BBB-‘, respectively.
The negative outlook reflects what we believe is a greater than
one–in–three likelihood of a further downgrade due to a further
deterioration of Brazil’s fiscal position, potential key policy reversals
given the fluid political dynamics, including a further lack of cohesion
within the president’s cabinet, or due to greater economic turmoil than
we currently expect.
On Sept. 9, 2015, Standard & Poor’s Ratings Services lowered its long-term
foreign currency sovereign credit rating on the Federative Republic of Brazil
to ‘BB+’ from ‘BBB-‘, and the long-term local currency sovereign credit rating
to ‘BBB-‘ from ‘BBB+’. The outlook is negative. We also lowered the short-term
foreign currency rating to ‘B’ from ‘A-3’ and the short-term local currency
rating to ‘A-3’ from ‘A-2’. We also lowered the transfer and convertibility
assessment to ‘BBB’ from ‘BBB+’. We affirmed the ‘brAAA’ national-scale rating
and revised the outlook on this rating to negative.
We believe Brazil’s credit profile has weakened further since July 28, when we
revised the outlook on Brazil to negative. At that time, we signaled increased
execution risks to the corrective policy changes already underway, mainly
stemming from fluid political dynamics in Congress associated with spillover
effects from investigations of corruption at state-owned energy company
Petrobras. We now perceive less conviction within the president’s cabinet on
Brazil’s 2016 budget proposal tabled on Aug. 31 incorporated yet another
revision to the government’s fiscal targets in a short period of time. The
proposed budget is based on a primary deficit of 0.3% of GDP, rather than the
previously revised 0.7% of GDP surplus target that was announced in July. This
change reflects internal disagreement about the composition and magnitude of
measures needed to redress the slippage in public finances.
Without an unexpected overperformance, the proposed fiscal target in the
budget would yield three consecutive years of primary (non-interest) fiscal
deficits and a continual rise of net general government debt. While the
Ministry of Finance is working on putting forward various measures to regain
the 0.7% of GDP initial surplus target, they will need to be negotiated
piecemeal with Congress. More importantly, the series of events leading to the
budget proposal suggests to us diminished cohesion within President Rousseff’s
cabinet and contributes to our assessment of a weaker credit profile. Given
the magnitude of the challenges on the political, economic, and fiscal fronts
facing Brazil, we had assumed unwavering cabinet support in order to maximize
the executive’s negotiating power with Congress.
We now expect the general government deficit to rise to an average of 8% of
GDP in 2015 and 2016 before declining to 5.9% in 2017, versus 6.1% in 2014.
slow-to-decline) interest burden (given higher interest rates and the impact
of the weaker Brazilian real on outstanding foreign exchange swaps)
contributes to the large deficit. The slightly larger change in general
government debt to GDP vis-à-vis the headline deficit incorporates some
fluctuations in central bank repo operations and an end to off-budget
We expect general government debt, net of liquid assets (not including
international reserves), to rise to 53% of GDP this year and to 59% next year
from 47% in 2014. We also expect interest to revenues to remain above 20% this year and next, from 15% last year, and to moderate slowly given the
depreciation of the Brazilian real and higher interest rates. We assess
contingent liabilities from the financial sector and all Brazilian NFPEs
(nonfinancial public enterprises, including Petrobras) as “limited,” as our
criteria define the term.
Our rating on Brazil reflects our view of its established political
institutions and broad commitment to policies that maintain economic
stability–albeit somewhat weaker than before. We find that the ongoing
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.
These independent investigations and subsequent prosecutions of corrupt practices are a testament to the institutional framework in Brazil, which contrasts with that of other emerging economies. At the same time, they have weakened near-term political cohesion and coalition dynamics. Stressed coalition dynamics between the Workers’ Party and the Brazilian Democratic Movement Party augur poorly for approval of needed fiscal adjustment measures, even with a relaxed fiscal target, in our view. This is against a backdrop of low approval ratings for President Rousseff and her government, which have declined to less than 10%, and the possibility that the president may be impeached (although this outcome is not our base case).
Indeed, we continue to believe that economic weakness exacerbates execution
risk. We now expect the contraction in real GDP to be deeper and longer, with
another revision to our growth outlook. Our projections estimate a contraction
of about 2.5% this year followed by another 0.5% contraction in 2016, before
returning to modest growth in 2017.
With per capita GDP of about US$8,900, Brazil’s growth prospects are, in our
opinion, below that of other countries at a similar stage of development.
Notwithstanding the more recent hesitation on the magnitude of the needed
fiscal adjustment, the government has adopted other policies to lay the
foundation for growth over the medium term. The government is reducing
off-budget spending and removing various economic distortions, including
artificially suppressed administered prices. To contain inflation and
inflation expectations, the central bank embarked on another tightening cycle.
It had also moderated intervention in the foreign exchange market (through
some curtailment of the offer of U.S. dollars via its real-denominated foreign
exchange swap program), facilitating depreciation of the real, though it has
increased intervention recently. The government has also placed renewed
emphasis on private-sector participation in infrastructure projects. We do not
see, however, that these positive steps have turned around business sentiment.
In our observations, policy decisions have damaged business sentiment in
recent years, and the uncertainties and spillover effects associated with the
corruption investigations continue to hold sentiment back. It now appears that
Brazil is further away from a shift to positive growth until some of the
political uncertainties settle.
We expect Brazil’s external vulnerability will rise somewhat over the next
several years. We don’t expect foreign direct investment (FDI) to fully cover
Brazil’s current account deficit at about 4% of GDP in 2015-2017. We expect
narrow net external debt to average of 36% of current account receipts from
2015-2017. Our estimates of external debt are calculated on a residency basis.
They include nonresident holdings of locally issued real-denominated
government debt estimated at about US$153 billion (55% of current account
receipts) in 2014. These holdings have risen in reais terms so far this year
(though were down on a monthly basis in July); however, given currency
depreciation, we expect them to be lower in 2015 and 2016 in U.S. dollar
terms. Our external debt data, however, do not include debt of approximately
30% of current account receipts raised offshore by Petrobras and transferred
in the form of FDI to the head office. That said, despite the wider current
account deficit, Brazil has low external financing needs compared with its
current account receipts and its high level of international reserves compared
with some of its peers.
The local currency rating on Brazil is higher than the foreign currency
rating, reflecting our view of the credibility of its monetary policy, its
floating exchange-rate regime, and the depth of its capital markets. In
accordance with our criteria, we lowered the local currency rating two notches
to narrow the gap between the two ratings because of Brazil’s fiscal
of cohesion within the cabinet. A downgrade could also result from greater
economic turmoil than we currently expect either due to governability issues
or the weakened external environment.
We could revise the outlook to stable if Brazil’s political uncertainties and
conditions for consistent policy execution were to improve across branches of
government to staunch fiscal deterioration and stregthen GDP growth prospects.
We expect that these improvements would support a quicker turnaround and could
help Brazil exit from the current recession, facilitating improved fiscal
performance and providing more room to maneuver in the face of economic