Markets Expect Downgrading of Brazil’s Credit Rating

02/18/2014 – 09H16

Fears that Brazil’s credit rating may be downgraded have begun to affect share prices, the exchange rate with the dollar and interest on Brazilian debt.

This suggests that good news about public debt – such as tighter control over government spending – could be of potential benefit to the country’s finances in the short term.

This week the government is due to announce the value of this year’s budget. Analysts suggest that an economy of more than R$40 billion (USD $16.8 billion) would indicate that the government wants to avoid any increase in public debt and is trying to keep it at a stable level (at around 35% of GDP).

This effort might help to save Brazil’s credit rating from downgrading.

Standard & Poor’s, the largest ratings agency, said last June that it was considering downgrading the country’s rating as a result of increased public spending at a time of slow economic growth. This reduces available revenues and increases government debt.

Brazilian assets have already lost enough value to make downgrading a near certainty, according to the chief economist at the LCA consulting firm, Bráulio Borges. Borges puts at 96% the possibility of a revision of Brazil’s credit rating.

As a result, he says, the real has lost between five and ten per cent of its value against the dollar; the São Paulo stock exchange has fallen by between ten and fifteen per cent, and interest rates of long-term securities have risen by 1.5%, to 7% per annum.

The assessment is made by comparing the country’s risk in relation to others with the same credit rating. This is calculated by means of a credit default swap (CDS), a kind of insurance against default.

Colombia, for example, has the same rating as Brazil (BBB). Like Brazil, it is subject to loss of capital to the United States. However, the Colombian CDS is at 120 points, while Brazil’s is at 186 – 50% more.

Brazil’s score is close to that of Uruguay, on 185 points, which has a credit rating one grade lower according to the ratings agencies (BBB-).

Borges recognizes that this week’s good news regarding the government’s finances has the potential to reverse these trends. “The stock market could increase, the currency could recover its value and interest rates could fall,” he says.

How much this occurs, he says, depends on the government. “It’s no use just to announce cuts in spending. We need to say how exactly it will be done.”

The economist Alessandra Ribeiro, from the consulting firm Tendências, agrees that investors have already taken action and devalued Brazilian assets. In her opinion, reversing these trends will be more difficult.

“There might be a break, in the short term, but the market won’t give carte blanche to the government,” she said. “The tendency is that prices are adjusted as the government announces the successful attainment of its targets.”

For Eduardo Velho, of the brokers INVX, “Even more important than the government’s announcement of spending cuts is that the plan is seen as credible. If not, we will see a movement in the other direction, towards higher interest rates.”

Translated by TOM GATEHOUSE