Brazil election tension rises as Fitch sounds warning

Brazil election tension rises as Fitch sounds warning


A failure by the Brazilian government to keep fiscal dynamics under control after the October election could prompt a downgrade from Fitch Ratings, the agency cautioned on Thursday.

While defending Fitch’s BBB rating and stable outlook on Brazil, future tightening of fiscal policy was “a necessary pill”, said Shelly Shetty, the agency’s head of Latin American sovereigns. The agency would look at whether the government “stays the course” of rebalancing its fiscal account, taming inflation, attracting private investment in infrastructure — and resisting “raiding” the public-sector banks.

The warning from the rating agency came as anxiety builds among Brazil investors about the potential for market volatility to accompany the election.

Still, Brazil enjoyed political stability and an understanding among policymakers of the importance of macro-economic stability, said Shetty. But the agency would monitor events after the elections, she said, looking for greater fiscal conservatism including public sector bank lending — which she said would “dictate our judgments” on the country’s debt trajectory.

Brazil’s sovereign rating has been in particular focus since Standard & Poor’s downgraded the country to BBB- in late March. But there was no “explosive situation” in Brazil’s government debt, Shetty said.

“In some ways, Brazil comes out as one of the strongest in the Fragile Five,” she said, referring to Morgan Stanley’s label for the five emerging markets it sees as particularly vulnerable to tighter US rate. “We don’t think Brazil is necessarily underperforming other key emerging markets.”

Fitch took note of Brazil’s growing macro-economic problems and more troublesome inflation outlook “a couple of years ago”, said Shetty. This had stopped the agency becoming too optimistic on the sovereign when Brazil’s weaknesses were less widely acknowledged than they are today, she said.

Slowing economic growth and rising inflation were important factors in the agency’s consideration of risks in Brazil, according to Shetty. The agency was also monitoring the deterioration in the state’s primary surplus to 1.9% of GDP last year, and its debt-to-GDP level of 58% — much higher than the 40% median for triple-B sovereigns.

Nevertheless, she noted “policy corrections in the last few months” including higher benchmark rates, more flexibility on the exchange rate, government policies to attract more private investment in infrastructure, and “signals that the government would prevent future fiscal deterioration”.

She also referred to the country’s large central bank reserves, making Brazil “one of the strongest creditors in the BBB category” despite its weak economic growth and high government indebtedness.

Brazil’s downgrade by S&P has not hindered its access to bond markets. It sold a bond in euros just days after the rating cut, part of a renewed effort by the sovereign to deepen its engagement with European investors, the country’s head of debt management, Paulo Valle, told LatinFinance. LF

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