Brazil: Moody's rating downgrade provided with some breathing space

Moody's downgraded Brazil's sovereign rating to Baa3, from Baa2, and changed the outlook to stable. The downgrade was broadly expected to take place this month, almost a year after the change in outlook last September and following a recent field trip from the agency's analysts team. However, the change in outlook to stable surprised the markets, to some extent, as S&P's recent change in outlook to negative increased the risks of other agencies to not only downgrade but also follow suit on the negative outlook.

The conditions to avoid another downgrade will not likely be met, increasing the likelihood of a change in outlook in Q1 16. In a nutshell, Moody's expects real GDP growth of c.2%, coupled with a primary surplus of 2% of GDP, to stabilize debt in 2017-18 to avoid another downgrade. As of now, the government targets a 1.3% primary surplus for 2017. It is very likely that by Q1 16 at the latest, the agency will change the outlook to negative, as these numbers for growth and the fiscal balance are not expected to be achieved.

The consequent downgrade could come in early Q1 17, unless there is a meaningful change in the political coordination between the government and Congress. The current political crisis is affecting the economic environment and postponing important adjustments that could structurally change how fiscal expenditures grow in Brazil and avoid a deterioration path of the gross debt. 

"We do not see conditions being met for an improvement in the relationship between the executive and legislative branches, and the president's lack of popularity and the Car Wash operation only hamper this possibility," notes Barclays

Ultimately, the risk of Brazil losing the IG status by at least two rating agencies now looks farther away than two weeks ago. If today's downgrade is followed by a negative outlook, it would mean that one year from now, in Q3 16, S&P and Moody's would likely be on the verge of downgrading the Brazilian rating by another notch. Moody's stable outlook gives at least a further 18 months for the agency to downgrade Brazil's rating again - likely six months to change the outlook and another 12 months to materialize the downgrade - unless an extreme scenario materializes, on the political and economic fronts, such as an approval of measures that increases medium-term fiscal accounts' sustainability or heightened political turmoil.