Brazil’s S&P rating: A negative outlook means the clock has started to tick

Today S&P put the Brazil sovereign rating (BBB-) outlook to negative, citing a one-year time horizon in order to re-assess the fundamentals of the economy as well as the fiscal indicators. Among the factors that drove the downgrade are (i) the economic growth recession, which is proving to be longer and deeper than previously anticipated, and (ii) the political situation that increases the odds of seeing a reversion of the various policy corrections that are underway by the new economic team. Finally, the agency also sees the external fundamentals of Brazil deteriorating to some extent. This event, in the short term, increases the risks that other rating agencies not only downgrade the sovereign rating during the next few months, but also keep the negative outlook.

Based solely on the economic outlook, it will be very hard to avoid a downgrade one year from now. Given the change in incentives for the Congress from last week's event, the fiscal accounts should lead to higher debt levels, and there are risks of a wider recession this year coupled with possible negative growth next year, as sentiment continues only to fall. 

All together, a still-deteriorated fiscal and growth situation (which are quite linked) will make it very hard to build a case to keep the investment-grade rating one year from now. The external fundamentals of Brazil are not weak, and could serve as a counterpoint, especially if the international reserves are kept at relatively high levels and the capacity to pay external debt is not changed.

In the medium term, only a change in the relationship between the government and the Congress could help avoid an extreme event. There are a couple of ways that this could be achieved, such as members of Congress being sensitive to the more imminent than ever threat of losing the investment-grade rating, although the odds are low given the lack of popularity of the president. 

Another way is if the speakers of the House of Representatives or the Senate are forced to step down from their position due to involvement in the corruption investigations held by the Prosecution Service of the Union. The two speakers define the agenda of Congress and have been very vocal in their opposition of the fiscal measures that the government proposed, and any replacement of them could represent a window of opportunity for the government to improve its relationship with the Congress and increase the likelihood of seeing changes in the fiscal path that is currently outlined.