Moody's: Brazil sovereign ratings reflect adverse fiscal conditions

Moody's Investors Service has published its annual credit analysis report for Brazil to reflect the factors that led the rating agency to downgrade Brazil's issuer and government bond ratings to Baa3 from Baa2 on August 11, 2015, as well as change its outlook to stable from negative.

The new credit analysis incorporates Moody's view that Brazil's key credit metrics will deteriorate materially in 2015 and 2016, despite the government's fiscal consolidation efforts.

"We expect that government expenditures will continue to increase despite efforts to tighten fiscal and monetary policy and cut discretionary spending," says Mauro Leos, a Moody's Vice President and Senior Credit Officer. "As a result, primary surpluses will not be large enough to arrest and reverse the country's rising debt."

Moody's also notes that these trends have led Brazil's government debt burdens to worsen materially compared with its Baa-rated peers, which the rating agency expects will continue through 2016-17.

Political instability also weighs on Brazil, with President Dilma Rousseff's approval ratings at record lows, and the lack of political consensus between the executive branch and congress challenging efforts to reduce the mandatory spending increases in place, which will be necessary to improve the country's fiscal position.

Events related to the Petrobras scandal and the continuing Lava Jato corruption investigation are negatively affecting economic activity, with widespread economic repercussions. As the largest company in Brazil, Petrobras' decision to significantly cut capital spending over the next four years will severely curtail growth in multiple sectors. The construction sector in particular continues to be hard-hit by the corruption investigation.

However, Moody's believes that Brazil merits an investment-grade rating given ample international reserve buffers that give the sovereign a strong ability to withstand external financial shocks, a government balance sheet with relatively limited exposure to foreign currency debt and non-resident debt holdings compared to peers, and the underlying credit benefits derived from Brazil's large and diversified economy.