Todd Martinez, co-head of sovereign ratings for Latin America, sees fiscal uncertainty for Brazil in the medium term
02/06/2025
Fitch Ratings deems it unlikely that Brazil will regain its investment-grade status during the current government. Restoring the “good payer” status entails more than just meeting the targets of the current fiscal framework, according to Todd Martinez, co-head of sovereign ratings for Latin America. “It’s not just about having a balanced primary result in a few years, but rather a significant surplus. The current framework demands spending constraints, not cuts,” he told Valor.
The agency upgraded Brazil’s rating to “BB” with a stable outlook in 2023 and reaffirmed this assessment last year. Another review is expected before July.
Mr. Martinez noted that the positive surprises in GDP growth have not benefited Brazil’s fiscal situation as expected. He also emphasized the need to determine whether this stronger growth is a result of government spending or if recent reforms have genuinely made Brazil’s economy more dynamic.
The executive also remarked that U.S. President Donald Trump’s policies and the Federal Reserve’s actions could impact Brazil but the primary risks for the country are domestic. For Mexico, however, a widespread tariff war could be devastating, necessitating close scrutiny of President Claudia Sheinbaum’s microeconomic policies.
Valor: Fitch reaffirmed Brazil’s “BB” rating last year with a stable outlook, citing fiscal issues as a major constraint. Since then, the government has met the 2024 target and approved an adjustment package. How do you assess the situation now?
Todd Martinez: Last year’s fiscal result shows the government not only met the minimum required but exceeded expectations. There was a 0.1% GDP deficit, or 0.4% if we account for spending on Rio Grande do Sul. A year ago, markets didn’t expect the government to meet its 2024 target, and projections for 2025 have improved rather than worsened. The challenge is that, despite being on track to meet targets, the government has not gained market credibility. Last year’s target achievement was largely due to temporary rather than structural measures. The disappointing effect of the 2023 tax measures, which could have provided a structural revenue boost, also played a role. The positive fiscal surprise in 2024 stemmed from extraordinary revenues and the government’s decision to bring forward court-ordered payments of federal debts to 2023. Without these, there wasn’t a significant improvement. We remain concerned about the fiscal situation, as does the local market, due to considerable uncertainty. The government may have reached a fatigue point with Congress after tax reform approval. [Congress] doesn’t seem inclined to approve additional measures to increase structural tax burdens, while significant spending cuts are challenging due to a rigid budget.
Valor: How committed is the government to fiscal consolidation?
Mr. Martinez: We recognize the government’s commitment to fiscal targets. However, the challenge is that the fiscal framework and targets may not be enough to improve market confidence and ease pressure on the Central Bank to maintain high interest rates. The government has room to continue meeting its targets, but unfortunately, this may involve more improvisation, such as advancing dividends or freezing the budget. While these measures help, they are not structural solutions. Therefore, uncertainties about medium-term projections will persist.
Valor: The economy has grown more than expected. Could this help improve fiscal dynamics?
Mr. Martinez: The pace of economic growth is probably the best news for Brazil and was already partially reflected in our 2023 rating upgrade. Many economies surpassed expectations post-pandemic, but Brazil continues to positively surprise years later. However, it is still unclear whether 3% growth is the new normal or simply the result of a fiscal stimulus that will not be sustainable in the medium term. There are strong arguments that recent reforms and the recent tax reform could foster greater investment appetite, boost productivity, and thus support higher growth levels. But only if this strong growth continues without fiscal stimulus will we be convinced that this is the new normal. If the economy is growing more, why isn’t that enough for a higher rating? In many countries, stronger growth would improve fiscal conditions, but that has not been the case in Brazil. Higher growth has helped boost revenue, but much of the government’s spending is mandatory and tied to revenue increases. While economic growth aids revenue, it doesn’t equally improve the fiscal situation. There’s political pressure to spend more, so any positive revenue surprises often lead to higher spending. Additionally, strong growth has required the central bank to keep interest rates high, significantly increasing government interest expenses.
Valor: Do you see a scenario of fiscal dominance?
Mr. Martinez: Today’s Central Bank is very different from a decade ago, which was one of the reasons why we upgraded Brazil’s rating in 2023. The Central Bank has gained substantial credibility and formal autonomy, making it one of the most prudent and proactive globally. However, there are limits to what it can do. Given concerns over fiscal risks, raising interest rates may not be as effective as it would be otherwise. That doesn’t mean Brazil is in an extreme fiscal dominance scenario where rate hikes trigger fears over fiscal sustainability, prompting capital flight and making interest rate increases inflationary rather than deflationary. We still believe that rate hikes, on balance, help anchor confidence.
Valor: How does the relationship between the Executive and Legislative branches affect Brazil’s rating?
Mr. Martinez: One reason we upgraded the rating in 2023 is that, despite challenges and political tensions, we saw dramatic improvements compared to a decade ago. Challenges remain, but what’s positively surprising is that despite sometimes tense relations, Brazil manages to pass certain measures and has enacted significant reforms. That isn’t the reality in other Latin American countries. The fragmented Congress requires many negotiations to pass legislation, often leading to delays and dilution, yet Brazil ultimately approves measures. In the fiscal realm, the challenging relationship with Congress complicates the government’s fiscal consolidation agenda, primarily consisting of increasing revenue. Promoting spending cuts is difficult.
Valor: Do you believe Brazil can regain investment-grade status during the current administration?
Mr. Martinez: It’s difficult to foresee the positive fiscal shock needed to regain investment-grade status in the current government’s final two years. Improving public finances and market confidence would require more than budget freezes and minor measures, which are typically temporary. Significant improvement in revenue and changes in the structure of mandatory spending rules to reduce medium-term spending pressure would be necessary. This would require constitutional changes and a supermajority in Congress, which are unlikely decisions before an election. However, after the election, regaining investment-grade status is not unattainable. It would require more than just meeting the fiscal framework—a significant surplus, not just a balanced primary result, would be necessary. The current framework demands spending constraints, not cuts, and depends on revenue improvements that we do not expect to materialize.
Valor: How might U.S. President Donald Trump’s policies and their consequences for the Federal Reserve affect Brazil?
Mr. Martinez: We’re closely monitoring the U.S. now, as they pose a significant risk to the global economy, especially Latin America. Potential risk channels include tariffs, interest rates, immigration, and relations with China. Many of these aren’t as relevant to Brazil as they are to Mexico, for instance. Fed is the most relevant. Trump’s policies are inflationary, as higher tariffs can pressure U.S. prices, alongside fiscal expansion. Additionally, a larger fiscal deficit means a greater supply of Treasuries later on, which pressures the long end of the U.S. yield curve. All of that matters for Brazil. Nonetheless, local monetary policy depends more on domestic factors and confidence in fiscal developments.
Valor: Mexico is more vulnerable to the U.S. scenario. What should we expect from the Sheinbaum administration?
Mr. Martinez: Comparing Mexico with Brazil is interesting because they share similar strengths and weaknesses. Mexico’s debt is lower but its fiscal situation has deteriorated recently. However, like Brazil, external finances are a source of strength. Mexico’s central bank is also strong and credible. The difference is that despite having a left-wing government, they seem to have internalized that being too fiscally expansive could have market confidence repercussions. The major concern is with microeconomic policies. We saw the previous government make changes in the energy sector and intervene in airport construction, affecting economic dynamics. The question is whether President Claudia Sheinbaum will adopt a more pragmatic stance, allowing the country to leverage nearshoring. Recently, we saw judicial reform approval, and the country will now elect judges, a source of uncertainty for the business community. Overall, our main concern is the relationship with the U.S. The baseline scenario is that Mexico could remain a strong U.S. ally. The most likely outcome is sector-specific rather than universal tariffs. If that’s the case, it could negatively impact growth in the coming years, affecting the fiscal situation and the government’s ability to reduce its deficit. It would be a very negative scenario that could affect Mexico’s investment-grade status. As Brazil’s example shows, losing investment-grade status isn’t difficult if many things go wrong simultaneously, and regaining it is challenging.
Valor: What is your view on Argentina?
Mr. Martinez: We became more optimistic about Argentina towards the end of 2024. We raised Argentina’s rating from “CC” to “CCC,” which is still very low but reflects our view that the country is unlikely to restructure its debt. That is a risk, although not the most likely one. The government embarked on an aggressive fiscal adjustment and devalued the currency, and it wasn’t clear if these measures were sustainable. However, they managed to maintain the adjustment without a significant drop in popularity, so Milei’s political position remains strong. The exchange rate policy is concerning. The two anchors of the economic program are fiscal surplus and currency crawling peg [gradual adjustments], as inflation is so high that within a year, Argentina went from a cheap to an expensive country. It’s a risk since whenever Argentina has relied on currency appreciation as a political anchor, it hasn’t ended well. We don’t see the current policy leading to a reserve accumulation, which Argentina needs to stabilize the economy and repay its debts. Nonetheless, the government has done an excellent job of boosting confidence. Therefore, we believe Argentina can get through the year without major changes to its exchange rate policy and reach elections. However, it’s unclear how sustainable it is in the medium term.
*By Álvaro Campos — São Paulo
Source: Valor International