Change comes just over two weeks after Brazil reduced the fiscal target for 2025

05/02/2024

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Dario Durigan — Foto: Marcelo Camargo/Agência Brasil

Moody’s raised on Wednesday (1) Brazil’s Ba2 credit rating outlook to positive, from stable, indicating an improved chance of upgrading the country’s rating in the future. The agency cited positive GDP growth prospects and continued, albeit gradual, progress toward fiscal consolidation. The change comes just over two weeks after the country reduced the fiscal target for 2025 and 2026, which caused market stress and losses for domestic assets.

Last year, the other two main rating agencies—S&P and Fitch—upgraded the country’s rating. However, in the three agencies’ reading, Brazil remains below the best-rated countries, those with an investment grade. Despite the improved outlook, Moody’s cited negative aspects of the Brazilian economy, such as a high public indebtedness.

In the assessment released on Wednesday (1), Moody’s affirmed that GDP growth prospects are “more robust than in the pre-pandemic years, supported by the implementation of structural reforms over multiple administrations, as well as the presence of institutional guardrails that reduce uncertainty around future policy direction.”

The agency expects real GDP growth of around 2% in 2024 and 2025, on average. Over the medium term, the expectation is well above the annual average rate of a 0.5% contraction seen from 2015 to 2019.

“In the next few years, Moody’s anticipates growth will be broad-based extending to both the industry and the services sectors with domestic demand propelled by a strong labor market and higher real wages,” the agency wrote, also citing the government’s energy transition agenda.

The report also highlighted improvements in the monetary policy framework, strengthening of the Central Bank’s independence, improvements in the governance of state-owned companies, and measures to boost the business environment.

“The upcoming overhaul of the tax regime, while taking effect over a long period, also marks a notable structural reform,” the report says.

As for the fiscal scenario, the agency says the framework introduced last year is expected to result in gradual consolidation of public accounts. “Moody’s expects Brazil’s primary and overall fiscal deficits will narrow in 2024-2025 supported by revenue measures,” the agency said, projecting stabilization of government debt in a few years unless there is some type of shock in the economy. However, Moody’s points out that risks to fiscal consolidation efforts remain due to the government’s reliance on fiscal revenue growth and restricted ability to cut spending.

The maintenance of the Ba2 rating reflects “still relatively weak fiscal strength, given Brazil’s spending rigidity, high debt burden, and weak debt affordability.” The rating also takes into account Brazil’s sovereign credit strengths, which include a large and diversified economy, moderately strong institutions and governance, and a solid external position.

Among the factors that could lead to an upgrade in the rating, Moody’s cited an improvement in the primary result and fiscal deficits, which would enhance fiscal policy credibility, as well as continued solid GDP growth. Negative risks would be a weakening of the commitment to fiscal consolidation and, as a consequence, negative credit pressure. “Persistently low GDP growth would represent a credit-negative development that would adversely affect Brazil’s credit profile,” the report says.

Although the review of Brazil’s rating outlook by Moody’s is considered positive by the market, agents pointed out that the timing was unexpected, especially given the signals that the government has been sending in the fiscal area.

For Carlos Kawall, former Treasury Secretary and a partner at Oriz Partners, the government’s attempts to weaken the fiscal framework and structural reforms of recent years go in the opposite direction of the points cited by Moody’s.

“In recent months, the government has been taking steps towards weakening the framework, questioning the Central Bank’s autonomy and privatizations, and seeking to change the labor reform, while the improvement in the outlook is linked to these reforms,” he argues. “The intentions expressed to go backward in these reforms are in the opposite direction to the improvement in the outlook,” he points out.

Mr. Kawall argues that the government should not consider the outlook change as an endorsement of recent measures. “That would be an opportunistic reading. The change in the outlook is positive but it was made looking back, seeing reforms that ensure greater potential growth,” he said.

Alberto Ramos, head of Latin America economics research at Goldman Sachs, sees the new bias in the current rating as positive. “However, the timing was unexpected, following the market stress around the change in the trajectory of the government’s primary results,” he said. “Fiscal concerns have grown, not diminished. And a lot remains to be defined regarding reforms, including tax overhaul.”

In the opinion of Marcelo Fonseca, chief economist at Reag Investimentos, the change was “inappropriate” as it did not consider, for example, the shift in fiscal target announced last month. “It seems like we are talking about two different countries,” he said.

According to him, “the shift to a more flexible fiscal regime, as was the approved framework, does not place the country on a level of stability.” Furthermore, “fiscal targets are also very difficult to achieve.”

“Even from a political point of view, the government has struggled to defend its agendas in the Parliament, which will impact the primary result,” he said.

According to Mr. Fonseca, the change is not expected to have major impacts on asset prices. Combined with the fact that it does not change Brazil’s “speculative” grade, “investors know what the real risks of investing in Brazil are.”

The improvement in Brazil’s rating outlook was welcomed by the government. To Valor, Dario Durigan, executive secretary of the Ministry of Finance, said the review reinforces that the federal government’s economic agenda is “on the right track.” As examples of the strengths of the Brazilian economy, he mentioned “growing GDP, falling unemployment, increasing household income, strong external accounts, low inflation, and recovering fiscal [situation].” Mr. Durigan also emphasized the implementation of “important reforms” to increase the “productivity of the economy in the medium and long terms,” including tax overhaul.

Another source from the government’s economic team adopted a similar speech but acknowledged that the warnings made by Moody’s reinforce “the importance of not slacking off and remaining firm” in pursuing the balance of public accounts. For this source, the game “is not over”, and society “needs to continue supporting our agenda for the sake of the country.”

Government officials also used their social media accounts to comment on the change and highlight the roles of the Legislative and Judiciary branches. Finance Minister Fernando Haddad said the review “has to do with the joint work of the three branches of government, which placed the country’s interests above surmountable differences.” Minister of Planning and Budget Simone Tebet said there is a joining of “efforts by the government, Parliament, and the Judiciary to overcome budgetary challenges and boost our economy.” President Lula said Brazil “is once again respected worldwide” and “has credibility.”

*Por Augusto Decker, Estevão Taiar, Caetano Tonet, Gabriela Pereira — São Paulo and Brasília

Source: Valor International

https://valorinternational.globo.com/