Brazil’s finance ministry and central bank have moved to defend the country’s image in financial markets after ratings agency Standard & Poor’s (S&P) dealt a blow by cutting its sovereign debt rating a day before.

S&P cut Brazil’s ratings to just one notch above “junk” but improved its outlook from “negative” to “stable”. Photo from The Hindu.

Brazil’s rating was knocked down a rung on Monday from BBB to BBB-, meaning the economy is now categorised at the bottom end of “investment grade” and just one notch above “junk” territory.

Brazil’s Ministry of Finance moved quickly to label the adjustment as “contradictory” and “inconsistent with the conditions of the Brazilian economy,” quipping that last year’s GDP performance, indicating growth of 2.3%, was among the best seen in emerging markets.

The lower the rating, the higher the borrowing costs the government will pay on world markets. And ultimately, the sovereign rating trickles through to the interest rate costs that Brazilian corporations will pay to borrow. Higher borrowing costs across the board will slow the economy.

The Central Bank played down the news. “Brazil has responded and will continue to respond […] robustly to the challenges that have been set in the new global framework,” a press statement from the bank said, adding that Brazil was “well positioned” as the global economy normalized.

As the economy enters a period of pre-election uncertainty, the downgrading is the last in a run of bad news for President Dilma Rousseff, who has been grappling with concerns over the energy sector, recent defeats in Congress, and a torrent of criticism over the World Cup and its preparations.

‘Mixed signals, weak outlook’

Justifying the downgrade, S&P said “mixed policy signalling by the government, with negative implications for fiscal account and economic policy credibility” and “a subdued outlook for growth over the next two years” would weigh on “policy flexibility and performance”.

The agency did provide some good news in assigning a “stable” outlook for Latin America’s largest economy, which some interpreted as a signal that the new BBB- rating would stay for now and better Brazil remains investment grade than gets downgraded again.

São Paulo stock exchange, Bovespa: 25 March.

Indeed Brazil’s main São Paulo-based stock exchange, the Bovespa, appeared to shrug off the downgrade, buoyed by the “stable” outlook and probably the fact the previously touted downgrade had finally happened. The benchmark index jumped in early trading and ended the day up 0.39%.

However, there is concern that the downgrading could hamper international investment, particularly if fellow agencies Moody’s Investors Service and Fitch Rating follow suit. As well as higher costs, the lower ratings are indicative of higher risk, meaning the country might have more limited access to credit.

S&P’s Sovereign Ratings Director Sebastian Briozzo told reporters that the government’s policy inflexibility was not the only factor, and confirmed that the current situation with Brazil’s energy sector, which has suffered due to severe droughts, also weighed on the new rating.

Reforms ‘unpalatable’ in election year

Ratings agencies have said they want to see adjustments made to Brazilian fiscal policy, and S&P said it could raise its rating “following more consistent policy initiatives to strengthen the fiscal accounts or outline a more proactive reform agenda” to strengthen growth medium-term.

“Public spending is high, but it needs to be redirected into building Brazil’s productive capacity and ploughed into investments, particularly infrastructure, rather than wages and pensions,” Capital Economics’ emerging markets economist David Rees told the Anadolu Agency.

But diverting money away from wages and pensions and effecting policy reforms would be “politically unpalatable” for a government gearing up for this October’s general elections, in which President Dilma Rousseff will seek a second term at the helm, Rees said.

Economists say fiscal policy changes to shore up the economy by bringing in greater tax revenues will be required once the elections, which Rousseff is expected to win, have come and gone but given Rousseff’s track record on fiscal reforms and dwindling support in Congress, those reforms do not appear likely.

Written for Anadolu Agency