Brazil Suffers First Downgrade in Decade as Deficits Boost Debt

Brazil’s credit rating was cut by Standard & Poor’s, which said sluggish economic growth and President Dilma Rousseff’sexpansionary fiscal policies are fueling an increase in debt levels.

S&P downgraded the country one step yesterday to BBB-, its lowest investment-grade rating, with a stable outlook. The new ranking is in line with Spain and the Philippines, one level below Russia and two levels below Mexico. Brazilian bond yields have have climbed 1.03 percentage points in the past year to 5.13 percent, according to JPMorgan Chase & Co.

The move ends a decade-long stretch of upgrades for Latin America’s biggest economy. The country’s leaders have tried to fuel growth by ramping up public spending at the same time they’ve sought to tame inflation by raising interest rates. The efforts have damaged fiscal accounts and economic policy credibility, S&P said. The rating company expects growth to slow to 1.8 percent this year from 2.3 percent in 2013.

“I hope that it serves as a wake-up call for the government,” Ricardo Lacerda, chief executive officer at BR Partners, a Sao Paulo-based investment bank and former Goldman Sachs executive, said by phone. “To lose the investment-grade status would be catastrophic.”

The presidential press office referred questions to the Finance Ministry.

“The announced change is inconsistent with the solidity and the fundamentals of Brazil,” the Finance Ministry said in an e-mailed statement. “Assumptions regarding trajectory of investments in Brazil aren’t justified.”

Quickening Inflation

Rousseff’s administration has tried to boost growth by increasing state-subsidized lending. The country’s expansionary fiscal policy has helped keep inflation above the midpoint of the central bank’s target range of 2.5 percent to 6.5 percent since August 2010.

Rising prices have prompted policy makers to boost interest rates by 3.5 percentage points since April. They had cut borrowing costs by 5.25 percentage points since August 2011.

Surging consumer prices and demands for better public services triggered nationwide protests last year that brought 1 million demonstrators to the streets of Sao Paulo and Rio de Janeiro. Rousseff is still forecast to garner 43 percent of votes and win October’s presidential election, according to the results of an Ibope opinion poll last week.

‘Fiscal Slippage’

Brazil missed its fiscal target in 2013 as government spending outpaced revenue by the widest year-end amount on record. The budget gap reached 157.6 billion reais ($64.9 billion).

In February the government said it would cut 44 billion reais from this year’s budget, as policy makers seek to rein in inflation and shore up fiscal management.

“The downgrade reflects the combination of fiscal slippage, the prospect that fiscal execution will remain weak amid subdued growth in the coming years, a constrained ability to adjust policy ahead of the October presidential elections and some weakening in Brazil’s external accounts,” S&P said in a report. “These factors underscore the government’s diminished room for maneuver in the face of external shocks.”

In almost half the instances, yields on government bonds fall when a rating action by Moody’s Investors Service and S&P suggests they should climb, according to data compiled by Bloomberg on 314 upgrades, downgrades and outlook changes going back to the 1970s. When S&P downgraded the U.S. government in 2011, bonds rose and pushed Treasury yields to record lows.

Brazil’s investment grade status reflects solid government balances and manageable foreign debt levels, the Finance Ministry said in its statement.

Creates Pressure

S&P last upgraded Brazil in November 2011. The country is rated BBB by Fitch Ratings and an equivalent Baa2 by Moody’s Investors Service, which in October cut its outlook on the rating to stable from positive.

“We must not underestimate the impact that this move will have on the government and the pressure it will create for concrete and material change to fiscal policy after the October election,” Tony Volpon, head of research for the Americas at Nomura Holdings Inc., said in a note to clients yesterday. “The threat of an eventual return to a speculative grade rating will, we believe, work to be a powerful incentive to spur government action.”

To contact the reporter on this story: Boris Korby in New York at bkorby1@bloomberg.net

To contact the editors responsible for this story: Brendan Walsh at bwalsh8@bloomberg.net David Papadopoulos, Lester Pimentel

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