No Love for Brazil Budget Plan as Stocks, Real Lead World Losses

Brazil's Currency Tumbles on Slashed Surplus Target
Brazil's Currency Tumbles on Slashed Surplus Target
  • Finance Minister Levy reduces goal for primary surplus target
  • Move raises concern nation more likely to see rating cut

Brazil traders see Finance Minister Joaquim Levy’s admission that the government won’t meet its fiscal goals as a bad omen.

The real touched a 12-year low, while the Ibovespa led declines among major equity benchmarks after the government asked lawmakers to approve a reduction in its target for the budget surplus before interest payments. The move sparked speculation that the nation will lose its investment-grade status amid forecasts for the worst recession in a quarter century.

Chart of real over past five years
Chart of real over past five years

“There’s now a higher risk that Brazil will be downgraded by one notch,” Pablo Spyer, a director at Mirae Asset Wealth Management, said by phone from Sao Paulo. His firm oversees 4.5 billion reais ($1.37 billion). “The possibility of the nation losing its investment grade would be awful as a huge amount of money could flee the country at a time when the economic scenario is very discouraging.”

Spending Cut

President Dilma Rousseff has confronted opposition in Congress to her efforts to shrink spending and boost revenue in a bid to stave off another downgrade after Standard & Poor’s cut the country’s rating to the cusp of junk in March 2014. Moody’s Investors Service, which met with officials in Brazil last week, has a negative outlook on the nation’s grade.

The Ibovespa dropped 2.2 percent to 49,806.63 at the close of trading in Sao Paulo, led by banks. The real slid 1.9 percent to 3.2857 per dollar, the most among major currencies.

Levy said he’s targeting a primary surplus target equal to 0.15 percent of gross domestic product, a reduction from his original aim of 1.1 percent. He will freeze an additional 8.6 billion reais in spending to meet the new target.

“The objective is to reduce uncertainty in the economy by announcing the target we consider achievable, adequate, certain,” Levy said in a news conference with Budget and Planning Minister Nelson Barbosa on Wednesday.

Fitch Comments

While the government has made some progress on its agenda related to fiscal measures, the plan to revise the primary surplus target highlights the difficulties Brazil is facing amid a recession, Shelly Shetty, a senior director at Fitch Ratings, said in e-mailed note.

One-month implied volatility on options for the currency, reflecting projected shifts in the exchange rate, rose to 18 percent, the highest since June. In addition to budget turmoil and a slumping economy, the nation is also struggling with above-target inflation, the threat of a Chinese slowdown and an expected boost in U.S. borrowing costs by the Federal Reserve.

Currency Support

Brazil refrained from adding support for the currency Thursday, extending the maturity on 6,000 foreign-exchange swaps, the same amount as Wednesday. The central bank declined to comment on the real’s drop.

A further depreciation of the currency to 3.5 per dollar is needed to make exports more competitive, according to Mark McCormick, a foreign-exchange strategist at Credit Agricole SA. He shares the view of Wall Street firms including Goldman Sachs Group Inc. and Morgan Stanley, which have said that a weaker real would be good for Latin America’s largest economy.

“Brazil has spent the last year with an overvalued real, which has weighed on its competitiveness, and the only way to support growth now is through a weaker currency,” McCormick said from New York.

Brazilian exporters from JBS SA to Vale SA, the world’s largest producers of meat and iron ore, respectively, rallied as the real extended this year’s plunge to 19 percent.

In addition to weakening the currency, the change in the fiscal budget target added to the risk of investing in government bonds. The cost to protect against a default by Brazil climbed to highest level since March. The jump on Thursday was the biggest among 71 countries tracked by Bloomberg after Finland and Cyprus.

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