• Ratings company cuts Brazil's grade by two steps to Ba2
  • Credit metrics have deteriorated `materially,' Moody's says

Brazil’s sovereign rating was cut to junk by Moody’s Investors Service, the last of the major ratings companies to strip the country of its investment grade, as President Dilma Rousseff struggles to shore up fiscal accounts amid deepening political turmoil.

The country’s benchmark stock gauge declined after the rating was reduced two steps to Ba2, putting the Moody’s grade in line with Standard & Poor’s and one level below Fitch Ratings. The outlook is negative, meaning more downgrades may be coming, Moody’s said in a statement Wednesday.

Brazil’s credit metrics have deteriorated "materially" in the past few months and will worsen over the next three years, according to the ratings company, which also cited a jump in the government’s leverage ratios and the increasingly high cost of servicing its debt. The cut -- Brazil’s third in as many months from major ratings companies -- adds pressure on Rousseff to win lawmakers’ support for measures to raise taxes and reduce spending as she fights off efforts to impeach her.

"Even though it wasn’t a surprise, it still sends a negative signal to investors," said Arnaud Masset, an analyst at Swissquote Bank SA in Gland, Switzerland. "Unfortunately, Brazil’s outlook remains very cloudy as the market expects more from lawmakers than minor reforms."

Moody’s later cut its rating on state-controlled Petroleo Brasileiro SA by three levels to B3, six levels below investment grade, saying it now thinks government support is only moderately likely. It had previously assigned a high likelihood to state support.

“Moody’s believes that the government’s current fiscal situation could prevent it from supporting Petrobras sufficiently to avoid a default,” it said in a statement on Wednesday.

Brazil’s gross debt as a percentage of its economy -- a measure of its indebtedness -- has jumped by almost a third in the past two years to 66 percent. It will continue to increase through 2018 and likely exceed 80 percent of gross domestic product, Moody’s said in its report.

That becomes more and more problematic as local interest rates stay high, according to the ratings company. Brazil’s benchmark local bonds due in 2025 yield 15.7 percent after reaching 16.7 percent last month, the steepest in at least nine years.

High borrowing costs “will contribute to low debt affordability, with interest payments accounting for more than 20 percent of government revenues,” Moody’s said.

The government remains committed to undertaking a fiscal adjustment that would stabilize public debt and bolster the outlook for Brazil’s economic recovery in the medium term, the Finance Ministry said in a statement after the downgrade.

The Ibovespa stock gauge dropped 1 percent Wednesday as state-controlled companies including Petrobras and Banco do Brasil SA declined. The real was little changed, leaving its decline over the past year at 29 percent, the most among the world’s 16 most-traded currencies. Emerging markets fell globally on Wednesday.

Economists are forecasting that Brazil is in the midst of its worst recession in a century as a rout in commodity prices and a slowdown in China damp revenue from exports including soy and iron ore. At the same time, annual inflation is running at the fastest pace in more than 12 years, curtailing central bank policy makers’ ability to lower interest rates in an effort to stoke economic growth.

On Tuesday, Congress approved a watered-down version of a bill to increase taxes on capital gains, a measure that was part of the government strategy to boost revenue and narrow a record budget deficit. Rousseff’s administration said last week it would ask Congress to lower the government’s fiscal target for this year to a deficit before interest payments rather than surplus, as the economic downturn crimps tax collection efforts.

Lawmakers moved last year to begin impeachment proceedings against the president for allegedly using irregular accounting measures to hide a fiscal deficit. While her approval rating has recovered from the record lows reached in October, climbing to 22 percent in a poll released Wednesday, the political turmoil has distracted from efforts to bolster the country’s economy and shore up its deficit.

"Macroeconomic and fiscal developments over the next two to three years are expected to produce a materially weaker credit profile," Moody’s said. "The negative outlook contemplates the risks of further deterioration to Brazil’s credit profile emanating from macroeconomic shocks, deeper political dysfunction or the need to support government-related entities."

The government now estimates gross domestic product will shrink 2.9 percent this year, rather than the 1.9 percent decline forecast in November, Budget Minister Valdir Simao said Friday. The economy contracted 4.1 percent in 2015, according to the central bank’s economic-activity index, which is a proxy for GDP.

S&P cut the country below investment grade in September -- and downgraded it again this month -- while Fitch lowered the nation’s debt in December. All three have a negative outlook on Brazil.

Moody’s expects the economy will shrink at an average rate of 0.5 percent a year between 2016 and 2018.

"Addressing Brazil’s fiscal challenges will require significant political will and consensus,” Moody’s said. "While discussion of structural reforms is a positive development, their approval by Congress will be difficult."

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