Brazil Widening Budget Gap Increases Credit Downgrade Risk

Brazil’s budget deficit widened more than analysts predicted, adding to speculation its sovereign credit rating will be downgraded. Credit-default swaps rose.

The budget gap in September widened to 22.9 billion reais ($10.2 billion) from 22.3 billion reais a month earlier as the public sector posted the biggest deficit before interest payments in almost five years. The median forecast from four analysts surveyed by Bloomberg was for a gap of 19.3 billion reais.

Credit-default swaps, contracts protecting holders of the nation’s debt against non-payment for five years, increased to the highest level this month as prospects of more government spending next year cause market confidence in Brazil to deteriorate, according to Klaus Spielkamp, a fixed-income trader at Bulltick Securities LLC. Standard & Poor’s and Moody’s Investors Service this year lowered the outlook on Brazil’s credit rating.

“The government is giving the impression to the market that it gave up on reaching its goals,” Spielkamp said by phone. “That gets reflected in confidence levels. Standard & Poor’s is not going to forgive the government for its change in position.”

Brazil’s five-year default swaps increased seven basis points, or 0.07 percentage point, to 173 basis points at 4:05 p.m. local time.

Swap Rates

Swap rates on the contract maturing in January 2017, the most traded in Sao Paulo today, rose 19 basis points to 11.49 percent. The real weakened 2 percent to 2.2345 against the U.S. dollar.

S&P in June placed Brazil’s rating on negative outlook, and Moody’s this month lowered its outlook to stable from positive. Moody’s cited Brazil’s 59 percent government debt-to-gross domestic product ratio, versus a 45 percent median for other nations whose sovereign bonds have the same rating. Both companies highlighted the increase in public lending.

S&P and Moody’s assign Brazil’s sovereign debt the second-lowest investment grade rate, BBB and Baa2, respectively.

“While this number alone may not trigger an action, the recent trajectory has worsened and increased the possibility of a downgrade,” said Carlos Kawall, chief economist at Banco J. Safra.

Worsening Performance

The worsening fiscal performance undermines policy makers’ efforts to rein in inflation, he said. The central bank this year has raised the benchmark interest rate to 9.5 percent from a record low 7.25 percent to slow inflation that twice breeched the upper limit of the 6.5 percent target range.

Consumer prices in the 12 months through mid-October rose

5.75 percent, according to the national statistics agency. The central bank targets annual inflation at 4.5 percent plus or minus two percentage points.

The primary budget balance of the central government, which excludes municipalities, states, and state companies swung to a

10.5 billion-real deficit from a surplus of 87 million reais a month earlier, the National Treasury said in a report distributed in Brasilia this morning.

Finance Minister Guido Mantega today announced plans to extend training for unemployed workers as the government seeks to lower turnover and jobless benefits.

‘Always Seeking’

“We are always seeking measures to reduce costs and improve fiscal results,” Mantega told reporters in Brasilia. “The government is worried about meeting its fiscal goals.”

Payments of one-time social security benefits and part of the 13th salary employees receive at year-end contributed to the deficit, Treasury Secretary Arno Augustin said.

Brazil’s primary surplus as a percentage of gross domestic product in the year through September was 1.6 percent, compared to the official target of about 2.3 percent.

The administration will maintain its central government primary budget surplus target of 73 billion reais for this year, Augustin said. In the 12 months through September, the surplus was 61.4 billion reais.

“The revenue in September was not good but should get better in coming months,” Augustin told reporters in Brasilia. He cited demand of $10 billion for a sovereign bond sale this month as evidence of investor confidence in Brazil’s economy.

(Updates with trader comment in fourth paragraph.)
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