Brazil's Fall From Darling to Doldrums Cemented by Junk Status

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  • Second sub-investment-grade rating likely to spur outflows
  • Brazil is now the world's largest junk-rated sovereign

Brazil’s breathtaking fall from investor favorite to emerging-market pariah shows no signs of slowing.

On Wednesday, Latin America’s largest economy lost its investment-grade status when Fitch Ratings became the second of the three main debt-ratings firms to cut Brazil to junk. And a third downgrade, this time by Moody’s Investors Service, can’t be far behind as fiscal accounts deteriorate and a political stalemate persists, according to Torino Capital LLC’s Jorge Piedrahita.

Instead of rising star, Brazil now has a new title: world’s largest junk-rated sovereign borrower. It’s a stunning reversal from its heyday in the late 2000s when the country, riding the commodities boom, shrugged off the financial crisis that rocked the developed world and won its first investment grade.

In 2009, the real was the world’s best-performing major currency and the Ibovespa’s 145 percent gain in dollar terms topped every other major stock market globally. This year, the real is posting the second-biggest drop and the benchmark index is down 38 percent.

“Investors turned a blind eye to the imbalances building up” during the boom years, said Piedrahita, the chief executive officer at Torino, which trades more than $1 billion per month in emerging-market debt. “This sets a very bad tone for next year. Politics is taking the country hostage.”

For many investors, it’s hard to imagine how things could have been any worse this year. Not only has a sweeping corruption scandal helped tip the country into a recession and led to a surge in bankruptcies and joblessness, but lawmakers are locked in a fight for survival that’s preventing them from focusing on getting the economy back on track.

Impeachment proceedings have begun to oust President Dilma Rousseff, and both heads of the Senate and lower house have been accused of graft.

“The rationale for the downgrade is a statement of the blindingly obvious: The dramatic deterioration in the political environment is exacerbating the economic downturn and severely undermining the prospects for reform,” said Nicholas Spiro, a London-based managing director at Spiro Sovereign Strategy. “The political, economic and financial problems are all feeding on each other.”

Brazil’s junk status may spur investors to sell $1.6 billion of the nation’s bonds, Barclays PLC economist Bruno Rovai said in an e-mailed note Wednesday.

Here’s a snapshot of how far Brazil has fallen since winning investment-grade status from Standard & Poor’s, Fitch and Moody’s in 2008 and 2009:

1. Brazil’s real has tumbled 60 percent since it’s 2011 high of 1.54 per dollar. Meanwhile, the cost of insuring Brazilian debt in the credit-default swaps market quadrupled. The real fell 0.7 percent Thursday to 3.9113 per dollar as of 2:32 p.m. in Sao Paulo.

2. As Brazil’s finances deteriorate, inflation has skyrocketed. The budget deficit has exploded to 9.5 percent of GDP in the 12 months through October 2015, compared with 1.3 percent in the year ending October 2008. Consumer prices increased 10.5 percent at the end of November, more than twice the mid-point of the central bank’s target range and the highest rate since September 2003.

3. Consumer and industrial confidence have fallen to record lows as the economy is forecast to contract 3 percent this year and 1.3 percent in 2016.