Moody’s yesterday placed Brazil’s Baa3 sovereign rating on review for downgrade to ‘junk’ citing, “Fiscal and economic activity indicators continue to sharply deteriorate with no clear sign of when they will bottom out”. Although the market was expecting the rating agencies to react to the country’s economic and political meltdown, the pace at which the agencies have reacted has taken the market by surprise. In our proprietary analysis of countries, Brazil was highlighted as a basket case way before any downgrades had occurred; in fact regular readers would have seen the daily on 9th September highlighting the risks of a downgrade, and within hours S&P announced their one notch downgrade to sub-investment BB+ rating. Fitch’s move to cut to one notch above junk, BBB-, (also on negative watch) soon followed in October.
There have also been a record number of downgrades to companies headquartered in Brazil this year, and in the latest setback, Moody’s also cut its rating for the country’s multinational energy corporation, Petrobras, by one notch to Ba3 and placed this on negative watch for a further downgrade. Earlier this month, Fitch stated that more than half of Brazilian companies are on negative watch, and to make matters worse, the ratings agency estimates that it may slash the ratings of as many as 10 companies for every 1 it upgrades next year.
Such companies have reportedly accounted for ~73% of defaults just this year as the Petrobras corruption scandal probe ensues and consumes all in its wake. In fact just last week, President Dilma Rousseff was facing impeachment proceedings. Moody’s concerns were visible in their statement, which emphasised the uncertainties surrounding the government budget, “The initiation of impeachment proceedings against the President in early December casts further doubt on the prospect of cooperation between Congress and the President to approve meaningful fiscal consolidation measures in 2016, and leaves very little chance of tackling the worsening medium-term fiscal trends”.
As the world's seventh-largest economy suffers from a deepening recession, rising unemployment, burgeoning budget deficit and worsening government control and accountability, Moody’s echoes our sentiment that there is a “diminished likelihood of trend reversal in the next 2-3 years.” Although Brazil has always been part of our bond universe as it has a ‘3-star’ rating (trending toward 2-star), we have never held any Brazilian debt, whether sovereign or corporate as our fundamental analysis of Brazil alongside our macro views have made us reluctant to add exposure to the country, despite the offering of high yields of ~6.5% on the benchmark ten-year.