The Daily Update - Brazil

Brazil looks to be in the midst of a perfect storm. On our 2011 net foreign asset estimates, Brazil at 47 percent net foreign liabilities (NFL) as a percentage of GDP was within our cut off of less than 50 percent NFL; IMF research indicates levels above this threshold are associated with increasing risk of external crises. But we have avoided Brazil due to its deteriorating economic fundamentals. In the past seven trading days the yield on the USD 4.25% January 2025 Brazilian sovereign debt has backed up 44 basis points to 5.57% suggesting the market is rapidly losing confidence and last week Brazil cancelled a local government debt auction citing poor market conditions.

Reasons for the loss of confidence include; First, the President Dilma Rousseff’s popularity has reached an all-time low; corruption investigations into the misuse of funds from Petrobras, the state-controlled oil company, have continued to spread and escalate through the senate and lower house leading to public demonstrations calling for her impeachment. Second, the Brazilian economy has been in recession falling 1.9% in Q2 after shrinking 0.7% in Q1. Plus, the Brazilian real has plummeted and inflation has remained stubbornly high. Third, Brazil’s current budget deficit including interest payments is ~8.8 percent of GDP and on August 31 the 2016 draft budget projected primary deficit of 0.5% of GDP, the first deficit since the Fiscal Responsibility Law was enacted in 2001, and well down from the 2% surplus target at the start of the year. Admittedly, scope for manoeuvre is limited with 90% of spending predetermined, but there is now the concern whether the Finance Minister, Joaquim Levy will remain in office. Earlier in the year Joaquim Levy’s appointment had instilled confidence, particularly for the rating agencies, that a more prudent and appropriate economic policy with fiscal reform would be undertaken but he has struggled to get reforms implemented; the budget forecasts have been downgraded twice in the past couple of months. The targets for 2017 and out to 2019 also look optimistic to say the least. Dilma Rousseff lacks support to pass measures to address the fiscal problem and Joaquim Levy is now looking increasingly isolated.

Brazil’s sovereign rating is still investment grade but this is looking increasingly under pressure. On July 28, S&P downgraded the outlook on Brazil to negative but maintained its BBB- long term foreign currency rating reflecting “challenging economic and political circumstances” citing negatives such as the corruption scandal and increased risks to effective policy implementation. S&P stated that they could lower the ratings if “there were further deterioration in Brazil's external and fiscal indicators resulting from what we might view as a backtracking by Brazil from its commitment to its stated policies.” They go on to state “Over the coming year, failure to advance with (on- and off-budget) fiscal and other policy adjustments could result in a greater-than-expected erosion of Brazil's financial profile and further erosion of confidence and growth prospects, which could lead to a downgrade.” This now seems precisely the path that Brazil is taking and general government gross debt to GDP looks likely to exceed 70% in 2016.

Moody’s also downgraded its rating of Brazil on August 11 to Baa3 with a stable outlook citing weaker than expected economic performance, a lack of fiscal reform and deterioration in debt affordability as the debt to GDP ratio continues to rise. Moody’s state “The rating could come under additional pressure if government debt metrics were to deteriorate further and faster than we expect, and if we were to conclude that Brazil was unlikely to achieve the growth and fiscal consolidation needed to ensure fiscal sustainability over the medium term. In our view, Brazil needs to achieve GDP growth and primary surpluses of at least 2% of GDP during the second part of this administration to arrest the rise in debt and provide assurance of fiscal sustainability beyond the span of this administration.“

While a combination of high level of international reserves, and foreign direct investment flows which offset to a large extent the current account deficit of ~4% of GDP, reduce Brazil’s external vulnerability, the absence of more effective policy and macroeconomic management over the next 12-18 months will put its sovereign rating at risk of being downgraded to junk. 

Please read this important information before proceeding. It contains legal and regulatory notices relevant to the information on this site.

This website provides information about Stratton Street Capital LLP ("Stratton Street"). Stratton Street is authorised and regulated by the UK's Financial Conduct Authority. The content of this website has been prepared by Stratton Street from its records and is believed to be accurate but we do not accept any liability or responsibility in respect of the information of any views expressed herein. The information, material and content provided in the pages of this website may be changed at any time by us. Information on this website may be out of date and may not be updated or removed.

The website is provided for the main purpose of providing generic information on Stratton Street and on our investment philosophy for the use of financial professionals in the United Kingdom that qualify as Professional Clients or Eligible Counterparties under the rules of the United Kingdom Financial Conduct Authority (the "FCA"). The information in this website is not intended for the use of and should not be relied on by any person who would qualify as a Retail Client. Products and services referred to on this website are offered only at times when, and in jurisdictions where, they may be lawfully offered. The information on this website is not directed to any person in the United States. The provision of the information on this website does not constitute an offer to purchase securities to any person in the United States (other than a professional fiduciary acting for the account of a non-U.S person) or to any U.S. person as such term is defined under the Securities Act of 1933, as amended.

The website is not intended to offer investors the opportunity to invest in any Alternative Investment Fund ("AIF") product. The AIFs managed by Stratton Street are not being marketed in the European Economic Area ("EEA") and any eligible potential investor from the EEA who wishes to obtain information on the AIFs will only be provided with materials upon receipt by Stratton Street of an appropriate reverse solicitation request in accordance with the requirements of the EU Alternative Investment Fund Managers Directive ("AIFMD") and national law in their home jurisdiction. By proceeding you confirm that you are not accessing this website in the context of a potential investment by an EEA investor in the AIFs managed by Stratton Street and that you have read, understood and agree to these terms.

No information contained in this website should be deemed to constitute the provision of financial, investment or other professional advice in any way. The website should not be relied upon as including sufficient information to support any investment decision. If you are in doubt as to the appropriate course of action we recommend that you consult your own independent financial adviser, stockbroker, solicitor, accountant or other professional adviser. Past performance is not necessarily a guide to the future. The value of investments and the income from them may go down as well as up. An application for any investment or service referred to on this site may only be made on the basis of the offer document, key features, prospectus or other applicable terms relating to the specific investment or service.

Where we provide hypertext links to other locations on the Internet, we do so for information purposes only. We are not responsible for the content of any other websites or pages linked to or linking to this website. We have not verified the content of any such websites. Such websites may contain products and services that are not authorised in your jurisdiction. Following links to any other websites or pages shall be at your own risk and we shall not be responsible or liable for any damages or in other way in connection with linking.

By using this site, you should be aware that we may disclose any information that we hold about you to any regulatory authority to which we are subject, or to any person legally empowered to require such information.

This website uses cookies to improve user experience, by clicking the "I Accept" button below means you consent to the use of cookies on our website.