This week Fitch affirmed its LT foreign rating on Brazil at BB- (stable outlook). Fitch highlights Brazil’s onerous government debt level at 79% of GDP which it forecasts to continue rising and which compares poorly versus the current BB median which is at 46.7%. Moreover, on their estimates ‘it will likely require an improvement in the primary budget balance of around 3pp of GDP to stabilize government debt/GDP, which could be challenging in the current environment of weak growth performance and divided politics, unless there is an increase in trend growth or a lasting downward shift in government borrowing costs.’ Bolsanaro’s lack of a stable base in congress makes passing reforms challenging, although the badly needed Social Security Reform did get through congress. Supporting the rating, Brazil current account deficit at 2% of GDP in 2019, a robust foreign exchange reserve buffer, flexible exchange rate and FDI flows help to reduce Brazil’s external vulnerability.
Brazil, is part of Stratton Street’s PAINTBRUSH list of countries: this comprises 14 vulnerable countries we identified in February 2014 that fall into our 1 and 2 star net foreign assets (NFA) ranking categories. Stratton Street’s investment approach uses NFA analysis to rank countries between 7 star (strongest creditors) to 1 star (most vulnerable debtors). We currently favour credits from creditor nations with any exposure to debtors being where net foreign liabilities (NFL) are less than 50% of GDP (3 star or better): IMF research indicates that countries with net foreign liabilities in excess of this threshold are associated with increasing risk of external crises.
As a guide, the Brazilian real is down 44% (spot basis) against the US dollar since the end of February 2014 and Brazil has certainly had a torrid time in recent years with the rating agencies downgrading its rating to sub-investment grade in the latter part of 2015 (S&P and Fitch) and 2016 (Moody’s).
From an NFA perspective, Brazil has moved between 2 and 3 star rankings on our estimates depending on when the numbers were run. Using updated forecasts that factor in a changes such as the exchange rate, which make a difference, Brazil is currently ranked 3 star. We have and continue to avoid Brazil based on: its challenging debt and fiscal position; expensive valuations (e.g. Brazil 5.625% 2047, using Fitch’s BB- rating, trades close to 3 credit notches expensive on our models); and it being the wrong time in the cycle to be targeting lower rated issuers or for venturing into the sub-investment grade space.