Fitch Ratings Places Brazil's Sovereign Ratings On Rating Watch Negative.

Business Editors

NEW YORK--(BUSINESS WIRE)--Aug. 1, 2002

Fitch Ratings has placed Brazil's sovereign ratings on Rating Watch Negative status in light of continued unfavorable market conditions facing the country and the consequent impact on credit fundamentals. The ratings remain at 'B+' for both foreign and local currency (Brazilian real) denominated obligations.

Fitch plans to resolve the Rating Watch Negative status within a relatively short period. To that end, Fitch will monitor market conditions, especially the domestic debt auctions and the exchange rate; official foreign exchange intervention and the level of international reserves; the effect of national elections on the current economic policy settings; and, any additional multilateral financial support for the country's increasingly tenuous balance of payments position.

Since late June, the Brazilian Real has continued its slide, falling 13%; gross foreign exchange reserves have fallen US$2.8 billion; the authorities have continued to shorten domestic debt maturities and have not fully rolled over maturing debt at auction; sovereign bond spreads have widened approximately 800 basis points; and the spread between the overnight interest rate and the one year swap rate still stands at over 1,100 basis points. In addition, domestic demand conditions appear to be slackening and the global environment - notably, liquidity for emerging markets - has deteriorated, evidenced by recent trends in global asset prices.

Given the vulnerability of Brazil's public debt burden and balance of payments to investor sentiment and little likelihood that this sentiment will improve markedly in the coming months, Brazil's sovereign credit fundamentals have continued to deteriorate. This comes in spite of a robust policy response in recent weeks, including an increase in the public sector primary budget surplus to 3.75% of GDP, actions to address market volatility, and additional support from the multilateral financial institutions, including the IMF.

Brazil's balance of payments vulnerability has increased. The central bank has had to intervene in the spot market and use foreign exchange repos to provide liquidity and signal its support of a stronger Real. Furthermore, external borrowing and portfolio inflows have been severely constrained, though FDI has remained robust through June 2002. However, with gross reserves at approximately US$39 billion in late July, with the continuation of the US$50 million daily intervention policy in August, and allowing for sovereign debt amortizations and debt buybacks, there is not much room left for spot foreign exchange intervention, perhaps around US$5 billion. Given heavy private sector external amortizations (approximately US$15 billion in the second half), Brazil's balance of payments remains tenuous. Further substantial multilateral support, in addition to a lower IMF-agreed floor on net international reserves, could provide the authorities with some room for maneuver. However, successful navigation through the crisis would require an election result that calmed the markets and allowed Brazil to return to the international capital markets.

On the political front, whichever candidates and parties prevail in the October elections, the incoming governments will be challenged to navigate Brazil's fractious political system in order to maintain or even tighten the current macroeconomic policy settings and to put economic reforms back on track. In the coming weeks and months, Fitch will closely monitor developments in the political sphere, financial market conditions, economic performance, and prospects for further multilateral assistance, as Fitch resolves the Rating Watch Negative status on Brazil's sovereign ratings.