Fitch Affirms Brazil at 'BB'; Outlook Negative.
A full list of rating actions is at the end of this release.
KEY RATING DRIVERS
Brazil's ratings are constrained by the structural weaknesses in its public finances and high government indebtedness, weak growth prospects, and weaker governance indicators compared with peers and recent history of periodic political instability that weighs on policy making. These weaknesses are counter-balanced by Brazil's economic diversity and entrenched civil institutions, with its per capita income higher than the 'BB' median. The country's capacity to absorb shocks is underpinned by its flexible exchange rate, robust international reserves position, a strong net sovereign external creditor position, and deep and developed domestic government debt markets. An improved policy environment, reduced external imbalances, and the passage of some microeconomic reforms in recent months are supportive of the credit profile.
The Negative Outlook reflects continued uncertainties around the strength and sustainability of Brazil's economic recovery, the prospects for medium-term debt stabilization given large fiscal deficits, and the progress on the legislative agenda, especially related to the social security reform. A challenging political environment continues to impede progress on the social security reform, which is important for the medium term viability and credibility of the spending cap. The 2018 election cycle could also detract from reform progress and weigh on economic recovery.
Fitch expects a moderate cyclical rebound to take hold in Brazil, with growth expected to accelerate from 0.6% in 2017 to an average of 2.6% during 2018-2019. A recovery in consumption has taken hold, underpinned by lower inflation boosting real wages, stabilization in the unemployment rate and the prior deleveraging by households which has opened up space for renewed growth of consumer credit. A recovery in investment is also anticipated in 2018-2019. Downside risks to growth could come from lingering political, fiscal and reform uncertainties.
The government has renewed its focus on the microeconomic reform agenda to boost productivity and investment prospects. Over the past few months, the authorities have passed an outsourcing law, a labor reform and the law for converting a subsidised long-term lending rate ('TJLP') to a market-based long term lending rate ('TLP'). While important, the positive spill-overs from these initiatives will likely take time to materialize.
Fiscal deficits are high although declining, reflecting largely the easing of the interest burden from lower interest rates. The general government fiscal deficit is expected to decline to 8.5% of GDP in 2017 (compared with the 'BB' median of around 3%) and average around 7% of GDP in 2018-2019. Despite the tighter control of discretionary spending, the growth in mandatory spending and revenue underperformance have frustrated the consolidation of the primary deficits, with the government revising up its primary fiscal deficit targets for 2017-2020 twice this year. This continues to weigh on Brazil's fiscal credibility.
Near-term downside risks to meeting fiscal targets include a weaker economic recovery and difficulty in cutting spending to confront potential revenue shortfalls, especially in an election year. Beyond 2018, a new government could also alter fiscal targets. Moreover, implementation of a social security reform and other spending adjustment measures will be needed to secure expenditure savings and to ensure the compliance with the spending cap over the medium term.
Fitch projects that Brazil's government debt will continue to increase during the forecast period even after incorporating the impact of the expected prepayments of Treasury loans by the Brazilian development bank, BNDES in 2017-2018. Fitch projects general government debt to reach 76% of GDP by the end of 2017 (compared with the 'BB' median of around 45%) and increase to close to 80% by 2018, thereby eroding fiscal space to confront future shocks.
Brazil's political environment has remained challenging and the corruption-related allegations against President Temer appear to have eroded his political capital and congressional support, making the passage of the social security reform more difficult. As such, uncertainty remains if and what type of reform could pass, especially as the window of opportunity to make progress on this issue is shrinking due to the impending election cycle. Brazil's 2018 presidential and congressional elections could also introduce uncertainty given the fragmented electoral landscape, reduced trust in institutions, and the ongoing Lava Jato investigations. The policy orientation of the next administration gains importance in the context of Brazil's large fiscal imbalances and adverse debt dynamics, which will require sustained austerity and reform efforts to support confidence, growth and reduce concerns about medium-term public debt sustainability.
Some of Brazil's macroeconomic imbalances continue to decline. The disinflation process has gained pace with the IPCA inflation rate falling to 2.54% in September 2017 (well-below the 4.5% target) and inflation expectations are well-anchored around the target for 2018-2019, highlighting gains in the central bank's credibility. The central bank has cut interest rates by a cumulative 675 basis points (bps) since the last peak, and Fitch expects the monetary easing cycle to end this year.
The current account deficit has adjusted significantly with Fitch forecasting the deficit to reach below 1% of GDP in 2017 and remain below 2% of GDP during the forecast period. The current account deficit has declined by 80% during the first nine months of 2017 compared to the same period a year ago, underpinned by a surging trade surplus. Moreover, foreign direct investment has remained resilient and is fully financing the current account deficit in 2017 and is expected to continue to do so during 2018-2019. Brazil's international reserves position remains strong and the central bank has reduced the stock of FX swaps significantly, giving the country space to confront external shocks.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Brazil a score equivalent to a rating of 'BBB-' on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
--Public Finance: -1 notch, to reflect Brazil's rapidly worsened general government debt ratio which is likely to continue increasing during the forecast period. Moreover, fiscal flexibility is constrained by the highly rigid spending profile and a heavy tax burden that makes adjustment to shocks difficult.
--Structural Features: -1 notch, to reflect Brazil's challenging political environment and corruption-related issues that have made it difficult for the country to make timely policy adjustments. In addition, the Ease of Doing Business indicators are weaker than the 'BB' median, reflecting structural constraints to growth.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
The main factors that individually or collectively, could lead to a downgrade are:
--A setback in the domestic reform agenda that undermines confidence in the trajectory of medium-term public finances and weighs on economic recovery.
--Failure to arrest the pace of increase in the government debt burden. Crystallization of contingent liabilities would be negative.
--Erosion of international reserves and deterioration in government debt composition.
The Rating Outlook is Negative. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a high likelihood of leading to a positive rating change.
Future developments that could individually, or collectively, result in a stabilization of the Outlook include:
--Improvement in policy implementation and reform progress that supports confidence, investment and growth prospects.
--Fiscal consolidation that leads to greater confidence in the capacity of the government to achieve debt stabilization in the medium term.
--Maintenance of improved macroeconomic stability.
--Fitch assumes that China (an important trading partner for Brazil) will be able to manage a gradual slowdown and is forecasted to grow at 6.7% in 2017 and 6.3% in 2018. Argentina's economic performance (key destination of manufacturing exports) is forecasted to improve over the forecast period as well.
--Fitch assumes that Brazil maintains international and domestic market access even if there is return of higher international financial volatility and further domestic confidence shocks.
Fitch has affirmed the following ratings:
--Long-Term Foreign-Currency IDR at 'BB'; Outlook Negative;
--Long-Term Local-Currency IDR at 'BB'; Outlook Negative;
--Short-Term Foreign-Currency IDR at 'B';
--Short-Term Local-Currency IDR at 'B';
--Country Ceiling at 'BB+';
--Issue ratings on long-term senior unsecured foreign-currency bonds at 'BB';
--Issue ratings on long-term senior unsecured local-currency bonds at 'BB'.
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|Publication:||Daily the Pak Banker (Lahore, Pakistan)|
|Date:||Jan 30, 2018|
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