By Jeffrey T. Lewis And Rogerio Jelmayer
SÃO PAULO-- Moody's Investors Service downgraded its credit
rating for Brazil to one notch above junk status on Tuesday, citing
weak economic growth and rising government spending, dealing
another blow to embattled President Dilma Rousseff's political
standing
Moody's lowered Brazil's government bond rating to Baa3 from
Baa2, and changed its outlook to stable from negative. The change
still leaves the country's ratings out of line with other countries
in a similar debt situation, but Brazil's large, diverse economy
and "low susceptibility to event risk" help justify the investment
grade level, Moody's said.
Brazil's government last month slashed a key fiscal target as it
struggles to boost tax revenue and get spending under control. It
now expects to have a primary budget surplus, which is a measure of
its ability to save and cut debt, equal to 0.15% of gross domestic
product, compared with the previous target of 1.1% of GDP.
"It will be challenging for Brazil to achieve and sustain
improving fiscal trends," Moody's said. "The numbers confirm that
the authorities have been unable to deliver primary surpluses large
enough to prevent an increase in debt ratios in 2015-2016."
GDP growth of at least 2% and primary surpluses of at least 2%
of GDP will be required to stabilize debt ratios, according to
Moody's, and Brazil is unlikely to meet these conditions this year
or next.
This will likely lead to the continued deterioration of
government debt burdens and may only stabilize toward the end of
the administration, the ratings agency said.
The downgrade put the rating agency in line with Standard &
Poor's Ratings, which also has Brazil's rating one notch into
investment-grade territory.
Despite the downgrade, Moody's move to a stable outlook could be
considered positive, suggesting no more changes in the short
term.
"It was good that Moody's didn't cut by two notches, and has a
stable outlook. It amounts to saying that, despite the fiscal
deterioration, Brazil can still keep its investment grade," said
Jankiel Santos, chief economist at BES Investimentos do Brasil in
São Paulo.
Investors had expected the downgrade, but were surprised when
Moody's offered Brazil a stable outlook. The market had largely
baked in a negative outlook following the downgrade in light of the
earlier downgrade by S&P.
"Expectations were below investment grade or moving towards
that," said Kathryn Rooney Vera, senior macro strategist at
Bulltick Capital Markets.
Brazil's benchmark U.S. dollar denominated notes due 2025 rose
1.5% after the downgrade was announced and the Brazilian real
appreciated 1% against the dollar. Stock trading closed shortly
before Moody's announcement, with the Ibovespa index closing 0.6%
lower.
After growing just 0.1% in 2014, Brazil's economy is expected to
contract 1.8% this year and post no growth in 2016, according to a
weekly central bank survey with economists.
Growth has been weak and may remain so, and consumption has been
hurt by adverse labor market conditions, Moody's said. Also, a
decline in employment and reduction in real wages have put a dent
in household spending.
The sluggish economy, and a spreading corruption scandal
involving state-controlled oil company Petróleo Brasileiro SA, have
driven President Rousseff's approval ratings to record lows. Her
government is now struggling to get its economic proposals passed
in Congress, and Ms. Rousseff faces a threat of impeachment over
some fiscal maneuvers from her first term.
"Whether this will cause the politicians to react and approve
the fiscal adjustment that's necessary, we'll have to wait and
see," said David Fleischer, a emeritus professor of political
science at the University of Brasília. "Because if Brazil gets
downgraded to junk, a lot of people are going to lose their
shirts."
Investors are awaiting news from Fitch to see if Brazil is in
near-term danger of falling below investment grade. A knock to
below investment grade by two out of the three ratings firms, Ms.
Rooney Vera said, would signal a selloff by pension funds,
insurance companies and others who are limited in their ability to
hold bonds that are below investment grade.
"You can't underestimate the impact of selling pressure," she
said. "It would be very very bad for Brazil. It would send bond
yields higher, making the cost of financing their fiscal deficit
higher. You'd see more pressure on companies that borrow in the
international markets as well--those yields would go higher. You'd
have public debt ratios also increasing."
Angela Chen, Julie Wernau, Paulo Trevisani and Reed Johnson
contributed to this article.
Write to Jeffrey T. Lewis at jeffrey.lewis@wsj.com and Rogerio
Jelmayer at rogerio.jelmayer@wsj.com