Dagong Global Credit Rating Co., Ltd
January 31, 2018
Dagong Global Credit Rating Co., Ltd. (hereinafter referred to as “Dagong”) has today downgraded the local and foreign currency sovereign credit ratings of the Federative Republic of Brazil (hereinafter referred to as “Brazil”) from BBB- to BB+, each with a negative outlook. Political uncertainty leads to the deterioration of Brazil’s debt repayment environment. Structural problems in the economy restrict wealth creation abilities. The government’s debt burden has risen from an already high level, and the risk of local currency devaluation has increased. Therefore, government solvency in both local and foreign currencies has been significantly eroded.
The main reasons for Dagong’s downgrading of the sovereign credit ratings of Brazil are as follows:
1. The domestic political environment has deteriorated, with growing uncertainties. The country’s anti-corruption investigation renders the ruling coalition increasingly divided and government leadership has rapidly declined. There is great uncertainty in the presidential and parliamentary elections of 2018 and the continuity of policy is severely challenged. In terms of the credit environment, low inflation offers space for Brazil’s central bank to pursue an accommodative monetary policy and banking soundness has generally improved. However, the Brazilian stock market has been considerably deviating from the fundamentals of the economy and soars. Therefore, risks of the capital market deserve attention.
2. Consumption and investment drive economic recovery, and structural problems restrict economic growth in the medium and long term. In the short term, the real income of residents will continue to grow due to stable inflation and an improvement in the labor market. Meanwhile, the central bank’s rate cuts will help promote household consumption and business investment. It is expected that Brazil's growth rate will slightly increase to 1.5% and 2.0% in 2018 and 2019, respectively. In the medium and long term, structural problems such as the country’s single and underdeveloped industrial structure, the serious shortage of infrastructure, a low domestic savings rate, and an incompatibility between high-welfare-spending patterns and economic development, will all curb Brazil’s growth potential. It is projected that Brazil’s economic growth will average 2.0% in the medium and long term.
3. The fiscal deficit has not been effectively addressed, government debt is rising from an already high level, and solvency of the local currency is deteriorating. Although the fiscal expenditure growth ceiling forces fiscal expenditure to be controlled, the past three years have witnessed Brazil’s government finances deteriorate sharply while political turmoil increases the difficulty of fiscal adjustment. It is expected that Brazil’s general government will witness the fiscal deficit reach 9.3% and 8.8% in 2018 and 2019, respectively. High fiscal deficits and rising interest expenses have caused the general government debt burden to rise to 87.7% and 91.1%, respectively. Therefore, government financing needs will soar substantially, and Brazil’s local-currency solvency will thereby be undermined significantly.
4. Foreign-currency solvency has been weakened. In 2017, the coverage of Brazil's international reserves on total external debt dropped by 10.3 percentage points to 56.9%. In the meantime, government bond spreads will narrow as the U.S. Federal Reserve raises interest rates. Given the uncertainty of the new government policies, there is depreciation pressure upon the Real, which will damage the government's foreign-currency solvency.
Over the short term, political uncertainty hinders the reform of the pension system, which is crucial for making up for fiscal deficits and maintaining financial sustainability. It is not conducive to the stability of government finances, and Brazil’s debt burden is rising from what is already a high level. That, combined with the pressure of local-currency devaluation, will lead the solvency of the Brazilian government to be undermined. In summary, Dagong expects to maintain a negative outlook upon the local and foreign currency sovereign credit ratings of Brazil for the next one to two years.