Brazil’s Uphill Downgrade Damage Control
Brazilian stocks and bonds remained in the performance cellar as S&P beat other ratings agencies to a sovereign junk assignment with a negative outlook as fiscal impasse added to a long list of economic policy and governance misery. In the days preceding the downgrade, Finance Minister Levy’s resignation was rumored as congressional opposition defeated spending and tax proposals to restore a primary budget surplus. The real hurtled toward the 4/dollar previous low during the early 2000s crisis, as big bank and corporate demotions including for Petrobras and BNDES were next in line. With $45 billion of dollar bonds outstanding, the former could become the largest US “fallen angel” after General Motors and may not feature in standard high-yield indices to force more selling. Brazil’s CEMBI spread at 700 basis points was the widest since 2009 as General Shopping signaled a likely restructuring. The Car Wash scandal claimed political allies of President Rousseff and her predecessor Lula’s chief of staff, amid talk that he could be directly implicated in the parallel Odebrecht construction contract bribery investigation where the CEO is already under arrest. In the US shareholder class action lawsuits are proceeding as the Foreign Corrupt Practices Act may invite Justice Department prosecution for money allegedly exchanged in hotel rooms. In Brasilia impeachment proceedings have not been ruled out, with the only precedent President Collor de Mello’s ousting over two decades ago for illegal home repair payments. He is caught up again in the current kickback suspicions, but so far President Rousseff has not been tied personally.
GDP shank 2 percent in Q2 and the recession is projected to last through next year, inflation is near double digits, and unemployment worsened to 7.5 percent. The central bank benchmark rate is already punishing at over 14 percent as the 3-month loan default ratio approached 5 percent. Banks have also been spooked by likely re-imposition of a financial transactions levy as state retail giant Caixa postponed an IPO for its insurance unit. The current account deficit is stuck at 4.5 percent of GDP, with FDI sputtering the past year, and a federal rescue may be needed for local governments like Rio Grande do Sul in default. Mass protests continue reflecting the President’s under 10 percent approval rating, and the gridlock has extended to central bank position appointments as a new economic policy chief is in limbo. Foreign banks like HSBC have exited, and local investment houses are increasingly scouting prospects outside in the sub-region, which may only be marginally better positioned.
Lapsed Mercosur partner Argentina has attracted attention heading into the October presidential election, with the August primary indicating a second-round Scioli-Macri run-off with the former the incumbent’s chosen successor and still the favorite. He has been boosted by pre-poll spending returning positive growth while widening the fiscal deficit. Privately-tallied inflation is over 25 percent and the parallel market peso premium is 60 percent, as formal devaluation will await the transition with $33 billion in reported international reserves. The trade surplus is down on flagging farm exports, and the holdout drama will extend into the next administration with split New York court rulings for the funds on possible access to local dollar-bond payments, and for the government denying the central bank is a sovereign alter ego in the long masquerade.
