UPDATE 3-Brazil stripped of investment grade rating as crisis deepens

* Fitch cuts Brazil to BB+ amid economic, political crisis

* Second downgrade to junk in 3 months

* Move could spur billions of dollars in capital flight

* Finance minister says he feels sidelined (Adds analyst comment; details, background)

By Alonso Soto and Marcela Ayres

BRASILIA, Dec 16 (Reuters) - Brazil lost its coveted investment-grade rating on Wednesday after Fitch became the second credit agency to downgrade the country’s debt to junk status, citing concerns about an economic and political crisis threatening to topple President Dilma Rousseff.

Fitch downgraded Brazil to BB+ with a negative outlook less than 24 hours after the left-leaning Rousseff moved to loosen next year’s budget targets in a bid to safeguard spending for welfare programs. The decision undercut her orthodox finance minister, who staked his reputation on an austerity agenda that has now stalled in Congress.

The real currency and dollar-denominated bonds tumbled amid forced selling after the downgrade, which came just three months after Standard & Poor’s cut Brazil’s rating to junk, further clouding the outlook for an economy reeling from its sharpest downturn in a quarter-century.

Investors barred from owning junk bonds could dispose of about $20 billion in Brazilian sovereign and corporate debt after two agencies downgraded Brazil, analysts at JPMorgan Securities estimated in October.

It marked a bitter reversal for Latin America’s largest economy, seven years after a commodities-fuelled boom helped propel it to investment-grade status, feeding optimism that its economy was finally coming of age.

Fitch said a deepening political crisis had restricted the government’s ability to right the economy. Rousseff’s opponents have accused her of breaking budget rules and are trying to impeach her, while key allies are threatening to bolt her coalition amid a widening bribery scandal at state-run oil company Petrobras.

With Fitch leaving Brazil’s credit outlook on negative, and Moody’s Investor Services also reviewing its rating, further downgrades to the country’s creditworthiness could follow.

“The impeachment proceeding is a setback,” Shelly Shetty, Fitch’s head of Latin American sovereign ratings, told Reuters after the downgrade. “Impeachment delays implementation of fiscal measures.”

The Supreme Court on Wednesday was weighing the legality of impeachment proceedings against Rousseff after Congress packed a special committee with the president’s opponents in a secret ballot last week.

Lower house Speaker Eduardo Cunha, who started the impeachment proceedings, was one of many lawmakers whose homes and offices were raided on Tuesday in the Petrobras probe, which has thrown Congress into disarray and delayed debate of key economic reforms.

“It’s hard to be surprised by the Fitch downgrade. Political uncertainties prevent any clarity about the economic outlook,” Candido Bracher, chief executive of Itau BBA, the investment bank unit of Brazil’s largest private bank, told Reuters.


Following the downgrade, Finance Minister Joaquim Levy said losing the investment-grade rating was “serious” and showed the government had not done everything required. He was silent when asked if he would stay on as finance minister.

Levy set out to win back investor confidence this year with an unpopular austerity agenda but has faced fierce resistance from congressional allies and ministerial rivals, raising expectations for his resignation.

Earlier on Wednesday, Levy said he felt “slightly sidelined” by Rousseff’s decision to water down a crucial fiscal savings target for next year.

His comments and the Fitch downgrade added to market pressure from a widely anticipated U.S. interest rate hike on Wednesday, which has drawn investors away from riskier emerging markets like Brazil in recent months.

The Brazilian real, fell about 2 percent in Wednesday trading. Dollar-denominated bonds also tumbled sharply, and five-year credit default swaps rose 28 basis points to 482 bps, according to data from Markit.

“Local rates and currency will be under pressure in the next couple of days because of forced selling by index funds,” said Bernd Berg, director for emerging markets strategy at Societe Generale.

Standard & Poor’s cut Brazil’s rating to junk in September, and Moody’s Investors Service put the country on review last week for a possible downgrade to that level.

Fitch’s downgrade of the sovereign credit rating worsens the outlook for large corporate borrowers already contending with the rising borrowing costs, said Alberto Gallo, head of global macro credit strategy at Royal Bank of Scotland in London.

Downgrades could drive up borrowing costs for large-scale borrowers such as iron ore company Vale SA and Petroleo Brasileiro SA, as Petrobras is known. The nation’s largest banks, such as Itaú Unibanco Holding SA and Banco Bradesco SA, may also face higher borrowing costs.

This year, global bond offerings by Brazilian companies have plummeted 82 percent to about $5.7 billion, according to Credit Suisse Group AG data. Brazil has accounted for less than 9 percent of Latin American global debt offerings this year, down from 32 percent in 2014.