July 29, 2015 / 12:59 AM / 4 years ago

Brazil investment grade rating is at risk, S&P warns

SAO PAULO (Reuters) - Standard & Poor’s on Tuesday said Brazil could lose its coveted investment-grade rating in the coming year if fallout from a number of corruption investigations further stymies economic growth and implementation of austerity measures.

Brazil's Finance Minister Joaquim Levy speaks during the launch of an infrastructure program at the Planalto Palace in Brasilia, Brazil, June 9, 2015. REUTERS/Bruno Domingos

The warning is a setback to Finance Minister Joaquim Levy’s efforts to win back investor confidence in Latin America’s largest economy, headed to a steep recession.

S&P affirmed Brazil at BBB-minus, its lowest investment grade rating, and revised the outlook on that rating to negative from stable, signaling a downgrade is possible over 12 to 18 months.

The Brazilian real BRL= slid 2 percent after S&P's announcement to 3.43 per dollar, the weakest in more than 12 years. It trimmed most of those losses to close at 3.37 after the ratings agency's analysts said the country could still head off a downgrade.

“We’re assuming an even weaker fiscal story (in 2016), but we’re also assuming that it will improve and that Brazil will avoid a rating downgrade,” S&P analyst Lisa Schineller said on a conference call, citing the example of India.

India, also rated at BBB-minus by S&P, last year avoided a downgrade to junk after Prime Minister Narenda Modi unveiled an ambitious reform agenda.

Still, Schineller said there was significant risk that Congress may not approve the austerity policies.

Investors said the threatened downgrade should be a wake-up call to the government.

“This is the consequence of years of bad fiscal policies. They are finally taking their toll on Brazil,” said Will Landers, who oversees $2.1 billion in Latin American equities at BlackRock Inc. “We need to see how the government deals with this decision.”

Although some Brazilian government officials had fretted about the country’s ratings, few saw the S&P revision coming so soon. “This caught the team by surprise,” a Finance Ministry official said.

Asked about S&P’s decision, Planning Minister Nelson Barbosa said the government is working to improve the economy and that those efforts will bear fruits.

Brazil’s Finance Ministry said in a statement later on Tuesday that the government remains committed with fiscal austerity and structural changes aimed at improving public spending.

The Ministry said it will go ahead with plans to speed up collection of tax debts and to sell stakes in state-run companies to increase revenues.

Levy himself considered the S&P warning an incentive for Congress to speed up the approval of austerity measures, a government source who heard the minister’s remarks said.

Some lawmakers seemed to agree. Senator Romero Juca, a leader with Brazil’s largest party, the PMDB, said Congress “needs to act fast not to let the situation deteriorate even further.”

Yet most market participants now expect Brazil to lose its investment grade from S&P and at least one other rating agency by the end of 2016, a Reuters poll showed.

Levy has been trying to retain Brazil’s investment grade rating through spending cuts and tax increases aimed at curbing fiscal deficits that ballooned during President Dilma Rousseff’s first term.

But his strategy has fallen short. Last week, the government slashed its budget savings target for this year and the next.

Government revenues have plunged since the beginning of the year. The economy is expected to shrink this year and possibly in 2016. Inflation remains above target, forcing the central bank to raise interest rates.

A massive corruption scandal at state-run oil company Petrobras (PETR4.SA) has also damaged investor sentiment, along with a growing political crisis which included calls for Rousseff’s impeachment.

Brazil's President Dilma Rousseff in Brasilia, July 17, 2015. REUTERS/Ueslei Marcelino

Loss of the investment-grade rating would boost financing costs for Brazil’s government and companies. It also would hurt dollar inflows to the country since many investors are barred from buying junk-rated securities.

S&P was the first of the Big Three ratings agencies to raise questions about Brazil’s investment grade. Both Moody’s Investors Service and Fitch Ratings have the country at BBB, two notches above junk, with a negative outlook.

(For S&P's statement, see bit.ly/1D64qMG)

Additional reporting by Alonso Soto, in Brasilia, Guillermo Parra-Bernal and Marcelo Teixeira in Sao Paulo; Editing by David Gregorio and Lisa Shumaker

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