On February 24, 2016, Moody’s stripped Brazil of its cherished investment grade (here), following similar moves by S&P and Fitch. Like the other two agencies, Moody’s sent a strong message: it reduced the credit rating by two notches at once, for foreign and local currency issues, and kept a negative outlook.
The core reason for the downgrade is straightforward: the government has run a large budget deficit and has failed to put forward a credible plan to cut it down. Together with poor GDP performance, this has caused a huge buildup in the public debt, from 51.7% of GDP in 2013 to 66.2% of GDP in 2015. In the most likely scenario, the public debt will surpass 80% of GDP at some moment in 2017-18. At this level, it will become extremely complicated to stabilize the dynamics of the public sector accounts, as interest payments on the debt will feed back into the budget deficit and raise financing requirements.
A key element in this analysis is the assessment that the government will be unable to approve fiscal and structural reforms to change that dynamics within the horizon covered by the ratings (2016-18). According to Moody’s, this includes “to raise the minimum retirement age, improve fiscal flexibility, and reduce revenue earmarking”, in addition to reducing “mandatory growth in various spending categories despite weak revenue performance”. The three credit rating agencies blame the failure to move ahead with such an agenda on political gridlock in Congress; in particular, on the unwillingness of Congressmen to pass unpopular reforms.
I beg to disagree. The real constraint, in my view, lies elsewhere. What has paralyzed the reform agenda is the Rousseff’s government opposition to them and its unwillingness to make the sacrifice to share the political burden with Congress. Suffice it to say that in other crises Congress has supported presidents proposing equally unpopular reforms, and most reforms that Rousseff has sent to Congress have been approved
Instead, the government’s strategy lies in raising the tax burden (think CPMF) to keep popular expenditures on the rise, without letting the deficit rise too fast. Meanwhile, it tries to appease the market by paying lip service to reforms that are supposed to kick in only in future administrations (see here), while renewing broken promises of fiscal austerity. So far, this strategy has worked well and the government has had no problems meeting its large financing needs. If all works according to plan, it will leave the time bomb of the rising public debt for the next administration to disarm.
I like to compare reports issued by credit rating agencies to medical examination reports: they are important and informative, but what matters at the end of the day is how well the patient is. Now we have three expert examiners judging the Brazilian economy to be in very poor health. It is scary that knowing this the patient insists on keeping on with its unhealthy ways.