Brazil: Fitch Ratings not happy about fiscal deterioration

"G-2": Brazil's President Lula and Mexico's President Calderon: Whose fiscal ship faces calmer seas?  Source:  Google Images
“G-2”: Brazil’s President Lula and Mexico’s President Calderon: Whose fiscal ship faces calmer seas? Source: Google Images

Fitch Ratings published a report this month analyzing Brazil’s fiscal deterioration this year (see press release below).  Brazil’s public finances have slipped just like in just about every country in the world.  Fitch highlights Brazil’s heavy government debt burden relative to its emerging market peers.  Brazil’s fiscal deterioration — characterized by rising spending, tax cuts, and a poor tax intake — will at the very least slow any upward movement in Brazil’s credit rating, currently at BBB- for foreign currency debt, and could in fact lead to a downgrade if a fiscal consolidation is not forthcoming over the medium term, suggests Fitch. 

Yet Fitch rates Mexico fully two notches above Brazil (BBB+), albeit with a Negative Outlook (meaning the rating should go down within two years).  Brazil’s government debt to GDP ratio is nearly 70%, whereas Mexico’s is below 40%.  What they don’t highlight is that Brazil’s debt to tax revenue ratio is lower than Mexico’s (nearly 170% in South America’s largest economy vs. Mexico’s nearly 200%).  Mexico’s woeful tax performance is a perennial problem gone unfixed for decades.  Moreover, the Mexican government relies on oil-related revenues, even though oil production south of the Rio Grande is declining.  The Mexican government won’t allow private investment in the energy sector as a way to increase production (and can’t, due to popular opposition).  Mexico is a mess (not least because of its heavy dependence on one country, eh-hem, eh-hem, the United States), and Fitch acknowledged as much in July when it said it will monitor fiscal measures in the wake of the mid-term legislative election to decide whether or not to downgrade.  Signs are that an austere budget may be in the works.

Debt is measured against both GDP and revenues to indicate a country’s ability to grow out of its debt burden, i.e. to raise enough revenues to pay future debt obligations.  The debt to revenues measure is arguably a better proxy for this capacity, even though most analysts look at debt to GDP because GDP is more standardized…and perhaps out of laziness  Sure, Mexico has a vast untaxed portion of the economy it  could draw on to service its debt.  But it hasn’t ever done so and it won’t.  An owner of a Mexican trucking company once told me, he doesn’t pay any taxes.  So, Mexico’s fiscal picture is at least as bad, if not worse, than Brazil’s.  What’s more, Brazil’s external balance sheet is stronger than Mexico’s, with lower net external debt to exports and a stronger sovereign net external creditor position.  Its economy appears more resilient, not least due to its diversification.

Yet Mexico still remains two notches above Brazil due to sticky credit ratings and the inability of the rating agencies to take dramatic action.  Such dramatic rating action would suggest that rating agency analysts have been wrong for some time.      

Fitch: Brazil’s Fiscal Deterioration – A Slippery Slope
03 Sep 2009 2:05 PM (EDT)


Fitch Ratings-New York-03 September 2009: Fitch Ratings believes that Brazil will need to begin the process of fiscal consolidation, as an expected economic recovery begins to take hold, in order to preserve its fiscal credibility. Fitch has published a special report on Brazil’s deteriorating fiscal situation and the potential impact on its credit profile.

The degree of fiscal deterioration in Brazil’s public finances is quite evident when comparing the fiscal outturn of the first seven months of 2009 with the same period a year ago. The central government primary surplus has declined by 60% in the first seven months of 2009 compared with the same period in 2008 as a result of fast-paced spending growth and weak revenue performance.

‘The structure of Brazil’s public spending is deteriorating as a significant part of the increase is related to personnel and pension benefits, which will be harder to adjust in the future and cannot be classified as strictly ‘counter-cyclical’ in nature,’ said Shelly Shetty, Senior Director in Fitch’s Sovereign Group.

On the positive side, the scale of Brazil’s counter-cyclical fiscal stimulus package is modest by international standards, and the expected deterioration in the country’s fiscal balance is somewhat less than its rating peers. In addition, the government has domestic and external market access to fund the higher deficit. However, Fitch notes that the country’s starting fiscal position is weaker when compared with its peers. Brazil’s general government debt burden is significantly higher than the ‘BBB’ median (66% of GDP compared with 27% for the ‘BBB’ median) and will increase further this year.

Fitch recognizes that Brazil has a good track record in delivering and surpassing fiscal targets even when economic conditions are difficult, such as in 2002-2003. Across the globe, 2009 has been a challenging year, and many emerging markets have seen deterioration in their fiscal balances. However, the sharp increase in spending growth observed so far in 2009 needs to be curbed for the authorities to achieve even the reduced primary surplus target for this year, and more importantly, to return to the higher primary surplus target of 3.3% for 2010, as set under the Budgetary Guidelines Law.

‘Given the uncertainty in the pace of economic recovery and thus revenue growth, greater resolve to contain spending growth (especially current) would be positive for the credibility of fiscal targets,’ added Shetty.

While Brazil’s external finances remain strong and the country has weathered the global financial crisis relatively well, the deteriorating fiscal picture could potentially dampen the upward momentum of Brazil’s credit trajectory. On the other hand, persistent and significant deterioration of public finances and debt dynamics could undermine fiscal credibility, increase investor risk premia, and adversely affect investment and growth prospects, which in turn, could weigh on Brazil’s creditworthiness.

Fitch currently rates Brazil’s Long-Term Issuer Default Ratings at ‘BBB-‘ with a Stable Rating Outlook.

The full report ‘Brazil’s Fiscal Deterioration: A Slippery Slope’ is available on the Fitch Ratings web site at ‘www.fitchratings.com.’

Contact: Shelly Shetty +1-212-908-0324 or Erich Arispe +1-212-908-9165, New York.

Media Relations: Kevin Duignan, New York, Tel: +1 212-908-0630, Email: kevin.duignan@fitchratings.com; Sandro Scenga, New York, Tel: +1 212-908-0278, Email: sandro.scenga@fitchratings.com.

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