Archive for the ‘Mexico’ Category

Latin America: Economist Special Report

September 19, 2010
Latin America: anti-inflation consensus and strong fx reserves  Source: vivirlatinamerica.com
Latin America: anti-inflation consensus and strong fx reserves Source: vivirlatino.com

The Economist’s lengthy Special Report on Latin America last week is worth a read (see leader below), even though it failed to emphasize and adequately explain two critical causes of the region’s recent success — 1) the consensus among Latin American politicians that conquering inflation has benefitted the poor and strengthened democracy; and 2) the massive build-up in fx reserves that has insulated the region from the global crisis, driven in part by healthy macro policies.  These issues were mentioned in passing by The Economist, but not given the focus deserved.  On the other hand, the longer articles in the Report on education, the informal economy and productivity were rich in detail and deserve a read. 

Latin America’s performance during the global economic crisis that began in 2008 was notable for the fact that the recession there was mild and the subsequent rebound robust.  One used to say that when the United States sneezed, Latin America caught the flu, but this time, the region has been inoculated against the contagion that has spread throughout the advanced economies.  In the 1980s, 90s and early 2000s, when economic shocks occurred in the advanced economies — including rising interest rates and lower prices for commodities and financial assets, this led to fiscal and balance of payments crises in Latin America, and often near or outright sovereign defaults (a la Greece).  This time, the Latins were ready.  The reason — strong fx reserves immunizing them from shifts in international capital flows.  How did they achieve this Gibraltar of reserves?  Through higher demand for their commodities from China and others, to be sure, but also through sound macro policies — floating exchange rates, an inflation-targeting monetary policy, and at least some fiscal restraint.  These policies have ensured that the balance of payments (the supply and demand of foreign exchange) adjusts to shocks, thereby bolstering investor confidence, which in turn limits capital flight during a crisis.  It’s a completely new ball game for most Latin countries.  Let’s hope they don’t let the weakest of these pillars — the commitment to fiscal prudence — slip, or they risk a return to the bad old days of boom and bust, especially when commodity prices inevitably weaken.

The Economist likewise points to Latin America’s strengthening democratic institutions as providing the political stability required to promote growth.  No argument there, but I would give a lot of credit for this to the taming of the inflation monster in the region.  After years of hyperinflation, driven by fiscal deficits and monetary accommodation, Latins broke the cycle in the nineties.  When leftists subsequently came to power, the fear of a fiscally-induced return to inflation rocked the capital markets.  President Lula was a case in point (see my post on the matter).  During his election to a first term in 2002, the bond markets sold off to default spreads, but recovered early in his tenure when they realized that this leftist, former union leader, imprisoned by Brazil’s military regime in the 1970s, retained much of his predecessor’s macro policies.  He did so because he understood that his constituency, the poor, had been hurt by inflation more than any other segment in society.  You see, the poor cannot index to inflation.  The understanding of this dynamic has led to a broad consensus in Latin society on economic policy, even when political institutions are weak and ineffectual, as in Peru and Mexico and to some extent in Brazil.  Deeper reforms that would underpin improvements in productivity, education, and the state bureaucracy remain elusive.  However, the three key pillars to macroeconomic stability (and to the political consensus) — again, flexible exchange rates, inflation targeting and fiscal prudence — remain largely in place.  With GDP growth averaging 5.5% per year in the five years to 2008, the impetus to reform is currently lacking.  See my in-depth analysis of Latin democracy here in Scherblog, written during the region’s last major election cycle (2005-07), when I discussed the delicate balance between populism and reform.   

As  a long-time Latam hand (I managed Fitch’s Latin American Sovereign Ratings group for seven years), I believe more emphasis than you will find in The Economist Special Report should be paid to the region’s 1) anti-inflation consensus, and 2) victory over the rollercoaster of balance of payments crises.   Have a read in any case…

Leader on Latin America from The Economist (Sept. 11-17):

The United States and Latin America

Nobody’s backyard

Latin America’s new promise—and the need for a new attitude north of the Rio Grande

Sep 9th 2010

THIS year marks the 200th anniversary of the start of Latin America’s struggle for political independence against the Spanish crown. Outsiders might be forgiven for concluding that there is not much to celebrate. In Mexico, which marks its bicentennial next week, drug gangs have met a government crackdown with mayhem on a scale not seen since the country’s revolution of a century ago. The recent discovery of the corpses of 72 would-be migrants, some from as far south as Brazil, in a barn in northern Mexico not only marked a new low in the violence. It was also a reminder that some Latin Americans are still so frustrated by the lack of opportunity in their own countries that they run terrible risks in search of that elusive American dream north of the border.

Democracy may have replaced the dictators of old—everywhere except in the Castros’ Cuba—but other Latin American vices such as corruption and injustice seem as entrenched as ever. And so do caudillos: in Venezuela Hugo Chávez, having squandered a vast oil windfall, is trying to bully his way to an ugly victory in a legislative election later this month.

Yet look beyond the headlines, and, as our special report shows, something remarkable is happening in Latin America. In the five years to 2008 the region’s economies grew at an annual average rate of 5.5%, while inflation was in single digits. The financial crisis briefly interrupted this growth, but it was the first in living memory in which Latin America was an innocent bystander, not a protagonist. This year the region’s economy will again expand by more than 5%. Economic growth is going hand in hand with social progress. Tens of millions of Latin Americans have climbed out of poverty and joined a swelling lower-middle class. Although income distribution remains more unequal than anywhere else in the world, it is at least getting less so in most countries. While Latin American squabbling politicians blather on about integration, the region’s businesses are quietly getting on with the job—witness the emerging cohort of multilatinas.

As they face difficulties in an increasingly truculent China, no wonder multinationals from the rich world are starting to look at Latin America with fresh interest. Sir Martin Sorrell, a British adman, talks of the dawn of a “Latin American decade”. Brazil, the region’s powerhouse, is the cause of much of the excitement. But Chile, Colombia and Peru are growing as handsomely and even Mexican society is forging ahead, despite the drug violence and the deeper recession visited on it by its ties to the more sickly economy in the United States.

Two things lie behind Latin America’s renaissance. The first is the appetite of China and India for the raw materials with which the continent is richly endowed. But the second is the improvement in economic management that has brought stability to a region long hobbled by inflation and has fostered a rapid, and so far sustainable, expansion of credit from well-regulated banking systems. Between them, these two things have created a virtuous circle in which rising exports are balanced by a growing domestic market. Because they were more fiscally responsible during the past boom than in previous ones, governments were able to afford stimulus measures during the recession. There is a lesson here for southern Europe: Latin America reacted to its sovereign-debt crisis of the 1980s with radical reform, which eventually paid off.


The danger of complacency

Much has been done; but there is much still to do. Building on this success demands new thinking, both within Latin America and north of the Rio Grande.

The danger for Latin America is complacency. Compared with much of Asia, Latin America continues to suffer from self-inflicted handicaps: except in farming, productivity is growing more slowly than elsewhere. The region neither saves and invests sufficiently, nor educates and innovates enough. Thanks largely to baroque regulation, half the labour force toils in the informal economy, unable to reap the productivity gains that come from technology and greater scale.

Fixing these problems requires Latin America’s political leaders to rediscover an appetite for reform. Democracy has brought a welcome improvement in social policy: governments are spending on the previously neglected poor, partly through conditional cash-transfer schemes, a pioneering Latin American initiative. But more needs to be done, especially to improve schools and health care, if everyone is to have the chance to get ahead. Also needed is a grand bargain to tackle the informal economy, in which labour-market reform is linked to a stronger social safety-net. And, even if some things like infrastructure and research and development plainly need more government spending, the worry is that triumphalism over escaping the financial crisis may prompt a return to a bigger, more old-fashioned state role in the economy—despite the failure of these policies in the region in the past.

Getting these things right will be easier if relations with the United States improve. Latin America needs to shed its old chippiness, manifest in Mr Chávez’s obsession with being in the hated yanqui’s “backyard”. More sensible powers, notably Brazil, should be much louder opponents of this nonsense. As they start to pull their weight on the world stage, working with the United States will become ever more important.

The attitude of the United States needs to change too. Worries about crime and migration—symbolised by the wall it is building across its southern border—are leading it to focus on the risks in its relationship with the neighbours more than on the opportunities. This is both odd, given that Latinos are already the second-largest ethnic group north of the border (see article), and self-defeating: the more open the United States is towards Latin America, the greater the chances of creating the prosperity which in the end is the best protection against conflict and disorder. After two centuries of lagging behind, the southern and central parts of the Americas are at last fulfilling their potential. To help cement that success, their northern cousins should build bridges, not walls.

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India: Fiscal worries

April 29, 2010
India: CSFB took a trip there to see what's what.  Source: Google Images
India: CSFB took a trip there to see what’s what. Source: Google Images

Countries with divided democratic government that have to pay off constituencies to hold together coalitions often run up government debt and put at risk not only sovereign creditworthiness, but also economic performance.  I have in mind Italy, Japan, Israel and Brazil.  India, alas, is the posterchild of this phenomenon.  By contrast, governments which alternate between parties or at least between stable coalitions of right and left often manage their debt burdens better.  This is because if you mismanage the economy, you’re thrown out of office.  The U.S., the UK, Germany, Mexico, and Chile come to mind.  Granted, not a perfect rule — Mexico can’t raise much-needed non-oil taxes — but an interesting idea nonetheless.

CSFB took a trip to India to explore how the economy is performing, what the status of reforms are, and what the prospects for infrastructure investment are in this lumbering, rising power that links East to West and has every imaginable problem plaguing Emerging Markets from war, terrorism and ethnic tension, to poverty, growing pains, and inflation.  See CSFB’s trip notes below.

India began reforming its public finances earlier this decade to get its government debt burden on a downward trajectory.  At over 80% of GDP, government debt is high, and with deficits in the double digits, not set to decline.  Luckily, GDP growth has been and is expected to be robust at 6-10% per year.  Yet the country is very poor, with per capita GDP of $1000, making China seem rich with about $3500.  This limits the government’s ability to raise taxes to balance the budget.  Moreover, it imposes a constraint on monetary policy because inflation, especially of food prices, means people starve.  So, an easy money policy has to be considered carefully.  

Like Brazil, India’s problems are domestic — India’s debt is not external.  It has amassed nearly $300 billion in fx reserves and has only a small current account deficit.  The problem of late is that measures to improve public finances over the medium term have fallen prey to politics, as the statement made in the first paragraph suggests they might.  Food subsidies and debt relief for farmers have been increased, and tax rates adjusted down in recent years.  As CSFB noted, a planned direct tax reform is on hold. 

With government finances in difficult straits, the only answer to improving India’s woeful infrastructure situation is through private investment, or at least public-private partnerships.  CSFB writes about these below…

From CSFB 4/29/10:

India
Devika Mehndiratta
+65 6212 3483
devika.mehndiratta@credit-suisse.com
We have just published a new report, India: Trip Notes (with a focus on infrastructure); we summarise our key findings below.
Earlier this month we were in India meeting corporates, banks and the government. Our focus was (1) on-the-ground feedback on sentiment, consumption/investment trends and any updates on government policy, and (2) specific meetings on infrastructure spending prospects in 2010 (year beginning April) given investor interest in this and market optimism that the government is giving a ‘big push’ to infrastructure spending in 2010 (particularly on roads).
Household consumption is apparently quite robust. We met with the CEO of one of India’s largest retail companies, who judged that growth in sales volumes was very strong and that some of the consumer goods companies (e.g., Fast Moving Consumer Goods or FMCG companies) were finding it a challenge to meet demand with their existing capacity. The picture on investment spending is still a bit hazy, however. Overall, while there does seem to have been some pick-up, it is not clear how strong this has been.
Housing prices have run up sharply. As the RBI recently indicated in its policy statement, housing prices in certain areas of Mumbai are already above their previous peak and, in Delhi, average prices are only about 5% below their previous peak. In our view, the RBI could tighten risk weights/provisioning norms for bank lending to the real estate sector sometime this year.
Direct tax reforms could be delayed by a year. In our talks with a senior government official, we learnt that implementation of direct tax reforms (scheduled for April 2011) could be delayed by a year.
On monetary policy, we maintain that the central bank is likely to hike the reverse repo and repo rates by 100bps by March 2011, coupled with more CRR hikes. The RBI stated at its meeting this month that it would like to “calibrate” rate hikes – as we stated then, in our view this implies that the RBI could end up having to deliver some intermeeting hikes in 2010.
We also had focused meetings with key players in the infrastructure sector to try to ascertain if infrastructure spending in 2010 is likely to pick up as strongly as many are expecting. Our meetings suggested that roads (national highways, specifically) is the only sector for which the government is clearly trying to speed up the awarding of new projects. Other than roads, the general assessment is that private sector investment in power is doing well and is likely to continue to do so in the year to come. Investment spending on railways, airports and ports, however, seems to be going on a slow/business-as-usual path.
Even within roads, it is worth remembering the government’s recent thrust is not across all categories of roads but is focused on national highways. Government estimates peg investments in roads (such as national highways, state highways, rural roads) in 2009 at about INR650bn (1% of GDP and 13.6% of total infrastructure investments). Of the total spending on roads, expenditure on national highways is likely to have been around 45%, according to government data.
Although the pace of awarding new highway projects has risen, actual construction activity is likely to pick up more in 2011 than in 2010, in our view. In a typical PPP (public private partnership) highway project, from the time that the project is awarded it takes about six months for financial closure, after which construction can begin. While the projects awarded in the past few months should start from 2Q 2010 (July to September) onwards, the clear step up in highway construction activity is likely to take place more at the end of 2010 and in 2011 (assuming the recent fast momentum in awarding projects is maintained through 2010).
Beyond 2010, many of the specialists we met made the point that financing could become an issue for infrastructure spending. Although land acquisition is highlighted as one of the key constraints in the infrastructure sector, many of the specialists we spoke to were concerned that in coming years financing of infrastructure projects is likely to become an issue, some estimating as early as in 2011. For debt, the Indian infrastructure sector is primarily dependant on credit from domestic banks, and most thought that the banking sector alone would not be able to meet the infrastructure sector’s funding requirements in coming years.

Mexico proposes sound fiscal plan, says CSFB

September 9, 2009

I discussed Mexico’s fiscal woes and compared them to Brazil’s in a previous post.  Today, financial market analysts reacted positively to the Mexican government’s fiscal plan, set to limit the widening of the federal deficit in 2010.  Like Barack Obama’s unwillingness to confront Congress on the cap-and-trade carbon emissions plan or health care reform, Felipe Calderon’s government once again skirted the issue of expanding Mexico’s narrow VAT tax to cover food and medicines.  Instead, the government will tax income more heavily.  CreditSuisse’s Alonso Cervera applauds this move because of the virtual impossibility of moving a budget through the Mexican legislature with a VAT expansion in it.  Calderon faces a congress in which his PAN party is dwarfed by the opposition PRI party, unlike the commanding position of Obama’s Democrats in both houses of the U.S. Congress. Nevertheless, Mexico’s budget, if passed, is a step in the right direction, especially since it controls spending and raises the share of non-oil taxes in government revenues. 

Read Alonso Cervera at CreditSuisse and Alfredo Thorne at JPM below:  

 From CreditSuisse’s Emerging Markets Economics Daily, Sept 9, 2009

“The government presented an ambitious budget proposal for 2010 that seeks to limit the widening of the deficit to 0.4% of GDP mainly by strengthening non-oil tax collections. The government released the comprehensive documents last night. Our first impression is a positive one, in that the government will seek to gain congressional approval for tax hikes equivalent to 1.4% of GDP, and for spending cutbacks equivalent to 0.5% of GDP. By applying an additional 0.7% from non-recurring revenues (those

currently existing in stabilization funds as well as projected ones), the government seeks to limit the widening of the fiscal deficit to 0.4% of GDP, from 2.0% this year to 2.4% of GDP next year. The government will also seek to strengthen the fiscal responsibility law by, among others things, eliminating the maximum reserve levels for stabilization funds so that the government can capitalize on the materialization of a revenue windfall.

The government presented in its policy guidelines document relevant comparisons that make it clear that non-oil tax revenues in Mexico are particularly low. The government made the comparison versus other OECD countries, Latin American countries and Brazil in particular. The government’s proposal to enhance non-oil tax revenues does not rest on the introduction of a value-added tax on food and/or medicines. We view this as a wise decision, given the strong opposition that both the PRI and the PAN had voiced in recent days regarding this potential proposal. Instead, the government is seeking to

achieve a combination of higher excise and income taxes, as well as the introduction of a new tax that has been labeled the “anti-poverty tax”.

Specifically, the government’s proposals on the tax front include: 1) the introduction of a 4.0% excise tax on telecommunication services that use a public network (excluding services in rural areas as well as public telephones); 2) increasing the excise tax on tobacco by 10.9 percentage points in 2010; 3) increasing the excise tax on beer from 25%to 28% in 2010-2012 and then reducing it back to 25% by 2014; 4) increasing the excise tax on lottery games to 30% from 20%; 5) hiking the maximum income tax rate on individuals and corporations to 30% in 2010-2012 from 28% at present, and then reducing it gradually back to 28% by 2014; and, 6) increasing the tax on cash deposits from 2% to 3% and broadening its application to cover smaller transactions.

Finally, the so-called antipovertytax would be a “2% tax on revenues generated by all types of economic activities, applied in all stages of production  in a non-cumulative manner”, according to the document. The proceeds, estimated at 72bn pesos (0.6% of GDP), would be applied to selected anti-poverty  programs. The government estimates that non-oil tax revenues could increase from 9.2% of GDP in 2009 to 10.8% of GDP next year. The bulk of the increase would come from income taxes, which would increase from 5.0% of GDP in 2009 to 5.6% of GDP next year. The government is also proposing some changes to the taxation of Pemex. Specifically, one of the proposals is to create a new flat tax rate of 15% for natural gas and crude oil extraction activities in selected fields, as opposed to taxing them based on a variable rate that is capped at 20%.

On the spending front, the government is seeking a reduction of 0.6% of GDP in programmable expenditures as well as the re-allocation of other expenses in favor of pension payments, health coverage and overall anti-poverty measures. Some specific measures to cut spending include the closing of three major government offices, 5% headcount reductions for high ranking officials and administrative staff, and 10% cutbacks in Mexico’s representative offices abroad. On the debt financing front, we highlight that the government will seek a net domestic indebtedness ceiling of 340bn pesos, which compares favorably to the ceiling it requested (and got from congress) of 380bn pesos for 2009. We think that this should be a relief for the local market, as the government will seek more actively than usual non-market financing sources abroad (mainly IFIs and other non-traditional sources). As for market debt issuance in external markets, the government’s plan is to simply issue an amount equivalent to market amortizations coming due in 2010 ($2.9bn).

Finally, the government’s outlook on the global economy in 2010 is somewhat cautious. The government’s documents presented to Congress yesterday state that the global situation continues to show a significant degree of fragility and that the global economic recovery will be moderate. Mexico’s real GDP is projected to expand at an average rate of 3.0% in 2010, with average annual growth seen at 4.2% in 2011-2015. This is partly based on the Blue Chip survey that puts US real GDP growth at 2.3% in

2010 and US industrial output growth at 2.5%. The government’s oil price assumptions are based on the formula set out in the budget responsibility law. Taking historical and projected prices, the formula yields an estimate of $53.9 per barrel for Mexico’s crude oil export mix in 2010 (roughly $60 for the WTI mix), which increases gradually towards $64.6 by 2015, which we view as conservative. Finally, in terms of oil output, the assumption is that it will average 2.5mn barrels per day in 2009 and in subsequent years, down from slightly over 2.6mn barrels per day in 2009. This assumption may be on the optimistic side, in our view.

In the remainder of this week we will expand our analysis of the comprehensive documents issued by the government last night. We reiterate that our initial reaction is positive, in that the government is putting on the table several measures that seek to close the gap created by falling oil and non-oil prices due to structural and cyclical factors. We also view the decision to keep off the negotiating table any proposal to introduce a valueadded tax on food and medicines as a good move by the government, one that may make negotiations smoother with the main political parties.

Finally, and on a separate note, the central bank will publish today at 10:00 am EST the inflation results for August; we estimate headline inflation was 0.28% last month (relative to July). If our estimate proves accurate, annual headline inflation will drop to 5.1% from 5.4% in July. Meanwhile, we estimate that core prices rose by 0.24% last month, which would put the 12-month reading at 5.1%, down from 5.3% in July. These would be the lowest 12-month readings since May 2008 in the case of headline inflation,

and since July 2008 in the case of core inflation. Market expectations are generally in line with our own. The latest survey released yesterday showed average forecasts of 0.26% and 0.25% for headline and core inflation, respectively. The survey also showed that the overwhelming majority of analysts (19 out of 24) thought that the central bank will keep the overnight rate unchanged at 4.5% in the remainder of the year.”

From JPMorgan’s Emerging Markets Today, Sept. 9 2009

“President Calderón yesterday announced the 2010 economic

package, calling for an austere budget with changes in the

public sector’s administration structure. To reduce expenses,

Calderón presented four administrative changes for next year

to be discussed by Congress. First, the Ministries of Tourism,

Agricultural Reform, and Public Ministry will be eliminated.

The first two entities will be reallocated to the Ministry of

Economy and Ministry of Social Development and

Agriculture, while the third will fall under executive powers.

Second, the federal government will reduce the large number

of civil servants and freeze salaries and compensation. Third,

spending on embassy, councils, and foreign activities will be

reduced. Fourth, other administrative expenses will be

reduced. The measures together are expected to reduce

budgetary expenses by MXN80 billion. Calderón

estimated that these expenditure cuts, combined with the

fiscal package (still pending at the time of writing), will

narrow the fiscal gap to MXN180 billion (1.4% of GDP).

Calderon also reiterated the government’s commitment to

reducing poverty noting that none of these expenditure cuts

will include social programs.”

Alfredo Thorne (52-55) 5540-9558  alfredo.e.thorne@jpmorgan.com

Brazil: Fitch Ratings not happy about fiscal deterioration

September 8, 2009
"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.