Brazil cut by Fitch, outlook negative on political gridlock

[SAO PAULO] Brazil was downgraded by Fitch Ratings, which kept a negative outlook on the nation's debt citing a deeper-than-anticipated recession and political instability.

Fitch cut the rating by one level to BB, in line with grades from S&P Global Ratings and Moody's Investors Service. Fitch had last downgraded Brazil in December. The rating is in line with those of Croatia, Bolivia, Paraguay and Guatemala.

Brazil is facing its worst recession in a century amid a widening corruption probe that's prevented Congress from approving measures to revive growth and shore up the budget. The failure to stabilize the outlook for public finances and political gridlock are hindering improvements in confidence, Fitch said.

While a political change if President Dilma Rousseff is removed from office could usher in economic adjustments and reforms, changes will be hard to implement amid rising unemployment and uncertainty surrounding the stability of the governing coalition, according to the ratings company.

"The continuing deep economic contraction reflects the high level of political uncertainty, depressed confidence, deteriorating labor markets and strong external headwinds," Fitch analysts wrote.

"Medium-term prospects also appear subdued, as the country's investment rate has fallen in recent years and microeconomic reforms to improve competitiveness and the business environment have not made material progress."

Brazil's finance ministry and central bank said they won't comment on the downgrade.

Fitch says the economy will contract 3.8 per cent this year, rebounding by 0.5 per cent in 2017. The government's debt burden is expected to reach nearly 80 per cent of gross domestic product by 2017, one of most indebted sovereigns in the 'BB' category, according to Fitch.

Brazil lost its last investment-grade rating in February, when Moody's downgraded the country by two levels. S&PGR cut Brazil to junk in September - and downgraded it again in February - while Fitch lowered the nation's debt in December.

Even as the economy slumps, Brazilian assets have rallied this year amid hopes Ms Rousseff will be ousted, paving the way for a government that can revive growth and end the political stalemate that has paralyzed Latin America's largest economy. Bond risk as measured by five-year credit-default swaps has fallen by 35 per cent from a peak in September.

"The impact of the downgrade could be limited," said Cleber Alessie, a currency trader at H Commcor DTVM in Sao Paulo.

"The timing is odd. It's like pushing a drunk person down the hill."

The Senate is scheduled to vote next week on whether to try Ms Rousseff. If a simple majority of the legislators vote against her - as is widely expected - she must step down for as long as 180 days and stand trial. In that case, Vice President Michel Temer would take over.

"Given the magnitude of the economic and fiscal challenges that Brazil is confronting, a strong political willingness and capacity to execute measures in a relatively short period of time will be required in order to materially improve confidence in the economic adjustment process," Fitch analysts wrote.

BLOOMBERG