Friday, September 11, 2015

From BBB-razil to BB+razil or the meaning of investment grade

So Brazil (or here about Petrobras, the State oil company) lost its investment grade status with Standard & Poor's. You would think this is huge given the media attention in Brazil. If you read S&P's actual rationale for the downgrading (here) it is essentially about the fiscal situation. They say: "We now expect the general government deficit to rise to an average of 8% of GDP in 2015 and 2016 before declining to 5.9% in 2017, versus 6.1% in 2014. We do not expect a primary fiscal surplus in 2015 or 2016." They do discuss the political problems too, the corruption investigations,* and the political instability that has plagued the government. There is a discussion of the external vulnerability, but here they are quite sensible and know there is no problem. The report says that: "despite the wider current account deficit, Brazil has low external financing needs compared with its current account receipts and its high level of international reserves compared with some of its peers." So this is a fiscal problem in their view.

And therein lies the problem. They had years ago also revised the outlook of US debt negatively (my comments here), also on the basis of fiscal, and political, factors. As much as the US then, Brazil now has no risk of not paying its internal debt in domestic currency. And yes, the fiscal outlook has worsened, and the reasons are no secret. It's austerity. If you cut spending, output falls, and the recession leads to lower revenue and higher deficits. It's part of the problems caused by policies that S&P's analysts actually favor. Austerity also is the cause of the recession, and the worsening of the growth outlook in the next couple of years, which are also discussed in S&P's rationale for the downgrade. So the fiscal problems that are the main cause for the downgrade are self-inflicted wounds (see Serrano and Summa), and the cause of the lack of growth and the worsening of the future fiscal balances.

But more importantly, the downgrade itself is kind of irrelevant. S&P doesn't think, as I quoted above, that the external situation is particularly problematic. The recession will actually reduce the current account problems, by reducing imports. So there is no external crisis. The devaluation of the real has been part of a global trend, and in part has been reinforced by the government that seems to believe, incorrectly in my view, in the New Developmentalist philosophy that fiscal adjustment (to control inflation) and devaluation (to promote export-led growth) are part of the solution. If the downgrade cannot worsen the external situation, certainly it cannot have an effect on the ability of the government to pay its bills in domestic currency.

At any rate, even if in this case the downgrade is kind of irrelevant, it is important to remember that credit rating agencies were, and still are, one of the worst citizens in international financial markets. They were co-responsible in the bubble, that preceded the crisis, and in the meltdown of the financial sector in the 2008 Global Financial Crisis. The fact that they complain about corruption in Brazil, while they profited giving triple-A ratings to subprime junk is outrageous. And as they say, their views are just opinions. I would add biased and not particularly accurate. They should be put out of business with a public rating agency.

* I could go on on the corruption stuff, but I'll post something later.

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