Moody's Downgrades Brazil to Edge of Junk Territory -- Update

By Jeffrey T. Lewis And Rogerio Jelmayer 

SÃO PAULO-- Moody's Investors Service downgraded its credit rating for Brazil to one notch above junk status on Tuesday, citing weak economic growth and rising government spending, dealing another blow to embattled President Dilma Rousseff's political standing.

Moody's lowered Brazil's government bond rating to Baa3 from Baa2, and changed its outlook to stable from negative. The change still leaves the country's ratings out of line with other countries in a similar debt situation, but Brazil's large, diverse economy and "low susceptibility to event risk" help justify the investment grade level, Moody's said.

Brazil's government last month slashed a key fiscal target as it struggles to boost tax revenue and get spending under control. It now expects to have a primary budget surplus, which is a measure of its ability to save and cut debt, equal to 0.15% of gross domestic product, compared with the previous target of 1.1% of GDP.

"It will be challenging for Brazil to achieve and sustain improving fiscal trends," Moody's said. "The numbers confirm that the authorities have been unable to deliver primary surpluses large enough to prevent an increase in debt ratios in 2015-2016."

The downgrade put the rating agency in line with Standard & Poor's Ratings, which also has Brazil's rating one notch into investment-grade territory.

Despite the downgrade, Moody's move to a stable outlook could be considered positive, suggesting no more changes in the short term.

"It was good that Moody's didn't cut by two notches, and has a stable outlook. It amounts to saying that, despite the fiscal deterioration, Brazil can still keep its investment grade," said Jankiel Santos, chief economist at BES Investimentos do Brasil in São Paulo.

After growing just 0.1% in 2014, Brazil's economy is expected to contract 1.8% this year and post no growth in 2016, according to a weekly central bank survey with economists.

The weak economy, and a spreading corruption scandal involving state-controlled oil company Petróleo Brasileiro SA, have driven President Rousseff's approval ratings to record lows. Her government is now struggling to get its economic proposals passed in Congress, and Ms. Rousseff faces a threat of impeachment over some fiscal maneuvers from her first term.

"Whether this will cause the politicians to react and approve the fiscal adjustment that's necessary, we'll have to wait and see," said David Fleischer, a emeritus professor of political science at the University of Brasília. "Because if Brazil gets downgraded to junk, a lot of people are going to lose their shirts."

Paulo Trevisani and Reed Johnson contributed to this article.

Write to Jeffrey T. Lewis at [e-mail] and Rogerio Jelmayer at [e-mail]