Achieving investment grade is a kind of Holy Grail for Brazil. Not only would it allow the government and companies to raise loans at cheaper rates on the international markets but it would also have great prestige value. Although Brazil is within reach of investment grade no-one can say that it will certainly come about or when. Until that occurs Brazil will remain behind other developing countries which do have investment grade, such as Mexico, Chile and Russia. In this interview, Mauro Leos, vice president and senior credit officer of the sovereign risk unit of Moody´s Investor Services, talks about the challenges ahead, how Brazilian companies with good credit standing are able to achieve a rating above the sovereign rating and also comments on Argentina´s remarkable recovery since it defaulted on its foreign debt in 2002.       

Mauro Leos: The outlook is stable and current conditions validate our present sovereign rating of Ba2 which puts Brazil two notches away from investment grade alongside countries like Colombia, Peru and Costa Rica. A comparison with four years ago shows that great progress has been made in a number of areas, such as reducing inflation, the external debt, debt servicing and interest rates, and increasing the trade balance. Reducing inflation has been a particularly good achievement since once low inflation becomes embedded in the system it starts to bring benefits.

However, if you look at the fiscal side, the same level of progress has not been made. In most cases the statistics are not much different from 2002. For example, government revenues as a percentage of GDP are now 39% compared with 37%, the fiscal balance is -3.3% compared with -5.3%, and the primary balance is 4.25%. Improvements have been made but they are not enough to help Brazil move up to investment grade and join countries like Chile, Mexico and Russia. In some areas, Brazil has better indicators than investment grade countries e.g. Brazil is better in terms of government efficiency than Russia and equal to Mexico. Nevertheless, the improvements on the external side have to be matched by equally impressive progress on the fiscal side. There is still a lot to do. 

Leos: We have never worked to a timetable for upgrading countries apart from some exceptional cases involving Eastern European countries like Romania and Bulgaria which were trying to meet conditions for entry to the European Union. We obviously discuss this matter regularly but any decision we make is based on the indicators we monitor. If these show evidence that Brazil is going in the right direction, are sustainable and converging to the ratios and benchmarks of countries with investment grade then we will discuss an upgrade at the appropriate committee and make the decision. At the moment we cannot say when investment grade will be given but it could be within the next few years if we see improvements on the fiscal side. 

Leos: The pension system drives primary spending and would be the key area to reform. Changes have been made, such as altering the age limit, but these will only bring benefits in the medium term. A specific issue which could be tackled would be ending the link between the minimum wage and pension benefit so that pensions are not automatically raised in line with increases in the minimum wage.  Perhaps because this was an election year, the government was very generous in increasing the minimum wage and this, in turn, has had a direct impact on the fiscal deficit.  The government was not obliged to make an increase of this level either in the minimum wage and, subsequently, the pension. Had the government simply stuck to the rules and increased pensions by the rate of inflation then it would have more room to maneuver. Maybe it will compensate for this in the coming years but no-one knows what will happen when the next election year comes round. 

Leos: The government is currently trying to create a coalition and it is not yet clear whether this will be stronger than the previous one. However, the situation in Congress does not look much different from before and means that many of the coalition members will not agree to reform the pension system. At the same time, there is a feeling in the air that the government has to do something to sort out the fiscal area, including the tax and social security system. How extensive these changes will be is another matter. A new administration, even if assuming a second mandate, generally tries to attend to matters which were left unattended by the previous government and need to be addressed. It will not be easy but this is a good starting point and I don´t think there is any opposition in principle to discussing these maters.

Leos: There could be a change in external events, such as a fall in commodity prices. There is no doubt that this will happen but no-one knows when and by how much. Since Brazil is a big exporter of commodities, like coffee, soy, sugar and orange juice, this will certainly have some effect. However, this would only be a cyclical element and not have any fundamental effect. Our current rating for Brazil is based on our belief that the economy is in a robust shape and ready to withstand any abrupt external changes.

Leos: We decided to be more flexible in this area after seeing that a government moratorium on its debt does not necessarily lead to a moratorium in corporate debt. It used to be assumed that if a government had problems then everyone in that country would have problems too but in most cases even if a government imposes a moratorium it does not do so on all debts. We feel that the risk of the Brazilian government imposing a moratorium is moderate and introduced this new rating - BA1 - which is one notch above the sovereign rating. Four companies – Petrobras, CVRD, Aracruz and Embraer - and four banks – Banco do Brasil, Itau, Bradesco and Unibanco - now have it.

Leos: Argentina is certainly doing better than expected but it is not clear that this is because of the moratorium. There are three factors to consider in Argentina´s recovery: 1) the total collapse meant that the economy was starting from a very low level and the only way was up; 2) the external situation has been favorable and higher commodity prices have boosted exports; and 3) the fiscal and, to an extent, the  monetary policy have been pro-cyclical. On the other hand, government spending is rising and inflation is running at around 10%. This situation is the result of a combination of elements over four or five years. Whether the economy will continue to grow at an annual rate of 8% or whether this is just a passing phase is the big question.         
© John Fitzpatrick 2006