News out of Brazil has gone from bad to worse. Despite efforts by President Dilma Rousseff's government over the last few months to divert a recession, sliding commodity prices and corruption scandals have forced the hand of Standard & Poor’s to downgrade the world's eighth largest economy from investment grade credit rating to “junk’ status.
Citing mounting political turmoil and the difficulties faced in tackling growing debt, the U.S. rating agency said it had no choice but to initiate the downgrade.
runaway commodity prices and reduced all-around austerity have sent the country into a recession
The S&P had awarded Brazil an investment-grade rating in April 2008, when the country's economy was on the rise. However, runaway commodity prices and reduced all-around austerity have sent the country into a recession and all of Rousseff's left-wing austerity efforts to cut spending, raise taxes and reining in inflation have failed to lift business and consumer confidence from record lows and have, instead, wrought havoc with her governing coalition.
Brazil's rating was cut Thursday from BBB-minus to BB-plus, which denotes substantial credit risk.
The S&P downgrade came sooner than had been expected and is considered a major setback for Finance Minister Joaquim Levy's attempts to shore up public finances.
2.44% Contraction
Brazil's economy shrank 1.9 percent in the second quarter on top of a decline of 0.70% in the first quarter and analysts expect it to contract by 2.44% this year, marking the worst performance since 1990 when it contracted by 4.35 percent. The Central Bank said Tuesday that it expects inflation to hit 9.29% for the year, a revision from last week, when analysts predicted that Latin America's largest economy would contract by 2.26% and inflation would come in at 9.28%.
The numbers meet the conditions of a recession which is technically defined by economists as six consecutive months of negative GDP. Analysts were forecasting a contraction of 1.97% until four weeks ago, but the numbers have been revised downward for the last two months.
President Rousseff admitted in public that her policies had significantly contributed to the current recession. She acknowledged that her government was over zealous with government stimulus and said she plans to cut back on these efforts.
Speaking via a video posted online in celebration of Brazil’s Independence Day, Rousseff called for "bitter medicine" to strengthen the Brazilian economy and affirmed her assurances to implementing the austerity moves advanced by Finance Minister Joaquim Levy that would halt the country’s slipping budget targets and return the country's investment-grade credit rating.
"If we made mistakes, and that is possible, we will overcome them and move on," she said.
She attributed outside factors to the country’s situation such as China’s recent currency devaluation and economic slowdown which added to Brazil’s drop in commodity prices particularly in iron ore, oil and soy beans, its three biggest exports. She also pointed to the lack in government confidence resulting from a wide corruption scandal at the state-run oil company Petrobras that continues to affect some of the Brazil’s largest civil construction companies.
The country’s biggest engineering groups have seen executives jailed and contracts frozen in the scandal, and the resulting freeze on major public works and investments in the energy sector have put even more pressure on an already weak economy. Several noted politicians are involved in the scandal and the political fallout has turned key congressional allies against Finance Minister Joaquim Levy as well as Rousseff, disrupting her austerity efforts, squashing spending cuts and tax increases and pushing her approval rating in recent polls into single digits.
Some opposition figures have called for Rousseff’s impeachment and hundreds of thousands of Brazilians gathered in the streets last week calling for her removal only seven months into her second term of office.
This is not the first time Brazil has faced simultaneous political and economic crises, most recently from the mid-1980s to the mid-1990s, when it dealt with a president who was impeached for corruption and hyperinflation.
According to Alan Gandelman, CEO of ATS Brasil, a Brazilian company jointly owned by Americas Trading Group and the New York Stock Exchange, "Brazil, in worse (times) than where it is today, has shown a lot of resilience in getting out of crisis, so my take is (this is) just another crisis."
Fiscal Reforms Needed
Still major fiscal reforms are called for if the country wishes to return its previous growth track. These have been difficult to implement and many, such as increasing revenue and cutting spending, face significant opposition in congress. Still, some changes seem to be slipping through. After months of disagreements, Brazil's Senate on Wednesday, passed a key austerity bill that would raise taxes on companies—a huge win for Rousseff's government.
And despite the grim situation in the country, some analysts are optimistic that the country will weather the storm. The summer Olympic Games, scheduled to take place in Brazil next year, should help move things along at a quicker pace. Gandelman believes that "Everything will be ready for the Olympic Games, and it's going to leave a legacy after the games for the city of Rio de Janeiro. In general when Olympics do well, it has a very positive effect on the economy."