Overview

• We expect Brazil's GDP growth and fiscal performance to suffer in 2020 due to the COVID-19 pandemic and extraordinary government spending, before gradual economic recovery and fiscal consolidation resumes.
• In addition, uncertainty has increased regarding the country's capacity to advance its structural reform agenda once the pandemic dissipates, given ongoing disagreement between the executive and legislative powers.
• We are revising our outlook on Brazil to stable from positive and affirming our 'BB-' long-term and 'B' short-term sovereign credit ratings.
• The stable outlook reflects our updated fiscal and economic expectations after the COVID-19 shock, and our assumption of slower-than-expected progress to pass and implement meaningful legislation to reduce structural fiscal vulnerabilities and to raise medium-term GDP growth prospects.

Rating Action

On April 6, 2020, S&P Global Ratings revised its outlook on its long-term ratings on Brazil to stable from positive. At the same time, we affirmed our 'BB-/B' long- and short-term foreign and local currency sovereign credit ratings. We also affirmed our 'brAAA' national scale rating and our transfer and convertibility assessment of 'BB+'. The outlook on the national scale rating remains stable.

Outlook

The outlook revision to stable from positive reflects diminishing prospects for an upgrade over the coming year due to the negative impact of the COVID-19 pandemic. We expect Brazil's GDP growth and fiscal performance to suffer in 2020 due to the pandemic and extraordinary government spending, before gradual economic recovery and fiscal consolidation resumes. We also assume slower-than-expected progress on the reform agenda to address structural fiscal vulnerabilities and to improve low medium-term GDP growth prospects.

We could raise the ratings over the next two years if the fiscal trajectory recovers more quickly than we expect, along with better prospects for implementing structural reforms, suggesting stronger economic growth and debt stabilization in the medium term. We could also raise the ratings if we perceive that Brazil will maintain a net narrow external creditor position in the next three years despite global uncertainty.

Alternatively, we could lower the ratings over the next two years if--once the effects of the pandemic dissipate--the fiscal profile remains weaker than expected for a prolonged period, harming the prospects for a slow decline in government deficits or quickening the rise in debt. We could also take a negative rating action should unforeseen weakness in Brazil's balance of payments arise that impairs market access. Finally, a meaningful deterioration in monetary policy credibility, marked by a weakened commitment to a floating exchange rate, would also weigh on the rating.

Rationale

The spread of the COVID-19 pandemic in March 2020 substantially changed the economic, political, and fiscal scenario for Brazil in the near term. Given structurally large fiscal imbalances and low economic growth, Brazil has limited fiscal room to address the shock without a significant rise in its debt burden. On the other hand, its large international reserves, low external debt, proactive monetary policy, floating exchange rate, and favorable sovereign debt composition constitute relative credit strengths that provide key resiliency that should enable it to address the challenging and volatile global environment.

Despite considerable uncertainties, we assume that following the current shock, the fiscal deficit will only decline slowly on prospects for moderate recovery from the economic contraction, additional nonrecurring revenues, a lower interest rate, and ongoing fiscal consolidation measures. However, ongoing disagreement between the legislative and executive branches, which could become more acute as the pandemic evolves and social pressure increases, could limit the passage and implementation of significant structural reforms during the rest of the administration, in our opinion.

The number of COVID-19 cases in Brazil has increased rapidly in a little over a month and has spread across all 27 states, with more cases in large cities such as São Paulo and Rio de Janeiro. On March 17, the federal government declared a state of public calamity. At first, some states ordered lockdowns, while the federal government response has been slower, raising political and social tensions. Nevertheless, the administration has announced an increasing number of fiscal and monetary measures to mitigate the health and economic crisis.

Brazil's economic growth in 2020 will be severely hurt by the impact of COVID-19 locally and globally. On the domestic front, the impact of containment measures, lower investor confidence, and financial market volatility will likely constrain consumption and investment. In addition, exports will fall as around two-thirds are destined to China and the U.S. markets. We project Brazil's economic growth will contract by 0.7%, down from growth of 1% in 2019, although the risks are tilted to the downside. At this point, we evaluate the shock as temporary and without negative long-term consequences on the Brazilian economy. We expect GDP growth to accelerate to 2.9% in 2021, explained largely by a statistical effect.

Brazil's growth prospects have been below those of other countries at a similar stage of development, in our view. We expect GDP per capita of US$7,280 for 2020.

Brazil's fiscal vulnerability poses a challenge for the government to design measures to minimize the effects of the pandemic. The declaration of public emergency allows for the temporary suspension of the primary fiscal target. The authorities announced a package of fiscal measures adding up to 3.5% of GDP, a large share corresponding to reallocations within the 2020 budget. Compared with other emerging markets, the response of the Brazilian government is seen as significant (at this point, fiscal measures announced by Russia total 0.3% of GDP, Mexico 0.7%, India 0.1%, and Argentina 1%).

The package includes temporary income support to vulnerable households, temporary tax breaks, credit lines for firms to protect jobs, lower taxes and import levies on essential medical supplies, and new transfers from the federal to state governments to support higher health spending and as a cushion against the expected fall in revenues. The central government will also provide support to local governments with a temporary suspension of debt payments to the central government, debt renegotiation with state-owned banks, and support for credit operations through government guarantees. In addition, legislators introduced a constitutional amendment to implement a temporary war time budget. All spending related to the COVID-19 pandemic would be separate from the rest of the budget, which would allow the government to comply with the spending cap.

We expect the fiscal deficit and debt figures to deteriorate throughout 2020, driven by higher spending. Revenues would also decline due to economic contraction, tax relief related to COVID-19, and declining oil royalties because of low crude oil prices. We assume that in 2020 the general government fiscal deficit will increase to 12% of GDP from 6% in 2019.

Gross general government debt would increase by almost 10 percentage points to 85% of GDP and net general government debt would also increase about 10 percentage points to 66% of GDP. In the following years, we expect net general government debt stabilization around 70% of GDP, given our assumption of fiscal consolidation.

In the near term, the agenda of structural reforms will take second place as Congress will focus on measures related to the pandemic. Afterwards, we expect the administration will implement consolidation measures to reduce the large fiscal deficit, although risks of delays are significant. Moreover, a potentially more divisive political environment could harm the government's capacity to build effective alliances in Congress to advance its reform agenda during the remainder of the administration.

Since its start, the administration of President Jair Bolsonaro has pursued policies and structural reforms aimed at strengthening Brazil's fiscal accounts and encouraging greater private-sector participation in the economy. Although the executive cannot rely on a solid coalition in Brazil's fragmented Congress, legislators have nonetheless shown broad support to implement needed fiscal and economic reforms, as demonstrated by the passage of pension reform in October 2019.

The list of reforms envisaged before the COVID-19 outbreak was extensive and included bills to control mandatory spending, simplify the tax system, and reduce the role of the state in the economy, as well as policies to increase financial intermediation and the formal autonomy of the central bank. Progress on aspects of this agenda has been delayed because of different political and social concerns.

Recently, the president's relationship with Congress, which has been strained since he assumed office, has deteriorated further. We now believe the government might face more challenges in advancing the rest of the economic and fiscal agenda, in particular because several of the reforms require constitutional amendments, a critical and very particular condition of Brazil's institutional framework.

On the monetary front, Brazil's central bank decided to lower the selic rate by 0.5 percentage point to a record low of 3.75%. The monetary authorities announced a broad set of measures--totaling Brazilian real (R$) 1.2 trillion (around 16% of the GDP)--to maintain the stability of the financial sector and provide liquidity to the corporate sector. The creation of a US$60 billion swap line with the U.S. Federal Reserve for the next six months gives the Central Bank of Brazil extra tools to smooth exchange-rate movements in the short term.

The Central Bank of Brazil has consolidated its credibility over the past three years. Actions under the inflation-targeting regime enabled it to anchor inflation expectations. We expect average annual inflation of around 4% in 2020-2023, in line with targets.

The environmental, social, and governance (ESG) factors relevant to the rating action are:

• Strategy, execution, and monitoring; and
• Health and safety.

Key Statistics

Table 1

Ratings Score Snapshot

Table 2

Related Criteria

• General Criteria: Methodology For National And Regional Scale Credit Ratings, June 25, 2018
• Criteria | Governments | Sovereigns: Sovereign Rating Methodology, Dec. 18, 2017
• General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
• General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009
• General Criteria: Methodology: Criteria For Determining Transfer And Convertibility Assessments, May 18, 2009

Related Research

• S&P Global Ratings Cuts WTI And Brent Crude Oil Price Assumptions Amid Continued Near-Term Pressure, March 19, 2020
• Sovereign Ratings History, March 13, 2020
• Sovereign Ratings List, March 13, 2020
• Sovereign Ratings Score Snapshot, March 3, 2020
• Banking Industry Country Risk Assessment Update: February 2020, Feb. 21, 2020
• Sovereign Debt 2020: Global Borrowing To Increase To $8.1 Trillion Amid Favorable Financing Conditions, Feb. 20, 2020
• Global Sovereign Rating Trends 2020: Sovereign Debt Buildup Continues, Jan. 29, 2020
• Brazil Outlook Revised To Positive On Prospects For Sustained Fiscal Improvements; 'BB-/B' Ratings Affirmed, Dec. 11, 2019
• Brazil Has Passed Pension Reform: What's Next?, Oct. 24, 2019
• Banking Industry Country Risk Assessment: Brazil, March 28, 2019

In accordance with our relevant policies and procedures, the Rating Committee was composed of analysts that are qualified to vote in the committee, with sufficient experience to convey the appropriate level of knowledge and understanding of the methodology applicable (see 'Related Criteria And Research'). At the onset of the committee, the chair confirmed that the information provided to the Rating Committee by the primary analyst had been distributed in a timely manner and was sufficient for Committee members to make an informed decision.

After the primary analyst gave opening remarks and explained the recommendation, the Committee discussed key rating factors and critical issues in accordance with the relevant criteria. Qualitative and quantitative risk factors were considered and discussed, looking at track-record and forecasts.

The committee's assessment of the key rating factors is reflected in the Ratings Score Snapshot above.

The chair ensured every voting member was given the opportunity to articulate his/her opinion. The chair or designee reviewed the draft report to ensure consistency with the Committee decision. The views and the decision of the rating committee are summarized in the above rationale and outlook. The weighting of all rating factors is described in the methodology used in this rating action (see 'Related Criteria And Research').

Ratings List