Analysts prepare to downgrade Brazil as the heat rises

Brazil’s country risk score remained largely stable through the first half of 2019, according to Euromoney’s risk survey.

The country even moved up one place in the global risk rankings to 54th out of 186 countries thanks to a year-on-year improvement in several economic and political indicators.

The reason for that is clear: a general election was held in 2018, and with another not due until 2022, political risk has calmed.

In addition, earlier in the year, the IMF predicted GDP growth would accelerate in real terms to 2.1% in 2019 from 1.1% in 2018, before climbing to 2.5% in 2020.

However, in Euromoney’s second-quarter survey analysts had become a little tetchier ahead of the official announcement in July from the economy ministry it was downgrading its growth forecast for 2019 from 1.6% to 0.8%.

This reflected the weak start to the year and the prospect of a challenging trade environment, not to mention uncertainty over pension reforms delaying investments.

Now Brazil is facing an altogether new challenge: the dangers of ignoring climate change.

The Amazon fires, sparking public protests and raising international awareness, are highlighting the acute dangers of environmental risk.

The use of fires for forest clearance is a normal dry-season activity, and the issue is certainly a more complex one than recent media reports suggest, involving myriad domestic and foreign commercial interests.

However, the fact this year’s fires are the worst in a decade, exacerbated by drought, highlights the sensitivity of an issue feeding directly into the climate-change debate just as the topic is growing in prominence due to record global temperatures and melting sea ice.

What makes it most troubling is the stubborn attitude of the right-wing climate-change sceptic president Jair Bolsonaro.

He has barely been in office a year and stands accused of taking a blasé attitude by interfering in independent scientific research and accelerating commercial deforestation, causing a diplomatic rift with French president Emmanuel Macron, and condemnation from other world leaders.

“Bolsonaro is a man of strong and controversial opinion, and the authorities lost all control of the situation,” says an economist at CEIC Data who wished to remain anonymous.

“According to specialists, the crisis was caused by the easing of environmental controls, something that was promised [and] fulfilled by Bolsonaro.”

Bolsonaro has moved away from the traditional deals with Congress to consolidate his power and now may have problems passing any major legislative change, including the much-needed social security reform 

 - Tiago Freire, economist

Bolsonaro has since stepped back a little after Macron threatened to scupper the EU-Mercosur trade deal when he refused to accept aid from the G7.

Troops were sent into the Amazon to control, combat and reduce the magnitude of the forest fires in its territory, notes Félix Larrañaga, operations and logistics professor at Sumaré University Centre, and one of Euromoney’s risk survey contributors.

“However, the output of this decision will be weak and Bolsonaro’s relations with G7 will continue to be tumultuous,” he says. “The Brazilian country risk probably will increase.”

The fact Bolsonaro is pushing Brazil away from its traditional multilateral and pro-environment approach is endangering foreign trade and investment, not least with some light sanctions imposed, although these issues are not considered the defining ones.

“It seems unlikely France and Ireland will carry through their threat to block the trade treaty between Mercosur and the EU [agreed in June] – the deal is too big and involves many more parties than just France, Ireland and Brazil,” says economist Tiago Freire, another contributor to the survey.

“Furthermore, the international risk from a boycott of agricultural products from Brazil has started, but remains small, and does not seem to be gaining momentum.”

It may deliver some reputational damage, but, as CEIC’s economist points out, it does not seem to have had much impact on five-year credit default swap spreads, which have increased slightly but remained low at around 133 basis points in August.

Crucially, analysts such as Freire, Larrañaga and CEIC’s economist are more concerned by the domestic implications.

“The Amazon fires give Congress more ammunition against Bolsonaro in their fight for power,” says Freire.

“Bolsonaro has moved away from the traditional deals with Congress to consolidate his power and now may have problems passing any major legislative change, including the much-needed social security reform.”

He adds: “With this bad blood between Congress and the president, the Amazon fires and in particular the popular protest in the street empower Congress to move away from the legislative priorities of Bolsonaro and may not approve the proposals from his government.”

Bolsonaro has made a habit of attacking opponents at every opportunity, and in turn all they desire is to prevent his government from succeeding.

Which is bad news for addressing Brazil’s fiscal challenges, given the economy is failing and Argentina – an important export market – is plunging into crisis.

Although Brazil’s external risks are mitigated by robust reserves, a flexible exchange rate and a fully financed current account, compliance with the federal expenditure ceiling beyond 2019 is conditional on passing pension reform and other consolidation measures.

And with the debt burden rising, the clock is ticking.

For these reasons, Freire expects to downgrade specific economic and political risk indicators.

With Larrañaga and others likely to follow suit, Brazil’s standing is looking shakier, which is making higher-ranked Colombia, Uruguay and Peru much safer bets.