The move had been widely expected, but the timing still took most investors by surprise – as did the markets’ reaction.
"[Before the downgrade] analysts were in two camps [regarding the likely market reaction if the downgrade came]," said Eduardo Loyo, chief economist of BTG Pactual, at a LatinFinance conference on March 26, "those who thought there would be a big [negative] impact and those who thought the impact would be small. No one expected the markets to improve. But we shouldn’t be fooled into thinking the rating [action] is irrelevant just because the markets didn’t get worse. Maybe it is just that a lot of the rating impact was already reflected in the markets."
Risk spreads have widened for Brazil in the past 12 months and many economists see Standard & Poor’s downgrade to BBB- from BBB as lagging behind the market. However, Murilo Calvalcanti, chief economist at M Safra & Co, says he doesn’t expect the other two agencies to follow S&P’s lead and downgrade the sovereign. "Each individual agency has a specific approach and a specific set of data [they use to rate sovereigns]," he says. "S&P had a negative outlook based on the fiscal performance, the lack of fiscal transparency and [the rating analysts] came to the country to discuss these issues with the authorities. Obviously they weren’t convinced with the answers." He says the fact that S&P changed the country’s outlook to stable from negative is perhaps more important than the downgrade. The latter was expected, but with the stable outlook it is unlikely the agency will downgrade Brazil below investment grade for the next year – or at least until after the presidential elections in the fourth quarter and the new government signalling likely economic policy.
Marcelo Carvalho, head of Latin American research at BNP Paribas, thinks the downgrade might have the unintended consequence of removing pressure on the government’s fiscal management and further weakening the country’s GDP growth prospects,which he already believes will be nearer 1% than 2% in 2014. "We hope the downgrade acts as a wake-up call," says Carvalho. "My concern is that it might backfire – the Brazilian government might feel it is off the hook. Now they know they aren’t going to get [another] downgrade this year – the other two agencies [also] have a stable outlook and seem to be willing to give the authorities the benefit of the doubt."
