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Brazil’s Budget Deficit Widens to Record as Downgrade Looms

Brazil’s Budget Deficit Widens to Record as Downgrade Looms

Posted by Juan Gavasa on October 31, 2014

Brazil’s budget deficit unexpectedly widened to a record in September, prompting the government to say it won’t meet its fiscal target as a possible credit downgrade looms. Swap rates rose.

The budget deficit widened to 69.4 billion reais ($28.4 billion), more than twice the 31.1 billion reais median estimate in a Bloomberg survey of six analysts. The gap is the biggest since the series began in December 2001, and for the first time ever, Brazil posted a primary deficit for the first nine months of the year, totaling 15.3 billion reais.

Fresh off the closest election win since the return of democracy, President Dilma Rousseff faces the challenge of pulling Brazil out of recession, slowing above target inflation and preventing a further deterioration of fiscal accounts that threatens the country’s investment grade status. This week the central bank surprised analysts with a interest rate increase, marking the first measure in an effort to regain investor confidence. Now the government has to cut spending, said Jankiel Santos, chief economist at Banco Espirito Santo de Investimento.

“The credit rating firms have made it clear that the fiscal dynamics are very bad and a downgrade will happen if there isn’t a clear, very strong and credible signal the government will reverse spending increases,” Santos said in a phone interview from Sao Paulo. “It remains to be seen if the government will be able to do so.”

Real Weakens

The real weakened 2 percent to 2.4510 per U.S. dollar at 1:16 p.m. local time after the budget report, erasing part of the 2.41 percent gain yesterday. Swap rates on the contract due in January 2017, the most traded in Sao Paulo today, rose 16 basis points, or 0.16 percentage point, to 12.37 percent.

Standard & Poor’s in March downgraded Brazil’s credit rating to one level above junk, citing a slowdown in economic growth and a deterioration in fiscal accounts. Moody’s Investors Service signaled it could cut Brazil’s credit rating to one level above junk when it lowered the outlook to negative last month.

The primary surplus, which excludes interest payments, narrowed to 0.61 percent of gross domestic product in the 12 months through September, compared with a 1.9 percent target for 2014.

The government will present a bill to revise its fiscal target in November, Treasury Secretary Arno Augustin told reporters in Brasilia today. He said the 2015 target of at least 2 percent of GDP is still viable.

“I don’t believe” Brazil will be downgraded, Augustin said.

Weaker Activity

The September result “arises from weaker economic activity, falling revenue and rising investments,” said Tulio Maciel, the central bank’s director of economic research, to reporters in Brasilia. “This result signals that at the end of the year we will have an expansionary fiscal policy, when we had been assuming a neutral policy.”

Fiscal policy should tend toward neutrality by the end of 2015, Maciel added.

The central bank on Oct. 29 raised the benchmark interest rate a quarter-point to 11.25 percent in a bid to slow inflation, surprising traders and most economists who forecast a hold. It was the first increase since April.

The cost to protect the nation’s debt securities against non-payment for five years dropped yesterday as investors interpreted the central bank move as a sign Rousseff is willing to unwind policies that fanned inflation and boosted the budget deficit.

Annual Rate

Inflation in the month through mid-October accelerated to 0.48 percent from 0.39 percent a month earlier, while the annual rate held at 6.62 percent. The central bank targets annual inflation of 4.5 percent, plus or minus two percentage points.

Brazil’s economy entered recession after gross domestic product shrank 0.6 percent in the second quarter in the biggest quarterly contraction since 2009. That followed a revised 0.2 percent drop in the first three months of the year.

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