If Brazil’s country risk is top-notch, why isn’t it investment-grade yet?

. Jul 24, 2019
If Brazil’s country risk is top-notch, why isn’t it investment-grade yet? investing

Less than a month ago, Forbes’ Kenneth Rapoza spread the word of Brazil returning to the attentions of Wall Street and beyond, with global investors reconsidering the country as a possible destination for their investments. One of the signs of this movement is Brazil’s five-year Credit Default Swap (CDS).

The CDS works as insurance held by a country’s public debt holders (like banks) and insurers, who can cover losses in case the country defaults. Basically, it is a risk thermometer, measuring the likelihood of a country to default on public debt—the lower, the better. This week, Brazil reached 128 points, the lowest level since 2014.

</span></p> <p><img class="alignnone size-full wp-image-21181" src="" alt="brazil 5-year cds" width="1200" height="800" srcset=" 1200w, 300w, 768w, 1024w, 610w" sizes="(max-width: 1200px) 100vw, 1200px" /></p> <p><span style="font-weight: 400;">At the time, Brazil was considered a safe place to invest by the world’s most famous credit rating agencies—Moody’s, Fitch and S&amp;P—a status that was lost in the following year, due to the crisis that hit the country. </span></p> <p><span style="font-weight: 400;">But if the CDS recovered from the worst recession in the country’s history—as well as an impeachment process and the toughest election in 30 years—why is Brazil’s credit quality rating the same as it was during the recent crisis period?</span></p> <p><span style="font-weight: 400;">The answer lies in reaction times. Markets are always looking ahead and currently reflect more promising prospects for the Brazilian economy and institutions, as noted by Patrícia Pereira, an economist at Mongeral Aegon Investimentos. </span></p> <p><span style="font-weight: 400;">“We’re two levels below investment grade because markets are always faster to react. The change in the government and the country’s prospects make investors reassess the country. So, we have a new economic team, and pension reforms savings are expected to be even better than market projections. Additionally, for the first time, we have a Congress that is leading a movement of institutional improvement,” she told </span><b>The Brazilian Report. </b></p> <p><span style="font-weight: 400;">“Also, I don’t think we’ll go back to inertia after the pension reform’s approval. It started a movement in Congress, they want to contribute to society. There’ll be tax reform, the government’s de-bureaucratization agenda may go forward, reducing the costs involved in opening a business. It’s very positive. This is what the CDS is reflecting.”</span></p> <div class="flourish-embed" data-src="visualisation/533950"> </div> <p><script src=""></script></p> <h2>Former market movers</h2> <p><span style="font-weight: 400;">When Brazil earned the investment-grade title in 2008, an unprecedented level of euphoria overtook Brazilian markets. To illustrate the significance of this achievement, Ibovespa, the benchmark Brazilian stocks index, reached its highest level, in dollar terms—a level that has not been attained since.   </span></p> <p><span style="font-weight: 400;">“I believe these agencies’ reputation has fallen over the past few years because they were behind the curve. It happened with Brazil, and with companies’ grades. People started to question what was their analysis was. Of course, the ratings remain important, but more in terms of capital attraction, because there are many sovereign funds or trust funds that can only invest in top-notch countries”, Pereira said.  </span></p> <div class="flourish-embed" data-src="visualisation/533903"> </div> <p><script src=""></script></p> <h2>The early bird catches the worm</h2> <p><span style="font-weight: 400;">Those who are waiting to see if Brazil is <a href="">really worthy of investments</a> may actually arrive late to the party. The Brazilian market has been operating with better prospects for a long time, but this has accelerated in the past few months. The improved scenario priced-in in the country’s CDS is also showing up in assets. </span></p> <p><span style="font-weight: 400;">Ibovespa’s stock index is set to show double-digit growth for the fourth year in a row—or 14 percent, as it is currently. The Brazilian real lost value versus the American dollar in the past few years, but it is slowly starting to recover. Meanwhile, the prospect of better public finances— as exemplified by pension reform—and the sluggish economy make the case for lower interest rates, which would reduce the cost of loans and debts for individuals and companies, fostering consumption and investment. For comparison’s sake, 6 months ago, ten-year interest rates were about 9 percent. On July 24, they are 7.23 percent. </span></p> <p><img class="alignnone size-full wp-image-21185" src="" alt="brazil yield curve" width="1200" height="900" srcset=" 1200w, 300w, 768w, 1024w, 610w" sizes="(max-width: 1200px) 100vw, 1200px" /></p> <p><span style="font-weight: 400;">“The entire yield curve is lower because, if the country is pro-business and I have more trust in it, interest rates have to be lower too. We see the forex exchange rates reflecting a better environment, it is less depreciated (&#8230;) The assets are pricing-in the acknowledgment that we have a government that is thinking about the country for the long term,” argued Ms. Pereira.

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