We can reassess the direction for Brazil if there is no fiscal improvement, says vice president of Moody’s

NEW YORK – The risk rating agency Moody’s Brazil’s credit rating outlook improved from stable to positive, but still sees a “challenging” fiscal situation in the country. The change, announced this Wednesday, 1st, was motivated by the economic growth trajectory, which improved when compared to pre-pandemic years, and also by the expectation of a more positive design of public accounts, with the new fiscal framework working to stabilize Brazilian debt ahead.

“If this doesn’t happen, we will have to reassess the direction, right?”, warns Moody’s vice president for sovereign risk, Samar Maziadfrom New York, in an exclusive interview with Estadão/Broadcast. In his view, more than ambitious fiscal targets for the coming years, what matters is the direction, the commitment to the fiscal framework, which has not yet been able to convince the market.

As for Brazil’s chances recover the investment grade in the government of the president Luiz Inácio Lula da Silva, Maziad reinforces the chorus to the inspector: “This question will still have to be answered, but it will still be some time before we can talk about another positive movement”. Brazil is two steps below investment grade by Moody’s. Below, check out the main excerpts from the interview.

Moody’s changed Brazil’s outlook to positive, but maintained the rating. Why? What motivated the change at this time?

We have to have a more medium-term vision. About the moment of improvement in the outlook, some good news, some bad, coming. So our decision is not driven by the news cycle. It’s more of a medium-term and future vision. But, the main trigger is that we already see a reinforcement in the credit profile due to growth performance, which will be weaker this year than last year, but we see an expansion dynamic different from the pre-pandemic period, when we had years of low growth, and even the recovery from the (Operation) Lava Jato crisis, which was slow and took a long time.

But Brazil will grow less this year…

Looking ahead, we have a different growth dynamic. In the last two years, we have been positively surprised and even our future projections are not bad. We forecast an expansion of 2% this year and this is an indication of an improvement in the credit profile. So we hope this continues. This was a key factor in improving the outlook (from Brazil’s note) to positive. We also consider the fiscal trajectory and base our scenario on gradual fiscal consolidation. And fiscal will be better than last year, and I hope it will be consistently better over time. Therefore, we would like to see gradual but consistent fiscal consolidation.

But recently, the government changed its fiscal goals and announced less ambitious targets for the coming years. What is Moody’s view of this review? How concerned is the agency?

Our scenario foresees a primary deficit this year and a smaller primary deficit next year. So we see this improvement. In a way, what matters is the direction and stance, the commitment to the fiscal framework, which still needs some work, because the market is not aligned with the government’s forecasts. The implementation or results of the new rules are fundamental to improving the credibility of the framework.

Is changing fiscal targets a threat to this year’s target or the framework?

The limitations or deficiencies of the new fiscal framework remain, which is the dependence on revenue. That somehow hasn’t changed. Changing goals creates noise and doubts about the risk of further revisions. However, the review is related to a lower volume of revenues due to measures approved in Congress, which requires actions on the expenditure side, and we have not yet seen that. But it does not mean that this year’s fiscal target will be revised. The point is that additional measures will be needed to reach the target in 2025. It is still a challenging framework, but overall, improving performance over time and allowing for debt stability, which is what we have in our base scenario, then talk with a positive outlook. If that doesn’t happen, we’ll have to reevaluate the direction, right?

But the need for new measures to meet fiscal targets arises amid the deterioration of the government’s relationship with Congress. What are the risks?

We mention the measures and reforms in changing the perspective. This is also behind the improvement in the credit profile. This not only refers to what happens in government, but also in Congress. We recognize, of course, the role of Congress in enabling reforms or fiscal consolidation. So, for next year, not all measures were approved and this has to do with political risk and perhaps the goals will not be achieved because of this. It’s a risk factor. And, if this risk factor remains and revenues do not come in, the government may have problems achieving fiscal targets.

Could changing fiscal targets postpone an improvement in Brazil’s rating?

Changing the goal means lower ambition. That is the problem. This is a risk factor and not just the target. For us, the important thing is not only to change the number, but the policy, the direction. Therefore, the fiscal does not improve, which means that the debt does not stabilize. The change in the fiscal target is a sign, but if the improvement is implemented, that’s what matters.

Moody’s mentioned the benefit of reforms in changing Brazil’s outlook. In the agency’s view, which are the most important after tax?

We are not seeing a major initiative on the horizon, but it is necessary to continue supporting investment and improving the business environment. Currently, the biggest advance that could happen is on the fiscal side, showing that the new framework can provide fiscal sustainability. This is essential at this time. This will support a lower risk premium, lower interest burden and more overall confidence in the direction of fiscal policy. But specifically, measures that support energy transition and attract investments in clean energy will be important for medium-term growth prospects, which is indeed a key factor in improving Brazil’s rating outlook.

But does Moody’s see the current government’s appetite for reforms, to work on these points? Because we see different currents in the current administration…

After tax reform, and we still need all the regulation, which should be at the top of the agenda, but it is important because, without it, the reform cannot be implemented. A fundamental step is to focus on the green taxonomy, the carbon market and elements that support more investments in this area. So those are the two areas where I think we see a lot of discussion.

Is Brazil on track to recover investment grade under Lula’s government?

We have a positive outlook. A higher rating will depend on the fiscal path, so that question has yet to be answered, but it will be some time before we can talk about another positive move. Brazil is two steps below investment grade at the moment.

The Fed kept interest rates unchanged again and the market fears that the first cut will be delayed even further due to inflation, in addition to greater geopolitical risks. How could the external scenario impact Brazil in terms of growth and monetary policy?

The position of monetary policy in Brazil may be somewhat influenced by global interest rates, but perhaps less so, because the differential is still very high between local and US rates. So, there is room for the Central Bank in Brazil to continue pursuing its objectives. But most importantly, driving the risk premium and borrowing costs for the government, is the uncertainty surrounding the fiscal path. This is an important point because Brazil pays a lot of interest on its debt, and this is fundamental. It is also a credit constraint. Improving the credibility of the fiscal framework will reduce interest burdens as rates begin to decline.

Do domestic problems weigh more than external ones?

For Brazil, at this moment, probably yes. I think the balance of risks is more influenced by domestic factors.

How concerned is Moody’s with the choice of the future president of the Central Bank in Brazil?

Now, we have an independent Central Bank in Brazil. This was an improvement that supports the monetary policy framework. So we just have to see that. We cannot comment on this.

The Minister of Finance, Fernando Haddad, spoke about the expectation of reports from Moody’s and Fitch. Was the release today already planned or did it have something to do with the minister’s speeches?

We have a process and we give authorities a chance to review the release before it is released to the press and then we publish it. Therefore, it was unrelated.