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Has Brazil’s downgrade already been priced in?

Is the market indifferent to S&P’s downgrade?

Respected – and sometimes demonized – the credit rating agencies are proud of their technical criteria and collegiate decision-making.

When they shine their spotlight on countries, they judge – with an impartiality that they claim to achieve by using econometric tools – the quality of sovereign credit. But the truth is they do much more.

Contrary to what the agencies themselves say or what those who are “ranked” would like to hear, these ratings have an impact that goes beyond credit institutions. Although they seek scientific objectivity, the agencies also use subjective criteria. For that reason, they make a lot of mistakes. But they get a lot right too.

This works on two levels. On the first level, it has an impact on economic actors who, for statutory reasons or because of decisions by their boards of directors, do not allow capital inflows to countries that have not reached “investment grade”. On the second level, the ratings become veritable weather-vanes for the formation of expectations about the performance of the whole economy. 

The agencies’ tendencies to mold opinions on a broader horizon, not just restricted to the “credit” issue, is also perceived by multilateral economic institutions.

In recent times, the IMF and the World Bank have been used more as a source of statistics and forecasting than in their original respective roles as emergency provider of liquidity and support for development.

Everything was going great and the agencies seemed right on target when they promoted Brazil in 2008. But there was a large dose of subjectivity in that “upgrade” as well.

Today, the market – having supposedly already “priced in” Brazil’s risk – appears indifferent to Standard & Poor’s recent decision. In this context, the downgrade seems not merely ill-timed and wrong, but also harmless.

There is, however, another dimension to Brazil’s downgrade. When the external debt was a big issue on the international agenda, the agencies also considered “good will in honoring debts”. This is something that cannot be measured in numbers.

Whether we like it or not, they now also assess “readiness to promote reforms”, which they see as leading to growth and competitiveness. They look at a country’s predisposition to change course and the political capital necessary to do this.

Maybe the market has actually anticipated – and assimilated – the deterioration in the quality of credit arising from some fiscal imbalance, the bad management of state-run enterprises, micro-management of concessions and the adventure of the “new economic model”. Even if these negative vectors are played down, other aspects of the downgrade may gain more strength in 2015 and 2016.

We are talking about the absence of any appetite for structural reforms (to the labor market, to the fiscal situation and the business environment) and about Brazil ’s growing distance from the great centers of world trade. These are problems that take more time to show up, but they are more corrosive.

Without reforms and greater integration with the global economy, a substantial part of the bill for the downgrade will arrive only in the next few years – and it will be large.

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