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DE RUEHSO #0768/01 2571932
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TO RUEHC/SECSTATE WASHDC PRIORITY 7470
INFO RUEHBR/AMEMBASSY BRASILIA 8583
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RUEHRI/AMCONSUL RIO DE JANEIRO 8327
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RUCPDOC/USDOC WASHDC 2901
RUEATRS/DEPT OF TREASURY WASHDC
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RUEHC/DEPT OF LABOR WASHDC
RUEHRC/USDA FAS WASHDC 0690

UNCLAS SECTION 01 OF 03 SAO PAULO 000768 
 
SIPDIS 
 
SIPDIS 
 
STATE FOR WHA/BSC, WHA/EPSC 
STATE PASS USTR FOR KATE DUCKWORTH 
STATE PASS FED BOARD OF GOVERNORS FOR ROBITAILLE 
STATE PASS EXIMBANK 
STATE PASS USTDA FOR AMCKINNEY 
STATE PASS OPIC FOR DEMROSE, NRIVERA, CMERVENNE 
NSC FOR TOMASULO 
TREASURY FOR JHOEK 
USDOC FOR 4332/ITA/MAC/WH/OLAC 
USDOC ALSO FOR 3134/USFCS 
 
E.O. 12958: N/A 
TAGS: EFIN ECON EINV BR
SUBJECT: BRAZIL: INVESTMENT GRADE BY 2008? 
 
 
Summary 
------- 
 
¶1.  (U) Amid public speculation surrounding Brazil's possible ascent 
to an investment grade bond rating, Econoffs visited the credit 
ratings agencies Standard and Poors (S&P) and Moody's to solicit 
their views.  Both ratings agencies have divergent opinions about 
the quality of Brazil's fiscal accounts and thus differ on when they 
see a potential move to investment grade for the country.  S&P 
believes the increase in Brazil's public sector spending is 
controlled, while Moody's remains concerned that the spending on 
domestic programs is too high.  The decision to upgrade is, 
therefore, far from certain, and as Brazil lags behind other 
investment grade countries especially in its relatively high 
external debt burden, the ratings agencies appear to be proceeding 
cautiously.  Ultimately, Brazil must convince the ratings agencies 
that Brazilian investments are stable and secure before they are 
willing to risk their reputations.  Both agencies agree that even if 
Brazil obtains an investment grade credit rating, the benefits 
likely would be minimal because investors already consider many 
Brazilian assets investment grade.  End Summary. 
 
Considerable Divergence Among Ratings Agencies 
-------------------------- 
 
¶2.  (U) Credit ratings agencies Moody's and Standard and Poor's 
(S&P) presented two different views of Brazil's progress toward 
achieving an investment grade sovereign bond rating in recent 
meetings with Econoffs.  S&P Managing Director for Brazil, Regina 
Nunes said that the rating agencies are less consistent in Brazil 
than in any other country with S&P having moved Brazil to one step 
below investment grade significantly earlier than Moody's when they 
made the move back in March of this year.  Only on August 20 did 
Moody's upgrade Brazil's foreign currency sovereign bond rating to 
investment grade and the local currency rating to one notch below 
investment grade with the overall rating remaining one notch below 
investment grade.  S&P, on the other hand, looks more favorably on 
local currency bonds, which are investment grade, than on foreign 
currency bonds, at one step below. 
 
¶3.  (U) Luiz Tess, Representative Director for Moody's Latin America 
told Econoffs that Brazil's fiscal performance indicators do not 
meet the standards of other investment grade countries.  In 
reviewing Brazil's spending patterns over the long term and in light 
of past trends, Moody's sees a troubling trend in increased 
government spending.  Tess pointed to 26,000 new public sector jobs 
and increased spending of more than $3 billion USD planned for next 
year.  In order for Moody's to have a positive outlook, Brazil needs 
to show that interest rates, its debt profile, and other fiscal 
indicators are declining.  [Note: This more cautious view of 
Brazil's chances of obtaining the investment grade rating was called 
into question when Moody's Investor Services Vice-President recently 
told Brazilian press that Brazil is very close to obtaining 
investment grade.  End Note.) 
 
¶4.  (U) S&P painted a more positive picture of the Brazilian fiscal 
sector.  Nunes told Econoffs that S&P believes the Brazilian 
government is spending more than last year, but not above what the 
government budgeted for the year, and therefore S&P has already 
built it into their models.  Furthermore, she acknowledged that 
Brazil spends a lot, but noted the capability of payment and the 
quality of spending determines Brazil's future ability to pay, and 
Brazil also is capable of financing itself domestically.  (Note: 91 
percent of Brazil's public debt is domestic.  End Note.)  She also 
highlighted that qualitative spending is more important for Brazil 
than quantitative spending targets, and in Brazil's case, simply 
cutting spending could do more damage than good. 
 
SAO PAULO 00000768  002 OF 003 
 
 
 
¶5.  (U) Mauricio Oreng, Vice President of Economic Research at Banco 
Itau, Brazil's second largest bank, sees no problems in the external 
sector but agreed with Moody's that the fiscal sector is 
problematic.  He told Econoffs that foreign reserves are at an 
historic high, external debt is declining, and the GoB is 
maintaining the primary surplus at 4.5 percent of GDP, a figure that 
the GoB would be unable to reduce due to delays in implementing 
infrastructure and government expenditure projects.  He believes 
fiscal policy previously was the Achilles heel to getting investment 
grade, but does see an improvement there as well. 
 
Debt Burden an Obstacle 
----------------------- 
 
¶6.  (U) Financial analysts often cite Brazil's net debt burden as 
one of the primary arguments against classifying Brazil as 
investment grade.  Both S&P and Moody's noted that other investment 
grade countries have much lower debt to GDP ratios than Brazil's 44 
percent.  Even Mexico's debt to GDP ratio, considered high among 
investment grade countries, is about 30 percent, but has the 
important advantage of the proximity to the US market.  Brazil's 
over $160 billion USD in foreign reserves demonstrate its ability to 
repay, however potential repayment does not mean Brazil would 
actually repay or that creditors would accept prepayment of Brazil's 
debt.  Nunes did note, however, that S&P was more concerned about 
Brazil's debt profile two years ago than today, despite higher 
spending, because Brazil has brought its net debt to GDP ratio down 
from 56 percent in 2002. 
 
Investment Grade Not the Silver Bullet but a Big Advantage 
------------------------------------ 
 
¶7.  (U) Brazil is unlikely to see any major improvements if the 
ratings agencies upgrade its sovereign rating to investment grade, 
but there are considerable benefits on the margins.  A sovereign 
rating usually serves as a credit ceiling for companies and 
government alike, and an upgrade to investment grade would 
immediately raise the credit worthiness of those companies and 
government agencies impeded by the country's overall credit rating. 
 
 
¶8.  (U) Ratings agencies have already designated several Brazilian 
companies and banks investment grade.  Furthermore, Tess told 
Econoffs that the market already has calculated the upgrade into 
asset prices.  An upgrade would, however, open up the possibility 
for institutional investors to buy Brazilian assets that are 
otherwise restricted to investment grade assets.  It also would help 
improve Brazil's debt profile by extending debt maturities and 
reducing the spreads between Brazilian bonds and U.S. Treasury 
Bills. (Note: Nearly one third of Brazil's public sector debt 
matures in less than three years.  End Note.)  Lower borrowing costs 
also would free up cash for investments. 
 
Split Rates Problematic 
----------------------- 
 
¶9.  (U) Two of the three ratings agencies already assign different 
credit ratings to local and foreign currency bonds, but consistent 
local and foreign currency bond ratings of investment grade are 
normally required for investors to consider a country investment 
grade.  The likely scenario in which only one of the two primary 
agencies (S&P and Moody's) upgrades Brazil also complicates the 
immediate benefits that Brazil would receive.  Some institutional 
investors are prohibited from buying assets if both agencies do not 
agree, and Brazil would have to wait for the other to upgrade before 
enjoying any positive advantage from the rating. 
 
SAO PAULO 00000768  003 OF 003 
 
 
 
Investment Grade by Next Year? 
------------------------------ 
 
¶10.  (U) The big question that everyone is trying to predict is 
whether Brazil will achieve investment grade by next year.  Oreng 
told Econoffs Brazil should have investment grade by the end of 
¶2008.  Nunes believes investment grade will come if Brazil's economy 
follows the status quo, but acknowledged that investment grade is 
not a slam-dunk yet.  S&P has given Brazil seven positive actions on 
the sovereign rating since 2002, and maintains a positive outlook 
over the next 18 months.  Brazil has beaten targets every month so 
far, but Nunes expressed concern that Brazil could have problems if 
liquidity and worldwide growth decline.  Tess said Moody's does not 
see investment grade in the near term unless the GoB exhibits more 
fiscal discipline and reduces debt levels. 
 
¶11.  (U) Credit ratings measure the level of risk within a country 
relative to other countries and the timing depends on the relative 
performance of other investment grade countries.  Brazil's foreign 
reserves are impressive, but not as high as other investment grade 
countries.  Russia, for example, has three times its debt in 
reserves, while Brazil's reserves barely cover net debt.  Nunes 
noted it took S&P seven years to rate Mexico investment grade and 
six years each for South Africa and Spain. Statistically speaking, 
she said S&P upgraded 36 percent of countries previously one notch 
below investment grade within two years, 17.3 percent in three 
years, and another 22 percent in five years. 
 
Comment 
------- 
 
¶12.  (U) Despite ratings agencies' and investment analysts' public 
pronouncements that investment grade is inevitable, the jury is 
still out whether Brazil will receive the coveted investment grade 
credit rating before the end of 2008.  Brazil's economic 
performance, however, continues to outpace expectations, so an 
upgrade could come sooner than expected.  The jump to investment 
grade is harder than other upgrades and ratings agencies' 
credibility rests in their ability to minimize investment risk. 
Brazil still needs to demonstrate that its economic performance, 
(currently anemic in comparison to similar developing economies), 
and fiscal policies are such that the odds of a reversal on the 
sovereign rating are minimal.  Only then will the agencies believe 
Brazil is a consistent investment grade option and grant the country 
the coveted investment grade rating.  End Comment. 
 
¶13.  (U) This cable was coordinated with the Treasury Attache and 
Embassy Brasilia. 
 
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