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Cablegate: Brazil: Investment Grade by 2008?

VZCZCXRO8204
PP RUEHRG
DE RUEHSO #0768/01 2571932
ZNR UUUUU ZZH
P 141932Z SEP 07
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC PRIORITY 7470
INFO RUEHBR/AMEMBASSY BRASILIA 8583
RUEHRG/AMCONSUL RECIFE 3784
RUEHRI/AMCONSUL RIO DE JANEIRO 8327
RUEHBU/AMEMBASSY BUENOS AIRES 2868
RUEHAC/AMEMBASSY ASUNCION 3108
RUEHME/AMEMBASSY MEXICO 0811
RUEHMN/AMEMBASSY MONTEVIDEO 2440
RUEHSG/AMEMBASSY SANTIAGO 2142
RUEHLP/AMEMBASSY LA PAZ 3485
RUCPDOC/USDOC WASHDC 2901
RUEATRS/DEPT OF TREASURY WASHDC
RHEHNSC/NSC WASHDC
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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