Brazil another socialist paradise where tight fisted control over business and trade creates failure.

Brazil at risk of recession as S&P downgrades debt to near junk

Rating agency cuts Brazil’s debt one notch to BBB-, citing “fiscal slippage”, bad economic management, and one-off tricks that flattered the public accounts

Brazil’s sovereign debt is one step away from junk after Standard & Poor’s downgraded Latin America’s powerhouse economy, prompting a furious reaction from the Brazilian treasury.

The rating agency cut Brazil’s debt one notch to BBB-, citing “fiscal slippage”, bad economic management, and one-off tricks that flattered the public accounts. It warned of a widening trade deficit and weak growth for years to come.

Marcelo Carvalho from BNP Paribas said the former darling of the BRICs quartet is staring “down the barrel of a recession”, a viewed echoed on Tuesday by Mark Mobius from Templeton Emerging Markets.

The economy escaped recession with a rebound in the fourth quarter but has relapsed this year as punitive borrowing costs exact their toll. Carlyle Group had to inject $67m this month into its Urbplan real estate venture as unsold malls and commercial projects build up in the major cities. Rental prices fell 15pc in Sao Paulo last year.

Marcelo Ribera from the hedge fund Pentagono Asset Management in Brazil said the country’s “decade-long bubble” has burst, warning that the real is likely to fall by 40pc against the dollar as the excesses are purged from the system.

Brazil, Russia, and Turkey are each on the brink of recession aftertightening monetary policy to defend their currencies. All three neglected reforms during the boom years and now face much harsher global conditions as the US Federal Reserve turns off the spigot of dollar liquidity.

Brazil’s authorities rejected S&P’s claims as completely “unfounded”, insisting that the country has a primary budget surplus of 1.9pc of GDP, “one of the highest in the world”.

The downgrade is a harsh blow for President Dilma Rousseff as she prepares to host the World Cup and braces for elections this year, though the government is unlikely to change policy.

S&P said Brazil has yet to feel the full impact of a 350 basis point rise in interest rates. Yields are now an eye-watering 13pc, or 7pc in real terms. This has sucked in a rush of foreign money but at a high economic cost.

Brazil has come down to earth with a thud after the glory days of the commodity boom, when the economy seemed near take-off as the top supplier of iron ore and grains for China. It became a textbook case of the “Dutch disease”, suffering from an overvalued currency that “hollowed out” core industry. Industrial output is barely higher today than in 2008, a picture more like Italy than an Asian tiger.

Neil Shearing from Capital Economics said private sector credit has soared by over 40 percentage points of GDP in a decade, the third most extreme case after China and Thailand. This sort of increase is often the precursor for banking crises in emerging markets.

“The lessons from history are ominous. The fall-out tends to be especially painful when lending is funded by borrowing from overseas and denominated in foreign currencies”, he said.

“This is a particularly toxic combination since, when the bubble bursts, investors tend to pull the plug, exchange rates collapse and the local currency cost of servicing debt jumps. This in turn causes default rates to soar and the economic downturn to deepen.”

The risk for Brazil is that it will remain stuck in the “middle income trap”, once again unable to make the break-through into the high-productivity elite of wealthy nations.

The root cause is a failure to push through radical reforms during the boom and hack away the barriers to investment. Brazil places 116 in the World Bank’s rankings for ease of doing business, below Ethiopia. It is at 121 for enforcing contracts, 123 for starting a business and 159 for paying taxes.

A separate study by the World Economic Forum ranked Brazil 134 for competitiveness. It is 114 for quality of infrastructure, falling to 120 for roads and 131 for ports, 127 for wage flexibility, 126 for tariffs, 129 for customs red-tape, 121 for quality of education, and 136 for maths and science education. Many of these indicators have been deteriorating.

President Rousseff has avoided grasping the nettle, flirting instead with industrial subsidies and trade barriers to shield industry from competition. Brazil is still clinging to practices that have ensnared Latin America time and again.