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Brazil's debt rating cut to 'junk' status by S&P

The Brazilian government's sovereign debt rating was cut Wednesday to "junk" status by one of the major credit agencies, ratcheting up pressure on President Dilma Rousseff to find a way out of an economic and political crisis.

Joblessness is 10% and corruption scandal has hurt already failing economy

Brazil's debt rating has earned 'junk' status, even as the economy tanks and there is a need for investment in clean water. Here, children play in a pool in Rio de Janeiro that has no drainage system to keep the water clean. (Silvia Izquierdo/Associated Press)

The Brazilian government's sovereign debt rating was cut Wednesday to "junk" status by one of the major credit agencies, ratcheting up pressure on President Dilma Rousseff to find a way out of an economic and political crisis.

Standard & Poor's said in a note that Brazil's hard-fought investment grade status that it held for seven years was gone and that its outlook on the country was negative, just as the nation enters recession and is expected to see an even worse 2016.

That means that it will be far more expensive for the Brazilian government to tap international credit markets and that much investor money, such as mutual funds that only plow money into investment-grade nations, will automatically be yanked out of the country.

S&P said that extreme political challenges for Rousseff "have continued to mount, weighing on the government's ability" to shore up its finances as promised.

$10B deficit in budget

The downgrade comes on the heels of Rousseff submitting a budget to Congress that already had a built-in deficit of about $10 billion, meaning she tossed to legislators the burden of figuring out where to make cuts.

The downgrade, while widely expected, came earlier than many analysts forecast and arrives at a time of extreme volatility for the Brazilian economy, with inflation hovering around 10 per cent and unemployment the highest it has been in decades.

Additionally, Rousseff has almost no political backing, with her approval rating in the single digits, the worst seen by any leader since the nation's return to democracy three decades ago.

S&P said that "the negative outlook reflects what we believe is a greater than one-in-three likelihood of a further downgrade due to a further deterioration of Brazil's fiscal position."

Corruption investigation

In particular, the agency cited the "fluid political dynamics" of Rousseff's leadership and a "further lack of cohesion within the president's cabinet . due to greater economic turmoil than we currently expect."

Brazil's economy is dependent on exports of its commodities, with commodity prices and global demand at very low levels.

The news couldn't be worse for Roussef, coming while her ruling Workers' Party is fighting for its political life amid the biggest corruption scandal yet uncovered in Brazil.

The scandal involves a decade-long kickback scheme that saw what prosecutors say was $2 billion in bribes paid to politically appointed executives at the state-run oil company Petrobras, who awarded Brazil's top construction and engineering firms contracts whose final costs were wildly inflated.

S&P stated that its negative view of Brazil is linked to "ongoing investigations of corruption allegations against high-profile individuals and companies" have led to "increased near-term political uncertainty" and that "we expect Brazil's external vulnerability will rise somewhat over the next several years."

Brazil's Finance Minister Joaquim Levy said in a Wednesday night note that "the Brazilian government reaffirms its promise to fiscal consolidation."

Finance minister wants austerity

Levy, a pro-market minister disliked by the left-wing base of Rousseff's Workers' Party, has repeatedly called for stronger austerity measures, cuts in spending and for the government finding new revenues, via taxes or other means.

However, given Rousseff's lack of political capital, her government is finding it difficult to push anything through Congress.

The U.S.-based Eurasia Group political and economic risk consulting firm said in a note that the downgrade severely hurts Levy, with his "leverage within the administration" being diminished.

That will only further spook investors who see Levy as the stalwart pro-market voice within the Rousseff administration and is likely to lead to zero effort on the part of lawmakers to "endorse more meaningful expenditure cuts or higher taxes."

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