“Low growth may reflect not just cyclical considerations, but more importantly the presence of structural problems, such as weak productivity growth and increasing unit labor costs which undermine international competitiveness. Moreover, a marked deterioration in investor sentiment, as evidenced by the downward trend in the Business Confidence Index, is further limiting the ability of the Brazilian economy to return to trend growth in the near term,” said Moody’s in a statement.
While it is highly unlikely an initial downgrade to Brazil’s credit rating would take the country to junk status right off the bat, the subsequent rise in yields on on Brazilian bonds would likely pressure ETFs like the Market Vectors LatAm Aggregate Bond ETF (NYSEArca: BONO). BONO allocates more than 30% of its weight to Brazil.
The iShares Emerging Markets Local Currency Bond ETF (NYSE: LEMB) allocates 12.6% of its weight to Brazil. EWZ, an equity-based ETF, could be vulnerable as well. Brazilian banks are increasingly lending to the government so it can spend the economy back to prosperity.
“Lastly, the third driver informing the change in outlook to stable involves the recurrent lending by the Treasury to public banks as well as the deterioration in reporting quality of the government accounts, based on the frequent use by the authorities of exceptions and other adjustments in primary surplus calculations. Recurrent Treasury borrowings to fund quasi-fiscal operations involving increased public sector bank lending have gone from 6.8% of GDP in 2010 to more than 9% of GDP at present adversely impacting government debt indicators,” said Moody’s.
EWZ allocates almost 28% of its weight to the financial services sector.
iShares MSCI Capped Brazil ETF
ETF Trends editorial team contributed to this post.