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Brazil ETF Deals With Specter Of Credit Downgrade

May 24, 2017 8:11 am
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The iShares MSCI Brazil Capped ETF (NYSE:EWZ) and other exchange traded funds with large exposure to Brazilian have recently been wracked by controversy as another political corruption probe works its way though Latin America's largest economy.

After plunging more than 16 percent May 18 in what was one of its worst intraday performances since coming to market nearly 17 years ago, EWZ rebounded Friday and has been performing admirably in the sessions since its tumble.

As Benzinga reported last week, “Brazilian President Michel Temer was allegedly caught on tape discussing cash payments to former Brazilian speaker of the house Eduardo Cunha. Investors had been hopeful that Temer’s economic agenda would bring an end to a period of political turmoil in Brazil, but they are now concerned that the Temer presidency will simply be more of the same.”

More political corruption in Brazil, a country all too familiar with such scenarios, is again threatening the country's sovereign credit rating.

“We are placing our 'BB' long-term foreign and local currency sovereign credit ratings on CreditWatch with negative implications,” said Standard & Poor's in a note out Monday. “The CreditWatch listing reflects increased risk that a disruptive or slow resolution of recent political developments could delay and undermine the ability of Brazil's political class to advance corrective policy measures in a timely fashion–in this instance, ahead of the 2018 presidential and legislative elections–while its economic and fiscal challenges continue to mount.”

If S&P downgrades Brazil's sovereign rating, it wouldn't be the first time. In 2015, the ratings agency downgraded Brazil's sovereign credit rating to BB+ from BBB- becoming the first major ratings firm to lower Brazil into junk territory. 

That downgrade came with Brazil's economy slumping and former President Dilma Rousseff's administration mired in a sweeping corruption scandal. Brazil is one of the largest emerging markets issuers of bonds, so another downgrade could weigh on some emerging markets bond ETFs holding Brazilian debt.

“The political dynamics in Brazil have worsened following recent allegations of corruption against President Michel Temer during the course of the ongoing Lavo Jato investigations,” said S&P. “ The former negative outlook on the long-term rating, which we affirmed in February 2017, reflected the risk that the government's strategy to stabilize the economy and its fiscal position could be undermined by fluid political dynamics following three years of recession and by potential fallout from corruption investigations. However, should these recent allegations against President Temer be corroborated, the president's ability to remain in office and govern effectively would likely become untenable. This could set in motion a transition process that has not been tested before.”

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