Latin Debt Warning Sounded

Latin American credit-worthiness was called into question Thursday as Moody’s Investors Service downgraded Brazilian and Venezuelan bonds and issued warnings about Mexico and Argentina.

The downgrades, on the heels of Colombia’s decision Monday to devalue its currency, heightened jitters across the region and sent markets tumbling anew.

“We think circumstances have fundamentally changed. It’s the external environment, the reduced availability and higher cost of financial resources for emerging markets” that prompted the downgrade, said Moody’s senior analyst Ernesto Martinez-Alas.

The “external environment” meant the growing cloud over all emerging markets as the effects of financial crises spread from Asia and Russia.

“It’s not the news the region needed on a day like this,” said James Upton, Latin American equity strategist at Credit Suisse First Boston. “The markets have lost the ability to make a distinction between countries or look at fundamentals, and they are really in a panic. They have turned on emerging markets and on Latin America.”

Meanwhile, Moody’s today said it also may downgrade China’s foreign-currency-denominated debt, as China faces weakening exports and falling foreign investment.

In Latin America, Brazil’s main stock index fell 8.6%. South America’s largest economy also revealed it has spent more than $10 billion since July to defend its currency, the real, leaving about $60 billion in foreign reserves.

That’s about what Brazil spent during a run on the currency late last year, which it successfully fought off with an austerity program and interest rate hike.

“The more negative stimuli that hit the market, the greater becomes the prospect of a self-fulfilling prophecy regarding further contractions in the market,” said Lawrence Goodman, economist at Santander Investment.

At a meeting with Latin finance ministers in Washington, the International Monetary Fund offered support for Latin American economic policies but stopped short of pledging immediate cash.

In Mexico, stocks slid 2.4% and the peso plunged to a record low of 10.14 to the dollar, the first time it has closed below the psychologically important barrier of 10.

Some analysts predict Brazil may have to raise interest rates to keep capital from fleeing the country, although few expect a devaluation. The administration of President Fernando Henrique Cardoso is reluctant to raise rates because that would stifle growth and worsen the government’s deficit.

Analysts including Edmar Bascha, economist at Bank BBA-Creditanstalt in Sao Paulo and a former Cardoso advisor, reiterated the need for fiscal reforms to reduce government spending.

Moody’s cut Brazil’s bonds by a notch to B2 from B1, or five levels below investment grade.

The downgrade means Brazil will pay a much higher interest rate as it rolls over or adds to its $220 billion in dollar-denominated debt. Over the next 15 months, Brazil is expected to refinance about $15 billion of its debt, said Jaime Valdivia, Latin American debt strategist at Morgan Stanley, Dean Witter, Discover.

The lower rating, which puts Brazil in the same category as Bulgaria, means Brazil will have to pay 20% interest on 10-year bonds, up from 13% now, Valdivia said.

That will only add to Brazil’s yawning budget deficit, which now represents about 7.5% of economic output, or twice the prudent ratio. Moody’s downgrade did not come as a complete surprise--Brazil had been on Moody’s “watch” list.

“If they continue to lose reserves, they will have to tighten up monetary policy, raise interest rates. Ideally, that should come with a new fiscal package that would include significant spending cuts and reforms,” Bascha said.

But Brazil’s leaders are working a delicate balancing act in that they can’t raise rates so high that they fall into “the Russian trap,” lifting them to a level that borrowers cannot pay, Bascha added.

Venezuela’s debt was also downgraded to B2 on a day that saw the government fail for a third time to sell the state-owned aluminum business, proceeds from which are needed to lessen a budget shortfall. Venezuelan stocks plunged 7.5%.

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Crumbling Latin Markets

Latin American stock markets plunged anew on Thursday after Moody’s Investors Service cut Brazil’s and Venezuela’s debt ratings. The main share index in Brazil plunged 8.6% to a two-year low. In Mexico, the Bolsa index slid 2.4% after having rebounded Wednesday from a two-year low.

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BRAZILIAN STOCKS

Bovespa index, monthly closes and latest:

Thursday: 6,218.51

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MEXICAN STOCKS

Bolsa index, monthly closes and latest:

Thursday: 3,102.39

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Source: Bloomberg News