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Why S&P Warning Brazil With Junk Rating Might Actually Be Good

There is yet another incident happening in South America, and it just makes you wonder how long the vicious cycle of socialism versus capitalism can be played as a financial and economic shell game. Tuesday afternoon brought news that the ratings agency of Standard & Poor’s was threatening Brazil with potential “junk bond” ratings.

It may seem counterintuitive here, but S&P’s warning to Brazil could ultimately bring good news down the road. 24/7 Wall St. would like to pose this question: What if Brazil is actually forced back into ultimately living up to its economic growth potential again?

S&P did maintain the “BBB-” rating for Brazil, the lowest rung of investment grade. Where this gets complicated is that S&P changed the outlook for Brazil’s foreign-currency debt to “negative” from “stable.” That means that S&P would likely be able to downgrade Brazil in the months or quarters ahead if there are no improvements in Brazil or if things continue to get worse.

If you want things complicated further, outside of what S&P’s warning noted, Brazil’s political bias under more socialist regime that is less friendly to business and less friendly to capital makes seeing how things will improve very difficult. Many corporate conference calls around earnings from the largest US companies keep pointing to the challenges around the Brazilian economy.

This matters for the likes of Petróleo Brasileiro S.A. (NYSE: PBR), or Petrobras, and iShares MSCI Brazil Capped (NYSEMKT: EWZ), even their values did not fall on the news. Again, it could ultimately force Brazil’s politicians and voting public into a more realistic economic climate that is sustainable over time.

It was just four months ago that S&P had reaffirmed its stable outlook for Brazil. S&P noted that the country’s political and economic conditions have deteriorated quickly since then. The risks have also tilted toward the downside with a deeper economic slowdown and political resistance to use austerity to lower its debt burden.

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S&P now sees greater than a 1-in-3 chance that Brazil’s fiery politics will undermine the previous efforts to improve Brazil’s economy. The nation just seems to be unable to live within the means that President Dilma Rousseff had indicated. Rousseff’s allies and backers have been turning away from her – approval ratings for President Rousseff and her government having declined to less than 10%. Does this set the stage that perhaps Brazil’s political regime ahead might revert back to being more friendly to business.