People stand in front of graffiti mocking the Brazilian currency note, the real, in downtown Rio de Janeiro, Brazil July 31, 2014.
People stand in front of graffiti mocking the Brazilian currency note, the real, in downtown Rio de Janeiro, Brazil July 31, 2014.

Moody's Investors Service on Tuesday warned it may cut Brazil's credit rating in the next couple of years as the economy slows, piling pressure on the winner of October's presidential elections to change course on economic policy.

Ahead of the Oct. 5 vote, debate about whether to tighten fiscal policy is now a hot campaign topic. President Dilma Rousseff, who has indicated she won't radically alter policies if re-elected, faces a strong challenge from environmentalist Marina Silva, who is keen to cut government spending.

While Rousseff has not directly responded to Moody's, the Finance Ministry said in a statement the ratings firm based its decision on temporary factors that hurt growth in the first half of the year, without taking into account a possible recovery in the next few months.

Aecio Neves, who stands third in opinion polls, said in a statement Moody's decision is a reminder Brazil's social and economic progress is “at risk” due to fiscal indiscipline.

Representatives for Silva were not immediately available to comment.

Under Rousseff, growth has slowed to an average of less than 2 percent a year, with a recession in the first half of 2014, while heightened government spending has led to an increase in Brazil's debt burden.

Moody's revised the outlook on Brazil's “Baa2” rating to negative from stable, saying it could downgrade if it sees indications the next government will not tighten fiscal policy and if growth remains at a low 1 to 2 percent.

“Should the deterioration in the country's key credit metrics, in particular fiscal and government debt indicators, remain unchecked during the first two years of the incoming administration, this can significantly undermine Brazil's sovereign creditworthiness,” Moody's said in a statement.

The firm expects Brazil's gross domestic product to expand less than 1 percent in 2014 and less than 2 percent in 2015, below a potential growth rate it estimates at around 3 percent.

A “marked deterioration” in investor sentiment caused by “widespread market perception about the interventionist approach of the current administration” contributed to the decision, Moody's said.

Brazilian markets slipped further after the warning, with many analysts considering a downgrade almost inevitable. Both the real and the Bovespa stock index closed with losses of nearly 1 percent, also hurt by an opinion poll that showed Rousseff narrowing Silva's lead in a likely runoff in late October.

A downgrade could add to Brazil's problems as it could increase government borrowing costs.

“The downgrade will come in the beginning of next year,” said Marcos Casarin, an economist with Oxford Economics in London. “The fiscal situation will not improve until the first quarter of next year and may even worsen when we find out how deep this [fiscal] hole is.”

Standard & Poor's cut Brazil's credit rating to the near junk status of “BBB-minus” in March. Fitch Ratings is the only of the big three ratings agencies to keep a stable outlook on Brazil with a “BBB” rating, equivalent to Moody's “Baa2”.    

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