Brazil’s debt affordability is deteriorating and progress on fiscal reforms has proved slower than expected, clouding the sovereign credit outlook, credit rating agency Moody’s said.

The agency changed Brazil's credit rating outlook from positive to stable, but also affirmed the country's Ba1 long-term local and foreign currency issuer ratings.

The outlook change reflects "a tapering of upside credit risks in light of a pronounced deterioration in debt affordability and slower-than-expected progress in addressing spending rigidity and building credibility around fiscal policy," despite adherence to primary balance targets.

Moody's said the government's ability to materially reduce fiscal vulnerabilities and stabilise debt burden remains constrained by spending rigidity and rising borrowing costs, offsetting upside investment potential and economic reforms.

The agency now expects Brazil's debt burden to stabilise around 88% of GDP over the next five years, up from 82% projected in October 2024, driven by larger-than-expected interest payments.

The interest-to-revenue ratio is estimated to peak near 21% in 2025, up from around 15% in 2023.

Brazil's debt structure is highly sensitive to interest rate movements, with the central bank raising the benchmark Selic rate to 14.75% amid rising inflation expectations.

The rating agency said deeper reforms - including reducing revenue earmarking and de-linking social benefits from minimum wage increases - would be needed to address spending rigidity meaningfully.

Building consensus around such reforms would require coordination between government, Congress and the public, likely taking considerable time.

“Over the past three years, Brazil's real GDP growth has remained strong around 3%, and the government has met its primary deficit targets as expected. However, a material increase in inflation and inflation expectations in the context of strong economic activity led the central bank to resume forceful monetary policy tightening,” said Moody’s.

“As the government debt structure is very sensitive to interest rate movement, interest payments will increase materially and lead to larger overall fiscal deficits and debt accumulation in 2025-2026 than we previously expected. Market concerns over the direction of fiscal policy have also contributed to the rise in inflation expectations and risk premium on government debt.”

This comes after last week’s statistics office IBGE report indicating that Brazil's economy expanded 1.4% in the first quarter as a record soybean harvest drove agricultural output up 12.2%. The quarterly growth marked the 17th consecutive quarter of positive year-on-year expansion at 2.9%.

Agriculture, representing 6.5% of GDP, led the surge with favourable weather conditions boosting soybean production 13.3% and corn 11.8%. Services, accounting for 70% of the economy, posted modest 0.3% growth while industry declined 0.1%.

Despite industrial weakness, São Paulo's influential Fiesp trade group upgraded its 2025 growth forecast to 2.4% from 2.0%, citing expected government stimulus measures and continued investment growth to offset monetary policy headwinds.

Brazil's labour market showed resilience with 257,528 formal jobs added in April—the best performance since 2020—bringing total job creation to 922,000 positions through the first four months. The employment gains occurred across all 27 states and economic sectors despite elevated interest rates.

The economy generated BRL3.0 trillion ($524bn) in current values during the quarter, with household consumption up 1.0% and gross fixed capital formation surging 3.1%, signalling robust investment activity.