Brazil’s fiscal position remains a source of concern for investors, even though we expect only a modest rise in the public debt ratio over President Lula’s term. Importantly, Brazil’s debt structure disincentives sustained fiscal slippage.
- Brazil’s fiscal position will deteriorate over the course of President Lula’s term, as he seeks to balance his desire to support lower income households with fiscal and political constraints.
- In our central case, Brazil’s public debt ratio will rise as the global recession justifies fiscal support. The key question is: how will Lula’s fiscal policies evolve beyond 2023?
One underappreciated feature of Brazil’s economy is that the high share of inflation and policy rate-linked debt acts as a deterrent against running a loose fiscal policy for a prolonged period. Alongside the BCB’s independence, the structure of debt acts as another institutional constraint, reducing the chances that debt goes onto an explosive path.
- That said, debt is still likely to rise moderately over time, keeping fiscal policy at the forefront of investors’ concerns. Debt reduction looks challenging given Brazil’s low potential growth rate, Lula’s pro-social spending policy stance and the risks of populism.
- Ultimately, the fiscal outlook will remain a key source of volatility for Brazilian assets over Lula’s term. However, we would need to see a more radical policy shift to justify a significant increase to Brazil’s risk premia.