MercoPress. South Atlantic News Agency

Debt, inflation and a hostile Congress: the economic challenges of Lula’s fourth term

Public debt has risen by more than ten points during the current term and exceeds 82% of GDP, driven by growing mandatory spending

Luiz Inácio Lula da Silva will begin his fourth term as Brazil’s president on January 1 with an economy that has grown more than expected and record-low unemployment, but with fiscal imbalances that markets punished heavily on Monday, the first trading day after his re-election. The dollar rose more than 12% at one point to 5.60 reais, the Ibovespa index triggered an automatic trading halt at the open and long-term interest rates jumped almost two points.

The reaction reflects investors’ bets on a victory by Senator Flávio Bolsonaro, who promised sharp spending cuts. On Friday, the dollar had closed at 4.99 reais and the Ibovespa at 205,082 points, close to the record it reached after the first round. Analysts agree that the president’s first test will be the make-up of his economic team and his fiscal framework. These are the five main challenges he faces.

Debt

Public debt has risen by more than ten points during the current term and exceeds 82% of GDP, driven by growing mandatory spending, which leaves less than 8% of the federal budget for adjustable items. Lula has at times played down concerns over debt, arguing that stronger growth will solve the problem. His team has pledged to keep the current fiscal rules, which cap spending growth and set primary surplus targets, but meeting them will be harder given the commitment to raise the minimum wage above inflation, which also increases pension costs, and the new benefits announced during the campaign.

Inflation and interest rates

The Central Bank has cut the Selic rate five times in a row to 13.75%, but annual inflation exceeded the 4.5% tolerance ceiling in September, against a 3% target. The Monetary Policy Committee meets on November 4, and the real’s depreciation complicates further cuts. Lula proposes lowering rates through greater fiscal discipline without touching social programmes, while most economists argue a faster decline would require spending cuts.

Household debt

According to credit agency Serasa, nearly 84 million Brazilians and 9.3 million companies are behind on payments, a record attributed to high interest rates. The government is preparing new relief measures, such as buying distressed mortgages from banks at a discount and forgiving tax debts for small business owners, which analysts see as temporary relief.

A hostile Congress

Bolsonaro’s Liberal Party will hold the largest bloc in both the Chamber of Deputies and the Senate, in the most conservative Congress since the return to democracy. That will hamper the government’s plans to cut tax exemptions and the approval of appointments to the Central Bank, regulators and the Supreme Court, which were already difficult during the current term. Bolsonaro, moreover, does not recognise the result and has said he will seek to annul the election.

Tax reform

The new value-added tax, approved in 2023, takes effect in January, but the government has yet to set its effective rate, which independent analysts put at around 28%. The government also postponed during the campaign a bill for a selective tax on products harmful to health or the environment, such as tobacco and alcohol.