Luiz Inácio Lula da Silva won Sunday’s presidential runoff against the right-wing senator Flávio Bolsonaro, securing a fourth term that begins in January. The result ends a tense campaign, but it opens a harder phase. Brazil’s economy has beaten expectations in recent years, yet the government now faces mounting debt, expensive credit and indebted households, and it must govern with what is described as the most conservative legislature since the country’s return to democracy in the 1980s. The political mandate is clear, but the room to act on it is limited. Five challenges stand out.
Brazil’s public debt has risen by more than 10 percentage points of GDP during Lula’s current term and now exceeds 82% of GDP. The growth has pushed up borrowing costs, as investors demand more to lend to a government whose finances appear to be deteriorating.
The underlying cause is structural. Years of rising mandatory spending, such as pensions, social benefits and wage-linked items, have left less than 8% of the federal budget adjustable. In practice, most of the budget runs on autopilot, and governments can alter only a small slice without changing the law.
Signals from Lula himself have been mixed. At times he has dismissed worries about debt as “nonsense,” arguing that strong growth would solve the problem. His team has pledged to keep the current budget rules, which cap the growth of spending and set targets for the primary balance, meaning revenue minus expenditure excluding interest payments, and has hinted at tightening them. But the commitments pull against each other. Lula has promised to raise the minimum wage faster than inflation, which also lifts pension costs, and has already increased welfare benefits and promised new spending. Hitting the fiscal targets will therefore be harder, and markets will judge the new government on whether it chooses discipline or the programmes it has promised.
The second challenge is the price of money. Interest rates stand at 13.75%, yet annual inflation of 4.6% is still above the central bank’s tolerance range of 1.5% to 4.5%. The central bank delivered its fifth consecutive rate cut last month, prompted by signs of an economic slowdown, but markets expect inflation to stay above the official 3% target until as late as 2029.
That forecast is a significant constraint. It suggests that rate cuts will be gradual, and that the central bank has little room to ease quickly without risking its credibility. Lula’s platform promises lower rates through fiscal discipline that spares social programmes. Most economists, however, say rates will fall faster only if Brazil cuts spending, and it is unclear how the government will reconcile the two goals. The tension is the central macroeconomic puzzle of the coming term: borrowing costs depend on confidence in the public finances, while the political programme depends on spending.
The third challenge is private debt. A record of nearly 84 million Brazilians and 9.3 million businesses are behind on debt payments, according to the credit bureau Serasa, as high interest rates bite. That is a very large share of the population, and it helps to explain a paradox of the past years: public dissatisfaction has persisted despite strong indicators such as record-low unemployment and wage growth outpacing inflation. Employment and rising pay do not help much when a large part of income goes to servicing expensive loans.
Lula plans a new round of debt relief. The measures include discounted purchases of distressed household loans from banks and tax-debt forgiveness for some small business owners. Analysts say such steps offer only temporary relief, since they address the stock of debt but not the cost of new credit. The government has also discussed with the central bank how to restrain heavy use of easy but expensive credit, such as credit cards and unsecured consumer loans, though no proposals have been detailed. Without a change in how credit is priced and used, relief could be followed by a new cycle of borrowing and arrears.
The fourth challenge is Congress. Voters elected the most conservative legislature since the 1980s. Although Lula defeated Bolsonaro, Bolsonaro’s Liberal Party and its allies are set to control both chambers. That matters for every item on the economic agenda.
Lula’s aides have signalled that he will continue to press for reductions in tax breaks, a way of raising revenue without raising headline tax rates. But lawmakers have repeatedly resisted measures that increase the effective tax burden, and a more conservative Congress is unlikely to be more receptive.
The problem extends to appointments. During his current term, Lula has struggled to name nominees and win Senate approval for them at key institutions, including the Supreme Court, the central bank, the securities regulator and the antitrust watchdog. With the Senate shifting to the right, such confirmations are likely to become harder. That raises the possibility of vacancies or contested appointments in the very bodies that anchor investor confidence.
The fifth challenge is the implementation of the tax reform. In 2023 Lula won approval for a sweeping overhaul of consumption taxes, and a new value-added tax is set to take effect in January. Yet with under three months to go, the government has still not disclosed the effective rate, which independent analysts estimate at around 28%.
Fearing a backlash during the campaign, the administration also held off on sending Congress a bill to regulate a new tax on products considered harmful to health or the environment, such as cigarettes and alcohol. The delay could push back revenue from that tax and has fuelled criticism of the government’s handling of tax policy. With the election over, the incentive for delay is gone, and businesses will want clarity quickly in order to plan for the change.
These five issues feed into each other. High debt keeps borrowing costs elevated; high borrowing costs squeeze households and firms, which raises demands for relief that cost money; relief measures and spending promises put pressure on the budget rules; and a hostile Congress makes it harder to raise revenue or reform spending to compensate. The tax reform, meanwhile, could either support revenue and efficiency if implemented smoothly or add uncertainty if poorly communicated.
The strengths are equally real. Unemployment is at a record low and wages are growing faster than prices, which gives the government a base of popular support and some defence against the dissatisfaction caused by debt. The economy has surprised on the upside in recent years, and the central bank has begun cutting rates.
Several signals will show the direction of the new term. The first is the composition of the economic team and the early messages on the fiscal framework: a confirmation of the spending cap and primary-balance targets would reassure markets, while a loosening would raise yields. The second is the treatment of the minimum wage and pensions in the 2027 budget. The third is whether the government discloses the VAT rate and moves the delayed bill on the health and environment tax. The fourth is how quickly the central bank can continue to cut rates given inflation that stays above target. The fifth is the early relationship with the new Congress, which will show how much of the agenda can pass.
The broader conclusion is that Lula’s victory settles who governs, not how the country’s finances will be managed. His fourth term will be judged less on the growth that has surprised in the past than on whether he can combine social commitments, fiscal credibility and a divided political landscape, a combination that so far his own government’s signals have not fully resolved.
Comments