Brazil vote offers opposing politics, similar fiscal outcomes

Brazil’s October election offers voters yet another stark left-versus-right choice, but investors see less difference on the fiscal front with debt likely to keep rising under either candidate. Flávio Bolsonaro, the son of far-right firebrand and former President Jair Bolsonaro, has painted a picture of a troubled economy as he aims to unseat leftist President Luiz Inácio Lula da Silva, whom polls show holding a narrow lead.

Analysts are pricing a Lula victory followed by an adjustment that only slows the pace of debt accumulation, but markets are skeptical that either candidate could make a credible start on significantly changing the trajectory of debt. Stabilizing Brazil’s debt by 2031 would require a fiscal effort of at least 2.5 percentage points of gross domestic product, or roughly 350 billion reais ($68 billion) according to Roberto Secemski, the New York-based chief Brazil economist at Barclays.

But any fiscal tightening is made exceptionally difficult by Brazil’s rigid budget and fragmented Congress. Voters will also elect all 513 lower-house lawmakers and 54 of 81 senators, making the legislative result part of the president’s ability to deliver. “It seems unlikely that either candidate would be able to engineer a full fiscal effort” of that size, Secemski said, adding that it makes the opening measures sought by the winner an important marker, because they must be large enough to convince investors more will follow.

Brazil’s nominal deficit averaged 8.6 per cent of GDP from 2023 through 2025 and widened to 9.99 per cent in the 12 months through June, central bank data show. Gross government debt reached 81.9 per cent of GDP, up 3.3 percentage points in the first half. A central bank survey shows market economists expect primary deficits through 2029, contrary to government targets. The 2026 budget classifies 92 per cent of primary spending as mandatory, leaving discretionary expenditure at roughly 2 per cent of GDP. A lasting adjustment would have to reach pensions, payrolls, social benefits and spending indexation.

“There are virtually no ‘low hanging fruits’ in the fiscal effort to be pursued ahead,” Secemski said. TS Lombard argues Lula would pursue spending reforms after the election, even as mandatory outlays leave progressively less room for other cuts. Under its reform scenario, however, debt peaks at 94.7 per cent of GDP in 2034. It models a faster adjustment under Bolsonaro, including a proposed debt-linked spending rule, but still sees debt peaking at 90% in 2032. It also noted that Bolsonaro dropped earlier proposals to loosen the automatic indexation of government spending after encountering political opposition.

“Maybe he’d have a greater willingness,” said Marcelo Kalim, CEO of Brazilian digital bank C6, when asked whether Bolsonaro would adjust more. “But I think you only know once someone actually has the pen in hand.” The real, up 5.8 per cent this year versus the dollar and nearly 20 per cent stronger since the end of 2024, shows why investors can expect limited fiscal progress and still remain invested in Brazil.

A 14 per cent benchmark policy rate, against annual inflation of 4.44 per cent, combines with a weak dollar, strong external accounts and favorable terms of trade to further support the currency. Median forecasts in the central bank’s weekly survey of economists see the benchmark rate at 13.75 per cent by year end and 12 per cent in 2027, preserving much of the differential that fuels carry trades.

Morgan Stanley said the real’s unusually high carry could absorb more election pressure than in previous cycles, shifting some of the repricing into domestic interest rates. The support has narrowed, however. Non-residents pulled $4.2 billion from Brazilian equity and debt portfolios between March and June after adding $18.8 billion in January and February, IIF estimates show.

Richard Hall, EM portfolio manager at T. Rowe Price, said hedge funds and local investors have also reduced their exposure, leaving less fuel for a sudden unwind than several months ago. High interest rates have deeply impacted the economy, with spikes in corporate bankruptcies and families’ indebtedness.But the next president may have little sway over the real’s performance.

Hall said that, while carry gives Brazil a buffer, an external shock combined with pressure on indebted households and weaker companies could trigger a sharper slowdown, currency depreciation and even higher rates. Pramol Dhawan, head of emerging-market portfolio management at PIMCO, said those economic constraints would matter more than the winner’s ideology.

Without restored fiscal credibility, he said, Brazil would lack the conditions for a sustainable decline in interest rates, deepening the pressure on growth and debt. “The only question,” he added, “is whether that adjustment happens proactively or is ultimately imposed by market forces.”

Meanwhile, Brazilian government is evaluating mechanisms to curb the use of workers hired as legal entities rather than employees in a potential reelection of President Luiz Inacio Lula da Silva, Finance Minister Dario Durigan said on Monday.