Key facts
- Brazil's presidential candidates offer contrasting approaches to reducing long-term interest rates.
- Investors anticipate continued debt increases regardless of the election outcome.
- Significant fiscal tightening is needed to stabilize Brazil's debt by 2031.
- Brazil's nominal deficit and gross government debt have both increased.
- The Brazilian real has strengthened significantly against the dollar this year.
- Non-resident investors have reduced their exposure to Brazilian assets.
Brazil's October election presents voters with a stark ideological choice between the leading candidates, but investors anticipate limited divergence on fiscal policy, with debt expected to continue its upward trajectory regardless of the winner. Analysts suggest that stabilizing Brazil's debt by 2031 would necessitate a fiscal effort equivalent to at least 2.5% of GDP, or approximately 350 billion reais. However, Brazil's rigid budget and fragmented Congress make such fiscal tightening exceptionally difficult. The 2026 budget already designates 92% of primary spending as mandatory, leaving little room for discretionary cuts.
Roberto Secemski, chief Brazil economist at Barclays, noted that there are "virtually no 'low hanging fruits' in the fiscal effort to be pursued ahead." He added that the opening measures taken by the winner will be crucial markers for investors, needing to be substantial enough to signal further fiscal discipline.
Brazil's nominal deficit has averaged 8.6% of GDP from 2023 through 2025 and widened to 9.99% in the 12 months through June. Gross government debt reached 81.9% of GDP, an increase of 3.3 percentage points in the first half of the year. Market economists, according to a central bank survey, anticipate primary deficits persisting through 2029, contrary to government targets.
TS Lombard models suggest that while Lula might pursue spending reforms post-election, debt could peak at 94.7% of GDP in 2034. A faster adjustment is modeled under Bolsonaro, with debt peaking at 90% in 2032, though he previously dropped proposals to loosen the automatic indexation of government spending due to political opposition.
Despite these fiscal concerns, the Brazilian real has shown remarkable strength, appreciating 5.8% against the dollar this year. This resilience is supported by a high benchmark policy rate of 14% against annual inflation of 4.44%, a weak dollar, strong external accounts, and favorable terms of trade. Morgan Stanley suggests the real's high carry could absorb more election pressure than in prior cycles.
However, investor sentiment has narrowed. Non-residents withdrew $4.2 billion from Brazilian equity and debt portfolios between March and June, following significant inflows earlier in the year. Hedge funds and local investors have also reduced their exposure. High interest rates have impacted the domestic economy, leading to increased corporate bankruptcies and household indebtedness. Without restored fiscal credibility, Brazil may struggle to achieve a sustainable decline in interest rates, potentially deepening pressure on growth and debt.