Brazil’s economic challenges after the Lula–Bolsonaro runoff

Whether incumbent President Luiz Inácio Lula da Silva or opposition candidate Flávio Bolsonaro wins Sunday’s runoff, the next president will face significant economic challenges in 2027.

With a population of 214 million and a nominal GDP of US$4.1 trillion, Brazil is the second-most populous country in the Americas and the continent’s second-largest economy, trailing the United States in both categories.

It is also a member of the G20 and the de facto leader of the South American Mercosur bloc. Its election is therefore being closely watched around the world, particularly in Argentina, one of Brazil’s key trading partners.

According to the analysts consulted by the Herald, whoever takes office on January 5 will have to balance efforts to ease the government’s fiscal burden against the risk of slower economic growth.

Where Brazil’s economy stands ahead of the runoff Honorio Zabaleta, an economist at consulting firm Eco Go, told the Herald that Brazil’s economy is entering the runoff with “resilience,” although it is “gradually losing some momentum.”

According to official data, GDP grew 0.5% quarter-on-quarter and 2% year-on-year in the second quarter.

Meanwhile, the IBC-Br, a monthly economic activity indicator published by Brazil’s Central Bank, rose just 0.3% in August after declining in June and July. The figures point to a slowdown after stronger growth at the start of the year.

Zabaleta noted that the unemployment rate stands at 5.3%, down from 5.6% a year earlier, while real wages are rising. However, he said, “the latest data point to a slowdown, particularly in consumption.”

“This makes sense in a context of very high real interest rates,” the economist added.

Brazil’s benchmark interest rate, the Selic, stands at 13.75%, while consumer price inflation, as measured by the official IPCA index, reached 4.2% year-on-year in August.

Federico Vaccarezza, an economist and lecturer at the National University of La Plata’s (UNLP) Institute of International Relations, told the Herald that the high interest rates are attracting substantial capital inflows.

However, he stressed that they also have a significant downside. “These high interest rates are generating very high levels of household debt,” Vaccarezza said.

He identified high household indebtedness as one factor behind Lula’s poor performance in the first round on October 5.

In May, Lula expanded the coverage of the Desenrola Brasil program, which was created to help households renegotiate their debts and address the country’s high default rate. Defaults reached a record 6.6% among loans without government subsidies.

Brazil’s fiscal problem The biggest challenge facing Brazil’s economy, however, is its fiscal position.

For Zabaleta, this is the regional powerhouse’s “Achilles’ heel.” He explained that while primary revenues and expenditures — excluding interest payments on government debt — are “more or less in order,” including debt-servicing costs reveals the scale of the problem.

He stressed that interest payments leave a “significant hole” in the Lula administration’s accounts, with the fiscal deficit reaching around 9% of GDP.

According to Brazil’s Central Bank, gross general government debt reached 82.9% of GDP.

The figure is even higher under other methodologies. Argentine brokerage Portfolio Personal Inversiones (PPI), for example, said in one of its latest reports that the ratio rises to 97% of GDP under the IMF’s methodology.

Gustavo Pérego, director of consulting firm ABECEB, told the Herald that whoever wins will have to address the deficit, which he considers “already unsustainable,” despite having few tools available to tackle it. Approximately 88% of Brazil’s public spending is “automatic,” he explained.

Fiscal austerity and slower growth Echoing that assessment, Zabaleta said the priority for either Lula or Bolsonaro should be to present a credible fiscal plan to stabilize public debt and reduce uncertainty.

He believes Lula would probably focus on tighter spending controls while preserving social programs and public investment, although he said it would be difficult for him to convince investors of his commitment to fiscal discipline.

By contrast, Bolsonaro is “more likely” to pursue an agenda centered on greater fiscal discipline, spending cuts, privatizations and structural reforms, Zabaleta said.

Regardless of who wins, Zabaleta expects fiscal restraint to slow economic growth in 2027.

“Market consensus forecasts growth of 1.8% this year and 1.3% next year,” he said.

Vaccarezza said he does not expect any substantial change in economic policy if Lula wins reelection. If Bolsonaro wins, however, “the focus will be on reducing government spending.”

He nevertheless pointed to a key challenge: “He will cut public spending and seek to narrow the deficit, but he will have to strike a balance between reducing spending and keeping the economy growing.”

For an economy the size of Brazil’s, he argued, annual growth needs to reach around 3% to ensure a “sustainable pace of development over time.”

For that reason, he suggested Bolsonaro might cut public spending during the first two years of his administration before seeking to “boost growth again.”

Pérego, meanwhile, said that to rein in spending, a government led by the Liberal Party (PL) candidate would have to change the formula used to adjust the minimum wage so that increases no longer outpace inflation.

The same would apply to pensions and spending on healthcare and education, he said. Such measures would come at a time when inflation has already exceeded 5% annually, above the government’s own target.

He also suggested that stronger exports next year could help sustain economic growth. However, prices for Brazil’s main commodity exports, including soybeans and oil, would need to remain close to current levels.

Potential weather-related disruptions, such as the El Niño phenomenon, which has been particularly strong this season, could pose an additional risk.

No major changes to the economic model Vaccarezza argued that, unlike in Argentina, Brazil’s underlying economic debate has already been settled: “The fundamental economic model is not going to change.”

“Sometimes it may be a little more orthodox, sometimes a little more social-democratic, but the model is established, both in economic terms and in terms of foreign relations,” he added.

Pérego, for his part, said that if Lula is reelected, he would have to govern with what Pérego described as the most right-wing Congress Brazil has had since 1998.

“It would be very difficult for Lula to govern in a new term because, first, he would face the immediate economic challenges of running the government and, second, he would have a Congress working against him, regardless of whether his proposals were good or bad,” he argued.

Jair Bolsonaro’s son, by contrast, would likely have greater room to govern, Pérego said, “at least during the first stage of his administration.” However, he cautioned that “no one has a blank check.”

With 88% of the budget committed to fixed expenditures, the remaining 12% is divided almost equally between the Executive and Legislative branches. This gives Congress a degree of “budgetary autonomy” that allows it to set its own agenda, regardless of who occupies the presidential palace in Brasília.