The risks were starkly evident. President Luiz Inácio Lula da Silva’s top economic advisors had repeatedly warned him: tampering with the fiscal austerity plan would trigger a selloff in Brazilian financial markets. Despite these warnings, Lula chose to ignore them. He instructed his team to include tax-relief measures for the poor in the package, undermining the fiscal savings that the plan was supposed to generate. As predicted, the markets reacted immediately—stocks dropped 2.4%, continuing their months-long decline, and the Brazilian currency hit an all-time low against the dollar.
At 79 years old, Lula finds himself facing a critical juncture in his presidency. Nearly two years into his second term, he has proven less of the pragmatic political figure who made tough decisions to keep investors satisfied, as he did in the past. Now, the key question is whether he will continue to resist the advice of his economic team and push forward with a deficit-reduction plan that lacks the aggressiveness needed to stabilize Brazil’s economy.
Following the currency slump, traders have started to speculate that Brazil’s central bank might have to raise interest rates as high as 15%—at a time when most countries are cutting borrowing costs—to control inflation. Milena Landgraf, a partner at Jubarte Capital, remarked, “The government is not willing to bear the political cost needed to improve the outlook for public accounts. It missed the opportunity to change expectations.”
The fiscal plan aimed to cut roughly 70 billion reais ($11.6 billion) by 2026, through limiting hikes in the minimum wage, top civil servant salaries, and bonuses for low-income workers. It also set a minimum retirement age for military personnel and prohibited the creation or expansion of tax cuts when there’s a primary budget deficit.
But when it came time to announce the spending cuts, Lula was concerned about public reaction. According to sources familiar with the matter, Lula even sought input from his campaign marketing advisor on how to frame the announcement. This led to the decision to exempt workers earning up to 5,000 reais per month from income taxes. To make up for lost revenue, the government proposed higher taxes on incomes above 50,000 reais.
This decision was a clear setback for Lula’s economic team. Many were left hoping that investor sentiment would improve once the measures were debated in Congress. Tiago Sbardelotto, an economist at XP Inc., noted the frustration among officials: “The package not only fell short of expectations, but it also included a complex measure that could worsen fiscal outcomes in the short term.”
By the following day, Brazil’s political leadership moved quickly to limit the fallout. House Speaker Arthur Lira reassured markets on social media that Brazil’s fiscal rules would be upheld. Senate President Rodrigo Pacheco’s office issued a statement clarifying that changes to income tax rules wouldn’t be implemented until conditions permitted. Finance Minister Fernando Haddad also tried to contain the damage, suggesting that the fiscal package was not the final word on Brazil’s fiscal reforms and that future changes could be made to disability benefits and social security.
While these comments helped slightly stabilize the situation, the damage was already done. The real ended the week 2.8% lower, and stocks fell 2.7%, hitting their lowest point since June. The market began pricing in multiple rate hikes from the central bank in the coming months.
Guido Chamorro, senior portfolio manager at Pictet Asset Management, noted that despite the high yields in Brazil’s local assets, the fiscal uncertainty remains a significant concern. “For investors, the fiscal issue is the cloud on the horizon that doesn’t go away.”
After reassessing the numbers, several private-sector economists drastically lowered the government’s estimated savings from the fiscal plan. Banco Santander reduced the expected cuts to 40 billion reais over two years, just over half the government’s estimate. Bradesco forecasted cuts of only 10 billion reais in 2025 and 22 billion reais in 2026, with most savings coming from indirect measures.
In addition to the income tax exemption, investors were disappointed by what they saw as overly cautious changes to minimum wage hikes and gradual cuts to bonuses for low-income workers.
As Brazil’s fiscal situation worsens, especially with rising borrowing costs, the challenge for Lula will only grow. Public debt stood at nearly 7.1 trillion reais in October, nearing an all-time high, while the government’s budget deficit had surged to 9.5% of GDP—double the figure when Lula took office in January 2023.
The government hyped up the market for weeks, only to combine the cuts with the tax exemption,” said Gordian Kemen, head of emerging markets sovereign strategy at Standard Chartered. “It’s just terrible optics.
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