Five economic challenges facing Brazil’s re-elected President Lula

Brazil’s economy has exceeded expectations in recent years, but mounting debt and entrenched structural problems could complicate leftist President Luiz Inácio Lula da Silva’s fourth term, which begins in January.

Here are the five main economic challenges he faces:

1. Soaring debt

Brazil’s public debt has surged by more than 10 percentage points during Lula’s current term to over 82% of gross domestic product (GDP), driving up borrowing costs.

The root cause is years of rising mandatory spending, leaving less than 8% of the federal budget available for adjustments.

Lula has sent mixed fiscal signals, at times dismissing debt concerns as “nonsense” while arguing that strong economic growth would solve the problem.

His team has pledged to maintain the government’s current budget rules, which cap spending growth and set primary balance targets — revenues minus expenditures, excluding interest payments on public debt — while hinting at possible tightening.

Meeting those targets will be more difficult given Lula’s promise to raise the minimum wage faster than inflation, which also increases pension costs. His administration has already raised welfare benefits and promised additional spending.

2. High interest rates and persistent inflation

Even with interest rates at 13.75%, Brazil’s annual inflation rate of 4.6% remains above the central bank’s tolerance range of 1.5% to 4.5%.

The central bank delivered its fifth consecutive rate cut last month amid growing signs of an economic slowdown, but markets expect inflation to remain above the official 3% target until as late as 2029.

Lula’s platform promises lower interest rates through fiscal discipline that protects social programmes. However, most economists say rates will fall more quickly only if Brazil cuts spending, and it remains unclear how Lula will reconcile the two objectives.

3. Debt-laden households and businesses

A record nearly 84 million Brazilians and 9.3 million businesses are behind on debt payments, according to credit bureau Serasa, as high interest rates take their toll.

The situation has fuelled public dissatisfaction despite positive economic indicators, including record-low unemployment and wage growth outpacing inflation.

Lula plans another round of debt relief, this time through discounted purchases of distressed household loans from banks, alongside tax debt forgiveness for some small business owners. Analysts say such measures offer only temporary relief.

The government has also discussed with the central bank ways to curb the heavy use of easily accessible but expensive credit, including credit cards and unsecured consumer loans. However, it has yet to provide details of any proposals.

4. Limited political capital for reforms

Lula will likely struggle to push his economic agenda through Congress after voters elected the most conservative legislature since Brazil returned to democracy in the 1980s.

Although he defeated right-wing Senator Flávio Bolsonaro in Sunday’s runoff, Bolsonaro’s Liberal Party and its allies are set to control both chambers of Congress.

Lula’s aides have indicated that he will continue pushing to reduce tax breaks, but lawmakers have repeatedly resisted measures that increase the effective tax burden.

During his current term, Lula has struggled to nominate candidates and secure Senate approval for key positions at institutions including the Supreme Court, central bank, securities regulator and antitrust watchdog. The rightward shift in Congress is likely to make the process even more difficult.

5. Uncertainty over tax reform

Lula secured congressional approval in 2023 for a sweeping overhaul of Brazil’s consumption taxes, with a new value-added tax scheduled to take effect in January.

With less than three months remaining, the government has yet to disclose the effective tax rate, which independent analysts estimate will be around 28%.

Fearing a backlash during the election campaign, the administration also delayed submitting a bill to Congress to regulate a new tax on products considered harmful to health or the environment, including cigarettes and alcohol.

The delay could postpone revenue from the tax and has fuelled criticism of the government’s handling of tax policy.

Credit: Reuters