Key takeaways
- The direction of economic policy is unlikely to change under Lula
- Long term inflation expectations have increased above the BCB target but should decline as uncertainty fades.
- Brazil seeks to position itself as a key player in the current geopolitical map, looking to increase Brazil’s trade links with Asia and lead the BRICS group together with China.
Economic policy developments
Since Lula Da Silva took office on 1 January, there has been a series of changes in Brazil’s economic and foreign policies. Despite initially questioning the Brazilian Central Bank’s independence and need for lower interest rates, Lula has recently toned-down his criticism of BCB President Campos Neto. However, the appointment of Gabriel Galipolo, a senior official at the Ministry of Finance, as monetary policy director at the BCB has been seen as another attempt from the government to influence the central bank’s actions.
On 3 May the BCB kept interest rates unchanged at 13.75% for the sixth consecutive meeting. There is speculation on when the BCB will start cutting rates to support the economy which, according to IMF projections, is expected to see its GDP grow by less than 1% in 2023.
The BCB said that cutting interest rates will depend on inflation getting close to the 3.25% target and the anchoring of long-term inflation expectations. The first condition has already been met while the second condition remains challenging. The de-anchoring of long-term inflation expectations is attributed to the risks of persistent global inflationary pressures and the uncertainty surrounding the new fiscal rule which will impact the trajectory of public debt and thus inflation expectations.
In March, Minister of Finance Fernando Haddad presented the new fiscal rule which sets annual primary fiscal balance targets and limits real spending growth to 70% of real revenue growth. This limit could fall to 50% if the primary balance target is missed. Being now linked to revenue, as opposed to inflation under the previous rule, the new fiscal framework risks making public spending more pro-cyclical. However, the additional condition to meet the primary fiscal target is expected to limit the scope for the administration to be fiscally irresponsible.
Stepping up foreign policy efforts
Lula has renovated Brazil’s foreign policy relations with key trading partners since January. Lula’s visit to Xi Jinping in April was important to support investment and trade between the two countries. Brazil represented the main destination for Chinese investments in 2021, accounting for almost 14% of China’s investment abroad. Moreover, Chinese investments in Brazil increased to USD 5.9 billion in 2021, the highest value since 2017, matching the amount invested by China in the rest of South America combined.
Investors were also concerned over two events during Lula’s visit to China. First, Lula suggested that Brazil and China should stop using the US dollar for trade between them and called for the BRICS countries to find an alternative currency to be used for commerce among the group. Trade with the BRICS represents a third of Brazil’s exports, with China being the top destination. Additionally, Lula condemned the invasion of Ukrainian territory but was critical of Western countries’ response to the war. In line with Brazil’s historically neutral stance on previous global conflicts, Lula used the meeting with Xi to discuss the creation of a so-called “peace club” of countries to negotiate a solution to the conflict.
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