A slowing economy
The economy is projected to enter a recession in Q1 2023, following two consecutive quarters of negative growth. This is expected to be driven by a deceleration in private consumption, as household finances are affected by high borrowing costs and the cumulative effects of a hawkish Brazilian Central Bank (BCB).
Fiscal policy
The incoming government will inherit a complex fiscal situation. One of the main challenges in the near term for the Brazilian Congress is to agree on the budget for 2023, which should be voted on before the end of this year. Lula wants to pass a constitutional amendment to allow an extension of the fiscal spending cap to provide additional support to Brazil’s welfare program and increase the minimum wage, two of his campaign promises.
Analysts close to Lula’s PT party estimate the government would need an extension of the spending cap equivalent to approximately 2% of GDP to meet its fiscal plan. The bill under consideration excludes welfare programs and, in some circumstances, public investment in healthcare and education from the spending cap. This is expected to be funded by increasing public debt, which declined from over 88% of GDP in 2020 to just under 75% of GDP in 2022.
This is unlikely to be received positively by markets and opposition parties, meaning the bill is expected to be modified. Markets anticipate that Congress will finally agree on extra-cap spending between 1.2%-1.5% of GDP, limiting the deterioration of Brazil’s primary fiscal result, to a deficit of close to 1% of GDP in 2023.
Fewer, but deeper, reforms
Although in the short-term the outlook for Brazil remains negative there are a series of factors to remain optimistic for the second half of 2023. The new government will need to deal with two pending reforms, an administrative and a tax reform. However, given the opposition in Congress is stronger than in previous PT administrations, this is not expected to be a reformist government. This removes the extreme tail risks associated with the return of a left-wing party to power in Brazil.
Implications for financial markets
Brazil has not escaped the negative issues affecting the global economy: the tightening of monetary policy in the US, the rise in global inflation, the effects of China’s zero-Covid policies and the geopolitical consequences of the Russia- Ukraine conflict.
On the domestic front, Brazil will endure a deterioration of macroeconomic conditions as a result of tighter financial conditions following successive interest rate hikes by the BCB to contain inflation. Higher borrowing costs will continue to put pressure on households while expanding fiscal support will require a special approval by Congress. On the external front, the boost from high commodity prices will fade, while the global deceleration of growth will be a headwind for the Brazilian economy.