Late last month, leftist leader Luiz Inácio Lula da Silva won Brazil’s presidential runoff election over right-wing incumbent Jair Bolsonaro and will take office on Jan. 1. Lula, who served two terms as the country’s president in the 2000s, ran on a campaign of restoring prosperity to an economy struggling to reemerge from the COVID-19 pandemic, among other priorities. We asked Alberto Ramos, head of the Latin America Economic Research team in Goldman Sachs’ Global Investment Research, about the election and its implications for Brazil’s economy, fiscal outlook and investment environment. His responses are below.
How different is the situation in Brazil now versus when Lula last held power?
The macro-financial picture is materially different than when President-elect Lula last held power. First and foremost, the fiscal picture is a lot more fragile, with public sector debt currently tracking at close to 80% of GDP, near all-time highs, and structural primary fiscal deficits. The tax burden on the economy is also significantly higher (historically and against the emerging-markets average) and public investment is very low. Furthermore, potential GDP is lower, given low-investment/low-productivity over the last few years and the scarring effects from the deep 2014-16 recession. Finally, the external backdrop facing the Brazilian economy is more challenging, at least in the near term.
The country urgently needs policies and reforms that would leverage investment and growth and leave behind a long period of very modest growth and stagnant social and economic conditions. After all, between the first quarter of 2011 and the second quarter of 2022, average real GDP growth per capita was zero (-0.01%), and real investment spending is still 10.7% below the levels in mid-2013. A policy regime shift is needed.
What macro factors are working in his favor? What factors are working against him?
In President-elect Lula’s favor are the solid external balance sheet, a consolidated and credible inflation targeting regime, and the fact that a number of macro and micro reforms were approved in the last six years (e.g., labor reform, social security reform, etc.). The regulatory framework is also more investment friendly.
Working against the new president are the weak fiscal picture, widespread fiscal rigidities (extensive revenue earmarking and spending mandates), low potential GDP, and the complex and investment-unfriendly tax code.
How is Lula’s election likely to impact Brazil’s deteriorating fiscal position?
President-elect Lula made a number of fiscally expensive promises during the campaign. Post-election public statements made by senior members of the transition team suggest that the fiscal picture (fiscal deficit and public debt stock) is likely to deteriorate visibly in 2023. We now expect the consolidated public sector primary balance to switch back into deficit and for public debt to resume its upward trend in 2023. Overall, we see growing short- and medium-term fiscal risk in Brazil; a concerning development when taking into account that Brazil already has a much higher debt load than its EM peers, exhibits a modest growth potential, and has structurally higher real interest rates.
How are the electoral results in the legislature likely to impact his ability to make good on his campaign promises?
With the Oct. 2 legislative election, the bi-cameral congress became less fragmented, but more polarized and on balance leaning right-of-center and more conservative. President Bolsonaro’s PL party emerged from the Oct. 2 legislative election as the largest party in the House and in the Senate.
President-elect Lula will be dealing with one of the most autonomous and independent legislatures in decades and the centrist parties will likely set some policy limits (checks and balances). A right-of-center dominated Congress is likely to, for instance, limit the scope for tax increases or very large expansion of unfunded permanent spending commitments; but it’s also likely to show limited appetite for major reforms. Hence, coalition management will be key for the next president, in particular because a broad multi-party political support base in Congress could ultimately be unreliable or unstable.
What will investors be looking for from Lula in the immediate term?
We expect President-elect Lula to pursue a tax-and-spend strategy given the deeply held belief that the public sector and state-owned enterprises should be key engines of growth and investment. Such strategy could lead to higher consumption growth in the short term but also high inflation, and larger fiscal and current account deficits. Over the medium term a more activist tax-and-spend strategy would entail higher fiscal risk premia (higher debt) and lower potential growth. Finally, a Lula administration is perceived to be more committed to an ESG agenda, which could eventually pay foreign policy dividends.
In the coming weeks, market and asset price direction will likely be a function of policy statements. The market will be paying particular attention to key cabinet nominations by President-elect Lula (first and foremost, who will lead the Ministry of Finance), the budget for 2023 and the magnitude of the spending-ceiling waiver to accommodate fiscally expensive campaign promises. Investors will also want to see a more detailed outline for the set of loosely formulated policy proposals he made during the campaign, such as tax reform, the new fiscal anchor to replace the constitutional spending ceiling, and potential changes around labor reform.