Brazilian stocks, the real and government bonds sold off sharply after Luiz Inácio Lula da Silva won re-election. Investors now want to know whether he can fund his promised social measures while containing the country's rising debt. Analysts expect initial signals of fiscal restraint, but his spending agenda and a hostile Congress could complicate that.
Brazil's benchmark stock index tumbled 13.9% on Monday, the sharpest daily decline since the start of the COVID-19 pandemic. The real fell nearly 8% against the U.S. dollar, the most since 1999.
The yield on Brazil's 10-year government bond rose 2.46 percentage points to its highest level in more than a decade. The moves wiped out a rally in Brazilian assets that followed Flávio Bolsonaro, seen as the more market-friendly candidate, winning the first-round vote in early October.
Costly promises meet nervous bond markets
Lula has promised expensive measures for his base, including minimum-wage increases ahead of inflation, tax cuts on food essentials and a 40-hour working week without pay cuts. Meanwhile, growth is slowing and inflation and interest rates are high.
Bond markets are already uneasy with Brazil's growing debt-to-GDP ratio, and are likely to demand an ever-higher premium if public spending rises significantly. The Brazilian Treasury canceled two planned bond auctions scheduled for this week amid concerns over demand and soaring yields.
Rafael Ch of Signum Global Advisors said he believes Lula will manage the tension through sequencing: reassure markets initially, then seek greater fiscal flexibility later. Reassurance will come through signals that he is preparing measures to increase the 2027 primary surplus and appointing a market-conscious finance minister, Ch added.
Analysts expect modest reform
Elizabeth Johnson of TS Lombard said Lula faces a fiscal crisis "largely of his own making". She said market-calming measures should be expected, including curbing civil-service benefits, reducing subsidized credit and a proposal for a new sin tax in the coming days.
Johnson's base case is a modest fiscal reform that helps avert a major fiscal crisis in 2027. Lula will rush to approve reforms before the new legislature convenes in February, she said.
In the short term, Brazilian stocks would nonetheless suffer, according to Russ Mould of AJ Bell. He noted that the Ibovespa had been the best-performing major stock market index this year.
Source: CNBC
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