Luiz Inácio Lula da Silva's unexpected re-election as Brazil's president on Sunday jolted financial markets into a tailspin. The Brazilian stock index took a nosedive, plummeting 13.9% on Monday. It's the steepest drop since COVID-19's early days. The Brazilian real didn't fare any better, tumbling nearly 8% against the U. S. dollar, marking its largest dip since 1999.
These financial upheavals wiped out gains seen after Flávio Bolsonaro led the first-round vote in early October. Bolsonaro, viewed as more market-friendly, had initially reassured investors. Now, Lula, who kicked off his term on January 1, 2023, after previously holding office from 2003 to 2011, faces a daunting economic landscape. Brazil's growth is slowing down, with inflation and high interest rates adding to the pressure.
In the face of these hurdles, Lula has promised to roll out costly initiatives aimed at supporting his grassroots base. He's committed to maintaining existing benefits, hiking the minimum wage above inflation levels, expanding housing and education programs, cutting taxes on essential food items, and reducing the workweek to 40 hours without cutting pay. But these pledges are likely to meet resistance. A predominantly right-wing Congress stands in opposition, and there's skepticism from the White House.
Rafael Ch, a senior analyst at Signum Global Advisors, pointed out the central dilemma Lula has to manage. Voters expect real improvements in their economic conditions, seeing the election as a mandate for more social spending. Meanwhile, bond markets are eyeing Brazil's growing debt-to-GDP ratio with caution. They might demand higher premiums if public spending ramps up.
The Brazilian Treasury's move to cancel two bond auctions this week reflects these concerns. Rafael Ch suggested that Lula might initially appease markets by indicating measures to bolster the 2027 primary surplus. This could involve a constitutional amendment to extend spending freezes and appointing a finance minister who has market credibility.
Elizabeth Johnson, managing director of Brazil research at TS Lombard, warned of a looming fiscal crisis that could largely be of Lula's own making. She expects market-calming measures, such as curbing civil-service benefits and reducing subsidies on goods like alcohol and cigarettes, to emerge in the coming days. Johnson also underscored Lula's urgency to pass reforms before the new legislature meets in February. This will hinge on his willingness to trim spending.
Johnson's analysis suggests that Lula will advance a modest fiscal reform, helping avert a major fiscal crisis in 2027. However, she noted that Brazilian stocks might experience short-term pain. Mould, the investment director at AJ Bell, questioned who will foot the bill for Lula's proposed welfare spending and debt moratorium for small businesses. He predicted a rise in the 10-year bond yield, making Brazilian equities less appealing.
Brazil's Ibovespa had been the best-performing major stock market index this year, buoyed by expectations of Bolsonaro's victory and the country's advantage from higher commodity prices. Mould noted that the recent decline could have a ripple effect, negatively impacting broader Latin American indices, like the MSCI Latin America index, which hit a 12-year high this year due to a political shift to the right.
