Publications /
Opinion

Back
It’s the Fiscal, Lula!
Authors
November 9, 2026

Denial of the fiscal problem, or an indication of a move toward adjustment—even if a gradual one?

A week of shock for Brazilian assets. Starting Monday (Oct. 26, 2026), the real depreciated, the stock market fell, and sovereign risk premiums rose. This movement was linked to investor reactions to the election results, uncertainties regarding fiscal policy, and an international environment of high interest rates. I spent the week answering questions about whether Brazil is already in a crisis or heading toward a "hard landing."

This first week after election, the dollar climbed 8.21% on Monday, closing at R$ 5.40, and remained near that level through Friday (Oct. 30) (Figure 1). By Thursday, the Ibovespa index had fallen approximately 18.4% compared to the trading session held before the second round of the election. Sovereign risk premiums and long-term interest rates also trended upward.

Figure 1 

Source: Michael Pooler and Joseph Cotterill, “Lula faces a fiscal reckoning after Brazil’s market rout”, Financial Times, October 26, 2026

This is clearly one of those moments of "hyper-adjustment" in asset prices—involving "overshooting"—where the risk parameters perceived by investors shift, leading to a sudden realignment of investment portfolios. It seems evident that this stems from a prevailing perception—intensified by Lula’s unexpected victory—that the public debt-to-GDP ratio is likely to continue its upward trajectory. This, combined with high risk premiums and the interest rates demanded by bond buyers, creates a sort of "vicious cycle."

The "fiscal framework" under Lula’s third term failed to curb the deterioration of the fiscal situation. Federal primary spending rose from 17.8% of GDP in 2021–22 to 19.6% in 2023, remaining high over the following two years. With the continued growth of mandatory expenditures—a structural feature that has persisted since the early 1990s—the room for other types of spending to increase without widening public deficits has steadily shrunk.

Gross public debt is projected to rise from 72% of GDP at the end of 2022 to nearly 83% by 2026. I find the estimates by Solange Srour and the UBS Global Wealth Management team quite compelling: given Brazil’s typical GDP growth and interest rate levels, a shift in the public balance of around 4% of GDP would be required to achieve stabilization. 

This figure should not necessarily be pursued to the letter—it would be unrealistic to imagine such a drastic change happening overnight—but it does illustrate just how explosive the current trajectory is if left unaddressed. This is what drives the “hyper-adjustment” in asset prices.

Marcello Estevão and Martin Castellano, from the IIF, propose that “a reasonable baseline benchmark is an improvement in the effective primary balance of at least 0.5 percentage point of GDP per year in normal conditions, subject only to an escape clause, until the surplus reaches roughly 2–2.5% of GDP” (Figure 2).” 

Figure 2

From: Marcello Estevão and Martin Castellano, “Brazil: The Fiscal Mandate After the Vote”, IIF, October 23, 2026

There are three ways to approach this issue. The first—voiced by some members of the current administration (and by Lula during his campaign)—is the notion that no fiscal adjustment is needed at all. This fantasy rests on two possible premises: 1) that public debt service can be paid in Brazilian reais without regard for the likely inflationary consequences—ignoring the fact that even domestic creditors would refuse to purchase government bonds if interest rates were artificially forced downward; or 2) the dream that investments and productivity gains could drive GDP growth to a rate higher than real interest rates. Reaffirming such a stance would only reinforce the prospect of a crisis and a “hard landing.”

A second approach would be the “Milei style”—named after the Argentine president—which entails an immediate, massive fiscal adjustment. However, a downward spiral in this direction would be self-destructive, leading to a collapse in economic growth and widespread default.

A third path would involve a gradual fiscal adjustment, encompassing all branches of government (executive, legislative, and judiciary). This would entail a phased review of expenditures based on their social efficacy and contribution to growth—reducing parliamentary earmarks, eliminating "perks" within the judiciary, and adjusting the indexation mechanisms for income-transfer programs and social security. It would not be easy, but this appears to be the only viable path.

Parallels can be drawn to the period leading up to Lula’s first term—starting in mid-2002, when markets were jittery and Lula issued his "Letter to the Brazilian People." Once in office, in addition to reaffirming his commitment to a floating exchange rate and the operational autonomy of the Central Bank, Lula raised the primary surplus target from 3.75% to 4.25% of GDP. Not only did sovereign risk premiums fall, but the country also achieved—for the first and only time to date—an "investment grade" rating from credit rating agencies (a status later lost).

Lula eased fiscal discipline midway through his second term, following the global financial crisis—a pattern repeated by the first Dilma Rousseff administration. By the time Dilma attempted a belated fiscal adjustment at the start of her second term, conditions had already turned against her (compounded by the impact of the *Lava Jato* investigation on the construction sector and the developments that paved the way for her impeachment). While Lula initially endorsed Minister Palocci’s plan during his first term, his third administration has failed to provide Finance Minister Haddad with the full conditions necessary to implement a genuine adjustment plan—with internal opposition within the government proving more effective now than it was during that first term.

Hence the critical importance of the signal regarding fiscal policy that Lula must provide at this juncture, ahead of a potential fourth term. Will he persist in denying the fiscal problem, or will he offer an indication of adjustment—even if gradual—accompanied by credible signs that the program, and those responsible for it, will not be sabotaged from within?

 

RELATED CONTENT

  • Authors
    April 1, 2026
    We are now in the fifth week since the U.S. airstrike that killed top leaders of the Iranian regime, initiating a war involving the United States and Israel against the country. More than a month of mutual bombardments between Iran and Israel has ensued, extending to other Persian Gulf nations, U.S. military installations—and even Cyprus. From a global perspective, the impact has stemmed primarily from disruptions to regional production of goods and the blockade of the Strait of Hor ...
  • January 23, 2026
    The post-1945 international order, an architecture born of war-weariness and colonial twilight, is now a majestic but empty shell. Its foundational promise—a universal system of rules administered impartially—has been hollowed out by decades of selective enforcement, instrumentalized law, and a chasm between the rhetorical ideals of its custodians and their geopolitical practice. This is not a temporary dysfunction, but a systemic failure of legitimacy. From the invasion of Iraq und ...
  • Authors
    November 21, 2025
    This report addresses the business environment in Brazil as one of the determinants responsible for the weak evolution of productivity in recent decades. After addressing this productivity performance, we define what constitutes the business environment, using as a reference the three ways in which the World Bank has been addressing the subject.Next, we highlight how the business environment affects productivity in a country. Finally, we review some recent reforms in the country's b ...
  • Authors
    Sérgio R. R. de Queiroz
    Nicholas S. Vonortas
    May 9, 2025
    This paper aims to demonstrate how certain transformations in the international economy since the 1980s¾notably the globalization of firms and industries¾combined with a set of domestic challenges, disrupted the path of industrial and technological development that Brazil had pursued since the 1930s. In essence, growth strategies based on the scale of the domestic market ceased to be effective. The innovation and economic challenges the country now faces cannot be addressed without ...
  • November 24, 2023
    Debt in the Global South was a key point of discussion during the last annual meetings of the World Bank and International Monetary Fund which took place in Marrakesh on October 2023. Whi ...
  • Authors
    October 26, 2023
    The Brazilian economy is stuck in a so-called middle-income trap—growth that stalled long before Brazil caught up with the living standards of the highly industrialized countries. After exhibiting a stellar performance in the decades before the 1980s, the economy has since been unable to sustain growth for long periods. The predicament can be summarized using a medical analogy: Brazil has been suffering from both productivity anemia and public sector bloat. On the one hand, it hasn ...
  • Authors
    Xiaofeng Wang
    October 13, 2023
    The surprising victory of Javier Milei, the unconventional ‘anarcho-capitalist’ candidate, in the August primaries ahead of Argentina’s October 2023 general election, can be largely credited to his commitment to dollarize the Argentine economy, a move perceived as the ultimate solution to bring an end to the nation's economic turmoil. The potential shift from the local currency to the dollar has sparked concerns about Argentina's bilateral currency swap line with China. This swap l ...
  • Authors
    May 11, 2023
    This paper aims to investigate the impact of an inflation targeting framework adoption by the central bank, on the reduction of public debt ratios in emerging countries, through the potential discipline-enhancing effect of inflation targeting on the conduct of fiscal policy in general. The impact evaluation method used is the Propensity Score Matching (PSM), which allows the evaluation of the treatment effect of inflation targeting on fiscal discipline, in terms of public debt reduc ...
  • Authors
    December 30, 2022
    L’objectif de ce papier est d’essayer d’examiner si l’implémentation du cadre de ciblage de l’inflation par la banque centrale, permet une réduction de la dette publique dans les pays émergents, à travers l'effet disciplinant du ciblage sur la conduite de la politique budgétaire en général. Pour ce faire, la méthode d’évaluation d’impact utilisée est l’appariement par score de propension ou Propensity Score Matching (PSM), qui permet l’évaluation de l’effet de traitement ...