Brazil’s economic outlook brightens under Lula

Yet during last year’s election campaign, few thought Lula would be so lucky for a second term as president. The economy he inherited was not much richer than the one he bequeathed to his successor, Dilma Rousseff (see chart 1). Under her leadership, the country fell into a deep recession. Her impeachment over a corruption scandal tarnished Lula’s Workers Party (PT). The economy still bears the scars of the pandemic, which killed nearly 1 million Brazilians and caused a 4% loss gross domestic product. Total government debt is currently 88% gross domestic product— a coveted level for an emerging market with a history of macroeconomic crises — and inflation well above the central bank’s target. Most disturbingly, he has taken charge of a country whose environment and democratic institutions have been wrecked under the leadership of his Trump predecessor, Jair Bolsonaro, whose supporters stormed the capital, Brasilia, in early January government building.

So Lula really did his job. Brazil urgently needs to invest in its infrastructure and invest in education to train Brazilian workers for better jobs and make up for lost learning during the pandemic. The health of the Amazon rainforest depends on efforts to strengthen and enforce anti-deforestation rules, requiring more spending. So will poverty; after falling for much of the 2010s, it has soared during the pandemic. Creating policies to meet these needs means more than maintaining the unity of the Democratic-led congressional coalition. platinum, Also master the difficult budgeting algorithm.

This year’s spending plan is likely to exceed the annual budget growth cap introduced in 2016. To sidestep that potential hurdle, Lula helped Congress pass a constitutional amendment that removed some spending caps in December before his inauguration. But that has its own risks: undermining investors’ trust in Brazil’s commitment to a solid budget. Recognizing this, Lula’s government laid out a plan of tax increases and spending cuts. But achieving budget reform will prove a legislative challenge. Therefore, Brazil remains vulnerable if investor sentiment is hit by poor growth, a gloomy global economic outlook, or some other shock.

From these perspectives, now does not seem like a good time for Lula to return to the presidency. This year looks set to be tough for much of the global economy, as many countries have raised interest rates to fight high inflation, while China’s economy continues to slump amid a property market collapse and draconian coronavirus restrictions. Even recently, many economists have warned that a global recession may be imminent. The combination of weak global growth, falling commodity prices and rising interest rates could easily send Brazil into crisis.

Meanwhile, lower inflation expectations in rich countries, especially in the United States, mean interest rates are unlikely to climb as feared this year and lead to a weaker dollar. That eased pressure on economies around the world, including Brazil, where yields on 10-year bonds initially fell by nearly a percentage point. Brazil’s inflation rate has also eased, falling to just 5.8% in December from a peak of over 12% last year (see Chart 2).

That’s still well above the central bank’s 3.25% target rate for 2023, and core inflation, which excludes volatile items, has slowed more slowly. But falling inflation in Brazil, combined with easier global financial conditions, may finally allow Brazil’s central bank to cut its policy rate to a painful 13.75%. The central bank’s aggressive rate hikes starting in 2021 will help curb inflation and maintain market confidence. But high interest rates have raised borrowing costs for the government and dampened a possible pick-up in investment during a period of rising commodity prices.

Healthy demand for commodities and more favorable financial conditions helped. But they can do little to address underlying structural problems. Brazil’s economy needs more radical reform. However, the new government admits it must be more cautious than before to avoid further political instability. Given the global interest in diversifying supply chains, the push to reduce trade barriers offers room for progress and could prove particularly beneficial. A deal between the European Union and Mercosur, a trade bloc of South America’s big economies, has been stalled by European concerns over deforestation in the Amazon, now likely to resume after Mr Bolsonaro’s departure. But serious reforms will require a big push from Lula, who appears to have other priorities—though in a joint article on January 22 he and Argentine President Alberto Fernandez pledged to deepen economic integration, including efforts to Create a common currency.

Nor has the shift in global fortunes made Lula’s second term as president easy. Current forecasts suggest that Brazil’s economy will grow by just 1% in 2023, so even the dizzying outperformance pales in comparison to the average under Lula.