Luiz Inácio Lula da Silva has made one of the most notable comebacks in Brazil's democratic history. Three weeks after finishing second in the first round, he won the second round on Sunday with 51.8% of valid votes compared to 48.2% for Flávio Bolsonaro. He is the first candidate since the return of democracy to win the presidency after finishing behind in the first round, and the first Brazilian to be elected president four times. His new term begins in January.
The markets will have a very different view. The Brazilian markets had not yet opened when this article was drafted, but a strong negative reaction is expected. Investors had clearly leaned towards a change of government: the Ibovespa rose more than 8% in early trading after the first round and long-term interest rates fell sharply in hopes of a shift in fiscal policy. Now it seems that much of that movement is going to be reversed, and the burden of proof rests squarely on the re-elected president.
A comeback that comes at a budgetary cost
The concern is not simply who won, but how.
In the three weeks between the two rounds, the government announced a 15% increase in the "Bolsa Família," the flagship cash transfer programme, and the higher payments took effect on 19 October. It eliminated federal taxes on gasoline and increased subsidies for ethanol and imported diesel. Lula enacted a law forgiving the federal tax debts of micro-entrepreneurs, a measure that, according to the government, could benefit more than 3.6 million people, and raised the income threshold for its simplified tax regime. The campaign promised non-repayable cash transfers of up to 5,000 reais for small businesses, a new monthly aid for low-income university students, and a new round of the "Desenrola" household debt renegotiation programme. Days before the vote, the government sent a constitutional amendment to Congress for free public transport on weekends and holidays, which would be funded by reallocating part of the budget modifications controlled by lawmakers. Congress also enacted the end of the six-day workweek, one of Lula's flagship promises, which reduces the maximum workweek from 44 to 40 hours without any pay reduction.
Some of these measures are temporary, and the government claims that the reductions in fuel taxes will be offset by extraordinary revenues from oil. Several of them still need congressional approval. Others, such as economic aid for students, would entail permanent commitments in a budget that is already nearly out of room. Overall, they send an unequivocal signal: when votes were at stake, fiscal prudence took a back seat.
Lula's campaign did promise fiscal consolidation, but at a slower pace than his rival and with the explicit condition that spending cuts would not fall on the poorest Brazilians. The government's own forecasts indicate that the primary balance will only gradually improve, reaching a surplus of 1.3% of GDP by 2030. His running mate, Geraldo Alckmin, pointed to financing electoral campaigns and excessive public sector salaries as areas where savings could be made. None of these measures come close to the magnitude of the problem.
The figures leave little room
Brazil has little room left for this type of policy. Gross public debt has risen to around 83% of GDP, an increase of more than 10 percentage points during this term, and a deficit close to 10% of GDP that is now almost entirely made up of interest. Brazil pays one of the highest real interest rates in the world for a debt that keeps growing, which is the very definition of an unsustainable trajectory, and the bill falls on both businesses and households as well as the Treasury.
A hostile Congress: limitation or stagnation?
Lula will govern facing a Congress dominated by his opponents. Bolsonaro's Liberal Party has secured the largest single-party bloc in the Chamber of Deputies since the 1988 Constitution, almost double that of Lula's Workers' Party, and is the largest force in the Senate. The Senate has already rejected one of his candidates for the Supreme Court, the first such rejection in 132 years, and the centrist parties of the "Centrão" will demand a high price for their support.
For investors, this has its pros and cons. A hostile Congress could block the most expensive electoral promises, such as free public transport, which requires a constitutional amendment. But it is equally likely to block revenue-raising measures and structural reforms, and demand costly concessions in exchange for votes. Stagnation is not synonymous with consolidation.
What the markets need to see
The first signal will be the composition of the economic team for the new term. Beyond the names, investors need a revised fiscal framework that generates primary surpluses wide enough to stabilise the debt, rather than targets that adjust when they become restrictive, along with measures on the indexing of benefits, mandatory spending, and tax expenditures, as well as a clear commitment to central bank independence.
The prize is still there
None of this changes Brazil's underlying strengths. It is an agricultural and energy superpower and is among the world's largest exporters of soybeans, beef, coffee, sugar, and cotton. Its external accounts are solid, with foreign direct investment more than covering the current account deficit; its currency floats, unemployment is near historic lows, and its central bank has demonstrated its credibility. Few emerging markets combine scale, resources, and institutional depth at this level.
Lula knows better than anyone what fiscal credibility can bring: in his first two terms, he combined primary surpluses with strong growth and secured Brazil's first investment-grade rating. If his fourth term begins by putting debt on a downward path, interest rates could fall substantially, private investment could recover, and public money could be directed towards infrastructure and services instead of creditors. Brazil would then be well-positioned to become the standout case in Latin America and all emerging markets. Otherwise, it will remain a country with excellent fundamentals that pays one of the highest real interest rates in the world, and the next correction will be imposed by the markets rather than being a decision from Brasília.
