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Brazilian elections: the calm before the storm?

The result of the polls that elected ex-president Luiz Inácio Lula da Silva as the nation's ruler for the next four years, does not scare the markets – at least not for now.

The statement comes from the report “Brazilian elections: the calm before the storm?” disclosed by Allianz Trade, a global company specializing in credit insurance

According to the study, the current Brazilian political framework, in which an ex-president will take over the government, offers few surprises to the markets. Proof of this is that the Brazilian Real (BRL) has been much less volatile during the present day than in previous elections, when changes in government direction (from left to right, or vice versa) were associated with greater volatility in the exchange rate.

For Allianz Trade experts, the biggest concerns for Brazil at the moment are external, such as the tightening of US financial conditions and oil prices (along with Chinese demand).

In the domestic field, the great apprehension is related to local inflation, which is still far from expected. Economists predict inflation of 5.1% in 2023 against the Central Bank's target of 3.25%. The expectation is that the Selic rate will remain at 13.75% until the end of 2022 and that it will begin to reduce in 2023, raising interest rates to 12% by the end of next year.

Focus on spending policy

Fiscal policy will be a central issue in the next government. When compared to Latin American peers, the country's public debt ratio is significantly higher at 93% in 2021 (Colombia is the second worst at 64%). The increase in the cash transfer program (Auxílio Brasil) by R$200 by the end of the year, in an environment of low economic growth, further deteriorated the fiscal outlook.

This even showed an evolution, thanks to government measures, such as the cut in fuel prices by Petrobras, in addition to tax exemption on fuel and electricity. Inflation expectations have also been holding back economic growth and higher interest rates for longer.

For this reason, the insurer's report warns about the fiscal balance. According to the study, an increase in spending of BRL 100 billion on average during the next term would lead to a primary deficit of -1.9% for 2023.

This means a return to the levels seen in 2015-2017 and one of the worst fiscal performances in the last 20 years – excluding the exceptional effects of the Covid-19 pandemic, as shown in the chart.

In this context, it is clear that the next government needs to resume the reform agenda to face the fiscal impasse. The expense growth rule and the potential growth of the economy have significant impacts on the projections.

The baseline scenario considers economic growth close to its potential (+1.9%) from 2024 onwards, after +0.8% in 2023. Certainly, the adoption of a fiscal rule consistent with achieving primary results positive results and the adoption of reforms that allow the potential growth of the economy will be fundamental for the reduction of the public debt.

Otherwise, Brazil's risk premium will certainly increase in the medium term, which will lead to lower growth, higher interest rates and, consequently, higher indebtedness.

Allianz Trade economists conclude that, in this regard, the task at hand for the next president is clear and one that investors will watch closely.

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Francisco Gomes

CEO - Fairfield BR

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