Salvador. Brazil will elect a new president on October 4th - and at the same time decide the balance of political power in the coming years. In business and investor circles, a fourth term in office for incumbent Luiz Inácio Lula da Silva is seen as a horror scenario. “If Lula wins, I'll emigrate,” is a sentence that is often heard in these circles. Many farmers are also skeptical about the 80-year-old's further term in office from 2027.
The fact that the business community once again rejects Lula so decisively is surprising at first. During his third term in office, the Brazilian economy has grown by an average of around three percent per year since 2023. Inflation is within the target range at 4.5 percent, and the unemployment rate is at a historic low of 5.6 percent. Only the USA and China attract more foreign direct investment worldwide than Brazil.
Lula can also boast political successes. His government has pushed through comprehensive tax reform. When it comes to environmental protection, the balance is also positive: deforestation in the Brazilian Amazon region is historically at its lowest level in more than a decade.
But the balance sheet is significantly less favorable when you look at the debt of the state, citizens and companies. In recent years, the government has boosted consumption primarily with state resources: through higher social benefits, minimum wages, pension increases above the inflation rate, tax relief, new loan programs for low earners and investments in state-owned companies. Because private consumption accounts for around two thirds of gross domestic product, economic growth repeatedly exceeded economists' forecasts at the beginning of the year.
The downside of consumption-driven growth is the rapidly increasing national debt. The budget deficit amounts to around ten percent of gross domestic product. With a debt ratio of 82.5 percent of GDP, Brazil is more indebted than almost all other major emerging countries. The state spends almost nine percent of GDP annually on debt service alone. If the spending policy of recent years continues, the debt ratio could rise to 150 percent of GDP within a decade.
However, Brazil is not threatened with an external debt crisis. The country has foreign exchange reserves of around $374 billion. They provide a significant buffer against external currency shocks, capital outflows and speculation against the Brazilian real.
The real problem lies domestically. Investors increasingly doubt that the state can stabilize its debt in the long term. You don't expect a payment default. However, they fear that rising inflation could reduce the real burden of government debt. At the same time, the key interest rate is 14 percent. In order to continue to lend money to the state, investors are demanding ever higher risk premiums.
The high interest rates are also putting a strain on private households. In Brazil, even everyday purchases are often paid for in installments. Many citizens are therefore more indebted than ever before. According to a study by Fundação Getulio Vargas, private individuals are on average stuck with half of their annual income. According to the central bank, Brazilian households now have to spend an average of a third of their income on debt servicing - more than in 20 years.
The high level of debt among private households is thus becoming an obstacle to growth. Domestic demand is unlikely to increase much in the coming years. Economist Armando Castelar Pinheiro therefore expects that stagnating consumption will limit Brazil's growth potential - regardless of the outcome of the elections.
Companies are already feeling the effects of this development. According to a study by the business medium “Valor Econômico”, the profits of the 300 largest Brazilian companies fell by 16 percent in the first half of the year compared to the same period last year. Your sales are declining while at the same time the capital costs for investments are rising.
According to data from management consultancy PwC, the inflation-adjusted sales of the 280 largest listed companies have been stagnating since 2022. According to “Valor Econômico”, the debts of the 1,000 largest companies in the country now correspond to 71 percent of net assets – the highest value in 26 years.
Therein lies the paradox of Lula's balance sheet: the economy has grown strongly - but consumers, companies and investors increasingly believe that the state-driven growth model cannot be financed sustainably.
In polls, Bolsonaro was behind Lula throughout the entire election campaign, but he has recently made strong gains. He wants to reduce the influence of the state on the economy and advocates stricter rules for financial policy, a reduction in administration, privatization and greater opening of trade.
Lula's rejection does not in any way result in enthusiasm for his challenger. At a meeting with São Paulo's business and financial elite three weeks ago, Flávio Bolsonaro apparently wasn't convincing. The participants then told “Valor Econômico” that its economic program seemed rather pale. None of them then publicly called for Bolsonara to be elected - which is usually the case after such meetings with the candidates.
This Sunday, in addition to the president, the Congress, the governors and the state parliaments will be elected. If runoff elections are necessary, they will take place on October 25th. Analysts at Morgan Stanley expect further gains for parties in the political center and on the right. Such a congress could slow down a Lula government more - but give President Bolsonaro greater freedom of action.
The forecasts for growth and key interest rates are correspondingly far apart. Morgan Stanley expects growth of 0.2 percent under Lula and 1.5 percent under Bolsonaro in 2027. The Selic key interest rate, Brazil's central monetary policy interest rate, could rise to 15.5 percent in the pessimistic Lula scenario, but fall to 9.75 percent in the optimistic Bolsonaro scenario. Morgan Stanley analysts expect that if a future government manages to credibly convince investors of falling government spending, interest rates could also fall quickly.
For analysts, the election is therefore primarily a duel between two opposing financial policy concepts. "It is a neck-and-neck race between Lula and Flávio Bolsonaro. The two represent fundamentally different political directions. However, which of them can be implemented depends on Congress, the governors and the future coalition formation," they write. “There’s a lot at stake.”
The uncertainty is reflected on the stock market. The Bovespa index, the most important stock index of the B3 stock exchange in São Paulo, reacts sensitively to the election forecasts. Flávio Bolsonaro has made gains in the polls since mid-August; Both candidates are now tied. In parallel with Bolsonaro's gains, the index rose by almost ten percent.
