Presidential election in Brazil: The economy needs in-depth reform, and neither Lula nor Bolsonaro has what it takes to respond

Democrats around the world shuddered after the first round of the Brazilian presidential election. Flavio Bolsonaro, son of a former coup plotting president, unexpectedly defeated the incumbent, Luiz Inácio Lula da Silva. He seems poised to win the second round this Sunday against Lula, as this 80-year-old left-wing icon is nicknamed. The capitalists, too, trembled - but with excitement. The São Paulo stock index jumped almost 8% the next day, the real (the Brazilian currency) strengthened and government bond yields fell.

It was a clear verdict on Lula's economic management. GDP growth has exceeded (gloomy) forecasts, unemployment is low and inflation has remained close to the 1.5-4.5% range targeted by the Central Bank of Brazil (BCB). But his fiscal laxity and anti-business rhetoric are scaring the markets. The “primary” budget surplus (i.e. before interest payment) that he inherited has turned into a deficit, and the IMF forecasts that public debt will reach 97% of GDP this year, compared to 84% in 2022. “We must put an end to all this nonsense which consists of generating a surplus and maintaining budgetary discipline,” he recently said.

Flavio Bolsonaro, on the other hand, takes inspiration from Javier Milei, the chainsaw-wielding Argentine president whose liberal reforms have had some success (and caused much suffering). The Brazilian, too, uses a sharp tool - a pair of giant scissors - as a campaign prop, pledging to cut taxes, bureaucracy and corruption. His economic ideas, however, remain vague. To finance the tax cuts he is proposing and the 900 billion reals (161 billion euros, or 6.6% of GDP) in infrastructure spending over four years, he wants to reduce the number of ministries, digitize public administration and sell federal buildings.

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This seems implausible: he would be lucky if these measures allowed him to achieve even half of the promised savings. This plan is also insufficient to meet the challenge. It would take real enthusiasm like Milei to overcome Brazil's economic difficulties. These are caused by a complex mix of high government spending, stubborn inflation and low savings. The result is a crippling cost of capital. Some analysts estimate Brazil's real interest rate - that is, the BCB's key rate adjusted for next year's expected inflation - at 9% or higher. This level is higher than that of Russia and four times higher than that of comparable countries in a stable situation, such as Chile, the Philippines or South Africa.

It all starts with public finances. Brazil's 65,000-word Constitution prohibits any reduction in nominal public sector wages and ties retirement, disability and unemployment benefits to the minimum wage, which is adjusted annually based on recent inflation and GDP growth. This ratchet mechanism increased mandatory spending to 90% of the federal budget.

Machine-translated from French