Lula returns: Brazil’s new president inherits huge economic challenges

By on 31/10/2022 | Updated on 31/10/2022
A picture of Brazil president Lula
Incoming Brazilian president Luiz Inácio Lula da Silva, who also served in the role from 2003 to 2010. Photo: Casa de América

Lula must tackle a hangover of Bolsonaro’s profligate public spending while attempting in a limited fiscal space to address growing poverty and malnutrition

The second round of Brazil’s presidential elections shaped up to be far closer than expected with leftist Luiz Inácio Lula da Silva only narrowly beating the right-wing incumbent, Jair Bolsonaro with 50.9% of the vote versus 49.1%.

With a difference of only 2.14 million votes out of 156 million registered voters, this is a clear sign of the division currently within a country struggling to cope with a multitude of crises.

The description of Jair Bolsonaro as right-wing applies more to his social views and disregard of environmentalism than any commitment to economic orthodoxy. As with many other populists on either end of the ideological spectrum, Bolsonaro was willing during COVID-19 – and twice during the presidential campaign – to loosen the state’s purse strings in order to build popular support.

He gutted the conditional component of the Lula-era Bolsa Familia conditional cash transfer programme of the early 2000s to make them straight-up cash transfers which benefitted more than 20 million families. And in the face of rising fuel costs and inflation, the Bolsonaro government also implemented a fuel subsidy programme including direct cash transfers to lorry drivers.

But Bolsonaro’s energy subsidy programmes have been at best a short-term palliative. The effort excluded support for basic household goods, and only temporarily halted the upward climb of inflation, lowering it in the final quarter of 2022 to under 10%.

Inflation is going to rise again

Most economists predict inflation will bounce back once the energy subsidies end and so maintaining them – even with the short-term benefits of artificially holding down inflation – would be fiscally irresponsible, breaking the government’s own fiscal ceiling and adding more debt to the country’s combined public and private debt load of 90% of GDP.

Fearing the risk of undermining the success of the Real Plan which controlled Brazil’s inflation in the 1990s after decades of struggle under Fernando Henrique Cardoso’s presidency, all the economists involved in the plan’s design announced their support to Lula in the second round.

If Brazil’s economy were projected to bounce back in 2023 and lift the growing numbers of those trapped in poverty and extreme poverty, these exceptional levels of public expenditure may be sustainable. But the economy is not about to bounce back

Added to this looming fiscal reckoning in 2023 is addressing one of the more recent scandals of the federal government’s ‘secret budget’. The budget is an executive transfer scheme to the leadership of the Brazilian congress, and the greasing of political wheels to ensure the passage of legislation is endemic in Brazil’s famously fractious congress which can comprise more than 20 parties and led to one of the largest corruption scandals during the Lula era from 2003 to 2010.

In 2005 the mensalão – which means big monthly payment – scandal revealed a system that extended to some of Lula’s closest advisors of systematic bribery to buy votes to pass executive legislation. The Workers’ Party (PT) then treasurer, Delúbio Soares, set up monthly payments to members of congress.

The scheme was supported by undeclared financial resources from large firms, the most famous of them being those of the businessman Marcos Valério. Estimates of the ‘secret budget’ scam indicate it reached R$53bn (around US$9bn), more than 500 times the scope of mensalão estimated at R$101m (around US$18m).

When it comes to the country’s governability, more important may be the implications of the Bolsonaro policy that devolved control of the slush fund to legislative leaders. This ‘secret budget’ is now controlled by congress rather than the executive, and a congressional kickback scheme makes it even more unlikely Brazil’s legislative body will be willing to tame its own patronage perks and profligacy.

If Brazil’s economy were projected to bounce back in 2023 and lift the growing numbers of those trapped in poverty and extreme poverty, these exceptional levels of public expenditure may be sustainable. But the economy is not about to bounce back. In 2022, Brazil’s economy will grow by a not-too-shabby 2.7%, but that growth is estimated to decline to around 1% in 2023.

Sliding economic growth, the need to balance basic support for the poor in the face of rising fuel and basic goods prices, growing public and private debt, and a tightening of global liquidity, all spell dark clouds on Brazil’s economic horizon

This slow growth occurs in the face of rising poverty, desperation, and food insecurity in South America’s largest economy. According to Oxfam more than 33 million Brazilians are currently in famine and 63 million are below the World Bank poverty threshold. Preventing their slide back into poverty after the bump provided by Bolsonaro will require sustaining public transfers but maintaining current levels of support of R$600 (US$110) per month could be a budget buster for the government.

Bolsonaro’s proposed budget for 2023 – with a projected US$12.25 billion fiscal deficit for the upcoming year – did not include those transfers but Lula included them in his proposed budget. While his transparency is admirable, such public generosity will be difficult to fulfil and sustain given the current debt ceiling and need for fiscal constraint.

Political division in congress hampers progress

There is also the issue of the perennial fractiousness of Brazil’s two chamber congress, both dominated by more than a dozen parties. The ‘secret budget’ may help much-needed economic reforms to make their way through the legislature, including a streamlining of the country’s tax system and budget restraint. But that ‘secret budget’ approved by Bolsonaro to soothe the congress remains an elephant in the room given the need to contain public budgets.

None of this bodes well for an easy ride for Lula as the new president. Sliding economic growth, the need to balance basic support for the poor in the face of rising fuel and basic goods prices, growing public and private debt, and a tightening of global liquidity, all spell dark clouds on Brazil’s economic horizon.

But his larger challenge may be political. As a reflection of Brazil’s polarised polity and recent history, both Bolsonaro and Lula suffered high levels of public disapproval during the campaign with around 40% of voters having a negative perception of both candidates. Lula will need to constantly walk a tightrope over a teetering economy between public support for a reversal of social development and of fiscal and monetary constraints – all with a thin political safety net. There is little room for error for the new president.

This article was first published on the Chatham House website, and is reproduced with permission.

Dr Christopher Sabatini is senior research fellow for Latin America, US and the Americas Programme, and Lilia Caiado Couto is research fellow, Global Economy and Finance Programme, both of Chatham House.

About Dr Christopher Sabatini and Lilia Caiado Couto

Dr Christopher Sabatini is a senior research fellow for Latin America, US and the Americas Programme at the Chatham House think-tank, and Lilia Caiado Couto is a research fellow in the global economy and finance programme at Chatham House.

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