Lula Has No Easy Choices

Brazil’s new president is hemmed in by protesters on one side and financial markets on the other. He needs to spend money to please the public, but he needs to demonstrate fiscal responsibility to keep investors from abandoning Brazilian assets, which could cause interest rates to soar and cripple the economy. Unfortunately, it will be extremely difficult to do both at once.

It’s a tough spot for President Luiz Inácio Lula da Silva, the leftist who served two terms from 2003 to 2010 and narrowly won election to a third term in October over the far-right incumbent, Jair Bolsonaro. On Sunday, thousands of Bolsonaro supporters broke into government buildings in the capital, Brasília, to protest what they falsely believe was a stolen election.

Lula, as he is known, was able to spend generously on social programs during his first period in office in part because of high prices for many of the commodities that Brazil exports. Brazil is a major producer of steel as well as agricultural products such as citrus and soybeans. Now commodity prices are faltering because of expectations of a global economic downturn. On top of that, Brazil’s central bank has raised its key lending rate to nearly 14 percent in an effort to extinguish inflation, which is running around 6 percent.

Bolsonaro, although far right in his politics, governed as a free-spending populist. His government bolstered fuel subsidies last year, which won him votes but worsened the government’s financial situation.

Lula, who was inaugurated on Jan. 1 in the company of his adopted pet dog, Resistência, has handed the vital job of finance minister to Fernando Haddad, a fellow leftist who hasn’t (at least yet) won the confidence of investors.

With Bolsonaro’s supporters roiling Brasília and other cities, “The capital flow of foreign buyers that entered the Brazilian market recently is likely to be undone,” Matthew Ryan, the head of market strategy at Ebury, a financial services firm, wrote in a note on Monday.

In a warning to investors, Filippos Papasavvas, a markets economist at Capital Economics, wrote in a client note on Monday that “any worries about widespread protests could see Lula double down on the more popularist (and less market-friendly) parts of his agenda, such as significant increases to social spending.”

For a closer look at Lula’s dilemma, I interviewed Monica de Bolle, a senior fellow at the Peterson Institute for International Economics. A native of Brazil, she was named an honored economist by the Order of Brazilian Economists in 2014 for her contributions to the Brazilian policy debate.

“He has no room to do the kinds of things that people expected him to do,” de Bolle told me. On the spending side, investors who worry about deficts spending will rebel if the government increases social spending or puts through a big increase in the minimum wage. Conversely, the public will rebel if he attempts to roll back subsidies on fuel that Bolsonaro put in place.

De Bolle said that Brazil’s Wall Street is thick with Bolsonaro supporters. She argued that they gave Bolsonaro the benefit of the doubt but aren’t cutting Lula any slack. I told her that sounded like a great opportunity for investors from outside Brazil: If indeed domestic investors are overly pessimistic about Lula’s ability to rein in spending, then prices of Brazilian debt must be too low, presenting a good deal for buyers. She agreed. “Brazil will certainly present that opportunity,” she said.

Then again, if Ebury’s Ryan is correct, foreign investors will be reluctant to scoop up Brazilian assets as long as the political situation remains uncertain. There’s no second honeymoon for Lula.

Outlook: Georges Ugeux

“Why is nobody talking about the debt?” Georges Ugeux, the chairman and chief executive of Galileo Global Advisors, a New York-based company that advises on mergers, acquisitions and management, asked in an article posted on Medium on Thursday. Rising interest rates have increased the burden of debt. It isn’t just a problem for emerging markets, he wrote. “The over-indebtedness of the United States, Europe, Japan and China could create a much more severe debt crisis, both at sovereign and at corporate levels.” He predicted that 2023 will be “the year where we will start paying the cost of our inconsiderate addiction to debt.”

Quote of the Day

“Japan’s experience of prolonged deflation suggests that it takes a great deal of effort to dispel anxiety over deflation. Nevertheless, there was no need to give up the challenge of overcoming deflation simply because the economy fell into deflation; against the background of the Bank’s monetary policy measures adopted since 2013, the economy has improved and is currently no longer in deflation.”

— Masazumi Wakatabe, deputy governor of the Bank of Japan, in his keynote speech at the annual meeting of the Japan Association of Business Cycle Studies, Dec. 3, 2022