Lula's comeback leaves Brazil's fiscal question unanswered

Lula's return to Brazil's presidency improves neither the country's unresolved fiscal problem nor the market's concerns about debt sustainability.

• Lula won the runoff with 51.8% of valid votes against 48.2% for Flávio Bolsonaro, after finishing second in the first round; his new term starts in January.
• Markets had priced in a government change: the Ibovespa rose more than 8% after the first round and long-term interest rates fell, but stocks and the real plunged after Lula's victory, triggering a 30-minute equity-market circuit breaker.
• During the three-week runoff campaign, the government raised Bolsa Família by 15%, cut federal petrol taxes to zero, increased fuel subsidies, forgave federal tax debts for potentially more than 3.6 million micro-entrepreneurs and proposed further transfers and subsidies.
• Fiscal space is limited: gross public debt is around 83% of GDP, more than 10 percentage points higher during the administration, while a deficit near 10% of GDP is now almost entirely interest; the government's projections reach only a 1.3% of GDP primary surplus by 2030.
• A hostile Congress may block costly promises such as free public transport, but it could also obstruct tax increases and reforms while demanding expensive concessions; Bolsonaro's Liberal Party has the largest bloc in the Chamber and is the biggest force in the Senate.
• Investors need to assess the new economic team, a fiscal framework capable of stabilising debt, reforms to benefit indexation, mandatory spending and tax expenditures, and a clear commitment to central-bank independence.

Takeaway: Brazil's agricultural, energy, external-account and institutional strengths could support falling rates and renewed private investment if Lula puts debt on a declining path; otherwise, markets are likely to force the fiscal correction.