Brazil & Southern Cone - January 2025

In some ways Brazil’s economy did quite well in 2024. At around 3.3% growth, the economy expanded at more than twice the pace that economists had projected at the beginning of the year, and unemployment fell to the lowest level in over a decade. The problem is that many economists and investors fear the country’s progress isn’t sustainable and that it is living above its means by spending money the government doesn’t have. 

The budget deficit of the public sector in the 12 months through November again crept higher, to 9.5% of GDP, the central bank said on 30 December. That’s more than double what it was when President Luiz Inácio Lula da Silva took office two years ago and one of the highest deficits on record.

Levels of confidence in the Brazilian economy have plummeted. The government had to pay local investors nearly 15% to buy a 10-year bond, compared with 5.8% for the equivalent in Chile and 2.4% in Germany. That is the highest yield the government has had to pay since the impeachment of former President Dilma Rousseff (2011-2016) amid a deep economic crisis.

The national currency has also been hit hard. The real lost 21% in 2024, making it the worst-performing of 31 currencies tracked by Bloomberg. On Christmas Day in 2023 the real stood at R$4.79 against the US dollar; a year later it had sunk to nearly R$6.20/US$1. The central bank, which has had a relatively hands-off approach in the currency market, intervened heavily in the final weeks of the year and sold over US$20bn of international reserves to try and prop up the real.  

At the heart of the problem is that Lula is borrowing money to fund his government, meaning public debt keeps on growing – and with it the share of the budget eaten up by interest payments. In a country that needs huge investments in education, health, infrastructure, and more, close to half of the government’s annual budget goes to service debt accumulated over the years.

When the Lula administration finally announced a plan to cut back spending in late November, it was perceived as underwhelming and then was watered down even more in congress in December, contributing to the freefall of the real.  

To be fair, other issues have weighed on the Brazilian currency as well, including a strong US dollar and the threat of protectionist tariffs hitting Brazilian exports. “The balance of risks for the Brazilian economy has worsened recently. In addition to global factors, fiscal imbalances have become an increasing source of concern, despite the recent measures proposed by the government,” the Spanish bank BBVA said in a December research note. “If left unaddressed, they could lead to a more negative macroeconomic scenario.”

But the result is the same. Deficitary spending and a weaker currency are bad news for inflation and, as a result, the central bank has already hiked interest rates by 75 basis points since September. It is likely to raise rates by at least another 50. And with that Brazil’s economic growth this year will again fall in line with its capacity, an expansion of around 2%.

The remedy – a credible fiscal policy that caps public debt – is simple economically but difficult politically. But Lula could be convinced to adopt belt tightening measures if the alternative of doing nothing proved more costly – which may already have become the case. According to a Datafolha poll published on 31 December, 61% of people polled consider the Brazilian economy to be on the wrong track.