Brazilian markets tumble as Lula dismisses investors’ budget concerns

(Bloomberg) – Brazilian markets fell on Thursday after President-elect Luiz Inacio Lula da Silva doubled down on plans to increase spending, ignoring investor concerns about fiscal responsibility.

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The Brazilian real fell more than 2% at the open, driving losses among its emerging market peers, after Lula said on the sidelines of the COP27 climate conference in Egypt that the government should start talking about ” social responsibility rather than fiscal responsibility”.

His team suggests that around 175 billion reais ($32 billion) of social spending should be exempted indefinitely from the country’s main fiscal rule, the so-called spending cap which limits the growth of public spending to the inflation rate of the previous year.

Read more: Lula’s team seeks $32.4 billion exemption from spending cap

“If the spending cap was supposed to prevent us from paying interest to the financial system, and we kept social policies intact, that would be fine,” he said. “But what’s happening is you’re taking money from healthcare, from education, from science, from culture.”

The real weakened 1.3% at 2:40 p.m. in Sao Paulo, paring earlier losses after rising above the 5.50 level to the dollar. The benchmark Ibovespa stock index fell 2.3%, while swap rates rose across the curve, with long-term contracts gaining more than 50 basis points.

Lula acknowledged that his comments could cause Brazil’s assets to plummet.

“Too bad,” he said, adding that markets are falling “not because of serious people, but because of speculators.”

Despite Lula’s dismissal of investors’ concerns, lawmaker Reginaldo Lopes, the leader of his Workers’ Party in the lower house, told reporters he would meet with market participants in Sao Paulo later Thursday.

More debt, higher rates

Investors, fearing spending will fuel inflation, are now pricing in that the central bank will no longer be able to cut interest rates next year. Some even fear that policymakers may be forced to resume an aggressive monetary tightening cycle that has already taken the benchmark Selic to 13.75% this year.

The spending proposal “reduces the central bank’s degrees of freedom to manage monetary policy,” said Alberto Ramos, senior economist at Goldman Sachs Group Inc. “At best, it could delay the delivery of rate cuts, but at extreme, it could also lead to the unfortunate situation where the central bank would have to raise rates again.

The central bank expects spending above the ceiling of 175 billion reais would raise the central government’s primary deficit to 1.5% of gross domestic product next year, from its current estimate of 0.8%.

“The increase in public debt between 2022 and 2023, from 77.7% to 81.9% of GDP, would be even greater,” bank boss Roberto Campos Neto wrote in a presentation on Tuesday. investors in New York.

Read more: Fear that Lula could rekindle inflation hurts Brazil’s assets

Brazilian assets outperformed their peers for most of the year and remained relatively calm ahead of the election, expecting neither Lula nor President Jair Bolsonaro to be likely to be fiscally irresponsible. But the mood has changed since the October 30 run-off vote as Lula’s camp continues to report more spending and further delays in announcing cabinet names.

Shares in the country have fallen more than 12% in dollar terms this month, by far the worst among major global indices. The real, which until the elections was one of the best performers of 2022, is the worst of a basket of 31 major currencies monitored by Bloomberg in November, down 5.4%.

The selloff, which echoes those seen in markets from the UK to Colombia, shows that investors have little patience for policies seen as fiscally irresponsible.

Read MMore: Lula’s spectacular return to economic reality

Investors are now focused on how the proposal will be received by Congress. Lawmakers must allow the government to break the spending cap rule.

“Our only hope is that congressional leaders fight back,” says Edwin Gutierrez, head of emerging market sovereign debt at Abrn.

–With assistance from Maria Eloisa Capurro, Brendan Walsh and Martha Beck.

(Updates with markets, meeting with investors from the fifth paragraph)

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Robert D. Coleman