Lula's Fiscal Credibility Crisis: Talk Consolidation, Govern Expansion

Brazil's government just extended a gasoline subsidy because oil hit $100 a barrel, while simultaneously announcing that a future Lula administration will need to cut mandatory spending to stabilize the debt. Finance Minister Dario Durigan said both things on the same Thursday. If you need a single image to capture everything structurally wrong with Brazilian fiscal policy, that is your image.

Let's be precise about what the numbers actually say. Gross public debt has reached 81.1% of GDP as of May, according to the Central Bank. NTN-Bs — Brazil's inflation-linked sovereign bonds — are trading with real yields above 8% across virtually every maturity through 2037, a level that Santander analysts say they have never seen in 18 years covering that market. Corporate debenture underwriters are warehousing paper on their own books because they cannot price it into the market. The IMF's Article IV report praised Brazil's "remarkable resilience" in one breath and called for greater Central Bank institutional autonomy in the next — which is the Fund's polite way of saying the plumbing is still leaking. Meanwhile, Congress closed the semester by approving a constitutional amendment adding R$28 billion in social security spending for community health agents and passing a package of unrelated legislative riders in the electricity sector that power companies estimate could add R$60 billion annually to electricity tariffs. In the same week. Without apparent embarrassment.

The external shocks are real and deserve acknowledgment. Brent at $100, U.S. tariffs at a cumulative 37.5% on key export categories, a potential additional levy tied to forced-labor investigations covering roughly $12.5 billion in annual exports — these are genuine headwinds that no government in Brasília would have chosen. But external pressure is precisely when fiscal credibility matters most, and the Lula administration is spending that credibility faster than the oil revenue windfall can replenish it. The R$18.5 billion in credit lines announced under the Brasil Soberano 3 program — R$13.5 billion from the Treasury, R$5 billion from BNDES — is being compared by serious economists to the post-2008 stimulus packages that contributed directly to the 2015-2016 fiscal collapse. Sergio Vale of MB Associados made that comparison explicitly. The government has not answered it.

What makes this particularly galling from a market-liberal perspective is that the structural argument for reform has never been stronger. The Mercosur-EU agreement is delivering: exports to the European Union grew 26% in the first two months of provisional implementation, adding $2 billion in May and June alone. The diversification strategy that Brasília claims as strategic vision is producing real results. The Selic at 14% is crushing credit-dependent industry — Brazil ranked 69th out of 90 countries in manufacturing industrial growth in the first quarter, down from 33rd at the start of 2024, according to Unido data compiled by Iedi. The case for addressing the structural deficit, rationalizing tax benefits, and freeing up monetary policy through credible consolidation writes itself. Instead, the government extended the diesel subsidy, approved R$60 billion in annual electricity cost riders, transferred the payroll cost of union-mandated civil servants to the Union, and relaxed the fiscal quarantine rules that were supposed to prevent states like Amapá from receiving federally guaranteed loans immediately after defaulting.

Durigan is not wrong that a future government will need to cut mandatory spending. He is wrong to treat that as a future government's problem while his own government adds to mandatory spending in real time. Markets are not confused about this arithmetic. Wells Fargo has reversed its positive read on the real, citing political-fiscal noise. Société Générale closed long positions on the currency ahead of elections. The Ibovespa is down 11% from its April high. These are not irrational reactions to external volatility — they are rational reactions to a government that talks consolidation and governs expansion. Brazil's problem is not that it lacks economists who understand the debt trajectory. It is that understanding the trajectory and acting on it are entirely different political propositions, and no external shock has yet made the second one any more likely than the first.