Although Brazil’s economic performance has improved following the COVID-19 pandemic, persistent structural challenges and an increasing government debt burden will be a drag on the medium-term outlook, as neither decisive fiscal consolidation nor broader structural reform will be forthcoming before the 2026 presidential and congressional elections. Although Brazil has managed to maintain systemic financial stability in the face of consecutive domestic political and international economic and financial shocks, such the global financial crisis of 2008-09, the car wash scandal (starting in 2014) and the COVID-19 pandemic in 2020-21, its economic performance has been disappointing with real economic growth averaging less than 1% over the past ten years. In the past three year, though, Brazil’s economic performance has improved, in part supported by increasing government expenditure. The lack of expenditure restraint has helped keep fiscal deficits high and has increased government debt substantially. Brazil’s its external financial position has remained sound, which had helped limit the probability of a near-term fiscal and debt crisis. But current fiscal deficits levels will prove unsustainable in the medium term.
> Real GDP growth averaged a 3.2% in 2022-2024, compared to a 2015-24 average of only 0.9% in 2015-24. Despite solid economic growth (by Brazilian standards), large fiscal deficits have increased gross government debt from 83% of GDP in 2022 to a projected 92% of GDP in 2025.
> The fact that most of Brazil’s government debt is owed in local currency and largely to residents limits financial risks. Non-residents hold only around 10% of Brazil’s domestic (real-denominated) government debt, down from 20% a decade ago. The government net foreign-currency creditor, meaning currency depreciation leads to a decline in the debt-to-GDP ratio.
Economic growth has been supported by increasing government expenditure, made possible by an unwillingness to consolidate large fiscal deficits more decisively, which is leading to an unsustainable medium-term accumulation of government debt, particularly in view of high real interest rates. In terms of fiscal policy, the Lula government’s efforts to reduce deficits has been low, as it prioritized increased government expenditure over more rapid fiscal consolidation. The government has sought to rely on increasing revenue while avoiding politically inopportune spending cuts. To that end, the Lula has also tweaked and weakened the fiscal framework on several occasions. Significant fiscal adjustment requires broader, politically difficult reform, as Brazil is characterized by a significant budget rigidity. The share of discretionary spending in total government spending is small due to legally and constitutionally mandated minimum expenditure targets, combined with the indexation of social security entitlements and social programs to the national minimum wage, as well as revenue earmarking. In terms of monetary policy, the government’s decision in June 2024 to establish a continuous (as opposed to annual) inflation has similarly weakened the monetary policy framework. Although the authorities maintained the 3% inflation for 2025, including a tolerance interval of 1.5% points either way, the modified framework provides the central bank with greater room to accommodate price shocks and deviations from the inflation target without requiring immediate monetary tightening. The fact that this modification took place in the context of persistent criticism of the central bank’s monetary policy by the president also points to a weakening of the monetary policy framework.
> Fiscal deficits will remain large and are projected to widen from 6.6% of GDP last year to as much as 8.5% of GDP this year. The gross government debt-to-GDP ratio is set to increase from 87% of GDP to 92% of GDP this year, while net public sector debt (accounting for central bank holdings of government debt) will increase from 61% of GDP last year to 66% of GDP. The IMF project gross government debt to reach nearly 100% of GDP by the end of the decade. This however implies significant progress in terms of fiscal consolidation during the remainder of the decade. It also looks somewhat optimistic in light of higher real interest rates.
> In August 2023, the Lula government modified the fiscal framework, setting a primary balance target, starting with 0.5% of GDP primary deficit in 2023 and improving it in 0.5% points increments per year to reach 1% of GDP in 2026. The framework also limited spending growth to below the increase in projected revenue. After modification and flexibilization, the government now targets a zero primary deficit this year, with a tolerance band of 0.25% of GDP in either direction. This represents a slower adjustment that originally envisioned. It is also too slow in the context of a continued rapid increase in the debt-to-GDP ratio from 83% of GDP in 2022 to projected 96% of GDP at the end of Lula’s term in 2026.
> Following the spike in inflation during COVID-19, inflation averaged 4.6% and 4.4% in 2023 and 2024, respectively, just in line with the respective 3.25% and the 3% inflation targets, once the 1.5 percent point tolerance interval is included. With inflation running at the upper end of the target range, the independent central bank will have little choice but to pursue a tight, high interest rate policy, which will further contribute to increasing interest costs.
Various structural economic factors limit Brazil’s economic growth potential and will make it challenging to put government debt dynamics on a sustainable path over the short- and medium-term. With congressional and presidential elections 12 months away, the government is not going to pursue costly political reform aimed at alleviating the constraints on economic growth. Such reform would need to tackle the following obstacles. First, investment and fixed capital formation remains low, constrained by a low economy-wide savings rate. Second, and relatedly, government policies, including social and pension expenditure, do not encourage household savings, while the government’s savings rate is negative, meaning government consumption exceeds government revenue (after transfers), contributing to the low domestic savings ratio. Third, increasing interest expenditure on increasing government debt further limits the availability of funds to support government investment and the ability to reduce expenditure and the fiscal deficit. Fourth, so-called “Brazil cost”, including a burdensome tax system and government “red tape”, make investment less profitable and lower the return of investment. Finally, Brazil is a very closed economy, particularly in terms of imports, which limits domestic competition and productivity growth. It also makes it attractive as an investment destination in terms of multi-nationals’ global value chain integration (unlike East and South-East Asian countries).
> At below 14% of GDP, Brazil’s savings ratio is low and constrains investment and economic growth. Limited savings contribute to high real interest rates. At present the policy rate is 15% and inflation is running at around 5%, translating into a real interest rate of 10%.
> In terms of trade, Brazil is 12th least open out of 195 economies with trade amounting to 34% of GDP, compared to a global average of 59% of GDP. In terms of imports, it is the sixth least open economy with imports amounting to 16% of GDP, compared to a global average of 29% of GDP. In terms of Brazil ranks 153 out of 199 countries. Brazil’s average effective tariff on industrial goods rate is high, making it the 153rd least open out of 199 economies.
In the run-up to the October 2026 elections, the government is not going to pursue fiscal restraint, short of a not very likely loss of investor confidence, but this will increase the pressure on the next government to implement credible fiscal reform. The government is not going to impose any significant spending cuts 12 months before the October 2026 elections. Nor will it pursue any significant revenue measures for fear of losing electoral support. In light of weakened monetary and fiscal governance, the government cannot afford to be profligate either for fear of triggering increased financial market volatility and an economic slowdown. However, large fiscal deficits will help keep inflation high and put a greater burden on monetary policy. If the next government fails to implement more credible budgetary reform, fiscal and debt burden will continue to increase, increasing the economic and political challenges for the next government. Should a non-market-friendly candidate run for president, similar to Lula in 2002, then the risk of financial instability will increase significantly. But even all the leading candidates pay lip service to pursuing fiscal discipline, a debt-to-GDP approaching 100%, high nominal and real interest rates, and, likely, slowing economic growth will increase the pressure on the new president to take more decisive action than his predecessor. If the government reins in spending, the short-term impact on economic growth will likely be negative. If the government does not rein in spending, then continued high interest rates, combined with an inability to further increase government spending, will weigh on the economic outlook. Either way, Brazil will be unlikely to generate growth more than 2.0-2.5% growth following the 2026 elections.
> The IMF projects real GDP growth to average 2.3% in 2026-30. It also sees consumer price inflation to converge to the central bank’s 3% target by 2030. It also, optimistically, predicts the fiscal deficit to shrink from more than 8% of GDP in 2025 to less than 5% of GDP by 2030. This would require a significantly more decisive fiscal adjustment than will prove politically and economically feasible, not least given increasing interest outlays due to a higher debt-to-GDP ratio.