Brazil’s Political Polarization and Fiscal Plans Pose Risks for Investors

Investors in Brazil, Latin America’s largest economy, have been given a reality check following the recent invasions of top government buildings by supporters of former president Jair Bolsonaro.

These events have highlighted the increasing political polarization in the country and the challenges that newly sworn president Luiz Inacio Lula Da Silva will face in maintaining stability and control.

Despite this institutional shock, investors and analysts are focused on fiscal issues when assessing the long-term impact of the new government. Brazil’s central bank may be able to start cutting interest rates in the second half of the year, which would boost the economy. However, this is dependent on the strength of the new fiscal framework put in place by President Lula.

The swift government response to the weekend violence has limited the market impact, and discussions of the new fiscal framework are key under Lula’s administration. Policymakers have highlighted inflationary risks arising from the President-elect’s $32 billion spending proposal to meet campaign promises.

Overall, while the short-term impact on markets looks contained, creditors will keep a close eye on the political and social dynamics in the coming weeks. The deep social and political polarization, as well as the potential for a mobilized opposition to turn violent, keeps risk premia high and could undermine overall governability in Brazil.