President-elect Luiz Inácio Lula da Silva’s transition team on Wednesday confirmed investors’ worst fears, presenting a constitutional amendment proposal that would allow the new government to spend on social programs outside the federal spending cap.
According to many economists, however, the bill, as drafted, would also essentially give the new government carte blanche to spend as much as it wants and for as long as it wants.
It will be up to Congress to decide whether to allow this to happen only in 2023, or for the next four years, as Lula wants. Meanwhile, Lula once again relativized fiscal austerity during a speech at the COP27 climate conference.
As expected, such a proposal brought the Brazilian stock market and currency down.
At 4:10 pm on Thursday, the Ibovespa, Brazil’s main stock index, was down by 2.3 percent. The Brazilian currency, meanwhile, is see-sawing, up by 0.74 percent at the same time, after having plunged around noon. This currency rally was prompted, among other factors, by investors believing that Congress will not give Lula the “license to spend” he is hoping for.
What worries the market most is the lack of predictability that comes with the proposal.
In addition to the effects on the Ibovespa and the Brazilian real, Brazil’s two-year government bond yield skyrocketed over 14 percent, above the current benchmark interest rate of 13.75 percent. This happened because investors understand that higher spending will pressure inflation and, consequently, interest rates.
When things are normal, short-term debt has a lower yield than longer-term debt — since the investor lending the money is taking on less risk.