Brazil Banks Warn: Fiscal Plan Essential Post-Election to Avoid 20% Rates

SÃO PAULO — Major investment banks are warning that Brazil’s next president must present a rigorous budgetary plan immediately after the October general election to prevent the country’s benchmark interest rate from soaring to 20%. With public debt approaching 82% of gross domestic product (GDP), financial institutions are sounding the alarm that the market is heavily pricing in the risk of a high-interest-rate environment and a potential sovereign debt downgrade if the next administration fails to deliver concrete fiscal adjustments.

The warning comes as Latin America's largest economy grapples with structural budget constraints. According to data from the Central Bank of Brazil, the country's nominal deficit—which includes interest payments on national debt—has hovered near 8% of GDP. Analysts at Itaú BBA, one of the largest private financial institutions in the country, project that the federal government will run a budget deficit for both the current year and the next, regardless of which candidate wins the presidential race.

The primary driver of this fiscal gridlock is the highly rigid nature of Brazil's federal budget. Approximately 91% to 92% of all primary government spending is mandated by the constitution and statutory laws, covering public pensions, civil servant payrolls, and social programs. This leaves the executive branch with virtually no room to cut discretionary spending without pursuing complex constitutional amendments through a highly fragmented Congress.

Two Paths for the Next President

In a comprehensive analysis of the post-election landscape, Morgan Stanley outlined two starkly contrasting paths for the Brazilian economy depending on the next administration's fiscal credibility. In the worst-case scenario—where the incoming government fails to implement a credible spending adjustment—the benchmark Selic interest rate, which currently stands at 14.0%, could climb as high as 20% per year to curb inflation and defend a weakening currency. This would drastically increase the cost of servicing Brazil's sovereign debt and elevate the risk of a credit downgrade by global rating agencies.

Conversely, an ambitious and credible fiscal plan could trigger a massive relief rally. If the next administration successfully convinces the market of its commitment to stabilizing the debt-to-GDP ratio, the Selic rate could fall significantly, potentially propelling the benchmark Ibovespa stock index to historic highs of up to 250,000 points.

The immediate challenge for the winner of the October election will be navigating these structural spending rules. While the current administration of President Luiz Inácio Lula da Silva has relied heavily on tax increases to boost revenue, rating agencies like Fitch Ratings warn that further tax hikes could weigh on economic competitiveness, meaning the next government must shift its focus toward cutting mandatory expenditures.

What it touches

The immediate fiscal credibility of the incoming administration will directly dictate the trajectory of Brazilian government bonds, the local currency, and domestic equities. A failure to deliver a post-election budget adjustment would heavily expose interest-rate-sensitive sectors—such as retail, real estate, and local utilities—to high borrowing costs, while boosting defensive, dollar-earning exporters. Conversely, a robust fiscal plan would relieve the deep discount on local equities, directly benefiting large-cap financial institutions and state-backed firms.