Brazil election: why Lula faces a much more challenging third term

The second round run-off in Brazil’s presidential election on Sunday saw the former leader, Luiz Inácio Lula da Silva, return to office for a third time. Lula, as he is know locally and who was president between 2003 and 2010, beat the incumbent Jair Bolsonaro by the narrowest of margins as he secured 50.9% of valid votes.

How the economy performed under Lula’s previous tenure

Lula’s first two terms in office, between 2003 and 2010, were marked by a period of strong economic performance. GDP growth averaged 4.1% per year, while a combination of relatively fast growth and social transfers reduced poverty. And all of this was achieved while also running fiscal surpluses such that the government’s gross debt ratio fell from 80% of GDP in 2003 to 63% of GDP when Lula left office at the end of 2010.

Brazil could badly do with a repeat of that performance once Lula enters office on 1 January. After all, GDP growth has averaged less than 0.5% per year over the past decade and the government’s gross debt ratio has reached more than 90% of GDP.

Lula’s policies

Lula’s campaign was more or less the mirror image of Bolsonaro’s, reviving many of the policies that were a feature of his first period in office. In particular, pledges to boost growth through increases in government spending on infrastructure and social programmes.

There was also much more focus on environmental goals to protect areas such as the Amazon and drive the transition to renewable energy. In his first speech as president-elect, Lula said “Brazil is ready to resume its leading role in the fight against the climate crisis, protecting all our biomes, especially the Amazon Forest”, aiming for zero-deforestation. Lula has also proposed the creation of a National Climate Change Authority to ensure that the country’s policies are in line with its Paris Agreement goals.

A more difficult backdrop than last time

However, Lula will face a much more challenging backdrop this time around.

For a start, whereas Brazil’s economy benefitted from a steady increase in commodity prices that drove a continual improvement in its terms of trade during Lula’s first tenure, the outlook is now less rosy. Commodity prices are under pressure as the global economy slows towards recession, while large interest rate hikes that have seen the Selic rate climb to a six-year high of 13.75% will increasingly weigh on domestic activity in the months ahead.

In addition, Congressional results mean that Lula will find it far more difficult to implement policies. Despite forming an apparently more centrist ticket with his former rival, Geraldo Alckmin, Lula will not command a working majority in either chamber of Congress (House of Deputies and Senate), meaning that compromises will need to made in order to pass legislation.

Investors will be particularly sensitive to changes in fiscal policy. Lula has stated a desire to reform the public spending cap, which allows government spending to increase only by the previous year’s rate of inflation. Signs of fiscal largesse will be received badly by markets. However, evidence of pragmatic policymaking could help Brazilian assets deliver on relatively cheap valuations.