Brazilian Markets Sink as Lula Dismisses Investors’ Fiscal Concerns

(Bloomberg) -- Brazilian markets pared losses after members of Luiz Inacio Lula da Silva’s transition team moved to ease fears of excessive public spending that had been fueled by the president-elect himself.

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The real closed just 0.2% lower, after declining of as much as 2.4% earlier, as Guido Mantega resigned from Lula’s transition team. The news, first reported by Folha de S. Paulo newspaper and confirmed by Bloomberg News, was welcomed by investors who associate Brazil’s longest-serving finance chief with policies that eroded the country’s finances.

Also helping to lift market prices were remarks by economist Aloizio Mercadante, the group’s technical coordinator, who mentioned discussions about cutting expenses. After markets closed, Vice President-elect Geraldo Alckmin made further nods to investors, saying the government is committed to fiscal responsibility and that there is no reason for markets to be stressed.

Stocks ended with losses of 0.5% in Sao Paulo, after sinking as much as 2.7% earlier. The early losses followed Lula’s comments on how the government needs to start talking about “social responsibility rather than fiscal responsibility.”

The president-elect, who was speaking on the sidelines of the COP27 climate conference in Egypt, acknowledged his comments could send Brazil assets tumbling.

“Too bad,” he said during a news conference, adding that markets fall “not because of serious people, but because of speculators.”

His transition team is suggesting that about 175 billion reais ($32 billion) in social spending be indefinitely exempted from the country’s main fiscal rule, the so-called spending cap that limits growth of public expenditures to the previous year’s inflation rate.

Read More: Lula’s Team Seeks to Exempt $32.4 Billion From Spending Cap

“If the spending cap were meant to keep us from paying interest to the financial system, and we kept social policies intact, that’d be fine,” he said. “But what happens is you take money from health care, education, science, culture.”

In addition to the deep selloff in assets since he won the Oct. 30 vote, Lula also faced backlash from former central bank chief Arminio Fraga, former Finance Minister Pedro Malan and economist Edmar Bacha, one of the architects of the plan that ended hyperinflation in the 1990s.

The trio, who had publicly supported the left-wing leader during the election, published an open letter addressed to him, saying that fiscal responsibility isn’t an obstacle to achieving social progress.

Despite Lula’s dismissal of investor concerns, lawmaker Reginaldo Lopes, the leader of his Workers’ Party in the lower house, told reporters he will meet with market participants in Sao Paulo later on Thursday.

More Debt, Higher Rates

Some investors fear that excess spending will fuel inflation and force policymakers to resume an aggressive monetary tightening cycle that has already lifted the benchmark Selic to 13.75% this year.

The spending proposal “reduces the degrees of freedom for the central bank to manage monetary policy,” said Alberto Ramos, senior economist at Goldman Sachs Group Inc. “At best it could delay the delivery of rate cuts, but at the extreme it could also lead to the unfortunate situation where the central bank would have to hike rates again.”

The central bank forecast that above-cap expenditures of 175 billion reais would increase the central government’s primary deficit to 1.5% of gross domestic product next year, from its current 0.8% estimate.

“The increase in public debt between 2022 and 2023, from 77.7% to 81.9% of GDP, would be even larger,” the bank’s chief Roberto Campos Neto wrote in a presentation made to investors in New York on Tuesday.

Read More: Fear That Lula Might Reignite Inflation Is Hurting Brazil Assets

Brazilian assets topped peers for most of the year and remained relatively calm ahead of election on expectations that neither Lula or President Jair Bolsonaro were likely to be fiscally irresponsible. But the mood has shifted since the Oct. 30 runoff vote as Lula continues to signal more spending and further delays announcing cabinet names.

The nation’s stocks are down more than 10% in dollar terms this month, by far the worst among major global indexes. The real, which until the election was one of best performers of 2022, is the worst in a basket of 31 major currencies tracked by Bloomberg in November, down 4.2%.

The selloff, which echoes those seen in markets from the UK to Colombia, shows investors have little patience for policies considered as fiscally irresponsible.

Read More: Lula’s Dramatic Comeback Faces an Economic Reality Check

Investors are now focusing on how the proposal will be received by congress. Lawmakers need to give the government permission to breach the spending cap rule.

“Our only hope is for the congressional leaders to fight back,” says Edwin Gutierrez, the head of emerging-market sovereign debt at Abrdn.

--With assistance from Maria Eloisa Capurro, Brendan Walsh and Martha Beck.

(Recasts with market move starting in headline)

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