Brazil's Lula Weighs Gradual Fiscal Adjustment to Cut Interest Rates and Stabilize Debt

What Lula's Fiscal Adjustment Plan Actually Contains

Brazil's President Luiz Inácio Lula da Silva, fresh from winning a fourth term, is facing pressure to define his economic team and fiscal strategy. The financial market reacted to his election with a stock market decline and a rise in the dollar, reflecting concerns that his government might not prioritize fiscal adjustment. Inflation projections have increased, growth expectations have fallen, and economists now estimate a higher exchange rate for the real.

In response, Lula's economic team has signaled that a gradual but consistent fiscal adjustment is on the table. Finance Minister Dario Durigan, who has been the campaign's economic spokesperson, has repeatedly said the government aims for an adjustment of about 2% of GDP during the 2027–2030 term. This would move the primary result from a deficit of roughly 0.4% of GDP in 2026 to a surplus of 1.6% by 2030. However, the Independent Fiscal Institution (IFI), a Senate-linked body, estimates that a surplus of 2.1% of GDP would be needed just to stabilize the public debt.

The measures under study include a more explicit commitment to meeting the fiscal target, a review of tax benefits, and new initiatives to strengthen the fiscal framework with additional brakes on spending growth. The government plans to send a bill to Congress to formally commit to hitting the center of the fiscal target in 2027. On the revenue side, the Finance Ministry is considering tax increases on offshores, exclusive funds, and interest on equity, which it classifies as reductions in tax benefits.

However, several proposals favored by economists are not on the government's radar. These include ending the real increase in the minimum wage, delinking pension benefits from the minimum wage, and setting interest rate targets to gradually reduce the Selic and the debt tied to it. The government has also ruled out cutting social programs. Durigan confirmed that the current formula for minimum wage increases above inflation (capped at 2.5% real growth) would be maintained, and pension benefits will remain linked to the minimum wage.

Why Brazil's Fiscal Math Is Harder Than It Looks

The Fiscal Math: Why 2% of GDP May Not Be Enough

The government's proposed adjustment of 2% of GDP over four years sounds ambitious, but it falls short of what the IFI calculates is necessary to merely stabilize the debt. A primary surplus of 2.1% of GDP is required just to stop the debt from growing. The government's plan would reach only 1.6% by 2030, leaving a gap. This gap matters because financial markets and the Central Bank are watching the trajectory of the debt, not just the annual primary result. If debt continues to rise, risk premiums will stay high, keeping the Selic rate elevated and undermining the government's goal of reducing interest rates.

Dario Durigan's Balancing Act

Finance Minister Dario Durigan is walking a tightrope. He must reassure markets that the government is serious about fiscal discipline while honoring Lula's campaign promises to protect the poor. His strategy of focusing on revenue measures — such as taxing offshores and exclusive funds — and reinforcing the fiscal framework avoids direct cuts to social programs. But revenue measures are often uncertain in their yield and can be challenged in Congress. Moreover, the government's definition of "reducing tax benefits" includes tax increases, which may face political resistance. Durigan's repeated denials of more radical proposals, like interest rate targets, signal that the government is not willing to challenge the Central Bank's independence or risk currency instability.

What's Off the Table and Why It Matters

The government's refusal to end the real minimum wage increase or delink pension benefits is a major constraint. These policies index a large portion of social spending to the minimum wage, meaning any increase automatically raises expenditures. By ruling out changes, the government limits its ability to cut spending structurally. This leaves the adjustment heavily reliant on revenue increases and marginal spending cuts. Economists argue that without addressing these indexation mechanisms, any fiscal adjustment will be temporary and debt will remain on an upward path. The market's skepticism is reflected in the Central Bank's decision to pause Selic cuts, as inflation expectations remain unanchored.

The Interest Rate Dilemma

The Central Bank's decision to hold the Selic rate on Wednesday highlights the tension between fiscal and monetary policy. Brazil already has the highest real interest rate in the world. The government wants lower rates to reduce debt servicing costs and stimulate growth, but the Central Bank needs credible fiscal consolidation to bring inflation down. The proposal to set interest rate targets, floated by some economists, was quickly dismissed by Durigan due to the risk of currency depreciation. This shows that the government is not willing to experiment with unorthodox policies that could spook investors. Instead, it is betting that a gradual adjustment will eventually convince the Central Bank to resume cuts.

Winners and Losers

If the adjustment proceeds as planned, the biggest winners would be Brazilian consumers and businesses, who would benefit from lower interest rates and more stable inflation. Investors holding Brazilian assets would also gain from reduced risk premiums. However, the adjustment's gradual nature means these benefits may take years to materialize. The biggest losers could be government ministries, which may face budget freezes as the government tries to meet the fiscal target. Taxpayers in certain sectors may also face higher taxes as the government targets tax benefits. Social program beneficiaries are protected, but the lack of structural spending cuts means the adjustment burden falls disproportionately on revenue increases.

What the Adjustment Means for Investors and Businesses

The most important insight: Brazil's fiscal adjustment is real but gradual, and it may not be enough to stabilize debt without additional spending cuts that the government has ruled out.

For investors and business leaders, the key takeaway is that Brazil's path to lower interest rates depends on the government's ability to deliver a credible fiscal adjustment. The Central Bank's pause on Selic cuts signals that it is not yet convinced. Here's what to watch and do:

• 0–6 months: Monitor the government's bill to Congress committing to the fiscal target center for 2027. If passed with strong support, it could improve market sentiment and open the door for Selic cuts later in 2027. Also watch for details on tax increases on offshores and exclusive funds — these could affect investment structures.
• 6–24 months: Track the primary result trajectory. If the deficit narrows faster than expected, the Central Bank may accelerate rate cuts. Conversely, if revenue measures underperform, budget freezes could hit ministries and slow public investment. Companies reliant on government contracts should prepare for potential delays.
• 2–5 years: The success of the adjustment hinges on whether the government can resist pressure to increase spending. If debt stabilizes, Brazil could see a sustained reduction in interest rates, boosting credit and investment. If not, the country risks a cycle of high inflation and high rates, harming growth.

Metrics to watch: The primary result as a percentage of GDP (quarterly), the Selic rate decisions, the dollar-real exchange rate, and the IFI's debt sustainability reports. Also monitor the minimum wage adjustment formula — any change could alter the fiscal outlook significantly.