Brazil President Lula Cuts Spending by $12 Billion as Investor Concerns Soar

(Bloomberg) -- Brazil Finance Minister Fernando Haddad unveiled a long-sought plan to cut 70 billion reais ($11.8 billion) from public spending through 2026 as investors’ fiscal concerns sink assets from the currency to stocks.

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The details underwhelmed financial markets. The Brazilian real dropped to an all-time low, falling as much as 1.1% at the open on Thursday to 5.99 per dollar. It’s down 19% this year, the worst among major currencies.

The measures include limits to minimum wage growth and cap high earnings for public workers. The government also decided to exempt monthly salaries of up to 5,000 reais from income tax, which is expected to have an impact of 35 billion reais on public accounts, Haddad told journalists on Thursday. That move is expected to be compensated by rising levies for monthly incomes above 50,000 reais.

“Brazil’s fiscal framework needs to be strengthened to give markets more visibility and help the central bank,” Haddad said on Thursday.

Brazil investors are demanding austerity after President Luiz Inacio Lula da Silva’s leftist government increased spending to improve living standards for the working class. Fiscal coffers have come under additional stress this year as the administration responds to natural disasters including historic floods and drought. At the same time, higher expenditures are fueling market bets that the central bank will have to raise interest rates beyond 14% to tame inflation.

Investors are casting doubt on whether the measures are capable of making the fiscal framework viable in coming years and of reining in debt.

“The announcement fell short of market expectations,” said Gustavo Okuyama, a portfolio manager at Porto Asset. “Many measures are already known and have little prospect of an effective impact. The package is not enough to improve the fiscal outlook in a structural way.”

The total estimated savings with the package is expected to reach 327 billion reais between 2025 and 2030, according to Haddad. The minister pledged to keep working for fiscal balance and will go back to Lula to request more measures if needed.

“These measures consolidate this government’s commitment to the country’s fiscal sustainability,” Haddad said in the pre-recorded message that was broadcast Wednesday evening on local television and radio. “Fighting inflation, reducing the cost of public debt and having lower interest rates are a central part of our humanistic view of the economy.”

Earlier Wednesday, Lula’s push to tack an income-tax relief measure onto the spending cut plan further deepened concerns about Brazil’s budget deficit and sparked a selloff in the currency and stocks. The income-tax reform will be neutral and is set to be concluded in 2026, according to Haddad.

“The major concern is that giving up revenue is much easier than approving the effective counterpart,” said Okuyama. “It is a very sensitive issue given the current fiscal fragility.”

Mandatory Spending

Signs that the administration was abandoning pledges for fiscal responsibility have wreaked havoc on local assets throughout 2024.

In recent weeks, however, Haddad has sought to convey to Lula that the government needs to rein in mandatory spending in coming months, thus heading off a problem when he seeks reelection in 2026.

The reasoning is that the growth of some expenditures beyond the limit allowed by fiscal rules — 2.5% above the inflation rate — will only create more pressure on the budget and propel public debt as time goes by.

“We reaffirm our commitment to Brazilian families: to protect employment, increase purchasing power and ensure sustainable economic growth,” said Haddad.

The nation’s nominal deficit stood at 9.3% of gross domestic product in the 12 months through September, according to the most recent central bank data. That compares to 4.9% when Lula started his term in January 2023.

For 2025, the government plans to eliminate the primary fiscal deficit, which excludes interest payments, with the help of 166.4 billion reais in extraordinary revenue. In April, it backed off its pledge for a surplus next year, sparking a wave of investor angst.

“If there was a real political commitment to stabilizing public finances, we’d have needed to see much more today. We didn’t get that,” said William Jackson, Chief Emerging Markets Economist at Capital Economics. “It also seems like some work still hasn’t been finalized.”

--With assistance from Gabriel Diniz Tavares.

(Updates with market reaction and details on the package throughout)

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