SÃO PAULO—Brazil is racing toward a debt crisis. This year, its gross debt-to-GDP is forecast to increase by around 8 percentage points, to 86 percent, with another 4 percentage points possible in 2027, according to my analysis. But the problem is not simply how much Brazil owes: it is also how much the government is paying to borrow.
Four decades of weak fiscal credibility have left investors demanding unusually high interest rates to hold Brazilian government debt. Successive governments, including the current administration under President Luiz Inácio Lula da Silva, have chosen to pay rather than reform. The result is that marginal increases in public spending are financed at enormous cost, while a substantial share of government resources goes to interest payments that accrue disproportionately to wealthy households.
Brazil has seen this film before
Fiscal policy has been called the Achilles’ heel of Brazil, and for good reason. Three times since emerging from military rule in 1985, Brazil has dropped the reins of spending control, and each time painful consequences followed. Most recently, amid the Lava Jato corruption scandal that began in 2014, Brazil endured the worst recession in its modern history.
In the immediate aftermath of this downturn, successive Brazilian governments did implement more responsible fiscal policy. The caretaker government of Michel Temer passed a landmark spending cap which froze expenditure increases in real terms, while the Bolsonaro administration implemented a moderate reform to pensions, the largest and fastest growing component of the budget. Just six years later, at the end of the Bolsonaro administration in 2022, a supposedly neoliberal government was loosening the purse strings to support Bolsonaro’s reelection bid. This trend continued into the current Lula administration, and it has left Brazil on the precipice of its fourth fiscal crisis in forty years.
The high price of high interest rates
Beyond the readily observable pain of higher unemployment and inflation, these repeated fiscal crises create an environment of high interest rates, which are an important driver of Brazil’s poor performance on development indicators relative to its peers.
When governments lose fiscal credibility in the eyes of markets—that is, when investors question the ability or willingness of the sovereign to pay its debts—they demand higher rates to compensate for the risk. Unlike several other Latin American countries that also defaulted during the 1980s debt crisis, Brazil did not then go on to fully reestablish fiscal credibility with markets. The result is a vicious circle: high interest rates mean Brazil must run larger primary surpluses to keep its debt stable. Several successive Brazilian governments have refused to pursue the tight fiscal policy that would break this cycle. Under Lula, Brazil has even expanded cash-transfer programs and subsidized lending, adding to fiscal concerns and stoking inflation. This adds further upward pressure on rates as the central bank tightens policy to compensate.
High interest rates are toxic to growth because they make investment more expensive. From highways and housing to metros and machines, long-term projects, be they privately or publicly funded, rely on financing. Borrowing for a fifteen-year infrastructure project at 12 percent instead of 6 percent more than doubles the all-in cost; due to interest costs compounding over an infrastructure-length timeline, the same budget can buy less than half the infrastructure when the rate doubles. Over decades, these effects compound into slower productivity growth and lower living standards.
The divergence from Brazil’s regional peers is striking. According to International Monetary Fund GDP per capita data adjusted for inflation, average Colombian and Chilean households have enjoyed real gains in wealth of 113 percent and 218 percent, respectively, since 1980. Meanwhile, the average Brazilian household has seen an increase of just 51 percent. Put differently, in 1980 Brazilians were 50 percent richer than Colombians and 30 percent richer than Chileans. Fast-forward to today, and Colombians have roughly caught up with Brazilians, while Chileans are now about 55 percent richer. Colombians joined Brazilians in buying refrigerators and cars. Chileans went beyond them and started investing in better healthcare and education, and they now live on average five years longer than Brazilians.
Who benefits from more spending?
Restoring Brazil’s fiscal credibility is a necessary condition for sustainable growth. The current administration’s refusal to shoulder this project is often explained as a desire to prioritize support for Brazil’s lower-income population, a key constituency of Lula’s party. The president himself has supported the false choice between responsible spending policy and a social safety net. Yet the results are diametrically opposed to the stated goals of Lula’s Workers’ Party.
Marginal increases in spending drive rates higher for two reasons: markets demand a higher risk premium when fiscal credibility is low, and extra spending in an already hot economy adds to inflation, prompting tighter monetary policy. In short, the administration creates the rate environment it bemoans.
The distributional effect, too, cuts against Lula’s intended goal. Thanks to its high rates, the Brazilian government spends more than 8 percent of GDP on interest payments, the second highest share in the world among advanced and emerging economies. Most Brazilians hold no financial assets, rendering the current policy deeply regressive.
There is nothing inherently objectionable about investors earning interest on government bonds; they are being compensated for lending to a risky borrower. The failure lies with the borrower. The Brazilian government is driving the country deeper into debt and risking an economic crisis. It is doing so for marginal increases in inefficient spending, financed at enormous cost, and paid to the wealthiest. And when the crisis does come, it will be the poorest who suffer the most. The paradox is striking: fiscal expansion, undertaken in the name of redistribution, directs significantly more resources to the top and makes progressive policy far more expensive, and those most in need of state support bear the risk of the unsustainable policy.
The answer isn’t austerity
If there’s a silver lining to Brazil’s fiscal problems, it is that the government has considerable opportunities for reform without cutting core social spending. Specifically, critical anti-poverty programs, such as Bolsa Família and public healthcare spending, can remain untouched.
Instead, the two most obvious targets for reform are entitlements and tax expenditures. For the former, pensioners currently receive real (after inflation) increases in benefits. By my calculations, limiting increases to inflation would stabilize debt growth within three years while preserving purchasing power. Assuming the reform also restores fiscal credibility and drives interest rates lower, it could reduce the interest bill by 2 percentage points of GDP. As for tax expenditures, which are estimated at between 4.5 percent and 7 percent of GDP, there is enormous scope for savings. The best scenario would be to reform both. This would generate even deeper savings on interest costs and allow for a reduction in Brazil’s world-leading consumption tax rate.
After the election, the bill comes due
With national elections upcoming in October, the window for reform is currently shut. But the problem will continue to get worse until it is addressed. Debt is growing at an alarming pace, and medium-term interest rates are at the highest levels since Lava Jato. The average Brazilian spends around 30 percent of their income on debt service despite relatively modest overall household debt levels. And thus far, the government’s response has been more subsidized credit, the equivalent of staving off a hangover with more alcohol.