Brazilian real hits all-time low as investors doubt cost-savings plan

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Brazil’s currency dropped to a record low on Thursday as a government promise to find R$70bn (US$12bn) in cost savings over the next two years failed to calm investors’ nerves over the public finances of Latin America’s largest economy.

The real fell 1.2 per cent, breaking through the psychologically significant threshold of six to the US dollar for the first time. The yield on the benchmark 10-year government bond rose 0.32 percentage points to 13.52 per cent, an all-time high, with markets doubting the efficacy of new spending restraints and tax changes designed to balance the budget.

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The long-awaited proposals, unveiled late on Wednesday, follow mounting concerns over fiscal policy under President Luiz Inácio Lula da Silva, who has promised extra cash for welfare and infrastructure in order to raise living standards for the population of 213mn.

Business leaders in the South American nation warn that rising state expenditure is feeding inflation and risks pushing debt to unsustainable levels.

“Even if we were positively surprised by details, attention would swiftly move to the challenges of having all measures approved in time for them to take effect at the start of next year,” said Viktor Szabo, emerging markets debt portfolio manager at Abrdn. “Brazilian markets just can’t ever be happy about anything done by the Lula administration.”

The savings drive seeks to ensure Brasília achieves a zero primary deficit in the budget — meaning before interest payments — which is a stated goal for both this year and next.

Finance minister Fernando Haddad on Thursday said the government would fulfil the 2025 target, adding that investors had been too pessimistic. “[These measures] will consolidate this government’s commitment to the country’s fiscal sustainability,” he said.

“The market needs to re-evaluate what the government is doing. The market made mistakes in both growth and deficit [forecasts].”

Marcelo Mesquita, founding partner of asset manager Leblon Equities, said of the fiscal package: “The direction is correct, but the dose of the medicine is insufficient. The government needs to reduce costs and taxes, as Argentina is showing is possible with extraordinary results.”

While Brazil’s GDP is expected to expand 3.2 per cent in 2024 and unemployment is close to the lowest point since records began, there are worries in some quarters that the economy is overheating.

The country’s central bank has stressed the need for fiscal discipline and recently began raising its basic interest rate in an attempt to contain consumer price inflation that is overshooting an official limit of 4.5 per cent.

In parallel, a 23 per cent fall in the real against the dollar means it ranks as the worst-performing major emerging market currency in 2024. São Paulo’s Bovespa share index closed down 2.4 per cent on Thursday.

Tiago Negreira, an economist at asset manager Tenax Capital, described the package as a “disappointment” and said the bulk of the changes were budget reallocations, estimating only about R$30bn in cuts.

“Today’s announcement weakens Haddad and demonstrates how unwilling the government is to move forward with fiscal adjustment,” he added.

Alongside the moves was an unexpected income tax reform from 2026 set to benefit the lower middle classes, aimed at softening possible public blowback against spending reductions.

An exemption from the payroll tax will be raised for salaries up to R$5,000 a month, costing R$35bn and in line with a campaign pledge by Lula. It will be paid for by increased income levies on the rich, according to Haddad.

Analysts noted overall spending was likely to continue rising despite the proposals, some of which require congressional approval, as the government’s own rules for the public accounts mandate that state expenditure in Brazil must grow annually.

Jason Tuvey, deputy chief emerging markets economist at Capital Economics, said the measures “failed to live up to expectations”.

“[They] reinforce the idea that political commitment to stabilising the public finances is lacking. One consequence is that the central bank’s tightening cycle may be more aggressive,” he said.

Brazil’s nominal budget deficit has roughly doubled since Lula took office at the start of last year, to 9.3 per cent of GDP in the 12 months to the end of September, according to central bank data.

Additional reporting by Beatriz Langella