Although Brazil's economic growth has increased in recent years, persistent structural challenges and an increasing government debt burden will be a drag on the medium-term outlook, as neither decisive fiscal consolidation nor broader structural reform will be forthcoming before the 2026 presidential and congressional elections. Over the past two decades, Brazil has managed to maintain systemic financial stability in the face of consecutive political and international economic and financial shocks, such as the 2008 global financial crisis, the 2014 Car Wash Scandal, the 2015 to 2016 impeachment of former President Dilma Rousseff and the 2020 COVID-19 pandemic. However, its economic performance was much weaker than during the noughties and weaker than most other emerging economies, including those in Latin America. Real economic growth averaged less than 1% over the past ten years. Over the past three years, however, Brazil's economic performance has improved. Higher growth has been in part supported by increasing government expenditure, which in turn has helped keep fiscal deficits high and increased government debt substantially. Brazil's external financial position has remained sound, which has helped limit the probability of a near-term fiscal and debt crisis. However, current fiscal deficit levels will prove unsustainable in the medium term.

• Real GDP growth averaged 3.2% between 2022 and 2024, over three times higher than the 2015 to 2024 average of 0.9%. In the meantime, large fiscal deficits have increased gross government debt from 83% of GDP in 2022 to a projected 92% in 2025.
• The fact that most of Brazil's government debt is owed in local currency and largely by residents limits financial risks. Non-residents hold only around 10% of Brazil's domestic (real-denominated) government debt, down from 20% a decade ago. The government is a net foreign-currency creditor, meaning currency depreciation leads to a decline in the debt-to-GDP ratio.

In recent years, economic growth has been supported by increasing government expenditure, which has prevented fiscal consolidation. Brazil's efforts to reduce its fiscal deficit have been low since President Luiz Inacio Lula da Silva took office for the third time in 2023. The government has prioritized increased government expenditure over more rapid fiscal consolidation. It has sought to rely on increasing revenue through higher taxes and the closing of tax loopholes while avoiding politically unpopular spending cuts. To that end, the government has also weakened the fiscal framework, which replaced a cap on government spending increases with a primary surplus target and then adjusted the primary fiscal targets to allow for higher spending on several occasions, to allow for higher public spending. Significant fiscal adjustment requires broad reforms, as Brazil is characterized by significant budget rigidity. The share of discretionary spending in total government spending is small due to legally and constitutionally mandated minimum expenditure targets, combined with the indexation of social security entitlements and social programs to the national minimum wage and revenue earmarking. In terms of monetary policy, the government's decision in June 2024 to establish a continuous (as opposed to annual) inflation target, meaning the central bank is obligated to meet the inflation target every month, has similarly weakened the monetary policy framework. Although the authorities maintained the 3% inflation target for 2025, including a tolerance interval of 1.5 percentage points, the modified framework provides the central bank with greater room to accommodate price shocks and deviations from the inflation target without requiring immediate monetary tightening. The fact that this modification took place in the context of persistent criticism of the central bank's monetary policy by the president also points to a weakening of the monetary policy framework.

• Brazil's fiscal deficit is projected to grow from 6.6% of GDP in 2024 to as much as 8.5% this year, according to the IMF.
• In August 2023, the government modified the fiscal framework to set a primary balance target, starting with a 0.5% of GDP primary deficit in 2023 and improving it in 0.5% increments per year to reach 1% of GDP in 2026. The framework also limited spending growth to below the increase in projected revenue. After modification and flexibilization, the government now targets a zero primary deficit this year, with a tolerance band of 0.25% of GDP in either direction. This represents a slower adjustment than was originally envisioned. It is also too slow in the context of a continued rapid increase in the debt-to-GDP ratio from 83% of GDP in 2022 to a projected 96% of GDP at the end of da Silva's term in 2026.
• Following a spike in inflation during the COVID-19 pandemic, inflation averaged 4.6% in 2023 and 4.4% in 2024, just in line with the respective 3.25% and 3% inflation targets once the 1.5 percentage point tolerance interval is included. With inflation running at the upper end of the target range, the independent central bank will have little choice but to pursue a tight, high-interest-rate policy, which will further contribute to increasing interest costs.

A failure to implement a tangible fiscal adjustment is leading to an unsustainable medium-term accumulation of government debt, particularly in view of high real interest rates. Brazil's primary surplus target for 2026 is 0.25% of GDP. However, a back-of-the-envelope calculation suggests that the government would need to run a substantially higher surplus to stabilize the debt-to-GDP ratio. Currently, the real interest rate stands at 10% (approximated by the main interest rate, or SELIC, minus inflation). But even if real interest rates fall to 5% and assuming medium-term real GDP growth of 2%, Brazil would need to run a primary surplus of at least 2% of GDP. Brazil is not going to generate a primary surplus of 2% in the next few years and if and when it does, will be insufficient to stabilize a by then higher debt-to-GDP ratio, particularly if real interest rates were to increase further on the back of increasing concerns about debt sustainability.

• Brazil's gross government debt-to-GDP ratio is set to increase from 87% of GDP to 92% this year. Net public sector debt (accounting for central bank holdings of government debt) will increase from 61% of GDP last year to 66%. The International Monetary Fund (IMF) projects gross government debt to reach nearly 100% of GDP by the end of the decade. This, however, implies significant progress in terms of fiscal consolidation during the remainder of the decade. It also appears optimistic in light of high real interest rates.

In addition to the government's fiscal policy decisions, other structural economic factors limit Brazil's economic growth potential, which will make it very challenging to put government debt dynamics on a sustainable path over the short- and medium-term. First, investment and fixed capital formation are low, constrained by a low economy-wide savings rate. Second and relatedly, government policies, including social and pension expenditure, do not encourage household savings, while the government's savings rate is negative, meaning government consumption exceeds government revenue after transfers, contributing to the low domestic saving ratio. Third, increasing interest expenditure on increasing government debt further limits the availability of funds to support government investment and the ability to reduce expenditure and the fiscal deficit. Fourth, a burdensome tax system and government red tape make investment less profitable and lower the return on investment. Finally, Brazil is a very closed economy, particularly in terms of imports, which limits domestic competition and productivity growth. It also makes it less attractive as an investment destination in terms of multinationals' global value chain integration (unlike East and Southeast Asian countries).

• Brazil's savings rate of less than 14% of GDP is low and constrains investment and economic growth. Limited savings contribute to high real interest rates. At present, the policy rate is 15% and inflation is running at around 5%, translating into a real interest rate of 10%.
• In terms of trade, Brazil is the 12th least open of 195 economies, with trade amounting to 34% of GDP, compared to a global average of 59% of GDP, according to the World Bank. In terms of imports, it is the sixth least open economy, with imports amounting to 16% of GDP, compared to a global average of 29% of GDP. Brazil's average effective tariff on industrial goods is high, making it the 153rd least open out of 199 economies.

In the run-up to the October 2026 elections, the government is unlikely to pursue a policy of fiscal restraint, which will increase the pressure on the next government to implement credible fiscal reform. The government is not going to impose any significant spending cuts 12 months before the October 2026 elections, nor will it pursue any significant revenue measures for fear of losing electoral support. Large fiscal deficits will help keep inflation high and put a greater burden on monetary policy. If the next government fails to implement more credible budgetary reform, the fiscal and debt burden will continue to increase, increasing Brazil's economic and political challenges. Should a non-market-friendly candidate stand a real chance of winning the presidency in 2026, then the risk of financial instability would increase significantly ahead of the election. In such a scenario, capital outflows would increase, the real would weaken and the central bank would be forced to raise interest rates. The economy could be tipped into recession, thus increasing pressure on the government to implement a broader macroeconomic adjustment following the elections. But even if all the leading candidates pay lip service to pursuing fiscal discipline, a debt-to-GDP ratio approaching 100%, high nominal and real interest rates and likely slowing economic growth will increase the pressure on the new president to take more decisive action than their predecessor. If the new government reins in spending, the short-term impact on economic growth will likely be negative. If the government does not limit spending, then continued high interest rates, combined with an inability to further increase government spending, will weigh on the economic outlook. If debt continues to increase, as it cannot increase forever, it will lead to increasing real interest rates, growing investor concerns and loss of economic confidence, which will then likely force the government to force through a draconian adjustment. If the government fails to do so, it is possible that the central bank will be forced into monetizing government debt to avert broader financial stability, which could then lead to increasing inflation as well as declining economic and financial confidence. In this case, it would also lead to a sharp weakening of the real due to increasing capital outflows, which, in a worst-case scenario where the government fails to take corrective action, might force the government to introduce capital controls.

• The IMF projects real GDP growth to average 2.3% between 2026 and 2030. It also sees consumer price inflation converge with the central bank's 3% target by 2030. It also optimistically predicts the fiscal deficit to shrink from more than 8% of GDP in 2025 to less than 5% by 2030. This would require a significantly more decisive fiscal adjustment than will prove politically and economically feasible, not least given increasing interest outlays due to a higher debt-to-GDP ratio.