Brazil - Lula vs market expectations

Markets are concerned and Lula cares less about that than he used to.

Markets in Brazil Plunge On Worries Over Election. That’s the New York Times headline from September 2002. With polls showing Lula might win in the first round, Brazil's stock market and currency plunged. Lula didn't win until the second round, but if you had bought Brazilian stocks at any point during late 2002 and held them for a few years, you would have made a solid profit. Brazil's economy boomed under Lula's first term in office as the regional commodities boom took off.

Two decades later, Brazilian markets took a hit last week as investors became nervous about the Lula economic agenda again. While Lula's economic team in 2002 took the economic fears seriously and did everything in their power to reassure markets, they're largely laughing it off this time. They have more experience and more than a bit of arrogant survivor bias.

It is notable that Lula doesn't seem concerned or pressured. He's not going out of his way to say the magic words that would soothe markets. He's not quickly naming a finance minister that will inspire confidence. Instead, he's focusing on social spending to reduce poverty domestically and on an international agenda that places Brazil at the center of the climate debate. He’s placing social responsibility over fiscal responsibility in his rhetoric. Behind the scenes, his team is lining up the votes in Congress to get their spending agenda passed.

Lula and his aides are banking on the fact that generating economic growth and jobs will more than make up for whatever deficits the country takes on. Markets are focused on those spending numbers, as well as the potential for a global economic slowdown next year, and are worried that it's all unsustainable.

There are two potential errors being made here. One is the overconfidence of Lula and his economic team, believing that because they pulled off an economic growth boom before means they can do so again under tougher conditions. The other is that market analysts may be making the same error they did in 2002, letting the bias against left wing policies cause them to miss a potential opportunity. At least one of those errors will turn out to be true.

Over the next few months, markets will boom and bust based on the announcement of Lula's finance minister (it'll be fine) and his first spending initiatives to Congress (they'll be big). But the longer term play is going to be about whether Lula's team can get past the global slowdown and return Brazil to high levels of growth. If they can get Brazil growing, the deficits won't matter much (they'll matter eventually, but he can kick the issue to well past his time in office). If growth stalls, then that debt becomes a huge weight that drags his government down.

Lula is probably correct that increasing growth, creating jobs and reducing poverty would more than make up for concerns about fiscal discipline during his term in office. He’s almost certainly underestimating how hard that will be in next year’s global economic environment.