Case Study 10 - Brazil's Fiscal Shortfall

Question 1

Exchange Rates (4.1.8)

Why did the Brazilian real depreciate to a record low against the US dollar in 2024?

Answer 1

• Fiscal concerns: Chronic budget deficit and rising public debt (debt-to-GDP ratio 78.6%, projected to exceed 80%) eroded investor confidence (Page 1: “plummeting investor confidence”).
• Central bank interventions: Sold $170bn to stabilize the real (Page 3: “central bank burnt through… spot market auctions”).
• Political factors: Market fears over Lula’s tax-and-spend policies and parallels to past crises (Page 2: “repeating the mistake made by Dilma’s government”).

Question 2

Public Sector Finances (4.5.4)

How has Brazil’s fiscal policy impacted its currency and economy?

Answer 2

• Rising deficits: Nominal fiscal deficit doubled to 9.5% under Lula, increasing borrowing costs (Page 3: “pushing up public borrowing”).
• Debt sustainability: Debt-to-GDP ratio reached 78.6%, creating uncertainty (Page 3: “very significant level… creates great uncertainty”).
• Structural challenges: 90% of budget allocated to mandated spending (e.g., pensions), limiting austerity options (Page 3).

Question 3

Macroeconomic Policies (4.5.4)

What macroeconomic policies has Brazil implemented to address the real’s depreciation?

Answer 3

• Monetary policy: Central bank raised Selic rate by 100 basis points, with further hikes planned (Page 2: “inflation above 4.5%”).
• Fiscal measures: R$70bn spending cuts and tax reforms (Page 1: “Fernando Haddad rushed… spending cuts”).
• Currency intervention: Sold $170bn in forex reserves to stabilize the real (Page 3).

Question 4

Exchange Rates (4.1.8)

How did investor behavior contribute to the real’s depreciation?

Answer 4

• Loss of confidence: “Absolute fear in the market” (Page 1) led to capital flight, increasing demand for USD.
• Delayed austerity: Delays in spending cuts and populist tax exemptions worsened sentiment (Page 4: “income tax exemption… damaged fiscal responsibility claims”).
• Contagion risk: Sovereign bond markets also affected (Page 1: “contagion… irrational despondency”).

Question 5

Public Sector Finances (4.5.4)

Why is Brazil’s rising public debt a concern for economic stability?

Answer 5

• Debt servicing costs: Higher interest payments exacerbate deficits (Page 3: “nominal deficit… includes interest payments”).
• Inflation risks: Depreciation increases import prices, fueling inflation (Page 4: “down one-fifth against the greenback… inflationary pressures”).
• Growth constraints: High debt limits fiscal stimulus for development (Page 2: “lowest investment rates… recorded in official data”).

Question 6

Macroeconomic Policies (4.5.4)

What challenges does Brazil face in balancing growth and fiscal discipline?

Answer 6

• Political tensions: Lula’s criticism of 12% interest rates vs. central bank’s inflation targeting (Page 2: “accused… high borrowing costs”).
• Policy credibility: Market doubts over austerity measures (Page 4: “emergency rate increase… might be an option”).
• External factors: Climate events (floods/droughts) impacting inflation and growth (Page 3: “moderation of growth in food prices”).