Growth under Fiscal Constraints: The Real Engine of Brazil's Economic Recovery

From Stagnation to Recovery: The Policy Paradox Behind the Data

Brazil's economy turned in a better-than-expected performance in 2023-2024. After average annual growth of only 0.2% from 2015 to 2022, GDP grew at an average annual rate of 3.3% in the first two years of Lula's third term. Even more noteworthy, per capita GDP growth reached 2.9%, nearly matching the 3.0% recorded during the period from 2003 to 2010, which was once called the "golden era." Considering that the population growth rate fell from 1.0% to 0.4% over the same period, the quality of "growth" is amplified in per capita terms.

However, the drivers of this recovery stand in sharp contradiction to the official narrative. The finance minister believes growth can continue automatically through consumption and private investment, while the central bank regards fiscal expansion as the culprit behind economic overheating and has used this as grounds for sustained interest rate hikes. But in fact, it was fiscal expansion—not the private sector's "spontaneous momentum"—that offset high interest rates and external headwinds, pulling the Brazilian economy out of the mire of stagnation.

The Unexpectedly Expansionary Fiscal Policy: The Real Engine of Recovery

Between 2015 and 2022, fiscal austerity and neoliberal reforms suppressed domestic demand, and by the end of 2022, Brazil's internal market was even smaller than in 2014. From 2023 onward, the situation reversed. The policy shift brought about by the change of government—including raising the minimum wage, increasing transfer payments, and restoring infrastructure spending—markedly boosted aggregate demand. Although the finance minister publicly emphasized debt stability, fiscal spending in actual implementation took on an expansionary trajectory.

This expansion was not entirely by design. After the Lula government took office, a series of committed expenditures (such as restoring the scale of the "Bolsa Família" program and raising the minimum wage) were rigid, and combined with political pressure, fiscal policy still followed an expansionary path despite the constraints of the "debt anchor." The result: government spending directly boosted consumption, and corporate investment also grew faster than GDP in 2024. Although the central bank's benchmark interest rate remained in double digits, the demand-pulling effect of fiscal expansion still outweighed the dampening effect of monetary tightening.

External Buffers: Why Could Growth Still Occur in an Era of High Interest Rates?

Historically, U.S. interest rate hikes have often forced emerging markets to tighten policy, but this time Brazil remained relatively calm. The reason lies in the profound changes in the structure of its external accounts. Since the mid-2000s, Brazil has accumulated substantial foreign exchange reserves, with short-term external debt accounting for less than 30% of reserves and total external debt at about 71% of reserves. More importantly, the "de-dollarization" of Brazil's external liabilities—with a large share of public bonds and equity denominated in local currency—has shifted exchange rate risk onto creditors, reducing the impact of sharp currency depreciation on balance sheets.This explains why Brazil was able to sustain large current-account deficits in 2023–2024 (driven by profit and interest remittances exceeding the trade surplus) while maintaining financial stability. Of course, external conditions were not without cost: the exchange rate depreciation in 2024 temporarily pushed up imported inflation, forcing the central bank to raise interest rates again. But compared with 2015–2016, Brazil's room for maneuver has clearly expanded.

Policy Contradiction: The Tug-of-War Between Fiscal Stimulus and Monetary Tightening

Brazil is caught in a cognitive melee of economics. The central bank regards fiscal expansion as a source of inflation, believes the economy is overheating, and has pushed real interest rates to levels higher than in any period between 2011–2014 and 2015–2022. The finance minister, meanwhile, insists that growth needs no additional fiscal stimulus, seemingly believing that private investment will naturally fill the demand gap.

The root of this contradiction lies in an outdated theoretical assumption: potential output is independent of aggregate demand. Under this framework, any demand expansion will trigger inflation without raising potential growth. But Brazil's empirical evidence points in the other direction—fiscal expansion is precisely the key to reversing stagnation, while austerity only brings zero growth. The lesson of 2015–2022 is already clear: austerity policies destroyed the domestic market but failed to improve debt sustainability.

The current high interest rates have already had a negative impact on residential investment. Corporate investment is still passable, but if rates remain high, manufacturing upgrading and infrastructure improvement will be hindered. Fiscal and monetary policies are moving in opposite directions, making growth difficult to sustain.

Industry and Exports: Who Benefits?

From an industrial perspective, the beneficiaries of this recovery are clearly tilted toward domestic-demand-driven sectors. Fiscal transfers and minimum wage increases have directly boosted the purchasing power of low-income groups, and consumer-related industries such as food, retail, and services have rebounded strongly. At the same time, due to the exchange rate depreciation in 2024, import-substitution sectors have gained some protection, and industrial output has recovered.

Agriculture and mining continue to play the role of export ballast. Commodity exports such as soybeans, corn, and iron ore have earned Brazil substantial foreign exchange, offsetting the current-account deficit. But the tendency toward "re-primarization" also means that export growth contributes little to technological innovation and industrial chain upgrading. What can truly support long-term growth is still an increase in the investment rate—and investment is precisely the most sensitive to interest rates.

Core Observations## Core Observations

• Fiscal expansion is the decisive force to reverse stagnation, but the official narrative deliberately downplays its role, instead attributing growth to the private sector, which may lead to policy misjudgment.
• External vulnerability has been greatly reduced; foreign exchange reserves and local-currency-denominated liabilities provide a buffer against external shocks, allowing Brazil to maintain policy space during the US dollar rate hike cycle.
• Monetary tightening is eroding the foundation of growth. High real interest rates suppress residential investment and manufacturing expansion. If sustained, this will weaken the effectiveness of fiscal policy.
• Agriculture and mining are external stabilizers but cannot replace domestic demand. What truly drives employment and income growth is domestic consumption and the service sector.
• The policy framework suffers from structural contradictions. Conflicts between fiscal and monetary objectives will amplify macroeconomic volatility and hinder long-term growth.

The Next Five Years: Rethinking the Role of Fiscal Policy

Looking ahead to the next five years, what Brazil needs most is a shift in macroeconomic policy philosophy. If it continues to cling to the dogma of "exogenous potential output" and treats fiscal expansion as a scourge, the economy is likely to fall back into the trap of low growth. Conversely, if it can acknowledge the positive role of fiscal policy in stabilizing demand and guiding investment, and shift monetary policy objectives from single-minded inflation targeting to broader growth and employment, Brazil may enter a more sustainable upward cycle.

Structurally, the quality of fiscal expenditure is crucial. Redirecting resources toward infrastructure, education, and green transition can both create short-term demand and enhance long-term productivity. Export revenues from agriculture and mining can support structural reforms, but the resource curse must be avoided—over-reliance on commodities while neglecting industrial competitiveness.

For investors, the current high-interest-rate environment offers relatively high risk-free returns, but it also implies high financing costs for the real economy. If fiscal and monetary policies move toward coordination in the future, Brazil may see a favorable combination of "growth plus rate cuts," from which both the stock market and the real economy would benefit. When this inflection point arrives depends on how deeply policymakers rethink the logic of growth.