The Brazilian Lula returns to power. The economic challenge will be much greater this time.

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About the Author: Desmond Lachman is a Senior Fellow at the American Enterprise Institute. He was previously Deputy Director of the Policy Development and Review Department at the International Monetary Fund and Chief Emerging Markets Economic Strategist at Salomon Smith Barney.

It would be an understatement to say that much has changed since the relatively successful presidency of Luis Inácio Lula da Silva from 2003 to 2010. The question as he returns to office following Sunday’s election victory is whether economic thinking de Lula has changed over time. If he wants to have a successful economic presidency this time around, he will have to think differently.

Time will tell if Lula learned from the economically disastrous presidency of Dilma Rousseff, his successor in the Workers’ Party. This presidency, characterized by fiscal profligacy and corruption, produced the worst post-war economic recession in Brazil in 2015-2016. It was also a major source of the country’s current fiscal problems.

If Lula’s economic thinking doesn’t change, Brazil could be in for another round of tough economic sledding. Hopefully, for both Brazil and the rest of the global economy, this will not turn out to be the case. Economic problems in Latin America’s largest economy are the last thing a strained global economy needs now.

Brazil’s public finances were in reasonable order under his previous presidency. But when Lula takes office on January 1, 2023, he will find his country’s public finances in disarray. With a public debt/GDP ratio close to 80%, questions arise about the country’s debt sustainability. At the same time, more than 90% of the budget is earmarked for compulsory spending, leaving Lula little room for maneuver when it comes to fiscal policy. Inflation, meanwhile, is running at 9%.

Lula made several promises during the election campaign that could further jeopardize the country’s public finances and increase inflation. He promised to increase social transfers, expand a social housing program and introduce a debt cancellation program. He also said he sees the government as the main driver of economic growth and would like to see a more flexible fiscal rule rather than a return to a cap on government spending.

Lula’s previous presidency took place in a relatively benign international economic context that allowed Brazil to ride an international super wave in commodity prices. He now takes office at a much more difficult international economic time.

The Covid and the real estate sector are causing a sharp slowdown in China, the world’s largest consumer of raw materials. This, combined with the threat of impending economic recession in the world’s largest advanced democracies, will likely put substantial downward pressure on international commodity prices and reduce demand for Brazilian exports. At the same time, aggressive Federal Reserve policy is leading to higher global interest rates, a rising dollar, and strains in US and global financial markets. This, in turn, should lead to continued capital repatriation from Brazil to the United States, which could complicate non-inflationary financing of the fiscal deficit.

One change from his previous presidency that could work in Lula’s favor is his lack of a majority in Congress. Lawmakers allied with outgoing President Jair Bolsonaro will instead be in charge. Admittedly, this could make it difficult for Lula to introduce tax increases or public spending cuts that could help clean up public finances. However, the lack of a majority in Congress will likely prevent Lula from delivering on the more hard-line parts of his economic campaign promises that would otherwise further jeopardize the country’s public finances.

In 2003, when Lula last assumed the presidency, many pundits predicted that Brazil was heading for economic disaster under the leadership of an irresponsible far-left political leader. Lula confounded his critics by following a prudent macroeconomic policy that helped strengthen the country’s public finances and brought economic dividends for the country.

We must hope that this time around Lula will recognize the much tougher economic challenges he will face and avoid the gross political mistakes of the Rousseff presidency that have cost the country so much. Otherwise, Brazil and the rest of Latin America could prove to be an undesirable source of international economic weakness.

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