Environmentalists celebrate Lula’s reelection in Brazil: ‘The Amazon can breathe a sigh of relief’

The re-election of Brazilian leftist Luiz Inacio Lula da Silva has caused market instability as investors, anticipating a victory for his conservative rival, expressed concerns about fiscal responsibility. The Sao Paulo stock exchange, which had previously reached new highs following Flavio Bolsonaro's lead in the first round, suffered a significant drop of 17% before stabilizing to a 14% decline.

The Ibovespa index, the country's benchmark, experienced a sharp decline, prompting the first 30-minute trading halt since the Covid-19 pandemic in 2020. Lula, who turned 81 on Tuesday, defied poll predictions to secure a resounding win with 52% of the vote. However, Bolsonaro, the 45-year-old son of former President Jair Bolsonaro, had been considered the more appealing choice for investors due to his market-friendly stance.

The outcome came as a surprise to economic observers who had been banking on a Flavio-led government and a political transition. The Brazilian real lost 8% against the US dollar by the end of trading after initially plummeting by 12%. Amidst growing fiscal pressures, Bolsonaro pledged to reduce government spending and reduce the state's size, but he did not specify where these cuts would come from or claimed to preserve social programs.

Brazil's fiscal challenges are evident with the public debt exceeding 80% of GDP and interest rates at a high 13.75%. In the final stages of the campaign, Lula introduced expensive initiatives like increased cash transfers to the impoverished and debt relief for micro-enterprises. These spending pledges need to be incorporated into market calculations, said Andre Perfeito, chief economist at Garantia Capital.

Lula needs to implement sound fiscal reforms to restore market trust and confidence for the long term. However, Lula faces an uphill struggle governing after conservatives secured a significant victory in Brazil's Congress, suggesting a potential check on spending. Additionally, Bolsonaro's refusal to accept the election result, coupled with his accusations against Lula over alleged abuse of power regarding campaign promises, may further unsettle markets.

Once immediate election gains are considered and Bolsonaro challenges the result, the main concern for Brazilian assets will be whether Lula can establish a credible fiscal strategy with the help of Congress, according to economists from Deutsche Bank.