Brazil's economy to slow next year on high interest rates, lower spending

By Gabriel Burin

BUENOS AIRES, Oct 19 (Reuters) - Brazil's economy will slow next year, a Reuters poll of analysts found, impacted by high interest rates and a moderation in public spending whoever wins an upcoming presidential vote run-off.

This would stabilize the country's debt trajectory which has become one of the main campaign issues for the October 25 election where Luiz Inacio Lula da Silva will confront opposition Senator Flavio Bolsonaro.

But the complex fiscal picture of Latin America's No.1 economy could face additional risks from higher inflation pressures due to the Iran war as well as the developing weather pattern of El Niño, analysts said.

Gross Domestic Product (GDP) is set to expand 1.5% in 2027 compared to this year's expected growth of 1.9%, according to the median estimate of 48 economists polled October 12-16. Next year's forecast is a slight downgrade from 1.8% expected in the July poll.

Sergio Vale, chief economist at MB Associados, said Brazil's current strict monetary stance would have to be supplemented with a shift to budgetary restraint after the election.

"We are seeing a very strong fiscal stimulus this year. By 2027, however, you will have to reverse course - you will need to implement a slowdown," Vale said.

Both Lula and Bolsonaro have made broad promises to consolidate the budget next year without cutting pensions and social benefits. Under Brazilian budget rules, they are rising faster than inflation and so have contributed substantially to a widening in the primary deficit.

This trend, in addition to the effect of other recent spending measures and soaring interest costs, has pushed up the country's gross public debt to 82.9% of GDP so far this year.

Brazil already has one of the highest ratios in Latin America, well above Argentina, according to the International Monetary Fund.

Gross debt to GDP will end 2026 at 83.4%, based on the median of 24 estimates, implying a significant 6.1% rise from 78.6% at the start of the year.

After that, analysts expect it to finish at 87.1% of GDP in 2027 and 90.0% in 2028, representing a slowdown in debt growth to more moderate rates of 4.4% next year and 3.3% in 2028, respectively.

Gabriel Leal de Barros, chief economist at ARX Investimentos, said this stabilization could become harder to achieve if the Iran war continues to drive US inflation and interest rates higher next year.

"For a country like Brazil, there’s no way around it. Even if you do everything right, your interest rates will also be higher. Consequently, this ends up affecting your debt," Leal said.

Brazil's benchmark rate was forecast to fall to 13.25% by the end of this year from 13.75% currently, even though most other central banks are hiking rates or considering raising them.

Banco Central do Brasil is then expected to keep easing its monetary policy gradually to reach 12.00% by end-2027.

Rafael Amiel, director of Latin America economics at S&P Global, said the possibility of a severe El Niño weather pattern also posed upside risks for Brazil's inflation.

In the poll, consumer prices were forecast to decelerate only marginally to an average rise of 4.4% next year from 4.5% in 2026, at the upper limit of the central bank's target of 3% plus a margin of 1.5 percentage points.

Of 28 answers to an additional question allowing multiple replies on what measures Brazil was likely to take in 2027, 13 were for spending cuts, 6 for tax hikes, 5 for "others" and 4 for privatizations.

S&P's Amiel said pension reform could be included as well "if politically feasible...(and) the reintroduction of a spending cap may also be considered."

However, Felipe Salto, chief economist and partner at Warren Investimentos, said Brazil was far from a situation of public sector insolvency requiring drastic steps.

"Since next year will be marked by low growth, a brutal adjustment in the first year (of the new administration) would not be advisable, as it risks triggering a recession in the second half of 2027," Salto said.

(Other stories from the Reuters global economic poll)