Brazil Under Lula: The First Year

Brazil Under Lula: The First Year

January 11, 2024, Covington Alert

Executive Summary

• President Lula da Silva concluded his first year successfully delivering on economic and social policies, and with good economic growth and job creation results.
• In contrast, he achieved mixed results in foreign policy and made little progress in his goal to curb what he perceives as threats to Brazilian democracy by the far right.
• The large, pro-business conservative majority in Congress continued to deliver both so-called “structural reforms” and new or improved sector-specific legal frameworks.
• 2024 will be an electoral year, but President Lula and Congress have a busy policy agenda.
• Companies doing business in Brazil should pay attention to the implementation of the 2023 tax reform, which will be crucial to deliver on the reform’s promises to simplify the tax system and reduce compliance costs for companies. They should also pay attention to further tax-related proposals to reform income and payroll taxes and potential legal frameworks on AI, cybersecurity, space activities, bioinputs, the carbon market, offshore wind power, and green hydrogen, among others.

Analysis

President Luiz Inácio Lula da Silva’s main goal for 2023 was to reignite economic growth and job creation with a particular focus on promoting gender equality, social inclusion, and environmental sustainability (details here).

Growth and Job Creation

Market players began 2023 expecting Brazil to grow 0.78% and improved their expectations up to 2.92% by December. While the official GDP growth rate will only be published later in 2024, the improved expectation points to a reasonably stable economic policy and a successful year for the administration.

In January 2023, players also expected annual inflation to reach 5.36%, but reduced it to 4.46% by December, a signal that monetary policy conducted by an independent Central Bank has yielded a positive result. The benchmark interest rate (SELIC), set at 13.75% since August 2022, was steadily reduced to 11.75%.

At the same time, official unemployment dropped to 7.5% by November 2023, the lowest level since February 2015, after peaking at 14.9% in March 2021.

The overall good economic performance was reflected in S&P’s decision to increase Brazil’s rating from BB- to BB in December, the agency’s first increase in more than a decade. This came after a similar decision by Fitch in July.

Economic Policy Deliverables

To achieve these results, President Lula and Minister of Finance Fernando Haddad set three policy goals for 2023.

First, the establishment of a new fiscal framework to stabilize public debt and create an incentive for the Central Bank to reduce the SELIC rate. The framework was introduced at Brazil’s National Congress in March (details here) and approved in August (details here).

Second, the approval of a major reform of the Brazilian consumption tax system at the federal, state, and local levels. The reform, a constitutional amendment, required four votes in the House of Deputies and two in the Federal Senate until a final text was agreed (details here and here). It simplifies the consumption tax system, reduces compliance costs for businesses, creates a new tax on goods and services, and changes taxes on property and financial transactions (details here).

Third, the increase of tax revenue through so-called “provisional measures” (MPs). MPs are issued by the President to change federal legislation. Once issued they need to be voted by Congress. If not voted in 180 days, MPs expire.

While President Lula and Minister Haddad were clearly successful in achieving the first two policy goals, they faced challenges with regard to the third. In 2023, President Lula issued 52 MPs. At least eight of them were focused on revenue increase, but only one was approved by Congress. Five expired and two are still in the 180-day window. The administration managed to partially remedy the situation by introducing and approving bills with similar or modified provisions of some of the expired MPs.

Social Policy Deliverables

The administration also put considerable effort into adjusting or recreating flagship social programs originally established by President Lula in his first two terms in office, from 2003 to 2010. These programs include:

• Conditional cash transfer for poor families to keep children in school (Bolsa Família);
• Increase of medical services offered to poor or underserved regions (Mais Médicos);
• Free or subsidized prescription medicine (Farmácia Popular); and
• Subsidies for low-income individuals and families to buy a house (Minha Casa Minha Vida).

Although impactful, none of these programs are new, a fact acknowledged by President Lula during a mid-year stocktaking of the administration’s results.

What seemed to be a new, key social policy deliverable was the program to help indebted individuals renegotiate their debt (Desenrola), which a former presidential contender and later supporter of Lula strongly sponsored during the 2022 election. The President created Desenrola by issuing an MP in June 2023 and later extending it in November. It has the potential to be a key political asset in the 2026 presidential election.

Mixed Results in Foreign Policy

President Lula invested considerable time in an active presidential diplomacy, visiting and hosting a number of heads of state and government, as well as attending high-profile international meetings.

On one hand, the administration was successful in reenergizing bilateral relations with key partners, including the United States, China, the European Union, Japan, and Argentina, among others. It also successfully organized a meeting of South American presidents, and strengthened cooperation with Amazon and tropical forest countries by hosting a summit in Brazil. Finally, it secured the hosting of the G20 in 2024 and of the United Nations Climate Change Conference (“COP”) in 2025.

On the other hand, the administration faced domestic and international criticism for its failed attempt to carve out a role for Brazil as a mediator between Russia and Ukraine. It also saw its proposed UN Security Council resolution on the Israel-Hamas conflict rejected by the body during its presidency. Moreover, it saw Brazil’s relative power diminish by a decision to expand the BRICS with countries that are China allies.

When it comes to trade policy, the administration was not able to conclude the EU-Mercosul trade negotiations. However, during the presidency of the South American trade block, Brazil secured a free trade agreement between Mercosul and Singapore. Brazil also joined the WTO Trade in Civil Aircraft Agreement, but suspended negotiations to join the organization’s Government Procurement Agreement.

Perceived Threats to Democracy

President Lula’s third term began with the storming of the buildings of the three branches of government in Brasilia by far-right protesters on January 8, 2023. The storming prompted a strong reaction from the administration, Congress, and the Supreme Court, including a congressional investigation on the matter.

However, the administration’s two key policy goals to curb what it perceives as threats to Brazilian democracy were not achieved.

The first goal was the approval of a social media and instant messaging legal framework to fight the production and spread of fake news. The so-called “Fake News Bill” had the support of both President Lula and the Speaker of the House, but faced strong opposition in Congress by the right as well as by technology companies (details here). As a result, the Speaker decided not to put it to a floor vote.

The second goal was the approval of a constitutional amendment to automatically send to the reserve any member of the Armed Forces on active duty who decides to run for office. This safeguard is designed to establish a wall between the military and politicians. The draft amendment was introduced in the Senate after a negotiation between the administration and the leadership of the Armed Forces, and marked up in the committee stage, but was not taken to a floor vote. If approved, it will need to be voted on by the House.

Congressional Action

Since 2015, Brazil’s Congress has been run by a large, pro-business conservative majority that controls both the speakership of the House and the presidency of the Senate, and, in many instances, acts independently of the Executive branch.

This recent political dynamic resulted in a consistent pattern of congressional action focused on so-called “structural reforms” combined with a number of sector-specific new or improved legal frameworks. Both trends continued in 2023.

Congressional leaders led the 2023 tax reform, the third installment in a series of structural reforms that include the 2017 labor laws and the 2019 social security entitlements reforms. In addition to it, Congress also approved sector-specific frameworks on (i) accessory tax obligations, (ii) agrochemicals, (iii) loan guarantees, (iv) sports betting, and (v) transfer pricing.

Congress also acted to revert Executive branch and Supreme Court decisions whenever it felt they would harm the private sector. Examples include congressional action to preempt a decision by President Lula to increase participation of state-owned enterprises in the waste and water management sector, and to revert a decision by the Minister of Labor and Employment to impose stricter rules related to work on weekends.

The Year Ahead

2024 is an election year. Brazilians will elect all mayors and city councilors in October. Nonetheless, the administration and Congress have a busy policy agenda for the year.

In the short term, the administration will need to introduce in Congress the implementing legislation for the 2023 tax reform, as well as proposals for both income tax and payroll tax reforms (details here). In addition, the administration will likely focus its effort on implementing the recently-launched climate transition plan, dubbed the “ecological transformation plan”, and its new industrial policy focused on so-called “neoindustrialization.” Two key elements of the climate plan require legislation: the establishment of Brazil’s carbon market and the creation and improvement of sustainable fuels programs. Two additional elements, spearheaded by Congress, are legal frameworks for offshore wind power and green hydrogen.

In parallel to the administration’s priorities, Congress will likely debate and vote on a legal framework for artificial intelligence. There is also a possibility that the administration will introduce a bill with a legal framework for cybersecurity, including the creation of a new regulator. The Senate is already debating a framework on space activities and the House is considering a framework on agricultural bioinputs.

Finally, Congress, in particular the House, will likely continue to pressure the administration to pursue a government human resources reform to curb spending. A draft constitutional amendment with the reform was introduced by then President Jair Bolsonaro in 2020, but was never voted on. The Speaker of the House has been signaling the need for such a vote for the past six months, stating that the new fiscal framework is over-reliant on revenue and that the administration must face a debate on spending cuts.

After the mid-year recess, both the administration and Congress will be focused on local elections. President Lula’s goal will be to convert his positive results in 2023 into electoral victories for his Worker’s Party.

Finally, a key political development after the local elections will be the campaign for congressional leadership as the House and Senate will choose their Speaker and President, respectively, in early 2025. The administration will need to decide whether to try to influence the result of this election or not. This decision will have a major impact on Brazil’s political dynamic.

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