Brazil

The fiscal trajectory is Brazil's most tangible medium-term vulnerability. Gross public debt reached 82% of GDP by mid-2026 and continues climbing, driven primarily by interest costs rather than primary spending. The overall deficit has widened to 8.6% of GDP, approaching pandemic-era levels, while the government revised its 2026 primary deficit projection to 0.6% of GDP. Brazil requires a debt-stabilizing primary surplus of 2% of GDP, the highest among major Latin American economies, yet no mainstream scenario achieves this level. Mandatory primary expenditures account for over 90% of the budget, with key spending lines indexed to minimum wage, inflation and revenue growth, leaving minimal room for discretionary adjustment. The combination of a weakened currency, above-target inflation and limited fiscal space leaves little margin for policy error. Government appointments and the extent of the expected spending cuts will determine the fiscal path into 2028.

Corporate stress is deepening at a pace that demands attention. A record 5,680 companies entered judicial recovery in 2025, and over 7.1mn businesses are in arrears nationally. Insolvencies are projected to rise a further +18% in 2026. The epicenter is agribusiness: 539 firms under court-supervised restructuring in Q1 2026 (+58% y/y), farm loan delinquency at its highest level in two decades, rural lending down -13% y/y and farm seizure auctions accelerating across producing states. The combination of the Selic at 14.25%, prolonged drought in key basins and volatile commodity receipts has created a structural cash-flow problem for mid-sized producers. Banking sector capitalization remains adequate, but credit standards are tightening and the transmission from agricultural distress to broader SME segments bears monitoring through H2.

Brazil's structural attractiveness rests on scale, diversification and resource depth. The economy has no single-sector dependency, and the ongoing shift in trade patterns, with US exports falling to a 30-year low while China and Asia absorb the surplus, is reducing geographic concentration. However, this also deepens strategic reliance on Chinese demand, creating new vulnerabilities that the current bilateral framework does not adequately hedge.

The 25% US Section 301 tariff imposed in July, covering a broad range of manufactured and agricultural goods (with exemptions for oil, aircraft and orange juice), marks a structural repricing of the bilateral trade relationship. It compounds the existing 10% baseline tariff and signals a durable shift in US trade posture toward Brazil. The short-term impact is modest at 0.1-0.3% of GDP on a 12-month basis, but the medium-term impact will depend on whether Brazilian firms can accelerate diversification and whether retaliatory measures remain contained.

On the environmental dimension, COP30 held in Belém in November 2025 confirmed Brazil's convening power but delivered weak binding outcomes without a fossil fuel phase-out roadmap or deforestation agreements despite the presidency's early ambitions. Amazon deforestation declined from its 2022 peak but remains elevated at nearly 5,800 km² in 2025. The gap between international climate commitments and domestic enforcement capacity continues to create ESG-related reputational risk for investors with Brazilian exposure. Lula's re-election is expected to sustain current environmental enforcement levels, in contrast to the opposition platform which favored relaxing land-clearing restrictions.

Regulatory complexity, infrastructure bottlenecks and judicial unpredictability persist as binding structural constraints. Tax reform implementation is advancing but slowly, and operational costs remain among the highest in the OECD. The 2027 phase of the consumption-tax reform, including the new excise tax, could add one-off price pressure early in the year.

Lula's re-election on 25 October with 52% of the vote settled the political question, but governability is now the binding constraint. The PL-led right-wing bloc (121 deputies, 29 senators) controls the largest contingent in both chambers and commands a working Senate majority with allies, giving it effective veto power over constitutional amendments. Lula will depend on costly Centrão negotiations (around 250 seats in the lower house) to advance any legislation, raising the political cost of fiscal adjustment and limiting structural reform opportunities.

Three factors will shape the political risk premium through 2027. First, the diplomatic relationship with Washington has deteriorated to its lowest point in decades amid the tariff escalation, visa denials to US officials and Argentina's diplomatic intervention. A continuity government offers no obvious pathway to normalization. Second, the opposition has filed an annulment request challenging the election result; while it is being pursued through institutional channels, it remains a source of headline risk and echoes the narrative pattern that preceded the January 2023 institutional crisis. Third, the decisive tests will come around the inauguration: the vote on the 2027 budget (which in principle must take place by end-December), early signals on the composition of the economic team (with the Finance Minister appointment as the single most important market signal) and the fate of the online-gambling provisional measure (which must clear both chambers by early March 2027 and will offer a first read on Centrão support).

Under the base case, markets should expect sustained fiscal pressure, gradual easing conditional on credible fiscal signals, and a foreign policy posture that prioritizes South-South diversification. The central risk remains a slow erosion of fiscal space through insufficient consolidation, rising debt ratios and crowded-out public investment. The post-election repricing has compressed the timeline: what was a medium-term concern is now a near-term policy imperative. A credible fiscal anchor could trigger a sharp relief rally in long-dated Brazilian assets, while its absence would entrench the adverse feedback loop that defines Brazil's sovereign risk premium.