Brazil sees worsening debt outlook despite rising primary surplus targets

By Marcela Ayres

BRASILIA (Reuters) -Brazil's government on Tuesday projected a sharp rise in gross debt despite an outlook for an improving primary balance, including a 0.25% of gross domestic product surplus target for 2026 and more ambitious goals in the following years.

In its annual budget guidelines bill, which requires congressional approval, President Luiz Inacio Lula da Silva's administration projected primary surplus targets of 0.5% of GDP in 2027, 1.0% in 2028, and 1.25% in 2029.

Still, gross public debt is expected to continue rising, peaking at 84.2% of GDP in 2028, driven by high interest payments in Latin America's largest economy.

Speaking at a press conference, Budget Secretary Clayton Montes acknowledged that spending and tax benefit reviews will be needed to meet the 2027 surplus target, as a waiver excluding large court-ordered federal payments from the primary balance calculation is set to expire by then.

"Necessary measures to deliver these results will be taken," said Deputy Treasury Secretary Viviane Varga, without providing details.

The new budget outlook represents a notable deterioration from estimates published late last year, when Brazil's Treasury forecast the gross debt-to-GDP ratio - a key indicator of a country's solvency - to peak at 81.8% in 2027.

The revision reflects expectations of higher interest rates following an aggressive monetary tightening cycle by the central bank to curb inflation, partly fueled by government spending.

The bill forecasts the benchmark Selic interest rate to reach a cumulative 14.02% this year, 12.56% in 2026, 10.09% in 2027, 8.27% in 2028, and 7.27% in 2029. The rate currently stands at 14.25%, and the central bank has already signaled another hike in May.

The government also projected an average exchange rate of 5.97 reais per U.S. dollar next year and an average oil price of $66.74 per barrel.

The Brazilian real closed at 5.89 reais per dollar on Tuesday, while Brent was priced at $64.67.

FISCAL WOES

If met, the 2026 fiscal target, which was previously anticipated by Finance Minister Fernando Haddad, would mark the first primary surplus in Lula's current term.

However, private economists and investors have expressed skepticism about the target, as Brazil next year holds general elections, which often correspond with higher public spending.

"The budget guidelines bill released today is unrealistic," investment firm Warren Rena said in a note, pointing to "inflated" revenue estimates and forecasting a primary deficit of 0.8% of GDP next year.

Lula, 79, has said he intends to run for re-election in 2026 if his health allows.

According to Tuesday's projections, Brazil's gross public debt - already high compared to emerging market peers - will have risen by 10.1 percentage points of GDP under his term.

The leftist leader has boosted social benefits and household income, relying on more progressive taxation to offset fiscal expansion.

Still, surging mandatory expenses, including pensions and welfare, have raised doubts over whether Brazil can stabilize public debt levels. Those concerns, along with a tougher global outlook, have driven 10-year sovereign bond yields above 14%.

(Reporting by Marcela Ayres; Editing by Chris Reese and Sonali Paul)