Brazil election: US-China conflict and huge government debt

Brazil’s presidential election begins with tough voting on Sunday, but the results are likely to be felt far beyond its borders.

Voters will head to the polls to decide whether incumbent Luiz Inacio Lula da Silva (colloquially known as Lula) should continue in office or be replaced by one of 12 alternative candidates.

If no candidate receives more than 50% of the vote in Sunday’s first round, the two candidates with the most support will advance to the final runoff on Oct. 25.

Opinion polls predict a close race, with front-runners Lula Bolsonaro and Flavio Bolsonaro virtually tied in terms of support among voters.

If the left-wing Lula wins, he will receive a fourth term as president, but if Bolsonaro wins, he is expected to return to his father’s right-wing movement.

Lula’s centre-left Labor Party (PT) has pioneered social programs aimed at lifting millions of people out of poverty, but has been tarnished by corruption scandals. Lula himself spent 18 months in prison after taking over waterfront property from an engineering firm involved in the so-called car wash corruption investigation. Former President Dilma Rousseff, who succeeded Lula in 2010, was impeached in 2016 on suspicion of budget manipulation.

Flavio Bolsonaro is a senator and the son of former president Jair Bolsonaro, who is currently under house arrest. Jair Bolsonaro, who lost to Lula in the 2022 presidential election, was sentenced to 27 years in prison for plotting a coup.

Bolsonaro is widely seen as his father’s political successor, with a policy mix that supports privatization, spending cuts and closer cooperation with the United States. The policy has recently seen success across Latin America, with conservative leaders in Bolivia, Chile, Colombia and Peru taking office in the past 12 months.

Meanwhile, Lula has put Brazil’s sovereignty at the center of his campaign. He also pledged to reduce Brazil’s traditional six-day work week, cut income taxes for low-income earners and enact police reforms.

The president has endured a rocky relationship with the Trump administration, which treated Jair Bolsonaro, colloquially known as “Tropical Trump,” as a close ally. US President Donald Trump has announced that he will impose 50% tariffs on Brazil in July 2025 in response to what he called a “witch hunt” trial against Jair Bolsonaro.

Ottaviano Canuto, a non-resident senior fellow at the Brookings Institution and former executive director of Brazil’s International Monetary Fund board, told CNBC that the vote is a “hinge election” for the United States and the broader region regarding the so-called “Don Roe Doctrine,” which is the Trump administration’s major focus on Latin America.

“Brazil is the largest economy in the region, and across the region there are currently 20 republics (in Latin America) ruled by right-wing leaders,” he said. “And, of course, a victory for Flavio Bolsonaro would deepen President Donald Trump’s plans for the United States and strategic alignment in the region. By contrast, a fourth term for Lula would frustrate Washington’s plans to dominate the region and crowd out Chinese influence.”

Paulo Nogueira Batista Jr., a Brazilian economist and former vice president of the BRICS New Development Bank, told CNBC that the two leading candidates are “fundamentally different” and the outcome of the election “will have a significant impact on every part of Brazilian life.”

“Flavio Bolsonaro has declared that he will work closely with Donald Trump, which could affect relations between Brazil and China, (and) China is our main trading partner,” he explained. “Brazil’s geopolitical situation will change significantly if Bolsonaro wins, and if Lula wins re-election, it will more or less continue as it has in recent years.”

Canuto said part of Brazil’s appeal to the U.S. government is its abundance of important minerals.

“President Trump has been very active in ensuring access to critical minerals, and Brazil is the second largest source of rare earth reserves on the planet (after China),” he said.

“So the conflict between the United States and China has spilled over into access to critical minerals and rare earths, and as we all know, all the signals coming out of Washington are in the direction of calling on countries in the region to impose restrictions on things like China’s access.”

Another major issue at the center of the election is Brazil’s mounting debt.

The vote will be closely watched by investors around the world, with questions swirling over whether the next government will be able to achieve fiscal credibility.

Brazil’s debt has steadily increased in recent years, reaching 82.9% of gross domestic product (GDP) in August.

Meanwhile, Brazil’s budget deficit has reached 9.48% of GDP, raising concerns about whether the next government will be able to establish fiscal discipline and gain stronger control over national finances.

However, while the overall economy is under pressure, with inflation hovering above 4% and the government cutting its economic growth forecast, Brazil has benefited economically from rising oil prices as a net oil exporter.

“Economically speaking, the Iran war benefited Brazil in terms of trade gains from higher oil prices,” Canuto told CNBC. “Of course, nothing is free, and the price shock ultimately posed a challenge for Brazil in terms of containing inflation.”

Whoever wins will be obligated to present a plan to control the finances, he added.

“While there is no (imminent risk of) a crisis in the short term, nominal debt levels reflect high interest rates, which in turn reflect fiscal fragility. Over time, debt tends to enter an unsustainable trajectory, and markets see this and impose premiums and higher interest rates, which will only make matters worse.”

Brazil’s benchmark 10-year government bond yield was most recently trading around 14.16%. In comparison, US yields are 10 year Treasury bill On Thursday, it hit a 24-year high of 5.3338%.

“The fact is that Brazil, like other countries in the region, has to go through some kind of fiscal adjustment process. It’s difficult when you have to negotiate with a divided parliament,” Canuto added.

But Kristin Reed, who manages the emerging market fixed income portfolio at NinetyOne, said the increasingly competitive presidential election meant the overall risk-to-reward ratio for Brazilian assets was improving.

“We see the most positive risk-reward asymmetry in local rates. Tightening polls increases the likelihood of fiscal adjustment in 2027, while tight monetary policy and the removal of pre-election stimulus should weigh on economic activity and support disinflation, leaving room for further rate cuts no matter who is elected,” he said in an email.

“The Brazilian real should continue to benefit from high interest rate carry, tight monetary policy and improving opinion polls, but with hard currency debt, fiscal fundamentals remain the key risk to Lula’s potential re-election, and current spreads do not factor in that risk,” he added.

Batista Jr. agreed that a new leader must address Brazil’s economic challenges, telling CNBC that the best-case scenario for Brazil would be a president who “remains vigilant and recognizes the fact that we have a difficult macroeconomic situation that we have to face.”

“Both candidates, if elected, will probably need to take measures to curb spending, such as raising taxes,” he said, but cautioned against widespread reform in the immediate future.

“In any case, I am not going to recommend strong and fundamental fiscal adjustment in the first year of this administration, because that would undermine the already depressed level of economic activity,” he said. “The economy is not growing well, with recent forecasts for this year showing gross domestic product (GDP) growth below 2%. And I think the very austerity measures suddenly imposed by the next administration will be the (worst-case) scenario.”

—CNBC’s Thomas Da Graca Barlow contributed to this article.