Lula's honeymoon with Brazil markets ends amid spending plan fears

Brazilian President-elect Luiz Inacio Lula da Silva meets with members of the government transition team in Brasilia

By Lisandra Paraguassu and Gabriel Stargardter

BRASILIA (Reuters) -Brazilian President-elect Luiz Inacio Lula da Silva's brief honeymoon with financial markets looked finished on Thursday, as he pushed for more room to grow social spending without setting long-term fiscal rules or naming his top economic policymakers.

Brazil's currency and benchmark Bovespa stock index, which rose last week as fears of political volatility subsided after Lula's election victory, plunged around 4% on Thursday on comments by Lula and details of his transition team.

The rout made clear that many investors were done waiting for more clarity over Lula's key ministerial appointments or details of how he aims to stabilize Brazil's public finances.

In a speech to lawmakers, Lula said he aims to prioritize social spending over market concerns, questioning the priority given to key parts of Brazil's economic policy framework.

Investors have called for Lula to restore firm rules for public finances after major outlays by current President Jair Bolsonaro through the pandemic and election season. Instead, the president-elect is pushing to dismantle old budget rules before settling on the alternatives proposed by his advisers.

Lula acknowledged market reaction in comments to reporters later on Thursday, but sought to downplay investors' concerns.

"The market is nervous for nothing," he said. "I have never seen a market as sensitive as ours. It's funny that the market wasn't nervous with four years of Bolsonaro."

Markets deepened losses after the announcement of four economists aligned with the leftist Workers Party to handle budgetary issues as part of Lula's transition team, including former Finance Minister Guido Mantega.

After markets closed, a key lawmaker who had met with the transition team confirmed some investors' fears that Lula wanted recurring exemptions from a constitutional spending cap.

Senator Marcelo Castro, the point man for the 2023 budget, said Lula backed a permanent spending cap waiver for the "Bolsa Familia" welfare program, which is slated to cost 175 billion reais ($33 billion) annually based on his campaign promises.

The negative reaction to Lula's comments and transition team is the latest example of investors delivering an immediate, bruising response to nascent governments' economic proposals, amid a challenging global backdrop of high inflation, weak growth and low risk appetite.

In Britain, former Prime Minister Liz Truss resigned after markets shunned her plans for major unfunded tax cuts, while leftist Latin American leaders Gabriel Boric of Chile and Gustavo Petro in Colombia faced market routs in their early months in office.

QUESTIONING PRIORITIES

In his speech to lawmakers, Lula insisted he would maintain fiscal discipline. But he also questioned the priority given to parts of Brazil's economic framework, including the spending cap that has been waived repeatedly under Bolsonaro.

"Why do people talk about the spending ceiling, but not social issues?" he asked. "Why do we have an inflation target, but not a growth target?"

Investors, calling for Cabinet picks or clear fiscal rules to show how Lula intends to conduct policy, were not impressed.

"In the past few days, the president-elect's focus has been on signaling a major expansion in social spending, without a counterbalancing point about fiscal responsibility, which strikes a different tone than expected," said Arthur Carvalho, chief economist at TRUXT Investimentos in Rio de Janeiro.

Lula has not yet designated his finance minister and said he would consider his Cabinet picks after returning from the United Nations climate summit in Egypt next week.

His advisers are already discussing with lawmakers how to open room for more spending outside the spending cap in order to deliver on campaign promises, including a possible constitutional amendment.

"The signals indicate that the spirit of the (proposed amendment) is very oriented around new public spending. For now, there seems to be no plan for where those resources come from and what will be the long-term adjustments," Dan Kawa, TAG Investimentos' chief investment officer, wrote in a client note. "The signals are terrible."

($1 = 5.3449 reais)

(Reporting by Lisandra Paraguassu in Brasilia, Gabriel Stargardter in Rio de Janeiro and Luana Maria Benedito in Sao PauloAdditional reporting by Ricardo Brito and Marcela Ayres in BrasiliaWriting by Gabriel StargardterEditing by Brad Haynes, Alistair Bell and Rosalba O'Brien)