Public debt reduces space for private debt, pressures investments

Public debt remains on the rise and crossed an important threshold this year: reaching 77.2% of GDP in April, it surpassed the share of private-sector debt, which includes households and companies, at 75.7% in the same month, according to a report by the Center for Studies on the Financing of Brazilian Companies (Cefeb) at the Institute for Economic Research Foundation (Fipe).

The development revealed a classic phenomenon in macroeconomics, “crowding out,” or the displacement effect, in which the public sector absorbs an increasingly larger share of available savings and financial-market resources to roll over its liabilities. Because the government is the lowest-risk borrower, it “pushes” the private sector out of capital markets and makes credit for productive investment more expensive.

Roberto Troster, coordinator of Cefeb and the study’s author, says the figures are a warning sign because they lead to a vicious dynamic. “The government demands more resources, and this raises the risk premium and interest rates for those taking out financing,” he says.

The study provides an X-ray of the mechanism through which monetary policy is transmitted to credit in the country and calculates a 0.97 correlation between the average funding cost of the federal government’s domestic marketable debt and that of private debt, indicating an almost symmetrical alignment. When the government finances itself at a higher cost, the private productive sector immediately feels the impact, Troster says. In this way, he argues, the state acts as the financial market’s “anchor price.”

At the same time, in the economist’s assessment, credit policy is poor and based on short-term operations, which increases defaults. As payment delays continue to rise, the supply of credit contracts and banks tighten lending criteria. Companies tend to shelve expansion plans as they seek to deleverage and improve operational efficiency.

“Fiscal policy has lost any countercyclical character,” says Carlos Kawall, a former secretary of Brazil’s National Treasury and founder of asset manager Oriz. “It is expansionary by definition, regardless of whether the economy is doing poorly or well, especially because it is doing well, with low unemployment.”

The study uses Gross General Government Debt (DBGG) as its basis, which includes the federal government (including the National Social Security Institute, or INSS), states and municipalities. Through the end of 2025, according to the report, public and private debt were growing in parallel, showing an economy becoming more leveraged. “In April 2026, the divergence becomes explicit. Public debt shoots up to 77.2%, while private debt falls to 75.7%.”

Troster says the last time the “crowding out” phenomenon occurred was under the government of Dilma Rousseff, between 2014 and 2016. However, the impact on the private sector now is likely to be much more dramatic because the country has never had a capital market that was as relevant to companies’ liabilities. According to the Cefeb study, the segment’s share of the debt of publicly traded companies rose from 14.8% to 22% between 2022 and 2026, while the share of bank credit fell from 38.4% to 31.2%, indicating a structural shift in companies’ sources of financing.

Kawall points out that investors are on the other side of these issuances, including a large number of individual investors. “We do not have this previous experience in Brazil, but international experience shows that the effect on how the economy functions tends to be amplified because it is more widespread,” he warns. According to him, a banking crisis generally remains more contained and under the control of the Central Bank. However, he notes that between 2023 and 2025, the country experienced a “crowding in” movement, with the “boom” in the private debt market, which largely replicates the public debt’s indexing structure, with securities linked to the CDI and IPCA.

The former Treasury secretary says it is “concerning” to see the government moving toward “crowding out.” It is, he says, a model that consistently depends on increasing the stock of public debt, but that has also used higher revenues to finance itself, through measures such as increasing the IOF financial transactions tax and taxing exclusive closed-end funds.

Economic growth, he assesses, was not enough to absorb the increase in spending, particularly mandatory spending, with the adjustment of the minimum wage and the reindexation of health care and education expenditures. Kawall points out that, when the fiscal framework was introduced in 2023, experts were already warning that it did not guarantee the sustainability of the debt trajectory.

Because the economy grew more than expected, the debt trajectory has not been explosive so far. Kawall notes that the request submitted to the Senate at the end of July for authorization to expand the capacity for sovereign borrowing abroad, proposing to replace the current cumulative ceiling of $100 billion with $35 billion, shows that the Treasury needs to broaden its investor base because of the growing difficulties with longer-term issuances in Brazil. The share of foreign-currency debt would rise from the current 3.8% of total debt to 7%.

“Even with the growth of recent years, the credit market is small compared with the needs of the private sector, while the state is too large. Government debt has grown much more than private debt,” says Jeferson Bittencourt, head of Macroeconomics at ASA Investments and also a former secretary of the National Treasury. He explains that there is the structural problem of Brazil’s low level of savings and the cyclical problem, which is fiscal stress.

The country’s savings, Bittencourt says, are made up of households, companies and the government. “What contribution does the government make to these savings? None; it generates negative savings, consuming other people’s savings, paying high interest rates, over short terms and with a low risk assessment.” Therefore, he says, “crowding out” manifests itself in higher interest rates and shorter terms for the private sector.

The largest companies can still issue debt in the capital markets, at an average cost of 13.68% for debentures, according to the Cefeb report, but smaller companies face greater restrictions, leaving them dependent on bank credit, at an average cost of 18.40% for legal entities, or investment funds in receivables (FIDCs). The difference, the study shows, reached 4.53 percentage points in April, the date of the data analyzed. “Issuing debt at this cost imposes a line of value destruction on most sectors of the real economy,” Troster says.

The effects of this asymmetry are showing up in companies’ financial health. The default rate among legal entities reached 4.8%, a historic peak: among micro and small companies, the rate reached 6%, while it remained at 0.5% among large companies. The number of companies with negative credit records also increased, rising from 6.66 million in January 2024 to 8.96 million in April this year, a 34.5% increase. Meanwhile, the difference between corporate and sovereign borrowing costs, according to Cefeb, remained reasonably stable between January 2022 and April 2026, generally fluctuating within a range of 2.5 to 4.5 percentage points.

Subsidies guaranteed to certain sectors worsen the problem, Bittencourt says, because they are shielded from monetary policy and end up putting further pressure on interest rates. The provision of cheaper credit to certain sectors is also cited by professor Carlos Pedroso, former chief economist at MUFG Bank Brasil, who notes that the presence of the Brazilian Development Bank (BNDES) has been growing again. He expects lower GDP growth next year, a scenario that would only be avoided if there is an adjustment in the public sector.

In an interview with Valor, the executive secretary of the Ministry of Finance, Rogério Ceron, declined to comment specifically on the Cefeb study but offered a conceptual assessment of “crowding out.”

For him, longer-term rates have three components: rising interest rates around the world, over which Brazil has no control; the trajectory of fiscal policy in Brazil; and the large supply of tax-exempt securities, which puts pressure on the placement of government bonds. “We want a country with lower interest rates; that is a consensus. How do we do that? We need to start dismantling [the two components over which we have influence].”

According to Ceron, on the fiscal side, it is necessary to “send the signals needed to remove the risk premium from the curve resulting from uncertainty.” Regarding tax-incentivized securities, a subject the Finance Ministry has raised repeatedly, he advocates a broad debate because, given the strong growth in issuances, the volume is incompatible with the country’s long-term savings and the situation “is not healthy.”

For the secretary, “someone has to give”: “Either the Treasury itself has to extend the process of seeking the optimal composition of the debt or, on the other hand, these private-sector borrowers who use these instruments will also have to undertake some adjustment. This has to be debated and resolved. We can no longer postpone it.”

Kawall agrees that tax exemptions for certain investments, such as tax-incentivized debentures and real estate and agribusiness credit bills (LCIs and LCAs), are a distortion that worsens the problem, as the financial market itself has pointed out, but “not by a long shot” are they the fundamental reason Brazil is seeing stress at such high levels. “If there were a correction to this taxation, would the problem be solved? No.” The former Treasury secretary also points out that the government itself encouraged demand for these investments, which are more sought after by higher-income investors, by taxing, for example, contributions to VGBL private pension plans.

Bittencourt points to other problems. “There are countries that have higher debt than Brazil, others that have higher costs, but none that have both at the same time,” he says.

Other countries, he says, have more room to maneuver to cut spending. In the U.S., for example, 20% of spending is discretionary, while in Brazil that share is less than 5%. “Fiscal adjustment in Brazil is much more complex than in another country.”

(Jéssica Sant’Ana contributed reporting from Brasília.)

By Liane Thedim  — Rio de Janeiro

Source: Valor International