Expected fiscal boost may limit room for monetary easing

Ítalo Franca, head of fiscal policy and special studies at Santander, estimates that the federal government’s fiscal impulse was between -0.8 and -1 percentage point of GDP in the first half of the year. For the second half, however, he expects a positive impulse of about 0.5 points. For 2025 as a whole, Franca still sees a slightly negative figure. “I’m projecting -0.3 points of GDP, but across all models it ranges from neutral to slightly negative. The year has two different halves. From now on, things tend to accelerate,” he said.

Mr. Franca noted that Brazil has seen two strong years of fiscal stimulus. Between 2023 and 2024 alone, the federal government’s impulse reached 2 points of GDP, and the figure climbed to 2.5 points when including states, municipalities, and state-owned companies. “It was a significant fiscal push,” he said.

This year began with fiscal tightening. Of the R$30 billion in budget freezes announced in early 2025, only R$10 billion remain, Mr. Franca pointed out. Moreover, delays in approving the 2025 budget meant that government execution was low in the first half, pushing more spending to the second. Adding to that is the R$60 billion in court-ordered debt payments (precatórios) made in July, whereas in 2024, those payments occurred in February.

“We went through the first half with both fiscal and monetary policy pulling in the direction of slowing activity. Now, fiscal policy is set to become more expansionary,” Mr. Franca said. “We’ll likely see more execution of congressional earmarks and discretionary spending, with a stronger release of investment funds.”

Still, most economists forecast an overall slowdown in the second half due to the lagged effects of high interest rates. In this context, Mr. Franca noted that families may use precatório payments to reduce debt or build savings, rather than spend them, dampening the multiplier effect. “But I think the fiscal impulse will start to add resilience,” he said.

Fiscal boost

Looking ahead to 2026, Mr. Franca expects a positive fiscal impulse of 0.4 points of GDP from the federal government alone. “There’s a series of measures set to impact the economy. That’s where the market’s biggest uncertainty lies, how much of this stimulus will materialize.”

Spending by subnational governments could also play a major role. “States are in a position to go through one semester of adjustment and start expanding [spending] again in the last quarter of 2025,” Mr. Franca said. He estimates that state and local governments could add around 0.5 points of GDP in fiscal stimulus between the end of this year and mid-2026.

“Keep in mind they have around R$150 billion in net cash. Not all of it can be spent—some is earmarked for pensions—but it shows there’s fiscal space,” he said. States posted a R$26 billion primary surplus in the 12 months through July, but Mr. Franca expects that to shrink. “In 2022 [an election year for governors], state surpluses went from R$100 billion in April to R$3 billion in May 2023,” he recalled.

Some federal programs could further boost regional spending. The PROPAG debt repayment plan for states could add another 0.2 points of GDP in fiscal impulse, depending on how many governors participate.

Another factor is the proposed constitutional amendment (PEC 66), which would cap precatório payments by states and municipalities and allow longer timelines for settling pension-related debts. “So we should see rising fiscal stimulus from now on,” Mr. Franca said.

“The impact of income tax exemptions on demand could be significant

—Renan Martins

This is one reason why Santander continues to forecast Brazil’s benchmark interest rate Selic remaining at 15% through year-end. “Fiscal stimulus creates uncertainty. It may limit how much room monetary policy has. There are big questions about how this stimulus will affect demand and inflation. Rate cuts look more feasible in the first quarter of next year,” Mr. Franca said.

The government’s recently announced support package for sectors hit by U.S. tariffs also enters the picture. For now, BTG Pactual economist Fábio Serrano sees it as “well balanced” fiscally. But since the package falls outside Brazil’s spending cap and primary result targets, it risks becoming more expansive as it moves through Congress, he noted in a report.

Even with this new spending, Mr. Serrano projects that federal expenditures won’t grow more than 3% in real terms in 2025. “If we reallocate the precatórios paid at the end of 2024 to early 2025, when the money actually reached families and businesses, primary spending would contract 1.2% in real terms, after real increases of 8.1% in 2024 and 7.7% in 2023,” he wrote.

Economic consultancy 4intelligence estimated a negative fiscal impulse of -1.5 points of GDP in the first half of 2025, which helped to contain aggregate demand and inflation. That restraint, however, is unlikely to persist in the second half, with projections pointing to a nearly neutral fiscal impulse by year-end.

“The government has had some success in raising revenue, which eases concerns about the primary deficit,” said Renan Martins, economist at 4intelligence.

On the demand side, Mr. Martins noted that the planned expansion of income tax exemptions starting in 2026 may be fiscally neutral—offset by higher revenue—but will likely have a significant impact on consumption. “The income brackets that will benefit are the ones most likely to boost aggregate demand, which will affect inflation next year and beyond,” he said.

Mr. Martins has not factored in a potential increase in Bolsa Família cash-transfer payments, despite the upcoming election year. “Due to new eligibility criteria, many families no longer qualify for the program. If the government wants to increase payouts next year, there’s a bit of room for that,” he said.