Morgan Stanley Flags Brazil’s Fiscal Risks as Political Spending Clouds Economic Outlook

Morgan Stanley’s latest report, led by strategist Ioana Zamfir, delivers a stark warning about Brazil’s economic trajectory in 2025.

The American bank predicts a resurgence of fiscal uncertainty as Congress debates the delayed 2025 budget and spending pressures intensify ahead of the pivotal 2026 presidential election.

These dynamics, according to Morgan Stanley, will likely dominate Brazilian asset performance and investor sentiment in the coming months. The government’s fiscal framework, designed to curb deficits and stabilize debt, faces mounting political obstacles.

Without an approved budget, public spending is capped at one-twelfth of the proposed annual amount per month. This constraint pressures lawmakers to expedite negotiations, but the risk of overspending looms large.

Morgan Stanley estimates that fiscal turbulence could push the Brazilian real to R$6.3 ($1.05) per U.S. dollar by late 2025. There is potential for further depreciation if fiscal discipline falters.

Brazil’s central bank remains locked in a battle against persistent inflation, which ended 2024 at 4.83% and shows signs of creeping higher. Policymakers have maintained an aggressive monetary stance to anchor inflation expectations.

Brazil’s Economic Outlook

Morgan Stanley forecasts the Selic rate to peak at 15.75% by Q3 2025. This approach aims to stabilize prices, but it has come at a cost. Economic growth is expected to slow to just 2.1% this year, while rising interest payments strain public finances.

Amid these challenges, Morgan Stanley identifies opportunities in Brazil’s fixed-income market. The bank recommends a tactical position on the country’s interest rate curve: selling DI futures maturing in 2027 and buying those maturing in January 2031, targeting a spread of 60 basis points.

This strategy reflects expectations that fiscal risks will disproportionately impact long-term rates while short-term rates remain anchored by subdued growth prospects. Currency volatility further complicates the picture.

The real has already lost significant ground against the dollar this year. Morgan Stanley warns it could weaken further to R$6.7 ($1.12) or even R$7 ($1.17) per dollar under a worst-case scenario of fiscal dominance.

As Brazil grapples with these intertwined economic challenges, investors face tough decisions. The country’s ability to balance fiscal discipline with growth imperatives will be critical in restoring confidence amid an increasingly fragile economic backdrop.

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