Brazil's Real Sinks 12 Percent After Lula's Re-election as Stock Trading Is Halted

Brazil's real dropped sharply against the United States dollar after President Luiz Inacio Lula da Silva's unexpected re-election, as investors reacted with concern over increased spending and fiscal challenges.

The currency dropped against the dollar by 12 percent in spot trading on Monday. Bovespa stock index futures tumbled nearly 15 percent on the same day.

Brazil's stock exchange halted trading for 30 minutes. The Bovespa index fell 10 percent from its previous close, triggering a circuit-breaker safety mechanism and reversing a rally earlier this month amid expectations of a shift to the right.

Right-wing Flavio Bolsonaro, the son of former President Jair Bolsonaro, had led in the first round of voting earlier this month. Lula's victory in the runoff, after trailing in that first round, was outside many investors' calculations.

Rachel Ziemba, adjunct senior fellow at the Center for a New American Security, said she is not surprised the real is sinking sharply; traders are covering their bets that assumed a Bolsonaro victory and tighter fiscal policy.

Ziemba said Bolsonaro's refusal to concede the election has driven some financial uncertainty. However, she said the scale of the victory suggests the result will stand.

Investors assume more domestic spending and higher rates in Brazil under Lula. However, Ziemba noted the real is still likely to be supported by strong commodity revenues.

By contrast, stocks had closed on Friday almost 7 percent above their level before the first round, while the Brazilian real was nearly 5 percent stronger against the US dollar. Interest rate futures are up 3.1 percent, rising sharply after Lula's win.

Lula faces an increase in Brazil's debt and will be challenged with protecting both social programmes and investment. Investors are looking for signs of whether his gradual fiscal approach can bring borrowing costs down.

Lula's team aims to produce a budget surplus of about 1.3 percent of gross domestic product (GDP) by 2030. That would leave money to cover part of the interest bill, reducing the need for fresh borrowing. But public debt already exceeds 82 percent of GDP, while pensions and other legally required spending limit where savings can come from.

Divya Singaravelu, head of research at Meridian 1305 Capital, said Lula's policies have talked about spending cuts, but he has not gone into the details of how that is going to look.

Attention will now turn to Lula's choice of finance minister and what it signals about his fiscal approach, as investors wait for that signal.