Double-Digit Interest Rates Until 2028: Gustavo Loyola's Fiscal Warning

Gustavo Loyola, former president of the Central Bank, made a diagnosis that should concern any medium-term investor: Brazilian interest rates will remain in double digits at least until 2028. The reason lies not in monetary policy itself, but in the lack of fiscal discipline that has turned the Selic into a solitary protagonist in the fight against inflation.

This statement is more than just an isolated opinion. Loyola led the Central Bank during two distinct moments in Brazilian economic history and is well aware of the cost of maintaining interest rates as the sole stabilization instrument. The scenario he describes is not one of imminent crisis, but of gradual deterioration that could become irreversible if nothing changes.

The Vicious Cycle Between High Selic and Public Debt

The mechanism is relatively simple to understand, although difficult to resolve. When the government does not control its spending and the primary result deteriorates, the market begins to demand a higher premium to finance public debt. This puts upward pressure on interest rates. Higher interest rates, in turn, increase the cost of rolling over that same debt, widening the deficit and requiring even more interest. This is what Loyola calls a "snowball effect."

This phenomenon is not theoretical. Brazil has already experienced sharper versions of this cycle at other times. As we analyzed in our financial coverage, the trajectory of gross debt relative to GDP has been consistently deteriorating, without credible fiscal countermeasures from the federal government.

The central problem, according to the former Central Bank president, is that there is no monetary solution to a problem that is essentially fiscal. "It is useless to have a horrible fiscal situation and the Central Bank trying to hold everything together with interest rates," summarized Loyola.

Why the Central Bank Is Becoming Increasingly Isolated

In normal scenarios, monetary policy and fiscal policy work in complementary directions. The Central Bank raises interest rates to contain demand while the government controls spending to avoid additional inflationary pressure. What is happening in Brazil today is the opposite: fiscal policy remains expansionary while the Central Bank tries, alone, to anchor expectations.

Loyola was direct in stating that "one swallow does not make a summer." The metaphor conveys a significant institutional imbalance. The longer the Central Bank operates in isolation, the greater the political pressure for interest rate cuts, especially as the economy slows down and unemployment begins to become a concern.

The risk, in this case, is that the authority yields to the pressures. If this happens without corresponding fiscal adjustment, the result tends to be higher inflation, a more depreciated exchange rate, and, paradoxically, even higher interest rates in the future. It is a script we have already discussed when analyzing the recent dynamics of the exchange rate and its effects on the interest rate curve.

What Prevents a Faster Relief of the Selic

Even if there are favorable factors on the horizon, such as the slowdown of domestic economic activity and the retreat of commodity prices in the international market, they are not sufficient to create room for a significant drop in interest rates.

Three elements are blocking this relief. First, the inflation target of 3% per year is ambitious for a country with Brazil's inflationary history and requires a high real interest rate to be met. Second, the global inflationary process, although slowing down, has not yet returned to pre-pandemic patterns. Third, the behavior of the exchange rate remains pressured by the perception of fiscal risk, making imports more expensive and fueling cost inflation.

Loyola was categorical in stating that he does not see conditions for a return to the interest rate levels that existed before the pandemic. For investors, this means that the opportunity cost of risk assets will remain high for longer than many would like.

What This Means for Investors in Brazil

Interest rates in double digits for another two or three years have practical consequences for all asset classes. In fixed income, returns remain attractive, but credit risk increases as more leveraged companies feel the squeeze. In equities, growth stocks continue to be penalized by high capital costs, while defensive and export sectors tend to benefit.

For the private credit market, maintaining the Selic rate at restrictive levels prolongs the cycle of default and hinders the recovery of sectors such as construction and retail. As we discussed in previous analyses of the Brazilian macro scenario, selectivity in allocation has shifted from being a recommendation to a necessity.

In the foreign exchange market, the prospect of high interest rates supports some carry differential, but the fiscal risk premium limits the potential appreciation of the real. Foreign investors look at Brazil and see high yields but increasing risks, which explains the cautious stance of portfolio flows.

The Dangerous Path That Loyola Sees

The former president of the Central Bank made a point to calibrate his message: this is not an imminent crisis. Brazil has robust international reserves, a capitalized financial system, and a reasonably credible Central Bank. But the trajectory is what worries him. Without political engagement in the fiscal agenda, the country is heading towards a scenario where the available instruments become increasingly ineffective.

The lack of willingness from the political class to face budgetary constraints is not new. What has changed is the margin for error. With public debt as a proportion of GDP consistently rising and real interest rates among the highest in the world, the room for errors in economic policy has become narrow.

For investors, the message is clear: plan for a scenario of high Selic for a longer time. Those still betting on an aggressive cycle of cuts may be underestimating the depth of the fiscal problem that sustains interest rates at the current level.

This content is informative and educational and does not constitute an investment recommendation. Past performance is not a guarantee of future results.