It’s not unusual to hear an emerging market government be told to produce a credible plan showing public finances are sustainable. But when the person demanding it is the government-appointed head of the central bank, there may be greater reason for investor concern.

Paolo Guedes, Brazil’s economy minister, certainly didn’t appreciate the wake-up call late last month, swiftly challenging the central bank chief Roberto Campos Neto: “If he has a better plan, then ask him what his plan is.”

Mr Campos Neto, however, had a point. Mr Guedes is an acolyte of the free market principles of Milton Friedman and a believer in smaller government. But he has gone on one of the emerging market world’s biggest coronavirus-related spending sprees, using a metaphorical credit card which was already maxed out before the pandemic. The extra spending has helped Brazil avoid a deep recession this year, but at what price?

“I’m seriously concerned about the medium-term and the short-term fiscal picture,” says Alberto Ramos, Latin America chief economist at Goldman Sachs. He notes that Brazil has one of the highest levels of public debt to gross domestic product of any emerging market, predicting it will hit 94 per cent this year.

More than 90 per cent of Brazil’s government debt is issued in local currency according to National Treasury figures and the stress is starting to show in domestic markets.

The yield curve for Brazilian debt has steepened sharply this year with the 10-year bond now yielding 7.4 per cent compared with today’s central bank benchmark Selic rate of 2 per cent.

Luis Oganes, global head of emerging markets at JPMorgan, says it is “among the steepest yield curves on the planet” with long-term rates rising sharply from shorter-term ones. Investors are pricing in a rate rise of up to 300 bps starting in January, he adds, and “the government is issuing massively at the short end because it doesn't want to validate this curve".

Average maturities on domestic federal public debt are down to 3.57 years at the end of October from 3.83 years at the end of last year, according to Brazil’s national treasury.

Behind the jitters lies the fear that Brazil’s much-vaunted reform programme to cut high budget deficits — the main reason why investors feted Jair Bolsonaro’s election as president — has stalled.

“The problem is essentially political,” says Zeina Latif, an economic consultant in São Paulo. “The economy ministry knows what needs to be done but we are seeing an economy minister who has been greatly weakened and who now doesn’t convince.”

Mr Bolsonaro, meanwhile, has discovered the electoral joys of welfare spending. His opinion poll ratings jumped after he launched a $110 a monthly subsidy for nearly a third of the population, at a cost of more than $9bn a month.

Line chart of Yield curve on government debt (7 Dec, %) showing Brazil

The snag is that the “coronavoucher” payments are due to end on December 31. As his re-election campaign cranks up, Mr Bolsonaro may find the attractions of literally buying popularity impossible to resist — particularly after his candidates fared poorly in November’s municipal elections.

Marcelo Castro, a portfolio manager at Brazilian hedge fund SPX Capital, believes a slow deterioration in Brazil is more likely than a sudden crisis. “It's bubbling and frothing but not exploding,” he says.

Mr Castro expects a rebound in growth next year to drive higher inflation, forcing rates up to 4 per cent by June. But he concedes “there are lots of risk scenarios around this".

Ilan Goldfajn, chairman of Credit Suisse Brazil and a former central bank head, believes nothing will happen on extending coronavirus spending or progressing reforms until February. “If that's the case, Brazil can surf the risks for a couple of months,” he says.

However, if next year brought extra spending without reforms, Mr Goldfajn says the risk of a market crisis would increase.

Marcos Casarín, Latin America chief economist at Oxford Economics, agrees the real test will come next year, with short-term debt equal to around 6 per cent of GDP needing to be rolled over by April. “Brazil is on a tightrope,” he says.

The scenario of a markets crisis in Latin America’s biggest economy is not one many Brazil-watchers want to contemplate. But Mr Casarin believes: “It’s increasingly likely that it will become the baseline scenario unless we see a U-turn from Bolsonaro.”

However, Mr Guedes ridiculed the idea that his plans lack credibility in his riposte to the central bank governor, saying: “The day that the stock market is falling 50 per cent and the dollar exploding, then I will say that credibility is lacking.”