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EXPLAINER-What do Lula and Bolsonaro propose for Brazil fiscal policy?

(Updates with proposals discussed by Lula advisers in paragraphs 14-16)

By Bernardo Caram

BRASILIA, Oct 10 (Reuters) - Both of Brazil's presidential candidates, President Jair Bolsonaro and former President Luiz Inacio Lula da Silva, have proposed changes to the constitutional spending limit that defined fiscal policy in Latin America's biggest economy for the past six years.

The following are some of their policy proposal differences.

WHAT IS CURRENT POLICY?

Brazil amended its constitution in 2016 to establish a fiscal 'ceiling' that only allows spending by the federal government to grow as much as inflation in the prior year.

Financial markets have treated the constitutional spending cap as Brazil's principal fiscal anchor in recent years, but politicians across the spectrum criticize it as a budgetary straightjacket during economic crises.

Congress has made exemptions and modifications to the spending cap a half dozen times under Bolsonaro, eroding the rule's credibility, according to many economists.

WHAT DOES BOLSONARO PROPOSE?

The president has supported repeated exceptions to the current spending cap, and said his Economy Minister Paulo Guedes is working on alternatives to be implemented in a second term.

"There are some changes you can make to the spending cap, as the team of Paulo Guedes has proposed. But we'll leave that to discuss after the elections," he said in a June interview.

Guedes said last month that the spending cap should be modified to allow, for example, revenue from the privatization of state firms to fund expanded welfare programs.

There are two main proposals under development in the Economy Ministry, according to officials who requested anonymity to discuss them. Both proposals would target public debt over gross domestic product (GDP) as a medium-term fiscal anchor to allow more short-term fiscal flexibility.

Under a proposal developed by Treasury staff, public spending could grow a set amount above inflation as long as gross public debt remains below a certain share of GDP.

The ministry's Special Advisory of Economic Studies has put forth a more flexible alternative in which government spending could grow above inflation, depending on both the rate of economic growth and the gross-debt-to-GDP ratio. The rule would also open room for more spending in the event of a recession, regardless of public debt levels.

WHAT DOES LULA PROPOSE?

Lula, Bolsonaro's leftist challenger, has been more explicit in his criticism of the current spending cap. But he has been coy when pressed for details of what new fiscal rules he would propose.

"I'm against the spending cap," he told a gathering of economists last month. "If you're responsible, you don't need a spending cap."

Economists from Lula's Workers Party are looking at two main proposals that would allow more public spending to jumpstart economic growth, while still showing a commitment to fiscal discipline, two senior aides told Reuters.

One proposal involves a target range for Brazil's primary surplus, so the government can spend more in an economic downturn. Currently, the primary budget target is fixed, which narrows the government's options for counter-cyclical policies.

A second proposal would limit spending growth to inflation plus some other unspecified indicator, allowing a real increase in government spending.

Lula also responds to questions about fiscal responsibility by pointing to his record as president. Brazil posted budget surpluses every year of his 2003-2010 presidency, due in part to strong prices for its commodity exports.

However, public sector outlays eventually outpaced revenue under his Workers Party successor, former President Dilma Rousseff. A lending spree by state banks also damaged fiscal credibility, eventually contributing to a deep recession.

Rousseff was impeached for breaking fiscal rules. Her replacement, former President Michel Temer, passed the country's constitutional spending cap to re-anchor fiscal policy. (Reporting by Bernardo Caram; Writing and additional reporting by Marcela Ayres; Editing by Brad Haynes and Alistair Bell)