Fitch: Brazil State's Declaration Could Steady Fiscal Imbalances

NEW YORK--()--Rio Grande do Sul's declaration (Estado de Calamidade Financeira) will allow the state to address severe fiscal imbalances in the near term, Fitch Ratings says. However, the local legislature (Assembleia Legislativa) must approve all of the state's proposed changes -- creating uncertainty around the declaration's full impact.

The waiver allows Brazilian states to delay their expenditures on public services and raise tax revenues. Brazil's Constitution requires the states to provide healthcare, high school services and law enforcement. Rio Grande do Sul is the second state to use this waiver. The state of Rio de Janeiro did so in June 2016 as the costs of the preparation for the Olympics grew.

Both Rio de Janeiro and Rio Grande do Sul previously proposed closing some government departments, putting government enterprises up for sale, withdrawing fiscal incentives granted to private companies, laying off public employees and increasing contributions to the pension system. However, the local legislatures have not yet approved these changes because the impact on public employees could come at high political costs.

If the legislatures delay these changes, we believe a direct or indirect federal government intervention to solve the short-term fiscal imbalances of the largest states (Rio de Janeiro, Rio Grande do Sul and Minas Gerais) will become more likely. Those three states account for roughly one-third of Brazil's GDP.

Rio Grande do Sul's fiscal imbalance has grown due to the decline in tax revenues during the recent economic recession and as expenditures have outpaced inflation. Other states have seen the same. For example, Sao Paulo, Rio de Janeiro and Minas Gerais saw their average personnel expenditures rise by 14.7% per year from 2010 to 2015. We estimate that these states will run fiscal deficits of USD6.5 billion in 2016 and USD7.1 billion in 2017.

Tax collections must rise before the states' fiscal balances will improve. Brazilian states have raised theirs faster than the federal government over the last five years. From 2010 to 2015, federal tax collections decreased by 1.5% to 21.5% of GDP while state collections rose by 1.6% to 8.8% of GDP. We believe most of the improvement in state collections is due to a strengthening of the collection systems, which were mainly sponsored by the Inter-American Development Bank.

The state of Sao Paulo has adopted many contingency policies to prevent its fiscal deficit from growing. Fitch rates Sao Paulo 'BB', with a Negative Outlook, reflecting the Outlook of Brazil's sovereign rating. Rio de Janeiro was downgraded to 'C' after the state missed the external debt payments that were fully guaranteed by the federal government. Fitch does not publicly rate Minas Gerais or Rio Grande do Sul.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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Contacts

Fitch Ratings
Paulo Fugulin, +55 11 4504 2206
Director
Fitch Ratings
International Public Finance
or
Humberto Panti Garza, +52 81 8399 9100
Senior Director
International Public Finance
or
Rob Rowan, +1-212-908-9159
Senior Analyst
Fitch Wire
or
Media Relations:
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New York
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Paulo Fugulin, +55 11 4504 2206
Director
Fitch Ratings
International Public Finance
or
Humberto Panti Garza, +52 81 8399 9100
Senior Director
International Public Finance
or
Rob Rowan, +1-212-908-9159
Senior Analyst
Fitch Wire
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com