State finances are the biggest risk for Brazilian economy

. Sep 05, 2019
State finances are the biggest risk for Brazilian economy Rio de Janeiro state servants protest salary delays. Photo: ABr

At this point, the approval of Brazil’s pension reform is considered by analysts as a matter of time. But, while it is set to give the federal government much-needed financial relief, the ruin of Brazilian states and municipalities is set to continue. 

In order to avoid further delays to what is the backbone of the government’s economic agenda, senators decided to split the pension reform into two pieces of legislation. As editor-in-chief Gustavo Ribeiro explained in our September 4 Daily Briefing, one bill preserves the text approved by the lower house, without changes, while another includes all the changes senators want, such as the inclusion of state- and municipal-level servants in the new retirement rules. With the reform being split into two pieces of legislation, the core of the proposal could be sanctioned as early as November.

</p> <p>The debate on whether to include states in the reform <a href="">started in the House of Representatives</a>. In the end, members of the lower house decided against it, in order to preserve their own political interests. Pension reforms are always unpopular, and lawmakers considered that state governors—i.e. those who would benefit the most from the alteration—didn&#8217;t show enough support for the bill, leaving the political burden solely upon Congress.</p> <p>From a purely electoral perspective, the reasoning makes sense. But members of Congress should perhaps be concerned about their states going completely bankrupt.</p> <p>Currently, seven of Brazil&#8217;s 27 states have declared financial calamity. They are: Rio de Janeiro, Minas Gerais, Rio Grande do Sul, Goiás, Roraima, Rio Grande do Norte, and Mato Grosso. In practical terms, the move shuts down several areas of state administrations and delays salaries for civil servants (which are then <a href=",1060946/parcelamento-de-salarios-de-servidores-de-mg-nao-tem-data-para-acabar.shtml">paid in delayed installments</a>). Meanwhile, Rio Grande do Norte has chosen to <a href="">default on banking loans</a> to be able to afford its own payroll.</p> <p>In February, credit rating agency Fitch had already warned that more states are set to join the list. Two weeks ago, Governor of Acre Gladson Cameli <a href="">said</a> the only thing that could prevent him from declaring financial calamity is Congress passing a pension reform for state servants.</p> <h2>How did this happen?&nbsp;</h2> <p>A <a href="">report</a> from the treasury department carries a grim diagnosis of Brazilian states&#8217; accounts. Despite a slight improvement in 2018—when states combined for a BRL 5.6 billion primary surplus after three years of deficits—administrations have much less money than they need, with an overall deficit of BRL 14.8 billion.</p> <p>The fiscal situation of states has worsened over the past few years, mainly due to a drop in tax revenue and royalties, and an accelerated growth in payroll expenditure. Since 2012, state spending on salaries and pensions jumped almost 40 percent on average. In Rio de Janeiro, this rise was over 110 percent. A significant part of this expansion is due to a growing number of retired civil servants, an expense that has increased BRL 9.35 billion in 2018 alone.&nbsp;&nbsp;</p> <p>“The rigidity of this expense, coupled with the escalation of the pension system’s situation, makes it harder to save for states that already direct a large part of their tax revenue to salaries or pensions. This message stresses the need to review pension rules for states,” reads the report.</p> <p>According to Brazil&#8217;s Fiscal Responsibility Law, approved in 2000, states aren&#8217;t allowed to spend more than 60 percent of their current net revenues on payroll. But 12 states (Tocantins, Minas Gerais, Mato Grosso, Rio Grande do Sul, Rio Grande do Norte, Acre, Goiás, Piauí, Mato Grosso do Sul, Paraíba, Rio de Janeiro, and Maranhão) have already crossed that line.</p> <h2>State bottomless pits</h2> <p>Beyond the federal government&#8217;s 134 state-owned companies, there are another 258 firms which belong to state administrations—the Northeast holds the record with 91 of them. On a state basis, São Paulo has the highest amount of companies (20), while Amapá has only two. These firms act in many sectors, with a special focus on development, sanitation, and financial services.&nbsp;</p> <p>But it is important to note that not all state-owned firms are created equally.</p> <p>Data gathered by the Treasury Department shows that 41 percent of state-level companies (i.e. 106 of them) are financially dependent on state budgets for survival. For the sake of comparison, that rate is 61 percent for companies directly controlled by the federal government.&nbsp;</p> <p>When it comes to profitability, regional state-owned companies are lagging behind. Taking the year of 2018 as a base, states have transferred BRL 11.4 billion as capital reinforcements and BRL 4.7 billion as subsidies, while having received only BRL 2.2 billion in dividends. The numbers, however, carry a distortion, as 46 percent of the companies did not provide this financial information.&nbsp;</p> <p>“When the withdrawal of resources from the states is bigger than the entry of funds, we can say that these companies are a burden for the state’s fiscal results,” said the report, adding that only Rio Grande do Sul, Mato Grosso do Sul, and Sergipe made a profit from state-owned companies.</p> <div class="flourish-embed" data-src="visualisation/648075"></div><script src=""></script> <div class="flourish-embed" data-src="visualisation/648018"></div><script src=""></script> <div class="flourish-embed" data-src="visualisation/647620"></div><script src=""></script> <h2>The Mansueto Plan&nbsp;</h2> <p>Over the past five years, the federal government has made at least three attempts to tame state- and municipal-level spending. Now, the Bolsonaro administration believes the fourth time&#8217;s the charm.</p> <p>Their newest bet is called the <a href="">Fiscal Balance Promotion Plan (PEF)</a>, commonly known as the &#8220;Mansueto Plan,&#8221; in reference to treasury secretary Mansueto de Almeida. The goal is to grant BRL 10 billion in federal loans each year to states in the worst financial situation until 2022—as long as they adopt fiscally responsible measures.</p> <p>Unlike previous attempts, this plan comes with a catch. Currently, only states awarded with good credit ratings by the Treasury—A or B levels, on a scale that goes until D—may borrow money with federal backing. But, should Congress approve the new plan, the 14 C-grade states will be able to request up to 3 percent of their current net revenue in loans. However, if they fail to comply with their end of the bargain, they will automatically be cut off.</p> <div class="flourish-embed" data-src="visualisation/649254"></div><script src=""></script> <p>The plan would represent a stark contrast with current measures. As explained by Fernando Dantas, communications consultant at Fundação Getúlio Vargas, whenever states fail to comply with the rules, the Treasury interrupts the flow of money from the State Participation Fund, which is a constitutional fund transferring resources from the federal government to the states. But some states have filed lawsuits, preventing the government from collecting debts—in a catch-22 situation harmful to all levels of government.</p> <p>The Mansueto Plan involves giving governors options on how to reach savings related to five percent of tax revenue. Mr. Almeida and his team drafted eight fiscal responsibility measures and each state must fulfill at least three of them in order to join the plan. These conditions include privatizing state-owned companies, trimming down benefits to state public servants, adopting spending caps, and opening up sanitation services to private companies.

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Natália Scalzaretto

Natália Scalzaretto has worked for companies such as Santander Brasil and Reuters, where she covered news ranging from commodities to technology. Before joining The Brazilian Report, she worked as an editor for Trading News, the information division from the TradersClub investor community.

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