Pandemic could ravage already-feeble Brazilian states’ finances

</p> <p>Congress and state governors were left incensed, as they claim even the BRL 125 billion is insufficient to keep their heads above water. Furthermore, it has been 70 days since the federal government first promised <a href="https://brazilian.report/newsletters/brazil-weekly/2020/05/04/amidst-covid-19-crisis-brazil-bails-states-municipalities-bot-sentinel/">bailout money to states</a>, and nothing has been paid out since.</p> <p>President Jair Bolsonaro has been <a href="https://brazilian.report/newsletters/brazil-daily/2020/03/26/governors-in-brazil-on-a-collision-course-with-president-bolsonaro/">feuding</a> with Brazil&#8217;s state governors since the beginning of the pandemic, largely due to the head of state&#8217;s opposition to social isolation measures implemented nationwide by individual state administrations. However, governors have been left in an increasingly weak negotiating position, as the budgetary impact of the coronavirus crisis becomes larger every day.</p> <p>States require support from the National Treasury, which has its <a href="https://brazilian.report/newsletters/brazil-daily/2020/01/30/brazil-public-deficit-smaller-dilma-coronavirus/">own problems to worry about</a>, with federal debts mounting.&nbsp;</p> <p>Economist Guilherme Tinoco, a specialist in fiscal policy, told <strong>The Brazilian Report </strong>that the state support package &#8220;had to be done.&#8221;</p> <p>&#8220;Income dropped severely and expenses are very tight. Most of this is payroll, and you can&#8217;t fire people. If the federal government doesn&#8217;t help, salaries won&#8217;t be paid, pensions won&#8217;t be paid.&#8221;</p> <p>Countries around the world are facing <a href="https://pages.eiu.com/rs/753-RIQ-438/images/sovereign-debt-crisis.pdf?mkt_tok=eyJpIjoiWmpNd01XVmtNV0psTkdSayIsInQiOiIxZTV3Y1wvWGhqNmRxSzkzZTVzUW5DTW0rUEE5ekxyNm9EcXZXTUNzc1IyS2JIYTRwZ1hOTkliU09aVGo2VFdoOXQ2M2VxTkc5SVR5cEpURTRuR3pCSzdwQ1VoNVdzRWxZWlNDdlZFTFwva21pRm9oUWhMN3RpUXF4SHppUXpiTUVLIn0%3D">sovereign debt crises</a>. In Brazil, Manoel Carlos Pires, an economist at think tank Fundação Getúlio Vargas, predicts 2020&#8217;s deficit to reach 10.5 percent of the country&#8217;s Gross Domestic Product (GDP). Officially, the Economic Ministry estimates the central government’s primary deficit at <a href="https://agenciabrasil.ebc.com.br/economia/noticia/2020-05/deficit-primario-devera-encerrar-2020-em-r-54053-bilhoes">BRL 540 billion</a> for 2020.</p> <p>Economist Josué Pellegrini, a consultant at the Senate-affiliated Independent Fiscal Institute, emphasizes the cost of the state bailout package on the federal government. “It affects the National Treasury, more than half is primary expenditure. It will have a <a href="https://brazilian.report/business/2020/03/02/brazilian-government-big-debtors-recover-unpaid-tax/">direct impact</a> on the primary deficit, which will already be extremely high, not only due to the support program but because of other measures, such as emergency aid.”&nbsp;</p> <h2>State finances sick during Covid-19 pandemic</h2> <p>Essentially, the coronavirus crisis impacts state finances on two fronts. First and foremost, it caused a profound drop in revenue. The main tax collected by state governments is the State Goods and Services Tax (ICMS), which is charged on consumption and economic activity in general, which has plummeted during quarantine measures.&nbsp;</p> <p>“On the revenue side, it is a tragedy. Preliminary data for April show a 20 to 30-percent drop,&#8221; warns Mr. Tinoco. &#8220;Before the crisis, the states in a better position already had very tight budgets. Those who are worse off have already started delaying salaries, taking money out of judicial funds to balance the books.&#8221;</p> <p>This also affects spending, as states are in charge of managing health care with transfers from the federal government. The estimated increase in expenditure is around <a href="https://oglobo.globo.com/sociedade/coronavirus-custos-adicionais-para-sus-sao-estimados-em-10-bilhoes-nao-410-bi-24329552">BRL 10 billion</a>.</p> <p>Since the late 1990s, fiscal rules prevent states from issuing debt to cover their own costs. The Fiscal Responsibility Law says that states can only borrow money from the federal government or with its approval. In the latter case, the National Treasury is also the guarantor of these operations. These rules, intended to control state debts, have the knock-on effect of leaving the burden for the Treasury.</p> <h2>Less coming in, more going out</h2> <p>Brazilian states have two main revenue sources. For rich states, it is the ICMS tax. For other, less-developed states, a crucial stream of income comes from the so-called &#8220;participation fund,&#8221; which is calculated on federal tax revenue.</p> <p>Both are directly influenced by economic activity. The financial market estimates a drop of between 6 and 7 percent in GDP in 2020. And, as mentioned by Mr. Tinoco, tax revenue is set to take a massive hit.</p> <p>The initial idea of the state bailout package was to cover these losses. However, with no consensus over how to calculate which state gets what, Congress settled on a fixed value.</p> <p>“Whether it is sufficient or not, it is hard to say,&#8221; says Mr. Pellegrini. &#8220;There are at least two unknowns: we do not know exactly how big the loss of revenue will be for May and June, and we don&#8217;t know how long the decline will last, or the recovery capacity of the states once isolation is over.&#8221;</p> <h2>Running up debts at home and abroad</h2> <p>One of the main problems for state administrations is the debt they have with the federal government. When the Fiscal Responsibility Law was enacted in 1999, Brasilia took on states&#8217; liabilities with private institutions. In exchange, the federal government created a repayment plan which involves adherence to strict budget rules for states, who have been trying to reform this agreement ever since.</p> <p>In March, the São Paulo state government appealed to the Supreme Court, asking for the right to stop making repayments. Supreme Court Justice Alexandre de Moraes allowed a suspension of six months, with guarantees that state governors would spend the funds spared on fighting the pandemic. Since then, at least 17 other states won the right to suspend repayments to the federal government.</p> <p>In response, the central government allowed all states to suspend debts until December, allowing these administrations to save around BRL 32 billion this year.