This paper describes major economic developments in Brazil in 1997. A number of issues were analyzed in the paper, including the slow progress being made in the negotiation of the fiscal adjustment programs with the states, the sustainability of the growing current account deficit, as well as the strength of the banking system following macroeconomic stabilization. The paper discusses the post-Real crisis in the states and the state adjustment programs being negotiated with the federal government. Privatization and the associated foreign direct investment flows are also described.


This paper describes major economic developments in Brazil in 1997. A number of issues were analyzed in the paper, including the slow progress being made in the negotiation of the fiscal adjustment programs with the states, the sustainability of the growing current account deficit, as well as the strength of the banking system following macroeconomic stabilization. The paper discusses the post-Real crisis in the states and the state adjustment programs being negotiated with the federal government. Privatization and the associated foreign direct investment flows are also described.

II. The Post-Real Fiscal Crisis in the States9

38. Most of the state governments in Brazil fell into fiscal crisis in 1995 and 1996 because they were too slow to adjust to the new low inflation environment and because their finances were hurt by very high real interest rates. In response, the federal government has been trying to negotiate fiscal adjustment programs with the states. These programs, in conjunction with debt restructuring plans, are intended to help the states return to creditworthiness, by reducing their debt to sustainable levels, and by allowing them to generate primary surpluses sufficient to finance their debt service payments. This process has been slower than expected, with only three states, São Paulo, Mato Grosso, and Ceará having signed specific fiscal adjustment programs as of end-1997; seven states have signed debt restructuring contracts to date, out of 22 who had signed protocols in 1996 and 1997. Furthermore, the possibility that many states will use their privatization revenues to increase spending is one of the main risks to the overall fiscal program in 1998.

A. Background

39. Fiscal crises are not new to the states; neither are bailouts by the federal government. As a matter of fact, the current debt restructuring negotiations with the states marks the third time in the last ten years that the federal government has come to their rescue by assuming state debt (to nongovernment creditors) that was not being serviced, and negotiating a program with the states for them to repay the federal government over a longer period than was the case with the original loans. In 1989, the federal government formally assumed much of the external debt of the states, with the states then incurring an equal liability to the federal government in domestic currency, but with a longer maturity and an interest rate equivalent to that being paid by the federal government.10 In 1993, the federal government once again assumed debt of the states, this time owed to federal financial institutions, and which the states also had stopped servicing for a few years.11 The new liability of the states to the federal government had a maturity of 20 years, with a real interest rate equal to the average real interest rate of the original debt (between 6 and 8 percent). A ceiling of 11 percent of net revenues (i.e., own revenues plus transfers from the federal government less transfers to the municipalities) was also placed on the amount of annual debt service arising from all of these rescheduled debts, with any excess being capitalized.

40. Yet another form of federal bailout for the states was the troca de títulos with the central bank, i.e., the swapping of state bonds for central bank bonds, which began in 1994 and which started the process of the federalization of state bonded debt that was eventually formalized with the most recent debt restructuring agreements. States had begun finding it increasingly difficult to place their bonds in the private market at the beginning of the Collor administration in 1992. Ultimately, the state-owned commercial banks, which typically were the underwriters of this debt, found themselves holding unmarketable state bonds, and at the same time facing liquidity problems, because of the growing practice by the states of simply forcing the state banks to capitalize their interest payments. The federal government, concerned about the possibility of a financial crisis among the state banks, agreed to allow the state banks to temporarily exchange the unmarketable state bonds for central bank bonds. At the same time, however, by accommodating the continued rollover of state debt and capitalization of interest payments, the federal government de facto spared the states the necessary fiscal adjustment measures that the market, through its refusal to hold state bonds, was trying to impose.12

41. Why did the states, so soon after having a major debt restructuring in 1993 fall again into fiscal trouble just two years later? The reasons can be distinguished in two groups: the structural factors, (i.e., those institutional factors which explain the apparent susceptibility of the states to fall into fiscal crises); and the proximate factors, (i.e., those factors which precipitated the crisis).

B. The Structural Factors Behind the Fiscal Crisis

42. Three structural factors largely account for the 1995–96 fiscal crisis: the inability or unwillingness of the federal government or the senate to exert control over the growth of state debt; the heavy reliance of the states on the inflation tax during the high inflation period, which led to the neglect of their tax administration and expenditure management systems; and the changes in revenue-sharing and spending responsibilities resulting from the 1988 Constitution.

43. The inability and/or unwillingness of the federal government and the senate to exert forceful control over the states allowed the latter to continue unsustainable fiscal policies, always with the expectation that a federal bailout would be forthcoming. According to Afonso (1997), referring to the repeated debt bailouts of the states by the federal government, “sooner or later … the principal ends up being renegotiated, without conditions that would force the [state] governments to show more austerity than in the past.”

44. Two important factors may explain the lack of effective control by the federal government and the senate over state indebtedness, despite a growing arsenal of instruments at their disposal to enforce such control (Box 3). First, Afonso has suggested that part of the willingness of the federal government to “federalize” the debt of the states in the past was a realization that its own macroeconomic policies, for example a maxidevaluation or a sharp rise in real interest rates, often were the factors that precipitated the fiscal crisis in the states by causing so large an increase in debt service costs as to make it nearly impossible for the states to comply.

Instruments of Federal Government and Senate Control over State Debt1/

I. Prohibitions/Restrictions on Borrowing

  • The Constitution (1988) gives the senate the sole power to set the debt ceiling of the states.

  • Law 7492 (1986) prohibits state borrowing from its own commercial bank.

  • Amendment 3 to the Constitution (1993) prohibits the issuance of new bonds by the states until 2000, except to finance the payment of judicial claims existing at the time of the 1988 Constitution. The amendment does not prohibit the rollover of principal or the capitalizatioin of interest on existing bonds, however. These are determined by the senate on a state-by-state basis.

  • Central bank resolution 2008 (1994) places a ceiling on state debt (other than bonds) held by private commercial banks.

  • Through the External Financing Commission (COFIEX), the federal government controls state access to external financing.

  • Senate resolution 11 (1994) requires that new borrowing must satisfy debt service and growth of debt criteria:

    • (a) debt service criterion: the debt service (on existing and proposed debt) cannot exceed the current account of the previous 12 months, or 15 percent of revenues, whichever is smaller.2/

    • (b) growth of stock criterion: new borrowing within any 12-month period cannot exceed the level of existing debt service, or 27 percent of revenues, whichever is larger.

II. Enforcement Mechanisms

  • Loans to states by the federal government or federally owned institutions are prohibited if the states are in default on any obligation to the federal government, including debt service, social security payments, or debts to federal enterprises.

  • The federal government can withhold constitutional transfers, or garner state VAT revenues to ensure their compliance with debt service obligations associated with the previously rescheduled debt with the federal government.

1/ The information in this box was obtained from Dillinger (1994).2/ Debt service is defined to exclude the principal rollover and interest capitalization permitted by the senate; and the current account refers to the difference between revenues (less transfers to the municipalities) and recurrent spending (including interest payments).

45. The second factor that has contributed to the lack of effective control over the states has been their ability to exercise considerable influence in the national congress. The latter, according to Afonso, has tended to act like a “national congress of state and municipal legislators”13 in matters relating to the tax system, the federal budget and the public debt. Indeed, in many instances the senate has acted in ways to reduce the urgency for the states to undertake fiscal adjustment; for example, by amending the 1993 debt rescheduling agreement to set a ceiling on the debt service of 11 percent of net revenue; and, since mid-1994, allowing the states to rollover virtually all their securitized debt.

46. The high inflation era masked a host of unsustainable fiscal policies and practices that were exposed once inflation declined sharply in the second half of 1994. At the root of these fiscal disequilibria was the reliance on the inflation tax as an important source of revenue. For example, Oliveira (1996) cites the frequent deliberate practice of the states delaying payments so as to take advantage of inflation financing; the large size of the payrolls (on average between 70 and 80 percent of net revenue); the habitual practice by the state treasuries of assuming various debts of independent state agencies, including state-owned enterprises; and the neglect of the tax system, which manifested itself in the excessive tax concessions and exemptions and in a large rate of tax evasion. Another fiscal malady attributable to the high inflation era was the lack of attention paid to expenditure control, especially, but not limited to payroll spending. In Brazil, with revenues reasonably well indexed to inflation, governments could rely on inflation to eat away the real value of whatever nominal increase in spending was budgeted.14

47. Largely as a result of the 1988 Constitution, the states assumed relatively more spending responsibilities without receiving relatively more resources with which to finance them. The 1988 Constitution shifted resources away from the federal government to the municipalities, with the states remaining basically unchanged in terms of their relative share of total general government revenues. A decentralization of spending also took place since the 1988 Constitution, with the states and the municipalities assuming more responsibility especially in the area of education, health, water and sanitation, and public works as the federal government reduced its relative size.15 However, relative to the increased responsibilities that they assumed, the states’ increase in resources has been far less, particularly compared with the municipalities (Box 4). According to Afonso, what is needed is a further process of decentralization, a “municipalization” of services now provided by the states, in accordance with the redistribution of resources brought about by the 1988 Constitution.

Distribution of Net Revenues Among the Three Levels of Government 1/

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Sources: Afonso (1996); ministry of finance; and ministry of planning.1/ Net revenues are equal to own revenues plus net transfers from other levels of government.

C. The 1995–96 Fiscal Crisis

48. Apart from the structural factors cited above, the immediate causes of the fiscal crisis in 1995 were the large increases in salaries granted to state employees at the end of 1994, the sharp rise in domestic interest rates in early 1995, and a stronger effort by the federal government to close the borrowing opportunities available to the states.

49. In late 1994, outgoing state governors, as was traditionally the case, granted civil servants large increases in salaries. However, unlike during the era of high inflation, the real financial burden of these increases did not dissipate during the year. In São Paulo, for instance, the wage bill increased on average by 27 percent in real terms in the 12 months following the introduction of the Real Plan, while in Rio de Janeiro and Minas Gerais the increases were 56 percent and 50 percent, respectively. Such increases in the wage bill, which were typical of increases in the other states, were enormous compared with the real increase of just under 10 percent in states’ ICMS tax revenues. As a result, the ratio of payrolls to net revenues rose substantially in many states, with some, such as Alagoas, Rio Grande do Sul, and Rondônia, rising to more than 100 percent.

50. The other immediate cause of the fiscal crisis in 1995 was the rise in scheduled debt service payments for the states. For the states which had renegotiated debt with the federal government in 1989 and 1993, amortization payments began falling due following the expiration of the grace periods associated with both renegotiations. For the states having substantial contractual or securitized debt, the sharp rise in interest rates in March created severe problems in terms of meeting debt service.

51. The resulting cashflow problems led the states to turn increasingly turning to short-term revenue anticipation loans (AROs) from commercial banks at market interest rates, to accumulate arrears with respect to payroll and payments to suppliers, rollover 98 percent of securitized debt and capitalize the accrued interest (both authorized by the senate) and, in many cases, accumulate arrears in the servicing of loans to state-owned commercial banks.16 With the thirteenth salary, holiday payments, and ARO debts falling due at the end of 1995, most of the states were in fiscal crisis as the end of the year approached.

52. In response, the federal government authorized the Caixa Econômica Federal to provide emergency lines of credit to the states in early 1996. There were three lines of credit: one to be used to pay wage and other outstanding arrears; another to finance voluntary retirement programs; and the final one to refinance outstanding AROs. In exchange for these loans, which carried market interest rates and maturities up to the end of 1998, the 17 states that signed agreements with the federal government promised to implement fiscal adjustment policies consistent with obtaining zero operational balances, including by reducing payroll spending to 60 percent of net revenues by 1998; to privatize state assets; to improve and modernize their systems of tax administration and public expenditure management; and to refrain from contracting new AROs.17

53. In all, the Caixa disbursed about R$2.5 billion under this program between late 1995 and 1996. However, the results fell short of expectations. Some of the objectives of the fiscal adjustment program were unrealistic.18 Also, the fiscal adjustment programs were slow to get off the ground because the federal government was still in the process of developing its manpower capacity to monitor the finances of the states. At the same time, because the entire amounts of the loans were disbursed up front, the urgency to implement reforms on the part of the states waned once the immediate crisis of meeting payroll expenses had been taken care of. The voluntary retirement programs also met with only limited success. As 1996 evolved, with the fundamental situation of the states unchanged (many states had begun to accumulate arrears again) it became clear that the problem of the states’ debt burden had to be tackled, and that modifications to the fiscal adjustment programs would be necessary.

D. The Design and Intent of the Debt Restructuring and Fiscal Adjustment Programs

54. By the end of the third quarter of 1996 the federal government had developed a new framework to address the fiscal crisis in the states. It involved a comprehensive restructuring of state debt, including the securitized debt, so as to allow the states to meet their debt service obligations as well as to make the necessary adjustments to correct their fiscal imbalances on a lasting basis.

55. Of a total state debt of R$143 billion, the amount to be restructured equaled about R$75 billion as of December 1996, composed of securitized debt (R$41 billion), AROs (R$0.5 billion), debt owed to the Caixa Econômica Federal arising out of Voto 162 (R$2.5 billion), borrowing to finance the cleanup of state banks under PROES (R$3.5 billion),19 and other debt (R$28 billion) including bank debt owed mainly to state-owned commercial banks and debt owed to suppliers (Table 2). Previously rescheduled debt was excluded from this new restructuring. São Paulo alone accounted for 58 percent of the restructured debt and, together with Rio de Janeiro, Minas Gerais, and Rio Grande do Sul accounted for 91 percent of the restructured debt (Figure 9). In September 1997, the federal government received authorization to issue R$103 billion in treasury securities, enough to take care of the debt restructuring of the states and to finance PROES.

Table 2.

Brazil: State Fiscal Indicators, 1996 1/

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Sources: Data provided by the Brazilian authorities; and Fund staff estimates.

Preliminary data.

Figure 9.
Figure 9.

Brazil: Indicators of State Debt, 1996

Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A002

Sources: Data provided by the Brazilian authorities; and Fund staff estimates.

56. In the new framework, these debts are to be consolidated, and the newly restructured debt is divided into two portions: one portion, the conta gráfica, which in most cases is equal to 20 percent of the restructured debt, has to be amortized by the end of 1998 using the revenue from the privatization of state assets; the remaining 80 percent is amortized over 15 to 30 years at an interest rate of 6 percent plus the rate of inflation as measured by the IGP-DI index. In most cases, the states are required to identify in a debt restructuring protocol (letter of intent) agreed with the federal government, those assets that are to be used to amortize the conta gráfica.20 For each state a time path is set for the ratio of total debt to net revenue to fall to one (from an average value in 1996 of 2.2), an d new borrowing in any year is prohibited if it would cause the ratio to exceed the target for that year.

57. In designing the fiscal adjustment programs, the first objective is to ensure that any projected financing gap would be eliminated (Box 5). Since, for the most part, the capitalization of interest, the rollover of principal and new borrowing are prohibited, this means generating primary surpluses sufficient to cover debt service obligations (there will be a ceiling on debt service due on the newly restructured debt plus previously rescheduled debt of 11 to 15 percent of net revenues, with the excess being capitalized). At the same time the program has to be consistent with the time path for reducing the debt-revenue ratio. Finally, the fiscal adjustment program seeks to eliminate structural imbalances and improve the quality and efficiency of spending. For this reason, three common features of the fiscal adjustment programs being negotiated have been the introduction of new taxes earmarked for reducing the growing deficits in the state pension programs, measures to reduce payroll spending, and planned increases in investment spending.

58. The debt restructuring agreements involve both an up-front forgiveness of debt and an interest rate subsidy on the restructured debt. The debt forgiveness involves the states’ securitized debt. In this case, the states’ liability is to be computed by taking the outstanding stock at a specific cutoff date (e.g., March 31, 1996 in the case of São Paulo) and capitalizing all accrued interest up to the time of the signing of the contract, using an interest rate equal to 6 percent plus the IGP-DI inflation. As a result, the federal government is assuming the portion of the capitalized interest representing the difference between the overnight rate and the interest rate on the restructured debt, which was about R$6.2 billion, or 0.7 percent of GDP, by the end of 1997. In 1997 the interest rate subsidy would have amounted to some 10 ½ percentage points (given an average overnight rate of 24.6 percent in 1997), or some R$8 billion (1 percent of GDP) in annual accrued interest payments. In 1998 the interest rate subsidy will be even higher, at 17 percentage points, assuming an average overnight rate of 27 percent.

The Design of the Fiscal Adjustment Programs for 1998 and 1999

Three states, São Paulo, Ceaŕa, and Mato Grosso have agreed on specific fiscal adjustment programs with the federal government. The process of calculating the fiscal targets, and consequently the required amount of fiscal adjustment, was done as follows:

1. The schedule of total debt service was calculated. This is equal to:

(a) the debt service of the newly rescheduled debt; plus

(b) the debt service on other debt—including previously rescheduled debt, external borrowing from international institutions, and debt to suppliers; plus

(c) the amortization of the conta gráfica in 1998.

2. A current policies fiscal projection of the primary balance was made, based upon agreed parameters, e.g., inflation, state GDP. Also, all sources of financing are tallied which, given the borrowing constraints imposed upon the states, equal the sum of privatization receipts and loans from the international financial institutions approved by the federal government. Where projected privatization receipts are in excess of that required to amortize the conta gráfica, the projected surplus is used either to reduce other debt (as in the case of São Paulo) or set aside as a reserve to capitalize a new state pension fund (as in the case of Ceará).

3. Given the projected primary balance and sources of financing, a financing gap is calculated. The federal government and the state then negotiate a fiscal adjustment program aimed at eliminating this gap. In all contracts signed so far, the states have pledged higher tax yields through improved tax administration, and introduced a new tax to help finance pension benefits. These measures were designed to generate enough revenues not only to close the various financing gaps but also to allow for sizable increases in investment (in São Paulo and Mato Grosso investment is projected to more than double from 1996 levels, while in Ceará, where the investment program had not been cut back in previous years, the increase is projected at 25 percent). In Mato Grosso, an important component of the fiscal adjustment program was an 8 percent reduction in the wage bill so as to comply with the Lei Camata, which requires the federal and state governments by 1998 to spend no more than 60 percent of their net revenues on personnel. For São Paulo and Ceará, which are on track to comply with this requirement, adjustment in personnel spending was not a significant aspect of their fiscal adjustment packages.

59. In exchange for this debt and debt service relief, the federal government is hoping to advance a number of important items in its policy agenda, not just that of returning the states to fiscal viability. The agreements also will serve to advance the federal government’s policy objectives in the areas of privatization and financial system reform. The federal government has pushed for the privatization of state electricity companies, the most valuable assets for most states, because this is the most expedient way of quickly reducing the states’ stock of debt and easing their debt burden. These privatizations, along with the sale or closure of state-owned banks (which the federal government is also urging in the debt restructuring negotiations), also would improve the prospects for long-term fiscal performance by eliminating two important sources of inappropriate financing traditionally used by the states.

60. Getting the states to privatize their electricity companies would enhance the federal privatization program as well. For the most part, the states own the electricity distribution companies, while the federal government-owned Eletrobras is largely an electricity generation company. It was felt that privatizing electricity generation while the distribution part remained in the public sector (with the prospect of continued managerial inefficiency and lack of investment) would significantly dampen investor interest and lead to underpricing at the time of sale. Thus, apart from including privatization as a requirement in the debt restructuring agreements, the federal government, beginning in 1996, had sought to encourage the states to privatize their electricity companies by having the National Development Bank (BNDES) advance money to the states in exchange for claims on the assets of the electricity companies.

61. Apart from contributing to the fiscal reform of the states, getting the states to relinquish control of their banks is also an integral part of the federal government’s policy of reforming the financial system. The process of preparing these banks for privatization is promoted in two ways. First, the replacement of loans to the states with federal securities will significantly strengthen the balance sheets of the state-owned banks, given that most of the nonperforming loans in the portfolios of these banks were credits to the states. Second, through the PROES program, the federal government pledges to provide finance up to 100 percent of the cost of preparing the banks for privatization, in a manner similar to that done for the private banks under the PROER program.

E. Performance and Assessment

62. The progress in concluding debt renegotiation and fiscal adjustment accords between the states and the federal government in 1997 has been somewhat disappointing. While 19 of the 22 states that signed protocols did so by early 1997, only 3 states, São Paulo, Mato Grosso, and Ceará had signed contracts with the federal government containing both debt restructuring and fiscal adjustment agreements as of end-1997 (even though all the protocols had originally envisaged final contracts being signed within 90 days). Moreover, so far only in the case of São Paulo (the largest state) has a contract been ratified by the senate (all contracts require senate approval). The delay in arriving at final agreements stems mainly from the difficult negotiations that the federal government has had with the larger states, Minas Gerais, Rio Grande do Sul, and Rio de Janeiro, over the appropriate amount of fiscal adjustment and the use of privatization receipts. Despite a willingness on the part of the federal government to agree to substantial increases in investment spending by the states (as illustrated in the cases of the three states that have signed agreements), the other three large states have been pressing to use excess privatization receipts to finance even larger increases in project spending, implying less fiscal adjustment than the federal government has been willing to accept. In the meantime, up until September 1997, the states had not been paying any debt service on the debt to be renegotiated, having received a temporary reprieve as a reward for the quick ratification of the protocols by the state legislatures.

63. In recent months, seeing that the discussions had bogged down, with the states having little incentive to reach a final agreement, the federal government stepped up efforts to bring negotiations to a close. It issued a presidential decree (medida provisória) requiring the states to begin debt service payments in September 1997 in accordance with the conditions in the protocols.21 Further, the federal government set a deadline of March 1998 for all states to sign debt renegotiation and fiscal adjustment contracts, failing which, the federal government would withdraw completely from negotiations. In November, as part of its fiscal package, the federal government also prohibited lending by federal financial institutions to states that had not signed debt renegotiation and fiscal adjustment contracts by end-January 1998. Also in November, the senate passed a resolution requiring the states to use at least 50 percent of their privatization revenues to reduce debt. It is not yet clear to what extent this resolution is enforceable.22

64. In December 1997, in accordance with a new medida provisória governing the restructuring of state debt, the federal government signed debt restructuring contracts with four of the smaller states, leaving the fiscal adjustment programs to be negotiated subsequently.23 These four states are Rio Grande do Norte, Sergipe, Bahia, and Pernambuco. The federal government decided to go ahead with the debt restructuring agreements, albeit without accompanying fiscal adjustment programs, because these states were not viewed as having serious debt problems. While two of the states, Rio Grande do Norte and Pernambuco have payroll/revenue ratios of over 70 percent, the federal government decided that their situations were not critical enough to require a fiscal adjustment program to be in place at the same time as the debt restructuring. Given the difficulty in arriving at fiscal adjustment agreements with the larger states mentioned above, the decision by the federal government to sign debt restructuring contracts without fiscal adjustment agreements appears risky. Clearly, however, these states have nowhere near the political clout of Rio Grande do Sul, Minas Gerais, or Rio de Janeiro.24

65. While there are encouraging signs among the states in the area of fiscal reform, as a whole, the state governments appear to be the weakest link in the fiscal adjustment effort for 1998. The debt restructuring and fiscal adjustment agreements signed by a few states have put them on track for sustained fiscal viability. Moreover, São Paulo, even before these agreements, had shown a commitment to undertake fiscal adjustment on its own.25 Meanwhile, Ceará and a few other states, most notably Bahia, have sustained records of prudent fiscal behavior, which allowed them to avoid the 1995–96 fiscal crisis.

66. For the most part, however, the states will have access to substantial privatization receipts in an election year, and the temptation to spend these funds will be high. This is especially so because during the past three years, the current administrations have been in severe financial straits, and forced to cut back sharply on project spending. Assuming that the states receive a 40–50 percent premium on the minimum prices for the companies that are scheduled to be privatized in 1998 (the average premium during the fourth quarter of 1997 was over 70 percent), the states as a whole could have increased spending potential of R$8.7 billion or 1 percent of GDP even if they satisfied the terms of the debt restructuring protocols (Figure 10).26 If, in addition, the states were obligated to use 50 percent of their privatization receipts to reduce debt (if this would amount to more debt reduction than amortizing conta gráfica), the incremental discretionary spending power in 1998 instead would be R$7.6 billion, or 0.9 percent of GDP. As Figure 10 shows, under the assumptions of this exercise, the increased spending potential is concentrated in two states, São Paulo and Rio Grande do Sul. Rio de Janeiro, on the other hand, would need to generate substantial fiscal savings to comply with its protocol. The fact that São Paulo has a fiscal adjustment program is reassuring since the state’s ability to use the projected large incremental spending power to worsen its fiscal balance would be constrained. This simply serves to underline, however, how crucial it is that the federal government redouble its efforts to negotiate fiscal adjustment agreements with those states without such programs as soon as possible.

Figure 10.
Figure 10.

Brazil: States’ Increased Spending Potential Assuming Compliance with the Debt Restructuring Protocols, 1998 1/

(in millions of reais)

Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A002

Sources: Data supplied by Brazilian authorities; and Fund staff estimates.1/ Increased spending potential equals privatization revenues and other available financing less new debt service arising as a result of the debt restructuring protocols (in the case of Sao Paulo and Ceara, this includes provisioning for capitalization of new pension fund)


  • Afonso, Jose R., 1997, “Decentralização, Fiscal, Efeitos Macroeconômicos e Função de Estabilização: O Caso (Peculiar) do Brasil” (CEPAL), (January).

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  • Bacha, Edmar, 1994, “O Fisco e a Inflação: Uma Interpretação do Caso Brasileiro.” Revista de Economia Política, Vol. 14 (1).

  • Dillinger, William, 1995, “Brazil. State Debt: Crisis and Reform,” World Bank Report No. 14842-BR (Washington: The World Bank), (November).

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  • Giambiagi, Fabio, 1995, “Uma Proposta de Engenharia Financeira para a Federalização da Dívida Mobiliária e de Ativos Estaduais” (BNDES Discussion Paper 31) (November).

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  • Oliveira, João do Carmo, 1996, “Controle do Endividamento dos Governos Estaduais e Municipiais,” Mimeo.

  • Ter-Minassian, Teresa (ed.), 1997, Fiscal Federalism in Theory and Practice (Washington: International Monetary Fund).


Prepared by Trevor Alleyne.


The 1989 rescheduling resulted from Law 7976 (December 1989).


This rescheduling was governed by Law 8727 (November 1993).


Originally, the amount that was exchangeable was limited to the amount that the state banks could guarantee using cash and other assets (excluding state loans) as collateral. In January 1995 this stipulation was waived. Whereas at the beginning of 1994, the central bank was holding no state bonds, by the end of the year, it was holding R$17.3 billion, or 71 percent of the state bonds in circulation.


Afonso, p. 3.


Bacha (1994) described this situation as the Oliveira-Tanzi effect working in reverse.


Afonso (1996) warns of being overly critical of the increase in spending by the states and municipalities. He argues that to some degree this increase is a natural consequence of the larger responsibilities assumed by the subnational levels of government since 1988.


In the more extreme cases, the state of Alagoas eventually fell eight months behind in meeting its payroll; and a few states and municipalities fraudulently issued bonds, ostensibly to pay off judicial claims (as permitted by the Constitution), but in reality to finance other current spending.


See Voto 162/95 of the Conselho Monetário Nacional for a detailed description of the program.


For example, the states were required to adopt measures to ensure actuarial equilibrium in their state pension systems, establish comprehensive privatization programs, formulate and implement centralized monitoring systems for their state enterprises—all by the end of the first quarter of 1996.


PROES is the Program to Reduce State Involvement in the Banking Sector (Programa Incentivo à Redução do Setor Público Estadual na Atividade Bancária). Under this program the federal government will provide financing to states to clean up these banks or prepare them for privatization. It is described in more detail in the staff report for the 1996 Article IV consultation (EBS/97/11; January 30, 1997) and in Chapter V of this paper.


There have been a number of exceptions to this general framework. In the case of Rio Grande do Sul, for example, the state is required to amortize only R$1.2 billion, which amounts to just 17.8 percent of the restructured debt. In the case of Rio de Janeiro, the state claimed to have state assets whose value amounted to only 10 percent of its restructured debt. As a result, the state was assessed a “punitive” interest rate on its restructured debt of 7½ percent plus IGP-DI inflation.


As of end-1997, all states have been complying with this order.


It is not clear whether the senate has the constitutional authority to tell states how they can use their privatization revenues. In December, the supreme court issued a temporary injunction against the implementation of the senate resolution. On the other hand, as has been mentioned earlier, the senate does have the constitutional authority to establish debt ceilings for the states. Thus, by lowering the debt ceiling of a particular state, the senate could indirectly force that state to use its privatization revenues to reduce debt. But, as has been mentioned earlier, the problem of controlling state debt has not been one of a lack of tools on the part of the senate, as much as an unwillingness to use them.


The medida provisória allows debt restructuring contracts to be signed with the states, but requires that fiscal adjustment programs be negotiated within 90 to 120 days.


The federal government is determined that it will only sign debt restructuring contracts with these states once fiscal adjustment programs have been agreed to.


São Paulo dismissed 105,000 workers (11 percent of its active employees) during 1995 and 1996.


Increased spending potential refers to the net new resources available to the states (i.e., privatization receipts and new loans from international financial institutions) after accounting for the new financial obligations assumed in 1998 (the debt service on the restructured debt and the amortization of the conta gráfica). It is assumed that the underlying trend of fiscal improvement continues for the states, so that it is reasonable to assume that new financial resources only need to be applied to new obligations, rather than also having to cover increasing financing gaps from a deteriorating underlying fiscal position.

Brazil: Recent Economic Developments
Author: International Monetary Fund