As states tighten belts, Brazil edges closer to recession

BRASILIA (Reuters) – Brazilian states and cities are scrambling to raise taxes and cut spending after years of excesses, nudging an already weak national economy closer to recession.

Growing budget deficits, the biggest in more than a decade, have prompted some states to temporarily suspend payments to suppliers and freeze billions of reais in services and infrastructure projects, from road maintenance to healthcare facilities.

The measures rippling through rich and poor, big and small states mirror President Dilma Rousseff’s own efforts to regain credibility with investors at the federal level after years of lavish government spending and tax breaks for select industries.

While a return to fiscal rigor in states and cities may help Brazil keep its coveted investment grade credit rating, it could seriously hamper investment crucial for Latin America’s largest economy to avoid a painful recession this year.

States and cities posted a primary budget deficit of 7.8 billion reais ($2.7 billion) in 2014, the first since 1998. Twenty-one of Brazil’s 27 states saw payrolls as a percentage of net revenues rise in the past four years, and 17 are close or beyond a legal limit for their staffing bill.

States’ outstanding net debt grew by 21 per cent between 2010 and 2014 to nearly half a trillion reais, driven by a surge in public spending and federal government efforts to relax debt limits to increase investments.

To be sure, states haven’t replicated the reckless spending that triggered fiscal crises in the 1980s and 1990s. That traumatic period led Brazil to pass a landmark Fiscal Responsibility Law in 2000 that placed strict limits on the ability of states and cities to take on new debt without federal government approval. While Rousseff’s government has agreed to some requests to ease those limits, ratings agencies say debt levels remain manageable.

Still, the belt-tightening could not come at a worse time for the economy, which is already on the brink of recession and could shrink as much as 2 per cent this year, according to recent market forecasts.

“This will certainly have an impact on activity and push the economy further into negative territory,” said Rafael Bistafa, economist with Sao Paulo-based consultancy Rosenberg. “But you can’t keep raising states’ debt limits. It is not sustainable.”

Obliged to follow strict spending rules on healthcare, education and other essential services, states and cities have little option but to cut back on investments, public-finance expert Mansueto Almeida said.

State governors have sought to reassure voters that key projects will remain on schedule.

There have been no cuts to the budget for the 2016 Olympics in Rio de Janeiro and the state governor insists the city will be ready to host the event.

But analysts say many initiatives, such as a flagship project to build “pacification” police units in Rio’s slums, will need to be scaled back.

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