Crisis-hit Brazil threatened by US$89b state debt time bomb

[BRASILIA] Amid the worst political crisis in decades, Brazil's federal government also faces a spiraling state debt crisis that could cost it as much as US$89 billion in lost revenue.

Brazilian states, hit by a two-year recession that has depressed tax revenues, are seeking to apply simple rather than compound interest on debt owed to the federal government. The change could cost the Treasury 313 billion reais, according to finance ministry calculations.

Brazil's Supreme Court ruled last week in favor of Santa Catarina state, which had requested the change. The decision, albeit an injunction issued by the court before its decision on the case's merit, could open a precedent allowing other states to demand the same treatment, finance minister Nelson Barbosa warned on April 8.

Brazil's 12-month budget deficit widened to a record 2.1 per cent of gross domestic product in February, as political turmoil that could result in the impeachment of President Dilma Rousseff put austerity measures on hold.

The government proposed in March a bill to renegotiate debts as a severe recession has put some states on the brink of insolvency. Lawmakers have already made amendments to that proposal, reducing obligations state governments had to agree to in exchange for debt relief.

"This is a symptom that shows the government is in political shambles," said Andre Perfeito, chief economist at Sao-Paulo based brokerage Gradual Cctvm.

"Every state governor is taking advantage of Rousseff's frailty to solve their situation without considering the impact over the country as a whole."

More Lawsuits

Alagoas state governor Renan Filho, son of Senate president Renan Calheiros, met with finance minister Nelson Barbosa on Tuesday to inform him that he will also file a lawsuit at the Supreme Court to have the decision extended to his state.

"More states are expected to file lawsuits against the government," Mr Filho told reporters before the meeting.

"Any governor who doesn't seek the Supreme Court will be simply admitting that it's fair to pay compound interest. The debt renegotiation proposal helps, but this injunction makes a big difference for Alagoas' debt."

Mr Barbosa argues that the Treasury's debts pay compound interest and that is why it isn't possible to change the interest charged on states' debt.

"This is very dangerous for Brazil's fiscal dynamics if it isn't stopped," said Mr Perfeito.

"There is a good chance this will become a time bomb."

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