• Decision could deal another blow to strained public finances
  • `Absolutely no predictability' on how Supreme Court will rule

Brazil’s Supreme Court is to begin ruling Wednesday on a case that will either torpedo the federal government’s budget or leave cash-strapped states struggling to pay for basic services.

At stake is whether three states -- Minas Gerais, Rio Grande do Sul and Santa Catarina -- will be allowed to re-calculate their debts using simple rather than compound rates. A ruling in their favor would pave the way for all debtor states to be granted the same treatment, setting the federal government back 402 billion reais ($114 billion), according to estimates by the Finance Ministry.

Brazil is already grappling with a rapid deterioration of its public finances that cost the country its much-coveted investment grade credit rating. Attempts to oust President Dilma Rousseff for allegedly doctoring fiscal accounts exacerbated the worst recession on record, drying up tax revenues. States, too, are in dire straits. Court justices will effectively choose which level of government to punish, according to Rubens Glezer, a professor at the Getulio Vargas Foundation’s law school in Sao Paulo.

“The argument of fiscal stability is important to them, but whether they prefer the fiscal stability of states or the union is something very much unprecedented,” said Glezer, who coordinates the university’s study of Supreme Court rulings and performance. “There is absolutely no predictability for this case.”

Impeachment Process

As Congress trained its focus on the ongoing impeachment process, economic measures to improve government finances have been put on the back burner. Brazil’s budget deficit has more than tripled in two years to 10.8 percent of gross domestic product, and its gross debt jumped to 67.6 percent of GDP from 51.7 percent at the end of 2013.

The federal government will have to freeze more spending if Congress doesn’t revise its 2016 budget target excluding interest payments to a deficit of as much as 97 billion reais, Finance Minister Nelson Barbosa said April 20.

A day earlier he told states that the correct solution for their debt is renegotiation to extend maturities and lower payments.

That may not do the trick. Five states have debt loads exceeding 1.5 times their annual revenue. Rio de Janeiro, which will host the Olympics in less than four months, has debt virtually double its income and this year has delayed salary payments to active and retired public servants including police officers and teachers. Strikes and protests have broken out.

Olympic Games

“Rio de Janeiro is a snapshot of what all Brazilian states will be,” Raimundo Colombo, governor of Santa Catarina state, said at a Supreme Court session on April 19. “What will Brazil do during the Olympics with delays in salaries, without gasoline in police cars, without medicine?”

Rio Grande do Sul, the country’s southernmost state, defaulted on a payment it owed the federal government in August after delaying payments to workers. That was the first since the nation’s municipal debt meltdown in 1997, when the federal government rescued states and forbade them from issuing debt in capital markets. If the court rules in favor of the three states, all other states will be filing suit the following day, Glezer said.

“This is an absurd situation that could cost a fortune to the country," David Beker, chief Brazil economist and fixed income strategist at Bank of America Merrill Lynch, said by phone from Sao Paulo. "In a scenario dominated by political headlines, we forget the country’s main problems are still out there -- this is one of them. It’s like a skeleton that was forgotten and is now being brought to light."

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