• Recession and oil crash have shrunk Rio’s tax revenue
  • Treasury says it has funds to cover government-backed debt

Brazil’s Treasury covered the foreign debt that Rio de Janeiro state failed to pay amid its budget crunch, raising the specter of additional bailouts by a cash-strapped federal government.

The Treasury paid the 8 million reais ($2.24 million) Rio owed to French development agency AFD, Treasury Secretary Otavio Ladeira told reporters in Brasilia. He said the Treasury has the funds to cover state debts that are guaranteed by the government.

Rio’s financial straits left it unable to properly manage and stock its hospitals and forced it to delay salaries for public servants this year. It even failed to pay for an emergency alert system. The state’s capital will host the Summer Olympics in just over two months.

Following Rio’s failure to pay the AFD, Fitch Ratings put the state’s credit rating on negative watch. Moody’s said in a report Monday that Rio’s decision to not honor the payment is negative for all states as it underscores the extent of the recession’s impact on their liquidity. The federal government made the payment within the grace period, and has yet to assume Rio’s skipped 922,000-real ($258,000) debt payment to the Inter-American Development Bank, Ladeira said.

Rio’s acting governor Francisco Dornelles told reporters Monday the state’s problems are grave, and it is counting on an understanding with the federal government to renegotiate its debt. Rio’s finance secretary Julio Bueno said in an interview this month that states striking a “grand bargain’’ with the federal government is the only solution to the debt crisis.

“We’re going to deal with this issue as a priority in the coming days, in a way that not merely addresses it in terms of temporary relief, but in fact gives states a horizon for coming years,” Finance Minister Henrique Meirelles said in a speech to business leaders in Rio on Monday.

Rio’s debt was almost twice as much as its revenue at end-2015, the third-highest of any state, according to data compiled by Bloomberg. It trailed only Minas Gerais and Rio Grande do Sul.

Rio projects a 20 billion-real deficit this year, of which 12.5 billion reais correspond to a pension system in need of overhaul, according to Bueno. The state is also bringing in considerably less revenue owing to a two-year recession shaping up to be Brazil’s worst on record, the massive corruption probe that crippled the supply chain of Rio-based oil company Petrobras, and a drop in oil royalties due to lower international crude prices, Bueno said. The state estimates 3.8 billion reais in royalties this year, less than half the 8.7 billion reais of 2014.

In an attempt to mitigate the oil royalty shortfall, Brazil’s national monetary council authorized 3.5 billion reais in financing for Rio earlier this year, according to the state’s finance secretariat. However, the federal government’s capacity to help is limited given its own fiscal constraints, with a nominal budget deficit equal to nearly 10 percent of GDP.

Rio is one of many states hoping for debt relief, some of which are waiting for a Supreme Court decision on whether they can pay simple interest rates rather than compound rates. A ruling in their favor would further stress the federal government’s finances.

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