Strengthening Fiscal Responsibility at the Subnational Level by Paulo Medas, Roberto Perrelli, and Fernando González published by IMF (9/2020).
“The fiscal challenges of Brazil’s states and municipalities can have a significant impact on the economy and the provision of core public services. The subnational governments (SNGs) account for a large share of public expenditures, including public investment. As such, their fiscal problems can hamper the economic recovery and the public finances of the federal government. In recent years, many states and municipalities have been struggling with high debt or severe liquidity pressures. Some have already defaulted on part of their debt and are running payment arrears (wages and suppliers). The federal government has already provided a substantial package of financial support through debt service relief.
The fiscal responsibility legislation was intended to prevent this harmful scenario, but its effectiveness has been diminished over time. 1 Since the late 1990s–early 2000s, Brazil has developed a complex and heavy framework of administrative controls and fiscal rules intended to promote fiscal transparency, constrain excessive borrowing by SNGs, and promote public investment. The reforms had some positive effects in the first years, but the framework gradually unraveled. Crucially, the framework did not eliminate the expectation of bailouts by the federal government. Over time, several problems emerged:
• The debt of most states was significantly reduced; however, this was not the case in the largest states, and they became increasingly vulnerable to economic shocks. This in part reflected the loosening of administrative controls that allowed excessive borrowing. The complex framework has also led some states and municipalities to run arrears even if their debt levels were relatively low.
• Public expenditures have been highly volatile and procyclical, which reflects weaknesses in the design of the rules, as well as widespread revenue earmarking in conjunction with mandatory spending.
• The lack of consistent accounting standards and poor data quality make it difficult to monitor the fiscal rules and risks. Weaknesses in internal and external controls have facilitated the use of creative accounting to circumvent the rules; in some cases, these weaknesses undermine budgetary processes due to the use of extrabudgetary spending and arrears.
• Significant legal uncertainty has arisen over the application of the Fiscal Responsibility Law (FRL) because the courts have been granting temporary injunctions that prevent the enforcement of the sanctions for several years…”
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