Brazil takes state of Rio to court over debt

news.ft.com By Raymond Colitt in São Paulo Published: January 9 2003 0:35 | Last Updated: January 9 2003 2:16

The Brazilian government was on Wednesday battling the country's third-largest state in court for defaulting on a debt payment.

The federal treasury last week had confiscated R$86m (US$25m) in tax revenue from Rio de Janeiro state to make up for a debt payment it missed in late December. Following a supreme court order, the government yesterday returned the funds but is appealing against the decision.

The incident highlights the difficult debt situation of several state governments and is one of the first tests of the new administration's financial ingenuity. The leftwing government of Luiz Inácio Lula da Silva, which took power last week, faces one of the tightest budgets in recent years.

The challenge for the Lula da Silva administration is to negotiate limited relief for a few states without opening a broader and very costly debt renegotiation, argues Raul Velloso, a Braslia-based expert in public accounts. "It's a potential Pandora's box."

Half a dozen states with total debts of more than R$100bn ($30bn) say they have difficulty in meeting their obligations. The government has already made concessions to Minas Gerais, the country's second-largest state, offering funds to build roads.

That offer prompted other governors to seek aid as well. "It's difficult [for the government] to explain help to Minas and not to Esprito Santo," said Paulo Hartung, governor of the small coastal state.

The Lula da Silva administration had hoped to put off the issue of state debt, which resurfaced when several governors said they found barren coffers on taking office.

The supreme court admitted Rio de Janeiro's argument that vital public services were threatened by the debt payment. If upheld, the ruling could encourage other states to seek legal action.

A moratorium on interest payments by Minas Gerais sparked the currency crisis that forced Brazil to abandon its crawling peg in favour of a floating exchange rate in 1999.

The former administration successfully renegotiated states' debt in exchange for budget discipline and transparency and introduced tough penalties for non-compliance. Governors who fail to account for their budget or to meet targets can now go to prison.

"If the government offers fresh aid, they will have to ask for more belt-tightening in return," said Mr Velloso.