MINISTRY OF FINANCE

Joaquim Vieira Ferreira LevyJoaquim Vieira Ferreira Levy National Treasury SecretaryNational Treasury Secretary

Finance Municipalities and Sub-National Governments Seminar

Washington, September, 30, 2004

Brazil:Brazil:Trends in Financing Trends in Financing Sub-National Government and Sub-National Government and

Para-State Entities Para-State Entities

Background

Macro imbalances were reflected in high inflation until 1994

* Consumer Price Index - IPC (FIPE)

Background # 1Background # 1

2003 Debt Dynamics Summary

2002 2003

Net debt (R$ billion) 881 913

GDP (R$ billion) 1.346 1.514

Net debt/ nominal GDP 65,5% 60,3%

Net debt/ GDP valued by IPCA

60,9% 58,8%

Net debt/ GDP valued by IGP 55,5% 59,0%

Debt/GDP (adjusted by the IPCA)

30

35

40

45

50

55

60

65

1996 1997 1998 1999 2000 2001 2002 2003

(Rel

ação

DLS

P/P

IB)

Background # 2: fiscal imbalances continued until 1999

Debt/GDP will

drop again in 2004

Background # 3: the long road to strengthening subnational finances

1988: new constitution and democracy foster increases in the role and spending of subnational entities

1989: perception that subnational borrowing was a national problem dawns

The federal government assumes the foreign debt of states and municipalities refinancing it(Law 7.976)

1993: A second bailout (started in 1991) concludes, with the rescheduling of the debt of subnational entities with federal institutions (Law 8.727)

(In both cases, the refinancing was in concessional terms)

Requisite for renegotiation: Fiscal adjustment programs with Requisite for renegotiation: Fiscal adjustment programs with established targets for the effective reduction of debt.established targets for the effective reduction of debt.

Interest rates: inflation + 6%-7.5% (lower than the funding cost Interest rates: inflation + 6%-7.5% (lower than the funding cost of the central government and of subnationals when accessing of the central government and of subnationals when accessing credit markets). credit markets).

Amortization period of up to 30 years, with service in the range of Amortization period of up to 30 years, with service in the range of 11,5%-15% of state net current revenue.11,5%-15% of state net current revenue.

Down payment of 20% of the rescheduled debt. Down payment of 20% of the rescheduled debt.

FPE (tax transfers) or other tax revenues as collateral. FPE (tax transfers) or other tax revenues as collateral.

Fiscal Responsibility Law (2000) forbids new renegotiationsFiscal Responsibility Law (2000) forbids new renegotiations

LAW 9.496 – a definitive arrangement LAW 9.496 – a definitive arrangement

A new approach to subnational debt

the federal government financed the resolution/cleaning up of the federal government financed the resolution/cleaning up of state financial institutions, with the cost added the amount to the state financial institutions, with the cost added the amount to the outstanding loan obtained under the Law 9.496/98 (i.e., spread outstanding loan obtained under the Law 9.496/98 (i.e., spread over 30 years).over 30 years).

most banks privatized the restructured banks (there are still most banks privatized the restructured banks (there are still three banks scheduled to be privatized) three banks scheduled to be privatized)

government support was limited to 50% in the case of the few government support was limited to 50% in the case of the few states that decided to keep their banks (e.g., ES and RS)states that decided to keep their banks (e.g., ES and RS)

PROES – PROES – Federal support for the Federal support for the liquidation, extinction, liquidation, extinction, privatization, restructuring of privatization, restructuring of problematic problematic state banks, state banks, allowing for the creation of development agencies, which allowing for the creation of development agencies, which could not borrowcould not borrow

Closing the drain of state-owned banks

Interest rate of inflation (IGP-DI) + 6%-9%. Option to lower Interest rate of inflation (IGP-DI) + 6%-9%. Option to lower interest rates (7,5% or 6%) for those municipalities that paid off interest rates (7,5% or 6%) for those municipalities that paid off 10% or 20% of the debt in the first 30 months of the contract10% or 20% of the debt in the first 30 months of the contract

Repayment period of 30 years, with a ceiling of 13% of net Repayment period of 30 years, with a ceiling of 13% of net real revenue on debt service. real revenue on debt service.

programs tied to fiscal targets.programs tied to fiscal targets.

Renegotiations of Municipalities – MP 2.185/01Renegotiations of Municipalities – MP 2.185/01

Refinancing the Debt of Municipalities

Provides for the establishement of FISCAL TARGETS, Provides for the establishement of FISCAL TARGETS, limitations on tax expenditure, subsidies and the financing of limitations on tax expenditure, subsidies and the financing of current expenditurecurrent expenditure

Requires the publication of timely and comphreensive Requires the publication of timely and comphreensive information on local and states accounts (which are later information on local and states accounts (which are later consolidated by the National Treasury).consolidated by the National Treasury).

Establishes limits on personnel expenditures (including by Establishes limits on personnel expenditures (including by government branches) and mechanisms for correct slippagesgovernment branches) and mechanisms for correct slippages

Establishes limits for the public debt of subnational Establishes limits for the public debt of subnational governments and convergence paths toward these limitsgovernments and convergence paths toward these limits; ; AArt. 31 Par. 4º directs the Treasury to list every month those rt. 31 Par. 4º directs the Treasury to list every month those government entities that may be exceeding these debt limits.government entities that may be exceeding these debt limits.

Background # 4Fiscal Responsibility Law

Proposed Limit Date Path

3,5 (*) Immediate

2,0 (**) w ithin 15 years

Reduction of debt to 1/15 of

exceeding amount

1,2 (**) w ithin 15 years

Reduction of debt to 1/15 of

exceeding amount

Government Entities

Federal Government

States

Municipalities

(*) Under discussion (Senate).

(**) (**) Res. SF. nº 40/2001.

Debt Limits (Art. 30, I) Net Consolidated Debt over Net Current Revenue (DCL/RCL)

Fiscal Responsibility Law

Fiscal Responsibility Law – art. 32: The Ministry of Finance Fiscal Responsibility Law – art. 32: The Ministry of Finance is responsible for certifying that subnationals and public is responsible for certifying that subnationals and public enterprises are in condition to contract credit operationsenterprises are in condition to contract credit operations.

Senate Resolution 43/2001: Regulates how the Ministry of Senate Resolution 43/2001: Regulates how the Ministry of Finance is to exercise its duty regarding the authorization of Finance is to exercise its duty regarding the authorization of credit operations by government entities.credit operations by government entities.

COPEM is created within the STN, receiving support from COPEM is created within the STN, receiving support from regional branches of the Central Bank to receive credit regional branches of the Central Bank to receive credit applications and supporting documents.applications and supporting documents.

The Constitution establishes that subnational loans ought to be The Constitution establishes that subnational loans ought to be authorized by the Senate and delegates the analysis to the authorized by the Senate and delegates the analysis to the National TreasuryNational Treasury

The National Treasury as an agent for the Federal Senate

Results

Fiscal Responsibility: The cornerstone of the economic policy

Public Sector Primary Surplus (% GDP)

Fiscal Commitment: an effort shared by all

Regional Government Primary Surplus (% GDP)

Primary Result - Regional GovernmentsAcummulated 12 months

1,23%

-0,40%

0,00%

0,40%

0,80%

1,20%

1,60%

jan

-99

jul-

99

jan

-00

jul-

00

jan

-01

jul-

01

jan

-02

jul-

02

jan

-03

jul-

03

jan

-04

jul-

04

% G

DP

Lower debt service and higher primary: the road to debt sustainability

Source: MF/STN/COREM

R$ billion at Constant Prices – General Price Index

(40,0)

(20,0)

0,0

20,0

40,0

60,0

1995 1997 1999 2001 2003

Debt ServicePrimary Result

DCL/RCL < 1,0 1,0 < DCL/RCL < 1,5 1,5 < DCL/RCL < 2,2 DCL/RCL > 2,2

2000 11 4 6 6

2001 11 5 7 4

2002 9 6 4 8

2003 11 5 6 5

2004 * 11 5 6 5

* April

Debt Limits: StatesDebt Limits: States

Debt Limits: Municipalities (Capitals)Debt Limits: Municipalities (Capitals)(*) Source: RGF States.

(*) Source: RGF Capitals.

Debt and macroeconomic shocks

DCL/RCL < 0,3 0,3 < DCL/RCL < 0,7 0,7 < DCL/RCL < 1,2 DCL/RCL > 1,2

IQ/01 14 4 2 2

IQ/02 13 5 0 1

IQ/03 15 0 4 1

R$ million at constant prices

State Spending

020.00040.00060.00080.000

100.000120.000140.000160.000180.000200.000

1995 1996 1997 1998 1999 2000 2001 2002 2003

Personnel Retired personnel Investiments Other

Source: MF/STN/COREMConstant Prices – General Price Index

Municipalities are being able to sustain investment programs

Source: MF/STN/COREM

Investiment Expenses over Net Real Revenue

0

0,02

0,04

0,06

0,08

0,1

0,12

0,14

0,16

1998 1999 2000 2001 2002 2003

Inve

stim

ents

/RL

R

Capitals under refinanc.programs 3.215 municipalities

Capitals 147 municipalities under refinanc.programs

Municipalities account for 1/3 of total public investment

Outlook

Real Interest Rate on inflation indexed NTN-C bonds

Source: National Treasury

Aug-04

What really matters: public financing at a lower cost

Lower real interest rates are fundamental to foster public and private investment

Still...

(20,0)

0,0

20,0

40,0

60,0

80,0

1995 1997 1999 2001 2003

R$

bill

ion

(co

nst

ant

pri

ces)

Budget Outturn New Borrowing

... Several states can borrow very little!

Thus, the challenge when considering borrowing is to

be selective and focus on investments with fiscal return or clear capacity for cost recovery

continue to improve the tax basis and collection

address the issues of spending on personnel and budget rigidities

Multilaterals can have a constructive role if they are attuned to the needs of fiscal responsibility and the very real limits faced by subnationals entities

A successful partnershipA successful partnership with the IMF: with the IMF:

Sanitation on Sustainable Bas Sanitation on Sustainable Baseess

A sector mired in problems, with a tradition of low efficiency A sector mired in problems, with a tradition of low efficiency and poor serviceand poor service

Low levels of financing in recent years, with budget Low levels of financing in recent years, with budget expenditure by the Federal Government hindered by poor expenditure by the Federal Government hindered by poor implementation and lack of accountability (Public Accounting implementation and lack of accountability (Public Accounting Office Report – 2003)Office Report – 2003)

Huge demand and a positive tradition of Huge demand and a positive tradition of willingnesswillingness to pay for to pay for serviceservice

National Treasury & Ministério das Cidades develop a plan for National Treasury & Ministério das Cidades develop a plan for self financing economic sustainable investment in sanitationself financing economic sustainable investment in sanitation by by subnational entities, which is supported by the IMF.subnational entities, which is supported by the IMF.

FIRST RESULTS & a Good OmenFIRST RESULTS & a Good Omen

Contracts amounting to about USContracts amounting to about US$ 1 billion signed as of June $ 1 billion signed as of June 20042004

Beneficiaries: 12 States (Sanitation States Companies) and about Beneficiaries: 12 States (Sanitation States Companies) and about 328 municipalities.328 municipalities.

Population reached: around 7 millions habitants (1,8 million Population reached: around 7 millions habitants (1,8 million families)families)

Strong focus on performance improvement, with Strong focus on performance improvement, with stringent requirements in terms of efficiency and stringent requirements in terms of efficiency and institutional strengtheninginstitutional strengthening

Careful screening by MCidades Careful screening by MCidades to ensure that only economically to ensure that only economically sustainable projects qualifysustainable projects qualify

(other experiences)(other experiences)

PSH – A successful way to provide housing to the very poor PSH – A successful way to provide housing to the very poor (income equal or below 1 minimum wage)(income equal or below 1 minimum wage)

Central Government provides subsidy for construction and Central Government provides subsidy for construction and financing – subsidies are auctioned to foster efficiencyfinancing – subsidies are auctioned to foster efficiency

Subnationals typically provide the land and some infra-structureSubnationals typically provide the land and some infra-structure

Subsidies are paid up-front, reducing fiscal risk, and Subsidies are paid up-front, reducing fiscal risk, and tailored to allow relatively short payback periods. Such tailored to allow relatively short payback periods. Such an approach reduces the risk of default and operational an approach reduces the risk of default and operational costs (which used to eat up most of the value of low-costs (which used to eat up most of the value of low-income finance when the subsidy was reflected in low income finance when the subsidy was reflected in low interest rates over a long-term loan, rather than the interest rates over a long-term loan, rather than the upfront reduction of the principal of the loanupfront reduction of the principal of the loan

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