1. MINISTRY OF FINANCE Joaquim Vieira Ferreira Levy National Treasury Secretary National Treasury Secretary Finance Municipalities and Sub-National Governments Seminar Washington, September, 30, 2004 Brazil:Trends in Financing Sub-National Government and Para-State Entities

2. Background

3. Macro imbalances were reflected in high inflation until 1994 * Consumer Price Index - IPC (FIPE) Background # 1

4. 2003 Debt Dynamics Summary Debt/GDP (adjusted by the IPCA) Background # 2: fiscal imbalances continued until 1999 Debt/GDP will drop again in 2004

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

6. ë Requisite for renegotiation: Fiscal adjustment programs with established targets for the effective reduction of debt. ë Interest rates: inflation + 6%-7.5% (lower than the funding cost of the central government and of subnationals when accessing credit markets). ë Amortization period of up to 30 years, with service in the range of 11,5%-15% of state net current revenue. ë Down payment of 20% of the rescheduled debt. ë FPE (tax transfers) or other tax revenues as collateral. ë Fiscal Responsibility Law (2000) forbids new renegotiations LAW 9.496 – a definitive arrangement A new approach to subnational debt

7. ë the federal government financed the resolution/cleaning up of state financial institutions, with the cost added the amount to the outstanding loan obtained under the Law 9.496/98 (i.e., spread over 30 years). ë most banks privatized the restructured banks (there are still three banks scheduled to be privatized) ë government support was limited to 50% in the case of the few states that decided to keep their banks (e.g., ES and RS) PROES – Federal support for the liquidation, extinction, privatization, restructuring of problematic state banks, allowing for the creation of development agencies, which could not borrow Closing the drain of state-owned banks

8. ë Interest rate of inflation (IGP-DI) + 6%-9%. Option to lower 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 contract ë Repayment period of 30 years, with a ceiling of 13% of net real revenue on debt service. ë programs tied to fiscal targets. Renegotiations of Municipalities – MP 2.185/01 Refinancing the Debt of Municipalities

9. ëProvides for the establishement of FISCAL TARGETS, limitations on tax expenditure, subsidies and the financing of current expenditure ë Requires the publication of timely and comphreensive information on local and states accounts (which are later consolidated by the National Treasury). ëEstablishes limits on personnel expenditures (including by government branches) and mechanisms for correct slippages ëEstablishes limits for the public debt of subnational governments and convergence paths toward these limits; Art. 31 Par. 4º directs the Treasury to list every month those government entities that may be exceeding these debt limits. Background # 4 Fiscal Responsibility Law

10. (*) 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

11. ë Fiscal Responsibility Law – art. 32: The Ministry of Finance is responsible for certifying that subnationals and public enterprises are in condition to contract credit operations ë Fiscal Responsibility Law – art. 32: The Ministry of Finance is responsible for certifying that subnationals and public enterprises are in condition to contract credit operations. ë Senate Resolution 43/2001: Regulates how the Ministry of Finance is to exercise its duty regarding the authorization of credit operations by government entities. ë COPEM is created within the STN, receiving support from regional branches of the Central Bank to receive credit applications and supporting documents. The Constitution establishes that subnational loans ought to be authorized by the Senate and delegates the analysis to the National Treasury The National Treasury as an agent for the Federal Senate

12. Results

13. Fiscal Responsibility: The cornerstone of the economic policy Public Sector Primary Surplus (% GDP)

14. Fiscal Commitment: an effort shared by all Regional Government Primary Surplus (% GDP)

15. Lower debt service and higher primary: the road to debt sustainability Source: MF/STN/COREM R$ billion at Constant Prices – General Price Index

16. Debt Limits: States Debt Limits: Municipalities (Capitals) (*) Source: RGF States. (*) Source: RGF Capitals. Debt and macroeconomic shocks

17. R$ million at constant prices State Spending Source: MF/STN/COREM Constant Prices – General Price Index

18. Municipalities are being able to sustain investment programs Source: MF/STN/COREM Municipalities account for 1/3 of total public investment

19. Outlook

20. 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

21. Still...... Several states can borrow very little!

22. 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

23. A successful partnership with the IMF: Sanitation on Sustainable Bases ë A sector mired in problems, with a tradition of low efficiency and poor service ë Low levels of financing in recent years, with budget expenditure by the Federal Government hindered by poor implementation and lack of accountability (Public Accounting Office Report – 2003) ë Huge demand and a positive tradition of willingness to pay for service ë National Treasury & Ministério das Cidades develop a plan for self financing economic sustainable investment in sanitation by subnational entities, which is supported by the IMF.

24. FIRST RESULTS & a Good Omen ë Contracts amounting to about US$ 1 billion signed as of June 2004 ëBeneficiaries: 12 States (Sanitation States Companies) and about 328 municipalities. ë Population reached: around 7 millions habitants (1,8 million families) ë Strong focus on performance improvement, with stringent requirements in terms of efficiency and institutional strengthening ë Careful screening by MCidades to ensure that only economically sustainable projects qualify

25. (other experiences) ë PSH – A successful way to provide housing to the very poor (income equal or below 1 minimum wage) ë Central Government provides subsidy for construction and financing – subsidies are auctioned to foster efficiency ë Subnationals typically provide the land and some infra-structure ë Subsidies are paid up-front, reducing fiscal risk, and tailored to allow relatively short payback periods. Such an approach reduces the risk of default and operational costs (which used to eat up most of the value of low- income finance when the subsidy was reflected in low interest rates over a long-term loan, rather than the upfront reduction of the principal of the loan

26. www.tesouro.fazenda.gov.brwww.tesouro.fazenda.gov.br or brazildebt @ fazenda.gov.br www.tesouro.fazenda.gov.br The Brazil we all know… and the Brazil that we are building Thank you !