Itaú BBA - What is the fiscal position of municipalities?

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What is the fiscal position of municipalities?

febrero 21, 2017

The fiscal position of municipalities is less concerning when compared with the central government and the states.

Municipalities do in fact have a fiscal problem, but to a lesser extent than the central government or states. Municipalities do not bear large deficits or have large and growing debt levels. Municipal debt receded after the crisis. The decline in revenues, albeit widespread, is more modest than for states and the central government. Furthermore, most municipalities managed to adjust their expenses in order to achieve relative balances in their accounts. The picture is worse, however, for municipalities that rely more heavily on revenue transfers from states and the central government. With a sharper decline in revenues and little cash, the adjustment in expenses by these municipalities is insufficient, given the large share of spending on personnel. In such cases, accounts are balanced through delayed payments and increased net budget leftovers (so-called restos a pagar), showing the need for structural adjustments in municipalities’ expenses as well. We consolidated fiscal indicators in order to rank municipalities with populations of 200,000 or more. Indeed, municipalities that declared a state of financial calamity had the worst numbers. Among state capitals, fiscal performance is worse in the North and Northeast regions, and in isolated cases in the South, such as in Florianópolis.

In aggregate terms, municipalities do not face a debt problem or large and growing primary budget deficits. Between 2013 and 2016, municipal net debt receded to 1.0% from 1.6% of GDP (or to 23% from 40% of their revenues), partially driven by a retroactive change in their corrective indexes[1] established in late 2015. Meanwhile, their primary balance slid from 0.1% of GDP to 0.0% of GDP (see chart).

The fiscal position of municipalities is less concerning in level terms and in its trend, when compared with the central government and the states. Importantly, municipal debt did not increase before or after the recession and is smaller than state debt (see chart). Among states, between 2013 and 2016, net debt expanded from 9% to 11% of GDP (or from 101% to 120% of their revenues), even though their primary surplus (which shrank from 0.2% to 0.1% of GDP during this period) did not incorporate the increase in net budget leftovers from 32 billion reais (0.5% of GDP) to 44 billion reais (0.7% of GDP) in the past two years. In comparison, the central government’s primary balance worsened to a deficit of 2.5% of GDP from a surplus of 1.7%, while net debt climbed to 33% of GDP from 19% (or to 192% of revenues from 103%) between 2013 and 2016.

For municipalities, the fiscal issue is liquidity. Given that municipalities cannot easily issue debt either autonomously or backed by the National Treasury, they must adjust expenses and/or withdraw funds when revenues fall. For instance, between 2014 and 2015, at least 13 of Brazil’s 26 state capitals underwent reductions in their cash availability, while eight reported negative cash levels, excluding net budget leftovers.

In order to track the fiscal picture of municipalities, we built a sample of cities with 200,000+ residents. With data provided by the Treasury for 135 municipalities (out of 148 with such populations) between 2014 and 2015, we divided six indicators into two groups. As situational indicators, we chose the budget balance (in millions of reais) and real growth in revenues and expenses. As structural indicators, we chose personnel spending as a share of total spending, transfer revenues as a share of total revenues and debt as a share of total revenues. While situational indicators seek to describe the municipality’s current picture, structural indicators show how difficult an adjustment could be.

Although widespread, the drop in municipal revenues is less acute than the decline in revenues among states and the central government. Among all municipalities studied, 73% posted a real reduction in revenues in 2015 (see table). However, in that same year, while municipal revenues fell 2.0% in real terms, tax revenues for states dropped 2.8% and federal revenues plummeted by 4.8%. In 2016, excluding inflows associated with the repatriation of funds held overseas by residents, federal tax revenues fell 6.0% and state revenues declined 4.8%. Meanwhile, net current revenues of state capitals slipped just 1.0% in the 12 months through October 2016. This trend reflects differences in the breakdown of municipal revenues and those of other government spheres. Municipalities’ own revenues are tied to the Service sector (ISS tax, for instance), which has been declining less sharply than GDP, or than the Industrial sector and to Real Estate (IPTU tax, for instance), which is generally less sensitive to current activity. 

Most municipalities responded by adjusting expenses and managed to keep their accounts relatively balanced. Only 17% of municipalities posted negative budget results in 2015, 37% posted real increases in expenses and 7% have debt higher than 50% of their revenues. 

Breaking down by region, the Southeast had proportionally more municipalities with falling revenues and negative fiscal results. In the Midwest, municipalities did not adjust expenses in the same way, as revenues were not as big a problem and personnel expenses are still a large share of total expenses. The North and Northeast were in the median, as municipalities rely heavily on transfers from the federal government and have low debt levels.

The situation is worse for municipalities that rely more heavily on revenue transfers from states or the central government. With a greater decline in revenues and little cash, the adjustment in their expenses is insufficient, given the large share of personnel expenses. In such cases, accounts are balanced through delayed payments and increased net budget leftovers, showing the need for structural adjustment in their expenses.  

We ranked municipalities according to indicators gathered. An average of six standardized indicators for each municipality produces an overall score. The higher the score, the better the municipality’s position compared with all others. The best were São José (in Santa Catarina state) and Vitória (Espírito Santo); the worst were Macapá (Amapá) and Itaboraí (Rio de Janeiro).

We found that municipalities that declared a state of financial calamity, in fact, had the worst indicators (see table) and, therefore, were not well ranked. We found 12 municipalities with 200,000+ residents that declared a state of financial calamity. On average, their revenues fell more sharply (-7.6% vs. -3.1% on average for the sample) and their expenses declined to a lesser extent (-7.3% vs. -1.3%). Their revenues are more dependent on transfers from states and the federal government (66.5% vs. 59.3%), and their debts are slightly higher (21.8% vs. 20.5%).

For state capitals, we gathered higher-frequency indicators and included observations for the year of 2016 (see table below consolidating the information). These indicators are published by Municipal Finance Secretariats and are similar to those reported by the National Treasury. We used real growth in net current revenues (NCR) and expenses during the 12 months through October 2016, net consolidated debt, personnel spending as a share of net current revenues in August 2016 and cash availability as of the end of 2015 (measured in months of expenses).

Indicators for state capitals confirm that, despite an overall decline in revenues, there is no debt problem, but rather an issue of cash availability — liquidity rather than solvency. No state capital had consolidated net debt near the threshold of 120% of net current revenues, according to the Fiscal Responsibility Law (FRL)[2] . However, 16 capitals have insufficient cash to cover expenses for at least one month. Of these, eight have negative net cash in net budget leftovers, with Florianópolis and São Luís in the worst situation. As for revenues, 15 municipalities posted declines that were sharper than national GDP (-3.5%) in the 12 months through October 2016, with Belém (-16%) and Vitória (-14%) experiencing the steepest drops. The revenue slide in Vitória showed that even municipalities in better fiscal positions (according to the analysis of indicators until 2015) were not immune from further declines in tax revenue nor the need for more adjustments.

As with the federal government and state governments, the large share of personnel expenses makes a structural adjustment more difficult. Wage increases above inflation and additional hiring made expenses more rigid for state capitals. That, along with the economic crisis and falling tax revenues, reduced room for them to adjust their accounts. In October 2016, two capitals (Florianópolis and Macapá) posted expenses above the maximum limit of 54% of net current revenues allowed by the Fiscal Responsibility Law. Another 10 were above the warning threshold (90% of the maximum limit, or 48.60% of net current revenues; see chart). In that sense, the approval of the Social Security reform, which will be appraised by Congress throughout 2017(setting a minimum age for retirement and the end of special pension regimes), would help to solve part of the imbalance between personnel spending by municipalities and their own pension regimes.

In particular, capitals in the North and Northeast and some isolated cases in the South, such as Florianópolis, revealed a worse fiscal position overall. In these municipalities, the decline in revenues was sharper and the adjustment in expenses was less, given larger personnel expenses. On the positive side, capitals in the Midwest performed better in terms of revenues, and thus they experienced less fiscal tightening.


 

Pedro Schneider



[1] The index that corrects municipal debt with the federal government changed retroactively from IGP-DI plus 9% p.a. to the lowest index between IPCA plus 4% p.a. and the Selic benchmark interest rate. As for the states, the index changed from IGP-DI plus 6% p.a. to the lowest index between IPCA plus 4% p.a. and the Selic rate.

[2] Municipalities with debt lower than their cash position and other available resources have a negative indicator, as is the case for João Pessoa, for instance. São Paulo has the highest debt but benefitted from the change in the corrective index, and its debt fell from 185% of revenues in December 2015 to 80% in August 2016.


 

 



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