OREANDA-NEWS. If Brazil's Supreme Court agrees to change the interest rate calculation on the debt that the states owe to the federal government, the benefit to the states would depend on their current respective budgetary situations, Fitch Ratings says. The proposed cut would save the states approximately BRL400 billion (USD115 billion) over the entire term of the loans, which amounts to almost 90% of their outstanding debt.

The Supreme Court will likely clarify a vagary of the federal law that governs these loan agreements (Lei Complementar 148/2014). Since 2013, the law has set the interest rates on the loans at "accumulated interest rates," which were interpreted as "compound interest rates" and the states paid at that level. The case, brought by Santa Catarina, is arguing that the states should pay simple interest. Recently, the governors of Sao Paulo, Rio de Janeiro, Rio Grande do Sul, Minas Gerais, Santa Catarina, Mato Grosso do Sul and Alagoas have testified in favor of Santa Catarina's argument. Late last week the Supreme Court said it would rule on the matter in approximately 60 days, allowing the states to pay simple interest rates in the meantime.

Fitch believes the use of simple interest rates to calculate the states' costs would directly benefit the most indebted states, including Sao Paulo, Minas Gerais, Rio de Janeiro and Rio Grande do Sul. It could also have a positive secondary effect on all of Brazil as those four states would regain some of the investment capacity they lost during the recession. Combined, they account for more than 60% of Brazil's GDP. The poorer states, mainly in the north and northeast (for example, Para and Maranhao), could indirectly benefit from that economic recovery as they rely on federal transfers that may rise with the economy.

However, the magnitude of these changes would not result in material changes to the states' credits, as Fitch would not view the debt service relief as operating revenue. Fitch's Outlook for the states is negative. We rate five and expect them to maintain very slim operating margins (even negative in some cases), as last year's increase in the tax levy on some sectors will not compensate for the rises in pension and headcount costs. While this relief from debt service would provide substantial reduction in debt service going forward, long term expenditure controls are a higher priority.