OREANDA-NEWS. According to figures released this morning, Brazil's GDP's continues to contract. It is now expected to fall 3.7% this year and 2016 has been revised down to a further GDP decline of 2.5%. The impact of these declines on its states will vary based on their revenue sources, Fitch Ratings says. States driven by commodities activities should fare best, followed by those reliant on domestic demand. States with weak tax collection processes are expected to fare worst in the group.

Commodities-driven states will continue to benefit from export growth driven by the depreciation of the Brazilian Real. It fell by 58% in the year ended October 2015. Export-related activities are as much as half of some states' economies. Despite being tax exempt, exports support other economic sectors as well. States like Espirito Santo, Goias and, to some extent, Santa Catarina (BBB-/Negative) are in this group. Some are considering raising tariffs.

Sao Paulo (BBB-/Negative), Minas Gerais and Rio Grande do Sul exemplify the large states that mostly rely on domestic demand to generate revenues. They face the same downside risks as the country. Sao Paulo's proposed tax hike on non-essential products, for example, will not be big enough to boost tax revenues. Further, we do not expect significant benefits from the efforts to curb informal markets and collect delinquent taxes. These states make up almost 50% of Brazil's economy.

States with the lowest tax collection performance will fare the worst. Some have already been hurt by low oil prices and relatively high dependence on federal transfers. Rio de Janeiro (BB/Negative), Pernambuco and Maranhao (BB/Negative) are in this group. Rio de Janeiro's economy largely depends on oil royalties and on oil-related industries. Pernambuco and Maranhao are more reliant on federal transfers, mainly taxes on industrialized products (IPI-Imposto sobre Produtos Industrializados) and income tax (IR-Imposto de Renda).

According to the Brazilian Central Bank, aggregate, nominal ICMS tax revenues (equivalent to value added tax in other countries) for the ten largest states rose by only 4.5% in the year ended September 2015. These states accounted for roughly 80% of the total ICMS tax collected nationwide. Only Parana (BBB-/Negative) was able to post real tax growth. It raised tariffs to 18% from 12% on various sectors and reduced some tax exemptions granted to companies.

All 26 Brazilian states and the Federal District will need to continue to curb expenditures to cope with much lower revenues. So far, cost reduction has meant merging some departments and shutting down others, laying off temporary workers and freezing state-financed investments. These steps will reduce overall spending by 20% in 2015.