Analyst: Colombia & Brasíl’s Local Governments Pressured By Low Commodity Prices

Local and regional governments (LRGs) in Brazil and Colombia should face similar challenges from the decline in commodities prices and their importance to their economies, according to Fitch Ratings. LRGs in Colombia and Brazil suffer from high numbers of informal workers (those partially or fully outside of the reach of government regulation and taxation) and budgetary planning that often does not adequately prepare for external and structural shocks.

Fitch says it expects declining commodity pressure to mainly affect the small- and mid-sized state and local governments in both countries. Antioquia and the capital Bogota Distrito Capital, Colombia’s largest states, and Sao Paulo, Brazil’s most populous state, are fairly dynamic and diversified economies with strong service sectors. The decline in oil-related activities will primarily affect the second largest Brazilian state of Rio de Janeiro and several smaller states in Colombia, including Meta, Casanare, Arauca and Putumayo.

LRG expenditures in Brazil are rigid and do not offer financial flexibility. A relevant portion of their revenues must be directed to education, healthcare and law enforcement, irrespective of local needs. LRGs in Colombia depend more on national transfers, especially for education and healthcare.

During 2015, Brazil’s Real and Colombia’s Peso devalued by approximately one third versus the U.S. dollar. The Colombian and Brazilian central banks increased interest rates to limit inflationary pressures and better anchor inflation expectations. Fitch estimates that Brazil’s economy will contract by at least 2.5% in 2016 (after a 3.7% contraction in 2015). Growth prospects for Colombia should slow to 2.6% in 2016 from 2.8% expansion in 2015.

The ongoing recession in Brazil and moderated growth in Colombia will negatively impact tax revenues in both countries. However, Colombian LRGs are not exposed to foreign currency debt, which will limit their financial burden to further currency depreciation. And Brazilian LRGs are less exposed to the construction economic cycle, which is likely to slow down in 2016, with negative impact on Colombia’s economy.

Several states have already adopted contingency procedures such as canceling commercial contracts, freezing investments and reducing headcount. Once restricted to the fourth largest state of Rio Grande do Sul, the states of Rio de Janeiro, Tocantins and Sergipe are expected to also delay payments to their employees in early 2016. In Fitch’s opinion, these states will have to look for additional measures to balance their budgets.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.