OREANDA-NEWS. As a reduction in federal tax collections takes hold, Brazil's fiscal pressures may prompt budget imbalances for states with the greatest reliance on federal transfers, Fitch Ratings says.

The country's Fiscal Responsibility Law gives the federal government significant sway over the states, including the right to regularly supervise debt levels and personnel expenditures. It must approve every new credit line. The federal government also guarantees all outstanding debt denominated in US dollars. The federal government sets standards such as the minimum wage for teachers and is the largest creditor to the states as well. For example, 90.7%, or BRL199.3 billion (USD52.4 billion) of the state of Sao Paulo's debt in 2014 was owed to the federal government.

Some states, notably Maranhao and Rio de Janeiro, depend on federal transfers. The decline in the price of oil has already pressured transfers and could reduce the financial support that Fitch believes these states would receive from the federal government in emergencies. States such as Santa Catarina and Parana will experience less downward pressure from the sovereign as they have greater fiscal autonomy. Tax collections exceeded 70% of operating revenues in 2014 for both states.

The federal government will soften the fiscal blow for many states and some local governments. Beginning in January 2016, the federal government will likely accept lower interest rates due on federal loans and reduce the amount of debt the states owe. The retail inflation index IPCA will replace the general prices Index IGPDI. These measures would create positive cash flow for the states and improve finances for some cities. For example, the city of Sao Paulo estimates that the amount of debt it owes to the federal government would decline from BRL67 billion (USD 17.6 billion) to BRL26.6 billion (USD7 billion), based on June 2015 figures.

Last week, Fitch downgraded Brazil to 'BBB-' with a Negative Rating Outlook. Brazil's continued economic underperformance, increased macroeconomic imbalances, deteriorating fiscal accounts and a material increase in government debt are escalating downward pressures on the sovereign credit profile. Fitch does not rate any Brazilian state higher than the sovereign.