Amid the worst political crisis in decades, Brazil's federalgovernment also faces a spiraling state debt crisis that could costit as much as US$89 billion in lost revenue.

Brazilian states, hit by a two-year recession that has depressedtax revenues, are seeking to apply simple rather than compoundinterest on debt owed to the federal government. The change couldcost the Treasury 313 billion reais, according to Finance Ministrycalculations.

Brazil'sSupreme Court ruled last week in favor of Santa Catarina state,which had requested the change. The decision, albeit an injunctionissued by the court before its decision on the case's merit, couldopen a precedent allowing other states to demand the sametreatment, Finance minister Nelson Barbosa warned on Apr. 8.

Brazil's 12-month budget deficit widened to a record 2.1 percentof gross domestic product in February, as political turmoil that could result in the impeachment of PresidentDilma Rousseff put austerity measures on hold. The governmentproposed in March a bill to renegotiate debts as a severe recessionhas put some states on the brink of insolvency. Lawmakers havealready made amendments to that proposal, reducing obligationsstate governments had to agree to in exchange for debt relief.

“This is a symptom that shows the government is in politicalshambles,” said Andre Perfeito, chief economist at Sao-Paulo basedbrokerage Gradual Cctvm. “Every state governor is taking advantageof Rousseff's frailty to solve their situation withoutconsidering the impact over the country as a whole.”

More Lawsuits

Alagoas state governor Renan Filho, son of Senate presidentRenan Calheiros, met with Finance Minister Nelson Barbosa onTuesday to inform him that he will also file a lawsuit at theSupreme Court to have the decision extended to his state.

“More states are expected to file lawsuits against thegovernment,” Renan Filho told reporters before the meeting. “Anygovernor who doesn't seek the Supreme Court will be simplyadmitting that it's fair to pay compound interest. The debtrenegotiation proposal helps, but this injunction makes a bigdifference for Alagoas' debt.”

Barbosa argues that the Treasury's debts pay compound interestand that is why it isn't possible to change the interest charged onstates' debt.

“This is very dangerous for Brazil's fiscal dynamics if it isn'tstopped,” said Perfeito. “There is a good chance this will become atime bomb.”

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