General description for each presentation: Presentation at Ministry of Finance, P.R. China-World Bank Summit on Subnational Debt Management and Restructuring, Nanning, Guangxi Province, P.R. China. October 22, 2015.

1. Subnational Debt
Management in Brazil and
Mexico
Fernando Blanco
Lead Economist
Macroeconomics & Fiscal Management Global Practice
Equitable Growth, Finance and Institutions Vice-Presidency
The World Bank
Presentation at Ministry of Finance, P.R.China-World Bank Summit on Subnational Debt Management and Restructuring,
Nanning, Guangxi Province, P.R. China. October 22, 2015.

2. 1. Context
2. Subnational debt crisis
3. From soft budget constraints to tough
and credible hierarchical rules
4. Results
Brazil and Mexico: different approaches to manage
subnational debt
1. Context
2. Subnational indebtedness in the
2000s
3. From a pure market approach to
hierarchical regulations
4. Debt restructurings in 2013 -
BRAZIL Mexico
5. Final Reflections

3. Context - Brazil
 Population: 202 million
 Area: 8.5 million km2
 Economy: GDP of US$2.2 trillion (9th largest in the World)
 Per capita GDP of US$ 11.200
 (upper-medium income country)
 5 Regions with high diversity (rich South / poor North)
 Federation with 3 levels of government:
 Union
 27 state governments (1 federal district)
 and 5,570 local governments

4. Subnational debt crisis in the nineties
 The Constitution of 1988 promoted an uneven
devolution of revenues and spending responsibilities which
was the origin of fiscal disequilibria –
 Constitution of 1988 strongly decentralized revenue
(tax and transfers)
 But, constitution of 1988 expanded the responsibilities
of the State – Universal Access to health, education and
social security
 This in a context of devolution of responsibilities
generated expenditure pressures for subnational
governments
0
1
2
3
4
5
Transfers
Tax
Revenue
Borrowing
Spending
pos 88 Previous

5. Subnational debt crisis
State governments were a permanent
source of fiscal disequilibria in the late
eighties and nineties
3 bail out operations (89, 93 and 97)
Debt restructuring agreements of 1997
and fiscal adjustment programs
Fiscal Responsibility Law in
2000

6. From soft budget constraints to hard and credible rules
The 3rd Subnational Bail-Out (1997)
 Bail-out of 1997 amounted 13% of GDP, comprised bonds issued domestically.
 Initially, it encompassed the 27 states, but later it was extended to 200 municipalities.
 State debts in the market were swapped with federal debt
 Clean up and closure of state banks
 Federal government became the creditor of 95% of the subnational debts
 Debt restructuring contract of 30 years with a cap on debt service of 13% of subnational
revenues. Interest rate of 6% + Inflation. Any amount above of the 13% is capitalized in a
residual to be paid in ten years after the end of the contracts (2027 onwards)

7.  It was a Conditional Bail-Out: Debt refinancing in exchange of a fiscal adjustment programs
until the end of the debt agreement (2027) and structural reforms (privatization of state banks)
with objective targets and penalties in case of non compliance
 Fiscal Adjustment Programs: 7 fiscal targets rolling over for 3 years, however the relevant
ones are: primary surplus, debt, personnel expenditures and own revenue collection. Plus -
structural reforms: Privatization programs
 Penalties: withhold of transfers in case of non-compliance and no access to new borrowing
 SNGs supervised by the National Treasury
 Prohibition of bonds issuance until 2016
 New borrowing just with the approval of the National Treasury
 Improved transparency
 But this time was different:
From soft budget constraints to hard and credible rules
The 3rd Subnational Bail-Out (1997)

8. National Council Monetary Restrictions
• Banks should have less than 45% of their net equity allocated to public sector
financial entities (Caixa, BNDES, BB)
• Temporary credit rationing measures (US$ 1 billion for the entire subnational
level between 2002-2004)
External credit:
• Borrowing Operations with International Financial Institutions to be approved by
the Ministry of Finance National Treasury (PAFs and any other request to
obtain the guarantee from the Union)
• Federal Senate involved
From soft budget constraints to hard and credible rules
Credit supply restrictions (1999-2002)

9. Adoption of a Fiscal Rule and regulations on Public Finance Management
 Indebtedness: 200% of Revenues
 Debt service burden:15% of Revenues
 Personnel expenditures: 60% of Revenues
 New Borrowing: 8% of Revenues
 Fiscal Transparency: Standardized fiscal accounting
 Fiscal Crimes Regulations
From soft budget constraints to hard and credible rules
The Fiscal Responsibility Law (2000)

10. Results
• Subnational governments improved their
fiscal performance: they generated primary
surpluses and reduction of indebtedness,
reduction of personnel spending and some
recovery of investment
• Fiscal transparency
• Cultural change
Sustainable improvements???

11. Context: Mexico
 Population: 124 million
 Area: 1.972 million km2
 Economy: GDP of US$1.3 trillion
 Per capita GDP of US$ 10,400 (upper-medium income
country)
 Rich North / poor South)
 Federation with 3 levels of government:
 Union
 31 state governments (1 federal district)
 and 2,440 local governments

12. Mexico Subnational Finances: High dependence in Transfers and
Recent Indebtedness
0.0 20.0 40.0 60.0 80.0 100.0
USA
ISL
DEU
CAN
CHE
AUT
FRA
ISR
SWE
ESP
FIN
PRT
SVK
SVN
CZE
IRL
EST
ITA
LUX
POL
DNK
BEL
NOR
HUN
KOR
GBR
NLD
MEX
0
1
2
3
4
Transfers
Tax
Revenue
Borrowing
Spending
Base Pre 1990s 2000s
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
40%
50%
60%
70%
80%
90%
100%
2008 2009 2010 2011 2012 2013
Debt/Participaciones Debt/GDP (right axis)
Large vertical gap Financed by transfers And recently by debt

13. Subnational Indebtedness in the 2000s
Financial innovation in 2001
Use of intercepts – trust funds financed by federal general transfers
Trust
Fund
Federal
Government
BanksState
Treasury
Other
earmarked
transfers
Federal General
Transfers are
automatic and
mandatory
Securitization
• Participation of credit rating agencies
that assess the TF and the issuer
• Despite very low risk – sovereign risk,
banks charge premiums of 150-200
basis points.
• Focus on the trust fund, not on the
solvency of the issuer
• More than one trust fund
• Weak fiscal management

14. 1350
1400
1450
1500
1550
1600
1650
1700
2008 2009 2010 2011 2012 2013
Spending
Revenues
Subnational Indebtedness and Global Financial Crisis
0%
50%
100%
150%
200%
250%
300%
Coahuila
Chihuahua
QuintanaRoo
NuevoLeón
Veracruz
Nayarit
Sonora
DistritoFederal
Chiapas
Michoacan
Zacatecas
BajaCalifornia
Jalisco
Colima
Tamaulipas
Durango
Oaxaca
BajaCalifornia…
Morelos
Sinaloa
E.deMexico
AguasCalientes
SanLuisPotosí
Guanajuato
Puebla
Hidalgo
Guerrero
Yucatán
Tabasco
Querétaro
Campeche
Tlaxcala
Increase of spending and
revenues stagnated
Some states with high indebtedness levels
(debt to transfers)

15. Subnational Indebtedness: recent adoption of hierarchical
controls
Subnational debt at 3% of GDP does not represent a systemic risk
However there are specific cases that need restructuring
Debt restructuring agreements with Banks but with participation of the Ministry of Finance
through the State Development Bank (BANOBRAS) which is imposing covenants to the
agreements
Up to date 6 debt restructuring agreements
General approach
Fiscal Discipline Law in the Congress – contains a fiscal rule on fiscal balance with
thresholds that vary with an alert system (debt indicators)
Will have to restructure debt and sign fiscal
adjustment programs

16. Managing subnational debt
3 basic constraints to establish borrowing controls
Debt Restructuring
Agreements
Supply side
constraints
domestic credit
FRL: limits to
debt, personnel
spending, credit
operations, NO
BAIL OUT
• Fiscal
Accounting
• Subnational
Bankruptcy
Regulations

17. Some reflections
• Current system is based exclusively on hierarchical rules: FRL (Fiscal
Responsibility Law); Debt renegotiation contracts with the Treasury and National
Monetary Council constraints on credit supply.
• Effective in assuring fiscal solvency and improving indebtedness indicators.
• However, as a hierarchical rule-based system, it may provide inefficient credit
allocation since it treats all subnationals the same even though they individually
may have very different situations.

18. What is feasible in practice may by the second-best option
While Imposing a top-to-bottom hard budget constraint on the subnational
government is a second-best solution…
Yet, it is often the best that one can achieve in practice:
• In some institutional settings, it may be the only way of guaranteeing subnational fiscal discipline
• They may even help build the conditions for subnational debt market development.
Political feasibility:
• Sometimes it may be the only way to (politically) trade a one-shot debt relief from the center
in exchange for imposing a long-term borrowing constraint at the subnational level (as it
was the case in Brazil).