The worsening fiscal prospects at the provincial level are likely to eat into the consolidated primary surplus in the coming years, and may force a new national bail-out of provincial debt.
SUBJECT: The deterioration of provincial fiscal accounts.
SIGNIFICANCE: The worsening fiscal prospects at the provincial level are likely to eat into the consolidated primary surplus in the coming years, and may force a new national bail-out of provincial debt.
ANALYSIS: Although official figures are limited, the primary surplus registered by the 24 provincial administrations fell by 45% year-on-year in 2006, according to a report by the consultancy Economia y Regiones published in early January. The global result (after debt payments) declined by 145%, from a surplus of 1.8 billion pesos (588 million dollars) in 2005 to a deficit of 436 million, the first provincial deficit since 2002. This was mainly attributed to the fiscal position in the two largest jurisdictions, with most other provinces maintaining a surplus: Buenos Aires province recorded a deficit of 1.3 billion pesos in 2006, and has approved a budget foreseeing a deficit of 1.6 billion pesos for 2007. Efforts by Governor Felipe Sola to increase tax have been thwarted by the provincial legislature (whose members face elections this year, whereas Sola is unable to stand for a further term).
The city of Buenos Aires, which recorded a deficit of 400 million pesos in 2006, was unsuccessful in adopting a 2007 budget envisaging a deficit of 1 billion pesos. The budget eventually adopted appears to overestimate fiscal resources -- as do other provincial budgets. Provincial public spending rose by 24% year-on-year in 2006, in comparison with a rise of 20% in income, primarily due to salary increases, public works and a rise in education spending, required under the education financing law. Public sector wages, which are expected to increase further this year as wage demands mount and the number of state employees rises in advance of the October elections, account for 47% of provincial public spending, in comparison with 11% at the national level. For 2007, Economia y Regiones envisages a provincial primary surplus of only 400 million pesos and a global deficit of 2.6 billion, as the cost of debt servicing rises owing to the indexation of a large portion of provincial debt (70% of which is held by the national government).
Provincial finances. Provincial finances had improved significantly since the 2001-02 crisis, with the provinces reaching a total primary surplus of 1.5% of GDP in 2004 (see ARGENTINA: Pre-election provincial spending to rise - July 4, 2006). In 2002, ten provinces reached a primary surplus, rising to 19 in 2003 and including all 24 provinces in 2004 and 2005. In part this reflects the success of the so-called 'orderly financing programmes' agreed by the national government and a number of provinces, under which the federal government bought back some 7 billion pesos worth of provincial bonds issued during the crisis and provided significant deficit financing, with the stipulation that any province overspending its budget would lose such federal assistance. It also reflects improved tax collection at the provincial level, a function of economic recovery, and the rise in federal revenues available for sharing (coparticipation).
However, the requirement that provincial spending cannot expand at a greater rate than revenues has not been adhered to, with primary spending up 15% more than revenues in 2005. The new bilaterally agreed financial assistance programmes that replaced orderly financing programmes in 2004 may allow the federal government some scope to impose fiscal discipline at the provincial level, not least given the lack of alternative financing sources available. However, the fact that the new programmes allow the federal government to suspend payments of coparticipated revenues if provinces issue new bonds has thus far proved ineffectual: the governments of both Buenos Aires and Neuquen provinces issued bonds last year to finance public spending.
In any case, it could be argued that the strong fiscal results in the provinces in recent years were exceptional, and related to strong growth and inflation-driven revenue increases, rather than improved fiscal management. Moreover, until 2006, wages at the provincial level remained well below pre-crisis levels, favouring public accounts. The impact of worsening accounts is felt at the national as well as the provincial level: although the consolidated primary surplus remains around 3.5% of GDP, the provincial contribution to it has been falling, from 1.5% in 2004 to around 0.5% last year.
Coparticipation conundru. m Tepid proposals to renegotiate the current coparticipation scheme evaporated following President Nestor Kirchner's decision to pay off Argentina's debt to the IMF and end its programme with the Fund (see ARGENTINA/BRAZIL: Debt plan cuts IMF monitoring role - December 21, 2005). (The last coparticipation law expired in 1990, although interim agreements have maintained the percentages of both primary distribution -- 42% to the federal government and 57% to the provinces -- and secondary distribution to each province established in that law.) Prospects for any advance in this area, which might serve better to structure provincial fiscal management, are remote, given that any such negotiations would inevitably involve discussion of whether the 'temporary' financial transactions and export taxes adopted during the crisis should be shared with the provinces:
At present, only 30% of the financial transactions tax is shared with the provinces, while export taxes are retained exclusively by the national state. These two taxes are crucial to maintenance of the federal primary surplus, making any such move unfeasible. At the same time, provincial governors have seen their leverage with the national government reduced by the granting of budgetary 'superpowers' to the executive (see ARGENTINA: 'Superpowers' limit fiscal oversight - August 9, 2006), which limits the need for the executive to negotiate with provincial representatives in Congress.
However, as a result of this distribution, provincial administrations receive only 29% of total tax revenues, while accounting for 46% of primary public spending. At the same time, the amount of tax actually collected by the provinces is substantially lower (around 20%), reducing the accountability of provincial administrations for their fiscal efficiency in the eyes of their own taxpayers (and voters). On the contrary, provincial governors may enjoy the political benefits of overspending on their constituents, while efforts to increase local tax collection could only have an inverse effect on their own popularity. Fiscal rules adopted by some provinces have also proved ineffective in disciplining public spending, as has the national 2004 fiscal responsibility law, which fixes a ceiling for debt servicing of 15% of current revenues -- a figure exceeded by six provinces even in the boom year of 2005.
Outlook. In general terms, fiscal management tends to worsen when tax revenue falls: fewer resources give the central government less leverage over provincial administrations; while economic slowdown generates demand for increased government spending.
With the growth in both GDP and tax revenues likely to slow in 2007, this pattern may be repeated, exacerbating the downturn in provincial finances seen in 2006. In particular, the presidential, gubernatorial and legislative elections scheduled for this year provide a substantial incentive to raise public spending; indeed, the proposed budgets of both provincial governments and their legislatures are set to rise sharply this year, primarily to facilitate an increase in personnel whose electoral loyalty may be swayed by personal considerations of job security.
CONCLUSION: Despite improvements in recent years, the fiscal structure of the provinces continues to tend towards deficit, and their dwindling primary surplus will raise pressure on the national government to boost its own surplus, even as spending demands rise. Political considerations and the lack of alternative financing sources may force the national government to take over additional provincial debt, despite the failure of existing arrangements to impose fiscal prudence.