Under the new bill, states would have the option to negotiate the transfer of assets to reduce their federal debts. The interest adjustment index could shift from the current rate of IPCA plus 4% to just the IPCA (Brazil’s benchmark inflation index). Moreover, states could receive a reduction of up to two percentage points on the interest rate by transferring assets amounting to over 20% of the total debt value.

If the transferred asset value falls between 10% and 20% of the total debt, states can secure a deduction of one percentage point. Additionally, the bill includes provisions for further reductions: one percentage point if the equivalent funds are invested within the state in education, infrastructure, or public safety, and another percentage point is allocated to the National Equalization Fund, which benefits all entities, including those without debts.

Originally, the Ministry of Finance had proposed that reductions in debt interest be contingent upon increasing enrollments in technical secondary education. However, Senator Pacheco’s bill stipulates that investments must be flexible but are conditional upon states achieving annual performance goals related to technical secondary education. Should a state fail to meet these benchmarks, 60% of the funds must mandatorily be directed towards developing vocational education.

Sources from the Ministry of Finance have expressed reservations about the Senate’s proposal, describing it as “far from ideal” and markedly different from the original plan proposed by the ministry. Preliminary internal evaluations suggest that the proposal could harm the federal budget by disrupting financial flows and may not even benefit states like Minas Gerais and Rio de Janeiro, which are actively seeking to renegotiate their debts.

When asked about the bill, Finance Minister Fernando Haddad acknowledged that he had not yet reviewed the text but emphasized the importance of ensuring it does not adversely affect federal accounts.

“We are aiming for zero impact on the federal government’s primary accounts. It’s crucial to maintain this stance, as any deviation could lead to significant issues with the national accounts, and we cannot afford errors in this area,” the minister told reporters.

Senate President Pacheco appointed Senator Davi Alcolumbre, the head of the Constitution and Justice Commission (CCJ) and a close ally, as the rapporteur. Mr. Pacheco aims for the proposal to be voted on by July 18th, just before the informal recess of the Brazilian Congress begins.

Despite the urgency, the Senate president has called for “collaboration” from his colleagues, acknowledging the lack of a unified stance among the Ministry of Finance and governors.

“We have a sustainable program, a project that has been thoroughly developed in collaboration with the Ministry of Finance and the governors. Clearly, not all points have been settled with the Ministry of Finance or the governors. Now is the moment for everyone to come to the table and work out what can be improved,” he stated.

According to government insiders, Senator Pacheco might be broadening benefits for states as a strategic move to counteract criticism from Minas Gerais Governor Romeu Zema, as both are locked in a political rivalry.

Senator Pacheco noted that if the indebted states join the Program for the Full Payment of State Debts (ProPag) and reduce the interest rate to 4%, their combined debts would decrease from R$700 billion to R$672 billion. Despite the federal government foregoing R$28 billion annually under this plan, Mr. Pacheco argues that the arrangement is ultimately beneficial for both parties.

“The federal government’s aim is to collect, and the state’s aim is to pay, yet the debt gap widens. We are offering a way to balance this out. This is more than a financial transaction—it’s about strengthening the federal relationship. It involves investing in the states, allowing the federal budget to effectively collect the principal,” he contended.

The proposed bill includes an option for states to transfer “net and certain credits” with the private sector to the federal government. For instance, this could allow the Minas Gerais government to apply what remains of Vale’s compensation payments for the Brumadinho dam disaster towards reducing its debt burden. Federal government officials, however, are cautious about this clause, expressing concerns about the inclusion of potentially unrecoverable debts.

As the bill was being drafted, governors and lawmakers pushed to incorporate options for negotiating discounts on both interest and principal amounts of the state debts. Senator Pacheco pointed out that such discounts would contravene the Fiscal Responsibility Law (LRF).

Efforts by governors to utilize funds from the States Compensation Fund, established during tax reform, to alleviate debt were also proposed but ultimately rejected.

Felipe Salto, former secretary of Finance and Planning for São Paulo and now chief economist at Warren Investimentos, expresses deep concerns about the Senate’s proposal. “In practice, real interest rates could effectively drop to zero. This poses a significant obstacle to achieving fiscal balance, as it could diminish vital financial revenue streams while simultaneously encouraging increased spending due to the created fiscal space,” he explained.

“As if that were not enough, they are still creating an equalization fund, for which a percentage point from the reduced interest for states that participate will be directed into this fund, which will then be distributed among all states. Essentially, this is throwing money out the window,” he remarked.

Marcelo Fonseca, chief economist at Reag Investimentos, acknowledges the potential benefits of the federal government acting as a “lender of last resort” due to its greater borrowing capacity compared to the states. However, he notes that, upon “initial review,” Senator Pacheco’s proposal appears “fraught with issues,”—some of which are recurrent—notably, the lack of “substantial conditions that allow adjustments and reforms,” which are crucial for states to improve their fiscal health.