Bailout expectations and moral hazard in debt by subnational governments: empirical evidence from Brazil
DOI:
https://doi.org/10.55532/1806-8944.2020.53Keywords:
Default, Socorros Financeiros Governamentais, Endividamento dos Estados, Restrição Orçamentária, Gastos PúblicosAbstract
The following article sheds light on the negative externalities created by the expectation that the federal government may bail out subnational governments in cases of fiscal insolvency and debt default. According to the literature on soft budget constraints, bailout expectations increase the willingness of financial intermediaries to lend for subnational governments. As a result of an expansion of borrowing possibilities, subnational governments over-borrow, reduce the allocation of own resources to investments and increase current expenditures.
In order to empirically test these hypotheses, this article explores the substantial increase in borrowing possibilities for Brazilian states after 2007. In the aftermath of the financial crisis, the federal government eased the restrictions on subnational government borrowing as part of a fiscal policy to boost economic growth. As a result, subnational governments over-borrowed. Moreover, the Brazilian context is very appropriate for testing these hypotheses, since the recent history of intergovernmental relations demonstrates that the federal government repeatedly failed in sticking to a no-bailout commitment.
By employing a dynamic panel model, it was estimated that an expansion of credit supply by R$ 1 million is correlated with a reduction in investments with own resources by R$ 570 thousand. Moreover, the findings indicate that a reduction of investments with own resources by R$ 1 million is correlated with an increase of current expenditures by R$ 800 thousand. Therefore, an expansion of credit supply by R$ 1 million is correlated with an increase of current expenditures by R$ 460 thousand.
This article concludes that, in the context of soft budget constraints, financial intermediaries are more willing to lend to subnational governments. The expansion of borrowing possibilities, in turn, encourages subnational governments to over-borrow, reducing the allocation of own resources to investments and increasing current expenditures.
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