By Paul Kiernan and Benjamin Parkin

RIO DE JANEIRO -- After four years of megaevents culminating in the 2016 Olympics, the party ended for Rio de Janeiro on Friday, when the state government unveiled a draconian austerity package aimed at unwinding years of fiscal profligacy.

Among the measures: Seizing up to 30% of the monthly pension checks of low- to middle-income retirees to shore up the state-workers' pension fund, which has become insolvent due largely to an overdependence on volatile oil royalties.

Rio is a microcosm of Brazil's problems. Its fortunes rise and fall with commodity prices, and its leaders have proven shortsighted during the good times. In a country where a rapidly aging population threatens to bring an explosion in entitlement spending, it is no coincidence that the pension system in Rio, one of Brazil's demographically oldest states, is one of the least solvent.

The state government's austerity package offers a glimpse of the pain Brazil's federal government could face if it fails to right its fiscal ship in coming years. With a deficit nearing 10% of gross domestic product and entitlement spending rising faster than inflation, Brazil is on track to become the world's most indebted emerging market in coming years, according to the International Monetary Fund.

Rio is among its most fiscally unbalanced states, with spending projected to exceed revenue by 40% this year. Given its fast-rising expenditures on pensions and civil servants, the deficit could nearly triple by 2018 if the state legislature doesn't approve the austerity package, the government warned Friday.

"These are tough measures, no one here is satisfied," Governor Luiz Fernando de Souza said at a press conference.

A major factor in Rio's crisis was the state's reliance on royalties from oil production in the waters off its coast. With crude oil trading above $100 a barrel between 2011 and 2014, oil royalties grew to more than 10 billion Brazilian reais ($3.1 billion), accounting for more than 15% of the state's net revenues.

But experts say it is what Rio's authorities did with the windfall that made the situation so precarious.

As oil prices were rising, Rio increased its payroll by an average of 16% a year from 2009 to 2015, according to the Finance Ministry. At the same time, it granted tens of billions of dollars in tax benefits to companies with operations in the state, state auditors say.

In those heady years, Rio agreed to host a global environmental conference in 2012 and World Youth Day in 2013. The city was the site of many key games, including the final, of the mens' soccer World Cup in 2014, and of the Olympics this summer.

When a drop in crude prices sent royalties spiraling down 65% from 2014 to a projected 3.48 billion reais this year, the state could no longer cover its payroll -- more than half of which is retired or "inactive."

"The state thought it could live forever on a peak in oil prices," said Istvan Kasznar, an economist at the GetĂșlio Vargas Foundation, who condemned Rio politicians' "irresponsible attitudes and actions."

The Olympics didn't help, giving the state government an excuse to build a $3-billion subway line connecting a string of wealthy neighborhoods in the capital and to spend heavily on security.

Those commitments added strains to the state budget. In the run-up to the Olympics, Rio declared a "state of calamity" by gubernatorial decree, prompting a 2.9-billion-reais federal bailout to help it continue paying bills during the Games to avoidan embarrassment.

Now that those funds have run out, leaders are dispensing bitter medicine.

In addition to docking retirees' pension checks, the government announced a series of tax increases on consumption on items ranging from beer to electricity to gasoline.

In an economy in which public-sector workers form the backbone of the middle class, economists say the measures could decimate consumption, coming in the midst of Brazil's deepest recession in more than a century.

Locals also worry that deteriorating working conditions for the state's police could fuel resurgent crime.

Investigative police chief Fernando Veloso stepped down in October, saying a lack of resources prevented officers from doing their jobs. Some police stations are so short of funding for even basic supplies like printer paper that they have called on companies and the general public for donations.

(END) Dow Jones Newswires

November 04, 2016 18:56 ET (22:56 GMT)

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