PBR Petroleo Brasileiro ADR

RIO DE JANEIRO—Days after the close of the 2016 Olympics, the state government of Rio de Janeiro had its credit rating slashed three notches by Standard & Poor's, in the latest development in a fiscal crisis that shows no sign of letting up.

Rio state—responsible for key services, such as policing and sewage, as well as an unmet commitment to clean up heavily polluted waterways in time for the Games—faces a "heightened risk of default," S&P said Wednesday night in a press release. The ratings firm cut Rio's debt to CCC- from B-, indicating that "a default, distressed exchange or redemption appears to be inevitable" barring "significantly favorable" changes in the state's circumstances.

Rio's fiscal problems trace to the commodity boom, when high oil prices and an ambitious expansion plan by national oil company Petró leo Brasileiro SA seemingly promised to fill the state's coffers with royalties. So the state went on a hiring spree, more than doubling its payroll between 2009 and 2015, and took on major spending commitments, such as a $3 billion subway line for the 2016 Olympics.

Then oil prices fell, and Brazil's worst recession in generations clobbered Rio's tax revenues. Rigid spending requirements on health and education, combined with laws that make it nearly impossible to lay off public-sector employees, caused the state government's deficit to balloon.

The federal government temporarily plugged Rio's budget hole with a 2.9 billion reais ($899 million) cash injection after the state governor declared a fiscal "calamity" in June, warning of draconian cuts to public services. But it is unclear how long that will last.

S&P said Rio's operating deficit will likely reach 8.4 billion reais this year, equal to about 17% of expenses, and will maintain similar deficits in the next 12 to 18 months.

Rio's Finance Secretariat said Thursday in an emailed statement that the state "is concentrating its efforts in pursuit of balancing its finances, but the recovery of Rio's economy depends also on the Brazilian economy."

Most states' debt in Brazil is guaranteed by the federal government, which paid 535 million Brazilian reais to creditors on Rio's behalf between May and July after it missed payments. But with an estimated 2.5 billion reais in debt service coming due in the next six months, Rio's ability to meet its obligations "is doubtful" without help, S&P said.

"The ratings on Rio reflect a deep financial stress…a deteriorating cash position, and greater uncertainty over the state's capacity and willingness to make full and timely payments on its financial obligations," S&P said. "However, we believe that the institutional framework in Brazil, though confronting increasing risks, continues to provide support."

Brazil's first Olympic Games, which ended Sunday, were regarded as an operational success despite minor problems, such as long lines at venues, transport headaches and a diving pool that mysteriously turned green. Sporting victories, including Brazilian gold medals in men's soccer and volleyball toward the end of the Games, helped the host country finish on an upbeat note.

But critics have said the money used to host the Olympics could have been better spent.

Although officials say the Games' total cost was about $13 billion, the true cost—including lost productivity, land grants to the private sector and other factors—likely is closer to $20 billion, said Andrew Zimbalist, an economics professor at Smith College and author of "Circus Maximus: The Economic Gamble Behind Hosting the Olympics and the World Cup."

Beyond the economic costs, Mr. Zimbalist said, the Games exposed governmental inefficiency and corruption, Rio's pervasive urban violence and other problems, tarnishing the city's image.

"If the Rio brand has improved, I'm flabbergasted," he said.

Reed Johnson contributed to this article.

Write to Paul Kiernan at paul.kiernan@wsj.com and Rogerio Jelmayer at rogerio.jelmayer@wsj.com

(END) Dow Jones Newswires

August 25, 2016 17:45 ET (21:45 GMT)

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