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(Adds comments from Meirelles)
By Marcela Ayres and Cesar Raizer
BRASILIA, Dec 14 (Reuters) - Brazil's government proposed a "fiscal recovery" bill on Wednesday that would allow state governments to suspend debt payments to the federal government in exchange for limiting spending and pursuing privatizations.
Finance Minister Henrique Meirelles compared the proposal being sent to Congress to the bankruptcy protection available to companies, with a series of conditions and potential penalties tied to debt relief.
The legislation would formalize largely ad hoc negotiations that have sprung up between the federal government and cash-strapped states, which have watered down austerity requirements attached to recent bailouts amid a severe recession.
To enter the proposed recovery process, states would need to show that their net revenues are below total outstanding debt, that the sum of all their costs exceed revenues and that liabilities surpass available cash, according to a finance ministry statement.
They would also be required to sell state-owned companies or other assets chosen by the federal government to raise cash for paying down debts.
States under the regime, which could last up to three years, would be barred from increasing payroll and obligatory spending or pursuing measures that reduce revenues. They would be allowed to suspend debt payments to the federal government and to renegotiate loans with financial institutions.
Meirelles told journalists the proposed legislation would have no impact on the federal government's primary balance, a fiscal gauge of revenue minus spending before interest payments, which has plummeted in the current crisis.
Brazil's two-year recession has taken its toll on state governments, with several now struggling to pay hefty pension and payroll bills. Rio de Janeiro state, which hosted the Olympics this year, is facing perhaps the most acute crisis.
President Michel Temer has already offered financial relief for struggling states in return for austerity measures, which have been relaxed in subsequent negotiations.
Many states have already turned to selling state assets to shore up their finances. Rio's water and sewage utility Cia Estadual de Águas e Esgotos SA has long been seen as a potential target for a full or partial sale. (Reporting by Marcela Ayres and Cesar Raizer; Writing by Bruno Federowski; Editing by Tom Brown)