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BRASILIA, Jan 10 (Reuters) - Brazil's federal government is less likely to authorize cash-strapped states to raise fresh debt after the Supreme Court forced the Treasury to use its own money to honor loans not paid by the Rio de Janeiro state, three government officials told Reuters on Tuesday.
As the guarantor of nearly all loans contracted by states, the Treasury has withheld states' own tax revenues to honor missed payments. However, last week's court order prevents the government from withholding those tax revenues, meaning it has to use its own resources to honor unpaid debts.
Over the last five years, Rio accumulated billions of dollars in government-backed loans with state-run lenders and multilateral banks to pay for infrastructure ahead of the 2014 World Cup and 2016 Olympics.
But Rio, like several other Brazilian states, is unable to pay back the money as the country's worst recession on record drags down its tax income and oil royalties.
Hospitals across Brazilian states are running out of supplies, police and teachers are not being paid and badly needed infrastructure projects are frozen because of the crunch.
"The decision was well intentioned, but it creates a huge problem. It fuels legal uncertainty that could undermine future loans," said one of the officials who asked not to be named because he was not allowed to speak publicly.
That uncertainty could discourage Brazil's Treasury from approving new debt to states, said a senior finance ministry official who also requested anonymity.
The ruling added pressure on President Michel Temer to reach a deal with Rio de Janeiro this week to ease its financial crisis before 6.5 billion reais ($2 billion) in local and external debts are due this year.
The treasury's press office declined to comment for the story.
A deal with Rio would lift the order the head of the Supreme Court, Carmen Lucia, that forced the federal government to release 374 million reais for Rio de Janeiro to pay for wages and services.
Critics say that such legal uncertainty hampers investment, as individual judges have broad discretion to suspend debt contracts, award labor compensations and halt building projects.
"If the court continues to grant those injunctions to states without any fiscal adjustment then we will have a problem," said Carlos Kawall, chief economist with Banco Safra and former head of the national treasury
The government paid 2.2 billion reais in debt Rio failed to honor last year, according to the Treasury. The state missed payments to the Inter-American Development Bank (BID) and Agence Française de Developpement.
Rio has about 340 million reais in payments due to the World Bank next year, according to the state's finance secretary.
Other states are considering asking for similar injunctions to prevent the government from withholding their transfers.
When a loan is not paid by a state, the federal government withholds federal revenues earmarked for those local governments to honor their obligations.
$1 = 3.197 reais Reporting by Alonso Soto; Editing by Lisa Shumaker