SNG Public Finance: Institutional & Analytical
Aspects
Debt Sustainability Analysis at Subnational Level Training
DSA at Subnational Level Trainning , Brasilia , December 5-9, 2011PRMED in collaboration with LAC PREM
Slides prepared by A. Manoel, J. Pradelli, L. Bandiera, and L. GarridoWorld Bank Copyright
Subnational DSA Institutional Specificities
Political Relevance of Subnational Government (SGs)
Decentralization devolves political power/responsibility for fiscal/debt management and policies
Urbanization creates infrastructure and public-service needs. Debt financing of sub-national investment spending. Inter-generational equity issues
Subnational debt markets developed to provide SGs with new sources of debt financing. New instruments and investors. Policy initiatives to promote subnational debt market
development
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Subnational DSA Institutional Specificities
Institutional settings shape fiscal and debt management policies of SNs & national governments (NG)…
Sources: transfers received from NG, financial guarantees, etc.
Constraints: earmarked transfers, limited tax bases, fiscal rules on SG’s budgeting and indebtedness, expenditure rigidities and externally imposed requirements (e.g., devolved public service delivery), etc.
Implications: for SG’s ‘fiscal space’, financing strategies, and budget and debt structure.
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Subnational DSA Institutional Specificities
Sources of Funding
Revenues:• Own revenues,• transfers from NG (co-participated taxes, grants, etc.),
including earmarked transfers associated spending requirements.
Market Financing:• Bank-based financing (Brazil, India) vs market-based
financing (US),• Credit enhancements: securitization of revenues, NG
guarantees,• Loans/bonds in local currency and short-medium
maturity risks.4
Subnational DSA Institutional Specificities
Subnational Fiscal Rules
Rationale: • eliminate “soft budget constraints”, • improve NG supervision and control of
potential contingent liabilities, • address issue of incentives that may
have been distorted by cross-government bail outs,
• Help address capacity deficits (e.g., regarding fiscal management and analysis) that may exist at the SN level.
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Subnational DSA Institutional Specificities
Subnational Fiscal Rules
Can take various forms:
• Ceilings on own revenue and spending, • limits on budget balances, • restrictions on borrowing (e.g., external) and
debt levels, • “golden rules” requiring balanced budgets over
specific horizons
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Subnational DSA Institutional Specificities
Degrees of Freedom Examples of Disciplines on SN borrowing in
several countries:
Complete Autonomy--Market Dicipline
SNGs Impose Controls on Own
Borrowing
Constraints on Borrowing Purposes
Some Numerical Targets (e.g.,
expenditures, fiscal balance, etc.)
Numerical Thresholds for Key
Variables (e.g., new debt, debt stock
Prior Approval Required from CG
SNG Not Permitted to Borrow without
CG Guarantee or On-lending
Canada Australia Italy Colombia (local) Brazil Argentina Mexico
Switzerland Germany Estonia Peru (local) Poland (local) India
No CG Control Some CG DiciplineFree --------------------------------------------------------------------------------------------------------------------------------------> Strict Central Government Control
Strict CG Dicipline on Borrowing
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Subnational DSA Institutional Specificities
Sub-National Fiscal Rules
Example: Brazil—2000 Fiscal Responsibility Law
In 2000, an FRL was enacted, enshrining hard budget constraints, and explicitly prohibiting refinancing operations between levels of government to address moral hazard created by frequent bailouts in the past.
The FRL includes the following key limits:
FRL LimitsPersonnel Expenditures <60% NCRNet Consolidated Debt <200% NCRDebt Service <11.5% NCR
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Fiscal Policy Management
Fiscal Risks:
• Concession Contracts: toll roads, public service infrastructure (electricity, water).
• Off-Budget Vehicles: SN-owned enterprises, special purpose vehicles, etc.
• Explicit Liabilities: guarantees, on-lending, joint ventures, etc.
Subnational DSA Institutional Specificities
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Subnational DSAAnalytical Specificities
Debt Dynamics and Projections
Budgetary and financing variables relevant for SGs:
• Own revenues local tax bases (SN GDP, sectoral production, real estate prices and related taxes, etc.).
• Co-participated revenues national tax bases and co-participation parameters.
• Primary current expenditure price-indexed values, historical ratios, etc.
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Subnational DSAAnalytical Specificities
Sustainability Indicators?
Without specific thresholds or definitions, must determine benchmarks on a case-by-case basis—e.g.:
• Debt burden: SN debt-to-SGDP , interest-to-revenue, debt service-to-revenue, etc. (see FRLs)
• Quality of SN public finances: own revenue-to-total revenue
Risks, vulnerabilities, and alternative scenarios:• Change in intergovernmental finance system (e.g. in co-
participation parameters) • Developments in SN debt markets• Fiscal consolidation strategy (e.g. reversing stimulus
measures)
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Impact of Global Financial Crisis
• The global financial crisis has had a profound impact on subnational finance across countries– Reduced economic growth rates => reduced fiscal
transfers and own revenues– Deteriorating fiscal balance driven by declining
revenues combined with expenditure rigidity or continuing expenditures.
– In general, countries’ fiscal needs are rising but fiscal space is narrowing, resulting in deteriorating fiscal positions across regions and tiers of the government
– 10/2008-1/2010: Moody’s rating actions affected 72 SNGs or 24 percent of the rated universe outside the United States. 96% of the actions were in a downward direction.
• For example, 31% of the actions were downward for Western Europe and Commonwealth of Independent States/Central and Eastern Europe countries, and 13% were downward in Asia Pacific.
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Subnational Governments Fiscal Balance in BRIC Countries (% of GDP)
-3.5%
-3.0%
-2.5%
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
2005 2006 2007 2008 2009
BrazilChinaIndiaRussia
Note: Fiscal data aggregated over all subnationals except for India where data are for states. source: Source: Canuto and Liu “Subnational Debt Finance and the Global Financial Crisis” World Bank 2010, data based on government websites, World Bank country teams, Center for Fiscal Policy (Russia)
Fisc
alBa
lanc
e as
Sha
re o
f GD
P
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Fiscal Balance as Share of GDP for Subnational Governments in Selected
Developed Countries
-3.5%
-3.0%
-2.5%
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
2005 2006 2007 2008 2009
AustraliaCanadaFranceSpain
Fisc
alBa
lanc
e as
Sha
re o
f GD
P
Note: Fiscal data are aggregated over all subnationalsSource: Canuto and Liu “Subnational Debt Finance and the Global Financial Crisis” World Bank 2010, data based on government websites, Fitch 2010
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Impact of Global Financial Crisis
• The global financial crisis has had a profound impact on subnational finance across countries (cont)
– Cost of borrowing through increased spread and shorten maturity
– Currency volatility. Even though subnationals in most developing countries are not allowed to borrow externally without sovereign guarantees, the interaction of currency and interest rates could affect subnationaldebt service structure
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Yield Spread and Maturity for Subnational Bonds Issuance Quarterly (2007-2010, excluding US)
5
6
7
8
9
10
11
12
0
10
20
30
40
50
60
70
07Q1 07Q2 07Q3 07Q4 08Q1 08Q2 08Q3 08Q4 09Q1 09Q2 09Q3 09Q4 10Q1
Spread
Maturity
YearsBasis point
Notes: 30% of bond issuances have yield spread recorded.Source: Canuto and Liu “Subnational Debt Finance and Global Financial Crisis” World Bank 2010, data from DCM Analytics
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Yield Spread of 10-year US Municipal General Obligation Bonds (2007-2010 Q1)
-200
-100
0
100
200
300
400
07Q1 07Q2 07Q3 07Q4 08Q1 08Q2 08Q3 08Q4 09Q1 09Q2 09Q3 09Q4 10Q1
AAA AA+
A+ BBB
Basis point
Source: Canuto and Liu “Subnational Debt Finance and Global Financial Crisis” World Bank 2010, data from Bloomberg
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Impact of the recession in US SNG
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• Pennsylvania's capital city filed for bankruptcy protection, in a case closely watched by other cities looking for ways out of dire financial troubles.
• Harrisburg's filing came after a faction of the city council repeatedly rejected a state-backed plan that called for selling or leasing assets to pay down debt.
• Pennsylvania lawmakers were expected to pass legislation that essentially would amount to a state takeover of the city's financial recovery plan. Later, a divided city council voted to file for Chapter 9 bankruptcy protection, becoming the second city to file ... (WSJ, 10/13/2011)
Capital files for bankruptcy Harrisburg (PA) rejects governor-backed plan to sell assets
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Canuto and Liu (2010) “Subnational Debt Finance and Global Financial Crisis”. Washington, DC, World Bank
Crokery, Michael and Maher, K. (2011). “Capital Files for Bankruptcy “. Wall Street Journal, 10/13/2011
Lucas, Jean-Marc (2011). US State and Local Government Finances: from Recession to Austerity. BNP Paribas, Conjoncture, April 2011
Ter-Minassian, Teresa and Fedelino, A. (2010). Impact of the global crisis on sub-national governments' finances. Rome: Banca D’Italia, Mimeo
Ter-Minassian, Teresa and Jiménez, Juan Pablo. (2011). Macroeconomic challenges of fiscal decentralization in Latin America in the aftermath of the global financial crisis. Santiago, ECLAC, Serie MacroeeconomiaDel Desarrollo No. 112, May.
Wessel, David (2011). “What sent states into fiscal tailspin?” Wall Street Journal, January 28-30, 2011
Main References
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