1 ST APG FORUM ON LOCAL FINANCE MANAGEMENT 7-8 May 2015, Lombok, Republic of Indonesia Ensuring fiscal sustainability of SNGs Camila Vammalle Economist/Policy Analyst OECD, Public Budgeting and Expenditure Division Public Governance and Regional Development Directorate

1. CHARACTERISTICS AND TRENDS OF SNG DEBTS IN OECD COUNTRIES - How large are SNG debts? - Why monitor SNG debts? - What drives SNG debts? - Who lends to SNGs?

SNG debt may seem small compared to CG’s Composition of public debt as a share of GDP (2013) Note: Korea, Switzerland: 2012 instead of 2013 All countries use consolidated data in SNA08 standard except: Switzerland, UK, USA (non-consolidated, SNA08), Canada, Turkey (consolidated, SNA93), Japan, Korea (non-consolidated, SNA93). Source: OECD National Accounts and Eurostat

But SNGs have limited autonomy to improve their financial situation SNG autonomy to increase revenues is usually limited An important share of SNG expenditure is mandatory and very difficult to cut 1.A large share of their spending is in critical sectors. 2.Some SNG expenditures are expected to rise due to demographic factors 3.Rules and standards of SNG expenditure are often dictated by higher levels of government Fiscal rules often constrain SNGs room of manoeuvre 4 SNG expenditure by function in OECD countries Source: OECD National Accounts and OECD Fiscal Decentralisation Database

Ratio of SNG debt to revenue is therefore more appropriate Evolution of SNG debt as a share of SNG revenues Note: Australia, Switzerland: ; Mexico: ; Poland: ; Korea: All countries use consolidated data in SNA08 standard except:Switzerland, UK, USA (non-consolidated, SNA08), Canada, Turkey (consolidated, SNA93), Japan, Korea (non-consolidated, SNA93). Source: OECD National Accounts and Eurostat.

Average levels of SNG debt hide wide variations within countries Dispersion of SNG debt-to-revenue in regions/states ( ) Note: accounting standards used for calculating debt differ between countries. Therefore this graph is useful in order to get an idea of how disparities evolved over , but countries should not be directly compared. Source: OECD Network on Fiscal Relations across Levels of Government and Territorial Development Policy Committee Questionnaire on Regional Finances.

Why it is important to monitor SNG’s debts 7 Debt creates externalities across levels of government The risk of contagion can disrupt financial markets SNGs often own public enterprises whose debt is not accounted for in the national accounts, and which may create contingent liabilities In most OECD countries, the CG is held politically responsible for SNG debt, often taking on the form of implicit or explicit guarantees For EU countries, Maastricht fiscal rules (fixing the maximum levels of deficits and debt) are calculated a the general government level (i.e. including SNG debts)

What are the main drivers of SNG debts? 8 Structural mismatch between SNG spending obligations and allocations of revenues (unfunded mandates) Economic downturns can generate temporary SNG deficits and contribute to build up SNG debt SNGs may be subject to soft budget constraints and moral hazard.

Who lends to SNGs in OECD countries? 9 Composition of SNG debt (2013) Note: Korea, Switzerland: 2012 instead of All countries use consolidated data in SNA08 standard except: Switzerland, UK, USA (non consolidated, SNA08), Canada, Turkey (consolidated, SNA93), Japan, Korea (non consolidated, SNA93). Source: OECD National Accounts and Eurostat. Loans Commercial banks SNG owned banks CG loans Bonds Growing but still limited Mainly in regional/state levels in federal/quasi- federal countries Commercial debt Debt with providers

2. MECHANISMS FOR MONITORING SNG DEBTS 1- Market discipline 2- Direct control and approval by higher levels of gov. 3- Fiscal rules - Enforcement of fiscal rules - Conclusion: main challenges faced for monitoring SNG debts

Market discipline 11 Necessary conditions… Free and open markets Sufficient information on borrower’s outstanding debt and repayment capacity Credible “no bailout” commitment from CG Borrower’s capacity to react to market signals …are often not met

Direct control and approval by higher levels of government 12 May be effective but has drawbacks: Implicit bailout guarantee, possible moral hazard CGs may not have appropriate information to assess SNG projects and decide which ones should be financed Administrative burden Type of approval required to issue SNG debt in OECD countries Source: OECD Network on Fiscal Relations across Levels of Government Survey on Sub-national Fiscal Rules and Macroeconomic Management, September 2011, updated in March 2013.

Fiscal rules (FR) 13 Type of SNG fiscal rules in OECD countries Source: OECD Network on Fiscal Relations across Levels of Government Survey on Sub-national Fiscal Rules and Macroeconomic Management, September See Annex 3 for details at a country level, updated in March FRs introduce numerical targets (ratios based on GDP, SNG taxes or SNG total rev.) Public investment is sometimes excluded from the ratios (golden rule) SNGs may have only 1 or many different FRs Effectiveness of fiscal rules depends on ability of SNGs to circumvent them: monitoring and enforcement mechanisms

Fiscal rules can be either self-imposed or imposed by higher levels of government 14 Usually imposed by higher levels of government Sometimes self-imposed, mainly in very decentralised countries Negotiated between levels of government Origin of SNG fiscal rules Source: OECD Network on Fiscal Relations across Levels of Government Survey on Sub-national Fiscal Rules and Macroeconomic Management, September See Annex 3 for details at a country level, updated in March 2013.

Intergovernmental bodies can help coordinating fiscal rules and debt policies 15 Some OECD countries have had intergovernmental bodies to coordinate debt policy for a long time Australian Loan Council since 1923 Belgium’s High Council of Finance Spanish Fiscal and Financial Policy Council Others have created such bodies more recently Germany’s Stability Council in 2010 High level bodies Usually composed of Ministers of Finance of the CG (federation) and of the SNGs (Regions/Länders/Provinces).

What happens if SNGs break the rules? 16 Fiscal rules are only effective if properly enforced, and SNGs breaking the rules are sanctioned Enforcement mechanisms and sanction mechanisms have been tightened recently in many OECD countries Actions that higher levels of government may take without changes in legislation

Conclusion: main challenges faced for monitoring SNG debts (1/2) 17 Insufficient information about SNG budgeting practices Survey on budgetary practices at SNG level? Lack of comparability of SNG financial data Homogenising accounting standards Insufficient appropriate and timely information about SNG finances and debt situation Improving transparency of SNG finances Ensuring reliability of financial information provided by SNGs Importance of audits and controls

Conclusion: main challenges faced for monitoring SNG debts (2/2) 18 SNG budgets should present a true, full and fair picture of SNG public finances Reduce/eliminate off-budget funds Consolidate accounts of local public enterprises Importance of well-designed insolvency procedures

THANK YOU! For more information, see: Hulbert, C. and Vammalle, C (forthcoming), Ensuring fiscal sustainability of sub-national government debts. Recent trends, monitoring practices and challenges in OECD countries, OECD, Paris