Subnational Credit Markets: “Up the Learning Curve” Presentation by John Petersen September 2002 The World Bank

Subnational Credit Markets2 What’s to be Learned? The subnational credit market project: What has been learned regarding local and regional governments accessing the credit markets? Review of country experiences from the early 1990s through the present. Some 17 countries are reviewed in a combination of updates and new studies.

Subnational Credit Markets3 Countries Reviewed Africa –South Africa –Zimbabwe Latin America –Mexico –Argentina –Brazil –Columbia North Africa –Morocco –Tunisia Asia –India –South Korea –Viet Nam –Philippines –Indonesia East/Central Europe –Hungary –Czech Republic –Russia –Poland

Subnational Credit Markets4 Why One Cares Promises of Devolution Markets and market discipline Mobilizing capital for infrastructure Rationalization of the investment process Enforcement of hard budget constraint Increased transparency and accountability

Subnational Credit Markets5 Objectives of Study Results of the studies and findings from other emerging/transitioning countries were scrutinized in an effort to see what works, where and why Countries represent differing governmental systems and stages of market development. All are undergoing changes in governance and credit market development

Subnational Credit Markets6 Organization of Study Borrowing not an end in itself, a derivative of capital needs and how they might be met Overview of political and market structures and changes Examination of interesting approaches and transactions Conclusions as to what works and does not work under various regimes.

Subnational Credit Markets7 Subnational as a Subtext Subnational borrowing is a subtext to much larger developments that have occurred: –Decentralization of governance has occurred in a variety of contexts and at differing paces –Markets have evolved in different patterns, but security markets have been slow to mature –Recurring currency crises and a faltering international economy have slowed the pace

Subnational Credit Markets8 Defining the “Credit Market” Where subnational markets can borrow –Numerous alternatives “Private” credit markets: –Bank dominated model –Securities market model Configuration has tended toward bank domination. Securities markets thin. Foreign ownership of banks; political risk and capital flight

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10 Contesting Development Patterns In government, towards the decentralization of spending, but limited local discretion –Revenue decentralization lags behind –Large numbers of small governments with revenue/responsibility mismatches In markets, contest among government financial institutions, private banks, and securities markets –Local government cash management often restricted

Subnational Credit Markets11 Banks Versus Markets Most developing/emerging countries come from government bank tradition Capital financing done by central government or its institutions … reinforced by donor programs Move toward private banking depends on decentralizing cash management Move toward securities markets depends on both dis-intermediation and institutional investors

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Subnational Credit Markets13 Macro-stability is Key Development of longer-term credit markets are dependent on long-term investors. These are few. National governments tend to swamp long-term domestic credit demands. Without macro-stability, any credit market access is difficult and long-term capital unlikely Lack of fiscal flexibility (discretion to adjust taxes and spending) greatly retards local government development. Local “autonomy” no sure cure.

Subnational Credit Markets14 Regulation of Borrowers Regulation is needed but is best accomplished through generic laws Laws need to be logical and consistent Laws should cover process and prudential limits. Details of transactions within parameters best left to market Market needs organization and credibility

Subnational Credit Markets15 Regulation of Security Distinctions needed by type of security Tradition of sovereign guarantee and approval Reinforced by donor on-lending programs that require guarantees Use limited-obligation (revenue) debt should be available “Vital services” can be protected

Subnational Credit Markets16 Regulation of Markets Local governments need to fit into overall framework, but have specific powers and needs Secondary market and liquidity are problems, but maybe over-stated Focus on reporting and disclosure process Fostering competition in small markets

Subnational Credit Markets17 Designing Assistance - I Encouraging local credit market access Small economies will need intermediaries to support local borrowing. Long-term funds Small units in even larger credit markets will likely need intermediary programs Larger units can access markets directly International markets need domestic credit markets

Subnational Credit Markets18 Designing Assistance - II Grants need to be integrated with loans Concessional loan terms erode the market On the margin, loans at retail should reflect “market conditions” Loans can be designed to provide incentives Use of trustees can build integrity of the market

Subnational Credit Markets19 Some Practical Problems Extension of the maturity of loans –Need to stimulate private sector to reduce annual debt service by longer maturities –Can be done with liquidity facilities and put options “Replication” if not the realization of competition –Expanding competition in credit markets is vital –Small markets may be unable to sustain competition

Subnational Credit Markets20 Practical Problems (Cont.) Mechanics: use of trustees –Experience in Argentina with trustees –Reaction in Philippines Mechanics: the intercept –With large transfers common, the fundamental credit support –Issue is how much discretion in local spending

Subnational Credit Markets21 Convergence of Interests Private credit markets getting a black eye Problem is not in the “principle” of markets, but in the application. Governance problems Markets, and local borrowing, need astute regulation and on-going objective surveillance Developing an ethos of “creditworthiness” is critical to subnational financial devolution Transparency and accountability need focal points