IPWA Financial Tools Task Force A. Pellegrini Centennial Group

The idea of revolving funds to support local government borrowing for infrastructure is not new even in developing countries Many countries of the developing world have set up revolving funds of various types to facilitate borrowing by local governments

Examples from developing economies Columbia Findeter Parana StateParanacidade Tamil NaduTamil Nadu Urban Dev authority TunisiaCaisse des Prets et de Soutien des Collectivity Local Sri LankaLocal Government Loans Fund JordanBanque de Development des Villes et des Villages

Examples from developing economies (continued) BoliviaServicio Nacional de Desarollo Urban Czech Rep.Municipal Finance Co. LatviaMunicipal Dev. Fund Latvia MoroccoFonds d'Equipement Communal) Philippiines Municipal Development Fund Office PanamaFondo de Desarollo Municipal etc,

There are over 60 such institutions in developing countries and the number is growing

Many were set up with limited objectives, as simple pass-through revolving funds for Multilateral Development Bank lending. The central government guarantees the multinational loan. Most will lend for a wide range of sub-national infrastructure and are not limited to a single sector such as water and sanitation

All lend to a wide range of local governments including financially weak ones. Some have performed well and others have not –E.g. Philippines MDFO and Paranacidade in Parana State in Brazil have essentially zero NPLs; –Kenya LGLA, Indonesia RDA: very high rates of NPL

Those revolving funds that perform well, typically require an intercept pledge of central or provincial government transfers in case of default, and lend within national guidelines that limit local government borrowing to prudential levels. A management contract with a private entity and a Board of directors that gives some independence from government is another positive indicator

Those that perform well Help create a credit culture among local governments Help establish track record of repayment Help encourage fiscal discipline among LGs

But…even when they perform well most do not serve a long term market role Most obtain capital exclusively from central or provincial government subsidy or loans from Multi- lateral Development Banks. Neither the national government nor MDBs can satisfy all investment needs of local governments; Danger that they may substitute public for private capital especially when they enjoy special advantages

Questions many countries should ask How can these “revolving funds” evolve to bring in domestic private capital and reduce the dependence of local government finance on national budgets or foreign capital; How to use domestic subsidies and MDB funds to leverage domestic funds;

What should the future of these funds look like? For those that wish to evolve, models from developed world exist:  The US Bond Banks;  The Canadian Municipal Finance Associations;  The Nordic Communal Banks.

Examples from advanced economies USA17 State Bond Banks Canada6 Provincial Municipal Finance Corps NorwayKommunal Bankan SwedenKommuninvest NetherlandsBank of Netherlands Municipalities ItalyCrediop DenmarkKommuneKredit FinlandMunicipality Finance plc Etc.

These institutions fill a market niche and have goals similar to SRF help small and medium sized local governments take advantage of the favorable terms of bonds by pooling borrowing needs among sub-national entities, taking advantage of economies of scale and sharing risks;

They employ operating principles similar to SRF to enhance security and raise credit ratings Over-collateralization through maintenance of reserve funds, e.g. six months expected payments; Pledge of full faith and credit from borrowing LGs; sometimes joint and several obligations. Other guarantees or security from LGs e.g. intercept, pledge of property tax receipts, etc.

Three LDC examples of enhancing access to domestic private capital Columbia, and Czech Republic Second tier institutions that rediscount private bank loans to Local Governments; Extend tenor of private bank loans and “introduce” private banks to LG market Tamil Nadu State Municipal Fund in India Private management; Some Private investment Successful domestic bond floatation with structure modeled on SRF supported by USAID

Proposals have been made in several developing countries to move in this direction. Tamil Nadu has already done so; The DOF in Philippines is considering restructuring MDFO; USAID and WB have both recommended Indonesia to consider this approach. IFC, ADB interested in these concepts

There are other measures that need to be considered in addition to setting up a financing institution: Stable macro environment; Domestic capital market regulations; disclosure rules; municipal credit ratings; Solid legal framework, contract enforcement but also LG code, regulation/limits for LG borrowing;; Local government and utility reform: tariffs, utility regulation, taxation, project analysis, transparent procurement, accounting, clear, accurate, consistent, timely, information on LGs

Implications for W&S Financing in Developing countries The performance of an existing revolving fund in a country, even an unreformed one, may be an indication of prospects for an SRF type mechanism for W& S in that country; A restructured revolving fund, modeled on those in the developed world, could itself be an important source of domestic currency for W&S; MDBs should consider the agenda of restructuring these revolving funds to bring them to market; The existing revolving funds can be a “home” for a specialized SRF type fund for W&S.

Philippines Decentralization supported by strong Local Government Code –1991; Significant equalization transfers of centrally collected taxes to LGs; Well defined own-source revenue base for local government (but very poorly used).

Philippines LG borrowing experience MDF established in 1984 as revolving fund for ODA to local governments and utilities; re-flows stay in fund; national gov. repays international loan. National gov. allows intercept of its flows to borrowing local entity as security for MDF loans; Good lending record: essentially zero NPL; Recently government owned development banks also lending to local entities, also with zero NPLs

Private capital use in Philippines for local government infrastructure 8 local government bonds issued in recent years demonstrating some market appetite; high cost of issuing bond compared to bank loans limits demand; No private bank lending to LGs or utilities; local banks do not have access to intercept and are not depository banks.

The MDF has accumulated on the order of 50 million dollars in re-flows from past loans that could be used to capitalize a pooling institution.

A healthy LG finance system in Philippines needs  Private bank lending for better off LGs  Direct bond market access; and  Market oriented specialized financial intermediary to help smaller LGs to increase access to domestic markets

Wider access to private domestic capital in Philippines will depend on  Leveling playing field for private banks to encourage gradual entry  Establishment of an intermediary that pools needs of multiple LGUs and floats bonds on their behalf;  Continued, capital market, local government and utility reform