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The views expressed in this presentation are the views of the author and do not necessarily reflect the views or policies of the Asian Development Bank Institute (ADBI), the Asian
Development Bank (ADB), its Board of Directors, or the governments they represent. ADBI does not guarantee the accuracy of the data included in this paper and accepts no responsibility for
any consequences of their use. Terminology used may not necessarily be consistent with ADB official terms.
Introduction
• Intergenerational equitable
• However, there are risks with undisciplined borrowing behavior leading to:
• disruptions in public service delivery at the subnational level
• Political economy reasons--- but even with a good fiscal decentralization design
• Local officials seeking local votes may see additional borrowing and spending as an expedite
way to get that support, while the (political) costs are shifted as responsibilities for other
officials in future years (e.g. the cutting of ribbons for infrastructure projects)
Why do local governments over-borrow? (2)
• A number of additional papers have also explored the role of borrowing and other fiscal rules at
subnational level (Jin and Zou, 2002; Rodden, 2002; Plekhanov and Singh, 2007; Martinez-Vazquez
and Vulovic, 2017).
• However, these studies still fall short of providing robust results about the effectiveness of the
different institutional arrangements that may lead subnational governments to the most
desirable fiscal outcomes.
Beyond FD design and borrowing rules:
Other Instruments
• Fiscal Responsibility Laws
• More complex and comprehensive than borrowing rules— involving budgeting procedures etc.
• Role of FRLs on fiscal outcomes appears to be mixed so far but an indication that they can be helpful.
• Fiscal Councils
• A more or less independent authority to monitor and help enforce fiscal rules
• Key aspect, whether it is a truly independent authority --similar to the role played by central banks regarding
monetary policy
• Rainy-day Funds
• Set aside savings in good times to protect budgets and spending against unexpected economic shocks and so
to minimize disruptions caused by economic fluctuations and sharp declines in revenues.
Importance of having an all inclusive definition
and quantification of subnational debt
• Debt is defined as a liability that consists of the payment of interest and principle by a
debtor to a creditor at a date(s) in the future ((IMF 2001) .
• Therefore, subnational government debt should be inclusive of all forms of all liabilities
either explicitly contracted (e.g., bank loans, bond issues or central government loans) or
otherwise created by sub-central governments (e.g. external borrowing vehicles, accruals
or arrears in payments to suppliers or providers).
Subnational Government Debt Trends
in NAEEs (as percent of GDP)
• Latin America: high levels but declining
25
20
15
% of GDP
10
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Years
4
% of GDP
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
12
10
% of GDP
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
• ii) Rule-based
• iii) Cooperative
• iv) Market-based
Borrowing Regulations Across Years in NAEEs
1990 2000 2010
Bulgaria Chile Chile
Chile
Prohibited
Poland
Romania
Brazil Mexico Mexico
Mexico Nigeria Nigeria
Administrative Russia Russia Slovenia
Slovenia Slovenia Turkey
Turkey Turkey
Colombia Brazil Brazil
Colombia Bulgaria
Hungary Colombia
Centrally-imposed rule Poland Czech Republic
Hungary
Poland
Romania
Russia
Self-imposed rule Argentina Argentina (None)
South Africa Romania Argentina
Cooperative
South Africa South Africa
Czech republic Bulgaria (None)
Market-based
Hungary Czech Republic
Subnational Borrowing Regulations in NAEEs
9
Number of Non-Asian Emerging Countries
12
10
Limit on debt Golden rule Foreign allowed Foreign prohibited Foreign approval
1990 2000 2010
Performance of Borrowing Regulations
• The index captures a variety of relevant fiscal regulations into a scalar taking
values between 0 and 3. Specifically, the borrowing autonomy index takes into
account whether an approval by higher-level government is required, whether
debt limits are in force, whether the “golden rule” is in place, and whether
foreign borrowing is allowed.
Subnational Borrowing Autonomy in NAEEs
9
Number of Non-Asian Emerging Countries
• FRLs are designed to address wider fiscal governance issues, including short time
planning horizons, moral hazard and common pool problems.
• They are framed within medium-term fiscal horizons, emphasizing budget transparency
and accountability, the monitoring of fiscal targets, the inclusion of enforcement
measures, and often carefully specified escape clauses (Liu and Webb 2016).
Fiscal Responsibility Laws (FRLs):
Response to Systemic Subnational Debt Crises
in Latin America
• Overall, the introduction of FRLs appear to have brought better coordination of fiscal
policies at the different levels of government and to have contributed to enhanced fiscal
sustainability, especially where they have been supported by other fiscal rules.
• Fiscal Targets
• Limits on spending
• Sanctions
• Restrict borrowing autonomy & cut unconditional grants
The difficult part: Enforcement of Borrowing
and Fiscal Rules…..
Non-Asian Emerging Economy Subnational Bailout History
Country Bailout Country Bailout
Argentina Yes Nigeria Yes
Brazil Yes Peru No
Bulgaria No Poland No
Chile Yes Romania No
Colombia Yes Russia Yes
Czech Republic No Slovenia No
Hungary Yes South Africa No
Mexico Yes Turkey No
Effective Borrowing:
Monitoring Compliance and Enforcement
• Effective successful practices require to go beyond subnational borrowing and fiscal rules (Rodden
and Eskeland 2003; Kumar et. al. 2009; Ter-Minassian 2015; Kotia and Lledo 2016).
• Preventive measures
• Monitoring
• Enforcement
• Sanctions, if needed
• Clearly, the strength with which the rules are applied, comprising the monitoring and
enforcement mechanisms, can be more important than the rules themselves on the fiscal
performance at the subnational level.
Prevention Measures
• The design and strength of the rest of the fiscal decentralization system plays an important role
(reduction of VFIs, etc.).
• Credit risk mitigation measures should not work against prudent and responsible subnational
borrowing.
• This can be achieved through accepting and enhancing the role of private credit rating agencies or
alternatively, an independent public authority (for example, an autonomous fiscal council).
• Some forms of central government loan guarantees, as in the case of on-lending
Monitoring and Enforcement of
Borrowing and Fiscal Rules
• Governments can rely on a strong market discipline if it is available.
• But as we have seen in most emerging economies the lack of financial market development can
significantly reduce the effectiveness of this approach.
• Fiscal Councils
Fiscal Councils in NAEEs
Monitoring of
Country Name Name of Fiscal Council Established in Coverage Fiscal Rules
Colombia Comite Consultivo para la Regla Fiscal 2012 Central Government Yes
Slovak Republic Council for Budget Responsibility 2011 General Ggovernment Yes
5
Number of countries
0
1990 1995 2000 2005 2010 2015
What are the lessons from those
experiences?
• First, good outcomes on debt governance are not only about borrowing rules and
other controls.
• Fifth, adopting Fiscal Responsibility Laws (FRLs) early and wide scope including the
national and subnational governments significantly reinforces the legal framework
behind borrowing rules and will help prevent fiscal indiscipline and national fiscal crises.
• Sixth, besides fiscal rules and borrowing regulations, enforcement and monitoring
mechanisms are vital for the rule strength.
Conclusion
• Subnational borrowing is both efficient and inter-generationally equitable.
However, subnational borrowing also poses clear dangers to the
macroeconomic stability of fiscally decentralized countries.
• Because of these dangers, the temptation may be just to prohibit it. But
that will not the optimal solution.