Subnational Credit Markets:

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Subnational Credit MarketsUp the Learning
Curve

• Presentation by
• John Petersen
• September 2002 The World Bank

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Whats 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.

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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

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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

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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

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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.

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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

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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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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
  

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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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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.

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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

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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

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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

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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

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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

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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

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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

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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