Subnational Borrowing

and Debt Management

Elena Okorotchenko
Managing Director – Lead Analytical Manager
Asia-Pacific Sovereign & Public Finance Ratings

Thailand, March 2011

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 Presentation Outline

 Current stage of subnational borrowing in Asia: where is

Asia on the global map?
 The importance of deep local bond markets
 Debt management
 The range of policies and practices
 Best practices in managing capital investments
and funding sources, debt structure, transparency
 Development of subnational borrowing in Asia – moving
forward

2.
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 The Most Developed Local Bond Market: The US Public Finance

• 85,000+ local and state government entities in the U.S.

and over 50,000 have issued municipal debt
• $2.7 trillion of municipal debt outstanding for > 1m
separate debt issues
• >$11 billion daily trading volume
• >50% of funds used for public construction projects
comes from municipal bond proceeds
• # of Ratings is often a good indicator of the stage of
development and depth of investors

3.
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 Subnational Ratings: A Useful Barometer of Development
• 10,000+ rated public sector entities in the US
• 320 rated LRGs in 33 countries excluding the US
• Asia-Pacific LRGs represent 9% of all ratings

4.
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 Asia Public Sector Borrowing: Market Overview

• LRGs in Asia would like to borrow, but:

– debt restrictions
– lack of debt management capacity, discipline, transparency
and credit culture; unsupportive national institutional
frameworks

• Only 28 LRG ratings in Asia-Pacific so far

• Most developed: Australia, New Zealand, Japan
• Some LRGs: India, Korea, Malaysia
• Potential: Philippines, Indonesia, China, Vietnam,
Thailand

5.
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 Central Governments Dominate LCY Issuance
Size and Composition of Asian LCY Bond Markets 2Q 2010, % of GDP.
Source: AsianBondsOnline, ADB.

200

180
Govt Corp

160

140
LCY Bonds Outstanding, %

120

100

80

60

40

20

0
China HK Indonesia Japan Korea Malaysia Philippines Singapore Thailand Vietnam
Sovereigns

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 The Importance of Deep Local Bond Markets

• Enhanced ability to cheaply and comfortably fund and

support higher investments and debt levels
• An important source of infrastructure funding
• Reduced vulnerability associated with excessive
dependence on external funding and sudden changes in
investor sentiment
• Government bonds serve as benchmarks, facilitate
development of corp bonds; municipal bond markets –
an important step forward

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 Local Government Borrowing Restrictions: A Snapshot
LRGs are not allowed to borrow commercially. But some benefit from debt assumed on their behalf and
China
guaranteed by the central gov-t. They also borrow extensively via investment companies.

The states are entitled to borrow, but they need approval from the central gov-t. States cannot borrow abroad, but
India can receive external funding from international org-s and development banks via on-lending from the centre.

The government moved to allow LRG bond issuance in 2007, but to date there have been no local government
Indonesia
issues: most LRGs fail to meet the min conditions set out by the central gov-t.

Currently 46 LRGs (out of 1,800 total) are allowed to access capital markets, including FX borrowings. The rest
Japan
either borrow from the central government or from banks.

Peninsular (west) Malaysia states are not allowed to borrow commercially. East Malaysian states have access to
Malaysia
capital markets (including FX borrowing) albeit requiring federal government approval.

LRGs can borrow in local currency only. For foreign currency they need central bank approval. In local currency
Philippines they tend to borrow from government-owned banks. Only a small number/amount of local bonds has been issued
so far, and all of them are guaranteed by the LGU Guarantee Corp.

Local governments are allowed to access capital markets in local currency, but need additional approval from the
Korea
Ministry of Finance and Economy (MOFE) to borrow in foreign currency.

Taiwan
Taipei,China LRGs can access capital markets for both local and foreign currency. Thus far such borrowing has been in LC.

Thailand LRGs can borrow commercially in local currency, but require central gov-t approval for any FX borrowings.

LRGs can borrow commercially in local currency, but require central gov-t approval for any FX borrowings. A few
Vietnam
large cities have issued domestic bonds.
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 Management Quality at the Local Level
• FMA - financial management assessment. Working
with the WB since 2007; 3 projects in 2008–2010: China,
the Philippines, Indonesia
• Philippines LGUs:
– Weak intergovernmental system; key-man risk factor and lack of
institutionalized policies
– Short-term focused planning framework, weak debt management;
But
– Sound to intermediate revenue & cash management
– Moderate financial flexibility
• China UDICs:
– Highly leveraged; liquidity shortages
– Challenging industry environments and/or broad policy mandates
with ad hoc projects; but
– Benefit from government fiscal stimulus plans
– Focused on improving financial management practices
• Indonesia – city of Jakarta; one of the stronger LGs in developing
Asia; mix of basic and sound practices in financial
management
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 Good Practices in Debt Management: An Overview

• Link to long-term and annual planning/budgeting

• Transparency: timeliness, detail, frequency
• Liquidity: linked to debt servicing needs among other
demands on liquidity; overdraft arrangements
• Managing GREs: debt as a contingent liability; guarantees

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 1. Linking Debt with Management of Capital Investments

• Approach to capital investments:

– Areas to invest: public sector vs. commercial interest
– Setting priorities: long-term strategy
– Multi-year investment budgeting
– Introduction of future operating costs into financial
projections
• Some current practices in emerging Asian countries:
– Involvement in commercial projects exposes LRGs
to commercial risks
– Tendency to invest in ‘visible’ capital projects vs.
realization of long-term priorities (political issues,
access to cheap money, corruption)
– Ad hoc financing (or based on residual funds)

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 2. Funding Sources for Infrastructure Projects
Source ‘pros’ ‘cons’
Own resources Cheap Rarely sufficient, esp. for large-scale
projects
Grants from central Cheap, technical support Restriction on the use of funds, slow pace
government and funding from funding orgs of approval, strict control, political issues
orgs
Loans from multilateral Long-term, amortizing, Often restrictions on the use of funds and
funding orgs favorable interest rates, FX risk; slow pace of approval
know-how
Bank loans Availability based on Often restricted capacity, limited maturity
relationship banking and illiquid (+FX risk for foreign)
Bonds Diversity of investors, Expensive depending on size, bullet
liquidity, depth of markets repayments (+FX risk for foreign)

Off-budget or borrowed via No direct costs Contingent liabilities, lack of transparency

enterprises and more expensive
PFI/PPP deals No direct costs, more Long-term agreement with
efficient private sector concessionaires, off-balance sheet risks
provision of services

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 3. Debt Policy and Debt Structure
Debt policy
• Financial policy includes guidelines on sustainable debt limits
and desirable debt structure (amortizing, fixed-rate, long-term,
local currency etc.)
• Risk-averse policy aiming at minimizing risks first, costs second
• Transparent use of guarantees and debt issued by government
companies
• Short-term debt is incurred for liquidity purposes only
• Long-term debt is used to fund infrastructure investments and
refinance existing debt
Debt structure
– Long-term debt represents the biggest part of the debt portfolio
– Debt structure allows for even repayments of principal
– Currency and interest risks are minimized or hedged
– Debt is diversified in terms of obligations and creditors

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 4. Transparency and Investor Relations
– Detailed debt servicing forecast is available and covers the duration of
the longest obligation; scenario analysis; timely and frequent
information
– Positive credit history helps reduce costs of borrowing. Publicly stated
commitment to pay debt in time and in full
– Timely public information on any significant event affecting the
government’s credit standing or related to its financial market
operations
– Timely and public info on the government’s contingent liabilities,
including debt obligations and finances of government enterprises
– Transparent use of guarantees; transparent selection and fee process.
Guarantees are not used as a “deferred payment” tool, when it is
known upfront that the borrower can not fulfill its obligations

14.
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 Moving Forward
 At the national level:
– transparent borrowing frameworks for LRGs/GREs;
– educating investors, issuers and developing credit culture at all
levels
– developing credit benchmarks
• At the subnational level:
– medium-term fiscal frameworks and visibility beyond political cycles
– improved transparency, financial discipline and debt management
capacity
– clear link to capital investments/infrastructure projects
• What's next?
– LRGs/GREs need to borrow directly in the current environment =>
develop the necessary prerequisites
– engage the private sector once markets open and free up financial
capacity at LRG level to implement more infrastructure
projects
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