subnational borrowing and debt management

17
Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Copyright © 2010 Standard & Poor’s Financial Services LLC, a subsidiary of The McGraw-Hill Companies, Inc. All rights reserved. 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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Page 1: Subnational Borrowing and Debt Management

Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s.Copyright © 2010 Standard & Poor’s Financial Services LLC, a subsidiary of The McGraw-Hill Companies, Inc. All rights reserved.

Subnational Borrowing and Debt Management Elena OkorotchenkoManaging Director – Lead Analytical ManagerAsia-Pacific Sovereign & Public Finance Ratings

Thailand, March 2011

Page 2: Subnational Borrowing and Debt Management

2.Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s.

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

Page 3: Subnational Borrowing and Debt Management

3.Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s.

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

Page 4: Subnational Borrowing and Debt Management

4.Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s.

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

Page 5: Subnational Borrowing and Debt Management

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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

Page 6: Subnational Borrowing and Debt Management

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Central Governments Dominate LCY Issuance

0

20

40

60

80

100

120

140

160

180

200

LCY

Bond

s Out

stan

ding

, %

China HK Indonesia Japan Korea Malaysia Philippines Singapore Thailand VietnamSovereigns

Size and Composition of Asian LCY Bond Markets 2Q 2010, % of GDP.Source: AsianBondsOnline, ADB.

Govt Corp

Page 7: Subnational Borrowing and Debt Management

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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

Page 8: Subnational Borrowing and Debt Management

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Local Government Borrowing Restrictions: A Snapshot

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

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

large cities have issued domestic bonds.Vietnam

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

Local governments are allowed to access capital markets in local currency, but need additional approval from the

Ministry of Finance and Economy (MOFE) to borrow in foreign currency.Korea

LRGs can borrow in local currency only. For foreign currency they need central bank approval. In local currency

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.

Philippines

Peninsular (west) Malaysia states are not allowed to borrow commercially. East Malaysian states have access to

capital markets (including FX borrowing) albeit requiring federal government approval.Malaysia

Currently 46 LRGs (out of 1,800 total) are allowed to access capital markets, including FX borrowings. The rest

either borrow from the central government or from banks.Japan

The government moved to allow LRG bond issuance in 2007, but to date there have been no local government

issues: most LRGs fail to meet the min conditions set out by the central gov-t.Indonesia

The states are entitled to borrow, but they need approval from the central gov-t. States cannot borrow abroad, but

can receive external funding from international org-s and development banks via on-lending from the centre.India

LRGs are not allowed to borrow commercially. But some benefit from debt assumed on their behalf and

guaranteed by the central gov-t. They also borrow extensively via investment companies.China

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

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

large cities have issued domestic bonds.Vietnam

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

Local governments are allowed to access capital markets in local currency, but need additional approval from the

Ministry of Finance and Economy (MOFE) to borrow in foreign currency.Korea

LRGs can borrow in local currency only. For foreign currency they need central bank approval. In local currency

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.

Philippines

Peninsular (west) Malaysia states are not allowed to borrow commercially. East Malaysian states have access to

capital markets (including FX borrowing) albeit requiring federal government approval.Malaysia

Currently 46 LRGs (out of 1,800 total) are allowed to access capital markets, including FX borrowings. The rest

either borrow from the central government or from banks.Japan

The government moved to allow LRG bond issuance in 2007, but to date there have been no local government

issues: most LRGs fail to meet the min conditions set out by the central gov-t.Indonesia

The states are entitled to borrow, but they need approval from the central gov-t. States cannot borrow abroad, but

can receive external funding from international org-s and development banks via on-lending from the centre.India

LRGs are not allowed to borrow commercially. But some benefit from debt assumed on their behalf and

guaranteed by the central gov-t. They also borrow extensively via investment companies.China

Taipei,China

Page 9: Subnational Borrowing and Debt Management

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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

Page 10: Subnational Borrowing and Debt 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

Page 11: Subnational Borrowing and Debt Management

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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)

Page 12: Subnational Borrowing and Debt Management

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Source ‘pros’ ‘cons’

Own resources Cheap Rarely sufficient, esp. for large-scale

projects

Grants from central

government and funding

orgs

Cheap, technical support

from funding orgs

Restriction on the use of funds, slow pace

of approval, strict control, political issues

Loans from multilateral

funding orgs

Long-term, amortizing,

favorable interest rates,

know-how

Often restrictions on the use of funds and

FX risk; slow pace of approval

Bank loans Availability based on

relationship banking

Often restricted capacity, limited maturity

and illiquid (+FX risk for foreign)

Bonds Diversity of investors,

liquidity, depth of markets

Expensive depending on size, bullet

repayments (+FX risk for foreign)

Off-budget or borrowed via

enterprises

No direct costs Contingent liabilities, lack of transparency

and more expensive

PFI/PPP deals No direct costs, more

efficient private sector

provision of services

Long-term agreement with

concessionaires, off-balance sheet risks

2. Funding Sources for Infrastructure Projects

Page 13: Subnational Borrowing and Debt Management

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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

Page 14: Subnational Borrowing and Debt Management

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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

Page 15: Subnational Borrowing and Debt Management

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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

Page 16: Subnational Borrowing and Debt Management

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Page 17: Subnational Borrowing and Debt Management

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