US State DepartmentWorkshop on Sustainable Cities

December 2004

Anthony Pellegrini

IADF and Centennial Group

Water and Sanitation is a key sub-national service

• 1 billion people still lack access to an adequate supply of water,

• 2 billion do not have adequate sanitation facilities.

• 3 million people still die every year from avoidable water-related disease

• 4 billion without sound wastewater disposal

Emerging international consensus on MDGs.

Goal 2: Ensure environmental sustainability• Between 2000 and 2015 halve the proportion of people

without sustainable access to safe drinking water• Halve the proportion of people without safe sanitation

by 2015

Goal 4: Reduce Child Mortality• • Reduce by 2/3 the under-5 mortality rate by 2015.

The financing requirements are great

The cost estimates vary – but

Halving the proportion of people without sustainable access to both improved water supply and improved sanitation would cost on the order of US$11 billion per year OVER current expenditures ( Source: WHO)

Increasing private domestic currency finance of infrastructure is one of the

keys to sustainability• There is not enough money available from

government grants, nor from aid institutions to finance needed infrastructure.

• Eventually finance will need to come from domestic capital markets and domestic banks.

• Foreign borrowing on large scale is feasible only for infrastructure that earns foreign exchange (e.g. ports) It is imperative that new approaches to access these markets be developed.

Decentralization has added a critical dimension to infrastructure financing

• LDC local Governments given major new responsibilities with little experience to draw on. Many bright young mayors – but cities don’t have the basic tools of good governance: systems for budgeting, urban planning, modern accounting systems, community participation, competitive procurement, training of civil servants.

• Banks and capital markets in LDCs are unfamiliar with local governments or have negative experiences. Banks have typically lent to national institutions. Bonds have been floated by national institutions. Risks of local governments are difficult to assess.

• Local governments unfamiliar with requirements of market. Mayors reluctant to be seen to pay “high” interest rates; invest in “expensive” feasibility studies;

Decentralization and urbanization has lead to an important new

development agenda• Help improve processes, procedures,

policies and institutions in newly empowered local governments

• Help improve interaction between domestic providers of funds and potential local government users of funds

Sustainable financing will involve a wide range of institutions including

• local banks and

• local bond market institutions

• Banks have potential advantage of understanding their local government borrowers through “relationship” style lending, but tenors are often short and i rates high.

• Bonds have the advantage of offering better rates and longer tenors – but issuing a bond is more costly

There are still few examples of local governments in developing countries issuing bonds ( even local currency bonds).

For small and medium sized cities it is costly and often impractical to float a bond.

Bilaterals and multi-laterals can play an important role in helping improve access by sub-national entities to

domestic capital markets

Most Multi-lateral and Bilateral assistance is through grants or lending

that directly support an individual project

• Financial impact limited to project being financed rather than promotion of long term sustainable finance solutions.

• Direct lending can sometimes discourage local institutions that have a hard time competing with official assistance.

• Direct lending by MDBs and Bilaterals is useful to support pilot projects that demonstrate a new approach and to promote reform

How can local government finance be put on more

sustainable basis ?

Tamil Nadu India and Johannesburg, South Africa are two recent positive examples of USAID and IFC assistance that demonstrate the utility of credit enhancements and partial guarantees that LEVERAGE official assistance with domestic private funds to have a larger impact.

Tamil Nadu, India: Issues that faced LGs

• Many LGs , though poor, did have some capacity to pay back a loan . However, there was no access to bond market and no bank lending to local governments without guarantee by state.

• New requirements for improved water and sanitation implied major investment by local governments

• State no longer in position to give needed guarantees• An existing local lending institution, TNUDF, wanted

foreign assistance to lend to local governments

Tamil NaduPooled Bond

• Tamil Nadu Urban Development Fund floated the first domestic “pooled” bond in the developing world without government guarantees on behalf of thirteen small, low income local governments.

• It was supported by a USAID Development assistance partial guarantee

What is a pooled bond?

A bond issued by a local financial institution on behalf of multiple small local government entities that would not have the wherewithal to issue a bond themselves individually.

Since bonds are costly to issue, pooled bonds take advantage of economies of scale

Tamil Nadu Result

• Successful floatation of fairly small initial bond (US 6.4 million)

• Being used by 13 local governments for env infrastructure• USAID not only leveraged their resources,

they established a more sustainable model for infrastructure finance in India.

• Followed by Karnataka bond and activity in several other states.

• Indian government issuing national guidelines to encourage other states.

JohannesburgIssues

• Need for sharp increase in environmental sanitation and other infrastructure especially in black townships

• National guarantees unavailable• No local gov in South Africa had issued a bond• Need for clean audit• Need for credit rating improvement• Etc.

JohannesburgMunicipal bond

• USAID provided technical assistance to local government finance and IFC provided a partial credit guarantee to a successful domestic bond issue by the Johannesburg Metropolitan Council

• A small guarantee led to significant leverage of local resources

JohannesburgResults

• Two successful bond issues of 170 million dollars each

• Reduced average cost of borrowing – saving 3.4 million dollars per year

• Improved the debt maturity profile by spreading debt service payments forward.

• Stimulated interest in municipal market by pension funds, etc

More systemic approaches along these lines will be needed to have a real impact on the scope of the problem

Tamil Nadu and Johannesburg are not isolated examples

In most developing countries local intermediaries ( like the early version of the Tamil Nadu Fund) have been set up by governments to on-lend official assistance to local governments

Several other developing countries are considering reform of local

intermediaries to enhance access to domestic private capital

The Philippines, Ukraine and Mexico among others

Many Other similar institutions exist. Eg. :

• Colombia Findeter

• Parana, Brazil Paranacidade

• Tunisia Caisse des Prets et de Soutien des Collectivity Local

• Sri Lanka Local Government Loans Fund

• Jordan Banque de Development des Villes et des Villages

Examples (continued)

• Bolivia Servicio Nacional de Desarollo Urban

• Czech Rep. Municipal Finance Co.

• Latvia Municipal Dev. Fund Latvia

• Morocco Fonds d'Equipement Communal

• Panama Fondo de Desarollo Municipal

• Etc.

The issue for sustainability is:

Can these existing institutions play a role in bringing in domestic private capital for infrastructure finance and reduce the dependence on national budgets and foreign borrowing?

Good models exist in the US and other advanced market economies of

specialized market based intermediary institutions for lending

to local governments for infrastructure

Examples from advanced economies• USA SRFs, and 17 State Bond Banks

• Canada 6 Provincial Municipal Finance Corps

• Norway Kommunal Bankan

• Sweden Kommuninvest

• Netherlands Bank of Netherlands Municipalities

• Denmark KommuneKredit

• Finland Municipality Finance plc

• Etc.

Its not just about creating finance institutions

Important governance measures also need to be implemented to make financing feasible

Governance Reforms needed for sub-national finance:

• Stable macro environment; • Domestic capital market regulations; disclosure rules; • Legal framework, contract enforcement; • LG code specifying roles and resources• National regulation of LG borrowing;• Local government and utility reform: tariffs, utility

regulation, taxation, project analysis, transparent procurement, accounting, and provision of clear, accurate, consistent, timely, information on LGs

Role of Official Assistance• Adopt the goal of improving access to domestic private

capital as one of the objectives of country assistance strategies

• Provide advice and technical assistance to get the sub-national governance framework right (legal, regulatory, policy, institutional)

• Support transactions that test the framework in a country

in order to identify necessary changes

The US bilateral and diplomatic assistance can play a key role in influencing the thinking of governments and multilaterals in recognizing the importance of local government infrastructure, MDGs and sustainable finance models for sub-national entities

US institutions can provide valuable assistance: US Bond Banks, credit rating agencies, etc

Thank You