ST 1 APG FORUM ON LOCAL FINANCE MANAGEMENT

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ST 1 APG FORUM ON LOCAL FINANCE MANAGEMENT 7 -8 May 2015, Lombok, Republic

ST 1 APG FORUM ON LOCAL FINANCE MANAGEMENT 7 -8 May 2015, Lombok, Republic of Indonesia Ensuring fiscal sustainability of SNGs Camila Vammalle Economist/Policy Analyst OECD, Public Budgeting and Expenditure Division Public Governance and Regional Development Directorate

1. CHARACTERISTICS AND TRENDS OF SNG DEBTS IN OECD COUNTRIES - How large are

1. CHARACTERISTICS AND TRENDS OF SNG DEBTS IN OECD COUNTRIES - How large are SNG debts? - Why monitor SNG debts? - What drives SNG debts? - Who lends to SNGs?

SNG debt may seem small compared to CG’s Composition of public debt as a

SNG debt may seem small compared to CG’s Composition of public debt as a share of GDP (2013) SNG CG + SS 3 2. 5 2 1. 5 1 0. 5 Ja p G an re ec e It Po al rt y u U Ir gal ni e te lan d St d Be ate lg s iu m Sp Ic ain el an F ra d U ni n te Ca ce d Ki nad ng a H dom un ga r Is y r av ael er a N Au ge et st he ri rl a G and er s m Sl an ov y e Fi nia n Sl l ov P and a o Cz k R lan e ec p d h ub Re li p c D ubl en ic m Sw ark Sw e itz de er n la Tu nd Au rke st y r N alia or w Lu K ay xe or m ea bo Es urg to ni a 0 Note: Korea, Switzerland: 2012 instead of 2013 All countries use consolidated data in SNA 08 standard except: Switzerland, UK, USA (non-consolidated, SNA 08), Canada, Turkey (consolidated, SNA 93), Japan, Korea (non-consolidated, SNA 93). Source: OECD National Accounts and Eurostat

But SNGs have limited autonomy to improve their financial situation • SNG autonomy to

But SNGs have limited autonomy to improve their financial situation • SNG autonomy to increase revenues is usually limited • An important share of SNG expenditure is mandatory and very difficult to cut 1. 2. 3. • A large share of their spending is in critical sectors. Some SNG expenditures are expected to rise due to demographic factors Rules and standards of SNG expenditure are often dictated by higher levels of government Fiscal rules often constrain SNGs room of manoeuvre SNG expenditure by function in OECD countries Others (Env+housing +recreation+ public order+others) 36% Economic affairs 14% Education 24% Health 10% Social protection 16% Source: OECD National Accounts and OECD Fiscal Decentralisation Database 4

Ratio of SNG debt to revenue is therefore more appropriate Evolution of SNG debt

Ratio of SNG debt to revenue is therefore more appropriate Evolution of SNG debt as a share of SNG revenues 2007 2013 250% 200% 150% 100% 50% U Ja p C ni an an te a d da St at e Sp s G a er in m Po an Sw rt y itz ug er al l N and or w Ic ay el Au an st d U r ni te F alia d ra K n N ing ce et d N her om ew la Ze nd a s Be lan lg d i Ir um el an d It Lu Av aly xe era m ge bo Sw urg ed Au en s Fi tria n Sl ov E lan ak st d Re on pu ia bl Is ic Cz r ec P ael h ol Re an pu d Sl bli ov c en G ia r D ee en ce m H ar un k g M ary ex ic Ko o re a 0% Note: Australia, Switzerland: 2007 -2012; Mexico: 2007 -2009; Poland: 2010 -2013; Korea: 2010 -2012. All countries use consolidated data in SNA 08 standard except: Switzerland, UK, USA (non-consolidated, SNA 08), Canada, Turkey (consolidated, SNA 93), Japan, Korea (non-consolidated, SNA 93). Source: OECD National Accounts and Eurostat.

Average levels of SNG debt hide wide variations within countries Dispersion of SNG debt-to-revenue

Average levels of SNG debt hide wide variations within countries Dispersion of SNG debt-to-revenue in regions/states (2007 -2012) 500% 450% 400% 350% 300% 250% 200% 150% 100% 50% 0% 2007 2009 2007 2010 2007 2012 2007 2011 2007 2010 2007 2011 2007 2008 2007 2011 2007 2012 2007 2011 Belgium Czech Republic Germany Mexico Switzerland US Finland Spain France Canada New Zealand Norway Italy Note: accounting standards used for calculating debt differ between countries. Therefore this graph is useful in order to get an idea of how disparities evolved over 2007 -2012, but countries should not be directly compared. Source: OECD Network on Fiscal Relations across Levels of Government and Territorial Development Policy Committee Questionnaire on Regional Finances.

Why it is important to monitor SNG’s debts • Debt creates externalities across levels

Why it is important to monitor SNG’s debts • Debt creates externalities across levels of government • The risk of contagion can disrupt financial markets • SNGs often own public enterprises whose debt is not accounted for in the national accounts, and which may create contingent liabilities • In most OECD countries, the CG is held politically responsible for SNG debt, often taking on the form of implicit or explicit guarantees • For EU countries, Maastricht fiscal rules (fixing the maximum levels of deficits and debt) are calculated a the general government level (i. e. including SNG debts) 7

What are the main drivers of SNG debts? • Structural mismatch between SNG spending

What are the main drivers of SNG debts? • Structural mismatch between SNG spending obligations and allocations of revenues (unfunded mandates) • Economic downturns can generate temporary SNG deficits and contribute to build up SNG debt • SNGs may be subject to soft budget constraints and moral hazard. 8

Who lends to SNGs in OECD countries? Composition of SNG debt (2013) Loans Bonds

Who lends to SNGs in OECD countries? Composition of SNG debt (2013) Loans Bonds (except financial derivatives) Insurance reserves Commercial debt • Loans ü Commercial banks ü SNG owned banks ü CG loans 120% • 100% ü Growing but still limited ü Mainly in regional/state levels in federal/quasifederal countries 80% 60% 40% United States Canada Korea Sweden Switzerland Hungary United Kingdom Germany Czech Republic Slovenia Estonia Turkey Finland Denmark Iceland Italy Japan Austria Australia Israel Spain Norway Belgium Poland Netherlands Luxembourg Slovak Republic Portugal Greece France Ireland 20% 0% Bonds • Commercial debt ü Debt with providers Note: Korea, Switzerland: 2012 instead of 2013. All countries use consolidated data in SNA 08 standard except: Switzerland, UK, USA (non consolidated, SNA 08), Canada, Turkey (consolidated, SNA 93), Japan, Korea (non consolidated, SNA 93). Source: OECD National Accounts and Eurostat. 9

2. MECHANISMS FOR MONITORING SNG DEBTS 1 - Market discipline 2 - Direct control

2. MECHANISMS FOR MONITORING SNG DEBTS 1 - Market discipline 2 - Direct control and approval by higher levels of gov. 3 - Fiscal rules - Enforcement of fiscal rules - Conclusion: main challenges faced for monitoring SNG debts

Market discipline Necessary conditions… • Free and open markets • Sufficient information on borrower’s

Market discipline Necessary conditions… • Free and open markets • Sufficient information on borrower’s outstanding debt and repayment capacity • Credible “no bailout” commitment from CG • Borrower’s capacity to react to market signals …are often not met 11

Direct control and approval by higher levels of government Type of approval required to

Direct control and approval by higher levels of government Type of approval required to issue SNG debt in OECD countries No approval by other levels of governments 35% Approval by another public body 15% Direct approval by the CG 15% Approval by the CG for certain kinds of SNGs 20% Approval by the CG under conditions 15% May be effective but has drawbacks: • Implicit bailout guarantee, possible moral hazard • CGs may not have appropriate information to assess SNG projects and decide which ones should be financed • Administrative burden 12 Source: OECD Network on Fiscal Relations across Levels of Government Survey on Sub-national Fiscal Rules and Macroeconomic Management, September 2011, updated in March 2013.

Fiscal rules (FR) Type of SNG fiscal rules in OECD countries 30 Number of

Fiscal rules (FR) Type of SNG fiscal rules in OECD countries 30 Number of responses 25 • FRs introduce numerical targets (ratios based on GDP, SNG taxes or SNG total rev. ) • Public investment is sometimes excluded from the ratios (golden rule) 20 15 • SNGs may have only 1 or many different FRs 10 5 0 Budget balance rule Borrowing constraint Expenditure limit • Effectiveness of fiscal rules depends on ability of SNGs to circumvent them: monitoring and enforcement mechanisms 13 Source: OECD Network on Fiscal Relations across Levels of Government Survey on Sub-national Fiscal Rules and Macroeconomic Management, September 2011. See Annex 3 for details at a country level, updated in March 2013.

Fiscal rules can be either self-imposed or imposed by higher levels of government Origin

Fiscal rules can be either self-imposed or imposed by higher levels of government Origin of SNG fiscal rules Negociated between levels of government 11% Imposed from above 61% • Usually imposed by higher levels of government Self imposed 28% • Sometimes self-imposed, mainly in very decentralised countries • Negotiated between levels of government 14 Source: OECD Network on Fiscal Relations across Levels of Government Survey on Sub-national Fiscal Rules and Macroeconomic Management, September 2011. See Annex 3 for details at a country level, updated in March 2013.

Intergovernmental bodies can help coordinating fiscal rules and debt policies • Some OECD countries

Intergovernmental bodies can help coordinating fiscal rules and debt policies • Some OECD countries have had intergovernmental bodies to coordinate debt policy for a long time ü Australian Loan Council since 1923 ü Belgium’s High Council of Finance ü Spanish Fiscal and Financial Policy Council • Others have created such bodies more recently ü Germany’s Stability Council in 2010 • High level bodies ü Usually composed of Ministers of Finance of the CG (federation) and of the SNGs (Regions/Länders/Provinces). 15

What happens if SNGs break the rules? • Fiscal rules are only effective if

What happens if SNGs break the rules? • Fiscal rules are only effective if properly enforced, and SNGs breaking the rules are sanctioned • Enforcement mechanisms and sanction mechanisms have been tightened recently in many OECD countries Actions that higher levels of government may take without changes in legislation Make recommendations on corrective measures Impose administrative sanctions that limit the. . . Impose financial sanction on a discretionary basis Impose financial sanction on an automatic basis Remove, replace of punish officials Oblige SNGs to offset breach in future budget Oblige SNGs to take corrective measures 0 2 4 6 8 Number of responses 10 12 16 14

Conclusion: main challenges faced for monitoring SNG debts (1/2) • Insufficient information about SNG

Conclusion: main challenges faced for monitoring SNG debts (1/2) • Insufficient information about SNG budgeting practices ü Survey on budgetary practices at SNG level? • Lack of comparability of SNG financial data ü Homogenising accounting standards • Insufficient appropriate and timely information about SNG finances and debt situation ü Improving transparency of SNG finances • Ensuring reliability of financial information provided by SNGs ü Importance of audits and controls 17

Conclusion: main challenges faced for monitoring SNG debts (2/2) • SNG budgets should present

Conclusion: main challenges faced for monitoring SNG debts (2/2) • SNG budgets should present a true, full and fair picture of SNG public finances ü Reduce/eliminate off-budget funds ü Consolidate accounts of local public enterprises • Importance of well-designed insolvency procedures 18

THANK YOU! Camila. vammalle@oecd. org http: //www. oecd. org/governance/budgeting/ For more information, see: Hulbert,

THANK YOU! Camila. vammalle@oecd. org http: //www. oecd. org/governance/budgeting/ For more information, see: Hulbert, C. and Vammalle, C (forthcoming), Ensuring fiscal sustainability of sub-national government debts. Recent trends, monitoring practices and challenges in OECD countries, OECD, Paris