World Economic Forum Financing for Development Initiative Sao Paulo October 2004 A. Pellegrini Centennial Group

Increasing private domestic currency finance of infrastructure is one of the keys to sustainability Needs are great: $180 billion to meet Millennium Development Goals for W&S alone. There is not enough money available from national government subsidies, nor from aid institutions to finance needed infrastructure. Eventually finance will need to come from domestic capital markets –at least for infrastructure that does not earn revenues in FX. It is imperative that new approaches to access these markets be developed.

Decentralization has added a critical dimension to infrastructure financing Local Governments given major new responsibilities with little experience to draw on Banks and capital markets unfamiliar with local governments or have negative experiences Local governments unfamiliar with requirements of market.

Sustainable financing will involve a wide range of institutions including local banks and bond market institutions

Banks have advantage of “relationship” but tenors are often short and i rates high Few examples of local governments in developing countries issuing domestic currency bonds. Very few examples of MDBs or bi-laterals providing assistance or credit enhancement. For small and medium sized cities it is costly and often impractical to float a bond.

MDBs can play an important role in helping improve access by sub-national entities to domestic capital markets but it will require doing business differently

Tlalnepantla, Mexico and Johannesburg, South Africa are two recent positive examples of IFC assistance to specific local governments that demonstrate the utility of MDB credit enhancements and partial guarantees. More systemic approaches will be needed to have a real impact on the scope of the problem

MDBs have traditionally helped countries set up local intermediaries to facilitate their lending to local governments

Examples Columbia Findeter Parana StateParanacidade Tamil NaduTamil Nadu Urban Dev authority TunisiaCaisse des Prets et de Soutien des Collectivity Local Sri LankaLocal Government Loans Fund JordanBanque de Development des Villes et des Villages

Examples (continued) BoliviaServicio Nacional de Desarollo Urban Czech Rep.Municipal Finance Co. LatviaMunicipal Dev. Fund Latvia MoroccoFonds d'Equipement Communal) Philippiines Municipal Development Fund Office PanamaFondo de Desarollo Municipal etc,

There are over 60 such institutions in developing countries and the number is growing

Most operate as revolving funds without leverage The MDB makes a large loan to the government, with a central government guarantee. The central government on-lends to the local intermediary. The local intermediary appraises subprojects proposed by local government entities and “retails” the MDB funds by on-lending for projects that pass agreed criteria.

These intermediaries lend to a wide range of local governments ---- including financially weak local governments. Some have performed well and others have not –E.g. MDFO in the Philippines and Paranacidade in Parana State in Brazil have essentially zero Non- Performing Loans; –Kenya LGLA, Indonesia RDA: very high rates of NPL

Those revolving funds that perform well, require collateral of some type from borrowers and lend within national guidelines that set specific limits on local government borrowing to prudential levels. (Collateral might be a pledge of tax revenues or an intercept of central or provincial government transfers, or even real property owned by the LG; ) A management contract with a private entity and a board of directors that gives some independence from government is another positive indicator

Those that perform well Help create a credit culture among local governments Help establish track record of repayment Help encourage fiscal discipline among Local Governments

But…even when they perform well most do not serve a long term market role and are not part of a sustainable financing framework Most obtain capital exclusively from loans by Multi- lateral Development Banks perhaps augmented by central or provincial government subsidies Danger that they may make it harder for local banks or other private financial institutions to enter market especially when they enjoy special advantages

Issue: Can these existing institutions play a role in bringing in domestic private capital and reduce the dependence on national budgets or foreign capital?

In most market economies, specialized intermediary institutions exist for lending to local governments  The US Bond Banks;  The US State Revolving Funds  The Canadian Municipal Finance Associations;  Nordic communal Banks

Examples from advanced economies USASRFs, and 17 State Bond Banks Canada6 Provincial Municipal Finance Corps NorwayKommunal Bankan SwedenKommuninvest NetherlandsBank of Netherlands Municipalities DenmarkKommuneKredit FinlandMunicipality Finance plc Etc.

These institutions fill a market niche They help small and medium sized local governments (many of which which would have difficulty floating a bond on their own) take advantage of the favorable terms of bonds. They pool borrowing needs among sub-national entities, and issue a large pooled bond in their own name, taking advantage of economies of scale and risk sharing.

They provide a credit structure to bonds to enhance security and raise credit ratings Over-collateralization through maintenance of reserve funds, e.g. six months expected payments; Pledge of full faith and credit from borrowing LGs; Other guarantees or security from LGs e.g. intercept, pledge of property tax receipts, etc.

Three LDC examples of enhancing access to domestic private capital Colombia, and Czech Republic Second tier institutions that rediscount private bank loans to Local Governments; Extend tenor of private bank loans and “introduce” private banks to LG market Tamil Nadu State Municipal Fund in India Private management; Some Private investment Successful domestic bond floatation with structure modeled on US SRF supported by USAID

Several developing countries are considering local intermediaries to enhance access to domestic private capital The government of India is issuing national guidelines to encourage states to set up pooled finance institutions; The Philippines, Ukraineand Mexico are also moving in this direction

There are other measures that need to be considered in addition to setting up a financing institution: 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 MDBs Adopt the goal of improving access to domestic private capital Make greater use of credit enhancements than direct lending (resource leveraging rather than resource transfer) Provide advice and technical assistance to get the framework right (legal, regulatory, policy, institutional) Support transactions that test framework in a country and identify necessary changes

Role of MDBs (Continued) Provide technical advice and financial support to develop local, market based specialized intermediaries to help small and medium sized sub-national entities access domestic finance for infrastructure. Help restructure existing traditional municipal revolving funds to bring them to market In the case of the World Bank this would be enhanced by ability to lend without sovereign guarantee