Source:
Citizens' Network on Essential Services
Nancy Alexander
Wed Dec 06 2006
A new pilot Subnational Development Program (SND) of the World Bank and the International Finance Corporation has projected commitment of $800 million over three years (2007 to 2009). The Bank loaned $2.8 billion to subnational infrastructure projects in fiscal year 2005, but the Bank's Articles of Agreement have prevented it from lending directly to subnational entities. The program is aimed at middle-income countries, such as Brazil, China, India, Mexico, Poland, Russia and South Africa.
The Bank loaned $2.8 billion to subnational infrastructure projects in fiscal year 2005, but the Bank's Articles of Agreement have prevented it from lending directly to subnational entities. The Articles stipulate that national governments must provide a sovereign guarantee or its equivalent for a subnational loan. Many national governments do not favor the provision of sovereign guarantees as desirable or feasible.
The Bank views the limitations in its subnational lending as a major obstacle to establishing public-private partnerships (PPPs), especially for infrastructure. It also prevents the Bank from deepening its work in decentralization, even though the Bank spent $5 billion to support decentralization reforms in fiscal years 2004 to 2005.
2003 Pilot Program
In 2003, as an experiment in lending to subnationals without sovereign guarantees, the Bank Group established the IFC Municipal Fund offering $100 million in financial support to subnational entities, which catalyzed $570 million in investments.
2006 Pilot Program
On July 1, 2006, a larger, $800 million subnational development (SND) program was launched to scaled up this initiative and offer guarantees and loans (mostly in local currency) to focus on three types of entities, which to provide or finance services: local governments, public utilities and development finance institutions. The SND program may have a fund for technical assistance to which donors would be expected to contribute. Alternatively, the assistance may be administered through the Public-Private Infrastructure Advisory Facility (PPIAF), a multi-donor consortium housed at the World Bank.
The IFC will bear the entire risk for the SND program.
Governance
To administer the program, the World Bank and the IFC established a joint department. The head of the SND Unit reports to the Bank Vice President for Infrastructure and the IFC Vice President for Industries. Projects will be approved by the IFC's Board of Executive Directors. A future option involves the World Bank's establish a subnational development institution run by its own management and staff.
Ultimately, the Bank may create a new legal entity, such as IDA, devoted to subnational lending in order to skirt the legal problem posed by its Articles of Agreement. This option is viewed as more feasible than amending the Bank's Articles of Agreement.
The program follows the IFC procedure which entails seeking consent for subnational lending from the national government on a no-objection basis before the loan proposal goes to the Board of Executive Directors for approval.
SND among donors and creditors
Each of the development banks has the capacity to lend to sub-sovereigns, including the African Development Bank, the EBRD, the European Investment Bank, the Asian Development Bank (as of August 2005) and the Inter-American Development Bank (as of March 2006). Many bilateral agencies also have this capacity, including USAID's Development Credit Authority, Germany's KfW, and Agence Francaise de Developpement (AFD).
SND services
Technical Assistance:
* Capacity and policy development
* Upstream market development
* Project facilitation
Financial Support:
* Leverage local private financial markets
* Use of guarantees and derivatives
* Loans (local currency)
Utility Eligibility
To qualify for financing from the SND program, public utilities would need to operate on commercial principles, independently of support from the national government.
Creditworthiness
The World Bank views its engagement with subnational entities as helping to enhance their credit ratings, so that they can borrow on domestic and foreign capital markets. In order to achieve this goal, subnational entities must become financially autonomous by raising sufficient taxes and fees (e.g. user fees for basic services) and diminishing reliance on central governments in order to cover their expenses. The Bank promotes Fiscal Responsibility Laws governing subnational debt that requires subnational entities to balance their budgets. In order to achieve balance, many subnational entities (as with central governments) have increasing levels of contingent (off-budget) liabilities.
Client countries
The program is aimed at middle-income countries. Indeed, the World Bank has produced in-depth analysis of the potential for SND in Brazil, China, India, Mexico, Poland, Russia and South Africa. However, it will not exclude low-income countries. Technical assistance in qualifying for SND program financing would be provided in the form of grants. The program anticipates providing 40-50 grants per year during FY07-09 to help subnational entities improve fiscal performance and financial management.
According to Aldo Caliari at the Center of Concern, the program raises concerns about its potential to encourage further privatization and high levels of indebtedness by sub-national entities. It is not clear that, in spite of the lack of national government guarantee this guarantee will not have to be provided in the case of a default (for example, direct lending by the private sector to Argentinean provinces had to be assumed by the National Government after the 2001 crisis). Further concerns are raised by the fact that some FTAs currently under negotiation, such as the Colombia - US, make rules protecting foreign investors applicable not only to sovereign debt, but also to sub-national sovereign debt. (For an explanation of problems raised by these rules please check http://www.coc.org/index.fpl/1267/article/2493.html and http://www.coc.org/index.fpl/1267/article/3781.html)
II. Brazil's criteria for sub-national borrowing
(Source: World Bank, Country Assistance Strategy (CAS) Progress Report for fiscal years 2004 to 2007, May 8, 2006, p. 11)
Some criteria for lending to states:
* Fiscal health. Strong fiscal and financial performance, as evidenced by compliance with the Fiscal Responsibility Law and debt rescheduling agreements with the federal government. Relevant projects must be included in the state's PPA ("Brazil for All" the national development strategy) and budgeted.
* Commitment to reform. "States must have demonstrated a commitment to a clear, unambiguous and unchanging reform agenda, elaborated clearly in the PPA, and the proposed project must play a clear and unambiguous role in achieving the core development objectives of the state".
* Public sector management impact. The state must have demonstrated commitment to building public sector institutional capacity and public sector expenditure efficiency and transparency and the proposed project should help address those objectives.
* Sustainable growth impact. Priority would be given to those projects which have a direct impact on sustainable growth, preferably in the context of regional development.
* Poverty levels and the impact of the proposed interventions.
Additional criteria for lending to municipalities:
* Clustering. In response to government request and to ensure economies of scope in preparation and supervision, all municipal projects would be clustered in a consortia or regional package. The legal (and financial, if relevant) structure for the clustering arrangement should be clear.
* Strategic intervention. Bank engagement must focus on competitiveness and growth of the municipality, and on improving fiscal performance, municipal management and economically-critical issues, such as land management. Specific investments must be embedded in, and supportive of, these higher-level objectives.
* Lending in local currency is to be done whenever appropriate and whenever agreed upon by the municipality and federal government.
SNGs need to comply with the requirements of Brazil's Law on Social Responsibility. The richer states of the South and Southeast are most severely indebted, whereas the poorer states of the North and Northeast have greater capacity to borrow. Bank just approved a subnational loan to the state of Minas Gerais that had not met two of the five rules within the FRL.
Examples of key client states:
India. India has a three tier government structure comprising the center, 28 states and about 2700 urban local bodies, of which only 50 are creditworthy enough to access domestic capital markets. Expenditures on core services account for 12% of subnational GDP, of which only 62% are covered by own revenue sources.
Brazil. Brazil has 25 states and over 5,500 municipalities. None of the subnational governments have domestic or foreign currency ratings. There are 267 public water, sanitation and sewerage companies, only 2 (Sabesp and Sanepar) have local and foreign currency ratings. Of the public sector electric utilities, three (Cemig, Cesp, and Copel) have local currency ratings and have accessed the domestic capital market. Two (Cemig and Copel) have foreign currency ratings and have accessed the international capital markets.
Philippines. Among 1,600 Local Government Units (LGU) which consist of four levels (provinces, cities, municipalities, and barangays), 435 LGUs have preliminary credit ratings of which 19 have final credit ratings from Local Government Units Guarantee Corporation (LGUGC).
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