Municipalities Borrow Better than the State
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Under the pressure of the cuts in transfers from the republican budget, municipalities in Serbia have financially and professionally matured and have shown that they can ensure for their needs better sources of finances than the terms under which the Serbian budget has currently borrowed. Valjevo, Kraljevo and Novi Sad are examples of transparency and a good debt management, and Arilje is most probably the most successful negotiator on dinar credits, says Ljiljana Brdarević, expert on public finances in USAID’s MEGA (Municipal Economic Growth Activity) project which has been offering municipalities professional assistance.
Bif: The Serbian Finance Ministry’s public debt administration has still not presented the latest figures on borrowing by municipalities, but, according to our sample, municipalities have made progress in the quality of their borrowing, in managing the public obtainment of credits and the conditions under which the credits are contracted. The progress is such that we can say that certain municipalities are more successful negotiators than the Finance Ministry itself?
Lj. Brdarević: Based on cooperation with 32 municipalities within USAID’s MEGA program we can conclude that municipalities have realized that in conditions of the major reduction of income from transfers at the level of the Republic they need to find additional financing, and they go out onto the financial market. Based on the assistance MEGA has offered to municipalities in carrying out the public obtainment of credits, I can conclude that the credit activity of municipalities increased this year.
According to the report of the Public Debt Office, the total indebtedness of municipalities at the end of 2009 was 38.8 billion dinars, which represents half of the legal maximum for the borrowing of all the local authorities in Serbia. Space for new borrowing by municipalities is at the same level this year, around 400 million euros. Among the total of 168 local authorities, 73 municipalities have no debts.
With the increase in credit activity, this year municipalities showed a much more serious attitude to borrowing, by following trends on the market and gaining an insight into the risk of borrowing. Certain municipalities have managed to agree on credits in euros with a fixed interest rate, avoiding the risk of a change in the interested rate, which became fixed at the moment when the Euribor reference interest rate was at a very low level. The last four municipalities to which we have offered technical assistance in carrying out the obtainment of credits have managed to borrow in dinars. One such example is the municipality of Arilje which has obtained a credit in dinars, under very favorable terms.
Bif: Earlier on we blamed banks for the inactivity of municipalities, but are they truly so rigid in crediting municipalities?
Lj. Brdarević: The old story about banks not being ready to accept a currency risk when crediting municipalities is slowly changing. The reason for this is the sobering up of municipalities, which are now much more serious when borrowing on the capital market. For example, within its tender documentation Arilje clearly defined in its credit request that it wanted exclusively credits in dinars. During the public obtainment three banks presented offers for credits in dinars. This is a very positive move by banks, which have around 60 percent of their sources of funds in a foreign currency (mostly in euros).
Bif: How large is currently the potential for municipalities to borrow?
Lj. Brdarević: The Law on the Public Debt enables municipalities to borrow maximally up to 50 percent of the current budget revenues, achieved in the previous year. The upper limit for the borrowing of municipalities this year is 20 percent lower than last year, due to the reduced revenues of municipalities from transfers from the republican budget. Last year, the limit for borrowing was a billion euros, while this year is it around 800 million euros. The municipalities that borrowed up to the maximal amount last, this year have a debt that exceeds their legal limit. Fortunately, there are not many such examples.
On our sample of 32 municipalities only one municipality exceeded the limit of the total debt. The city of Belgrade is also close to this legal maximum. However, under the Law, a municipality with good financial results, measured by the size of its surplus in the current budget, can receive an approval from the Finance Ministry to borrow above the legally defined limit. Belgrade, compared to other local communities, has a high current surplus and financial stability.
BiF: Over the past year many banks have changed their attitude to municipalities?
Lj. Brdarević: Banks with foreign capital have made considerable progress by having realized that municipalities are not high-risk clients. While they were becoming accustomed to our market, they needed time to accept the fact that the risk analysis for municipalities differs from the risk analysis of companies and the citizens. At the beginning, a big problem was the fact that our municipalities do not own property, so they were unable to offer property as collateral for their debt, and this was requested by banks. In time, banks realized that municipalities have more stable income than companies and that they can approve credits on the basis of a good assessment of the fiscal and financial capacities of municipalities, without mortgaging their assets.
If we take a look at companies, they have three inherent risks: the successful realization of the production cycle, the winning and preservation of the market and finally, the collection of money for goods and services. The only risk municipalities have is to collect and distribute public revenues, in accordance with the decision on the budget, which has to be taken in accordance with realistic macroeconomic presuppositions. Therefore, the risks borne by municipalities are much smaller than the risks borne by companies.
Bif: Nevertheless, there are municipalities that do not repay their credits regularly?
Lj. Brdarević: Municipalities can be somewhat slow, i.e. they can be late in the repayment of their credits, but when a bank activates its instruments for collection, the problem has to be resolved within a few days. The statistics of the National Bank of Serbia (NBS) shows that the placements in our public sector are 10 percent of the total bank placements. If we look at the statistics of problematic credits, the unsettled obligations stemming from the public sector’s credits account for only 0.9 percent of the total unsettled obligations originating from all the credits. This points to the conclusion that certain banks, which emphasize the risky nature of placements to municipalities, are not sufficiently familiar with the financial operations of municipalities or perhaps they want to receive a larger fee for the risk through a higher price of credits.
On the market of credits for local authorities there are eight banks that actively participate in the public obtainment of credits, while the others appear occasionally. The leading bank is Banca Intesa, which is followed by Hypo Alpe Adria Bank, Komercijalna Banka, Raiffeisen Bank, AIK Bank, UniCredit, Erste and Vojvođanska Banks. The largest market share, of over 60%, is that of Banca Intesa, despite the greater activation of other banks (for example UniCredit Bank) and the appearance of new banks on this market, such as KBC Bank. The reason for this is most probably the manner in which the procedure of the public obtainment of credits is carried out. This procedure is very complicated for banks, and it represents a waste of time and money with the results of the public obtainment being uncertain. Municipalities sometimes carry out the public obtainment in an insufficiently transparent manner.
BiF: Is it the city of Čačak that has set new standards in the public obtainment of credits?
Lj. Brdarević: After the publication of the public tender in the Official Gazette of the Republic of Serbia, the city of Čačak addressed a circular letter to all banks regarding the published tender. It resulted in a large response, and as many as seven banks presented their offers.
Within the MEGA program, a model for the tender documentation for the obtainment of credits was made, and it was accepted by banks. The municipalities that carried out the public obtainment according to this model were more successful in borrowing.
Bif: Does the state represent competition to municipalities in borrowing from commercial banks? And to what extent does the borrowing of the state affect the borrowing of municipalities?
Lj. Brdarević: The state is no competition for municipalities, because the credit potentials of banks exceeds the current needs of municipalities for borrowing. However, the conditions for the borrowing of the state have a return effect on the conditions for municipalities to borrow. The price of the state’s debt is the reference value of the debt of all the entities in the public sector, including municipalities.
I would be very happy if the Finance Ministry this time opted for issuing the first state bond on a five-year period. This would have an effect on the development of the capital market and directly on the borrowing of the public sector from investors, without the mediation of bankers because this should be cheaper.
BiF: The state has, however, now made a precedent that could backfire at municipalities as well?
Lj. Brdarević: If we take a look at the results of the offer of treasury bonds, we will see that the latest auctions of bonds on a two-year period were less successful. The reason for this is probably the high interest rate for a denomination in dinars, which did not satisfy the expectations of investors, because of the depreciation of the dinar. It was published, at the same time, that the Finance Ministry was borrowing from commercial banks in the amount of 250 million euros and on a five-year period. The price of a credit is equal to the Euribor enlarged by the margin, which ranges between 4.25 and 5.3 percent. Thus, the state has accepted both the currency risk and the risk of the interest rate with a high price for the state. The question being asked is why has at least the risk of the interest rate not been avoided.
BiF: How is it that municipalities were more successful than the state in agreeing on interests?
Lj. Brdarević: Compared to the state, some of our municipalities borrowed more favorably in the course of 2010. One of the municipalities with a credit rating borrowed for a period of ten years at an interest rate in the amount of the three-month Euribor enlarged by 3.55 percent. I am afraid that such borrowing of the state will jeopardize the favorable offers of banks to municipalities.
If the price of the credit is so high for the state, what can municipalities in Serbia expect? The only mitigating circumstance is the fact that certain banks are granting credits to municipalities from the agreed on credit lines with financial institutions in the EU (EIB, EBRD, KfW), so that this can eliminate the problem. Such conduct by the state can definitely have negative consequences. One of them is also the question as to whether municipalities will now be able to borrow in dinars, if the state itself does so in euros.
Bif: Municipalities are very much affected by the persistent avoiding of the issuing of bonds, but so are institutional and individual investors, i.e. citizens who wish to invest their savings are also at a loss?
Lj. Brdarević: Institutional and individual investors gravitate exclusively towards the banking sector, without any possibility of investing in other market assets, without an increased risk. The total assets of institutional investors is currently around 709 million euros. These assets cannot be invested to a larger extent in municipality bonds unless the public placement of these securities is enabled. Individual investors, i.e. the citizens, are prevented by the Law on the Public Debt from buying municipality bonds, so the only thing they can do is keep their savings in banks, with the obligation of paying interest on the income they obtain from the interest on saving in a foreign currency.
BiF: Why are investors not allowed to buy bonds?
The question of bonds should be a question for the profession, and not for politics. The profession must be strong enough to manage to obtain these instruments. Why? Here is an illustration. If you save in the bank in euros you will receive, let’s say, interest at a rate of 4.5 percent, on which you pay a 10 percent tax to the state and you receive the amount of 4.05 percent. Contrary to this, if you purchase a municipal bond with a 5.5 percent interest, you receive the entire income from the interest, since this income is relieved of the income tax. Furthermore, if you save in the bank and you happen to need the money at a certain moment, you have to discontinue a time deposit and lose the agreed on interest, while you can sell the bond on the market without any loss of the interest for the period of the possession of the security.
Bif: The neighboring countries finance themselves much more cheaply?
Lj. Brdarević: Croatia is considerably ahead of us in that respect. It has a higher credit rating than Serbia, which enables it to obtain capital on the market at a lower price and, unlike us, they have developed the capital market. There the state borrows by issuing state securities, and municipalities have successful issues of municipal bonds.
In Croatia, theory has been confirmed in practice. Observed from the aspect of the interest rates which the municipality pays, the price of the borrowing of municipalities through the issuing of bonds is lower than the average price of a bank credit to legal entities by 200 to 300 basis points depending on the currency.
BiF: Quite interesting is the example of Belgrade and Zagreb?
Lj. Brdarević: The city of Belgrade has the privilege of an enormous, developed market, it has stable fiscal income and large potentials for development. Its only problem in the future could be the level of its indebtedness, especially in conditions of uncertain and unpredictable income from transfers of the Republic.
In my opinion Belgrade, as the capital city, should work to obtain different sources of financing than a typical municipality in Serbia. The reason for this is not only the type of competence, but also the volume of the services that need to be provided to the users. The model of financing the city should be based more on local taxes, surtaxes and fees, and less on republican transfers.
I recall the example of the city of Zagreb, which has the possibility of introducing surtaxes on republican taxes. It is through the surtax that all those who come to Belgrade should pay for what they will be using, and which has already been built by the previous and other tax payers. This would ensure the stability and predictability of the income of the Belgrade budget, while transfers would go to those who need them more.
November 25, 2010