SEMINAR SERIES ON DECENTRALIZATION
Topic: Sub-national Access to the Capital Markets: The Latin American Experience
Panelists: Mila Freire (WBIGF) and Marcela Huertas (CMD)
Summary
Marcela Huertas and Mila Freire began the seminar by explaining the role of the
World Bank in assessing the potential of capital markets in Latin American
Municipalities. 1 According to the panelists, a global program on capital market
development at the sub-national level was launched one-and-a-half years ago. The first
step in the creation of this program was to develop a methodology to lend across regions
and to discuss issues such as moral hazard. Upon creating this methodology, Bank staff
met with the main regional players at seminars and conferences to explain the need for
capital markets. The LAC region held a workshop on capital markets and developed a
draft training manual and CD ROM to aid local authorities in the learning process.
Finally, the Bank staff in the region designed a financial strategy for implementation in
Bogota.
According to Huertas, the objectives for Bogata, Colombia, for which the city
financing strategy was approved by the CMU, were (1) to build the technical and
institutional capacity necessary to implement cash flow management, asset management,
and debt management through a financial framework; (2) to create in-depth working
plans for the city financing strategy; and (3) to disseminate crucial information on cash
flow, asset management and debt management through knowledge management
activities. Huertas then presented the results from two case studies, focusing on
international and domestic issues for big and medium sized municipalities.
Case Study I: Rio de Janeiro, Brazil
Brazil has the highest per capita sub-national debt in the LAC region. In 1997, the
aggregate state and municipal stock of debt reached more than $800 per inhabitant
compared to $500 in Argentina, suggesting that Brazil's macroeconomic volatility was
the result of an ineffective budget constraint. Rio de Janeiro has a population of
approximately 5.6 million people and is the home of many financial institutions,
including the Central Bank and the Banco do Brazil, and has the second largest stock
exchange in the country. In 1994 Brazil’s inflation rate was 929% caused partly by
heavy government borrowing. Such runaway inflation led to the introduction of the
Plano Real in 1994, a tight monetary policy that led to lower inflation of 9% by 1996.
The largest object of default was state bonds which reached R$31 billion at the end of
1994. In response, the Federal government implemented a troca arrangement, whereby
the floated bonds were transferred to more readily marketable Federal or central bank
bonds and the Federal government became responsible for repaying the debt. The
Federal government wished to avoid running into a fiscal deficit by federalizing the state
debt, which totaled $123 billion, and did not allow the state government to borrow to
1
For further information, refer to Freire, M., Huertas, M., and Darche, B., "Sub-national Access to the
Capital Markets: The Latin American Experience, Selected Cases"
refinance its own debt. This high level of sub-national debt suggests that Brazil suffered
from weak budget constraints in terms of sub-national borrowing. Moreover, Brazilian
states' access to capital markets clearly led to tremendous fiscal imbalances.
In response to this macroeconomic crisis, the state government of Rio de Janeiro
opted to issue bonds in order to refinance its existing short-term debt. The Eurobond was
issued in 1996 with an interest rate of 10 3/8 percent paid per annum and guaranteed by
the municipality. Issuing bonds had a positive impact on this municipality, as it made the
government very transparent, e.g., the budget was loaded onto the Internet. This also
demonstrated to the center that Rio de Janeiro's state government was capable of
obtaining credit. Among the obstacles that were faced, the state had to learn to analyze
local government finances and overcome unfair restrictions placed on it by the federal
government.
Case Study II- Municipality of Guaymallen, Argentina
Guaymallen is located in Argentina's Province of Mendoza with a population of
222,000 and is noted for its small industrial center for agriculture, wine, and cattle. In
1991, bonds ("ley de convertibilidad") were issued in an attempt to implement a
stabilization plan in Argentina. The plan required bonds to be placed simultaneously in
the international and domestic markets at a fixed exchange rate to the dollar. The
Ministry of Economy's power to devalue the currency was removed, and the monetary
base did not exceed the dollar value of international reserves. In 1992, a new Central
Bank charter enforced two measures on provincial banks: (1) to maintain liquidity,
provincial banks had to depend on depositors' confidence; and (2) the central government
could not continue to rediscount loans by provincial banks to provincial governments.
The impact of this budgetary constraint became apparent in 1994 when the Tequila Crisis
hit. What resulted was a tightening of the budget constraint put in place by the 1991
Convertability Law -- a very successful stabilization plan. Cuts in expenditure became
inevitable and had a negative impact on the provincial and municipal finances.
In response to these shocks, the government of Guaymallen issued bonds to raise
money for public works such as paving roads and fixing water pipes. The bonds were
divided into three tranches, the first being issued in 1996 to mature in 1999, during the
current mayor's term. The bond had a fixed interest rate of 10% with five principal
repayment periods, and was underwritten by Mercado de Valores de Mendoza S.A.
Guaranteed by Betterment Levies on Property Improvements, the bond was privately
placed in the Buenos Aires stock market with a AAA rating. The rating was given by
two agencies, Magister/Bankwatch Calificadora de Riesgo and Standard & Poor's, and
was based on several factors, including the municipality's image and credibility and more
importantly, the collateral base promised by the administration.
The second tranche was issued with a shorter maturity of one year. With 9.5%
interest on the note, the minimum purchase was USD $100. The third tranche never
materialized because the current government did not wish to transfer new debt
obligations to an incoming administration. The purpose of issuing these bonds was to
strengthen credibility in the domestic bond market, as well as to support public works
programs. Guaymallen was also able to benefit from effectively targeting institutional
investors in the Mendoza Exchange and is considered a best practice amongst capital
market development for a small to medium sized municipality.
Based on these case studies, Huertas pointed out the following: (1) that well known
and internationally recognized municipalities will have better access in international
capital markets. (2) Some form of collateral such oil revenues/ royalties will be
necessary for the issuance of revenue bonds. (3) International market players should be
aware that federal government guarantee and bail outs are unlikely and such risks are
likely inherent in these issues. (4) Since Bond rating processes are vital in the
structure/success of these capital market placements, one of the key concerns is the
maintenance of uniform standards of accounting, reporting and disclosure. Thus,
international accounting standards are to be used when preparing financial statements.
Moreover, a well established, self-regulated body for credit rating should be created for
structuring these bond issues. (5) The ability to measure the standard of performance of
investment bankers, lawyers and financial advisors is important, and the quality of
financial management information and reporting systems are also vital in the successful
placements of these instruments.
The session closed with a list of challenges and opportunities created by the
financial crisis which included fewer bail-outs from the central government and reducing
tensions between federal and sub-national government. Opportunities included focusing
on technical assistance and capacity building, improving financial management at the
local level, and preparing City Financing Strategies.