Market discipline during financial uncertainty:The case of local government debt in Poland

The purpose of the paper is to investigate the degree to which local governments have developed the structures and procedures necessary to effectively manage debt. We present a model of effective debt management, comprising a set of standards and criteria for measuring their implementation. The model was developed using literature, best international practices of select EU countries and of the U.S. market, and the authors’ experience. In addition, the authors drafted and sent out two detailed questionnaires to over 100 institutions and local governments in EU and the U.S. The questionnaires were concerned with finance, debt management, the raising of funds for investment projects and long-term planning.

The model is an extension of the approach we presented in 2008, which was a pioneering publication in municipal public debt literature (E&Y report, Better government program, 2008).   

The paper distinguishes several, both quantitative, and qualitative, major standards, which have an impact on effective debt management, and groups these standards into three areas:

• long-term financial planning with respect to debt;
• organizational methods that are conducive to effective debt management;
• technical instruments that aid effective debt management.

The empirical part of the paper examines, over 2004-2011, the degree to which Polish local governments meet best practice criteria (standards of the model). The examination was carried out on a statistical sample of 400 local governments (out of 3000). The authors collected data mainly through questionnaires sent out to all local government in the sample. In addition, the report made use of information found on the web pages of the Public Information Bulletins of individual local governments and the Ministry of Finance.

Finally, the paper compares some important indicators concerning debt and deficit of the local government sector in select countries of the EU and OECD. The results are based on data from the Eurostat Dissemination Database (for EU member countries), the  US Census Bureau (select data for USA have been estimated based on financial reports on local governments budget execution), the SourceOECD database (for USA and Japan), and the Government Finance Statistics (GFS) database of the International Monetary Fund.

In concluding remarks we identify a number of phenomena, which, if removed, could significantly improve the effectiveness of the financial management by local governments, including debt management, and make them more transparent. The authors indicate several reasons why local governments do not meet best practices and presented standards. They include: lack of implementation of operational programmes facilitating development of the municipal market in loan funds, lack of correlation between the creditworthiness of local governments and the interest rate, as a result of deficient market discipline, lack of central government authority stimuli to make the presence of local governments on the capital market more pronounced.

The authors propose several recommendations, put to the central authorities and local governments, the implementation of which, by the coordinated efforts of central authorities and local governments, will increase  implementation of the proposed standards, and improve the effectiveness of borrowing to finance local government investments.