LGU Bonds: Inhibiting and Enabling Factors

Bureau of the Treasury Philippines

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(Second of 3 Parts)

When the Province of Cebu successfully issued its P300M Cebu Equity Bond Unit (CEBU) in 1990, some people thought that other LGUs would follow Cebu’s lead. They were wrong. Out of 1,715 LGUs (81 Provinces, 145 Cities, and 1,489 Municipalities), less than 20 of them had so far dared to float bonds since 1991 when the Local Government Code (RA 7160), the law that enabled them to explore non-traditional financing sources such as bond flotation, took effect. It seems that when pressed to fund their development projects, most LGUs find direct loans as second-best option, next to whatever is left from their Economic Development Fund (EDF) allocations.

But 18 years later, after having overcome nasty legal and political issues, spin offs and mergers, a sprawling commercial center has risen in what is now known as Cebu IT Park in downtown Metro Cebu. CEBU was the spark that made property development in this part of that city boomed.

Cebu City IT Park
Portion of the Cebu City IT Park

Will other LGUs find more merit in CEBU-like bonds this time?

Maybe the more appropriate question should be: Do conditions exist for LGU bonds to break new grounds, flourish, and even fly?

Although discussions on the potential of LGU bonds have been going on since the early 1990s, nothing much has changed positively for a full-scale development of the market for LGU bonds. In a 1995 technical paper, Jaime C. Laya identified the key constraints that keep LGU bonds from attracting more than a fleeting fancy from both LGUs and the investing public, viz:

  • Government regulation of Bond Issues. In the absence of pertinent rules and regulations, Securities and Exchange Commission (SEC) rules on corporate bond issues had been applied to LGU bonds. But LGU financial operations are different from financials of private corporations, posing daunting tasks for agencies involved in the review and approval process for flotation of LGU bonds.
  • Constraints in the design of an LGU bond issue. Project identification and development for which bond proceeds can be used may not be a major constraint for LGU planners, considering the wealth of related trainings they have been exposed to. But the task of designing the instrument itself (bond packages)—which may require unique properties in terms of coupon rate, term/tenor, denomination, selling price and effective interest rate, for example—is new to many of them and may require hiring of financial advisor. It can add cost to a bond package that will have to compete with other investment opportunities in the capital market.
  • Marketability. How will LGU bonds compete with other public and private sector issues? Quoting Laya: “In the continuum of risk and return, debt instruments of the national government would expectedly have the lowest risk and the least returns. Other things being equal, the next would be LGU and government corporations, private corporation debt paper, preferred stock, and common stock. There would be gradations within each category: small LGU vs. large LGU, guaranteed and non-guaranteed LGU debt, banks as against nonbank financial institutions, public utilities as against ordinary corporations, and others.”
  • Bond ratings. Credit ratings, when persuasive, boost investor confidence. LGU bonds have a long way to go in this respect.
  • Liquidity mechanism. Another come-on for a debt instrument is the ease by which its holder can convert it to cash. However, repo and the secondary market for LGU bonds remains at fetal, if not embryonic, stage.
  • Adjusting to bond trading mechanics. For lack of a comprehensive legal and administrative framework, mechanics on pricing of bond issue as well as debt service payments by LGUs are open to operational risks involving a phalanx of government auditing and regulatory agencies.
  • Taxes. As in most other features for which an enabling environment is needed to buttress the marketability of LGU bonds, there is need for a comprehensive and coherent tax policy that can adequately inform prospective investors on their decision making process.
  • Payment mechanics. Whenever a debtor LGU runs into cash flow problems and its capacity to service debt is compromised, the available options—such as IRA intercept—almost always dampen investor appetite.

The above constraints are not easy to address. A law that specifically responds to them, and one that provides a comprehensive and coherent policy action for promotion of LGU bonds, should be helpful.

Offhand, the good news is that no one has to start from zero. There have been inroads from both government and private sectors towards pushing greater acceptability for LGU bonds. The Banko Sentral ng Pilipinas, for example, issued guidelines on flotation of bonds by LGUs in 1994 and 2003. The LGU Guarantee Corporation, a private firm put up by officers of the Development Bank of the Philippines and the Bankers Association of the Philippines, offers a range of services to LGUs interested in bond flotation—as Financial Advisor, Trustee and/or Guarantor. It also initiated steps that aim to establish a credit rating system for LGUs.

And maybe the one strategic resource that can hasten the building up of institutional capacity for LGU access to the domestic capital market is the combined experience and skills gained over the years by government (especially the Bureau of the Treasury) in managing Treasury Bills and Bonds. The BTr has technical knowhow and tools to provide training for LGUs on the basics of designing (eg pricing) bond packages, as well as on operational requirements related to flotation of bonds.

But then again—and this question has been raised a number of time elsewhere—why are LGU bonds important?

There are at least three pressing concerns that make LGU bonds worth looking at:

(1) The spatial distribution of economic opportunities is necessary for the countryside to develop. The government has a handy approach to get this process going: relocate government offices to provinces or cities that offer viable proposition for property development. Urbanization needs to be managed in such a way that investments are attracted to go local. The CEBU model has shown that business attracts in-migration, and in-migration, in turn, fuels business viability. This is why malls and condos keep sprouting in mega cities.

The unmitigated human and vehicular traffic congestion in big cities like Metro Manila and nearby areas, and the side effects it creates by way of pollution, overall inefficiency in economic activities, along with proliferation of street crimes, makes it necessary for government to look for non-traditional solutions to existing problems. Getting the LGUs primed up for the challenge by promoting non-traditional development financing schemes like LGU bonds could be one of the solutions.

(2) Most LGUs, especially provinces and municipalities, can hardly do anything more than paying for salaries of their employees unless they are able to raise the current level of their revenue intake. They live almost solely on the so-called Internal Revenue Allotment, or IRA. There is little they can do to aggressively pursue their development agenda. For example, poor LGUs may have a full complement of Agriculture Extension Workers, but none of them is going out to the barangays. The reason: nothing is left of the budget for Operating Expenses that will take care of their travel expenses.

One basic caricature of a poverty cycle shows people from rural areas migrating to cities because there is lack of livelihood opportunities in their communities. Employers, except the Mayor, do not exist. Businessmen shy away from the area because volume of human traffic hardly favors profitability. Farming? The habal-habal that takes their products to the poblacion charges more fees than what they can possibly earn in 12 hours of hard manual labor.

When the market fails—such as in situations where private investments are inhibited because of low prospects of return—the government must step in. The LGUs will need to expand their development portfolio. The national government will do well to enable them by providing greater access to financing outside of the IRA.

Breaking the poverty cycle requires more than your business-as-usual worldview. Innovation is key. LGU bonds could be an idea whose time has come.

(3) The capital market is big enough to welcome everyone, including small players, as shown by BTr’s Retail Treasury Bonds.

LGU bonds can stoke local pride. Like sports fans who patronize their home teams (related info: the Golden State Bridge in San Francisco, USA, was built by Municipal Bonds), the locals that create diaspora surplus can fuel LGU bonds. The dividends can be bigger than what people would initially think: buyers make money from their investments; LGUs are able to implement projects now rather than later; and the general public gets to benefit from those projects.

Further on, community buy in will raise the bar of stakeholdership. As people demand more accountability from their local officials, the latter will be pressed to perform and deliver, with competence and integrity. They raise collective support for good governance with their wallet, not with slogans.

Observers may find inspiration in symbolism: Buying RTB is placing a bet on the success of the government. Buying LGU bonds is like a wager on your local team.

 

References

Habito, C. F. (2014, December 2). The Promise of LGU Bonds. Retrieved from Inquirer.net: https://opinion.inquirer.net/80596/the-promise-of-lgu-bonds#ixzz5UMGmoEvZ

Laya, J. C. (1995). Developing a Philippine Local Government Bond Market. Journal of Philippine Development, 135-150.

Lim, F. (2014, March 13). Developing the Municipal Bond Market. Retrieved from Inquirer.net: https://business.inquirer.net/166027/developing-the-municipal-bond-market#ixzz5ULJZ875c

Orial, L. N. (2003). Philippines. In e. Yun Hwan Kim, Local Government Finance and Bond Market (pp. 385-427). Manila: Asian Development Bank.

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