Access to Debt Financing - Opportunities for Improvement of the Investment Capacity of Bulgarian Municipalities Articles (forEconomic the period Alternatives, 2003-2015) 2017, Issue 3, pp. 390-404 Access to Debt Financing - Opportunities for Improvement of the Investment Capacity of Bulgarian Municipalities (for the period 2003-2015 )

Desislava Kalcheva* Bulgarian National Bank and of the National Statistical Institute, data concerning state Summary debt, published on the official site of the Ministry of Finance, and data from a survey The activities regarding further conducted among Bulgarian municipalities. improvement of the degree of fiscal The research methods used are: historical decentralization in started in 2003. analysis; analysis and synthesis; induction As a result of initiated reforms, Bulgarian and deduction; descriptive analysis, survey. municipalities gradually improved their abilities to generate revenue, obtained new Key words: debt financing; decentralization; responsibilities regarding expenditures, investment capacity. including these for construction, maintenance JEL classification: H74; H76, G32, H63 and expansion of local public infrastructure, and gradually improve their access to debt 1. Introduction markets. nvestment capacity of local authorities This paper presents an examination means the potential and the ability of the development of debt financing I of local governments to participate in of municipalities in Bulgaria. The aim is the construction and maintenance of to reveal how decentralization opened public infrastructure. Main determinants up opportunities to finance municipal of municipal investment capacity are: investments through debt, as well as to the level of fiscal autonomy of local determine the character of debt financing as governments, structure and composition regards the increased municipal investment of budget revenues, the mechanism of capacity. The period of research is 2003- government transfers, revenue autonomy, 2015 because this period ensures more municipal expenditures and their structure, accurate results. The object of analysis access to capital markets (Hulbert, is debt financing while the research topic Vammalle, 2014, p.19). is the changes in the municipal domestic Debt financing of local public investments debt in Bulgaria. The main information base is a well-known practice. Countries with includes data about the performance of high level of decentralization actively apply municipal budgets, statistical data of the this practice. Local authorities have limited * Desislava Kalcheva, PhD in Finance, Currency Circulation, Lending and Insurance; Head of Risk Management Department at Fund for Local Authorities and Governments in Bulgaria – FLAG, JSC; e-mail: [email protected].

390 Economic Alternatives, Issue 3, 2017 Articles resources and borrowing from private capital services are the additional risks of debt markets allows them to make investments financing of local investments. In a situation in infrastructure that are far bigger than the with imposed high costs for debt service, ones they would have made if rely only on the local government is obliged to reduce its current funding. operating costs in order to avoid problems Debt financing is an attractive option for with the recovery of used borrowed funds. raising funds for local public investments. In this a case, because of reduced quality The major reasons for the rising demand for of local services and goods, it can lead the use of borrowed funds are: an increasing to dissatisfaction in the local community need for implementing and maintenance of (Swianievicz, 2004, p.8). local public investments; the lack of sufficient Local debt bears risk at the own budget revenues covering future capital macroeconomic level as well, since it is costs, the need for maintenance and a part of general government debt. Due rehabilitation of existing infrastructure. to economic costs, stemming from the The main advantages of debt financing government's refusal to provide financial of the construction and maintenance of support to local authorities, often central local infrastructure are: fair distribution of authorities guarantee repayment of local the benefits and of the burden of financing debt. This deteriorates local authorities’ costs - these conditions imply fairness discipline and the latter tend to transfer their between generations; reduction of operating expenditures to the central authorities. budget expenditures, promotion of economic According to the Golden Rule, it is development in the municipalities; use of appropriate to use debt financing for basic methods for analysis and assessment of investment purposes and as an exception investments and provision of improved access – for short-term debt to finance operational to European and other international funds costs. Capital markets determine the best and programs (Yilmaz, Ebel, 2002, p.39). way for municipalities to obtain loans The improvement of allocation effectiveness and thus encourage local authorities for is an additional advantage of debt financing responsible management of both- their own of local infrastructure. This is due to the fact funds and their borrowings (Kellermann, that debt financing creates incentives for local 2007, p. 1089). authorities to select the most appropriate and Considering the reforms in local finances cost-effective priority projects. in Bulgaria that started in 2003, municipal Of course, in the scientific literature we debt financing has gained popularity as can find arguments against debt financing an instrument for financing of local public of local public investments. For example, investments. It is assumed that municipalities' unduly high use of debt financing can increasing revenue autonomy is essential lead to the imposition of an additional tax to the improved access to capital markets burden for citizens and the emergence of (Petersen at all, 2000). The European perennial local budget deficits. The high Charter of Local Self-Government1, which level of indebtedness places the region in a was ratified by a law passed by the National situation of a debt trap or a debt overhang. Assembly in 1995, also recommends the The formation of budget deficits and use of borrowed funds to finance municipal debt servicing instead of providing public investment costs.2

1 Adopted in Strasbourg on 15 October 1985 2 Art. 9, p. 8 EHMS: In order to finance investment costs, local authorities should have access to the national capital market in accordance with the law.

391 Access to Debt Financing - Opportunities for Improvement of the Investment Capacity of Bulgarian Municipalities Articles (for the period 2003-2015)

2. Debt financing and Bulgarian Desislava Stoilova's research is of municipalities interest with regard to deficit financing of municipalities. She studies the general 2.1. Review of the research on the topic benefits and risks of local debt financing, The process of fiscal decentralization general opinions concerning the balanced is of interest to both business and the budget, mechanisms for limiting and control research communities. Basic prerequisites of the municipal debt, the practice of for municipal access to the debt market debt financing in CEE, an overview of the are the gradual rise in the level of fiscal municipal debt market in Bulgaria in 2005 decentralization and improved capacity (Stoilova, 2005). of the municipalities to generate revenue. The studies of Vladimirova and Authors that do research in the field of Naydenov are associated with the general fiscal decentralization and municipal debt issues concerning municipal debt and the financing in Bulgaria are Presiana Nenkova, regulatory framework of debt financing in Desislava Stoilova, Ludmil Naidenov, Todorka Bulgaria (Vladimirova, Naydenov, 2011). Vladimirova, Stefan Ivanov, Ginka Chavdarova Experts of the Ministry of Finance estimate (National Association of Municipalities in the and disclose periodically the indicators Republic of Bulgaria), Emil Savov (National for the assessment of the level of fiscal Association of Municipalities in the Republic decentralization and of municipal access of Bulgaria), Daniela Ushatova (National to debt markets. Experts in the National Association of Municipalities in the Republic Association of Municipalities in the Republic of Bulgaria) and others. of Bulgaria and in the Institute for Market The research of Presiana Nenkova Economy prepare a periodic analysis of the considers municipal debt financing in terms general indicators for fiscal decentralization and information about the overall municipal of the sources of municipal investments. debt market context. Municipal debt market Funds for capital investments, in addition to in Bulgaria is the subject of analysis in the government subsidies and sales revenue, annual reports prepared by the Network of are being provided by using loans from Associations of Local Authorities of South- financial institutions and the accumulation East Europe (NALAS). of resources through municipal bond issues The aforementioned studies explore (Nenkova, 2007, p.134). The issuance of basic features of the municipal debt municipal debt in Bulgaria is an alternative market in Bulgaria, but they do not expose option for raising of funds needed to improve the opportunities available to a single the quality of delivered municipal services municipality in order to have access to the and related infrastructure. Debt financing of debt market. local activities and local infrastructures is Municipal debt as a part of the consolidated considered as appropriate in case of a stable debt of Sector "General Government" is and adequate local revenue as well as a of interest at the macroeconomic level. sufficient managerial and financial capacity The impact of government debt on the for the responsible use of credit. Since the macroeconomic activities in Bulgaria can be majority of Bulgarian municipalities are in considered with regard to its short-term and a poor financial condition the use of debt long-term effect. financing may lead to further problems and The empirical results show that the inability to perform their duties (Nenkova at increase in short-term government debt all, 2005, p.39-40). stimulates real GDP growth. When long-

392 Economic Alternatives, Issue 3, 2017 Articles term impact is considered, however, the base and increase local government's stimulating effect of government debt revenue autonomy. Dedicated action to set growth on GDP dynamics is observed only a decentralized public finance system in up to a certain level, beyond which debt place resulted in a visible improvement of increase produces adverse effects on financial self-sufficiency of local authorities. macroeconomic activity (Velichkov, 2016). (Nenkova, 2014). The reform is a prerequisite for the 2.2. Practice of debt financing increase of the creditworthiness of of Bulgarian Municipalities local governments, and opens up new Since the start of reforms in the 1990s, opportunities to ensure additional funds for 3 Bulgarian municipalities have no right to the municipal budgets . use borrowed funds and to use their own Basic legislation concerning municipal property (different from state property) debt financing: State Budget Act, Municipal as a pledge. There was a legal limit for a Debt Act, Public Finance Act (which partially municipal budget deficit until 2001 – up replaced the Municipal Budget Act), Public to 10% of the total value of revenue. This Offering of Securities Act, guidelines, and restricts the right for use of debt financing. regulations of the Ministry of Finance, internal regulations of municipalities and Limited debt financing is determined by municipal ordinances regulating debt additional factors such as: low value of own financing, and others. local revenue, high dependence on state According to Art. 3 of the Municipal transfers and lack of opportunity to generate Debt Act, Bulgarian municipalities can take operational surplus. debt by a decision of the municipal council. As a result of reforms of fiscal The decision to take municipal debt decentralization, local authorities in should include: maximum amount of debt Bulgaria gradually increased their revenue expressed in nominal value; currency of and strengthened their administrative and the debt; type of debt; manner of provision financial capacity. The process began of collateral; terms of repayment; maximum to gather momentum in 2002 when the interest rate, fees, commissions and government adopted a Concept paper on others. The decision has to be taken by a fiscal decentralization and an action plan majority of more than half of the municipal on its implementation. A number of key councilors or following a local referendum reforms were pushed forward with the aim to conducted by virtue of a decision of the broaden the municipal own-sources revenue Municipal Council.

3 Local Authorities are allowed to independently determine the types and amounts of municipal fees, the right to introduce new prices for services by a decision of the Municipal Council, and the right to exempt indigenous groups from payment of the relevant fee, following amendments made to the LTFA in 2003. In 2006, municipalities began to administer local taxes independently. In 2007, by an amendment to Art. 141 of the Constitution of the Republic of Bulgaria, Municipal Councils of local jurisdictions acquire the power to determine the amount of local taxes under terms, conditions and limits established by law. For the first time Bulgarian municipalities acquire real tax powers as a consequence of the amendment. Based on the change, local authorities set rates in accordance with the legal restrictions, but do not have the competences in determining the types and the tax base of local taxes. During the period 2003-2015, the road tax was dropped from the scope of local taxes, but include: patent tax, tourist tax, and from 2016 the car tax for taxis. The essential prerequisites for achieving a higher level of investment capacity of local authorities are: increase of their authority to collect revenue, improved collection of local taxes and fees by a local administration, as well as enhancement of the expenditure responsibilities of municipalities and accordingly for increase of local investment capacity. The Municipal Budget Act was repealed by a Decision SG issue № 15 dated February 16, 2013

393 Access to Debt Financing - Opportunities for Improvement of the Investment Capacity of Bulgarian Municipalities Articles (for the period 2003-2015)

Upon assumption of debt and adopting of 2015 (Ministry of Finance). Bank` loans a debt strategy, the municipality should take have the largest share of municipal debt into account the provisions of the Public financing. According to the Methodology of Finance Act. According to Art. 32. (1): The the Ministry of Finance, debt to specialized annual amount of payments on municipal nonbank financial institutions like Fund debt for each municipality per year may not for Local Authorities and Governments in exceed 15 percent of the average amount of Bulgaria (FLAG), Energy Efficiency and own revenues and the general equalization Renewable Sources Fund (EERSF) and subsidy for the last three years, calculated Enterprise for Management of Environmental on the basis of data from the annual reports Protection Actions (EMEPA) is included in on the implementation of the municipal the total value of municipal` loans.4 budget. The nominal value of the municipal We have to note that at the end of the guarantees issued during the current budget budgetary year a major portion of the bank year may not exceed 5 percent of the loans are investment loans. The overdraft total revenue and the general equalization loans which the municipalities use are subsidy according to the last annual report extended for a period of one year and have on the implementation of the municipal to be repaid at the end of the year. Usually budget. The annual debt payments due at the end of the year local authorities include principal, interest, fees, commissions repay also the revolving loans Therefore, the and other payments on debt assumed by exposure of municipal debt at the end of the municipality. the year is used for financing of municipal Municipal debt consists of municipal investments, which is a prerequisite for the obligation bonds, debt taken thorough increase of the investment capacity of local contract for municipal loans, required authorities. municipal guarantees, interest-free loans Bulgarian municipalities increased the under the Public Finance Act and financial value of borrowed funds annually during the leasing and commercial loans (Municipal period 2003 – 2015. While at the beginning Debt Act). of the period the value of attracted resources The Municipality can take a long- in local budgets amounts to BGN 43 million, term debt for financing of investment in 2015 the value of domestic debt financing projects in benefit of the local community, reaches nearly BGN 697 million (Statistics for refinancing of current debt, debt for of the Bulgarian National Bank and the prevention and elimination of consequences Ministry of Finance). of force majeure and others. Bank financing has a dominant share The Municipality can take a short- in the total municipal` debt financing and term debt for financing of: public services represents between 50% and 75% of the in temporary shortage of funds in case of total amount of municipal debt financing. temporary cash disruptions in the municipal Financing through financial leasing budget; capital expenditures; urgent and commercial leasing is also on the rise expenditures for prevention and liquidation during the survey period. The municipalities of consequences of force majeure etc. finance through leasing the construction Debt financing of Bulgarian municipalities of street lighting, purchase of vehicles, has evolved substantially in the period 2003- purchase of waste collection equipment,

4 To encourage local investment, the state creates funds and non-banking institutions that support the financially weaker municipalities. Examples are the EERSF, EMEPA and FLAG.

394 Economic Alternatives, Issue 3, 2017 Articles etc. There is no requirement for additional local authorities with low creditworthiness pledge5 when municipalities leasе, and to borrow resources from FLAG, the State it is possible to negotiate longer term for has the right, at its discretion, to recover servicing of the obligation which means some of the interest payments incurred by less burden on the municipal budget. municipalities. At the end of 2015 FLAG Financial leasing is being used by big funding constitutes about 41% of the municipalities with a good fiscal position, domestic municipal debt, incurred through as well as by small municipalities with municipal loan contracts (Fund for Local limited fiscal assets. As at the end of the Authorities and Governments, 2015). survey period obligations under financial The increase in 2015 is due to the end leasing amounted to approximately 3% of of the payment period on projects under the domestic municipal debt (Ministry of the programming period 2007-2013. For the Finance, Information on general debt in successful implementation of projects under Sector "General Government") various European programs, municipalities In order to cover the temporary deficit actively use loans provided by FLAG for in municipal budgets, commercial banks bridge financing and for funding of their own provide financing thorough short term loans contribution. or loan overdraft to municipalities for the As already noted, besides FLAG, the implementation of infrastructure projects. State supports municipal debt financing In the period 2003-2015, municipalities’ through the EERSF and the EMEPA. debt exposure (bank financing) increased As at the end of the budget year, bank significantly. In 2003 the domestic debt investment loans have a significant share in exposure of bank financing stood at around the total debt exposure. Banks approve loans BGN 22 million and at the end of 2015 it was to municipalities with high creditworthiness. around BGN 602 million. Substantial growth The municipality has to be in a satisfactory was reported during the period 2010-2012 fiscal condition (including absence of or low and as at the end of 2015. value of reported outstanding liabilities and The financial support of "Fund for receivables, positive net operating balance, Local Authorities and Governments in etc.), should have good indicators for Bulgaria – FLAG", JSC contributed to liquidity, moderate indebtedness and have a the increased exposure of the municipal good credit history. 6 loans. The Company activities are targeted Municipal obligation bonds as a debt at supporting the municipalities in the instrument are important and popular among implementation of projects financed by the municipalities. Obligation bonds are an Structural and Cohesion Funds of the EU. alternative form of financing of investment It provides bridge financing and financing projects. They allow for raising of funds from of municipality`s own contribution in the capital markets at attractive prices as well European projects. as for diversification of investors/creditors. Small and medium-sized municipalities External resources accumulated through with limited own revenues are the financing bond issues are used only for financing of targets of the fund. In order to enable vital municipal projects.

5 except property that is acquired as a result of lease Ministry of Finance, information on the consolidated debt, Sector "General Government", www.minfin.bg. 6 According data of the Ministry of Finance, at the end of 2015 overdue liabilities of Bulgarian municipalities are equal to BGN 189.9 million. The number of municipalities without overdue liabilities is 116, and the number of municipalities with overdue liabilities is 149. , , and are municipalities with the highest level of overdue liabilities.

395 Access to Debt Financing - Opportunities for Improvement of the Investment Capacity of Bulgarian Municipalities Articles (for the period 2003-2015)

Total value of debt incurred by at the end of 2015 stood at BGN 570 municipalities under bond issues increased million which is close to the amount of in the period 2003-2011. During 2011 the total exposure of domestic municipal debt. bond issues reached their highest exposure Japan Bank for International Cooperation, – BGN 113 494 thousand. During the next European Investment Bank and European 2 years bond exposure decreased due to Bank for Reconstruction and Development repayment of part of municipal obligations are the main creditors of the Municipality of as well as because of deterioration of fiscal . The share of the Municipality of Sofia markets, which is the reason for lack of debt compared to the total municipal debt is investor` interest in municipal bonds. around 48% for 2013, around 52% for 2014 Although, during the study period the and around 47% for 2015. municipal bond issues reach up to 25% Municipality of , Municipality of the total domestic debt financing, they of Varna and Municipality of also remain a relatively rarely used by Bulgarian have access to the internal capital market. local authorities instrument. At the end of These municipalities use financing from 2015 municipalities with residual debt on the European Bank for Reconstruction and bond issues are only nine – Nessebar, Varna, Developments. The financing is targeted , , , , at important municipal investments for Plovdiv, and . The total education infrastructure, street infrastructure, value of municipal bond issues at the end rehabilitation of boulevards and others. of 2015 is around 14% of the domestic We reach the conclusion that during the municipal debt. surveyed period according to the statistics, The municipalities that use domestic debt financing of municipal investments debt financing for investment purposes are marks a significant growth in absolute value. the municipalities with good fiscal position, However, the data presented does not allow high share of own revenue, low dependence us to reach conclusions concerning the on state transfers. At the end of 2015, local opportunities for small and medium- size governments using debt financing intensely municipalities to access the debt market. are: Burgas (debt exposure is around 4.70% So a survey concerning the ability to access of the value of total domestic municipal debt), the debt market was conducted among Varna (debt exposure is around 11.4% of Bulgarian municipalities. the value of total domestic municipal debt), Plovdiv (debt exposure is around 5.06% of the 3. Study on attitudes of local value of total domestic municipal debt) and authorities regarding access (debt exposure is around 3.50% to debt financing of the value of total domestic municipal debt). Municipalities with debt exposure around A questionnaire regarding access to 2% of the value of total domestic municipal debt financing was prepared and sent to debt are: Kustendil, Pazardzhik and Shumen. Bulgarian municipalities in order to evaluate Municipal bond issues constitute a major the attitudes of Bulgarian municipalities portion of the debt.7 concerning the use of investment debt The Sofia Municipal Council uses debt financing. The research was done by financing only from foreign creditors. The the Department of Finance, University of debt exposure of the Municipality of Sofia National and World Economy, Sofia.

7 This information is based of public information accessible on the websites of the municipalities.

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The questionnaire addressed 60% of the 3.1. Comparison of debt instruments that Bulgarian municipalities. Responses were have been used by municipalities received from 37% of respondents. The big in the years 2003 and 2013. municipalities with high level of own revenue like Sofia, Varna. Plovdiv, Varna, Burgas, In the survey municipalities report on Stara Zagora and others are not included in the number of debt instruments which they excerpt. It is clear that these municipalities have used in the years 2003 and 2013. The have no difficulty to access debt financing. submitted survey information is in areas Small and medium – size municipalities are such as: bank investment loans; overdraft the main target of the research. loans; municipal bond issues; financing from The survey is instantaneous and concerns EMEPA; financing from EERSF; financing data for the years 2003 and 2013. The survey from FLAG; financing from foreign creditors. involves two groups of questions, namely: The selection of debt instruments is 1. What kind of debt instruments the municipality in line with the practice of municipal debt used in the years 2003 and 2013? financing during the last years. Even though 2. Did the municipality have difficulties in they are state enterprises which support accessing debt financing? If the answer debt financing of Local Authorities, the loans is yes, please point out the reasons. provided by FLAG, EERSF and EMEPA are As a result of the survey we received considered as debt instruments. answers from 57 municipalities or 37% of the FLAG provides loans to municipalities and respondents. The respondents are as follows: municipal companies with temporary shortage , , , Kula, of resources in the implementation of projects , , , , financed by the Structural and Cohesion , , , , Funds, EERSF finances the construction Nessebar, Chavdar, , , of energy efficient municipal buildings, Nevestino, Banite, , , including schools, and EMEPA finances the , , , construction of municipal infrastructure related Aksakovo, , Dimitrovgrad, Madan, to environmental protection. , , Aitos, , , Any debt area is reported as 1 if the Dulovo, Maritsa, , , municipality is funded by it and 0 if the Ruzhintsi, Popovo, , , Rila, municipality is not funded by it. The number , , Rodopi, , Dzhebel, of financings through one and the same (item Tvarditsa, Satovcha, Ruse, Chelopech, , , , , of) debt instrument within a municipality is not Gotse Delchev, , Strumyani. being recorded. The results after processing The results after data processing are as the questionnaires regarding the use of debt follows: instruments are shown in Table 1. Table 1. Results from analysis of debt instruments used during the period 2003-2013 by municipalities which participated in the survey.

Bank investment Overdraft Municipal Foreign Year EMEPA EERSF FLAG loan loan bond issues creditors

2003 71,4% 0,0% 0,0% 14,3% 14,3% 0,0% 0,0% 2013 22,5% 8,8% 1,3% 22,5% 3,8% 39,8% 1,3% Source: Questionnaires

397 Access to Debt Financing - Opportunities for Improvement of the Investment Capacity of Bulgarian Municipalities Articles (for the period 2003-2015)

The results for the year 2003 show that that regulates debt financing, the number of the municipalities have benefited most from municipalities which use debt financing, mainly bank investment loans - financing through bank investment loans, increased. this debt instrument represents 71.4% of all This conclusion is confirmed by the results types of financing, then the percentages of the survey for the year 2013. There is a are divided between funding by EMEPA and significant rise in the use of debt instruments by EERSF – around 14.3% for each debt in 2013. Around 74% of the respondent instrument. Total number of debt financings municipalities use debt financing for certain through all debt instruments is very limited. budget items. The biggest increase, however, Only five of the respondent municipalities was observed in the financing provided by have used debt financing, of which only Fund FLAG - nearly 40%. Zlatograd has benefited from funding under Bank investment loans and funding two items simultaneously. from EMEPA share around 22.5% each. This means that the 71.4% financing Municipal bond issues and financing from through bank investment loans are barely foreign creditors are the least used debt equal to five municipalities in absolute terms. instruments. It is not surprising that FLAG Or in other words, in 2003 out of 57 financing predominates because many municipalities which responded, only five municipalities which implement European municipalities have indicated the use of projects need additional financing. The bank investment loans. These municipalities reasons for using FLAG financing are: are Sevlievo, Zlatograd, Popovo, Loznica and temporary shortage of funds in the course Chelopech. One municipality - Zlatograd of project implementation (when the so stated in its response that it uses a loan called bridge financing is used, it recovers from EMEPA and another municipality the funds from the grant), and/or need of stated that it uses a loan from EERSF – funds to provide the own contribution of the the Municipality of Banite. There are no municipality in the project. reported municipalities which use bond In addition, payments to FLAG are not issues or overdraft loans. Based on the included in the percentage of the limit for processed results, a very low level of activity payments on municipal debt according the regarding the use of debt instruments by Public Finance Act.8 local authorities is reported in 2003. The prevalence of FLAG financing At the beginning of the fiscal cannot be interpreted unambiguously. On decentralization reform of 2003, it is worth one hand, local authorities use borrowed noting that there were no clear and exact funds under the rules of the Municipal legal regulations on municipal debt financing. Debt Act and the Public Finance Act, on Clear opportunities and rules for use of debt the other hand, municipal budget funds instruments by municipalities were established are not the source for the majority of debt in the adopted Municipal Debt Act. By a payments, and with the source are grants. subsequent amendment to the tax structure The latter inhibit the link between the and to the competences of the Bulgarian revenue capacity of local authorities and municipalities, and by improving legislation debt financing.

8 According to Art. 32. (1) The annual amount of payments on municipal debt for each municipality in each year may not exceed 15 percent of the average amount of own revenues and the general equalization subsidy for the last three years, calculated on the basis of data from the annual reports on the implementation of the budget of the municipality. (5) the limitation under par. 1 does not include the debt of municipalities in temporary interest-free loans and loans granted to them by others from the Sector "General Government". The Sector "General Government" includes FLAG.

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3.2. Difficulties in accessing yyMunicipality of Belogradchik states that the debt market the main obstacle are the high liabilities of the municipality, which creates difficulties When asked whether they encounter in accessing the debt market difficulty in accessing the debt market, 60% of yyMunicipality of Suvorovo states that "there the respondents indicate that they do not face are a variety of debt instruments to meet the difficulty, 12% of the respondents indicate that needs of each borrower. But legal restrictions they have difficulty accessing the debt market, do not allow free "shopping" of such products and 28% of the respondents did not answer. by municipalities . This creates difficulties in The municipalities which responded developing our investment program, which that they have no difficulty are: Gabrovo, must comply with these limits" , Chelopech, Gotse Delchev, yyMunicipality of Nevestino states that it Nessebar, Chavdar, Chepelare, Lovech, does not use debt instruments because Dimitrovgrad and Beloslav. municipal management considers debt High level of own revenue and good financing too risky as an instrument. creditworthiness are the characteristics of the yyMunicipality of Dolna Mitropoliya aforementioned municipalities. Municipality responded that the main obstacle for active of Chelopech and Municipality of Chavdar use of the debt instruments is the legal have high revenue from concessions which restriction for annual payment (15% of the own revenue and total equalization subsidy) often is higher than tax revenue. High budget yyMunicipality of Pirdop states that the revenue presupposes a lack of necessity for municipality is in a poor fiscal condition, additional attracted funds. with liabilities of over BGN 3 million A high percentage of municipalities did inherited from the previous mandate. not provide an answer. We should mention This circumstance impedes access to the municipalities of Rila, Loznitsa, Zavet, municipal use of debt financing. Financing Rodopi, Dzhebel - municipalities with low institutions have placed the municipality in own revenue and limited creditworthiness the risk group. and at the same time the survey shows they yyMunicipality of Zlatograd responded do not use debt instruments. The lack of that they used FLAG` financing during answers can be regarded as unwillingness the past years. Furthermore, another of municipalities to use debt instruments reason for selecting FLAG as a due to insufficient own revenue and poor financing institution is the compensatory fiscal condition. The fact that municipalities mechanism for interest paid and fees. have limited revenue, while paying debt A selection procedure under the Public may not exceed 15% of their own income, Procurement Act is compulsory for all suggests stronger restrictions on the access other credit institutions, which in turn of the debt market. greatly extends the duration of the Seven municipalities or 12% of the procedure for assumption of debt. 9 respondents report that they have a yyMunicipality of Belene states that difficulty in accessing the debt market. access to debt financing is difficult due The response of municipalities which have to lack of appropriate collateral which the difficulty is as follows: municipality can offer.

9 In 2016, based on the newly adopted Public Procurement Law- the selection of a financing institution for local governments was dropped from the scope of the law. This is a prerequisite for reducing the time for selection of banking services and products and to increase competition between banking and non-banking financial institutions.

399 Access to Debt Financing - Opportunities for Improvement of the Investment Capacity of Bulgarian Municipalities Articles (for the period 2003-2015)

We can draw the following conclusions years 2014 and 2015, we can confirm from the responses of the municipalities: the finding in the first part of the study – first – the limit of 15% for the annual amount municipal investment debt financing reports of payments on municipal debt from own a significant development during the revenue and the general equalization period 2003-2015. However, the main debt subsidy10 is the reason for limited access to instruments such as investment loans from debt financing; second - difficulties occur as commercial banks and municipal bonds a result of deteriorating financial conditions remain accessible only to big municipalities of the municipalities; third - unwillingness which are in a good fiscal position. of the municipal management to use debt The small and medium size municipalities instruments because of their high risk level. use debt financing through FLAG. The Since the study examines data from peculiarity here is that the debt instrument the year 2013, and we have to note the can be used only for financing of European amendment of the debt financing of municipal projects and can not be used for municipalities - object of the study in the financing of municipal investments under the years 2014 and 2015. capital program of municipalities. We can In 2014, 15 municipalities-respondents conclude that the investment capacity at do not use debt financing – Strumyani, local level can not be significantly improved Pavlikeni, Polski Trambesh. Kula, Ruzhintsi, if it depends on the access to debt financing. Krumovgrad, Nevestino. Boychinovtsi, Opportunities for improvement of the access Maritsa, Zavet, Dulovo, Tvarditsa, Elin Pelin, to municipal debt markets and the use of Chavdar and Chelopech. The number of best practices for debt financing of municipal municipalities which use FLAG financing is investments need to be explored. 28, this is around 49% of the respondents. FLAG financing represents around 10% of the 4. Opportunities for improved access debt exposure of 4 municipalities, between to municipal debt market 10% and 50% of the debt exposures of 12 municipalities, and 12 municipalities used The results revealed that although debt debt financing only from FLAG. financing in absolute terms during the survey In 2015, 13 municipalities-respondents period increased, the majority of municipalities do not use debt financing – Suvorovo, are not successful in the use of debt financing. Polski Trambesh. Kula, Ruzhintsi, Nevestino. Other conditions being equal, small and Boychinovtsi, Zavet, Dulovo, Tvarditsa, Madan, medium-sized municipalities with a limited Elin Pelin, Chavdar and Chelopech. The number revenue base have no access to capital of municipalities which use FLAG financing markets as indicated in the legislation and is 26, this is around 45% of the respondents. according to the practice of setting limits on FLAG financing represents around 10% of the municipal debt. However, there are options debt exposures of 3 municipalities, between that allow local authorities to benefit from 10% and 50% of the debt exposures of 11 investment debt financing. municipalities, and 12 municipalities used debt Municipal Development Funds and Local financing only from FLAG. Government Funding Agencies are the two On the basis of processed questionnaires innovative tools addressing financially weak and the additional information for the municipalities.

10 In 2010, the restrictions regarding the annual debt payments were amended downwards. According to the Municipal Debt Act until 2010 annual service charges on municipal debt should not exceed 25% of the amount of own municipal revenues and the general equalization subsidy in the last audited annual municipal budget.

400 Economic Alternatives, Issue 3, 2017 Articles Economic Alternatives, 2017, Issue 2, pp. 265-282

4.1. Local Government Funding Agencies guaranteeing reimbursement of borrowed funds by Local Authorities. Local Government Funding Agencies Due to observed difficulties in are financial institutions which can accessing financial markets for the increase investment funding for Local majority of Bulgarian municipalities, the Authorities such as municipalities, establishment of this type of a Company regions and states by facilitating the is justified. Local authorities get together access to capital markets using the and jointly issue common debt bonds on ‘joint procurement of credit’ principle. the basis of the so called "club deal". Each Local Authorities are the owners of the participant in the issue is responsible for agencies. In some cases the State may the payments on his share of the issue, hold a minority interest. The Agency and the Agency further ensures payment works as a cooperative in which Local of the debt to the creditors. Companies of Authorities participate together as one a similar type successfully operate in Italy, legal entity targeting lower interest levels Canada, France and the Scandinavian on loans. This type of companies are countries. not established for profit, and in case Improvement of the access to the of a generated profit, it is reinvested municipal debt market justifies the in their operations. Agencies work in a establishment of a similar type of self-control mode. Shareholders which institution in Bulgaria. Pooling several participate in the entity should be in municipalities into a consortium will allow a good financial condition and have small municipalities to obtain significantly acceptable creditworthiness in order for cheaper funding. Since the incidental the entity to be successful. expenses for the issuance of bonds are The Agency monitors and supervises not small, along with the economies of its members (shareholders) and takes scale, in the case of an association of immediate action upon detection of a a greater number of municipalities, basic deteriorating financial position of one of costs will be shared by all parties. its members. These actions are crucial for the rating of the agency and for the 4.3. Municipal Development Funds access of its members to capital markets. Municipal Development Funds (MDFs) The supervision is a safeguarding are created on the initiative of the central mechanism against over-indebtedness government. They support financially on the part of the Local Authorities. In weak local communities by granting Europe, the existing agencies which low-interest or interest-free loans, often support local investments by providing combined with grants for investments easier access to debt financing are in construction and improvement and located in Denmark, Norway, Sweden, the modernization of infrastructure within local Netherlands (Andersson, 2016). These jurisdictions. The funds provide consulting agencies were established at a time when services in order to support activities Local Authorities are under high pressure for improvement of the administrative to provide resources for infrastructure capacity of Local Authorities, assistance investments. The agencies use state with the preparation of financial plans, guarantees or other type of security project preparation, etc.

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The main target of proposed financing public investments, to promote market is the construction of urban infrastructure, competition in municipal financing and housing in poor neighborhoods, schools, provide preferential conditions, such as hospitals, parks, water facilities and other interest payments to municipalities at important local community infrastructure. below market rates. According the authors (Davey 2005, A fund with a structure similar to the Petersen 2005), MDFs are considered as structure of a Municipal Development transitional tools which prepare the Local Fund operates in Bulgaria - FLAG. As Authorities for a self-sustaining municipal already noted, the Company provides credit system that can use domestic financing only for municipal projects and international capital markets for under European programs which is the funding. Municipal Development Funds main disadvantage of its funding policy. are created in partnership with the In order to contribute to the improved international banking institutions11 and access of small and medium-sized can be considered as tools for deficit municipalities to debt financing, there reduction and substitution of government is a need to establish a Municipal transfers with commercial debt financing Development Fund aimed at financing of investment projects. capital expenditures of municipalities The literature under study (Dafflon, under their regular capital budget 2002; Davey 1988; Davey, 2003; Diamond, programs. Practices under study show 1984; Frere, Peterson, Valdez at all, that the typical restrictions regarding 2010; Magrassi, 2000) indicates that annual payments on debt and total the funds are established to support exposure of municipal debt, are a little decentralization processes in the more liberal when using funding from developing countries. Increasing the municipal funds. level of capital investments, improving 5. Conclusion local creditworthiness and access to the capital debt markets are the targets of Debt financing of municipal the fund. Main advantages of financing of investments is undergoing a significant this type of companies are: determining development in the period 2003-2015. the interest of the financing granted under The high degree of fiscal decentralization the market rate; government subsidies is a prerequisite for improved municipal on interest payments on the debt; more creditworthiness. Statistics and the liberal restrictions on debt ratios and results of the a survey show that during annual debt costs. the period under study municipal debt has Experience shows that in many increased not only in absolute terms, but cases the funds have a limited life. After increase in the number of municipalities achieving their goal, they decapitalize using debt financing is reported. and cease their activities. The length of However, the main debt instruments life depends on the motivation and desire used by Bulgarian municipalities are not of the central government to provide loan the standard loans from commercial banks resources for implementation of local and/or bond loans. General statistics

11 Like the World Bank, the European Bank for Reconstruction and Developments or USAID.

402 Economic Alternatives, Issue 3, 2017 Articles and the data obtained from the survey Diamond Douglas W. (1984) Financial show that a major share of the financing Intermediation and Delegated Monitoring, through bank loans is funded by FLAG. The review of Economic Studies, Vol. 51, The specific issue here is that through issue 3, pp. 393-414 this type of debt, the typical municipal European Charter of Local Self Government capital expenditures under the capital (Online) Last accessed at: https://www. program of the municipality cannot be coe.int/en/web/conventions/full-list/-/ financed. conventions/rms/090000168007a088 This, in turn, means that a major part of investment needs cannot be covered Frere M., Peterson J. at all (2004), because of lack of funding. In order to Subnational capital markets in developing increase the investment capacity at local countries: From Theory to Practice, A co- level by improving the access to municipal publication of the World Bank and Oxford debt markets, two recommendations University Press, Washington are made - the establishment of Local Fund for Local Authorities and Government Funding Agencies and Governments (Online) Last accessed at: establishment of Municipal Development http://www.flag-bg.com/?id=185 Funds. Naturally, the proposed instruments should be used, taking into account all the Hulbert, C. and C. Vammalle (2014), A potential problems which lead to shortage Sub-national Perspective on Financing of funding. Investment for Growth I - Measuring Fiscal Space for Public Investment: Influences, References: Evolution and Perspectives, OECD Anderson, M. (2014), Local Kellermann K (2007), Debt financing Government Finance in Europe, Marten of public investment: On a popular Anderson Production, 2014 misinterpretation of "the golden rule of public sector borrowing", European Journal Dafflon, B. Elgar E. (2002), Local Public of Political Economy 23(4):1088-1104 Finance in Europe: Balancing the Budget and Controlling Debt, Studies in Fiscal Magrassi Marco (2000), Subnational Federalism and State-Local Finance, Investment Needs and Financial Market Cheltenham, UK, Northampton, MA, USA Response, IADB, November Davey K. (1988), Municipal Development Ministry of Finance (Online) Last Funds and Intermediaries, World accessed at: https://www.minfin.bg/bg/ development paper, Office of the Vice page/1127 President, Development Economics, Municipal Debt Act (Online) Last accessed Working paper, World Bank at: www.minfin.bg/document/16803:2 Davey K. (2003), Investing in Regional National Association of Municipalities Development Policies and Practices in EU in Republic of Bulgaria (Online) Last Candidate Countries, Local Government accessed at: http://www.namrb.obuchi- and Public Services Reform Initiative, se.org/norway/bg-bg/%D0%BD%D0%B0 Open Society Institute – Budapest %D1%87%D0%B0%D0%BB%D0%BE.aspx

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Nenkova Pr. (2014) Fiscal Decentralization Public Finance Act (Online) Last accessed and Local Finance Reforms in Bulgaria: at: www.minfin.bg/document/12587 A Review of Ten Years’ Experience, Public Procurement Law (Online) Last Mediterranean Journal of Social Sciences, accessed at: https://www.mi.government. Vol 5 No 23, pp. 342-352 bg/en/library/public-procurement-act- Nenkova Pr. (2009), Local Finance, 357-c25-m258-1.html Economics University Press, Sofia (in Stoilova, D. (2005) Alternative: Deficit Bulgarian) or Balanced municipal budget - focusing the debate Southwestern University, Nenkova Pr., Iliev P., Ivanov St. at all (in Bulgarian) (2005), Fiscal decentralization in Bulgaria - for greater autonomy of local authorities, Swianiewicz, P. (2004), Local Local Government and Public Services Governments Borrowing: Risk and Rewards, Local Government and Public Reform Initiative: Revenue of Municipal Service Reform Initiative, Open Society Budgets: Achieving sustainable economic Institute, Budapest development of Local level pp. 24-47 (in Bulgarian) Velichkov N. Effects of Government Debt on Macroeconomic Activity (The Case Nenkova, Pr. (2007), Financing local of Bulgaria), Economic Alternatives, Vol. investments in Bulgaria – status and 1/2016, pp. 24-32 problems, FourthYearbook of College of Vladimirova T., Naydenov L. (2011), Economics and Administration, University Local Finance, Steno Press, Varna (in Press, Plovdiv, 2007 pp. 111-138 (in Bulgarian) Bulgarian) Yilmaz, S., Ebel R. (2002), Concept of Peterson, G. (2000), Building Local Credit Fiscal Decentralization and Worldwide Systems, World Bank Overview, World Bank Institute

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