The Future of Local Government Finance: Case studies from Romania, Bulgaria and Macedonia Editor, Marjan NIKOLOV Local Government and Public Service Reform Initiative November 2006, Skopje General information about CEA Address: CENTER FOR ECONOMIC ANALYSES (CEA) Bul. Jane Sandanski 63/3, 1000 Skopje Macedonia Tel: + 389 (0)2 24 44 766 GSM: + 389 70 834 636 TIN: 4030003479278 Reg. 5763061 Account number: Stopanska Banka AD Skopje Account number: 200000856268559 Web page and e-mail: www.cea.org.mk www.lsg-data.org.mk [email protected] The publication of these country reports has been funded by the Local Government and Public Service Reform Initiative of the Open Society Institute in Budapest. The judgments expressed herein do not necessarily reflect the views of LGI. All rights reserved. No part of this book may be reprinted or reproduced or utilized in any form or by any electron- ic, mechanical or other means, now known or hereafter invented, including photocopying and recording, or in any infor- mation storage or retrieval system, without permission in writing from the publishers. Contents FOREWORD . .4 COUNTRY REPORT: LOCAL GOVERNMENT BORROWING IN ROMANIA . .5 COUNTRY REPORT: LOCAL GOVERNMENT BORROWING IN BULGARIA . .39 COUNTRY REPORT: LOCAL GOVERNMENT BORROWING IN MACEDONIA . .63 3 Foreword This book is the result of a CEA research funded by the Local Government and Public Service Reform Initiative of the Open Society Institute (LGI/OSI) and managed by Marjan Nikolov, President of CEA. CEA approached LGI/OSI with an unsolicited proposal for a cross country study on LGU borrowing with an expectation to set out lessons that can be learned by Macedonia. The overall objective of the study on local government borrowing is to accomplish an all-encompassing review that systematically captures the entirety of the fiscal decentralization processes with an emphasis on local government borrowing in each of the three transition countries: Romania, Bulgaria and Macedonia. Macedonia is in a position to develop the legal and policy framework now, in anticipation of future devel- opment of a municipality credit market. Macedonia can learn from the Romanian and Bulgarian experience but also can learn from problems that have become clear in other countries as well. Excessive borrowing by sub-national government or debt issuance in the absence of an adequate legal framework (one that clar- ifies critical issues like the status of guarantees or the remedies available to lenders in the event of a munic- ipality's non-payment) has exacerbated any national economic crisis. Also, premature borrowing, prior to a municipality establishing its creditworthiness or having identified clear investment priorities, is likely to drain local budget resources and add risk to the fiscal system. The benefit of soundly based local borrow- ing is large, but the risks involved with poorly prepared borrowing can be great. Stakeholders-LGU, nation- al government, banks, and potential investors in municipal debt share an interest in ensuring that the poli- cy issues surrounding credit market development are well understood and that an appropriate legal frame- work is in place before the market actually opens. CEA wishes to express the highest gratitude to OSI/LGI Budapest for the financial and other support without which the project: LGU Borrowing in Romania, Bulgaria and Macedonia could not have been con- ducted, with particular thanks to Mr. George Guess, Mr. Adrian Ionescu and Ms. Marietta Kleineisel. The Center for Economic Analyses (CEA) is a think tank of economists who share a common vision for the Republic of Macedonia as an emerging new European economy integrated into the regional and world- wide markets. The Mission of CEA is to continuously research economic development and economic policy in the Republic of Macedonia and to offer recommendations, suggestions and measures where it is deemed appropriate. November 2006, Skopje Marjan Nikolov, MSc Contributors MARJAN NIKOLOV, M.Sc., is a Professor at the Faculty of Business and Economics in Skopje and a President of the Center for Economic Analyses-CEA. Marjan Nikolov has extensive experience in fiscal decentralization research. He has worked in numerous donors and Macedonian Government's sponsored projects. He has presented several papers at international conferences and workshops at home and abroad. MALGORZATA MARKIEWICZ graduated from the Department of Economics at the Warsaw University. She is a senior macroeconomists cooperating with CASE (Poland) and CEA (Macedonia). She specializes in public finance and participated in projects on economic policy reforms, fiscal management, and macro- economic modelling. She was working as a consultant in the following transition countries: Belarus, Kyrgyzstan, Georgia, Macedonia, Montenegro and Ukraine. She has published on fiscal policy, tax compe- tition and economic policies in transition. 4 COUNTRY REPORT: LOCAL GOVERNMENT BORROWING IN ROMANIA MARJAN NIKOLOV Center for Economic Analyses-CEA Sponsored by: Local Government and Public Service Reform Initiative Open Society Institute Budapest, Hungary November 2006, Skopje Disclaimer: Opinions expressed in this report are those of the Center for Economic Analyses-CEA and do not represent the opinion of other concerned institutions. It is the responsibility of other authors to cite this report when it has informed their research and publications. 5 Contents 1. Introduction . .9 2. Structure and scope of the Government . .9 3. Expenditure assignments . .12 4. Structure of the revenues . .16 Own revenues . .16 Shared revenues . .17 Capital revenues . .17 5. Intergovernmental transfers . .17 Earmarked transfers . .18 Equalization fund . .18 6. Borrowing pillar of decentralization in Romania . .19 External borrowing . .19 Internal borrowing . .19 Guarantees . .20 Characteristics of debt . .20 i. Maturity . .21 ii. Interest . .21 iii. Debt Service . .21 iv. Foreign Currency . .21 Approval, monitoring and disclosure . .22 Financial distress and insolvency . .23 7. Financial management issues . .25 8. Bonds . .26 9. Conclusion . .28 Annex 1. Field visit in Romania . .30 Annex 2. Relevant legislation in Romania . .31 Annex 3. Applications to the Commission to authorize borrowing . .32 Annex 4. Norms and procedures for authorizing local government borrowing . .34 6 List of abbreviations CEA Macedonian based think tank-Center for Economic Analyses CNVM Romanian National Securities Commission CSPD Romanian think tank-Center of Studies and Programs for Development EBRD European Bank for Reconstruction and Development IPP Romanian Institute for Public Policy ISPA EU pre-accession instrument, Instrument for Structural Policies for Pre-Accession LGAP Local Government Assistance Program LGU Local Government Unit LPF Law on Local Public Finances MPF Ministry of Public Finances PHARE EU pre-accession instrument, Poland and Hungary: Assistance for Restructuring their Economies PIT Personal Income Tax RON Romanian currency SAPARD EU pre-accession instrument, Special Accession Program for Agriculture and Rural Development USAID US Agency for International Development VAT Value Added Tax WB World Bank List of tables and figures Table 1 Municipal services in terms of self sustainability from user fees Table 2 Competencies at local and county level Table 3 Proportion of local public expenditure from total public expenditure Table 4 Romanian County expenditure as % of GDP Table 5 Wages and salaries as % of total expenditure Table 6 Capital expenditures as % of total expenditure Table 7 Evolution of own revenues as % of total revenues between 1999-2003 Table 8 Percentage of own revenues Table 9 Structure of revenues Table 10 Characteristics of financial crises and insolvency at LGU level Table 11 The profile of Romanian Municipal Bond Features, 2004 Table 12 List of people interviewed in Romania Figure 1 Government structure in Romania 7 Acknowledgments CEA wishes to express highest gratitude to the OSI/LGI Budapest for the financial and other sup- port without which this project could not have been conducted, especially to Mr. George Guess, Mr. Adrian Ionescu and Ms. Marietta Kleineisel. CEA also wishes to thank the CSPD and its Director, Ms. Gabriela Matei for the hospitality, organi- zational issues and useful comments on this paper. In spring 2006 the Parliament of Romania adopted a number of laws that will affect local govern- ments both in the short and long term. The package of laws contained the following five drafts: ! Amendments to Law No. 215/2001 on Local Authorities ! Decentralization Law to replace Law 339/2004 ! Amendments to Law No. 340/2004 on the Institution of the Prefect ! Draft Law on Local Public Finance to replace Ordinance 45/2004 ! Amendments to Law No. 188/1999 on Public Employees Functions The CEA visit to Romania took place between major changes in the legislation and this made it even more challenging to address the issues. CSPD was of great help in making clear what the changes in legislation were and how they affect the context of LGU borrowing in Romania. Special thanks go to the people in Romania that we interviewed both for their time spent in meet- ing us and for sharing their experience with us. Our beneficiaries in Macedonia: ZELS, represented by Mr. Ace Kocevski (Mayor of Veles) and Ministry of Finance, represented by Ms. Maja Parnardzieva (Head of Public Debt Department) hold a special importance for their contribution. This report has been prepared by Marjan Nikolov, MSc ([email protected]). Critical