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Learning from the Portuguese Municipal Recovery Fund

Created May 07 2015, 8:52 AM by Matthew Glasser

Take-aways from a fascinating presentation yesterday at the IMF on the 2014 Portuguese Municipal Recovery Fund:


  • Portugal uses graduated debt to revenue ratios to trigger eligibility for access to the recovery fund and recovery program
  • A €650 million recovery fund is financed 50/50 by national government and municipalities (though national government advanced the municipal share, to be repaid over three years).  This includes financially healthy and well managed municipalities!
  • Municipal debt problems hit many Portuguese cities in the context of the general financial crisis in Europe (this is historically true of most places - extrinsic shocks cause stress and the most vulnerable fail).  About a third of the problem debt was related to unpaid suppliers and contractors, and two thirds to financial institutions.  Of the financial institutions, the main actors were three private banks and one state bank.
  • As elsewhere, municipally owned enterprises housed significant risk - off-budget financing without the same accounting and accountability as municipal debt
  • The Government rejected a Chapter 9-style solution, which would have allowed for the discharge of debt in the case of municipalities who simply cannot pay.  This means that financial institutions will not have to write off the debt, and may eventually be made whole out of the fund.  Unfortunately, this bail out creates incentives for future over-lending in the expectation of future bail-outs.


The Portuguese system is well-designed, with the one significant flaw that it dilutes lender incentives to know the creditworthiness of their borrowers.  The best way to avoid over-indebtedness by municipalities is to subject them to the discipline of the market place.  This means that lenders must genuinely be at risk, and know that if they lend to a municipality that cannot reasonably be expected to re-pay, they will have to take the loss.  We want financial institutions to be diligent in interrogating the finances of municipalities. That is what creditworthiness is all about - demonstrating to investors that a city has the financial strength, sound management, and solid planning to justify their confidence, and to be entrusted with their capital. 


Financial institutions who lend irresponsibly should face the consequences "pour encourager les autres!"