Sovereign guarantees provided to local authorities by their central Governments have many merits, but they are no panacea. They sound most benevolent in that they facilitate local authorities’ access to capital markets, but are constrained by Governments’ fiscal space and are typically driven by political considerations. They mean to support financing, but at the risk of distorting markets as investors will rely on the central Government’s commitment to honor debt obligations no matter the credit worthiness of local authorities and their projects. This is not to ostracize sovereign guarantees, which often are the only way to promote investments where risks are too high. But when it comes to sovereign guarantees applied to sub-national financing, they have an additional side effect: perceived as the remedy for all ills, sovereign guarantees can be an alibi for not pursuing other, more sustainable, financing solutions. Instead of taking full ownership for their investment needs, local authorities in developing countries often rely exclusively on sovereign guarantees to determine what can and what can’t be accomplished.
This dependency by local authorities on allowances from the central Government is something that affects also the way the same local authorities are perceived by the international community. It’s as if local authorities were subordinate agents of development, merely reacting to conditions set at the central level. This misleading perception may affect also domestic capital markets as investors shy away from sub-sovereign transactions because of the perceived subordinate quality of institutions and projects at that level. In the end, it’s a self-fulfilling prophecy: if local governments don’t step up to the challenge and nobody helps them change course, the availability of financing at the sub-sovereign level will remain an ever-fading chimera. This will hinder significantly the prospects for development where it matters the most. Whether its climate change, population growth, massive migratory movements, or basic infrastructure needs, the struggle to advance the global fight against poverty through sustainable development may be won or lost primarily at the local level.
Many cities are beginning to view the private sector as a source of needed infrastructure financing and management expertise, and public-private partnerships as well as options for directly accessing private finance from banks or bond markets are increasingly seen as key elements in the overall infrastructure delivery strategies of cities. To be sure, such financing solutions require higher capacity levels by local authorities, and, just like in the case of projects backed by central governments, they are also no panacea. No financing mechanism is intrinsically better than the other. However, market-based transactions that are independent from the central Government’s support, force local authorities to apply higher standards in capital investment planning, project development and financing, as well as in the overall financial management of their administrations.
While tapping the full potential of domestic or regional capital markets is an ambitious goal that will require local authorities to become credit-worthy and to comply with central Governments’ fiscal responsibility laws and regulations, local authorities can immediately take action to move in that direction. By so doing, even well before reaching full credit-worthiness, they will directly strengthen their financial performance, they will be in a much better position to attract government/international assistance, and will be able to pursue smaller-scale transactions to accelerate their preparedness for larger and longer-term financing for development.