Local Governments and the Capital Market

LOCAL GOVERNMENTS AND THE CAPITAL MARKET

Professor Akin L.Mabogunje

Chairman, UnityBank Plc.

(being text of a keynote address delivered at the Conference of the Association of Local Governments of Nigeria (ALGON) in collaboration with the Developing Markets Associates Ltd. (DMA) and Baltimore Tax & Finance Ltd. (BTF) on the topic: Accessing Credit Ratings for Development for Sub-National Governments in Nigeria held at the Sheraton Hotel, Abuja on 18-19 March, 2009)

All Protocols observed.

Let me join in welcoming you all to this very important Conference on credit rating of subnational governments in Nigeria. I recognize that the ultimate aim of the Conference is to enhance the capacity of sub-national governments particularly local governments to access the nation’s capital market for critically needed finance for infrastructural development through first submitting their operations to the scrutiny of a credit rating agency. For this reason, I believe that my short keynote address on this occasion can be better appreciated if I went a little down memory lane.

In the late 1980s, the Federal Military Government of General Ibrahim Babangida initiated a programme for providing a framework for rural development through the activities of a Directorate of Food, Roads and Rural Infrastructure (DFRRI) and the operations of the National Board for Community Banks. As the execution of this programme was maturing, a proposal was presented for a similar initiative for stimulating development in the urban areas of the country. Since much of the needs of urban local governments was, however, for infrastructural development of roads, water, electricity, waste disposal, markets, and so on, the decision was taken that what was needed was to establish an Urban Development Bank of Nigeria (UDBN). The task of this bank was to help improve the financial management of local governments and enhance their capacity for resource mobilization within their jurisdiction so that they can be taken to the capital market to raise the ample financial resources that they need to meet the almost daunting challenges of their infrastructural development. The UDBN was established in 1991. However, because of the very poor quality of its own management from the beginning, it failed over 15 years to deliver on to the expectation of its mandate. Now that it has recently been re-structured and partially privatized, it is starting to move in the required direction of assisting state and local governments in packaging projects for funding from the capital market.

The direction which the UDBN was expected to take these subnational governments particularly the local governments could perhaps be best illustrated by the international experience of the medium size city of Naga in the Republic of the Philippines in South-east Asia. This city of just over 150,000 people was anxious to improve on its basic infrastructure by developing a central bus terminal. On calculating how much this would cost, the Local Council realized it could not undertake the project purely on its own resources. It therefore decided to float a municipal or local government bond on the nation’s capital market. This particular bond was of the “self-liquidating”, type, that is, that it is expected to generate the revenue for paying back the principal and interest of the loan raised by the bond on the capital market. This is in contrast to the second type of municipal bond known as the “general obligation bond” which is paid back from the proceeds of fees, rates, taxes and subventions collected by the local government each year. The Naga City Council passed the necessary bye-law approving the terms and conditions on which the bus terminal bonds was to be issued. It approved a five-year maturity period for the bonds, that is, five years during which the principal and interest of the bond would have to be paid back.

However, in order to make the process work, the Council began with a broad-based consultation of all the residents of the city through a referendum. The referendum showed a majority of the citizens approved of the decision of the Council to access the funds from the Capital Market. But so impressed were the citizens by the transparent and accountable posture of the Council as manifested through this consultation that they decided, rich and poor alike, to have a hand in the purchase of the bonds. Thus, instead of the usual practice of issuing bond coupon pricesin units of $1,000.00, coupon values were on this occasion allowed to range down to a minute US$20 or Aminibond@ for the poorer members of the city. This wide spectrum of coupon values prompted the city council to dub the issue the “rainbow@ bonds. But, it was an innovative strategy of ensuring that all the residents participated in and could be mobilised to have a proprietary interest and pride in the issuance of the bond and the eventual construction of the central bus terminal.

In the meanwhile, the City Council had approached the United States Agency for International Development (USAID) for assistance on how to access the needed funds from the Capital Market. Impressed with the transparent manner in which the Council had gone about the process of floating the bond, the USAID provided it with a financial advisor, a feasibility analyst and a policy analyst. Their task was to ensure that the financial resource base and the budgetary processes of the Council were such as to facilitate the liquidation of this debt as at when due. They also had to ensure that the bus terminal was constructed within the limits of the capital budget proposed.

All of this was to ensure that the City Council’s municipal bonds will pass the scrutiny of three agencies of the capital market which have to pronounce on the degree of risks the public runs in buying the particular bond. These three agencies are the underwriters, the trustee and the credit rating authority. The underwriters work with the Council to determine the structure, terms and prices for the bonds and develop syndicates to bid for and market the bonds. The trustees serve as guarantee of the interest of those who buy the bonds to ensure that the terms and conditions on which the bonds were sold and bought are kept to until the bonds mature. The credit rating authority is an independent agency that seeks to inform the market at large of how good or risky investment in a particular bond issue is. In other words, the credit rating authority is the institution that attests to the credit-worthiness of a corporate body or government that seek to borrow or raise capital from the Capital Market. Credit-rating is thus the process of ascertaining the credit-worthiness of any such body or government.

Credit rating thus entails establishing the quality of financial management of any corporation or government over time as a means of objectively assessing its credit-worthiness or its ability to repay a loan. Financial management, in turn, relates not only to how financial resources are spent but equally to how resources are mobilized and how robust are the sources of such mobilization. For local governments, for instance, subventions from higher levels of government are not regarded as important as the resources they themselves can mobilize through property tax or tenement rates or other forms of local taxes over which they have direct control. This is why participatory democracy in which the citizens are often consulted and kept informed of the activities of the local government makes it easy for local governments to achieve high credit rating. The NagaCity was able to achieve high credit rating and to raise its bond because of the consultation with its citizens. By the same token, participatory governance makes it easy to enhance the capacity of local governments to mobilize local financial resources from their residents through property tax, tenement rates and other taxes. And, of course, participatory governance is easy to sustain where local government is accountable to its citizens and its financial management seen to be very transparent.

Credit rating thus represents more than a strategy for sub-national governments particularly local governments to access ample financial resources from the Capital Market for promoting infrastructural development and service delivery to their residents. It certainly can also be the key for enhancing a higher quality of participatory governance at the grassroots level through its requirements for consultation, mobilization and accountability. This is why in an earlier keynote address that I gave at one of the biennial Africa-wide, Africities Conferences, I had suggested that for local governments to be willing to submit themselves to the scrutiny of a credit-rating agency is like striving to kill three birds (consultation, mobilization and accountability) with one stone.

This Conference on credit ratings of sub-national governments in Nigeria is thus for me pivotal for enhancing the vigour of socio-economic development and service delivery and improving the quality of governance at the local government level in the country. Given the repute and competence of the two collaborating professional organizations, namely the Developing Markets Associates Limited and the Baltimore Tax and Finance Limited, I have no doubt that much will be gained by local governments and the nation from this endeavour. I want to congratulate the Executive of ALGON for the initiative of hosting this Conference and thank you all for your attention.