Abstract
Subnational governments' access to credit is essential for smoothing out shocks to their revenue and expenditures, including those associated with large infrastructure projects. However, governments might pursue an unsustainable borrowing path unless they face appropriate incentives. Theoretically, credit markets can discourage excessive borrowing by charging risk premia rising with the level of indebtedness. We examine the robustness of this market mechanism under the evolving institutions of decentralised governance in a transitional country. Russia presents a perfect case for such analysis, for the market discipline was the only constraint on subnational borrowing there throughout the 1990s.
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Notes
3 In turn, regional governments had complete discretion to download these responsibilities further to the local level.
4 With an average share of ‘own-source’ revenue equal to 21% of total revenue in 1997, Russian regions had considerably less revenue autonomy than their counterparts in the US, Switzerland, and Belgium, but nevertheless more than in Spain, Germany, and Mexico (OECD, 1999).
5 These statements would need to be qualified if the local authorities can affect the behaviour and diligence of federal tax agents, who are responsible for collecting revenues to all levels of government. Although tax policy and tax administration are highly centralised according to the formal system, local authorities could use their informal influence on federal tax agents to affect the rigour of tax enforcement towards local enterprises.
6 Strictly speaking not all grants should be considered as equally negative in terms of revenue autonomy. For example, an equalisation grant based on stable formulas for both funding and distribution of the funds can bring much more stability and predictability to local budgets than ad hoc specific grants allocated every year.
7 Until 1998, the ‘subventions’ category reported compensation to the City of Moscow for the costs related to its status of a national capital. In 1999, the ‘subventions’ category accounted for the federal governments’ aid to regions in stocking up the supplies of necessities in localities of the Far North (being a relic of the Soviet planners’ decision on location, northern settlements have to be subsidised on humanitarian grounds before eventual retreat is carried out). The 1999 figures do not sum up to 100% due to the presence of unidentified ‘other’ transfers.
8 Although budget execution at the subnational level is still reported on a cash basis in Russia, by 1997 many subnational governments had started reporting accumulated payables to the higher-level government in a separate file according to the same classification used for actual outlays. With the adoption of the new Budget Code all subnational governments have been required to maintain a ledger of purchases registering terms of order and information about the supplier.
9 This statement holds even after accounting for the fact that the ruble devaluation of 1998 significantly reduced the real value of subnational debt.
10 Our specification is similar to Capeci (1994). We do not use Bayoumi et al.'s (1995) non-linear specification, which was derived for one functional class of probability distribution. We did however attempt to include non-linear terms in our equation but did not find any improvements in estimation.
11 Data on agrobond trades were provided by the Econometric Unit Vedi (Moscow).
12 For the benchmark federal bond (GKO076), the yield was fluctuating between 18.2% and 20.3% during June–September 1997.
13 The auction was structured in terms of the agrobond price. However, our analysis (and presumably investors’ decision) is based on the associated yield spread that is the difference between the yield to the maturity on the agrobond and the yield on a federal bond of a similar maturity taken on the day of the auction.
14 While agrobonds give us a unique opportunity to study yield spreads on a large sample of regions, it also limits our study to the pre-financial crisis period. Although by 2005 the subnational bond market completely revived in terms of trading volume, it has never represented such a broad number of regions. As of 2005, only about 35 subnational governments had its bonds traded on the market (Myazina, 2005). Although the looming financial crisis affected the ability of central government to bailout regions, the cross-regional nature of our analysis allows us to control for such common factors while assessing the impact of cross-regional differences in intergovernmental arrangements.
15 Lower yield ceilings set for prior trading sessions for which no purchases took place do not convey any additional information.
16 For seven out of the 19 unsold 1-year agrobonds the final ceilings were around 13% points over the GKO yield. For the remaining 12 issues the final yield ceilings seem to be evenly spread from 9% to 18% points over the GKO yield. At the same time, for one completely sold issue the final yield ceilings exceeded 13% points premium: Republic of Khakasia – 14.55% over the GKO yield.
17 Pulling together observations from the three different maturities would have added only one region to the sample, while introducing considerable difficulties in comparing risk premia across maturities.
18 As before year 2000 regional governments were not required to include outstanding debt in their budgetary reports, the relation between indebtedness and risk premia is a product of creditors' ability to both obtain this information from other sources and utilise it for risk assessment.
19 Post-2000 data indicate that regional governments account for less than 20% of subnational budget arrears (Martinez-Vazquez et al., 2006). Nevertheless, consolidated regional–local budget arrears can serve as a proxy for regional government liabilities to the extent that they are used by local governments as a strategic tool for extracting regional assistance. The effectiveness of local governments' arrears as a tool to squeeze regional funds ranges from quite high for wages and social payments to rather low for utility bills.
20 By ‘own-source’ we mean all revenue sources whose yield can be affected at the margin by regional governments, using their discretion to determine taxable bases or rates, or discretion to introduce the tax, or any combination of these three.
21 Wildasin's (1997) calculations provide at least one class of examples where there is a clear inverse relationship between jurisdictional size and availability of bailout. However, this is true in a one-shot game. In a sequential interaction, the central government might choose to deny a bailout to a large locality in order to send a strong signal to other jurisdictions and thus build a reputation for fiscal discipline.
22 An empirical regularity is that the MLEs can be approximated by dividing the OLS estimates by the proportion of non-censored observations in the sample (Greene, p. 697).
23 Theoretically, we can subtract these varying censoring limits from both sides of the regression equation and thus arrive to the uniform (zero) censoring limit. However, because the yield ceilings gradually approach the clearing levels, they are likely to be correlated with the same variables that determine the market risk premia (ie, indebtedness and revenue autonomy). Thus, if the censoring limits were explicitly accounted for on the RHS of our equation, we would run into the multi-colinearity problem.
24 The biplot display is drawn using Excel Macros from Lipkovich and Smith (2002).
25 We are interested in the true market yield spread, which is the latent variable in the Tobit model. Thus, the marginal effects of our interest are the estimated Tobit coefficients.
26 Creditors might favour larger jurisdictions because of more sophisticated financial management and economies of scale in fixed costs of debt transactions.
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I am grateful to Olga Shirokova, Econometric Unit Vedi (Moscow) for supplying some of the information used in this study. I am also grateful to Roland Anderson, Andrew Austin, Stepan Jurajda, Jorge Martinez-Vazquez, Saloua Sehili, Jan Svejnar, and participants of Ronald Coase Institute's Workshop in Institutional Analysis, 2002, and the 61st Congress of the International Institute of Public Finance, 2005, for helpful comments and discussions. All remaining errors are solely mine.
2 In 1992, consolidated budget expenditures accounted for about 30% of GDP. In fact, the extent of public provision was even larger. In the Soviet system many basic goods and services were provided by state-owned enterprises as fringe benefits to their employees. Hence, before being privatised such enterprises maintained huge social assets: housing, kindergartens, hospitals, and recreation facilities. Privatisation was accompanied by the process of divestiture, meaning a transfer of social assets and the responsibility for their financing to municipalities.
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Timofeev, A. Market-Based Fiscal Discipline Under Evolving Decentralisation: The Case of Russian Regions. Comp Econ Stud 49, 177–200 (2007). https://doi.org/10.1057/palgrave.ces.8100188
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DOI: https://doi.org/10.1057/palgrave.ces.8100188