Municipal Investment, Borrowing, and Pricing Under Decentralization: The Brazilian Case

Abstract

Very few researchers have addressed the long-term financing arrangements of municipal governments in developing countries. No research has evaluated empirically either the elements that affect municipal borrowing in developing countries or what those elements reveal about the municipal credit system. Analyzing Brazilian municipal loan and financial data with a series of simultaneous equations, this paper addresses the following questions: What factors determine municipal government investment levels, borrowing levels, and borrowing prices? What do empirical data reveal about the character of the Brazilian municipal credit system? The results show that investment, borrowing, and borrowing prices are interconnected. Furthermore, while some signs of a market-based system exist, there is evidence that investment and borrowing decisions are made within an administered market.

Fiscal institutions of Brazilian municipal borrowing

“…The control of borrowing through quantity, not price, has left a municipal borrowing system with little alignment between risk and return. There is evidence of subsidies to poorer municipalities, allocation to the municipalities with outstanding debt, and economy-of-scale pricing (Martell, 2003). The potential consequence of this arrangement is that the federal government bears the burden of default risk, which does little to discipline municipal borrowers, and ultimately could destabilise macroeconomic goals and undermine local authority.…”

“…The claims in this review are drawn from a series of studies of Brazilian municipal borrowing systems and legislation conducted by Martell (2000Martell ( , 2003Martell ( , 2004Martell ( and 2007. Two of the studies (2000,2003) empirically assess the relationship between loan data (amount, price) and explanatory factors.…”

“…The Brazilian municipal credit market is largely characterised as relationship-based and administered (Martell, 2000(Martell, , 2003. 6 Neither the amount of debt borrowed nor the amount invested is responsive to interest rates.…”

Theory and evidence of municipal borrowing in Chile

“…Two general systems that frame access to credit by sub-national governments can be distinguished (Martell 2003). One is the so-called relationship-based system, whereby borrowers are regulated by a set of norms intended to "protect" them from default.…”