The promise of LGU bonds
What do the Golden Gate Bridge in San Francisco, the Eiffel Tower in Paris, and the Taipei 101 Tower (one of the tallest buildings in the world) have in common? Answer: These world landmarks were financed wholly or partly by municipal bonds. These are debt securities that local government units (LGUs) issue to raise money for public projects, such as public markets, fish ports, bus terminals, hospitals, low-cost housing, and other special projects. When you buy a municipal bond, you are lending money to the LGU that issued the bond. In return, the borrowing LGU promises to pay you a specified amount of interest, usually semi-annually, and return your money at a specified maturity date.
Most Philippine LGUs have yet to discover bond financing as a way to raise funds to finance needed local infrastructure projects, especially income generating ones. And yet, local government bonds have been around for centuries elsewhere. In the United States and other mature economies, municipal bonds, also known as “munis,” account for a major portion of all bond issuances in their capital markets. In the United States, for example, about $366-billion worth of municipal bonds were issued last year, and a total of $3.7 trillion were outstanding and actively circulating. Local projects financed through municipal bonds amounted to 2.5 times more than those funded out of the federal budget.
Among our better-known municipal bond-financed projects is the Caticlan Jetty Port, familiar to anyone who has been to the resort island of Boracay. To construct this facility, the province of Aklan floated P40-million worth of bonds in 1999. Subsequent municipal bond floats in the country include those for Tagaytay City’s P220-million convention center and Antipolo City’s P400-million commercial complex.
Aside from floating municipal bonds, an LGU has several options for funding a local infrastructure project. It may, of course, use its internal revenue allotment (IRA) from the national government, or its locally generated revenues such as real property taxes and local business taxes. Or it may secure a loan from a government financial institution (GFI) like the Development Bank of the Philippines or the Land Bank of the Philippines. For the GFI, the loan is virtually free of risk because the LGU’s IRA normally becomes a direct collateral for the loan. This means that in the event of default, the GFI may intercept the borrower LGU’s IRA fund releases from the Department of Budget and Management.
Still another option is for the LGU to go via the public-private partnership (PPP) route, also known as the build-operate-transfer (BOT) mode. Here, a private firm finances and constructs the facility and is given the right to operate it and collect user fees to recover its investment and earn a reasonable profit.
Each financing mode above has its own advantages and disadvantages depending on the peculiar circumstances and the nature of the projects to be financed.
From a broader perspective, a particular appeal of municipal bond financing is the way it helps widen and deepen the capital markets. In particular, it expands the range of choices of investment instruments available to savers and investors. For one thing, municipal bonds can help channel rural savings and overseas workers’ remittances toward development of the localities where their families reside, giving them a direct stake and involvement in improving their own communities. Tagaytay City deliberately allotted a portion of the bond float for its convention center to small savers, thereby enabling its citizens to have a direct stake in the facility.
Abroad, municipal bonds are a popular investment instrument for small and large savers alike, especially because their earnings are usually tax exempt. Such tax exemption is desirable and necessary to offset the added transaction costs (underwriting fees, guarantee fees, and other costs) associated with floating a local bond, as against simply taking a GFI loan. Without such exemption, LGUs are likely to favor bank loans, and investors would have little incentive to buy the bonds over alternative interest-earning assets like Treasury bills, trust accounts and mutual funds. Not surprisingly, the main buyers so far of our municipal bonds have been the big banks themselves, making the bond issues no different from a syndicated loan to the LGU. Furthermore, many of the bond issuances are being prepaid before maturity by the issuing LGUs and converted to loans by GFIs, who are happy to push more loans with risk-free clients such as LGUs. But such practice undermines the capital market-deepening effect of municipal bonds.
In reality, we have yet to see our government pursue a policy of promoting LGU-bond financing. For the reasons described above, there should be. A basic requirement is that the tax exemptions commonly given elsewhere be also granted on LGU bond earnings here. It also requires that there be a good credit rating system for LGUs, and a good LGU credit guarantee mechanism in place. Both are already being partly fulfilled by the LGU Guarantee Corporation, but needs further expansion to widen its scope and coverage. And for LGU bonds to be instrumental in deepening our capital markets, we need to have a well-working fixed income exchange—i.e., the counterpart of a stock market for trading fixed-income assets like bonds. Some baby steps have been made in these directions in the past years, but it’s time to make greater strides so that through better local resource mobilization, we can help fill our glaring infrastructure gap both at national and local levels.
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