Phils

Philippines
Lydia N. Orial Senior Vice President Operations Group LGU Guarantee Corporation Manila
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Local Government Finance and Bond Markets
Acronyms
ADB BOT BSP COA DBM DOF DPWH GDP GFI IRA LGC LGU LGUGC MDFO NGA P PFI PNB Asian Development Bank build-operate-transfer Bangko Sentral ng Pilipinas (Central Bank of the Philippines) Commission on Audit Department of Budget and Management Department of Finance Department of Public Works and Highways gross domestic product government financial institution internal revenue allotment Local Government Code local government unit LGU Guarantee Corporation Municipal Development Fund Office national government agency peso private financial institution Philippine National Bank
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Executive Summary
Local government financing has become a key policy issue not only in developing but also in most industrial economies. It is a more pronounced issue under decentralized regimes, where governance is being redefined at all levels. In the Philippines, rapidly increasing local expenditure is creating intolerable fiscal pressure on the local tax base. e increase in demand for public services is mostly driven by population growth, caused by natural growth and migration. Local government units (LGUs) face a higher and more complicated level of competition in the third millennium. eir ability to maintain high economic growth to compete in the fast-emerging global economy while halting and mitigating environmental degradation will depend largely on how they manage development and administer their revenue as well as access capital to finance infrastructure and expand services. Expanding local government expenditure, ever-rising spending on, and demand for, social services, and the increasing cost of providing these services all strain local resources. Consequently, LGUs must (i) learn new fiscal management methods; (ii) establish an accountable, efficient, and dynamic organizational and management structure; (iii) enhance the capability of local leadership; and (iv) embark on comprehensive and extensive development planning and efficient revenue and resource mobilization with strong community participation to respond to the twin challenges of local autonomy and globalization. Innovative revenue generation and resource mobilization schemes must be explored as traditional central government budget allocations and international development agency financing are fast becoming insufficient. LGUs must broaden their financial horizons and redefine their financing strategies to respond to new challenges. Most LGUs in the Philippines follow established development processes, from traditional revenue generation schemes to nontraditional resource mobilization strategies. LGUs should, in addition, undertake more specific measures: Examine macroeconomic trends. ey should analyze records of recent revenue collection efforts to assess whether they are consistent with regional gross domestic product (GDP) trends, government expenditure, interest rates, and other economic and financial indicators. Revenue yields below the level of these macroeconomic trends undermine the principles of adequacy and elasticity. Consider inflation in tax collection. Market interest rates may be higher than interest and penalties on delayed tax payments, inducing taxpayers to delay or default on tax payments to finance business activity. Upgrade revenue collection targets, improve statistical information underlying revenue estimation, and develop mechanisms to enhance revenue projections and assessment of revenue impact of tax policy changes.
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Review the tax burden of the different economic sectors to improve equity. e tax rates on manufacturers and wholesalers vis--vis those on retailers under the Local Government Code (LGC) is a classic example of a regressive tax structure. Balance tax administration by lowering tax rates and broadening the tax base. Remove perverse incentives such as periodic tax amnesties. Implement a clear, concise, and regularly updated tax ordinance. Upgrade physical infrastructure and simplify procedures and forms. Establish a one-stop transaction center for customers to improve compliance and tax collection efficiency. Establish interagency information sharing to define the tax base and enforce effective tax collection. Penalize tax delinquency to encourage tax compliance. Be politically committed to revenue administration. Promote good governance through value formation of personnel. Improve public expenditure management to promote operational efficiency, reduce waste, and eradicate corrupt and excessive government spending. Get feedback from stakeholders and taxpayers to improve revenue generation. Promote participatory governance through consultations. Explore other areas of collaboration and partnership with the private sector and nongovernment organizations in service delivery.
Best practices in revenue generation and resource mobilization confirm that financially efficient LGUs are more inclined than less efficient ones to pursue complex, nontraditional, and innovative strategies, such as build-operate-transfer (BOT) arrangements or bond flotation. An efficient traditional revenue generation mechanism is a prerequisite to pursue nontraditional approaches. Decentralization requires fiscal sustainability. Different levels of LGUs gain and lose under the internal revenue allotment (IRA), and the national Government continues to fund some devolved responsibilities, suggesting that expenditure assignments between national and local governments should be reviewed to resolve overlaps and duplications. Minimum standards of service delivery to be financed by the IRA must be established. LGUs should be rewarded for efficient tax collection and service delivery. e absence of straightforward performance indicators in central government grant allocation could undermine LGUs tax efforts as well as their operational efficiency and accountability. An unconditional grant does not encourage LGUs to engage in long-term capital investments and other development projects beyond basic services. As LGUs confront devolution, however, and as they become increasingly aware of the extent of their responsibilities, the IRA formula should be reviewed as it has resulted in inequitable increments for LGUs. More and
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more of them, especially the urbanizing ones, are beginning to realize the importance of mobilizing local revenues and even adopting credit financing to underwrite the substantial financial requirements of devolution and development. To date, though, bond flotation to finance local infrastructure projects has not taken root among local chief executives. Much more needs to be done to establish the capital market for LGU bonds. Primary LGU bond issues are scarce due to lack of LGU awareness of bond flotation. Since 1991, only 13 LGUs have issued bonds, totaling P1.56 billion. e national Government has issued no policy direction on the LGU bond market. e private financial sector is not prepared to accept LGU risks without any form of credit enhancement, considering LGUs as high-risk, highly politicized entities. e lack of accessible, timely, and uniform LGU financial and other information from a single source does not help improve LGU creditworthiness. Investors will not choose LGU bonds, which have no national guarantee or tax benefits, over treasury bills and treasury notes, which have zero risk as they are guaranteed by the national Government. LGUs are discouraged from banking with private banks as LGU deposits and trust accounts are allowed only with government financial institutions. is compounds the gap between the private financial sector and LGUs and does nothing to stimulate private investor appetite for LGU bonds as they offer no compensating business. e institutional and procedural framework for the LGU bond market is still evolving. Investors and LGUs will be encouraged to look at bond floats if transparent bond processes and institutional arrangements are in place. To help develop the LGU primary and secondary debt markets, the following reforms are recommended: e executive branch of the Government should issue an executive order to support LGU bond market development. e lead national government agencies, in collaboration with the Department of Interior and Local Government, should conduct a nationwide information dissemination campaign on LGU bond flotation. e lead national government agencies should establish an institutional and procedural framework for LGU bond issuance. Bangko Sentral ng Pilipinas (BSP, Central Bank of the Philippines) and the Commission on Audit (COA) should remove restrictions on LGU deposits and trust accounts. e national Government should exempt bond team contracting from LGU guidelines on procurement of supplies and services. e national Government should provide tax incentives for LGU bonds and make LGU rating a requirement for LGUs issuing bonds. e national Government should establish a central depository of LGU data.
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Introduction
e global economic slowdown has lessened many national governments capacity to deliver basic services and implement critical infrastructure projects, leading to the conclusion that subnational units must be involved in them, especially in those developing countries where governments are highly centralized. In the early 1990s, developing countries began to decentralize politically. Among the first Southeast Asian countries to pass a law on decentralization was the Philippines. It enacted the LGC in 1991, expanding LGU responsibilities to deliver basic services and giving LGUs more fiscal autonomy to finance their new activities (Appendix 1 shows LGU classification by income bracket). e LGC effected a major paradigm shift in governance, mandating the devolution to LGUs of many functions previously carried out by national government agencies (NGAs) and providing for a higher LGU share in internal revenue taxes and taxes on national wealth. e LGC also allows LGUs greater autonomy not only in mobilizing resources but also in allocating them. e LGC grants LGUs the authority to issue bonds for revenuegenerating, self-liquidating projects. e devolution of basic services and activities to LGUs is expected to make them more effective in meeting peoples basic needs and advancing the national Governments social reform agenda. e LGC empowers LGUs to create their own revenue sources; levy taxes, fees, and charges; and access nontraditional LGU financing sources such as government and private bank loans, BOT or joint-venture arrangements, and bond flotation. LGUs are thus expected to depend less on transfers from the national Government, such as the IRA. LGUs, however, continue to use traditional sources of funding such as the IRA and tax revenues to finance expenditures, which are mostly for salaries and operation and maintenance. Capital outlays have been minimal at 7.5% of budget. Less than 30% of LGUs have accessed loans from government financial institutions (GFIs) and only 13 have issued bonds to finance development projects since the LGC was enacted. While the LGC has brought about gains, the following are concerns: continued involvement of NGAs in devolved activities; increased financial burden on some LGUs despite the IRA increase; increased risks in service delivery; and lack of clear policies, programs, and mechanisms for LGU access to financing sources, especially private financing sources such as the capital market. is chapter examines local government fiscal management since 1995 and
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LGU bond market development. Recommendations will be given to facilitate this development and to improve the LGUs financial situation. Areas where the Asian Development Bank (ADB) may be of assistance will be identified.
Local Government Structure and Powers

Structure
e Constitution identifies provinces, cities, municipalities, and barangays as territorial and political subdivisions. e barangay is the smallest unit of government; groups of barangays constitute a city or municipality. e province is the highest form of local government. e LGC empowers provinces to exercise general supervision over their component cities and municipalities. Highly urbanized and independent component cities are not under the supervision of the province.
Powers
LGUs exercise government and corporate powers and functions. Government powers include those necessary for governance, such as the promotion of health and safety, improvement of property, improvement of morals, maintenance of peace and order, and the preservation of the comfort and convenience of the inhabitants. LGUs also have the power to create their own sources of revenue and to levy taxes.
Economic and Political Trends since 1995

Major Economic and Political Changes
e LGC of 1991 introduced far-reaching political changes by transferring substantial powers, functions, and responsibilities from the national Government to LGUs, thereby allowing change and development to originate from the communities. e LGCs primary objectives are to enable LGUs to fully develop as self-reliant communities and transform themselves into active partners in pursuing national goals through a responsive and accountable decentralized local government structure. e LGC has transformed LGUs from mere administrators of local affairs to managers of communities through the following: devolving the service delivery functions of NGAs to LGUs;
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transferring the regulatory powers of certain NGAs to LGUs; enhancing the government and corporate powers of LGUs to enable them to discharge their devolved powers and functions; institutionalizing relations among LGUs, nongovernment organizations, and the private sector to ensure broad support for local autonomy; and requiring NGAs to deconcentrate the requisite authority and power to their respective regional and field offices.
Devolution of Functions from National to Local Government

e LGC was extremely relevant during and after the Asian financial crisis of 1997, when most economies in the region, including that of the Philippines, collapsed. e national budget deficit continued to soar, making transfers and aid from the national Government to LGUs less feasible even as they needed to deliver more basic services. e national Government abandoned important infrastructure projects, resulting in a substantial infrastructure gap. e LGC devolves the following responsibilities to LGUs: Agricultural Extension and On-Site Research. Most agricultural support services, including establishment of agricultural facilities, have been devolved from the Department of Agriculture to cities and municipalities. Provinces provide agricultural services and facilities that require more resources and cut across municipalities. Conservation and Protection of the Environment. LGUs share with the national Government the responsibility to manage and maintain the ecological balance. e LGC requires NGAs or government corporations engaged in projects that impact the environment to consult LGUs, nongovernment organizations, and other sectors before implementing such projects. Field Health Services and Hospital Services. e Department of Health (DOH), particularly the provincial, district, city, and municipal health offices, used to be responsible for delivery of health services and facilities. e LGC has transferred these functions to LGUs. Locally Funded Public Works and Infrastructure Projects. Most infrastructure projects were undertaken by the Department of Public Works and Highways (DPWH) through its district engineering offices. Most infrastructure projects have been devolved to municipalities. Provinces are assigned only intermunicipal projects and large undertakings such as reclamation projects. However, most municipalities lack the funds and technical capability to undertake all infrastructure projects devolved to them. e LGC thus allows the next higher LGU and the national Government to fund such projects. While the LGC devolves to LGUs responsibility over locally funded infrastructure facilities, DPWH retains responsibility over such projects
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when they are nationally funded. As long as the national Government continues to fund infrastructure projects devolved to LGUs, DPWH regional offices and district engineering offices will not be substantially affected by the devolution of service delivery. LGUs and DPWH may, therefore, find themselves providing the same infrastructure facilities in an area. DPWHs project implementation functions therefore should be clearly defined. School Building. e LGC gives to cities and municipalities the responsibility to build, rehabilitate, repair, and maintain public school buildings. e national Government may, however, continue to do the same for elementary and secondary schools. e Department of Education may continue to implement its own schoolbuilding program for as long as the national Government funds it. Social Welfare and Development. Services and facilities once provided by the Department of Social Welfare and Development offices from the regional to the municipal level have been devolved to LGUs. Tourism Promotion and Development. e Department of Tourism and its corporation, Philippine Tourism Authority (PTA), managed, operated, and maintained tourist facilities and attractions before the LGC. LGUs now undertake tourism development projects without need for PTA approval and perform these Department of Tourism and PTA functions. However, facilities established by the PTA are not covered by devolution. e LGC allows LGUs to regulate tourism establishments. Telecommunications. e Department of Transportation and Communication provides telecommunications services and facilities with the private sector. e LGC also requires provinces and cities to provide telecommunications services and to install, operate, and maintain public telephones in every municipality. Low-Cost Housing. Provinces and cities may undertake programs and projects for low-cost housing and other mass dwellings, except those funded by the Social Security System, Government Service Insurance System, and Home Development Mutual Fund. Only housing production by the National Housing Authority, the only government agency involved in direct shelter production, is covered by devolution. However, National Housing Authority programs and projects cannot be devolved unless provided by law. Little devolution, therefore, has occurred in housing provision. Other Services and Facilities. Cities and municipalities maintain public libraries, and provide information services, including for investment, jobs, and marketing. Provinces and cities provide services for industrial research, development services, transfer of appropriate technology, and investment support, including access to credit financing. e departments of science and technology and of trade and industry provide these services on a limited scale.
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Impact of Devolution on Local Government Finance

Devolution has several repercussions, among them the downsizing of NGAs, and the emergence of the need for a significant capability-building program for LGUs and for huge funding. LGUs have the power to create their own sources of revenue, and to levy taxes, fees, and charges that will accrue exclusively to LGUs. ey are allowed to borrow and secure credit from government or private lending institutions to finance local projects as well as to issue bonds, securities, debentures, collateral, notes, and other obligations to finance self-liquidating and income-producing development and livelihood projects. e LGU share in national taxes has been increased and fixed, the release of which should be automatic unless the national Government incurs an unmanageable public sector deficit. From 20% (and even less) before the LGC, the LGU share in the IRA increased to 30% in 1992, 35% in 1993, and 40% in 1994. Even with their expanded fiscal powers and increased IRA share, however, LGUs, especially the small ones, have not managed to perform their new functions efficiently. Staff from NGAs were transferred to LGUs, considerably increasing their personnel numbers. About 15,000 agricultural and fishery extension services staff and about 2,000 administrative services employees were transferred from the Department of Agriculture alone. Some employees were made redundant. Many local officials were wary that IRA increments would only be utilized for salaries of transferred personnel. Such apprehension, however, was unfounded. In the first year of the LGC, LGUs were entitled to receive an amount equivalent to the cost of devolved personnel services in addition to the 30% of IRA. IRAs in succeeding years were estimated to be sufficient to cover the cost of devolved personnel services. Depending on their classification, LGUs may appropriate only 4555% of their regular income for personnel services. LGUs should standardize salary structures to harmonize pay rates of local personnel with those of transferred national personnel. e restriction hampered LGU capacity to finance the salaries of national personnel despite the increased IRA. Provinces and municipalities, which acquired more responsibility, lost from devolution, while cities and barangays, which acquired less, gained. Provinces, for example, assumed the operation of provincial hospitals formerly managed and financed by DOH. Cities have a broader revenue base and taxing powers than provinces and municipalities, and are thus better able to absorb the additional functions. Government-wide salary standardization is imperative to eradicate or minimize wide discrepancies in the salary structures between national and local personnel. e
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LGC allows local councils to prescribe the salary structure of local personnel provided that it does not exceed budgetary ceilings. Personnel transfers also gave rise to excess staff for certain positions when LGUs already had the full staff complement. Several studies on decentralization have been undertaken. Loehr and Manasan (1999) focused on the effects of fiscal decentralization and economic efficiency in service delivery, revealing the following: Production efficiency has been improved, probably as a result of fiscal decentralization, as LGUs spent about 3.9% of GDP in 2000, compared to about 1.9% before the LGC. Lack of local capability has not been a major constraint, although the experience among LGUs has been uneven. Innovation has made revenue more productive. More services, such as education and law enforcement, should be devolved to LGUs in the medium term. Allocative efficiency has improved slightly. e mix of expenditures has changed since 1992, and LGUs preferences are better reflected in expenditure patterns. Changes in the expenditure mix have been very small and favor public welfare and internal safety (education, health, housing, nutrition, and peace and order) in lieu of general government. Fiscal efficiency needs to be improved. Most LGUs spend more in administering taxes (such as real property tax) than they collect in revenues. Macroeconomic stability is not threatened by fiscal decentralization. e study concluded that LGUs face the following problems: Few LGUs have fully exploited their own sources of revenue, yet all face hard budget constraints. Ultimately, allocative efficiency will be improved for those jurisdictions that improve revenue generation through local taxes, such as property and business taxes. Many LGUs, especially provinces, are unable to fulfill their devolved expenditure responsibilities, and have even created new expenditures when their share in the national taxes (i.e., the IRA) increased after the LGC. Inflation cuts into shared revenue before it is delivered to LGUs, it rarely comes from natural resource exploitation, and sometimes LGU revenue is lowered to meet national objectives. LGUs should receive the revenue mandated for them by the LGC. Employees should receive equitable and adequate pay, as well as skills training. NGAs have not fully yielded responsibility to LGUs for devolved services and should shift from supervisory to supportive roles.
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Local Government Fiscal Management

Local Government Fiscal Patterns
Data on the budgetary operations of the three levels of local government for FY19912000 are in the appendix tables. Appendix Table 2.1 summarizes the revenue and expenditure of all provinces combined; Appendix Table 2.2, for all cities; and Appendix Table 2.3, for all municipalities. Total revenue of all provinces, cities, and municipalities combined increased from P24.1 billion in 1991 to P66.5 billion in 1995 to P138.3 billion in 2000. e average annual growth rate of total LGU revenues in 19952000 was 15.8%. Due to legislated increases in IRA shares of LGUs, LGU revenue grew from 20% in 1991, to 30% in 1992, 35% in 1993, and 40% in 1994. Total expenditure of all provinces, cities, and municipalities combined also increased, from P22.8 billion in 1991, to P64.4 billion in 1995, and to P127.9 billion in 2000. e average annual growth rate of total LGU expenditure for 19952000 was 16.2%, while that for 19911994 was 33.2% due to the increase in LGU functions. LGU revenue as a share of GDP averaged 3.0% in 19921995 and 3.9% in 19962000. LGU expenditures as a share of GDP averaged 2.8% in 19921995 and 3.7% in 19962000. e increasing proportion of LGU revenue and expenditure in GDP shows how significant local government finance has become. LGUs contributed a net surplus to consolidated public sector finances in 19912000 (Appendix Tables 2.12.3). e main sources of local government income are tax and nontax revenue and income from external sources. Provinces are the most dependent on revenue from external sources, followed by municipalities, then cities (Appendix Table 2.4). e IRA is the major external source of income of LGUs. Since 1992, the IRA has never been lower than 95% of total external sources of income for all LGU levels. Cities had the greatest dependence on IRA, with an average of 99% in 19922000. Municipalities followed with 98%, then provinces with 97%. e average share of IRA to total revenue was 75% for provinces, 45% for cities, and 66% for municipalities (Appendix Tables 2.5 and 2.6). Revenue from local taxation (real property and business taxes) was the secondlargest revenue source for all levels of local government in 19922000. e average shares of local taxation to total local sources were 45% for provinces, 67% for cities, and 59% for municipalities (Appendix Table 2.7). Real property tax is the predominant revenue source for provinces, while real property and business taxes contribute almost equally to the coffers of cities and municipalities, making their tax base larger than that of provinces (Appendix Tables 2.12.3). Nontax revenue sources are receipts from economic enterprises, fees and charges,
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loans, and miscellaneous receipts. LGUs have not fully tapped these sources. Loans and borrowings, classified as nontax income, are a growing source for cities but not for provinces and municipalities. Receipts from economic enterprises are higher for cities and municipalities than provinces, although none of them gives this potential income source much importance. In 19932000, general government expenditure accounted for an average of 31% of total local government expenditure, decreasing significantly from pre-LGC levels. Public welfare and internal safety (health, education, nutrition, peace and order, etc.) accounted for 24%, and economic development for 13%. LGUs appropriated an average capital outlay of close to 10% (Appendix Table 2.8). e category others represents intergovernmental aid to hospitals and to barangays and other LGUs. Municipalities general government expenditures represent on average 53% of total LGU expenditure on general government; cities, 30%; and provinces, 17% (Appendix Table 2.9). Cuaresma and Ilago (1996) examined the equity and efficiency of the central government grant system and the IRA formula. LGU taxing powers and tax bases underscored the importance of LGU development plans and how they affect LGU revenue generation and resource mobilization. eir study essays the different revenueraising powers provided for in the LGC: local taxation, various forms of financing (bond financing or borrowing from government institutions, particularly GFIs), tapping private capital markets via BOT and its variants, and the IRA (Appendix 3). eir study concludes the following: e national Government has not adequately supported local development, and its expenditure is concentrated in Metropolitan Manila and other urban centers. It continues to give priority to debt servicing instead of poverty reduction, housing, and other social welfare programs. e national Government should give LGUs fiscal autonomy, and LGUs should improve their fiscal administration. While LGU revenue-raising powers and regulatory and administrative functions have expanded, the national Government continues to hold on to productive taxes with huge tax bases (such as income tax and tax on motor vehicles). e nationally mandated distribution of the internal revenue allotment has only minimally reduced the urban-rural fiscal gap. Because their revenue generation efforts have been limited, LGUs have not embarked on additional programs and projects. Much less local revenue has been generated than external revenue. LGU dependence on the IRA continues to deepen as larger amounts are allotted and automatically released. LGUs heavily depend on real property tax and business taxes and licenses. A great number of LGUs have not utilized their power to use nontraditional sources of financing. Few LGUs have issued bonds to finance development projects.
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Local development plans must include programs, projects, realistic funding estimates, and financing mechanisms. LGUs continued funding traditional development projects using the 20% development fund and the pork barrel of their Congress representatives or senators. e 20% development fund is usually used to finance infrastructure projects that do not meet pressing or long-term development needs.
Strategies to Strengthen Local Government Finance

Ever-increasing expenditure on social services and pressure on public services and infrastructure facilities, and the rising cost of providing public services such as health and education, seriously threaten the local revenue base. More funds must flow into the LGUs, and service delivery must be made more innovative and cost-efficient. Simply put, LGUs need to close the fiscal gap. To do this, they need to confront the major fiscal problems, i.e., high dependency on the IRA, outdated local tax codes, underutilization of real property tax bases, underassessment of local business taxes, poor operation and management of economic enterprises, insufficient utilization of financial resources, and poor planning and budgeting. LGUs need to undertake some critical revenue-generating measure, as listed in the following paragraphs. Traditional Sources of Revenue Such sources include real property tax and local business tax. Urbanization and development of LGUs have opened opportunities for increased tax earnings from high-value real property. Regular updating of property values and classifications and a comprehensive inventory of all real property through tax mapping will maximize the potential of property taxes. Innovative approaches to property taxation can be explored through the use of development or betterment levies, through which the social increment in land values, especially in urban and urbanizing LGUs, is made available for public use. Idle-Land Tax Imposing an idle-land tax will discourage large-scale land speculation, rationalize and optimize land use and management, maximize the property tax yield, and rationalize land prices. Computerization e real property administration system should be computerized through proper mapping appraisal and assessment, recording and billing, and tax collection.
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Automatic Indexation e general revisions of property assessments against the schedule of fair market value of the property should be automatically indexed. Automatic indexation will help avoid radical adjustments in the schedule and narrow the gap between the official schedule and true market value, thus making property taxation more dynamic and transparent. Automatic indexation will also insulate real property valuation from political interference. e assessors value and zonal value should be harmonized to ensure predictability, uniformity, and transparency. Real property tax collectibles should be monitored separately from delinquent accounts. Aggressive collection and enforcement through periodic posting of notices of delinquencies will significantly improve tax collection. Warrants of levy should be issued immediately to trigger auctions of delinquent properties. ese aggressive moves, however, require strong political will and support from local leaders. In addition to these measures, LGUs should be given incentives to collect taxes efficiently. e incentives can be part of the IRA formula to counteract any tendency of local officials to rely solely on IRA and forgo efforts to improve local revenue generation. Perverse incentives, such as tax amnesties, should also be stopped. e biggest anomaly in local business tax collection is underdeclaration of gross receipts of business establishments, which results in big losses for local governments. e staff of the local treasurers office, who are at the forefront of tax collection, must be trained to verify the authenticity of financial statements. LGUs must coordinate closely and share information with the Bureau of Internal Revenue to establish a formidable tax collection mechanism. e use of the presumptive income level, particularly for small and medium-sized establishments, should be explored to determine realistic gross receipts. is approach estimates daily output by examining unit price, electric bills, number of employees, and amount of inventory. LGUs need to use creative and innovative methods to cultivate this potent tax revenue source. Use of Market-Oriented Fees and User Charges e inherent costs of services delivered can be computed and reflected in the fee structures, especially in the operation of economic enterprises where LGUs exercise a proprietary function. Services and infrastructure can be made sustainable by charging beneficiaries the full cost. LGUs must avoid subsidizing costs when the beneficiaries are clearly and specifically identified. is is one way of injecting the entrepreneurial spirit into local government operations and avoiding depletion of meager resources.
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Regular Updating of Local Government Revenue Codes LGUs should marshal the political will to regularly adjust and update the rates in their revenue codes to ensure the buoyancy and elasticity of tax and nontax revenues. Encouragement of Cooperation among LGUs Because development concerns often transcend political boundaries, contiguous LGUs will greatly benefit from collective planning and pooling of resources, as in the Gingoog Bay Area, Partido District (Camarines Sur), and the eastern towns of Misamis Oriental. LGUs can capitalize on economies of scale and comparative advantage in trade, commerce, environmental management, etc. Efficient Use of Existing Financial Resources in Service Delivery Performance indicators and benchmarks can make the use of existing financial resources in service delivery more efficient. LGUs can establish performance indicators and benchmarks in service delivery by looking at the trend of the per capita cost of service delivery. Parallel surveys on the level of satisfaction of the constituents can be documented to validate the level of service. Initially, LGUs are not to be compared with each other; rather, their performance is to be measured over time. However, in the medium and long term, LGUs can start benchmarking with other comparable LGUs. Access of LGUs to the Capital Market Rural capital infrastructure is sorely lacking. LGUs can resort to borrowing for productive infrastructure such as economic enterprises, power generation, waterworks and sewerage, and irrigation. Other forms of financing such as bonds and BOT have significant potential. e modest countryside savings and capital market resources can be directly accessed. Municipal bonds can be made attractive to investors through viable projects and interest rates that are higher than at banks. Caution must be exercised, however, as the capital market is still in its infancy. e early evolution of an appropriate policy environment, legal mandates, and support structures such as liberalization of LGU depository banks, a disclosure system, a secondary market, and a credit-rating system for LGUs will enhance LGU entry into the capital market. For example, Mandaluyong City built its public market through BOT, while a number of LGUs, including the municipality of Victorias, the cities of Legaspi and Urdaneta, and the province of Aklan floated bonds to finance development and resource-generating projects. Although the increased IRA has to some extent been a windfall for many LGUs, their greater capacity and willingness to raise local revenue is the linchpin of LGU creditworthiness. e IRA is insufficient to meet the requirements of local develop-
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ment infrastructure and of a growing populace. While IRA flows can be leveraged into investment funds through credit, loans will still have to be repaid. LGU capability to repay these loans should, therefore, be developed at an early stage. ere is no substitute for sustained local revenue mobilization, including the collection of user charges for revenue and project maintenance. LGUs should pursue public-private partnerships (BOT arrangements or any of its derivatives, joint ventures, etc.) to gain access to sophisticated technology, costeffective design, and flexible financing, including the use of private capital. Strengthening of Planning and Budgeting LGUs revenue generation and resource mobilization must reflect the communitys vision and aspirations. Financing mechanisms and budgetary thrusts should work in concert with participatory planning. Projects should thus be prioritized to ensure fiscal and allocative efficiency.
Financing Alternatives and Local Government Financing Trends

Financing Alternatives
Traditional Funding Sources LGUs have a wide array of financing alternatives, from short-term cash-flow shortfalls to long-term capital-intensive infrastructure development projects (Table 1). Traditional funding sources of LGUs include internally generated revenue from real property and business taxes, fees and charges, and economic enterprises; IRA from the national Government, representing the LGU share in internal revenue
Table 1. Financing Alternatives for Local Government Units
Internal Sources Tax Revenues Real Property Tax Business Tax Nontax Revenues Receipts from Economic Enterprises Fees and Charges External Sources Borrowings Private Sector Tie-Ups Build-OperateTransfer Schemes Joint Ventures IRA Direct Loans Share in National MDFO Wealth GFIs PFIs Local/Foreign Grants, and Aid Bond Issuance
GFI = government financial institution, IRA = internal revenue allotment, MDFO = Municipal Development Fund Office, PFI = private financial institution.
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collections as of 3 years earlier; share in national wealth utilization for resources in LGUs; share in value-added taxes; financial aid from local or foreign sources; and donations in kind from local or foreign sources. Direct Loans Even before LGC implementation in 1992, aggressive local executives were already borrowing from special government loan programs and GFIs. Such loan transactions, however, are still one-to-one deals where the LGU deposits cover the loan amount or, at the very least, the annual debt service, and the lender automatically debits payment from the account of the LGU that is late in paying. e most active GFI in LGU lending is the Land Bank of the Philippines, with around P18 billion in its LGU loan portfolio as of the end of 2001. e now-privatized Philippine National Bank (PNB) released P6.83 billion to LGUs in 19962001, while the Development Bank of the Philippines had an outstanding LGU portfolio of P4.66 billion as of the end of February 2002. e Philippine Veterans Bank, a new player in the LGU market, lent P677 million to LGUs in 19992001. e Department of Finance (DOF), under its Municipal Development Fund Office (MDFO), implements a special LGU credit facility, the Local Government Finance and Development Project, which is funded by the World Bank and targets mainly low-income LGUs. In 19952001, MDFO released P1.96 billion in loans to LGUs. Unexpected credit support for LGUs comes from the Government Service Insurance System, the pension fund for public employees, which offers loans of up to P20 million to LGUs for their small funding needs. In 19931996, it loaned a total of P134.96 million to 11 municipalities. LGU loan terms were 110 years, with 35-year loan tenors. Most loans ranged from a few thousand pesos to around P20,000. Box 1 discusses the direct loan experience of Anda, Pangasinan, and Box 2 details the Municipal Development Fund (MDF) loan for a public market project evaluated under a best-practice report format by the World Bank. Appendix 4 enumerates the different LGU lending programs of GFIs and MDFO. Private Sector Tie-Ups When loans from GFIs or MDFO are difficult to access, LGUs can turn to the private sector for innovative financing packages, foremost among which are BOT and joint venture schemes, and bond flotation. Under BOT, a private contractor builds and finances an infrastructure facility, and supports its operation and maintenance in exchange for generated income within an agreed-on period. en the facility is turned over to the LGU. In a joint venture, the LGU participates in the project.
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Box 1. Case Study of Municipal Government of Anda, Pangasinan: Philippine National Bank Loan for a Public Market and Bus Terminal Anda, the only island town of Pangasinan, is primarily rural, with 18 barangays, a population of 32,833 as of 2000, an annual population growth rate of 1.36%, and an income of P21.03 million for 2000. The town has no big industrial companies. Most of its income is from fishing, salt making, and rice production. The administration decided to build a public market and bus terminal in 2002. The local council authorized the mayor to negotiate and contract a P20 million loan with Philippine National Bank (PNB) or with any financial institution, and to contract with an engineering or construction firm to prepare a feasibility study and project design, and manage construction of the projects. The council authorized the treasurer to transfer the internal revenue allotment (IRA) deposits from Development Bank of the Philippines to PNB. PNB approved the loan request 4 months later, on 7 February 2002. The loan is payable over 7 years, with a 1-year grace period on principal (allotted for the construction period), with principal and interest payable monthly. Interest is based on prevailing market rates and repriced quarterly. Lower interest rates may be given depending on the average daily deposit balance of the municipality. The loan is secured by the continuing assignment of the IRA, project revenues, and other sources of income. Problems Encountered Project planning, authorization, and execution were delayed due to (i) piecemeal dialogues regarding barangay concerns and direct benefits the barangay would derive from the project; (ii) overly long council deliberations; and (iii) very stringent government and/or Commission on Audit regulations on public bidding (accreditation of qualified contractors, prequalification requirements, etc.) imposed on the project contractor. Loan implementation was stalled for 2 more months because a Department of Budget and Management (DBM) directive provided that transfers of the IRA depository account would be effected by DBM only once a year, or in January each year. PNBs loan approval condition, however, was that releases would only commence upon the transfer of the IRA deposit account to PNB. PNB requested DBM to reconsider and allow the transfer of the IRA since it was a contractual commitment of the local government unit in the loan agreement. After 2 months, DBM yielded to the request upon examining the loan documents and council resolutions. Project construction began on 10 April 2002, for completion in 300 days.
ree LGUs have finalized two BOT arrangements and one joint venture aggregating $41.8 million. Only one project has been concluded. Two other LGUs are negotiating for BOT packages of P1.43 billion, including a marketplace, water
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Box 2. Case Study of Pulilan, Bulacan: Municipal Development Fund Loan for a Public Market Pulilan showcases the development efforts of a low-income, resource-poor local government unit (LGU). It is one of the most successful beneficiaries of the World Bank-assisted municipal development projects in the Philippines. The municipality built a public market, supported by strong political leadership, which led to increased trade and, therefore, increase in the income of the local entrepreneurs, provision of jobs and other sources of livelihood, and more income for the LGU. The availability and supply of diverse and quality basic goods and commodities in the public market satisfied of the needs of consumers and local entrepreneurs. The public market has significantly enhanced local economic growth and improved peoples lives. The municipality received two financing packages for municipal development projects. Local Component (P million) Subloan Equity Total MDP II (1993) MDP III (1996) Total 6.750 4.667 11.417 1.242 0.519 1.761 7.992 5.186 13.178 Grant (P million) 11.054 2.362 13.416 Total Package (P million) 19.046 7.548 26.594
MDP = municipal development project.
The local component financed the construction of two public market buildings. The grant component financed intrasite drainage facilities and various farm-to-market roads covering about 5.5 kilometers. Problems Encountered Problems were minimal during project preparation and implementation because the projects were directly implemented by the LGU, and strong technical assistance was provided. The LGU complied with all project documentary requirements on time, which resulted in smooth project execution. The projects were completed on schedule, and even fund disbursement was not delayed. The experience of Pulilan supported previous study findings that a bottom-up demand-driven project approach is more efficient and effective for successful project implementation results than a top-down preselected project-specific approach.
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supply systems, an integrated bus terminal, and information and communications technology. In a bond flotation, the LGC authorizes provinces, cities, and municipalities to issue bonds to finance self-liquidating, income-producing development or livelihood projects in accordance with local development plans or public investment programs. An LGU bond is an interest-bearing or discounted local government security that obligates the issuing LGU to pay the bondholder a specified amount at identified periods, and to fully pay the principal amount of the obligation at bond maturity. Since 1991, only 13 LGUs have issued bonds, aggregating P1.56 billion (Appendix 5). Seven bonds were for housing projects while the rest funded an abattoir, jetty port and port terminal, general hospital, dry-goods and public markets, a commercial center and toll parking, and a convention center. Bond amounts for a single LGU issuer ranged from P8 million to P620 million. Except for one issue, all bonds were guaranteed: four by the government-owned Home Guaranty Corporation (formerly Home Insurance Guaranty Corporation) and eight by the LGU Guarantee Corporation (LGUGC), a private guarantee corporation majority owned by the Bankers Association of the Philippines, with Development Bank of the Philippines as its minority partner. e longest tenor for the guaranteed bonds is 7 years. Boxes 3 and 4 summarize the bond flotation experiences of Urdaneta and Tagaytay cities.
Local Government Financing Trends

Loans and borrowings of all LGU types increased significantly in 19952000, proof that LGUs had to fend for themselves after the 1997 economic crisis. e new breed of local chief executive is more aggressive in using nontraditional sources of funding for basic service delivery and enterprise projects. Facing an unrestrained national budget deficit, local chief executives may well make full use of their fiscal powers to create debt to ensure the growth of their localities and delivery of basic services.
Current Local Government Bond Market Situation

Low Level of Local Bond Issuance
Since 1995, LGUs have obtained more than P20 billion in direct loans but have floated only P1.56 billion of LGU bonds since 1991. Clearly, local chief executives have not embraced bond issuance as an alternative source of project financing. ere are several major reasons for this.
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Box 3. Case Study of Urdaneta City: Municipal Bonds for Abattoir Upgrading Urdaneta has an area of 10,026 hectares, only 132 of which are urban, and a population of 100,623 in 1995. Among the major contributors to economic enterprise incomes are schools, a slaughterhouse, and wholesale and public markets. To complement the market and take advantage of its position as the second leading wholesale livestock market in the country, the city improved its abattoir. The project included value-added activities such as cold storage and meat-processing plants. After failing to obtain a direct loan for the project from various government and private financial institutions, the city decided to float bonds. The P25 million Urdaneta municipal bonds had a term of 5 years with interest payable every 6 months and a balloon principal payment upon maturity. Pricing was based on the 182-day treasury bill rate plus 3 percentage points. Assignments on the internal revenue allotment, project revenues, and project assets were offered as security. Repayment of principal was assured via a sinking fund mechanism where semiannual deposits were made to cover the full principal at bond redemption. Problems Encountered The local government unit (LGU) took 3 years to obtain financing because no bank was interested in the project. This led the LGU to opt for other financing sources. Urdaneta was the first LGU in the country to issue non-housing bonds since the Local Government Codes passage and became a test case for the potential of an LGU debt capital market. No financial institution was willing to underwrite the bonds without a guarantee. Although all the requisite approvals for the bond flotation were completed by the city (then still a municipality) in 1997, it was only in 1999 that the bonds were issued, after obtaining a guarantee from the LGU Guarantee Corporation. Construction began in 1998 and was completed in 1999. However, the operation of the facility was delayed, which caused the city huge opportunity losses and unnecessary pressure on its cash flow. The new mayor did not operate the new abattoir until May 2002, reportedly for political reasons. The city, however, has serviced its debt obligations on time and its sinking fund level is more than required. The 2-month operation of the abattoir has yielded revenues of around P200,000 per month, lower than projected. Political risk is something that cannot be avoided when dealing with LGUs. As in Urdaneta, well-meaning projects of an old administration may be sidelined or even mothballed by incoming officials for whatever reason. Constituents should thus be vigilant to ensure that their taxes do not go to waste. Active participation of nongovernment organizations and peoples organizations in LGU affairs is recommended.
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Box 4. Case Study of Tagaytay City: Local Government Bonds for a Convention Center and Lodging Facilities Tagaytay is becoming highly urbanized. Its population in 1999 was 34,126. Economic activities are mainly in tourism and agriculture. Of the citys 889,235 hectares, 144,038 are devoted to tourism activities, such as lodging and other commercial tourism facilities. The city prioritized the construction of an infrastructure complex with a convention center, function rooms with lodging facilities, assembly halls, and auditoriums to meet demand for convention venues and good lodging. Tagaytay has benefited from the experience of the first four local government units (LGUs) to float LGU Guarantee Corporation-guaranteed bonds, as the bond issuance process was shortened and requirements more established. While Urdaneta had to wait 3 years before launching its bonds (Box 3), it took Tagaytay less than 1 year. The P220 million Tagaytay city bonds had a term of 7 years, inclusive of a 1-year grace period on principal. Interest is floating, based on the weighted average of the 182-day treasury bill rate plus a spread of 2.5 percentage points. There is also a sinking fund requirement equivalent to the principal due annually deposited to the fund 2 years in advance. The bonds issued were in denominations of P1 million, P100,000, P10,000, and P1,000. Around P2 million-worth of bonds were sold to Tagaytay constituents. Problems Encountered Although project construction is ahead of schedule, deviations from project construction plans stipulated by the mayor without clearance from, or advice to, the trustee or guarantor have been reported. This is a gray area that must be addressed in future bond flotations by including clear provisions on the issue in the guarantee agreement and trust indenture documents. The idea is to professionalize the entire bond flotation process, including implementation of projects funded by the bond proceeds. Local chief executives must be made aware that they have contractual agreements that must be followed. Generally, Tagaytays bond flotation was smooth and problem-free due to strong leadership of the local chief executive and his ability to get the cooperation of the city council for the project, a well-prepared financial package and project feasibility study, a clear master development plan for the city, and good revenue potential of the project.
Lack of Knowledge. ere is little technical knowledge on bonds or how to float them at the local level. Some local chief executives may not even be aware that LGUs are authorized to float bonds to fund projects. Absence of Support. While it has actively participated in workshops on LGU bond development, DOF has not championed LGU bonds. Local officials from different NGAs involved with LGU finance thus receive mixed signals regarding
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LGU bonds. e absence of clear-cut executive direction on LGU bond development compounds the problem. No Private Financial Sector Confidence. e private financial sector has no confidence in LGUs, which are perceived to be very high risk and politically driven rather than management oriented. Few private financial institutions (PFIs) are willing to underwrite LGU bonds. Evolving Framework. e regulatory, institutional, and procedural framework for LGU bonds is still evolving (see next section). While some basic structures and processes have been identified through various workshops and dialogues among major LGU bond proponents and the few actual LGU bond issuers, the infrastructure is still shaky and may change. Most local officials thus prefer the more established direct loan route to less familiar bond flotation.
Regulatory and Institutional Framework for Local Government Bonds

Regulatory Framework Bonds issued by LGUs are exempt from registration with the Securities and Exchange Commission. However, before issuing a bond, LGUs must secure approval to issue from BSP in the form of a favorable opinion on the probable effects of the proposed bond flotation on the countrys monetary aggregates, price levels, and balance of payments. For projects involving real estate or the environment, clearances from the departments of agrarian reform and environment and natural resources are required before the project starts. LGUs must also have approval in the form of a council ordinance, and component cities and municipalities need a provincial council resolution. Institutional Framework To monitor LGU bond issuances, LGUGC has committed itself to provide DOF with timely information on LGU bonds guaranteed, as well as a copy of the official statement of the issue. DOF has yet to enter into a similar arrangement with the Home Guaranty Corporation. To help DOF capture information on all LGU debts, including bond flotation, in May 2002 BSP encouraged all banks and nonbank financial institutions to require a DOF certification of debt service ceiling from LGUs applying for any type of financial assistance. To ensure that the total annual debt service obligation of LGUs, inclusive of debt service arising from the contemplated bond float, will remain within the 20% debt service cap imposed by the LGC, DOFs Bureau of Local Government Finance will issue upon request a certificate of maximum debt service capacity for the concerned LGU. No LGU debt should be entertained by any financial institution without such certification.
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Figure 1 shows the bond issuance process and the institutional framework of the LGU bond market. A credit-rating agency is required to give investors confidence in the LGU issuer, but no such independent body exists. LGUGC has an LGU credit-screening and -rating system.
Market Players
e following are the major participants in the bond issuance process: Financial Advisor. An independent entity, it offers LGUs project identification, feasibility study, and financial packaging assistance; advice on the projects financing mode; and, if bond flotation is the financing mode, help in selecting the bond trustee, underwriter, and guarantor, negotiating their fees, and preparing the prospectus. Underwriter. An investment house or universal bank, it buys the bonds from LGUs then sells them to other institutions or individuals. Trustee. e custodian of the trust fund, which is composed of bond proceeds, project revenues, and project assets, the trustee represents the bondholders and acts as the bond registrar and paying agent. Guarantor. It pays all amortization due to bondholders in case LGUs fail to honor their obligation.
Impediments to Local Government Bond Market Development

e major constraints to primary and secondary LGU bond market development are regulatory, legislative, administrative, and structural.
Regulatory Constraints
Restrictions on Depository Accounts. While the LGC allows LGUs to choose their depository bank, BSP and COA restrict LGU deposits to GFIs. e same is true for LGU trust accounts. is restriction prohibits PFIs from offering their banking services to LGUs and so getting to know the LGU market better, and enables GFIs to dominate the LGU debt market and to keep local officials away from the capital market. Bidding of Specialized Professional Services. LGU guidelines require bidding for procurement of supplies and services, including those of financial advisors, underwriters, and guarantors. Due to these guidelines, many LGUs have difficulty getting the special expertise that bond packaging requires.
Figure 1. Bond Issuance Process and Institutional Framework
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LGU = local government unit, LGUGC = LGU Guarantee Corporation.
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Legislative Constraints
Tax Treatment. LGU bonds do not provide any tax benefits to bondholders. Bond interest income is subject to final tax. Documentary stamp taxes are imposed on the primary sale of the bonds and shouldered by the issuer. LGU bonds are less attractive than treasury bills and treasury notes, which have the full faith and guarantee of the national Government. LGU bonds should have a tax incentive to allow them to compete in the capital market. Debt Service Cap. e LGC limits the annual debt servicing of LGUs to 20% of their regular income to discourage them from undertaking capital-intensive but revenue-generating projects, as the maximum acceptable bond tenor is only 7 years.
Administrative Constraints
Accounting Treatment. Up to the end of 2001, COA had no guidelines to book bond proceeds, disbursements for projects funded by LGU bonds, and income arising from temporary placements of proceeds, among others. Local treasurers and accountants did not have records of bond transactions. is system bred corruption as information was limited to a few officials, and transactions were not fully disclosed. Newly elected chief executives are suspicious of inherited bond-funded projects. In Puerto Princesa City, for example, which issued P320 million in housing bonds in 2000, not a single bond document is available. e bond team (financial advisor, trustee, underwriter, and guarantor) had to brief a new mayor on the purpose of the bond, its terms and conditions, and the status of the project, and to provide a complete set of bond documents. Local Government Financial Records. Private financial sector confidence in LGUs is critical to bond market development. is confidence can be built by making LGU financial records available to possible investors on time and in an easily understood format. COA started revising the Governments cash accounting system to the more familiar accrual-based one. DOF has also revised the LGU budget operations statement and requires a quarterly rather than annual submission by LGUs. However, government agencies still need to rationalize their applied LGU account titles and treatment so as not to confuse the private sector. Discussions are ongoing among DOF, COA, and the Department of Budget and Management (DBM) to unify their LGU financial reporting systems. National Policy. e national Government has no formal policy declaration on LGU bond market development. NGAs, therefore, are not engaged in a concerted, focused effort to promote and support LGU bond flotation to fund local infrastructure projects.
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Structural Constraints
Lack of Credit-Rating Agency. e Philippines has no independent credit-rating agency with the database and experience to rate LGUs. Given that they are viewed as high risk, LGUs must have high credit ratings to attract private investors to buy LGU bonds. Weak Institutional Framework. LGUs have to deal with DOF, COA, DBM, and BSP for financial matters. e Department of Interior and Local Government sometimes also has a say in LGU fiscal policies, which is not conducive to LGU bond market development. Different agencies have occasionally issued guidelines detrimental to it. Bond Tenors. Bonds are the best instruments to finance capital-intensive projects. Such projects normally have long payback periods and, therefore, require long maturities. Unfortunately, the capital market has shown resistance to LGU bonds with tenors of over 7 years.
Conclusions and Recommendations

Overall Status of the Local Government Bond Market
e LGU bond market in the Philippines is in its infancy. LGU officials are unaware of the merits of bond flotation and do not have the technical knowledge to float a bond. e executive branch has issued no directives to support LGU bond development. A national blueprint for LGU bond market development is lacking, and no NGA champions it. e different NGAs give mixed signals on LGU bonds and some even issue guidelines that hinder their development. e private financial sector and private investors are not prepared to consider LGU bonds as investment instruments comparable to nonrisk treasury bills and treasury notes. Credit enhancement is critical and LGU bondholders should be given tax benefits and other incentives. LGU rating is equally important to encourage investor acceptance of LGU bonds.
Proposed Reforms
Immediate Reforms Executive Order. e executive branch should support LGU bonds. Executive officials often profess their support of decentralization, and the President recently praised a local official for issuing bonds to fund a local public market. Executive
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support, however, must be in the form of an executive order that identifies an NGA, logically DOF, as the lead agency; that directs all other NGAs to support LGU bond market development; and that provides the lead agency with the authority to achieve the mandated objective. Focused Information Campaign. e lead NGA and Department of Interior and Local Government should design and implement a sustained nationwide bond flotation awareness campaign, with private sector participation. Framework for LGU Bond Issuance. e lead NGA should study bond flotation practices and improve them if necessary. LGU bond market development should not be hampered by an eagerness to regulate or monitor the market. Market players and LGUs will welcome a predictable and transparent bond issuance process, including approval requisites, but not red tape. e approach should be motivational rather than regulatory. Short-Term Reforms (1 Year) e executive branch should remove the following hindrances to LGU bond market development, to encourage a conducive policy, regulatory, and legislative environment: Restrictions on LGU Depository Accounts. BSP and COA should revise their circulars limiting LGU deposit and trustee accounts to GFIs. Bidding of Specialized Professional Services. Contracting of financial advisors, underwriters, and guarantors for a bond flotation package should be exempted from guidelines on procurement of supplies and services. Financial advisory work is a highly specialized skill and involves much trust and confidence between LGU and advisor. Payment of financial advisory services when the bond float is successful and from bond proceeds will counter any potential for unfair contracting practices. As LGU bonds are not yet attractive, only a handful of PFIs are willing to underwrite or buy LGU bonds. Asking PFIs to even bid for this privilege is unimaginable. Finally, only two guarantee institutions will accept LGU risks: Home Guaranty Corporation for housing projects, and LGUGC for all types of revenue-generating projects. Guarantors end up paying for the bond amortization when the issuer defaults and, therefore, have no motive to bid. LGUs will benefit by getting a guarantor to improve the marketability of the bond issue. Tax Incentives. Tax benefits to make LGU bonds more attractive are: Exemption from tax, the interest income up to a certain percentage (up to the equivalent yield on treasury bills or treasury notes of the same tenor, for example). To limit forgone national government revenue and focus tax preferences, the tax exemption may be applied only to revenue-generating projects and bond tenors beyond 7 years.
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Exemption from capital gains from the resale of LGU bonds from income taxes to encourage the growth of secondary market for LGU bonds. Abolition of the documentary stamp tax on primary issues of LGU bonds for the first 10 years of LGU bond market development.
LGU Financial Statements. e President should mandate NGAs to unify the financial reporting systems imposed on LGUs, especially the chart of accounts and accounting method. Medium-Term Reforms (5 Years) LGU Rating. Since LGU bonds are exempt from Securities and Exchange Commission registration, LGUs have no incentive to seek a rating before they issue a bond. Investors, however, prefer to know if the bond issuer is creditworthy through an independent rating published regularly. e national Government should examine the internal LGU credit screening and LGUCG rating system, which United States and Australian experts have declared as meeting international standards, and determine how to help LGUGC create a separate, independent rating agency. LGUGC has repeatedly announced its intention to distance itself from the rating business once the rating activity can be self-liquidating. Central Repository of Local Government Information. A major barrier to maintaining an efficient and cost-effective rating system for LGUs is the cost associated with collecting and analyzing financial, economic, political, and social data on LGUs. e Philippines has no central repository for LGU data, which are dispersed in various NGAs. LGUGC reports 11 data sources for its internal LGU rating system. For an LGU credit-rating agency to be sustainable, a national repository of LGU data is necessary. Groundwork for Bond Banking. Small LGUs will always have difficulty penetrating the capital market. A bond bank that can pool their bond issues will give small LGUs the chance to take advantage of the benefits of the capital market, prepare to participate in the formal financial sector, and thus practice good governance.
Some Considerations for Successful Local Government Credit Financing

LGU credit financing will be highly successful when LGUs set up structures conducive to bond market development and if a stable macroeconomic environment for savings and investment is established. LGUs should do the following: Project an image of strong political leadership. Local government officials must become marketing managers, projecting sense and savvy.
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Support the right projects. Investors will support only those bond issues that will be used for productive projects. Project viability is a major criterion used by banks in evaluating loan applications. Project a positive image in the market. Clean, peaceful, and working communities attract the markets attention and confidence. Have properties to serve as collateral or security. Display disciplined and progressive management of financial resources. Continuously improve nondebt-related finances. Capacity to pay will be determined by taxes and fees that the LGU can collect.
Potential Areas for Asian Development Bank Assistance

ADB could help develop the LGU bond market and improve LGU fiscal management through the following: Aggressively advocate the issuance of an executive order supporting LGU bond market development and laying down the policy for it, identifying a lead agency, and urging all NGAs to help build market infrastructure and motivate private sector participation. Help the executive branch draft the executive order. Lobby for legislative reforms. Support NGAs and nongovernment organizations that help build LGU capacity and organize good governance projects or workshops. Support information campaigns to increase LGU awareness of nontraditional funding sources in general, and bond flotation in particular. Help establish the national central repository of LGU data. Help LGUGC spin off its internal LGU credit-screening and -rating system into an independent LGU credit-rating institution. Fund a study on bond banking to pool bond issues of small LGUs.
Endnotes
LGUs are provinces, cities, and municipalities. e Philippines has 79 provinces, 114 cities, 1,496 municipalities, and some 42,000 barangays spread over 16 regions, including the Autonomous Region of Muslim Mindanao. Office of the governor/mayor, local council, and following posts at provincial, city, or municipal level: administrator, budget officer, treasurer, assessor, and auditor.
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References
Cuaresma, Jocelyn and Simeon Ilago. 1996. Local Fiscal Administration in the Philippines. Quezon City: University of the Philippines Local Government Center and Public Administration Promotion Center, and German Foundation for International Development. De Guzman, Raul and Mila Reforma. 1992. Local Government: Organization, Powers and Functions, Relation with Central Government. In Strengthening Local Government Administration and Accelerating Local Development, edited by Perfecto Padilla. Quezon City: University of the Philippines Local Government Center and the Asia Foundation. Department of Finance; United States Agency for International Development; Accelerating Growth, Investments and Liberalization with Equity; and Governance and Local Democracy. 1999. Issues and Recommendations. Strategic Planning Workshop on Municipal Bonds. Manila. Financial Executives Institute of the Philippines (FINEX) LGU Committee. 2001. Municipal Bonds: A Manual. Makati: FINEX. FINEX. 2002. LGU Financing Options and Municipal Bond Process and Best Practice. Presentation materials for FINEX Seminar series on the making of a municipal bond. Lee, Kyu Sik and Roy Gilbert. 1999. Developing Towns and Cities: Lessons from Brazil and the Philippines. Washington, DC: World Bank. Loehr, William and Rosario Manasan. 1999. Fiscal Decentralization and Economic Efficiency: Measurement and Evaluation. Makati: United States Agency for International Development and Harvard Institute for International Development. Tabunda, Manuel and Mario Galang. 1992. A Guide to the Local Government Code of 1991. Makati. Villar, Maria Mildred Ambrosio. 1999. Impact Evaluation Study on the Pulilan Public Market under the Municipal Development Project. Masters thesis in urban and regional planning. University of the Philippines, Diliman, Quezon City. World Bank. 1997a. Implementation Completion Report, Second Municipal Development Project. Washington, DC. . 1997b. Performance Audit Report, Philippines Municipal Development Project (Loan 2435-PH) and Second Municipal Development Project (Loan 3146-H), Operations Evaluation Department. Washington, DC. . 2001. Implementation Completion Report, Third Municipal Development Project. Washington, DC. Zipagan, Romulo, Erlito Pardo, and Norberto Malvar. 1999. Training Manual on Local Government Mobilization and Financial Management. Manila: Local Government Academy, Department of Interior and Local Government.
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Appendix 1. Local Government Unit Classification by Income Bracket

As provided for under Sections 1 and 2 of Executive Order No. 249 issued on July 25, 1987 by the President, provinces, cities and municipalities, except Manila and Quezon City which shall remain as Special Class cities, shall be divided into six (6) main classes according to the average annual income that they actually realized during the last four (4) calendar years immediately preceding the year of reclassification. Accordingly, on the basis of the financial statements of LGUs for calendar years 19961999 as certified by the Commission on Audit, the classification of the three levels is based on the following income brackets:
Average Annual Income (P million)
Class First Second Third Fourth Fifth Sixth Provinces 255 or more 170 or more, less than 255 120 or more, less than 170 70 or more, less than 120 35 or more, less than 70 Below 35 Cities 205 or more 155 or more, less than 205 100 or more, less than 155 70 or more, less than 100 35 or more, less than 70 Below 35 Municipalities 35 or more 27 or more, less than 35 21 or more, less than 27 13 or more, less than 21 7 or more, less than 13 Below 7
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Appendix Table 2.1 Consolidated Budget Operations Statement, All Provinces Combined, 19912000 (P million)
1993 2,309.4 1195.0 804.8 390.1 1,114.4 300.0 204.8 106.9 502.7 7,756.6 7,615.6 141.0 10,066.0 8,348.5 2,241.3 2,657.5 1,862.7 275.9 1,311.2 514.8 8,863.3 1,202.7 3,045.9 1,462.5 1,043.6 419.3 1,583.3 389.3 177.4 330.7 685.9 10,721.5 10,478.7 147.6 95.1 13,767.4 11,083.8 2,557.0 3,785.4 2,175.7 513.7 2,051.9 1,301.6 12,385.4 1,382.0 3,368.7 1,576.5 1,122.4 454.1 1,792.2 460.9 209.6 292.0 829.6 12,711.6 12,106.5 161.5 443.5 16,080.2 14,339.5 3,358.0 4,895.8 2,997.6 465.5 2,622.5 1,205.3 15,544.8 535.4 4,935.0 2,003.9 1,286.9 717.0 2,931.1 484.3 276.3 822.0 1,348.5 13,449.0 13,317.0 82.2 49.9 18,384.0 15,721.9 3,728.5 5,637.2 3,136.8 626.5 2,593.0 1,473.6 17,195.6 1,188.4 5,607.2 2,167.0 1,581.2 585.8 3,440.2 587.6 305.9 966.8 1,580.0 17,173.4 16,836.3 285.1 52.0 22,780.6 19,618.7 4,743.5 6,936.3 3,704.2 757.7 3,477.1 1,718.4 21,337.1 1,443.5 5,188.3 2,352.0 1,864.2 487.8 2,836.3 547.3 384.5 477.3 1,427.1 19,545.0 18,737.0 738.2 69.8 24,733.2 21,492.0 5,303.2 7,472.4 4,424.5 425.3 3,866.6 2,214.0 23,706.0 1,027.2 5,431.5 2,711.0 2,029.0 682.0 2,720.5 539.7 379.8 599.2 1,201.8 21,909.1 21,247.6 627.0 34.5 27,340.6 22,667.3 5,489.1 7,660.0 4,167.6 466.6 4,884.0 1,981.5 24,648.8 2,691.8 7,141.6 3,003.0 2,245.4 757.6 4,138.7 625.1 427.0 1,516.1 1,570.4 26,570.5 25,968.1 543.7 58.7 33,712.1 28,135.9 6,557.9 9,361.7 5,302.8 605.5 6,308.1 2,013.5 30,149.4 3,562.7 31,672.2 13,813.4 10,129.1 3,684.3 17,858.9 3,245.0 1,983.0 4,673.4 7,957.5 111,358.5 108,212.4 2,437.6 708.5 143,030.7 121,975.4 29,180.1 41,963.4 23,733.4 3347.1 23,751.4 10,606.4 13,2581.8 10,449.0 1994 1995 1996 1997 1998 1999 2000 Total
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1992
Local Sources Revenue from Tax Real Property Tax Business Tax Nontax Revenues Receipts from Econ. Ents Fees/Charges Loans and Borrowings Other Receipts Aid and Allotments BIR Allotments National Aid National Wealth Total Income Current Expenditures General Government Public Welf. & Int. Safety Economic Development Operation of Econ. Ents Other Charges Capital Outlay Total Expenditures Excess (Deficit) of Income over Expenditures
2,554.8 515.3 372.5 142.8 2,039.5 191.3 31.6 333.7 1,482.9 3,246.1 2,769.2 476.8 5,800.9 5,047.7 1,656.2 525.3 1,150.3 98.0 1,618.0 374.4 5,422.1 378.8
1,793.9 773.5 574.8 198.6 1,020.4 174.1 32.4 55.6 758.3 4,620.9 4,499.8 121.2 6,414.8 5185.0 1,889.8 779.4 1,448.7 312.2 754.9 595.3 5,780.3 634.5
BIR = Bureau of Internal Revenue. Source: Bureau of Local Government Finance, Department of Finance.
Appendix Table 2.2 Consolidated Budget Operations Statement, All Cities Combined, 19912000 (P million)
1993 7,583.8 4,741.6 2,229.3 2,512.3 2,842.2 686.6 532.1 1,153.9 469.7 8,567.7 8,486.0 81.7 16,151.5 11,093.4 3,179.8 3,100.7 1,604.5 477.2 2,731.2 2,315.4 13,408.8 2,742.7 9,857.5 5,778.2 2,536.2 3,242.0 4,079.4 968.8 689.9 1,549.2 871.4 10,287.4 10,233.8 53.6 20,144.9 15,384.8 4,016.2 4,145.2 2,139.6 747.3 4,336.5 3,287.1 18,671.9 1,473.0 13,065.6 9,498.9 4,983.5 4,515.4 3,566.7 1,042.5 990.8 731.0 802.3 11,277.3 11,193.3 83.6 0.4 24,342.9 20,043.7 5,996.6 5,664.1 2,462.7 786.3 5,134.0 3,929.6 23,973.2 369.7 17,026.4 11,728.8 5,078.4 6,650.3 5,297.6 1,075.5 1,160.8 1,760.8 1,300.5 12,585.6 12,521.3 64.3 0.0 29,612.0 24,483.3 7,467.2 6,712.9 3,356.8 1,202.0 5,744.5 3,052.4 27,535.7 2,076.3 20,823.3 14,800.7 6,875.9 7,924.8 6,022.6 1,399.1 1,397.3 1,823.8 1,402.4 15,207.8 15,138.7 69.1 0.0 36,031.1 32,841.6 9,931.0 8,786.8 4,451.7 1,560.8 8,111.3 3,177.2 36,018.8 12.3 24,781.1 17,080.6 8,095.1 8,985.5 7,700.5 1,566.1 1,434.4 2,242.0 2,458.0 17,585.1 17,438.4 142.1 4.6 42,366.2 37,820.2 11,240.9 11,146.2 4,778.1 1,473.7 9,181.3 3,622.8 41,443.1 923.2 26,278.1 17,698.1 8,038.8 9,659.3 8,580.0 1,096.7 1,622.2 4,417.6 1,443.5 19,055.4 18,887.6 149.6 18.2 45,333.5 39,923.1 11,083.6 10,780.4 4,587.9 1,050.7 12,420.5 3,895.7 43,818.8 1,514.7 28,697.5 18,854.2 9,430.9 9,423.3 9,843.3 1,462.5 1,823.1 4,819.9 1,737.8 24,001.3 23,828.7 168.2 4.5 52,698.8 46,536.6 13,135.0 12,157.0 5,558.4 1,316.1 14,370.1 4,158.9 50,695.5 2,003.3 130,672.0 89,661.3 42,502.6 47,158.7 41,010.7 7,642.4 8,428.7 15,795.1 9,144.6 99,712.5 99,007.9 676.9 27.7 230,384.5 201,648.5 58,854.3 55,247.4 25,195.5 7,389.6 54,961.7 21,836.6 223,485.1 6,899.4 1994 1995 1996 1997 1998 1999 2000 Total
Philippines
1991
1992
Local Sources Revenue from Taxation Real Property Tax Business Tax Nontax Revenues Receipts from Econ. Ents. Fees/Charges Loans and Borrowings Other Receipts Aid and Allotments BIR Allotments National Aid National Wealth Total Income Current Expenditures General Government Public Welf. & Int. Safety Economic Development Operation of Econ. Ents. Other Charges Capital Outlay Total Expenditures Excess (Deficit) of Income over Expenditures
5,472.8 3,185.7 1,758.6 1,427.1 2,287.1 635.3 274.5 32.6 1,344.6 2,789.6 2,728.0 61.5 8,262.4 6,920.8 2,013.2 1,528.7 1,093.0 349.5 1,936.3 1,072.2 7,993.0 269.4
5,054.4 3,433.8 1,754.4 1,679.4 1,620.6 612.9 317.0 294.7 396.0 4,564.5 4,541.6 22.9 9,618.9 7,478.0 2,384.4 1,945.8 1,252.4 354.3 1,539.1 1,207.6 8,685.6 933.3
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Appendix Table 2.3 Consolidated Budget Operations Statement, All Municipalities Combined, 19912000 (P million)
1993 6,491.0 4,340.8 1,906.5 2,434.3 2,150.2 825.7 669.8 54.7 600.0 11,638.2 11,354.7 283.6 18,129.2 14,612.2 6,848.9 3,045.6 1,831.7 694.9 2,191.0 1,579.3 16,191.5 1,937.7 8,743.2 5,666.8 2,577.4 3,089.4 3,076.5 1,087.8 818.6 230.4 939.7 14,929.6 14,506.8 287.2 135.6 23,672.8 19,620.9 8,650.6 4,316.5 2,543.3 971.0 3,139.5 1,919.4 21,540.3 2,132.5 7,956.9 4,575.4 2,203.0 2,372.4 3,381.5 1,043.3 790.8 538.3 1,009.1 18,109.1 17,574.0 397.2 138.0 26,066.0 22,999.9 10,463.2 4,584.1 3,040.9 1,291.7 3,620.0 1,870.0 24,869.9 1,196.1 9,897.8 5,597.0 2,481.5 3,115.5 4,300.8 1,300.3 978.1 872.3 1,150.1 19,469.8 19,092.6 289.6 87.7 29,367.6 25,870.3 11,654.2 5,385.3 3,379.9 1,533.1 3,917.8 1,794.3 27,664.7 1,703.0 11,581.9 6,452.9 3,028.1 3,424.9 5,128.9 1,563.1 1,155.8 883.7 1,526.4 24,280.6 23,955.2 226.4 99.0 35,862.5 31,839.7 14,405.3 6,646.5 4,162.6 1,982.4 4,642.9 2,331.4 34,171.1 1,691.4 10,059.7 5,585.3 2,471.7 3,113.5 4,474.4 1,609.5 1,022.4 398.8 1,443.8 25,637.8 25,257.6 294.9 85.3 35,697.5 32,992.8 15,395.6 6,554.8 4,164.4 1,873.5 5,004.5 1,455.1 34,447.9 1,249.7 11,404.1 6,290.3 2,896.9 3,393.4 5,113.8 1,728.1 1,158.0 550.4 1,677.3 30,845.1 30,280.8 480.7 83.6 42,249.2 37,093.7 17,002.8 7,112.7 4,715.7 1,901.9 6,360.6 1,986.2 39,079.9 3,169.3 14,298.5 7,781.9 3,815.9 3,965.9 6,516.6 1,708.9 1,417.8 1,703.0 1,687.0 37,615.4 36,933.4 609.2 72.8 51,913.9 44,853.1 20,039.3 8,722.9 5,592.9 1,887.6 8,610.4 2,226.7 47,079.9 4,834.0 65,198.9 36,282.8 16,897.1 19,385.7 28,916.1 8,953.1 6,522.9 4,946.4 8,493.7 155,957.9 153,093.6 2,297.9 566.4 221,156.8 195,649.5 88,960.3 39,006.3 25,056.4 10,470.1 32,156.3 11,663.8 207,313.3 13,843.5 1994 1995 1996 1997 1998 1999 2000 Total
1991
1992
Local Sources 5,428.7 Revenue From Taxation 2,758.7 Real Property Tax 1,542.9 Business Tax 1,215.8 Nontax Revenues 2,670.0 Receipts from Econ. Ents. 728.9 Fees/Charges 423.9 Loans and Borrowings 24.5 Other Receipts 1,492.7 Aid and Allotments 4,634.1 BIR Allotments 4,385.6 National Aid 248.5 National Wealth Total Income 10,062.8 Current Expenditures 8,634.2 General Government 4,796.9 Public Welf. & Int. Safety 784.8 Economic Development 814.1 Operation of Econ. Ents. 503.8 Other Charges 1,734.7 Capital Outlay 796.4 Total Expenditures 9,430.6 Excess (Deficit) of Income 632.2 over Expenditures
4,998.4 3,209.5 1,593.7 1,615.8 1,788.9 698.8 505.9 42.7 541.5 6,671.5 6,431.8 239.7 11,669.9 9,898.9 5,883.4 1,176.7 941.3 502.3 1,395.3 940.4 10,839.3 830.6
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Appendix Table 2.4 Percentage Share of Externally Sourced Revenues in Total LGU Revenues 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Average 19922000 Provinces Cities Municipalities 56 34 46 72 47 57 77 53 64 78 51 63 79 46 69 73 43 66 75 42 68 79 42 72 80 46 72 79 46 72 78 43 70
Source: Calculated from Appendix Tables 2.12.3.
Appendix Table 2.5 Percentage Share of Each LGUs IRA to Its Total Revenues from External Sources 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Average 19922000 Provinces Cities Municipalities 85 98 95 97 99 96 98 99 98 98 99 97 95 99 97 99 99 98 98 100 99 96 99 99 97 99 98 98 99 98 97 99 98
Appendix Table 2.6 Percentage Share of Each LGUs IRA to Total Revenues 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Average 19922000 Provinces Cities Municipalities 48 33 44 70 47 55 76 53 63 76 51 61 75 46 67 72 42 65 74 42 67 76 41 71 78 42 72 77 45 71 75 45 66
Source: Calculated from Appendix Tables 2.12.3. For above tables: IRA = internal revenue allotment, LGU = local government unit.
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Appendix Table 2.7 Percentage Share of Each LGUs Local Taxes to Total Revenues from Local Sources 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Average 19922000 Provinces Cities Municipalities 20 58 51 43 68 64 52 63 67 48 59 65 47 73 58 41 69 57 39 71 56 45 69 56 50 67 55 42 66 54 45 67 59
Appendix Table 2.8 Percentage Share of the Different Expenditure Items to Total LGU Expenditures 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 General Government Public Welfare/ Internal Safety Economic Development Capital Outlay Others 37 12 13 10 27 40 15 14 11 19 32 23 14 11 20 29 23 13 12 22 31 24 13 11 22 32 24 14 9 22 32 24 13 8 22 32 25 13 7 22 31 24 13 7 25 31 24 13 7 26 Average 19922000 32 23 13 9 22
Appendix Table 2.9 Percentage Share of Each LGU General Government Expenditure to Aggregate LGU General Government Expenditures 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Average 19922000 Provinces Cities Municipalities 20 24 57 19 23 58 18 26 56 17 26 57 17 30 53 16 33 51 16 34 50 17 35 48 16 33 51 17 33 50 17 30 53
Source: Calculated from Appendix Tables 2.12.3 For above tables: LGU = local government unit.
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Appendix 3. Sample Internal Revenue Allotment Computation: Dagupan City

Step 1: Deduct the total cost of devolved functions from the total IRA allocation P 106.778 billiona - P6.539 billionb = P 100.239 billion Step 2: Multiply the balance by the statutory share for each LGU level; in the case of the cities, it is 23% P 100.239 billion x 23% = P 23.0543 billion Step 3: e resulting figure shall be subdivided into the three weighted factors Population Land Area Equal Sharing Total Step 4: a) b) - 50% x P23.0543 = P11.5271 billion - 25% x P23.0543 = P5.7636 billion - 25% x P23.0543 = P5.7636 billion = P23.0543 billion
Compute the proportionate share of the city to the aggregate of all cities for the three factors Population of the City = 130,328 = 0.00557 Total Population of All Cities 23,387,323 Land Area of the City Total Land Area of All Cities 1 Total Number of Cities = = 37.23 = 0.00135 27,665.12 1 113 = 0.00885
c) Step 5:
Combine steps 3 and 4 to determine the city share Population Land Area Equal Sharing IRA Share of Dagupan (Total) P11.5271 billion x 0.00557 = P64.2059 million P5.7636 billion x 0.00135 = P7.7809 million P5.7636 billion x 0.00885 = P51.0079 million = P122.9947 million
COA = Commission on Audit, IRA = internal revenue allotment, LGU = local government unit. a Using calendar year 2001 IRA data and cost of devolved functions. The 2001 IRA figure of P106.77 billion was derived by getting the third preceding years (1998) gross national collections less deductions such as direct shares of LGUs, COA share, occupancy tax, etc. b Refers primarily to health sector, mostly provincial hospitals, which will be distributed to concerned LGUs.
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Appendix 4. Lending Programs of Government Financial Institutions and Municipal Development Fund Office Rate of Interest Loan Term Loan Amount Collateral Requirement Assignment of portion of local government units (LGUs) regular income and internal revenue allotment (IRA)
Government Financial Institution
Eligible Projects
Development Bank of the Philippines Minimum of 3 years to Depends on project a maximum of 15 years, requirements inclusive of a maximum grace period of 5 years for principal repayment
Urban Water Supply and Sanitation Environment Infrastructure Support Credit Program Phase II, funded by Japan Bank for International Cooperation (JBIC)
Water supply and sanitation; Urban 9% plus spread, drainage; Pollution control; Projects that not to exceed 3% promote efficient use and management of natural resources; Projects that improve occupational health and safety; Environmental infrastructure projects underbuild-operate-transfer arrangements Minimum of 3 years to a maximum of 15 years, with 2 years grace period for principal repayment
Land Bank of the Philippines Depends on the reReal estate mortgage, quirements of the pro- chattel mortgage ject but not to exceed P50 million
1. Local Government Support Credit Health sector projects; Water system; Flood 1214% Program funded by JBIC control and sanitation; Forestry; Waste dis2. Private Infrastructure Project posal; Other environmental projects Development Facility funded by the Asian Development Bank 3. Water District Development Project funded by the World Bank Negotiable and Maximum loan term of shall depend on 7 years the cost of fund or source used
Philippine National Bank Depends on the project requirements but shall in no case exceed five times the sum of 20% of the regular income and 20% of IRA
Credit facilities for income- and revenue-generating projects
Batching plant; Public market; Slaughterhouse; Commercial building; Shopping center; Water system; Electrification projects; Heavy equipment; Renovation of local government unit halls; Buildings, farm tools
Lending Programs of Government Financial Institutions and Municipal Development Fund Office (contd.) Rate of Interest Loan Term Loan Amount Collateral Requirement
Philippines
Eligible Projects
Philippine National Bank - Assignment of 20% of IRA - Assignment of 20% of LGUs regular income - Assignment of profits or income of the project or economic enterprise to be financed - Assignment of other special sources of revenues, e.g., excise taxes, real estate mortgage, mortgage of properties not being utilized for the public or government General terms of 5 years Depends on the project Assignment of IRA hold-out requirement against deposit or time placements, real estate mortgage, and other assignable funds of LGUs
Livelihood projects; Low-cost housing
Veterans Bank
Credit facilities for revenue- Public market; Slaughterhouse; Transport Negotiable and shall generating projects terminals; Municipal water system; Stor- depend on the cost of age and infrastructure facilities; Hospital fund or source used and help facilities; Heavy equipment; Roads and bridge construction; Computer hardware and software
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Lending Programs of Government Financial Institutions and Municipal Development Fund Office (contd.) Rate of Interest Not lower than 14% per annum compounded monthly, to be reckoned from the date of the first release of the loan Maximum term 6 years, including a grace period on the repayment of the principal of not more than 1 year Maximum amount of P20 million per project by an LGU Loan Term Loan Amount Collateral Requirement 1. First mortgage on real property where the project will be constructed, including the building and improvements to be constructed thereon and machinery and equipment to be installed therein; or 2. First mortgage on other real properties owned by the LGU borrower IRA intercept
Eligible Projects
Government Service Insurance System
Tulong sa Lokal na Pamahalaan (Help for local government)
Municipal Development Fund Office Maximum of 15 years, Based on borrowing with 3 years grace on capacity principal
Local Government Finance and Develop- Market; Slaughterhouse; 14% per annum, fixed ment Project Municipal water supply system (expansion and rehabilitation); Municipal piers and wharves; Bus and jeepney trans port terminals; Postharvest facilities; Cold storage and ice plants
Philippines
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Appendix 5. LGU Bonds Issued after the Passage of the Local Government Code
Bond Name Project Tenor Guarantor Amount (years) (P million) 8 26 20 20 10 25 40 320 620 2 3 3 3 5 7 7 7 HGC HGC HGC HGC None LGUGC LGUGC LGUGC LGUGC Status/Experience
Victorias Mabuhay Bonds (Negros Occidental) Legazpi Suerte Bonds (Albay) Claveria Housing Bonds (Misamis Oriental) Puerto Princesa Housing Bonds (Palawan) Sto. Domingo Housing Bonds (Nueva Ecija) Urdaneta City Municipal Bonds Abattoir Upgrade (Pangasinan) Boracay-Aklan Provincial Bonds Jettyport and Port Terminal Puerto Princesa Green Bonds Socialized Housing (Palawan) Caloocan Katipunan Bonds General Hospital, Public Market and Commercial Center/Parking Tagaytay City Tourism Bonds Convention Center Iloilo City Bonds Employees Housing Program Daraga Municipal Bonds Public Market (Albay) Bayambang Aliguas Bonds Dry Goods Market (Pangasinan)
Settled Settled Settled Payment restructuring Project completed Project completed Project stopped Payment restructuring Project implementation Project implementation Bonds prepaid via direct loan from PVB Project 75% completed Project implementation
220 130 75 42
7 3 7 7
LGUGC LGUGC LGUGC LGUGC
= data not available, HGC = Home Guaranty Corporation, LGU = local government unit, LGUGC = LGU Guarantee Corporation, PVB = Philippine Veterans Bank.
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Sri Lanka
Amarakoon Bandara Former Head International Finance Division Economic Research Department Central Bank of Sri Lanka Colombo
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Acronyms
ADB BOT DFCC GDP GST LLDF RTGS SEC SLRe/SLRs US VAT Asian Development Bank build-operate-transfer Development Finance Corporation of Ceylon gross domestic product goods and services tax Local Loans and Development Fund real-time gross settlement Securities and Exchange Commission Sri Lanka rupee United States value-added tax
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Executive Summary
Sri Lanka has a well-organized system of local government influenced mainly by practices in the United Kingdom. With the 13 amendment to the Constitution in 1988, provincial councils were established as a subnational level of administration with legislative powers. Local government was put under the provincial councils, administration was devolved, and division-level administrative agencies took over local government and development functions. With the administrative mechanism transformed, and political decentralization and powers increased, local governments acquired greater responsibility but also faced difficulties in delivery of services to local communities due to fiscal constraints of the central Government and limited own resources. is chapter explores the possibilities of raising funds for local governments by issuing bonds. Before they can issue financial instruments in the domestic market, local governments must set the conditions to protect the interests of prospective investors and ensure the stability of the financial system. Local governments are saddled with a host of problems that hinder delivery of community services: lack of efficient cashflow management systems, substandard accounting practices, lack of transparency, and large revenue arrears. Lack of accountability rules, antifraud legislation, and an enabling regulatory environment compound these problems. us, the local issuance of bonds should be considered only in the medium term, after the required infrastructure for such bond issues is established, which includes, on the part of local governments: Improving accounting standards. Improving their financial condition. is would entail: (i) strengthening cash management of local governments to minimize such costs and allocate resources more efficiently; (ii) adjusting rates to reflect prevailing market-determined costs; (iii) introducing new rates for local government public services and strictly enforcing the law; (iv) improving garbage collection and charging for it (local authorities should also explore the possibility of using garbage to manufacture fertilizer commercially); (v) establishing parking meters to generate revenue and control traffic; (vi) building car-parking facilities in joint ventures with the private sector; (vii) establishing day care centers to meet the needs of working people, particularly middle- and upper middle-income parents; (viii) auctioning property rights; and (ix) auctioning pollution rights. Promoting private-public partnerships. Major infrastructure projects can be undertaken as joint ventures with the private sector, or the private sector can be allowed to undertake projects on a build-own-operate, build-operate-transfer, or build-own-lease-transfer basis.
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Promoting urban tourism and ecotourism. Building toll roads, raising the capital through bond issues or borrowing from international agencies such as the Asian Development Bank (ADB) or the World Bank. Formulating block grants so that they do not fill the gap between a predetermined proportion of the recurrent expenditure of the province and its collected devolved revenue. Improving local governance by introducing generally accepted accounting principles, transparency rules, provisions to ensure accountability, and antifraud legislation. Providing an enabling regulatory environment by either establishing a municipal securities board or using the Securities and Exchange Commission (SEC), with some modified rules and regulations to suit the local government bond market. Introducing antifraud legislation. Introducing legislation to facilitate bond issuance. Obtaining a credit rating. Introducing an insurance scheme for municipal bonds. Granting tax concessions. Establishing a special-purpose vehicle or asset management company. ADB can help develop local government bonds by:
Directly financing projects, which will support local government financing until the creation of a conducive environment for issuing local government bonds or securities. Guaranteeing local government bonds or borrowings. Providing technical assistance. Improving accounting standards by helping introduce accepted accounting principles, training local government staff, and funding equipment purchases. Improving project implementation by helping improve the technical skills of staff to evaluate, implement, and monitor projects. Strengthening cash management through technical assistance. Drawing up a long-term development plan, particularly for township development, to reduce commuter traffic, urban congestion, and environmental pollution. Providing technical assistance to help local governments acquire the legal expertise to draft antifraud legislation.
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Local Government Finance and Bond Financing

Sri Lanka has a well-organized system of local government, influenced mainly by practices in the United Kingdom. Local government powers and social responsibilities have gone through radical changes since independence in 1948. A major political change took place in July 1981 with the establishment of district development councils (DDCs), which took over the functions of town councils and village councils. DDCs organize all district-level development activities. e gramodaya mandalayas (village councils) and pradeshiya sabhas (regional councils) were also established to secure peoples participation in local administration and help DDCs carry out development programs. e establishment of pradeshiya sabhas is considered a landmark in the development of local government in Sri Lanka, paving the way for a new type of local authority to cover an area administered by an assistant government agent. In 1988, the 13 Constitutional Amendment paved the way for the creation of provincial councils, which are subnational administrative bodies with legislative powers. Local government was put under the provincial councils. Under this devolved system, local government and development functions were assumed by the division-level administrative agencies. With the administrative mechanism transformed, and with a higher level of political decentralization and increased powers, local governments acquired greater scope and responsibilities. Increased political decentralization and general economic improvement led to a higher demand for regional development and efficient delivery of modern economic and social services. However, local governments were hobbled by central government fiscal constraints and limited self-generated resources. High fiscal deficits over the past several years forced the central Government to restrict fiscal transfers to local government. Fiscal transfers to provincial councils dropped from 2.3% of gross domestic product (GDP) in 1995 to 2.0% in 1999, while local government revenue remained at 0.6% of GDP. e deterioration of social services was a clear reflection of local governments weak financial situation. Development works financed by own resources accounted for a minor fraction of total investments, indicating heavy reliance on fiscal transfers from the central Government. In 2000, the total revenue of provincial councils was sufficient only to cover 20% of their resource needs. Investments financed by own resources were limited to acquisition of fixed assets. e resource gap became even wider with political decentralization and the accompanying responsibilities and obligations to deliver services and achieve regional development. To strengthen their own resources, local governments increasingly turned their attention to long-term borrowings or the issuing of long-term bonds, as most infra-
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structure development projects are long term and cannot be financed through the usual annual revenue collections. Long-term financing arrangements not only avoids the mismatch between expected revenue flows and debt service payments, but also helps provide better and sustainable services. is chapter explores the possibility of raising funds for local governmentsprovincial and municipalthrough long-term loans or bonds to facilitate development work. e study will focus on Colombo Municipal Council and Western Provincial Council, given their dominance among the local governments.
Socioeconomic Responsibilities, Economic and Political Changes, and Fiscal Trends

Local Government Structure
e structure of local government has changed significantly since the early 1980s. Local government consists of municipal councils, urban councils, and pradeshiya sabhas (Figure 1). e provincial councils are subnational administrative bodies with legislative powers outside the local government structure. Provincial councils are established in eight of Sri Lankas nine provinces. Local authorities function under their respective provincial councils. In urban areas, local government consists of 18 municipal councils and 37 urban councils. In rural areas, local government consists of 256 pradeshiya sabhas. Local government bodies are supervised by the commissioner of local government of the Department of Local Government. Municipal Council Ordinance 29 of 1947, Urban Council Ordinance 61 of 1939, and Pradeshiya Sabhas Act 15 of 1987 govern the powers and functions of these institutions. eir functions fall within the categories of public health and environmental sanitation, public thoroughfares, and public utilities. Local authorities may raise revenues but, except for Colombo Municipal Council and Western Provincial Council, depend heavily on fiscal transfers from the central Government. Usually, the local government salary bill is paid by the central Government through the provincial councils. e central Government provides capital grants to provincial councils, which have the discretion to allocate these grants to local government bodies under them.
Socioeconomic Responsibilities
With the development of local government as a subnational devolved system of administration, the scope of local government activity has widened significantly
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Figure 1. Structure of Local Government

over the years. Socioeconomic responsibilities range from attending to traditional functions, such as maintenance of infrastructure, provision of public utilities and community services, and promoting and securing public health, to development planning and protection of the environment. Development and Maintenance of Infrastructure Ordinances require local governments to provide comfort to residents by, for example, maintaining roads. However, the level of road development and maintenance is far below public expectations due to a wide range of factors, some of which could be easily resolved if proper procedures were followed and accepted standards adopted. e major obstacles to the development and maintenance of infrastructure are: Lack of a clear-cut single authority responsible for coordination of road development and maintenance. A conflict arises, for example, when the powers of the Road Development Authority and Provincial Road Development Authority overlap. Incorrect concept of road maintenance. Repairs are usually started when roads are virtually beyond repair. Use of obsolete technology. Many nonmajor road development and maintenance projects used technology several decades old as a consequence of corruption and contractors lack of technical knowledge. Malpractices in awarding contracts. e award of contracts is influenced by political factors rather than technical know-how, and is made outside standard tender procedures, often resulting in substandard work.
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Lack of traffic regulation. Lack of an effective law to regulate traffic is a major problem. Heavy vehicles are damaging roads of light-weight capacity. Lack of financial resources. Local governments lack funds to deliver services, most obviously in road development and maintenance, an area easily deprived of allocation in case of financial constraints.
However, provision of financial resources alone will not improve road conditions. Institutional drawbacks and political influence are also stumbling blocks in the effective provision of infrastructure facilities by local governments. ese issues should be addressed hand in hand with the financial problems if local authorities are to be made efficient in developing and maintaining good road networks. Public Health Provincial councils are responsible for providing effective public health services through the local authorities. Public health services are preventive and curative. While major municipalities give equal importance to both, other local authorities focus on preventive health care. Local authorities operate maternity and child welfare clinics and dispensaries. e level of service is subject to the availability of financial resources and technical support. Local authorities are closely involved in preventive health care through the medical officers of health (MOHs) in major municipalities, and government MOHs in other local authorities, which include immunization among their health services. Local governments also provide other ancillary services that help maintain public health, including toilet facilities for all houses; maintenance of public buildings, lands, and places; garbage disposal; construction and maintenance of drainage; sanitary inspection of buildings; and stopping public nuisances. Environment Environmental protection has received special attention in recent years as the population grows and suffers the adverse effects of urbanization and development. Environmental protection became a function of local authorities with the devolution of the powers of the Central Environmental Authority (CEA). Under the National Environmental Act, CEA confers on local authorities the power to deal with minor pollution agents and to issue environment protection licenses. Local authorities, together with the central Government, also attempt to improve the environment by adopting proper town planning and landscaping. However, local authorities have not been successful in the discharge of their environmental responsibilities due to numerous factors: political influence, corruption, lack of interest, and lack of resources and technical skills. e health of
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urban residents is threatened by unauthorized construction of houses and buildings, construction of factories that lack facilities to minimize pollution, too much use of polythene, lack of a solid and liquid waste disposal system, and poor maintenance of drainage and sewerage systems. Water, air, and noise pollution have increased, as has the incidence of hepatitis, cancer, respiratory disorders, hearing defects, and diarrhea. A significant proportion of children in Western Province, where most industries are, suffer from asthma. Hospitalized asthma patients have increased significantly from 397 per 100,000 people in 1980 to 895 in 2000 (Department of Health Services 2000). Motorists use diesel fuel, which has a very high sulfur content. Evidence is increasing of adverse health effects, including premature deaths, due to such sulfur emission. Aside from serious health hazards to present and future generations, particularly the young and the poor, the lack of attention to environmental concerns also has financial implications for local governments as more resources are needed to control pollution. Local governments should finance environmental protection from taxes, user charges, and prohibitive penalties. Public Utility Services Local governments provide several public utility services, some of which have been taken over by specialized institutions. Water Supply. Municipal councils used to be in charge of it. Colombo Municipal Council, for example, was vested by the Colombo Municipal Council Waterworks Ordinance with powers to supply water to the public. is ordinance also applied to the Kandy and Galle municipal councils. e minister in charge of local government was vested with powers to apply the provisions to other municipal councils. In 1974, such responsibility was transferred to the newly established National Water Supply and Drainage Board as most local authorities had failed to deliver this service due to poor maintenance and weak management, which led to largescale waste and losses. Supply of Electricity. Local governments traditionally supplied electricity for consumers and for lighting of streets and public buildings. e Ceylon Electricity Board took over these functions. Local governments are now responsible only for lighting streets and public buildings, the cost of which is borne by local authorities. Drainage, Conservancy, and Scavenging. ese are basic functions of local government and directly affect daily life. No other public agencies can perform them at present. However: Drainage systems in many major municipalities, particularly in Colombo, are poorly maintained, resulting in flooding during heavy rain. e lack of a system to drain rainwater causes major flood-management problems.

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Philippines

Local Government Finance and Bond Markets

Local Government Finance and Bond Markets

Local Government Finance and Bond Markets

Local Government Structure and Powers

Economic and Political Trends since 1995

Local Government Finance and Bond Markets

Devolution of Functions from National to Local Government

Local Government Finance and Bond Markets

Impact of Devolution on Local Government Finance

Local Government Finance and Bond Markets

Local Government Fiscal Management

Local Government Finance and Bond Markets

Strategies to Strengthen Local Government Finance

Local Government Finance and Bond Markets

Financing Alternatives and Local Government Financing Trends

Local Government Finance and Bond Markets

Local Government Finance and Bond Markets

MDP = municipal development project.

Local Government Financing Trends

Current Local Government Bond Market Situation

Local Government Finance and Bond Markets

Local Government Finance and Bond Markets

Regulatory and Institutional Framework for Local Government Bonds

Impediments to Local Government Bond Market Development

Figure 1. Bond Issuance Process and Institutional Framework

Local Government Finance and Bond Markets

LGU = local government unit, LGUGC = LGU Guarantee Corporation.

Local Government Finance and Bond Markets

Conclusions and Recommendations

Local Government Finance and Bond Markets

Some Considerations for Successful Local Government Credit Financing

Potential Areas for Asian Development Bank Assistance

Local Government Finance and Bond Markets

Appendix 1. Local Government Unit Classification by Income Bracket

Local Government Finance and Bond Markets

Local Government Finance and Bond Markets

Source: Calculated from Appendix Tables 2.12.3.

Source: Calculated from Appendix Tables 2.12.3.

Local Government Finance and Bond Markets

Source: Calculated from Appendix Tables 2.12.3.

Source: Calculated from Appendix Tables 2.12.3.

Appendix 3. Sample Internal Revenue Allotment Computation: Dagupan City

Government Financial Institution

Local Government Finance and Bond Markets

Credit facilities for income- and revenue-generating projects

Government Financial Institution

Livelihood projects; Low-cost housing

Government Financial Institution

Government Service Insurance System

Tulong sa Lokal na Pamahalaan (Help for local government)

Local Government Finance and Bond Markets

LGUGC LGUGC LGUGC LGUGC

Local Government Finance and Bond Markets

Local Government Finance and Bond Markets

Local Government Finance and Bond Markets

Local Government Finance and Bond Financing

Local Government Finance and Bond Markets

Socioeconomic Responsibilities, Economic and Political Changes, and Fiscal Trends

Figure 1. Structure of Local Government

Local Government Finance and Bond Markets

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