Oleksandr Slobozhan, is Executive Director of the Association of Ukrainian Cities

 

Summary

 In the crisis caused by the 2020 corona virus epidemic, local self-government bodies have been faced with the need to change the financial model for a more contemporary one, a fiscal-credit. The essence of these changes is reflected in Art. 9, p. 8 of the European Charter of Local Self-Government, where it is proposed that LSGs be given access to the national capital markets for the purpose of borrowing for capital investment. Thus, the strategic approach to strengthening the LSG financial base is expanding access to long-term credit resources and developing the municipal borrowing market. In the article, the state of municipal borrowing in Ukraine, on the example of the 2020 year, is analysed as well as instruments and conditions for borrowing. Finally, the author summarises with identification of problems and directions for the development of the municipal borrowing market.

 

The 2020 corona virus epidemic turned out to be a black swan event for the global economy. Among its many negative effects, the pandemic provoked a financial and budgetary crisis everywhere. And Ukraine was no exception.

Most governments focused on anti-crises measures directed at supporting vital industries, redirecting public funds to support businesses and households, reducing costs, and attracting additional capital on financial markets.

Over 2020, the Ukrainian Government failed to take a single necessary step to soften the negative impact of this crisis. As a result, local governments were forced to independently overcome the social and economic consequences of the Government instituting a nationwide quarantine. According to Accounting Chamber estimates, UAH 10.26bn were spent additionally from the local budgets in 2020 to combat COVID-19.

In 2021, Kyiv once again shifted a significant part of the burden of dealing with the consequences of the crisis on local administrations. The situation has been made worse by the fact that the Government’s actions risk leading to a further shortfall of nearly UAH 80bn in municipal budgets this year.

In this extremely difficult situation, municipalities have been forced to increase their own options for mobilizing additional budget funding, since reviving the economy, modernizing infrastructure, and improving public services require substantial capital investments. For instance, capital investment in local budgets was UAH 43.56bn in 2020, according to DerzhStat, or about 10.4% of all investments in the domestic economy.

In addition to the obvious measures based on the fiscal-budgetary financial model, LSGs have been faced with the need to change this model for a more contemporary one, a fiscal-credit model. The essence of these changes is reflected in Art. 9, p. 8 of the European Charter of Local Self-Government, where it is proposed that LSGs be given access to the national capital markets for the purpose of borrowing for capital investment.

Thus, the strategic approach to strengthening the LSG financial base is expanding access to long-term credit resources and developing the municipal borrowing market.

Let’s take 2020 as an example for the state of municipal borrowing. According to the Finance Ministry, LSGs made 42 borrowings in 2020, for a total value of UAH 7.744bn and €28mn. All told, 90.7% of the borrowings were on the domestic market and only 9.3% were on external markets.

These credit relations involved:

• lenders – 4 out of 74 domestic banks or 5.4% of those operating in Ukraine, 3 of which are stateowned: Oshchadbank, Ukrgazbank and Ukreximbank, one commercial bank, Alfa-Bank, and one IFI, Nefko, as well as MinFin. The share of state banks in terms of the total credits dominates: the three state banks provided 85.2% of all credits, while IFIs provided only 7.7%, private banks 5.5% and MinFin 1.6% of the total;
• borrowers – 27 municipalities out of 1,470, or 1,8% of all municipalities in Ukraine. Six of the country’s major cities were the biggest borrowers, responsible for 80.7% of the total volume of municipal borrowings: Dnipro borrowed UAH 1.778bn, Kharkiv borrowed UAH 1.5bn, Odesa UAH 1.5bn, Lviv UAH 900mn, Kyiv UAH 770mn, and Zaporizhzhia UAH 500mn.

In addition to borrowings taken out by oblast centres like Ivano-Frankivsk, Lutsk, Mykolayiv, Rivne, and Sumy, smaller cities also borrowed: Brovary, Izmail, Lubny, Kamianske, Melitopol, Pavlohrad, Trostianets, Chuhuyiv, and others, although they accounted for only 19.3% of all credits.

The market structure of the municipal borrowings segment of the capital market looks like it is not entirely competitive. Oligopolies prevent capital markets from developing normally, given that the biggest players determine overall demand and supply, which affects the cost of credit. At the same time, barriers to entry limit the participation of new players on the market.

Let’s also look at the instruments and conditions for borrowing. Municipalities used two types of credit agreements: external and internal, as well as municipal bonds. In 2020, 63.2% of borrowings were credit agreements, while 36.8% were bonds. Indeed, only three cities issued bonds: Lviv, Kyiv and Kharkiv.

The term of these credits ranged from 3-5 years on internal borrowings and bonds, and 7-9 years on external borrowings. The cost of credit also fluctuated significantly, from 3-6% on external borrowings to 12-18% on internal ones. A significant component was MinFin’s approval of the decisions of local councils. The time between when a municipality submitted its application and when MinFin approved it ranged from 20 to 132 days, with the average 50 days.

Based on our “slice” of the municipal borrowing market, the main problems are fairly visible and we can see what direction it needs to develop in.

Trust remains the biggest problem. Most banks, foundations, IFIs and individuals do not trust municipalities in the role of borrowers and, as a result, don’t participate in the market. A broad improvement in trust and the provision of state guarantees would clearly foster the growth of the municipal borrowing market.

The question of institutional and organizational capacity among LSGs is evident in the minimal—less than 1.5%—involvement of municipalities as borrowers. To expand the rights of municipalities in the lending market requires a gradual improvement of their creditworthiness, the establishment of local credit institutions, and the provision of organizational and informational support, and government support in the form of resources. Once requirements are simplified and artificial barriers to entry removed, the conditions for the market to work should improve considerably and it should become transparent for all players.

As regulatory mechanisms are improved, over time they should reduce the risks and costs of borrowing, while extending the timeframes. In other words, local borrowing will finally become a strategic source of investment capital for carrying out long-term infrastructural projects. And this is precisely the common goal of the government and local administrations in order to improve the quality of life of ordinary Ukrainians.

Translated by Lidia Alexandra Wolanskyj

All terms in this article are meant to be used neutrally for men and women

---

Oleksandr Slobozhan has participated at the International Expert Exchange, "Development of Municipalities: trust, institutions, finance and people", organized by U-LEAD with Europe Programme in December 2020. His speech delivered during one of the workshops is to a great extent depicted in this article.

In the name of the U-LEAD with Europe Programme, we would like to express our great appreciation and thanks for both inputs of Mr. Slobozhan. The article will be included in future online publication Compendium of Articles.

Compendium of Articles is a collection of papers prepared by policymakers, Ukrainian and international experts, and academia after International Expert Exchange 2019 and 2020, organized by U-LEAD with Europe Programme. The articles raise questions in the fields of decentralisation reform and regional and local development, relevant for both the Ukrainian and the international audience. The Compendium will be published online in Ukrainian and English languages on the U-LEAD online recourses. Please, follow us on Facebook to stay informed about the project.