Municipalities are under pressure to provide services and infrastructure to rapidly growing populations. Often, however, they do not have enough state funding. Borrowing from the private sector can be made easier and cheaper if municipalities obtain credit ratings that reflect their ability to pay back loans.

A credit rating indicates the probability that a borrower will repay a loan as promised. This helps potential investors decide whether to invest in the borrower’s business. A paper from the Commonwealth Local Government Forum in the UK explains why it is useful for municipalities to obtain credit ratings and outlines the general procedure for obtaining one.

Local and national governments in developing countries have begun to realise that with limited state finance or donor funding available, major infrastructure development can be paid for by borrowing from the private sector. This can make large sums of money immediately available to municipalities, which are increasingly expected to raise their own funds as part of decentralisation. Long-standing debts, whether bank loans or long-term bonds, can be repaid by municipal income. This spreads the costs over generations of taxpayers who will benefit from infrastructure investment.

To keep down the cost of borrowing, municipalities must aim for the best possible interest rate. A private sector lender is likely to grant credit at low interest rates if it is convinced that the municipality is financially viable. An independent credit rating is key to this. Preparing for a credit rating may be difficult and expensive, but is worth it in the long-term, not least as a management tool.

A typical credit rating process might include the following steps:

• the municipality begins with an in-house assessment of its readiness
• a credit rating agency with experience of municipal matters is selected: international donors and banks may be able to help with foreign costs if local agencies are not suitable
• the selected rating agency provides the municipality with a formal rating proposal
• municipal officials are informed of the purpose of the exercise and personnel chosen to provide information
• the rating agency discusses its findings with the municipality
• the municipality decides on a publicity strategy for the rating, if it is to be released.
• If the credit rating is made public, the rating agency will continue to monitor relevant developments, and has the right to upgrade or downgrade the rating.

Municipalities, local government associations, and central government all have a part to play in opening up the flow of private sector finance for investment in municipal infrastructure services. The researchers recommend:

• Municipalities should undertake in-house assessments; consult their auditors; examine activities such as budget systems and revenue performance; consider what type of rating they want (such as a full published rating or non-published indicative rating); and ask local government associations for help in finding a rating agency.
• Local government associations should offer to help municipalities that are most likely to borrow; study the readiness of the national regulatory framework; and identify aid agencies that might help.
• Central government should examine the state of municipal borrowing; study changes needed to the regulatory framework; assist local government associations with international contacts; and be ready to initiate change.

Source(s):
‘Obtaining a Municipal Credit Rating: A Brief Overview’, CLGF Research Series, CLGF: London, by Barry M. Jackson, 2006 (PDF) Full document.

Funded by: Durban Investment Promotion Agency (South Africa)

id21 Research Highlight: 3 July 2007

Further Information:
Barry M. Jackson
Development Bank of Southern Africa
PO Box 1234
Halfway House
1685 Johannesburg
South Africa

Tel: +27 11 3133686
Fax: +27 11 3133686
Contact the contributor: barry@dbsa.org

Development Bank of Southern Africa, South Africa

Commonwealth Local Government Forum
16a Northumberland Avenue
London WC2N 5AP
UK

Tel: +44 (0)20 73891490
Fax: +44 (0)20 73891499
Contact the contributor: info@clgf.org.uk

Commonwealth Local Government Forum, UK

Other related links:
'Municipal Finance: Innovative Resourcing for Municipal Infrastructure and Service Provision' (PDF)

'Can local governments generate enough revenue to deliver services?'

'Financing cities'

'Decentralisation: do poor people benefit from local government expenditure decisions?'

'Urban governance and access to basic services'