51 Pages Posted: 20 Feb 2016
Date Written: January 2016
There are many positive things associated with subnational borrowing, including additional funding or promoting intergenerational equity. But it may also endanger fiscal sustainability and macro stability due to moral hazard and soft budget constraints. Thus borrowing controls are justified and also common. In this paper we review the different types of ex-ante and ex-post regulations used the international experience based on a large panel of developed and developing countries. Effectiveness or borrowing regulations in this paper is defined relative to the ability to preserve primary balances at the general government and subnational levels. There is a wide variety of both ex-ante and ex-post sub-national borrowing regulations that countries implement. Each has both advantages and disadvantages, with different suitability countries’ circumstances. For example, depth of financial markets is important when choosing market-based regulations. The presence of subnational tax autonomy contributes to an increase in the general government primary balance, but not significantly for subnational primary balances. A history of subnational bailouts is associated with lower primary balances on average at all levels. The “golden rule” (borrowing is only for capital investment purposes) and limits on debt and borrowing appear effective at all levels of government. However, we find that none of the broad types of sub-national borrowing regulations seem to have a distinct significant direct effect on the narrow definition of fiscal sustainability at the subnational level.
Keywords: Decentralization, Subnational Borrowing, Borrowing Rules and Regulations
JEL Classification: H70, H74, H63, H81
Suggested Citation: Suggested Citation
Martinez-Vazquez, Jorge and Vulovic, Violeta, How Well Do Subnational Borrowing Regulations Work? (January 2016). Andrew Young School of Policy Studies Research Paper Series No. 16-07. Available at SSRN: https://ssrn.com/abstract=2734301 or http://dx.doi.org/10.2139/ssrn.2734301