Lenders Municipal
Enterprise
(C) Financing Agreement
 
LFI
World Bank Local
Government
(D) Guarantee Agreement (A) Concession/ Operation /
  Service Agreement
 
 
(B) Support Agreement
Central
Government
(E) Indemnity Agreement
There will be five key contracts between each entity defining their contractual obligations:
-
concession /operating /service agreement between municipal enterprise and the local government, defining the operating guidelines and regulatory framework for the enterprise;
-
support agreement between the local government and central government, defining the obligations of the central government, if any, and the terms of claw-back payment from the local government to the central government in the event of guarantee payout and subsequent reimbursement by the central government to the World Bank under indemnity agreement (E);
-
financing/loan agreement between lenders and municipal enterprise as borrower;
-
guarantee agreement between the World Bank and the lenders defining the triggering mechanism of guarantee in the event of local government failure to honor its commitment under (A); and
-
indemnity (or counterguarantee) agreement between central government and the World Bank, to be called in the event of a payout of the guarantee by the World Bank under to the lender.
Advantages of Partial Risk Guarantees
Under this scheme, the guarantees would only cover risks related with regulatory framework and pricing policy defined by specific regulations and policies. Management and operation of the municipal enterprises are under the responsibilities of private operators and not expected to be covered by the guarantees. Compared with the conventional model of public borrowing through the central government or with central government guarantee (Treasury guarantees), the proposed scheme has distinctive advantages. Under the conventional model, the central government assumes the full risk of the borrowings and creating a corresponding amount of budgetary impact on the central government book. Under the proposed model, the private sector assumes the commercial aspect of the risks entailed in local infrastructure projects, leaving the local and central government strictly with the risks of unsatisfactory performance of their own conducts or obligations which are covered by the World Bank guarantees. This would allow both the local and central government to replace “full-fledged “ financial obligations created under the conventional model by indirect and contingent liabilities of self-assuring their own performance.
Another potential advantage may be found in the recognition of government debt profile. In many countries, the government’s contingent liabilities under commercial contracts are not fully reflected on the government debt table or budget appropriation process. In theory, if all the contingent liabilities are recognized on the government debt table, those government commitments, whether guaranteed by the World Bank or not, should be fully reflected, and the use of World Bank guarantee by itself should not change the government debt profile to any extent. Unless the host government adopts a policy of recognizing the World Bank-guaranteed debt selectively, the public debt profile will not be affected by the use of proposed guarantee scheme29. This point needs to be emphasized to avoid a stereotypic misleading notion that the World Bank guarantee would increase the government liabilities. If properly measured quantitatively, it is likely that scheme should give a positive impact on the government debt profile through the risk sharing mechanism with private participants.
The incentive structure under the guarantee scheme would work in such a way that the local government has a strong incentive to honor the agreement or contract it has entered into with private participants. In the event of a breach of contract, the World Bank will give the government a cure period before the guarantee is called during which the local and the central government could work out the situation and remedy the problems. In case the guarantee is paid, the central government is required to reimburse the amount to the World Bank, and at the same time, is entitled to recover from the local government out of future transferable resources, which will give a strong disincentive for the local government to act erroneously.
The proposed guarantee scheme will help the GOT to transform the conventional budget-based local government finance regime to a public/private partnership model where the project risks are allocated among the parties based on their capacity and efficiency to assume. Such public/private partnership will provide a market-based solution for modernizing the local government financing system by involving private sector participants in allocating credit and risks.
Partial Credit Guarantee
The GOT could also consider the other type of World Bank guarantee scheme. The second scheme, a partial credit guarantee, would be useful when the GOT wishes to support the market funding of the local intermediary such as the Iller Bank. Unlike the partial risk guarantee scheme being proposed above, a partial credit guarantee would not distinguish the type of risks to be covered. It covers a portion of credit risks of the borrowing by the intermediary agency. An illustrative model is shown below.
Conceptual Guarantee Scheme: Partial Credit Guarantee
Financing
Agreement On-lending
Lenders
Local Government
LFI
  
Support agreement
Partial Credit Guarantee
GOT
World Bank
Indemnity Agreement
With the World Bank’s AAA-rated credit covering a later part of maturity, the borrower would be able to extend the tenor of maturity much longer than that of regular borrowing on its own credit (or with guarantee by the Treasury). The scheme can be used for both local and international market, or for commercial bank loans and bond issues, which would partially expose the credit of the borrowing entity to the private financial market. This will help enhance the borrower’s access through the development of commercial credit appraisal to the borrower which previously had limited exposure to private market practices. As a direct benefit, longer maturity and lower pricing would reduce the intermediary’s lending cost for local infrastructure finance which typically requires a longer pay-back period to level the over-all tariff structure. Although this type of guarantee will not provide a risk-sharing mechanism in terms of regulatory or pricing risks, it can be useful as a transitional arrangement to bridge the gap from publicly-supported borrowing to full commercial borrowing by the borrower’s own credit.
1 Other additional service responsibilities include construction/maintenance and management of parks and other recreational facilities, clinics and welfare facilities, veterinary services, wholesale markets, slaughterhouses and cold storage.
2 Report prepared by Carl Bro International (2001); commissioned by EU
3 Source – The State Institute of Statistics, 2000 Statistical yearbook and the institute’s web page at www.die.gov.tr. Urban areas are defined as provincial and district centers while rural areas are all other areas.
4 The sixteen Metropolitan Municipalities currently include: Adana, Adapazari, Ankara, Antalya, Bursa, Diyabakir, Erzerum, Eskisehir, Gaziantep, Istanbul, Izmir, Izmit, Kayseri, Konya, Mersin and Samsun.
5 The composition of the increasing expenditures has changed. While 31% of expenditures were used for investments in both 1990 and 2000, the share of current expenditures decreased from 5%1 to 38% and the share of transfers increased from 18% to 31%.
66 Source: SPO data
7 Turkey Public Expenditure and Institutional Review, reforming Budgetary Institutions for Effective Government, World Bank, Report No. 22530-TU, August 20, 2001
8 The funds were closed on February 21, 2002 in compliance with the “Law on Annulment (Removal) of Some Funds”. The Municipal Fund and the Local Authorities Funds were the two most important funds. They were, according to the Law on Shares from the National Tax Revenues (no: 2380) to receive 3 percent and 0,25 percent respectively of the central budget tax revenues. The de-facto allocations were, however, much lower and were administered by Iller Bank, Ministry of Public Works and Ministry of Interior. The Municipal Fund was used for financing infrastructure projects identified in Iller Bank's annual investment programs. A number of smaller funds with mandates to improve service delivery in the municipalities were also abolished, including the Environmental Protection Fund (under the Ministry of Environment), the Petroleum Consumption Fund (under the Ministry of Public Works and Settlement), the Development and Support Fund (under the Ministry Housing Development Administration of Prime Ministry), the Traffic fund (under the Ministry of Interior) and the Culture Fund (under the Ministry of Culture).
9 In addition, transfers would need to be reformed to support the Turkish constitutional mandate on national standards for local public services, i.e. to ensure ”…The functioning of local services in conformity with the principle of the integral unity of administration securing uniform public services, safeguarding the public interest and meeting local needs, in an appropriate manner.” (article 127) “…the effectiveness, efficiency and stability in local authorities’ activities.” Also, changes would promote the Turkish constitutional principles for jurisdictional equity: “… speedy, balanced and harmonious development of industry and agriculture throughout the country…” (article 166), “ The principle of sharing by Turkish citizens as a whole… of benefits and burdens and all of the manifestations of living as a nation…” (Preamble).
10 Any increases in local taxes could be offset by decreases in central taxes to keep the fiscal burden constant and not increase the overall size of the public sector.
11 This estimate is based on budgeted revenues from 2000 and population data from 1997 for municipalities with populations of 10 thousand or more.
12 There is no aggregate data on debts to private banks, but they are believed to be very small as long term borrowing from domestic sources is virtually non-existent.
13 Total for the period 1992-1996
14 Law No. 2301 on the Establishment of the Bank of Municipalities, June 11, 1933
15 Law No. 4759, June 13, 1945
16 Table 24B of Iller Bank Report
17 In addition, Iller Bank demands co-financing from the municipalities of about 7 percent for water and wastewater investments and 32 percent for buildings. No co-financing is required for mapping and preparation of development plans.
19 Table 14A of Iller Bank Report
20 Includes US$ 87 million transferred from budget and US$ 182 million transferred from National Disasters Fund to Iller Bank to finance urgent investments in the Marmara Earthquake Zone
21 Table 22 of Iller Bank Report
22 Table 12 of Iller Bank Report
23 Table Table 21 of Iller Bank Report
24 The interest rate was 50 percent p.a. between 1995 and 2001, but was lowered to 35 percent p.a. in 2002.
25 Nominal interest rate minus wholesale inflation
26 Tables 21 and 22 of Iller Bank Report
27 The high interest income came from loans that were paid off during 2001. Loans outstanding by end 2000 amounted to US$293 million.
28 Water/wastewater projects in Ankara, Antalya, Bursa, Cesme-Alacati, Istanbul, Izmir; Urban projects include: Cukurova Urban Development, GAP region urban development (project preparation only)
29 The IMF’s discussion paper “Involving the Private Sector in Forestalling and Resolving Financial Crises-Private Project Finance Flows to Developing Countries” August 20, 1999 states in the footnote 31 that “ The host governments’ indemnity under the World Bank does not increase the government’s liabilities when the government is already directly obligated to the private sector on the same liabilities”.
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