The Imperatives And Policy Derivatives Of Local Government Borrowing In Ghana

The main problem of local government finance in Ghana is the gap between financial resources and the spending needs of the local authorities – known in Ghana as Metropolitan, Municipal and District Assemblies (MMDAs). Of course, the problem is aggravated by a status quo of derisory financial systems. The fast sprawling of cities and urban centres in Ghana, with their ‘swelling populations’ has left the MMDAs clearly outstripped in terms of financing their development plans and budgets. This mismatch between the MMDAs’ functions and finances, technically denoted as the lack of income elasticity, requires the effective implementation of pragmatic and popular frameworks to optimise the financing options to the MMDAs.

Indeed, the funding architecture of MMDAs in Ghana has not been different from local government financing systems elsewhere. Section 124 of the Local Governance Act, 2016 (Act 936) specifies the revenues of a District Assembly as comprising decentralised transfers, internally generated funds, donations, and grants; and from borrowing.

Interestingly, fiscal relations between the Government of Ghana (GoG) and the MMDAs are mainly characterised by the assignment of functions and expenditure responsibilities. These fiscal relations also comprise ways in which the MMDAs’ expenditures are financed; i.e., the assignment of revenue sources, the provision of intergovernmental fiscal transfers, and the formal framework underpinning sub-national borrowing. The MMDAs, like local governments in many parts of the world, are financed by a mix of intergovernmental fiscal transfers and the MMDAs’ own revenues – Internally Generated Funds. Apparently, this structure of revenue sources to the MMDAs had long become politically acceptable.

There is an avalanche of evidence showing that the existing ‘mixed sources’ of revenue do not generate adequate revenue for the MMDAs to meet their expenditures. The only stable and significant own revenue source to the MMDAs is the property rate; yet, the central government is making grievously unpopular decisions to undermine the gains fostered by Development Partners and Civil Society Organisations, especially in the administration of property rates. The decision by the GoG to implement ‘centralised control’ system or the so-called ‘common platform for property rate administration’ under ‘behind the scenes reforms’ will severely weaken fiscal decentralisation and diminish its dividends. In this charade of ‘broader property rate reforms’, the Ghana Revenue Authority (GRA) appears to be only positioned as a decoy to musk the true underhand procurement interests.

The manner in which the central government is interfering with the administration of property tax is paradoxical to the intimation that it would, by policy initiatives, expand the limits of borrowing by the MMDAs. Indeed, incontrovertibly, the Majority Leader of Ghana’s 8^th Parliament of the Fourth Republic, Mr. Osei Kyei Mensah Bonsu, recently shared government’s plan on local government borrowing in an interview with Fox FM, a Kumasi-based radio station. Mr. Osei Kyei Mensah Bonsu declared that “Government is in a process of considering some proposal. There is a bill on the way that suggests that assemblies should be allowed to use the strength of their balance sheet to borrow money to develop their localities”.

Universally, there are two types of control mechanisms which underpin subnational borrowing. One mechanism is to establish a set of rules and regulations which are enforced by central government; and the second is the private credit markets discipline. However, the second mechanism requires developed private financial markets. It becomes imperative therefore for countries with ailing private financial markets to rely on rules and regulations set by the central authorities. The general rationale for the imposition of strict limits on the borrowing ability of local governments has hinged, in particular, on the concern for macroeconomic imbalance. It would be convenient to say that Ghana adopts rule-based approaches to controlling subnational borrowing – a progressively more restrictive approach to borrowing by the MMDAs.

The set of rules which permits and regulates the borrowing behaviour of the MMDAs are expressed in law, particularly, in the Local Governance Act, 2016 (Act 936) and in the Public Financial Management Act, 2016 (Act 921). Specifically, Section 124(5) of Act 936 provides that “A District Assembly may borrow to finance projects in accordance with relevant laws”. However, Act 921 in Sections 73, 74 and 75 provides for borrowing by local government authorities and reporting requirements. An attempt to provide detailed set of rules for subnational borrowing is found in the Act 921. For instance, section 74 (1) states that “Subject to subsection (2) and without limiting section 73, a local government authority may borrow funds only:

(a) from within the country, and

(b) up to the limit determined by the Minister in consultation with the Minister responsible for Local Government, and consistent with the medium-term debt strategy and annual borrowing and recovery plan”.

Also, Section 74(2) of provides that “A local government authority shall obtain prior written approval of the Minister for:

(a) the issuance of debt securities to the public; or

(b) borrowing of an amount above the limit determined by the Minister under subsection (1).

Clearly, while the laws allow MMDAs to borrow with approval from both the Minister for Local Government and the Minister for Finance, borrowing from foreign sources is severely restricted. Of course, allowing the MMDAs to borrow from external sources presents inherent greater macroeconomic risks. In spite of applying a progressively restrictive approach, Ghana needs to develop an elaborate borrowing framework leading to the passage of ‘local government borrowing bill’. Unquestionably, a rule-based framework for local government borrowing, in general, provides transparency and helps to evade a negotiation process between local and central governments.

In most developed economies, local government borrowing forms an integral part of the system of local government finances. Although public sector borrowing for recurrent spending is generally considered a bad practice, public finance experts generally agree that it is appropriate for responsible and accountable local government authorities to borrow for the purpose of financing capital investments. Borrowing enables local government authorities to fund capital developments (such as roads or school buildings) that produce benefits over a longer period of time and spread out the financial burden for this investment over a number of years, thus providing a stronger link between the costs and benefits of the capital investment over time.

Interestingly, the rationale for local government borrowing is that it provides a source of financing for local capital development. However, borrowing for ‘consumption expenditure’ or for recurrent expenditure is prohibited by law in most countries. Indeed, allowing local governments to borrow also conveys with it a measure of conceivable risks, therefore, the funds borrowed must be channelled into highly profitable projects. Borrowing has been a negligible share of the total revenues of a District Assembly in any given year in Ghana. However, there have been some “local arrangements’ between the MMDAs and their bankers where overdraft facilities or ‘soft loans’ are given to them to assuage urgent needs; and amortised when transfers are made into their bank accounts in those banks, either from the District Assemblies Common Fund (DACF) or some other expected payments from internal or external sources. Many a time, these ‘urgent needs’ are recurrent expenditures the MMDAs cannot defer. Embarrassing enough, preparing for visiting presidents and their teams, has been one common ‘urgent need’ that has driven MMDA officials to making, more or less, off-the-record borrowing pacts with their bankers.

Borrowing by the MMDAs is crucial to their ability to finance capital development projects. The proposal for government to develop a local government borrowing framework hinges on the reasons adduced by Petersen (1998), that recurrent financing of capital development would be inefficient. Evidently, the amount of resources needed for capital projects is usually hefty to be raised from regular recurrent sources. Unlike most recurrent expenditures, capital infrastructure is bulky. And for many capital projects done by the MMDAs, all the expenses must be done before the purpose or benefits from the project are reaped. For instance, once you start a project such as a bridge, you cannot simply decide to build half the bridge and receive half the benefits.

Definitely, borrowed funds for capital projects must be repaid over an agreed time. If the projects were to be funded from recurrent incomes, it would create inter-temporal mismatch. It would require taxpayers to bear the full cost of the capital projects upfront, although the benefits from capital projects are spread out over many years. Borrowing to finance capital projects would restore the match over time between the costs and benefits of capital infrastructure. Indeed, this reasoning is sound for both social types of infrastructure such as clinics, hospital facilities, school buildings, etc. and also productive types of infrastructure such as markets facilities, roads, bridges, etc.

At both national and subnational levels, the infrastructure required to stimulate and to accommodate future growth must be put up today. Consequently, a postponement in providing the infrastructure would also point to slow economic growth. No doubt, the absence of certain types of infrastructure may be restraining to economic growth. Even though building a market centre or a ‘tollable road’ may generate economic activity, the financial resources to build the market or road only become available after the investment is in place. In the case of a market project or tollable road projects, user fees or increased economic activity are expected to generate extra local revenues. The absence of the capital infrastructure would also influence a locality’s ability to repay the debt. Needless to say, this argument is only sound if the borrowed resources are put into economically productive investment activities.

The issue of generational equity is mainly considered when it comes to borrowing to finance capital projects with long-term benefits. Indeed, in the absence of borrowing we would possibly ask one generation to pay for the infrastructure used by another generation – intergenerational equity. It is more equitable (fair) to have the people who will receive the benefits of the capital project over time to also contribute to the cost.

In countries such as Ghana, which often experience high inflation instability, the cost of capital projects now and in the future could be significantly different. Imperatively, the future increase in building and procurement cost can be avoided by building the project now. If the loans to the MMDAs can be arranged in a fixed rate, future inflation could also reduce the cost of borrowing. The future amortisation would be worth less than the value of the sum that was borrowed.

Notwithstanding the flowery benefits inherent in local government borrowing, it is much less common in developing economies, including Ghana. It is important for the GoG to consider, along with the sectoral stakeholders, the following imperatives on local government borrowing, which come with some policy derivatives:

Developing a Comprehensive MMDAs Borrowing Framework or Bill

The elaborate framework or bill will expand further the provisions for borrowing by MMDAs in both the Public Financial Management Act, 2016 (Act 921) and the Local Governance Act, 2016 (Act 936). The new framework would set the rules and confine MMDAs borrowing so that it only serves certain purposes, and to provide safeguards against abuse of the borrowed resources.

The MMDAs’ borrowing framework or bill should address the following options:

• A ‘rigorous rule’ on the purpose of MMDA borrowing should be set. It must be regulated strictly that no borrowing or credit proceeds can be used to finance current expenditures or for goods and services but for only capital investments. The purpose of borrowing must be prescribed explicitly in the framework or bill.
• Setting variable ceilings of borrowing for the categories of District Assemblies i.e., borrowing by Metropolitan Assembly, Municipal Assembly and a District Assembly can be variable in keeping with their revenue strength. Also, borrowing in any fiscal year should not exceed a certain percentage of their revenues in that year. Furthermore, the total debt of an MMDA should not exceed a certain fraction of the total MMDA revenues in any year.
• As it already exists, all borrowing by local governments is subject to approval by the Ministry of Finance. Also, all MMDAs’ debt must be registered with the relevant ministries, i.e., the Ministry of Local Government, Decentralisation and Rural Development and the Ministry of Finance which shall regulate and monitor compliance.
• The role of the central government in guaranteeing the debt of the MMDAs must be explicitly regulated. While I personally will not recommend central government guaranteeing for subnational debt because of its macroeconomic consequences, especially in the context of Ghana’s current economic trajectory, it must also be provided in the framework that MMDA debt cannot be guaranteed by the central government except under conditions discretionally viewed as necessary by Parliament.

Undisputedly, borrowing by both central and local governments can be a significant way to meet the initial capital costs of infrastructure, and ration the costs equitably among different users over time. However, it entails a strong regulatory framework to meet the requirements of creditors and manage overall levels of debt.

Integrating MMDA Borrowing and the Intergovernmental Fiscal Transfer Framework

The likelihood for MMDAs to default on their debt obligations creates a problem of a soft budget constraint. Linking the borrowing framework to the transfer system of MMDAs could improve the overall effectiveness of local finances by creating appropriate incentives for debt repayment. The borrowing framework should aptly be integrated with the transfer system, in such a way that MMDAs which default on their credit commitments would automatically be disciplined by having the loan repayment and any penalties recovered from their DACF transfers at source. Smoke (1999) contends that this would effectively reduce the moral hazard habitually encountered in local government borrowing schemes. Indeed, the closer integration of the MMDA borrowing and transfer framework would result in an overall enhancement in the system of MMDAs finances.

Improving Creditworthiness of MMDAs through More Transparent Budgeting and Accounting

Many MMDAs in Ghana typically lack creditworthiness – pecuniary ability to repay loans over time and the technical capacity to manage the debt, and therefore lack the ability to borrow from financial institutions. The situation is reinforced by the unpredictability of the DACF releases and relatively low collections of internal revenues. Creditworthiness can be improved through more transparent budgeting and accounting, and the development of autonomous sources of revenue for the MMDAs. A policy derivative of efforts to improve the MMDAs own revenue base, would be to leave the administration of property for the MMDAs as things go, rather than the centralised control system of property rate administration being attempted by the central government. It is important to point out that even if the MMDAs revenues and creditworthiness are suggestively improved, the necessary levels of borrowing may not happen because of market failure on the supply side.

Development of Steady and Reliable Revenue Sources for the MMDAs

The nature of the existing intergovernmental fiscal transfers directly impacts the MMDAs financing portfolio. Without central government’s guaranteeing for MMDAs to access credit, the MMDAs themselves must demonstrate reasonable and unfailing streams of revenue. The GoG must court Development Partners and other stakeholders to help in developing steady and reliable sources for the MMDAs. In addition, the Ministry of Finance and the Common Fund Administrator should produce a disbursement timetable of the DACF to the MMDAs, published at the beginning of every fiscal year. This would communicate a certain predictability of transfers, although the rota of disbursement may not give information of the size of the transfers to be made to the MMDAs.

Like the news of a man who has lost a wrestling bout at the bazaar, it is well known that the allocations of DACF are continuously characterised by uncertainty. The MMDAs are not only uncertain about when their allocations from central government will come, but also about how much they are going to get. Another problem is the central government’s cynicism about the capability of the MMDAs to mobilise revenue from potentially lucrative sources of local revenue. I can again state without a flake of doubt that this cynicism drives the tendency for ‘recentralisation’ in Ghana. A case in point is central government’s intent to tacitly usurp the collection responsibility of property rates from the MMDAs to a subcontracted entity. This is an attempt by central government to cling to the financial muscle.

Subnational Credit Market Development

While emphasis is put on controlling the demand for credit by MMDAs, the problem of market failure on the supply side cannot be ignored. Governments need a financial model to be able to structure the repayment of debt from steady revenues. To attract capital finance, MMDAs must also be able to prove a track record of project delivery and creditworthiness to reassure lenders.

In conclusion, while borrowing is a third possible funding source for local governments, borrowing only fills a temporal gap, as the debt ultimately has to be repaid with either own source revenues or intergovernmental transfers. It is pragmatic therefore for the Government of Ghana to develop the comprehensive MMDAs borrowing framework in keeping with the national public debt management framework.

By MOHAMMED S. MUSAH, Social Protection and Governance Specialist, © 2022

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