Subnational governments’ role in delivering public goods and services is becoming increasingly important. States and provinces are taking on more responsibilities in areas of public investment and the provision of goods and services. Such phenomena comes as a result of an overall decentralizing trend, devolving fiscal responsibility from central to subnational governments, which is associated to factors such as rapid urbanization, and the development and deepening of domestic financial markets across many countries and regions.
Financing the resulting additional subnational expenditures has relied primarily on intra-governmental transfers and own-revenue sources. In many instances, however, these sources of funding have not adequately kept pace with growing expenditure and investment needs linked to newly acquired fiscal responsibilities. This has led to a dramatic increase in debt-financed subnational public expenditure. In this context, assessing the sustainability of both fiscal policy and debt accumulation has become a crucial component of overall macroeconomic analysis and policy development.
The analysis and assessment of fiscal and debt sustainability have long been central to broader macroeconomic surveillance and analysis undertaken by central governments and international financial institutions, such as the IMF and World Bank (Joint IMF-World Bank Debt Sustainability Framework). These assessments tend to focus primarily on central governments. In the mean time, a significant proportion of aggregate public sector transactions related to subnational governments remain excluded.
Similarly, while the dynamics of central government fiscal management (e.g., with respect to sources of revenue and expenditure modalities) and related institutions are standardized and well comprehended across countries, those for subnational governments are much less clearly understood. Subnationals tend to have limited sources of revenue, limited flexibility with respect to both investment and expenditure decisions, and less discretion than central governments with respect to financing options.
While there has been much research and increased consensus over the past several decades into what constitutes a sustainable path for fiscal policy at the central government level and in sources of national debt distress, there is a noticeable lack of agreement regarding a unified approach for assessing subnational fiscal and debt sustainability. Cross and within country differences in policy flexibility, and in fiscal aspects such as revenue sources and expenditure obligations, together with the country-specific nature of intergovernmental financing, suggest that no single standard subnational fiscal and debt framework may be sufficiently robust to accommodate to all subnational fiscal structures. Such framework should be customizable and flexible enough to accurately reflect the institutional and policy specificities of the government being analyzed.
In this sense, it appears that benchmarks or indicators of sustainability at the subnational level should be developed on a case-by-case basis, reflecting some ex-ante guidelines that are relevant to the government in question. Moreover, a standard set of data and robust forecasts for key subnational macroeconomic and fiscal variables (e.g., subnational output, revenue and expenditure growth, etc.) are not always available, making it necessary to customize the subnational fiscal and debt framework to the information at hand, which certainly does not preclude endeavors to identify or develop own data and robust economic projections.
Subnational fiscal and debt sustainability assessments have been undertaken by World Bank’s Staff in several contexts, including, noticeably:
- Development Policy Loans to subnational governments: They generally require an assessment of the potential impact of any proposed World Bank lending operations on fiscal and debt sustainability. Such assessments are usually included in the DPL proposal and its underlying analysis.
- Analytical Work produced by the Bank for subnational clients: Insights from subnational fiscal and debt sustainability analyses contribute to improving public financial management, service delivery, and broader macroeconomic policy coordination in the context of broader analytical work produced by the Bank.