Prior to establishing the terms and conditions of a financing agreement (be it loans
or bonds), investors evaluate local governments' creditworthiness. The creditworthiness
of a local government measures both quantitatively and qualitatively its ability
to repay debt. This is a rather complex process and covers (i) a thorough analysis
of the local governments' financial position, (ii) an assessment of the local economy
in which the municipality operates (e.g. economic and political context) and (iii) an
evaluation of the national macroeconomic environment. The depth of such analysis
differs across financial institutions, depending on the degree of specialization
and knowledge on/ of the local governments' segment. Local governments should
perform a self-assessment of their creditworthiness prior to approaching financial
institutions. Thus they will be able to determine roughly how much money they can
borrow without impairing their financial stability. Moreover, this self-assessment
prepares local governments for the discussions with financial institutions which will
take place at the time when they want to issue debt. It can also be used as a diagnostic
tool by local governments to better understand the factors which may affect their
financial stability as well as to perform certain scenario analysis.
In general, the creditworthiness assessment of a local government is based on the following
three broad factors:
Economic Risk,
Political Risk, and
Financial Risk
In this chapter, we identify a series of economic and financial indicators essential for
understanding the past performance, projecting future financial position and consequently
assessing the creditworthiness of the local governments. While many of the
parameters are quantifiable, subjective judgments are also employed to assess qualitative
factors such as government's policies.