Municipal Loans
Go For Selective Approach

By Rup Khadka

MUNICIPAL functions can also be financed through loans. Municipalities can use both commercial and/or public sector loans. Since commercial banks or other types of financial institutions focus on commercially viable projects, it might be difficult to take commercial loans for poor municipalities that are in need of resources. So, from the perspective of regional balance or decentralisation, there is a need for the public sector loans for the municipalities of particularly underdeveloped areas.

Central governments provide loan to municipalities with no or subsidised rate of interest. Unlike grants that are provided on a pre-determined basis, loans could be tied up with the cash flow of the project.

In this context, there has been a growing practice to set up Municipalities Development Fund. The Ministry of Local Development generally runs them. In other countries the Ministry of Finance manages them. In other countries, an autonomous body also runs them. Theoretically, an autonomous body might be considered to be more professional than others regarding selection of the sound projects, monitoring and avoiding the situation of being implemented the politically motivated projects. Municipal governments are represented on the board.

Donors in various countries assist Municipal Development Funds. They also receive funds from the central government budget. In some countries, certain per cent of tax revenue is allocated directly to the fund. Thus, Municipal Development Funds are developed as revolving funds with money from central government and donors.

Municipal loan, like other types of public loans, is criticised on the ground that it causes inflation and "crowds out" private sector investment, which is considered more productive than public sector loan. Further, there is a risk of the money being used in the politically motivated projects. It is, therefore, necessary to adopt adequate safety measures to avoid such situation. It a necessary to follow up on cost recovery conditions of loans. Loans should not be sanctioned to the defaulters on the existing loans. Similarly, some conventional ratios of debt or debt service to revenue may be adopted.

Municipal loans should help generate income of the municipalities directly or indirectly so that municipalities are able to pay both principal and interests. Municipalities should insist in revenue generating projects. For example, in the case of self-liquidating investment such as water supplies, municipal loans could be paid through the user charges. There may not be much disagreement for the loan finance for this type of project. It may not be the case with non-self liquidating projects. Such a direct relationship cannot be established in the case of non-self liquidating projects such as roads. They need to be financed through tax revenues. Municipal Development Fund can also finance such projects which simplify tax procedures, broaden municipal tax base, strengthen revenue administration, set up tax procedures, increase the level of tax compliance that ultimately help enhance revenue collection of the municipalities.

In Nepal, a Municipal Development Fund was established in the name of the Town Development Fund (TDF) in 1989 as a semi-autonomous body. It was later set up under the TDF Act, 1997 as a fully autonomous financial institution, capable of administrating grants and loans to municipalities. A broad is created to provide directions to TDF.

TDF was financed from the loan assistance from the World Bank, grant and technical support from German Technical Co-operation (GTZ), and equity of HMG/N. Municipalities are divided into two groups viz, low-income municipalities and high-income municipalities for the purpose of the use of the TDF fund.

TDF is used for grants and loans to municipalities as well as for local consultancy services for project studies and construction supervision. In addition to the loan finance or grants, TDF also provides technical assistance in the form of design of the project, tender procedures and monitoring of the project. It also organises training for municipal officials in order to strengthen the capabilities of the municipalities.

Grants for social infrastructure projects are eligible up to 60 per cent for the high-income municipalities and 90 per cent for low-income municipalities of the project costs subject to a ceiling. Interest and loan repayment will be used by the TDF establish a revolving fund to finance further projects.

Loans are eligible for 90 per cent of the cost. After a grace period of two years, loans should be repaid at 6 per cent interest with constant repayments, over the next 10 years. The exceptions, however, are loans to high-income municipalities for income generating projects, which are charged at the interest rate of 12 per cent.

There are two types of projects that are eligible for TDF funds. They are social infrastructure projects and revenue generating projects. Social infrastructure projects include such projects as public and private toilets, strom-water drainage, parks and public green areas, paving of public open spaces, street lighting, municipal buildings, solid waste collection equipment and construction of disposal sites, footpaths, sidewalks, roads and bridges, pond rehabilitation, school improvement and extension, river bank protection, simple waste water treatment plants, slaughter-houses, drinking water supplies, and other similar social infrastructure projects. Revenue generating projects include projects like bus and truck parks, commercial centres and stores, public markets (retail and wholesale) and other similar revenue generating projects.

The total amount of loan raised by municipalities in 1998/99 was Rs. 53 million, while it was Rs. 20 million in 1997/98. The share of TDF and other loan in the total loan vary from year to year. For example, the share of TDF loan in the total municipal loan was 80 per cent in 1997/98 while the share of non-TDF loan was about 77 per cent in 1988/99.

Not all municipalities have made use of this source. There is a lack of detailed provisions relating to loans. Municipalities also lack technical know-how to develop economically viable projects to meet the requirements of the commercial banks or their financial institutions.

While municipalities could be borrow money from TDF or financial institutions to carry out their activities, particularly revenue generating projects, they should not depend excessively on this source, since excessive dependence on borrowing might lead to financial difficulties in the future. This is particularly important where projects might be viewed as risky projects, which might be politically motivated, and where municipalities lack managerial and administrative capabilities to run them successfully. It must be remembered that heavy dependence on loans now means large debt service and low level of municipal services in the future. So municipalities must be selective in taking loans, in line with their financial potential and managerial capabilities.

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