Measure isn’t needed yet

Kim Hong-whan

The head of the ruling Saenuri Party has floated the idea of introducing a bankruptcy system for underfunded and debt-ridden local governments to enforce fiscal responsibility.

The reasons cited for the idea make me wonder whether local politicians really have any knowledge about the bankruptcy system, debt levels and the fiscal crisis management of local governments.

We can refer to the United States and Japan, which allow municipal bankruptcies. When a local or district administration files for bankruptcy, the central government strips its autonomy and enforces stringent restructuring actions to cut down expenditures and increase tax revenue. Actions include hikes in property and other local taxes, as well as public utility fees such as public subway fares, parking lot fares and water bills.

To save costs, town and district outlets are closed or merged, civil servants and public employees are laid off and those remaining face pay cuts. Public assets - galleries, performance or community centers and parks - are sold off or closed.

But in our case, the administrative organization, staff and payroll of local governments fall under the legal jurisdiction of the central, not local, government. Public utility fees are also authorized and decided by the central government in view of overall inflation. Restructuring measures to help battered cities or local governments under legal grounds are limited.

Many are led to believe that local government debt levels are serious. Debt in itself is not bad. An individual would opt to seek a loan if he or she could borrow at 2 percentage points below the market lending rates.

But not all debt held by local governments is bad. Of the debt owed by local governments as of 2012, more than 90 percent carries an interest rate of less than 5 percent. Financial loans that can bring about a liquidity squeeze take up just 2.3 trillion won ($2.1 billion) of their combined debt of 27.1 trillion won. In short, their debt state is not as serious as people think.

As of 2012, 49 of 227 local governments have no debt and 191 have a debt-to-asset ratio of below 10 percent. Considering the central government’s debt ratio is 147 percent, the local governments’ debt levels are passable.

But the debt of umbrella entities of local governments is rising fast. A total of 391 public entities owned, or invested in, by local governments report a combined debt of 72.5 trillion won. But three city builders of the capital and satellite areas - SH Corporation, Gyeonggi Urban Innovation Corporation and Incheon Development and Tourism Corporation - take up nearly 50 percent, with a combined debt of 34.7 trillion won.

The debt-to-capital ratio of public enterprises owned by local governments was at 77.1 percent as of 2012, which is relatively sound when compared with the 145 percent average of listed companies. Most of the debt was raised to finance government policy projects such as housing for people without homes.

Under the law, local governments must seek endorsements from the central government on bond issues and their spending plans from a certain scale must be reviewed and approved by higher governments.

Bond and debt levels are closely watched and supervised by authorities. Local governments, like private corporate bond issuers, come under strict public disclosure regulations. In short, local debt is under close monitoring and scrutiny. A bankruptcy system should be discussed after local governments are given more liberty and authority in running public finance. Politicians should study the bankruptcy system, reasons for local debt, and crisis management system before they consider employing the mechanism.

*The author is a research fellow of the Governors Association of Korea.

By Kim Hong-whan