Guidelines on Local Government Borrowing and Recent Developments in South East Europe
4. Local Government's Creditworthiness Assessment

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.