Guidelines on Local Government Borrowing and Recent Developments in South East Europe
6. How to find and select the lender?

6.4. Securing liquidity for EU-funded projects' implementation
6.4.1. Borrowing for implementation of EU-funded projects

Grants offered by the European Union (EU) to both member and accession countries are a valuable contribution to the development of local infrastructure, services or administrative capacity. In member states such local government projects may frequently exceed 15 million EURO; indeed, they may come close to 100 million EURO as in the case of regional water and sewerage infrastructure. The value of the projects put forward bylocal governments in accession countries is smaller, but the benefits of financing local capital investment through EU grants are unquestionable nevertheless.

However, securing and spending EU financing are no easy tasks. While project preparation and contracting is not the realm of this paper, we will touch upon the instruments available to local governments to ensure liquidity for project implementation. The EU regulations and procedures require grant beneficiaries to contribute from their own resources to the project's eligible (up to 50% in revenue-generating projects) and ineligible expenditure. In addition, as a rule, the grant money is provided to the beneficiary local government as reimbursement of legal eligible expenditure, which means that local budgets have to cover fully the initial sets of invoices from local resources. Such requirements may have a negative impact on the cash available for recurrent operations of local governments and may cripple their capacity to provide other services. Hence, the need to make use of credit to pay for all or part of local contribution to EU funded projects without disturbing the other recurrent operations. Such a solution makes sense since much of the principal repayment is secured from the reimbursed grant; interest and fees will always be serviced by the borrower from its own resources.

Even traditional loans may undergo adjustments, usually under more favorable conditions than in case of loans for investment projects financed from the local government own resources. The existence of a Guarantee Fund, which can provide additional guarantees, would provide further support to this type of lending. For instance, in Romania numerous local governments, including rural ones, borrowed from banks to pre-finance23 or/and co-finance24 local capital projects with maturities ranging from 8 months to 2 years. Such practice is of course at variance with the recommendations of medium and long-term borrowing for capital investments, but it is a rational behavior given the reimbursement procedures and the scarcity of local budget cash at any given moment.

The actual pre-financing and co-financing needs may not be accurately estimated for a variety of reasons; the reimbursement process is likely to be delayed by lengthy clearance procedures or shortage of state budget resources; on the contrary, the payment of invoices may coincide with an influx of tax collections which provides the local government with enough cash in hand to meet all incurring commitments; or, the public procurement can result in a lower price than the initial estimations. Hence, a creditworthy local government may only want a credit line. The EU-funding for the project increases likelihood to obtain the financing. Also, subsequent to project implementation the operation of the investment can be financed by means of a working capital credit line.

In other cases, local governments which are more confident in meeting all project commitments from local resources may still evaluate the need for a bank guarantee (or letter of guarantee) from a bank or a guarantee fund for fear of unexpected inability to pay invoices from suppliers at any given moment or as a prerequisite for advance payments. The costs of a bank guarantee include usually a fixed commission paid periodically to the issuing financial institution over the life of the guarantee and also additional guarantee fees paid to a Guarantee Fund if the letter of guarantee is secured.

Bank guarantees for EU grant-funded projects in Romanian rural infrastructure
In Romania, the rural local governments which obtain financing from the EU-funded National Program for Rural Development (NPRD) may choose to receive advance payment before project inception (after public procurements is finalized and confirmed as legal) up to 50% of total eligible expenditure. The advance payment largely eliminates the need for a loan or a line of credit. However, the NPRD requires the receivers of advance payments to put forward a letter of guarantee from a bank or the state-owned National Guarantee Fund for Small and Medium Enterprises or the Guarantee Fund for Rural Credit. The letter of guarantee provides the management authority of the NPRD the option to call on the bank/ guarantee fund resources if the local government does not fulfill the requirement to repay the advance payment. The fee for the letter of guarantee issued by the two state-owned funds is set by order of the minister of agriculture. The guarantee may cover up to 110% of the advance payment. The collateral for the issuance of the bank guarantee is the local government's local budget revenue (i.e. revenue interception).

6.4.2. Legal incentives for debt aimed at local contribution to EU-funded projects

To encourage and support local government use of EU grants some countries conceive special provisions in the local public finance and debt legislation. Such provisions may have various objectives:

a) Simplify the debt approval process. Concrete measures could be:

Eliminate the need for central government approval or

Simplify the bureaucratic requirement for the approval process

b) Ensure all local governments which benefit from EU funding are permitted or able to take loans to ensure project liquidity. Specific tools could be:

Make exemptions from existing conditions and limits to borrowing

Provide state guarantees for loans taken to implement EU-funded projects by local governments or municipal enterprises which would otherwise not be deemed creditworthy.

c) Provide resources from national budgets to meet liquidity needs until disbursements are settled. To this end most obvious instrument is an advance payment of up to 30%- 50% of total eligible expenditure upon the conclusion of the financing agreement. The advance payment allows the local government to pay the first invoices from suppliers, but there are no guarantees it would suffice until disbursements begin in earnest. Moreover, the disbursing authority will retain a certain amount of each disbursement to offset the advance payment.

As noted, there are various options available to governments willing and able to encourage local governments to meet EU-funded project liquidity needs through borrowing. The choices are obviously a matter of political and macroeconomic considerations at the same time. Countries seeking to cut budget deficits will not encourage borrowing, but might put more emphasis on advance payments. Countries with less developed local credit markets or with numerous small local governments may ponder the option of guaranteeing the latter’s loans. Finally, countries trying to reduce the complexity and involvement of central government into EU-funded project implementation will allow local governments to borrow under privileged conditions.

6.4.3. Borrowing for EU-funded projects in South East Europe

Out of the participating territories covered by NALAS members to this paper three are already members of the European Union, namely Bulgaria, Romania and Slovenia. Others are candidate countries and will one day be persuaded to take support measures for their local governments’ absorption of EU funding. So far only the three member states adopted incentives for local governments to borrow for EU-funded project implementation. EU assistance for the other countries mostly takes the form of small projects wherein local contribution can be secured from own resources.

As stated above, countries have a wide range of support instruments to choose from. Bulgaria and Slovenia apparently chose a minimal approach, with only one type of incentive, while Romania has adopted a few.

Incentives to borrowing by local governments in European Union member states for the implementation of EU-funded projects
a. Debt taken to provide local contribution to EU-funded projects is exempt from the debt threshold and from the annual national threshold of contracting and disbursement. However, central government approval is still required.

b. Local government or regional water & sewerage company loans related to EU-funded road, water infrastructure, waste management, education and social assistance projects may guaranteed by the state through the National Fund for Loan Guarantees to Small and Medium Enterprises. The guarantees allow less creditworthy rural and town governments to borrow at lower costs or to attract lenders at all. In turn, the Ministry of Finance guarantees any lender the servicing of unpaid dues should any local government default. Subsequently, the MoF withholds general purpose transfers from the state budgets to the respective local government to recover the amounts it had paid to the lender. Loans guaranteed under this scheme benefit from the provisions at point a).

c. Advance payment to EU-grant beneficiaries is also available, up to 30%-50% of project eligible expenditure.

In Bulgaria, the central government provides local government with interest free loans for co-financing EU-funded projects (also called bridge financing). No state guarantees can be called upon.

Slovenian local government long-term loans secured to co-finance EU-funded projects are exempt from the debt threshold.