The forum opened with a keynote speech by Mr. Takero Doi, followed by a panel discussion. Panelists then responded to questions from the general audience.

Keynote Speech "Local Bonds and Fiscal Discipline of Local Governments" (Mr. Takero Doi)

• A special characteristic of the approval system for local bond issues is that the central government simultaneously determines the approval of the bond as well as its use and creditors. Although bondholders from the private sector are increasing, half of the bonds are purchased through public financing.
• Public funds are attractive to local governments since loans can be obtained at lower and long-term interest rate than private capital. The Ministry of Internal Affairs and Communications grants more public funds to local governments with weaker financial capacity, and this design allows local governments with little tax revenue to obtain loans.
• Local governments with little tax revenue of their own can incur debt because of three schemes: 1) measures through local allocation tax grants for repayment of principal and interest of local bonds; 2) the local public finance reconstruction plan; and 3) the approval system for local bond issues . These schemes support an "implicit guarantee by the central government."
• If a local government receives many grant measures for repayment of principal and interest, the standard financial need will be greater, and the grant will increase. Therefore, the system is designed in a way that allows local governments to incur debt by shifting the burden to the national tax, even if their own tax revenues are scanty. The perception of many local governments is that debt covered by the measure through local allocation tax grants is not debt of their own.
• Although new initiatives such as the issuance of bonds on a mini market, the adoption of the 2-table approach, and the attempt to jointly issue of bonds are desirable, it is of concern whether results can be obtained hereafter, while the "implicit guarantee by the central government" is left intact. There is a problem to attaching "implicit guarantees" even to local governments without sound fiscal conditions, and the direction to head for should be toward recognizing differences in conditions for bond issues according to financial conditions.
• The current system of local bonds functions on the incentive compatibility of the objective of local governments to provide administrative services with as little local burden as possible, with the objective of financial institutions to maximize profit. However, there is concern as to whether the burden is being shifted to present and future national taxpayers.
• Although some argue that there is an advantage to raising funds for local governments through national bonds at the lowest interest rate-since this means delivering administrative services of local governments at lower cost-the disadvantage is the loss of cost awareness. It is necessary to apply interest differences after comparing and weighing both the advantages and disadvantages.
• In the US, private financial guarantee insurance companies underwrite debts when local governments issue bonds by covering the difference in the interest rate. In Canada, local governments join to form finance corporations, and funds are obtained through the corporation that receives higher credit ratings. In this way, local governments provide administrative services at low interest.
• With respect to the local public finance reconstruction plan, although local governments included in the plan have succeeded in improving the real balance, investment costs have not been contained, and the principle source of revenue is local allocation tax. Fundamental fiscal consolidation has not necessarily been achieved. Furthermore, local governments do not demand reduction or cancellation of debt for liquidating existing debt; in part, an excessive burden is demanded from local allocation tax.
• As to whether default on debt obligations by local governments exist, local public corporations and such are already applying debt liquidation through specific mediation in some cases. Since specific mediations have a somewhat ad hoc characteristic, there is need to set clear rules for establishing the reduction and cancellation of debt as a way of debt liquidation.
• As a local bond scheme appropriate in this age of decentralization, self-responsibility must also be made clear. It is desirable that lending-borrowing transactions be conducted at prices determined in the marketplace, including through the indirect finance of market-oriented transactions. The central government, rather than providing advance relief such as grant measures, should take the form of monitoring local governments by fiscal rules and adopting early rectification measures.
• The risk of local governments of becoming incapable of servicing their debts with their own tax revenue exists in any country, and under any system. What matters is with whom to share such risk. One extreme view is that, under the current system, national taxpayers share the risk, but under a local bond scheme appropriate to this age of decentralization, the risk should be absorbed by sharing it broadly among a large number of participants in the market -- including local governments as debtors, financial institutions, and depositors.
• Local bonds are showing good signs of marketability; conditions must develop so that these can be widely distributed. For this, a credit rating system is necessary. Credit rating not only serves as an assessment by third parties, but it also makes issuing local bonds easier by standardizing them as financial products.
• Local bonds can be insured by the private sector as well.
• On top of the above considerations, the central government plays the role of complementing market failure. It will monitor local governments that conduct unsound fiscal management by fiscal rules.

[Panel Discussion]

(Yoshikawa)

• The problem is that, in Japan, the "local" in "local bonds" is in name only; they are not truly local government bonds. Since the central government ultimately looks after them, they are more akin to national bonds.
• With regard to the delivery of public services, from the viewpoint of efficiency, governance and discipline, it's better if local governments take on a little more of the responsibility for decision-making. More attention is paid to matters that appear before one's eyes. In the regions, discipline should work on fiscal affairs by voting on foot and by conventional voting. If the local government misbehaves, its residents will move out. Based on this premise, it is necessary to convert local bonds into true local bonds.
• The shift of the approval system of local bond issues to a system based on consultation in FY2006 is a step forward. However, the major point at issue from now on will be whether this is a midway stop or the final station.

(Yoshino)

• One problematic point is that, currently, indifferent to the type of project that the local bond is financing, these are transacted on the market at the same interest rate.
• In the future, rather than having a single local bond with the same interest rate for all projects, it is necessary to issue local bonds according to the type of project.
• Joint issuance and individual issuance should be separated. Projects within the national minimum, such as education, waterworks, and sewerage systems require joint issuance of bonds so that the fund can be absorbed at the lowest interest rate possible. One big problem in Japan is that there is no definition of national minimum.
• With regard to individual issuance, when there is awareness that bonds are ultimately insured by the central government, even if fiscal conditions or projects differ, all local bonds receive nearly similar ratings. A system to give market assessment to these is required.
• The revenue bond is a way to differentiate according to project. In this case, revenue generated from the project is used to pay the principal and interest on that bond.
• In the case of the revenue bond, since a good project would pay the principal and interest without fail and yield high interest, such a project will attract funds and keep developing. However, revenue bonds used for building unnecessary highways would not sell.
• Revenue bonds give a tangible form to public services that, until now, could not be seen in the market.

(Kumano)

• The discussion suggests that local public entities are arbitrarily involved in an array of projects, but that is not so in the least. Expenditure of the Tokyo Metropolitan government in the FY2005 budget has decreased 7 percent in comparison to FY1999, and there is an ongoing effort to curtail expenditures. Whereas expenditure is being reduced in the fiscal planning of local governments, it is increasing in the central government. If we are going to speak of the problem of moral hazard, it should be pointed out first to the central government.
• As a result of economic measures forced on local public entities by the central government after the burst of the bubble, with the central government's assurance that they will look after repayment of bonds to be issued with local allocation taxes, the outstanding amount of local bonds increased. Therefore, the central government should bear responsibility for the repayment of these bonds.
• An irresponsible budget assessment in the line of appropriating items in the budget-since the repayment of bonds to be issued will be made by local allocation taxes in the future-is unthinkable.
• To say "taking care of the repayment of issued bonds with local allocation taxes, is a shift to national taxes" is inappropriate, given that a certain proportion of the composition of local taxes and local allocation taxes is revenue that originates in the regions.
• Discussion on the measure through local allocation tax should not be limited to its relationship with local bonds, but be judged as a whole in the context of how to deal with the transfer of tax revenue sources and national treasury disbursements.
• Since, at times, public funds cause losses in the long run in comparison to private capital, the belief that "public works are conducted excessively because public funds have a low cost" definitely does not stand.
• When obtaining financing, besides acquiring funds at low cost, the Tokyo Metropolitan government also pays attention to stable fund-raising, so that it does not lead to a decline in community services. Furthermore, considering the event in which obtaining funds on the market becomes impossible, it is thinking about diversifying fund-raising methods and creditors. Accordingly, the actual fund-raising of local governments cannot be limited to market principles alone.
• In principle, I do not oppose the view that defaulting on local bonds is necessary. However, if local public entities are to be held responsible for the default, this cannot be without being granted taxation autonomy.
• Parallel to the fundamental reform of the system of local public finance of how to deal with taxation autonomy, it is necessary to examine the issue of local bond default as well.

(Ogawa)

• What lies at the root of the background of the sharp increase in local bonds is the fact that checks-and-balances system had been conducted quite ambiguously. Another point is that there are hardly any incentives for achieving fiscal consolidation with one's own effort.
• If regulations for bond issuance are eased, the decline of support and protection for local public finance would become a problem. In addition, improvement is required for maintaining sound local public finance and on dealing with local public entities with deteriorating fiscal conditions.
• Foreign systems vary by country. For example, there are countries like Italy, where centralization is advancing, and others like Germany, where protection and guarantees that were provided by the state to local governments until now are being eliminated by EU regulations.
• In Japan, for waterworks and sewerage projects and gas projects, among others, "revenue bond-imitations" are being issued. These are imitations because they are not formulated to service the debt through project revenues alone. Furthermore, the lack of disclosure must be improved. Revenue bonds that are issued that their own tax revenue as the source of repayment are difficult at this stage.
• Abroad, there are cases in which institutions like public enterprise finance corporations are being privatized. Even for relatively small-scale local governments, the function to obtain funds through public corporations is required from now on.
• The key is to conduct checks in various forms and to try to refrain from issuing unnecessary bonds.

(Yamamoto)

• "The view of local governments as fundamentally depraved" was mentioned before, but local government officials at the front line of fiscal affairs tend to have extremely high morals. Furthermore, since local governments are strict on interest rates, it is difficult for regional banks to raise profits.
• In 1998, a strong awareness to review publicly-offered local bonds-which are now increasing-emerged. A chain of financial uncertainty, the Russian bond default, registration of losses in the third sector, and the declaration of financial crisis of local public entities spread the mood that, even with official back-up, local bonds cannot be readily trusted. For this reason, an atmosphere was created that denied the creditworthiness of local bonds in terms of quality, in comparison to national and government-insured bonds and differences in interest rates began to appear on the market. In addition, there was a review of the Fiscal Investment and Loan Program in FY2001, which resulted in reduced proportions of public funding for the local bonds program.
• Since the default of local public entities is not a systematic problem or a problem of legal capacity, it is natural for the possibility of default to exist.
• With regard to local bonds, the discussions taking place mix size, like prefecture, ordinance-designated cities, and municipalities (cities, towns and villages), with local public entities, local public corporations, and the third sector.
• Liabilities act as a disciplinary force because there is management by the creditor and the possibility for settling assets exists. The trustee is of private character and cannot manage local public entities of public nature. For this reason, it is difficult to discipline in the case of local bonds.
• Based on the experience of Fiscal Investment and Loan Program (FILP) agencies, there is a strong possibility that assessment in the market will not reflect the degree of management discipline, such as the difference in liquidity due to the scale of bond issuance, and other factors.
• That projects will not be implemented if interest rates are high is a complete illusion. The duty of public administration is to carry out the project once its implementation has been decided, whether interests are high or low.
• Since the level of market interest rates changes from one moment to another, the difference in the condition for issuing bonds (up to some one-hundredth of a percent) has no significance.
• A detailed democratic process is what is most important; disciplining with local bonds is ridiculous. However, it is certainly a fact that as local public entities gain more freedom, disciplining will become necessary.
• There is a need to deepen the discussion on the nature of benefits and burdens, as well as on national minimum.
• With regard to revenue bonds, if the rates that are charged cover the repayment of principal and interest and still leave something more, rather than local public entities being responsible, the project should be privatized.

(Doi)

• I do not advocate "the view of local governments as fundamentally depraved" from the standpoint of "blame the system, not the people inside." Even if the will to serve residents exists, under the current system it is frustrating, like trying to scratch an itchy spot through the sole of one's shoes. To be able to reach the itch, it is necessary to change the system to one oriented to the market.
• With regard to the issuance of local bonds through market mechanisms, there is sufficient merit just by making it impossible to issue local bonds in large amounts like now, by denying more loans on such low interest.
• I often hear the argument that local bonds in the 1990s were forced by the central government, but the local governments must have had some projects that they wanted to develop as well.
• When we say "the repayment of local debts is being shifted to national taxes through the local allocation tax," its true meaning is that shifting the burden to national taxpayers, particularly to national taxpayers residing in other regions, is a problem.

(Yoshikawa)

• What is most important is what to use the money for, what kind of public services to provide, and what kind of investments to make.
• In this respect, the remark that administrative bodies carry out projects once the decision has been made, whether interests are high or for any other reason, is absurd. Speaking in terms of private companies, it is equal to saying that once a decision for investment on capital and equipment has been made, this will be implemented without consideration of the profit of stockholders.
• With respect to finance, the central government may be a problem as well, but the issues in question are whether incentives for local public entities are not being distorted, whether governance is not being eased, or whether problems of soft budgets are not being caused. There are certainly many problems related to these issues.

(Yamamoto)

• Is it adequate to consider the decision-making of private companies and public enterprises on same grounds? Companies make investment decisions taking into account the cost of raising funds and the rate of return on investment, but it is difficult to believe that local entities make decisions on investment returns in this sense.
• Also, as to the issue of yield differences on the bond market, basically, it is unthinkable that an administrative body would make a special decision to stop a project that was decided through a political process, because of a difference of a few tenths of a percent.

(Yoshikawa)

• Are the actual problems of local bonds truly concerned with the national minimum? A great number of pipe organs have been placed in regions.
• Public administration and private companies certainly differ, but the principle regarding the weight of debt is the same. The role of public administration is to maximize the present discounted value of the effect on its residents that may be obtained from the present into the future. With respect to how public administration issues bonds and what kind of real investments are made with these, in principle, it is no different from companies that maximize shareholder profit.
• There is also a need to sort out the relationship between local bonds and the national minimum.

(Yoshino)

• Most people are not aware of the fact that local bonds and national bonds must be paid back in the future with our taxes. That the efficiency for spending on local and national bonds issuance is not visible is the problem.
• Rather than issuing local bonds that combine everything, a system that shows which project is performing well is required. Local bonds should be issued to meet the national minimum; a different fiscal discipline should be applied, and one such way is the revenue bond.
• In the United States, even funds for large projects such as highway networks and airports are raised through revenue bonds.
• That the evaluation of FILP bonds is determined in instances other than the market, such as by political power, is true. The same goes for local bonds, so it is difficult to discipline each project with local bonds. Rather than spending for social security or spending for construction, separating spending by project and establishing a system in which earnings from each project clearly appears on the market will lead to enhanced fiscal discipline.
• It is also important to precisely define the national minimum and civil minimum.

(Kumano)

• Commonly, decisions for general projects are made by comprehensively judging the administrative purpose, administrative need, cost effectiveness, and future burden, leaving the revenue source until later. When determining whether to apply bond issuance for financing the project, the principal and interest is considered not in the context of the individual project but under the total finance of the Tokyo Metropolitan government.
• Corporate accounting for public enterprises and for quasi-public enterprises are mechanisms similar to the revenue bond, but if they are claimed to be falsely similar, then there are hardly any projects left to which revenue bonds can be applied. Perhaps urban regeneration or rezoning project would help. However, there is doubt as to whether funds can be raised at low cost even when adopting revenue bonds.

(Doi)

• In the event that revenue bonds are adopted when expanding railways and such, there is concern that outstanding debt will be subordinated if earnings are allocated with priority to revenue bonds. What about this point?

(Yoshino)

• For example, it is possible to admit public funds to the portion corresponding to the national minimum, including the portion of outstanding deficit, while adopting revenue bonds for the portion exceeding the national minimum.
• If there are no projects that can be implemented with revenue bonds, perhaps there is no need to carry out so many projects anymore. On the other hand, even in regions with a low overall rate of return, if a project with a high earning rate is designed, revenue bonds can be introduced.

(Ogawa)

• Until now, projects such as railways that strain fiscal conditions were often constructed based on optimistic demand outlook, but these should be thoroughly examined.
• In terms of rating standards, "implicit guarantees" are clearly separated from guarantees rightfully based on law. Investors should take note of this.

(Yamamoto)

• Hereafter, when the freedom of local public entities increases, the way discipline should be in a democracy will change.
• Basically, it is best not to issue too many local bonds.
• In the future, when decentralization advances and there is a system in which local public entities freely carry out projects, issue local bonds, and repay them on their own, the way financial institutions relate to local bonds in the marketplace will change.

(Kumano)

• Basically, decentralization should be steered in the direction in which decisions concerning benefits and burdens are made as close to the residents as possible. To do so, it is indispensable for this scheme to be constructed in the direction of leaving all programs, such as taxes, in the hands of local public entities. Furthermore, the nature of local bonds needs to be considered in this context.
• However, I question placing all local public entities under a uniform scheme.

(Ogawa)

• Hereafter, what will be questioned is how both central and local governments can maintain administrative services without increasing their debt. One way is to use market mechanisms.
• In doing so, we hope to produce a slightly more transparent local finance system, but the question is whether this will go well.

(Doi)

• The reform of local government bonds should be conducted as a four-tier reform package. That is to say, it is necessary to include the reform of local bonds in the Trinity Reform Package.
• As to small and weak local governments, the central government should shoulder local taxes along with the revenue source, so that local governments don't have to rely on debt. For this, the definition of the national minimum should be clarified.
• From now on, with regard to the general local bond scheme, it is basically necessary to advance on both wheels: market mechanisms and fiscal rules.

(Yoshino)

• The part corresponding to the national minimum requires equalization. For the part above, financing in the form of revenue bonds, for example, with clear discipline is required.
• Diversification of products is required in the case of local bonds as well, as is the case with national bonds. It is desirable that financial institutions not just purchase long-term bonds, but purchase them by matching the duration of liabilities and assets.
• Heading toward a system of local and national bonds where benefits and burdens are matched will also lead to fiscal discipline.

(Yoshikawa)

• A problem with the current local bond scheme is whether budgetary restraints into the future act as a disciplinary force. On this point, involvement of the central government should be reviewed.

[Questions and Answers Session]

(Audience A)

• What aspects of local bonds and of the four-tier reform package will be brought to the surface?

(Doi)

• Regarding local bonds, fiscal administration that allows repayment with local tax revenue is the basis. As to the measure through local allocation tax grants for repayment of principle and interest of bonds issued in the past, extremely speaking, the central government should repay the total amount using national taxes. On top of that, from now on, new allocation tax grant measures should be abolished and, basically, borrowings by local governments should be repaid using their own tax revenue and earnings from projects.
• This is not to say that local allocation tax grants won't be used to care for local bonds anymore, and that's all there is to it, because local bonds are the debts of local governments. Rather, I am thinking of an integrated reform in which local governments are given room to increase taxes as a revenue source for the repayment of local debt.

(Audience B)

• As personnel with relations to local public entities, that local public entities should repay debt with their own financial source in terms of revenue-despite not having the discretion of determining expenditure-sounds suspicious. Please explain again the role of local public entities and of the central government, as well as a simple way to understand their revenue sources.

(Doi)

• It is necessary to transfer the authority of both revenue and expenditure together. Duties of the central government should be financed entirely by the national treasury, even if local governments are asked to manage such duties.
• In Japan, in part, local governments have been asked to be excessively responsible for duties concerning social security. Returning this duty to the central government should be examined when reviewing the national minimum.

(Yoshikawa)

• That all local duties are determined by the central government is an overstatement. It is true that local governments carried out projects in their own discretion that were unconvincing even to themselves.

(Audience C)

• I have a comment, not a question. Although I believe that, as a matter of course, accountability held toward residents now must be directed to the market from the perspective of raising funds in the market, to demand of the market the function to rectify fiscal discipline, even for obtaining credit ratings, is going a bit too far.

(Ogawa)

• In relation to rating, in Japan the level of accountability toward residents is still low. If disclosure in the form of rating serves particularly to disclose the details of financial affairs, this will be a part of improving accountability toward residents.

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