October 09, 2013

Transferring to the market economy and facing increased pressure of decentralization and urbanization, local authorities are forced to find new ways to finance growth and development of their environment. A large number of municipalities in the United States of America and European Union find the way to get money for development of local communities more and more in issuing their own securities – the most often is issue of municipal bonds, which is a much favorable move than borrowing from the banks.

By: Miloš Grujić

A new ere in development of financial market and local community started in 2007 by adopting the Law on Debt Issuance and Guarantees of Republika Srpska, which provides towns and municipalities with possibility to get money for growth and development, with consent from the Ministry of Finance, by bond issuance.

An important affect of the issuing municipal bonds should be increasing of local authority responsibility since due to transparency of issue there is a more careful approach to projects development and increased control of public. Apart from providing cheaper financial sources, municipalities could dictate conditions of their borrowing in the sense of form of distributing assets for project realization, choosing interest rate and term i.e. way of repayment of borrowed assets.

Laktaši Municipality was the first municipal community in Republika Srpska to recognize opportunity collect financial means for realization of some project through borrowing resulting from issue of municipal bonds. The first issues provided BAM 10 million and the aim was to use the money and build a sports hall. Laktaši example was followed by Banjaluka and Bijeljina, as well as Municipalities such as Gradiška, Šamac, Brod, KotorVaroš, IstočniStari grad, Srbac, Lopare, Novi Grad and Kneževo, so total value of issued bonds amounts to BAM 75.5 million so far.

Most of the municipalities used their money gained from bonds for covering budget deficits but also for construction of roads, sport-recreational centers and improvement of infrastructure. Regardless the wishes of political parties, we could already say that, even now, financing of various projects through issue of municipal bonds proved to be a successful alternative against tax increase or bank borrowing.

At developed markets, investors are more than happy to invest in municipal bonds, since degree of secure paying principal and interest is very high – payment of debt is guaranteed by tax power or issuer’s property. In times of even more turbulent capital market, bigger solvency of municipal bonds is noted at the secondary market, which provides new possibilities for reinvestment of profit. Additional motive for buying these is the fact that insurance companies and banks are in a position to be guarantors for paying debts, and they are most often presented as buyers of these bonds. Additionally, many countries organize tax relieves for gained profits resulting from interests.

Issues of municipal bonds in Republika Srpska owe their success mostly to the Investment-Development Bank. However, if municipalities prove o be a responsible issuer, a greater interest of other institutional investors should be expected in future as well – investment funds and insurance companies in the first place. Due to this, municipalities should not change purpose of spending money or fail to pay annual amortizations on time, even if they get consent from all buyers of bonds, since this move sends bad message to the current and future investors.

One of ideas for increasing attractiveness for these bonds is their ‘package’ in municipal fund. This kind of fund would be managed by the Investment-Development Bank (IRB). At the beginning, the funds managed by the IRB would own all stakes in this fund based on redemption of already bought bonds. However, in time, this stake would be decreased, since the investors would get a chance to buy stakes of the fund at the stock market. By buying stakes of this fund at the secondary market, investors would face fewer expenses and less risk, and value of stakes would be increased for the amount of prescribed interests. For example, if the beginning stake value of municipal fund amounts to BAM 100, and if it was increasing based on paying principal and interest – in a year, it would amount for about six percent more – i.e. about BAM 106. Advantage of this model is that individual investor could ask for redemption of his stake in any moment in accordance with its current value. Additionally, the fund could use money gained from repayment of principal, interest and newly paid investments for investments in new bond issues. This way of increasing solvency and number of investors will help our capital market to prove its basic role – proper allocation of money and stimulation of economic development of Republika Srpska.