The formal approval of municipal debt includes a three-stage process
1. Municipalities need a 2/3 majority of cabilidos to approve any debt obligations (either from private or public sources).
· almost no municipality has this 2/3 majority
· almost all have 60% ruling by one party which controls the city council.
· Either bi-partisan agreements in the town councils are made to approve the debt or the municipal party in power buys off votes at the local level.
2. Then state congress must provide final approval before a municipality can take out debt. State congresses primarily make up their decision based on the good fiscal bases of the municipal budget.
3. States must report their municipalities debt issuance to the federal treasury (hacienda).
At the federal level, there are two budget constraints built into the system. There is the ex ante veto power that Hacienda at the project approval state. Hacienda allocates based on the budget and can just veto projects over budgeted. There are hard budget constraints that exist visa-a-vi Hacienda’s veto power but we don’t know how this works, because Hacienda does not report on the cases that have been vetoed. The second instance include soft budget constraints exist with the ex-post of the debt when municipalities are unable to payback their fund and seek bailouts. Creating “harder” constraints to become more ridge. Though legal and informally from the rating agencies meaning
Off budget banking with development banks creates new constraints into the traditional debt market. Commercial banks and private sector banks are looking at different outcomes and both have interests when bailouts occur. These deals filter through into the costs of interest rates and the potential for risk of their finances. It is much easier for development banks to provide finances for large infrastructure projects and not necessarily being reported by the municipality cabilidos or state congress. This is true for hard budget constraints and not soft because the municipality can’t afford to create new debt.
What the private sector doesn’t know about these off budgeting funds created by through development banks. Theses funds include as much as 1-4% GDP going through development banks since the 1990s. But after bailouts the marketplace adjusts for these actions with increasing the costs of all loans. Both development banks and commercial banks use the same pot of funds established by the federal government for debt. Therefore for less publicity—parties use development banks to host debt over municipal debt.
Over contracting debt or when a city is not able to pay for it the debt has negative effects to the market place—as it happened in Acapulco. Asking for debt pardoning from state and federal government is a political bailout. This isn’t federalism run wild—but political bailouts are more costly and lead to more restrictions to debt financing in the future
There is a continuum between soft with no restrictions and hard budget constraints with total control over the amount of funds. We are not talking about Brazil/Argentine problems that lead to macro economic instability but rather tightening to the credit markets. Ultimately this allows municipalities less finances (less of a pool) and constricted controls. The political bailouts create costs down the line for cities in the future, which want to take out debt and can’t because the pool is to small or can’t qualify for loans.