Subnational debt: developing a sustainable market

Decentralization of infrastructure responsibility to subnational governments and the immense needs of infrastructure financing argue for expanding subnational borrowing responsibly. India, Indonesia, the People's Republic of China, and the Philippines embarked on developing their subnational debt market at differing paces and progresses. The transition to market-based financing is path dependent, requiring sequencing of reforms. Moral hazard is inherent in subnational borrowing for both borrowers and lenders. Subnational borrowing also intertwines with the intergovernmental fiscal system, which prescribes the division of spending, revenues, and deficit financing among tiers of government. Linking borrowing to debt-service revenues and allowing fiscal space for subnational government borrowing are paramount. The challenges facing subnational governments from COVID-19 are similar to those from other macroeconomic shocks. A long-term view is required as to the allocation of fiscal space between sovereign and subsovereign. Financial transparency is key as markets need to digest comprehensive information to appropriately price risks.