Part 2 Subnational Insolvency Framework

Transcription

1 Part 2 Subnational Insolvency Framework

2

3 5 Colombia: Subnational Insolvency Framework Azul del Villar, Lili Liu, Edgardo Mosqueira, Juan Pedro Schmid, and Steven B. Webb Introduction The fiscal and debt stress of Colombia s subnational governments (SNGs) in the late 1990s and early 2000s, exacerbated by the economic downturn, led to substantial public finance reform. Addressing the insolvency of some SNGs was essential to this reform process. Colombia has several laws, mostly enacted between 1998 and 2003, that regulate the origination of debt by SNGs, encourage fiscal responsibility, and provide for central government assistance in rescheduling subnational debt when that becomes necessary. One law Law 550 (1999) deals explicitly with bankruptcy proceedings for SNGs. Although it was traditionally a centralist country, Colombia has become the most decentralized unitary republic in Latin America through a process that started in the early 1970s and accelerated in the 1990s. By the mid-1990s, a number of shortcomings in the decentralization framework had become evident. Besides the absence of fiscal responsibility institutions in these years to control subnational indebtedness, intergovernmental fiscal relations also suffered from a lack of institutions to ensure adequate allocation and use of transfers and to motivate SNGs to generate own revenues and provide required matching funds. 179

4 180 Until Debt Do Us Part During , the Colombian government passed several laws to discourage excess spending and borrowing. In 1999, it passed the first bankruptcy law (Law 550) in the country, which focused primarily on private, public, and mixed-ownership corporations, but Law 550 also included provisions under Chapter V for bankruptcy procedures of highly indebted SNGs. In 2000, Law 617 modified some features in the application of Law 550, addressing SNGs and decentralized services entities (not covered by a sector-specific superintendency). Regulation (Reglamento) 1248 in 2001 also clarified debt restructuring and central government guarantees. This chapter concerns Colombia s bankruptcy or insolvency framework its provisions and the actual experience of its implementation in the broader context of reforms to strengthen subnational fiscal discipline in the country. Most of the bankruptcy procedures were initiated in the early 2000s, to deal with subnational debt problems accumulated during the 1990s, which were further compounded by the general fiscal and economic crisis in the country from the late 1990s to early 2000s. The development and implementation of the bankruptcy proceedings were helped by enactment of several other fiscal reform laws ( ) that encouraged subnational fiscal responsibility and discipline. Strong economic growth after 2003 also helped the fiscal position of governments at all levels. The Colombian bankruptcy procedures for SNGs differ from those in countries such as Hungary and the United States. The procedures in Colombia are administrative within the legal framework, 1 led by the Superintendency of Corporations (Superintendencia de Sociadades, SOC) in coordination with other institutions such as the Ministry of Finance and Public Credit (Ministerio de Hacienda y Crédito Público, MFPC) of the central government. In contrast, the courts take the center seat in local government insolvency proceedings in Hungary and the Unites States. 2 The unique role of the SOC in Colombia arose in an historical context where the court system was weak, and thus an alternate arrangement was created, in which the SOC administers bankruptcy procedures for both corporations and most government entities. 3 Increasingly, SNGs in Colombia used the Law 550 process not because they borrowed too much from lenders, but because other

5 Colombia: Subnational Insolvency Framework 181 claimants (wage earners, suppliers, and so forth) have gotten court judges, outside the SOC, to recognize their claims to the unpaid SNG bills. The embargos by courts using intercepts of fiscal transfers and bank accounts force subnationals to pay these bills, with added penalties and interest payments. By initiating a bankruptcy process under Law 550, SNGs can obtain a halt to the embargoes, past and prospective, and go through orderly restructuring of their debts. The essence of the 550 proceeding is to evaluate and reconcile competing claims against the subnational debtor, according to a defined priority structure. There has been little divergence between the law and actual practice for dealing with subnational insolvency, in the sense that essentially all the debt restructuring and adjustment operations have been done according to procedures prescribed in the laws. Nonetheless, for any one subnational situation, each of the laws, and (even more), the group of laws, provides a variety of options for how to address the problems. Thus, understanding the actual practice requires seeing which options are usually chosen and why. To understand Law 550 its origins and its practice we review the evolution of the intergovernmental fiscal policy and context of the other laws that regulate it. The remainder of the chapter is structured as follows. Section two presents the structure of the Colombian decentralization framework and its development since decentralization started. Section three shows how the borrowing framework developed in order to provide both ex-ante fiscal rules and debt limitations and ex-postbankruptcy proceedings, as well as to enhance transparency in the context of SNGs medium-term fiscal frameworks. Section four describes the Law 550 framework for insolvency proceedings. Section five reviews the law s implementation and evaluates its effects. Section six summarizes and concludes. Structure and History of Subnational Governments 4 Colombia is a unitary republic composed of 32 regions (departamentos) and around 1,100 municipalities (municipios). Ten of these municipalities have the status of districts, which also manage the expenditures of the department in which they are located. Each department has a governor (gobernador) and a department assembly (asamblea

6 182 Until Debt Do Us Part departamental), both of which are elected by popular vote for a fouryear term. The municipal governments are headed by a mayor (alcalde) and administered by a municipal council (consejo municipal), which are also elected for four-year terms (see figure 5.1). Decentralization History and Challenges in the 1990s Until the early 1970s, Colombia was a strongly centralist country. National agencies controlled most of the subnational spending programs. This situation started to change with the constitutional reforms adopted in 1968 that obliged the central government to share its current revenues with SNGs through the so-called situado fiscal. 5 In addition, the reforms allowed SNGs to provide local services through public companies and decentralized service entities that are independent from the central government, and municipalities were granted autonomy to plan and coordinate local development and to provide services under the supervision of the departments (Bird 1984). Political considerations led to important extensions of decentralization in the 1980s. The Constitutional Reform of 1986 (Acto Legislativo 01) introduced popular elections for mayors starting in 1988, and Decrees 77 to 80 of 1987 transferred to municipalities the responsibilities for spending on basic infrastructure and social services. 6 Law 14/1983 widened the tax base for municipal and departmental taxes and also prescribed the ranges within which the SNGs could set their taxes, in order to avoid destructive tax competition or a negative Figure 5.1 Government Structure in Colombia Central government Decentralized service sector (entidades descentralizadas del nivel territorial) 32 regions (departamentos) Governor (gobernador) Regional assembly (asamblea departamental) 1,100 municipalities (municipios) Mayor (alcalde) Municipal council (consejo municipal) Source: Authors, based on the Colombian constitution.

7 Colombia: Subnational Insolvency Framework 183 impact on Colombia s international competitiveness. Revenue sharing also increased substantially with Law 12/1986, which intended for the national government to increase the transferred share of the valueadded tax up to 50 percent by Until the 1991 Constitution, the president appointed the governors of departments, making them more like deconcentrated branches of the national government than autonomous subnational entities. Thus, the decentralization of the 1980s was largely to the municipal level. This experiment was deemed a failure, however, because too many municipalities lacked the administrative capacity to deliver services, and some were being overrun by guerilla insurgencies (Dillinger and Webb 1999; Sánchez and Gutiérrez 1995; Rojas 2003). Decentralization accelerated substantially with the 1991 Constitution, which made the office of governor an elected post and (together with Law 60/1993) committed the national government to increase the amount of transfers assigned to subnational entities each year until it reached 46.5 percent of the central government s current revenues by These transfers were complemented by a system of natural resource royalties (regalías) that would remain mostly in the producing and transit localities, and a system of cofinancing in which the central government would transfer funds conditional on the participation of local governments for projects in the areas of urban and road infrastructure (Ahmad and Baer 1997; Dillinger and Webb 1999). The government plans to revise the rules for the royalties in The transfer system that resulted from the 1991 constitutional changes focused on the financing of education, health, and water and sanitation in order to equalize the provision of these services across regions. In addition, municipalities with a population of less than 30,000 could use up to 28 percent of these transfers to pay for working expenditures. However, the rapid increase of transfers, which could serve as collateral, also stimulated the growth of expenditures and debt in territorial governments 7 and diminished the incentives for SNGs to raise their own revenue. On top of the growing transfers, SNGs ran current fiscal deficits and new municipalities were created to gain access to transfers. The number of municipalities increased from 745 to 998 between 1994 and At the same time, the transfer system constrained the possibility of balancing central government finances, because 46 percent of

8 184 Until Debt Do Us Part any increase in current revenues went out to subnationals as additional transfers. Similarly, countercyclical fiscal policy by the central government became less effective, because subnational expenditures were cyclical with current revenues (Dillinger and Webb 1999). Together with enhanced political autonomy and the responsibility for local public service delivery, the transfer of current revenues to SNGs increased from 13 percent of national government revenue in 1973 to 49 percent in Since then, transfers as a share of total SNG revenues have declined, to less than 40 percent by 2010, partly because SNGs were increasing their own revenues (see figure 5.2). The increasing expenditure responsibilities of SNGs were not matched by adequate own-resource instruments, and transfers were excessively earmarked. Smaller SNGs struggled to cover the share of operating expenses that were not funded by transfers but had little incentive to manage other expenditures effectively. Besides the absence of fiscal responsibility institutions in these years, intergovernmental fiscal relations also suffered from the lack of institutions to ensure Figure 5.2 Regional Transfers to Subnational Governments as a Share of Current Central Government Revenues, Percent Year Source: Balance Fiscal Gobierno Nacional Central , MFPC, Note: Colombia fiscal year = calendar year.

9 Colombia: Subnational Insolvency Framework 185 adequate allocation and use of transfers and to incentivize SNGs to generate own revenues and provide required matching funds (Rojas 2003). The above situation blunted the SNGs incentives for fiscal discipline. Various factors had contributed to the fiscal and debt crisis at the subnational level in the 1990s, compounded by the economic recession in the late 1990s to early 2000s, which added to the fiscal problems at the national level. Starting in the late 1990s, the national government introduced a series of measures to bring subnational finances under control: increasing their own revenue collection, making fiscal transfers to SNGs more predictable in real terms, and introducing a legal and regulatory framework for fiscal responsibility in SNGs. The framework includes procedures to deal with insolvency of subnational entities; stronger limits on current expenditures, especially the wage bill; and procedures to implement adjustment plans and overcome insolvencies for SNGs. These measures, along with, among other things, the economic growth since the mid-2000s, helped Colombia constrain unsustainable subnational debt accumulation and contributed to the relatively healthy fiscal situation today in most of Colombia s subnationals. Subnational Responsibilities and Resources Expenditures by SNGs averaged about one-third of total government expenditures from 2005 to 2010, 8 with the combined spending accounting for about 27.5 percent of gross domestic product (GDP) during the same period. The share of SNGs in public spending overstates the fiscal autonomy of SNGs, however, because nearly half of subnational spending consists of earmarked transfers in the education and health sectors. This leaves the SNGs only limited control over resource allocation. 9 SNGs depend heavily on transfers from the center, which represent around 58 percent of their total revenues. Currently, there are three main transfers: the General Transfer System (Sistema General de Participaciones, GTS), direct royalties, and rentas cedidas (central government taxes earmarked for certain local administrative activities). The share of these transfers account for 47, 9, and 2 percent of total SNG revenues, respectively, and much of the GTS is earmarked for education and health services (table 5.1). The share of transfers varies widely, with

10 186 Until Debt Do Us Part Table 5.1 Total Revenues of Subnational Governments, Percentage of Total, Total revenue Tax revenue Nontax revenue Transfers (funcionamiento) Royalties CGT Cofinancing Others Source: NPD, Desempeño Fiscal de los departamentos y municipios, Note: CGT = Central Government Transfers; data may not tally due to rounding of decimals. large municipalities being mostly self-financed and small municipalities and poor departments depending almost entirely on transfers. Some SNGs with hydrocarbon and other mineral exports are well financed with royalties. Before 2001, transfers made subnational revenues and expenditures strongly procyclical, because the transfer formula was directly linked to current central government revenues. The constitutional reforms in 2001 and 2007 and Laws 715/2001 and 1176/2007 delinked transfers from central government current revenues and clarified the distribution of competences among different layers of government. The 2001 reforms aggregated most of the previous transfers 10 into the GTS and set it to grow on a real basis unrelated to central government revenues. As a result of the reforms, transfers to SNGs have followed a predictable path without the volatility of the late 1990s. 11 Today, the GTS is the largest transfer, amounting to 4.2 percent of GDP or 34 percent of central government current revenues and accounting for 47 percent of subnational revenues. 12 Under the 1991 Constitution, SNGs of regions producing minerals (mainly oil and coal) and serving as ports for exports keep the main share of natural resource royalties. Law 756/2002 specifies the royalty rate, which depends on the type of natural resource and the value of production in the entity. Up to 32 percent of the value of production is reserved for the National Royalty Fund (Fondo Nacional de Regalías), which was established to finance mining development, environmental

11 Colombia: Subnational Insolvency Framework 187 protection, and regional development projects nationwide. The remainder is distributed among producing departments, producing municipalities, and port municipalities, and these funds may be used only for investment in the National Pension Fund (Fondo Nacional de Pensiones en las Entidades Territoriales, FONPET), education, health (infant mortality, and health-for-the poor projects), or water supply and sewerage. 13 The oil price boom since the mid-2000s even since 2008, prices have remained high by historic standards has kept revenues in these subnationals above trend, and for those that have borrowed on that basis, a sustained fall of oil prices would bring a debt problem. Besides transfers and royalties, departments and municipalities also levy taxes. Tables 5.2 and 5.3 disaggregate them by departments and municipalities. On average, own revenue as a share of total revenue is 26 and 31 percent for departments and municipalities, respectively. While these values are relatively low compared with the expenditures responsibilities, Table 5.2 Department Revenues thousands of millions of Colombian pesos Revenue 2010 Percent Departmental taxes % of tax revenue Car Registry Liquor Beer 1, Cigarettes and tobacco Fuel sobre tasa Others 1, % of total Tax revenue 5, Transfers 9, Royalties 2, Nontax revenue 1,108 6 Cofinancing Others Total revenue 19,693 Source: NPD, Desempeño Fiscal de los departamentos y municipios, Note: Data may not tally due to rounding of decimals.

12 188 Until Debt Do Us Part Table 5.3 Municipal Revenues thousands of millions of Colombian pesos Revenue 2010 Percent Municipal taxes % of tax revenue Unified property tax 3, Tax on gross business receipts 4, Fuel sobre tasa 1, Others 1, % of total Tax revenue 10, Transfers 17, Royalties 1,850 5 Nontax revenue 1,945 5 Cofinancing Others 2,418 7 Total revenue 35,408 Source: NPD, Desempeño Fiscal de los departamentos y municipios, Note: Data may not tally due to rounding of decimals. the own-revenue base of SNGs is much higher than in other unitary Latin American countries (World Bank 2009). Departmental tax bases are narrow, with the bulk of resources being raised by taxes on alcohol, liquor, and tobacco, although in some wealthier departments the tax on vehicle ownership is important. Compared to departments, municipalities have a greater tax base, with the property tax and the tax on gross business receipts (impuesto de industria y comercio), which each contribute 30 and 40 percent, respectively, to the total municipal tax revenues, on average. The remainder comes from a host of other, minor taxes. Large municipalities raise more own revenue than the average, and small municipalities raise much less, often almost nothing in poor and remote places. Thus, own-revenue capacity of SNGs varies widely, and with it their capacity to service debt. As shown below, the fiscally stronger SNGs borrowed heavily in the 1990s and got into debt trouble, but in the 2000s, most of the entities with debt problems were smaller and poorer. Their debt problems arose less from formal borrowing than from arrears and other manifestations of general problems with governance and financial management.

13 Colombia: Subnational Insolvency Framework 189 Subnational Debt Subnational Borrowing Trends The 1991 Constitution gave territorial governments substantial autonomy over borrowing and bond issuance (Art. 287 of Carta Constitutional). The 1986 administrative regulation on debt limits still governed subnational borrowing. SNGs could borrow, including for current expenditures, as long as the ratio of debt service to current income was below 30 percent, and municipalities could incur higher debt levels if they were approved by the MFPC. Borrowing had to be approved by the departmental assembly or the municipal council. Art. 364 of the Constitution also stated that the debt of an SNG should not exceed its payment capacity, but the implementing law was only adopted in 1997 and applied in 1999, when the country was already in financial and fiscal crisis. Subnational borrowing increased in the 1990s. The increase in central fiscal transfers through Law 60/1993 stimulated borrowing from banks, which treated territorial entities as preferred debtors based on the formula-based transfers from the center. Banks were not sufficiently aware of the norms for subnational budgetary rules, and their risk management did not assess the real capacity to pay. Instead, they focused on the availability of collateral in the form of royalties and transfers, ignoring what claims other parties might already have on the same collateral. Also, many of the credits were used to finance current expenditures or investment projects with delayed payment streams. A central problem was that the transfers and the competences of the SNGs were not always aligned. Operational expenditures were growing at a higher rate than own revenues, which led to a build-up of current deficits. Current local expenditures as a share of local tax revenues increased between 1990 and 1999 from an average of percent in municipalities and from 169 to 314 percent in departments, with the gaps covered by transfers and credit. The combination of political autonomy, weak bank lending supervision, excessive reliance on transfers, and permission to borrow for current expenditure blunted SNGs incentives for fiscal discipline. The economic slowdown in the late 1990s to early 2000s also weakened the subnational fiscal accounts. Subnational debt increased from about 6 percent of GDP in the mid-1990s to 7.6 percent in 2000 (figure 5.3). The decentralized service entities utility companies owned by SNGs account for a significant share of subnational debt.

14 190 Until Debt Do Us Part Figure 5.3 Subnational Government Direct Debt as Percentage of GDP, % of GDP Year Departments and municipalities Total SNGs Source: Fiscal Affairs Department (Departamento de Asuntos Fiscales, DAF). Note: The solid line reflects SNGs total debt, including decentralized service entities; the dotted line sums only department and municipality debt. GDP = gross domestic product, SNG = subnational government. Although the debt level was not high by international comparison, there were two problems. First, the arrears (which are not included in figure 5.3), had been increasing. Second, the capacity of SNGs to service the direct debt had weakened, due primarily to the decline in own revenues and fiscal transfers. The National Planning Department (Departmento Nacional de Planeación, NPD) calculated fiscal performance indicators for all municipalities under Law 550. Table 5.4 compares the indicators for the municipalities under Law 550 debt restructuring with the national average, and it distinguishes municipalities according to the status of their debt restructuring agreement as of the end of Nineteen municipalities out of the 26 that had successfully completed the agreement (73 percent) were above the national average in this indicator. For the municipalities that were still carrying out the agreement, only a slight majority (41 percent) had indicators above the national average. Most of the municipalities with failed agreements had indicators below the national average, as one would expect. At the height of the problem in 2000, external creditors accounted for 38 percent of total SNG debt, and this declined to 30 percent as of

15 Colombia: Subnational Insolvency Framework 191 Table 5.4 Fiscal Performance of Municipalities under 550 Debt Restructuring Agreements Compared to the National Average for All Municipalities Municipalities Fiscal performance above national average Fiscal performance at or below national average Restructured debt fully paid off, as per 550 Agreement Agreement still being carried out as of Agreement still being negotiated Agreement failed 2 7 Source: NPD calculations, as of end-2010 falling from 3.5 percent to 1.3 percent of GDP, as shown in table 5.5. Subnational debt is highly concentrated in terms of the number of borrowers. The decentralized service entities utility companies owned by SNGs account for about two-thirds of SNG borrowing, both domestically and overseas. Twenty entities, including the capital city Bogotá and 10 decentralized service entities, account for 88 percent of subnational debt. At the department level, for its domestic debt composition, the largest source of subnational credit has been commercial banks 74 percent of the total. The rest consisted of central government onlending (8 percent), bonds (5.6 percent), and the government-owned FINDETER INFIS 14 (2 percent), as of end Capital markets remain small in Colombia. As of June 2010, only six subnational entities have issued bonds, of which three are SNGs, and three are decentralized service entities (that is, utility companies). 15 Most of the SNG bonds have been paid off; only Bogotá still had outstanding bonds as of June Overborrowing from banks in the late 1990s was concentrated in departments and bigger municipalities. Smaller municipalities more typically did not have a lot of bank debt, but rather accumulated arrears on salaries, contributions to pension funds, social security contributions, and payments to providers. The combination of increasing interest rates and slower growth in the late 1990s led to an unsustainable fiscal situation for SNGs (Dillinger and Webb 1999; Rojas 2003). Since the early 2000s, the SNGs overall have improved fiscal balances, going from an aggregate deficit of 1 percent of GDP in 1999 to a surplus

16 192 Until Debt Do Us Part Table 5.5 Composition of Subnational Debt as Percentage of GDP, Domestic Departments Capital municipalities Municipalities Decentralized entities External Departments Capital municipalities Municipalities Decentralized entities Total Source: DAF, MFPC: Informe sobre la Viabilidad Fiscal de los Departamentos, Vigencia Note: GDP = gross domestic product. of 1 percent in Thus, the problem of SNG debt since the early 2000s was not large in the aggregate size of the debt, but rather that the debt was concentrated in a small number of places, often those with guerrilla and drug problems. Thus, having instruments to deal with these places failed SNGs was important more for political and social reasons than for dealing with a macroeconomic problem. Both the number of places and the size of the drug problem have declined since the early 2000s. The strengthened regulatory framework, as explained in the next section, together with the turnaround in the economy and the broader reform in the intergovernmental fiscal system, have contributed to the improved subnational fiscal and debt position. When SNGs have gotten into fiscal distress and excess indebtedness since the early 2000s, it has usually not resulted primarily from formal spending and borrowing from banks and capital markets, given the new fiscal rules on direct borrowing. Rather, much of the excess debt has arisen from arrears in payments to employees, national tax authorities, and suppliers, and from contributions to pension funds, from court judgments against the SNGs, and from penalties and interest accrued on these. Sometimes these arrears occurred when the subnational treasury was unable or unwilling to pay. In other cases, there was collusion between the claimant and a local official and perhaps also with participation of

17 Colombia: Subnational Insolvency Framework 193 a lawyer and a judge who agreed to a delay of payment in order to be able to sue later for a much larger amount including penalties and interest for the late payment. A judge could then embargo (sequester) the bank accounts of the local government in order to seize central government transfers for payment of these judgments. Such conjunctions of legalism and collusions have negatively impacted the finances in a few localities, and the central government has adopted various legal and administrative measures to try to protect legitimate public finances. Such occurrences are more frequent in places with a high incidence of poverty and violence and with influence by narcotraffickers, guerillas, or the paramilitary. Legal Framework for Subnational Borrowing The subnational borrowing framework in Colombia developed in parallel with the political and fiscal decentralization and the fiscal crisis discussed above. The goal of the borrowing framework, developed mostly during , was to avoid situations of fiscal and debt distress in SNGs. However, if the ex-ante constraints on borrowing were insufficient, then the ex-post insolvency procedures discussed in the next section could be applied. Cross-country experience shows that deficits and debt arise from the joint decision of governments and their creditors (including suppliers allowing extended payments). These decisions are made in light not only of the rules governing issuance of the debt, but also the ex-ante expectations about what will happen to the debtor and the creditors if payment difficulties arise who will lose money or who will be forced into painful adjustment. The decisions of that lending moment become a fait accompli conditioning the subsequent decisions. This points to two important dimensions of control of government borrowing: (a) their type and timing relative to the initial lending decision, that is, ex-ante controls or ex-post consequences; and (b) whether the ex-ante controls and ex-post consequences act on borrowers or on lenders, as displayed in table 5.6 (Liu and Webb 2011). The legal framework currently governing Colombia s subnational borrowing and insolvency is summarized in table 5.7, which corresponds to the four quadrants shown in table 5.6. The first major step to increase the ex-ante control of subnational debt was Law 358/1997, which forbade borrowing to finance current

18 194 Until Debt Do Us Part Table 5.6 Channels for Control of Deficits and Debt: Lender-Borrower Nexus and Timing of Controls and Sanctions Timing relative to lending decision For borrowers For lenders Ex-ante controls Ex-post consequences All governments Debt and deficit ceilings Restrictions on international borrowing Publication of detailed fiscal results SNGs only Regulation of SNG borrowing, based on fiscal-capacity criteria (regulations by central government or SNG itself, central bank, or other institution) All governments Limits on central bank financing No bailouts (from central government or from international community) and no debt workout without adequate conditionality Publication of detailed fiscal results SNGs only Central government does not accept SNG debt Debt service withheld from transfers to SNGs Insolvency system All governments No direct central bank financing Regulations by central bank or other financial supervision agency SNGs only Cap on total borrowing by SNGs Increased capital requirements for lending to risky SNGs All governments Strong supervision of banks SNGs only Regulations require capital writeoffs for losses from SNG debt No central bank bailouts Well-functioning financial market can increase risk premium for lending Source: Adapted from Liu and Webb Note: SNG = subnational government. expenditures and linked subnationals issuance of new debt to their overall payment capacity. This so-called Traffic Light Law (Ley de Semáforo) introduced a rating system for territorial governments based on a liquidity indicator (interest payment/operational savings 17 ) and a solvency indicator (debt/current revenue). Both indicators had to be calculated for each new loan, determining whether the entity had the capacity to incur further borrowing. Any SNG in the red light category was prohibited from borrowing without case-by-case permission from the MFPC. 18 Entities in the yellow light category could contract new debt if the percent increase in debt outstanding was lower than the Consumer Price Index inflation for that year. Otherwise, municipalities and departments had to obtain permission for new credit from the departmental governor or the MFPC (see table 5.8). 19 The MFPC could make the permission conditional on the adoption by the SNG of an adjustment program that included measures to

19 Colombia: Subnational Insolvency Framework 195 Table 5.7 Ex-Ante and Ex-Post Fiscal Legislation Ex-ante controls Ex-post consequences (incentives for ex-ante caution) Borrowers Regulation of borrowing based on fiscal capacity Law 358/1997 and Law 795/2003: Traffic light system links borrowing to ability to pay Law 617/2000: Limits on current spending and new classification of capacity to pay Law 819/2003: Budget management and transparency rules Central government does not bail out SNGs Law 549/1999: Creation of the Pension Fund for Subnational Governments Ban on financial support of SNGs that are not in line with Laws 358 and 795 Debt service withheld from transfers in restructuring agreements Law 550/1999: Restructuring of insolvent subnational entities Decree 28/2007 Lenders Ban on credits to SNGs in violation of limits of Laws 358/1997, 617/2000, 795/2003, and 819/2003 Write-offs required for losses from SNG debt Law 550/1999 Law 617/2000 Source: Adapted from Liu and Webb Note: SNG = subnational government. cut costs and improve own-revenue collection in order to reestablish economic and financial stability and guarantee the repayment capacity (Art. 9). The adjustment program would be active until the ratio of interest payments/operational savings declined below 40 percent. The SNGs undergoing such a program had to report on a quarterly basis to the Fiscal Affairs Department (Departamento de Asuntos Fiscales, DAF), which evaluated the implementation of the program, in coordination with the comptroller general of the republic. Not implementing the adjustment programs and obtaining new borrowing in violation of the limits established by the law could lead to sanctions. Also, the Superintendency of Banks could penalize financial institutions that gave credits to subnational entities in violation of Law 358/1997 (Art. 10). Despite Law 358/1997, some governments with a red-light rating obtained new financing without MFPC permission by presenting defective financial information, which was only superficially analyzed by the creditors. In addition, the MFPC gave its authorization in cases where it should have denied it. As a result, department debt indictors deteriorated from yellow to red instead of improving from yellow to green, and subnational debt still grew by 15 percent a year, on average, during

20 196 Until Debt Do Us Part Table 5.8 Indebtedness Alert Signals Indicator Debt interests/ operational savings a (liquidity indicator) Debt balance/current revenue (solvency indicator) Effect Autonomous indebtedness green light Intermediate indebtedness yellow light < 40% 40% < 60% > 60% < 80% < 80% > 80% Territorial Entity (Entidad Territorial, ET) is allowed to contract new credit autonomously. (a) ET can contact autonomously. (b) Requires indebtedness authorization of the Ministry of Finance or the department, which will be conditioned to the signing of a Performance Plan with the financial institutions. Critical indebtedness red light Authorization is required to contract credit operations, thus a Performance Agreement with the financial entities should be signed. Source: MFPC. a. Operational savings is defined as current revenue current expenditure (excluding interest payments) Similarly, in the absence of a fixed ceiling on current expenditures of the core administration, adjustment programs did not always bring about stronger fiscal discipline at the local level. As a result, the current expenditures of the core administration continued to rise fast, and subnational entities remained dependent on transfers (Echavarria, Renteria, and Steiner 2002). Law 617/2000 introduced a more systematic framework for ex-ante measures to avert fiscal crisis, by controlling the growth of operational expenditures. For this purpose, Law 617 classified departments and municipalities according to population size and the amount of freely disposable (nonearmarked) revenues, and set limits on the ratio of discretionary current expenditure to nonearmarked current revenues. These limits were established in the law and depend on the size of the SNG. At the same time, the central administration (including the central bank) was not allowed to make transfers to SNGs that did not meet the requirements, and an extensive list of requirements for the

21 Colombia: Subnational Insolvency Framework 197 election of governors, mayors, legislators, and their relatives aimed to increase transparency. SNGs that exceeded the limits set forth in this law had to execute a fiscal adjustment program with precise performance targets in order to regain fiscal viability. The NPD and the MFPC supervised the execution of the adjustment plan for municipalities and departments, respectively. The NPD could order a new adjustment program should a municipality fail to meet the targets in its original program. Should a municipality again fail to establish viability within two years, it might be required to merge with another municipality, although this never actually happened. In addition, Law 617 allowed SNGs under specific conditions to request a central government guarantee for up to 100 percent of new credits that were contracted to finance fiscal adjustment plans (for example, the costs of personnel retrenchment) that were endorsed before June 30, To benefit from a guarantee, the territorial entities (a) had to be in need of a fiscal adjustment program but without own resources to implement it, (b) had to commit to implement it in line with the modalities established by the law, and (c) needed to have debt that had to be restructured to reestablish payment capacity. At the same time, SNGs creditors had to commit to give new credits to finance the fiscal adjustment program, and the liabilities had to be restructured in a way that assured payment capacity. In 2003, Law 795 and Law 819 further strengthened the borrowing framework for subnational entities. Art. 120 of Law 795 eliminated the yellow category of the traffic light system. Entities previously categorized as yellow then fell under the red rating, tightening the borrowing restraints on SNGs. The 2003 Fiscal Transparency and Responsibility Law, Law 819/2003, strengthened the traffic light system, adding to the indicators from Law 358/1997 the requirement that the budget has to be balanced over a 10-year period. The law also increased transparency and improved fiscal coordination among different levels of government, since it required both the central administration and local governments to present each year a consistent 10-year macroeconomic framework. Expenditure authorizations and revenue collection at all levels of government had to be consistent with this framework, and any deviations from the framework had to be authorized by the MFPC. Both the central and subnational budgets had to fully comply with the medium-term

22 198 Until Debt Do Us Part frameworks. Law 819 also introduced market-based incentives, since it required all subnationals with populations over 100,000 to get a creditrisk rating by a rating agency. The laws also tightened the regulations on the credit supply side, prohibiting central government financial support to subnational entities that were not adhering to the fiscal responsibility norms contained in Laws 617 and 358, or that had debt service arrears for credits to the national government or for credits that were guaranteed by the nation. Furthermore, credits from financial and territorial development institutions that did not meet the conditions and limits of Laws 358, 617, 819, and 795 were invalid, and borrowed funds had be restituted promptly without interest or any other charges. This would be punishment for both creditors and borrowers. The MFPC through the DAF monitors the adherence of the decentralized entities to the different borrowing and fiscal limits mentioned above. While the above laws strengthened ex-ante regulations of subnational debt limitations and fiscal management for both borrowing governments and lenders, Law 550/1999 addressed the bankruptcy proceedings for SNGs. The details of the content and implementation of Law 550 and its relationship to Law 617 as part of debt restructuring are discussed in the next section, Insolvency Procedures: Implementation and Effects. The national government was concerned not only about imprudent and unsustainable fiscal behavior by SNGs, but also about failures to deliver essential services, especially those financed by earmarked transfers. To address the poor service delivery by a few SNGs in sectors financed with transfers, the Colombian Congress approved in 2007 the Acto Legislativo No. 04, which the executive branch regulated through Decree 28 in January Both rules authorized the executive branch to monitor and control subnationals in the use of earmarked resources financed by the transfer system. Since entities that get into debt difficulties often, although not always, have similar problems in service delivery, Decree 28 provides for an extreme penalty and loss of local control for subnationals that do not cooperate in a fiscal reform agenda, including insolvency proceedings. Decree 28 thus added a new element and incentives in the institutional framework that impact the fiscal management of SNGs. The power of the central government to intervene, when the use of transfers does not fulfill the expected legal requirements, strengthens the power

23 Colombia: Subnational Insolvency Framework 199 of the central government for fiscal oversight and for avoiding situations where the judicial process impounds their transfers. SNGs with poor fiscal management face not only the risk of being subject to adjustment plans defined on the basis of the fiscal insolvency framework; the central government might also directly take over their financial management. Insolvency Legal Framework Subnational entities that surpass the spending and debt limits established in Laws 358/1997, 617/2000, and 819/2003 must undergo fiscal adjustment plans as described above. In addition, Law 617/2000 also includes the possibility of restructuring debt and obtaining guarantees and cofinancing to help subnational entities implement the measures as outlined in the adjustment plans. A subnational entity that becomes insolvent, defined as being overdue on payments for at least 90 days, including court-ordered payments, can also request protection under Law 550/1999 Colombia s subnational insolvency or bankruptcy law in exchange for a commitment to reduce expenditures and redirect revenues to pay creditors through a restructuring agreement. Law 550/1999 was introduced as a financial restructuring law for both private sector companies and subnational entities. The subnational entities covered are departments, municipalities, and districts, as well as the parts of the decentralized service delivery sector (entidades decentralizadas del nivel territorial) that are not overseen by any sectoral superintendency. 20 Law 550/1999 was supposed to remain in place for five years but was subsequently extended and finally made permanent for subnational entities by Law 1116 (Art. 125 and Art. 126) of Under the jurisdiction of Law 550, subnational entities are protected from any outstanding or new payment obligations and any court orders to pay once the insolvency proceedings under Law 550/1999 begin. The restructuring agreements seek to evaluate, reconcile, and restructure competing claims on subnational debtors. The insolvency proceeding is designed to be transparent, with public notices at all stages of the process, including disclosing the restructuring agreement. Institutional arrangement, process, and triggers. The intervention under Law 550/1999 is an administrative process, with the SOC acting as judge. The SOC, a unique institutional arrangement in Colombia,

24 200 Until Debt Do Us Part Figure 5.4 Restructuring Process under Law 550/1999 SN entity (mayor or governor) Solicits restructuring DAF verifies if conditions are met Designates promotor Promoter publishes note Signature of restructuring agreement Stopped due to unforseen circumstances Modifications Vote shares and agreement are defined Negotiation among claimants and the entity Supervised by DAF and Superintendency of Corporations Implementation of agreement Conditions fulfilled Superintendency of Corporations Settlement of the inventory of claims End Source: Summary by authors based on consultation with DAF. Note: SN = Subnational, DAF = Fiscal Affairs Department (Departaments de Asuntos Fiscales). handles all insolvency cases, due to the recognized weakness of the court system in the country. The parties involved in the subnational process are the concerned debtor, the creditors and other claimants, the promoter (to supervise and facilitate the restructuring proceedings), and the MFPC. Four types of creditors are distinguished: (a) workers and pensioners, (b) public entities and social security institutions, (c) financial institutions and other entities that are under the supervision of the Superintendency for Banks, and (d) other claimants (suppliers, contractors, and so forth). In the case of decentralized service providers, creditors can also be internal to the entity, such as shareholders or members of the service providers. Law 550/1999 outlines in detail the process for restructuring agreements, as summarized in figure 5.4. A subnational entity can request debt restructuring under Law 550 if two or more payment obligations are overdue for at least 90 days or at least two court payment orders have been issued. The accumulated value of the obligations in arrears must represent at least 5 percent of the total of obligations that fall due in less than a year. The process is initiated by a request sent to the DAF by the legal representative of the concerned subnational entity with the local congress s authorization.

25 Colombia: Subnational Insolvency Framework 201 Next, the DAF verifies that the above-mentioned conditions are fulfilled and, if they are, accepts the request to start the restructuring agreement negotiations. The DAF designates a civil servant or contractor to act as a promoter to supervise and facilitate the debt restructuring negotiations. The promoter checks the accuracy of the financial statements and projections, keeps all involved parties informed, and coordinates the negotiations. The promoter also calculates the voting rights of the creditors and is part of the committee that supervises the execution of the agreement (Art. 8, 550). Although the promoter does not vote on the agreement or any modifications thereafter, she or he plays a pivotal role in informally advising the subnational debtor and representing the views of the DAF, whose support is usually needed for the restructuring to succeed. Once the negotiations start, public services that were suspended must be resumed, and all existing or new payment orders, legal claims (procesos de ejecución), and seizures of assets are suspended and no new ones can be initiated. The entity is not allowed to make any payments or contract any new obligations that are not strictly necessary to sustain service provision, except with written previous authorization of the DAF. 22 Administrative costs (mainly wages and utility bills) must be paid during the negotiations and the life of the restructuring agreement and have priority over other claims. Creditors whose claims are guaranteed by specific collateral with the entity must decide whether to call the guarantee (take the collateral) or to include the claim in the restructuring agreement. Other creditors claims (including those who got judicial embargoes) are put on hold until the agreement is signed. An important responsibility of the promoter is to determine the voting rights of the individual creditors. The elements included in the calculation vary among creditors. For instance, the voting-share value of claims from labor, pension funds, and tax authorities include interest and penalties. Pension fund claimants get an extra 25 percent voting weight added to the principal of their recognized claim. Voting rights for financial sector and other claimants, in contrast, are based on only the principal overdue, excluding interest or penalties that have not been legally capitalized. The law provides four months for the promoter to create the inventory of claims and thus set the voting shares of the claimants and then,

26 202 Until Debt Do Us Part if the claimants accept the inventory, the claimants and the entity have four additional months to reach and sign an agreement. The process usually meets these two deadlines. Delays often come in the middle, when claimants protest because they are not satisfied with the size of liabilities they are assigned in the inventory. The SOC then resolves the disputes, which usually takes 6 12 months. The negotiations conclude with the voting on the agreement, which becomes binding if it is accepted by at least 51 percent of the votes. 23 The voting weight of each claimant in negotiating and settling on the restructuring agreement depends on the amount owed to the claimant (Art. 22); those with the largest claim (as settled in the middle part of the 550 process, with the SOC as referee) get the largest weight in determining the terms of the agreement, although the majority of claimants voting in favor must include at least one claimant from at least three categories. The agreements establish an 18-month period, starting when the agreement is signed, to go through the contingent liabilities, except those that require a judicial pronouncement to be recognized. The format and content of the restructuring agreement are also regulated in detail: It must be in written form, signed by all creditors who have voted in its favor, and deposited with the DAF (Art. 31). The agreement must outline detailed rules for the financial and administrative planning and execution of the entity, and the modalities and conditions for the payment of pension, labor, social security, and fiscal liabilities during the restructuring period. The agreement must also outline the contribution to the pension fund, FONPET, and the conditions and modalities to repay its creditors. In addition, the agreement must establish and outline the rules of an Agreement Supervisory Committee, which consists of all the creditors and the promoter, who has a voice but no voting rights. Other issues addressed in the agreement include the procedures in case of failure to fulfill the obligations in the agreement and, if necessary, any special labor agreements during the life of the agreement. The Superintendent of Banks does not seem to be an important player in the negotiations, although it plays a background role by enforcing the regulations for classifying the riskiness of loans and the corresponding capital risk weighing and provisioning, which helps shape the incentives of the financial institutions as they participate in