Abstract
Studies have shown that political variables can influence the volume of government debt and have recommended investigating the joint effects of diverse factors on the risk of local government default. Considering the relation between economic management and political constraints, this paper examines the joint influence of political and systemic factors on the risk of loan default by Spanish local governments. To do so, we analyze 148 city councils for the period 2006-2011, using a logit model with panel data and an artificial neural network. The empirical results indicate that the financial risk of local governments is affected both by political factors specific to each case and, simultaneously, by systemic variables for the country. Specifically, political variables such as the mayor not having economics-related university studies, the under-representation of female councilors in the municipal corporation, municipal government by a party with a progressive ideology, and ideological alignment between the municipal and the regional government are all associated with greater financial risk. Moreover, rising national unemployment, an increased sovereign risk premium, the impact of the electoral cycle, and that of declining economic growth are all factors that may increase the risk of default. The findings presented are of great potential interest for governments, managers, national and international fiscal authorities, financial regulators, and citizens at large, because an understanding of the significance of these variables can help authorities make appropriate decisions to prevent and/or overcome problems related to municipal insolvency.
Highlights
E economic recession that began in 2008 led to high levels of bank debt and budget deficits in the public sector, reducing solvency and restricting access to the credit market, as well as jeopardizing the sustainability of public services. e debt crisis produced great concern about credit risks, among policymakers, financial regulators, and fiscal authorities
The findings presented are of great potential interest for governments, managers, national and international fiscal authorities, financial regulators, and citizens at large, because an understanding of the significance of these variables can help authorities make appropriate decisions to prevent and/or overcome problems related to municipal insolvency
Despite the valuable conclusions presented in the above papers, many organizations in the field of public finances argue that a comprehensive analysis of government credit risk should include, besides political factors, systemic ones, such as the macroeconomic cycle, fiscal policy, and the electoral cycle, in view of the vulnerability of individual government entities to macroeconomic changes and the volatility of non-controllable variables (Aldasoro and Seiferling, 2014; Local Government Association of South Australia, 2019; Federal Accounting Standards Advisory Board, 2014; World Bank Group, 2015; US Department of the Treasury, 2013)
Summary
E economic recession that began in 2008 led to high levels of bank debt and budget deficits in the public sector, reducing solvency and restricting access to the credit market, as well as jeopardizing the sustainability of public services. e debt crisis produced great concern about credit risks, among policymakers, financial regulators, and fiscal authorities. International organizations have concurred with academic studies that public debt in these countries is of such a magnitude that major problems of repayment may arise and that there are worrying differences between public revenue and expenditure (European Commission, 2012; Aldasoro and Seiferling, 2014; Balaguer-Coll, Prior and Tortosa-Ausina, 2016; Navarro-Galera et al, 2015) In this context, taking into account that financial institutions are the main creditors of LGs, researchers have considered it especially interesting to study the risk of loan default (Arbatli and Escolano, 2015; Balaguer-Coll, Prior and Tortosa-Ausina, 2016; Elgin and Uras, 2013; Guillamón, Bastida and Benito, 2011). Various studies, including Balaguer-Coll, Prior and Tortosa-Ausina (2016), Elgin and Uras (2013) and Geys and Revelli (2011), have analyzed the influence of variables such as absolute majority government and political fragmentation on the volume of bank debt and on sustainability These papers examined only individual factors pertaining to each LG and did not address the causes of default risk. Have all recognized the need to study the joint effect of idiosyncratic factors (or individual ones, for a single entity) and systemic factors (such as the macroeconomic cycle, fiscal policy, and the electoral cycle) in the measurement of government credit risk
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