Municipal Bonds in Hungary: Constraints and Challenges

Abstract

After the collapse of communist rule, Hungarian local governments had to meet new challenges and expectations. Due to the decentralisation process, local governments’ revenues decreased significantly in the last two decades, while the level and scope of services provided decreased less rapidly, if at all. Consequently, local governments, short of resources, had to develop their ability to raise funds needed to meet local spending needs. This study examines the general theoretical framework of municipal borrowing, comparing the economic and social advantages of bank loans versus municipal bonds. It also evaluates the role of the national government’s central administration in regulating local authority indebtedness. It then presents and analyses the characteristics of Hungarian local government bond financing, assessing the appropriateness of bonds as a local government fundraising tool. The indebtedness of Hungarian local authorities has increased drastically since 2006, mainly through bond financing. A substantial proportion of these bonds were issued in foreign currencies because interest rates were lower. The subsequent economic downturn and devaluation of the Hungarian forint has left many local governments worse off because their indebtedness has increased in forint terms. Bond financing is often considered simply an alternative form of borrowing, and Hungarian local governments do not fully benefit from the flexible features offered by bonds. In today’s Hungary, bond financing offers opportunities to broaden local government financial freedom and reduce the financial risk related to borrowing, but they also pose risks, particularly in the absence of local expertise. Regulation of local government borrowing is still mainly based on the coercive effect of a credit limit. This is a one-sided approach to the problem, and current Hungarian regulations fail to meet the expectations of the most important players in the European capital market, namely, institutional investors. New regulations are needed which can enhance the beneficial characteristics of bonds, while preserving the security they provide to local governments and prospective investors.