2.8 Effects of the COVID-19 pandemic crisis on subnational governments

FIGURE 2.8

Effects of the COVID-19 pandemic crisis on subnational governments

a. Impacts on subnational government assets and liabilities b. Impacts on subnational government budget

Financial assets • Deposits and investments • Share in local public companies • Loans, etc. Nonfinancial assets • Value of land and properties, subsoil Debt stock Revenue Grants and subsidies (operating and capital) Tax revenues: • Shared taxes: PIT, CIT, VAT, excises • Own-source taxes: local PIT, local business tax, property-related taxes, sales tax, consumption taxes, tourist tax, energy tax, vehicle tax, etc. User charges and fees paid for local public services Revenues from financial and physical assets: interests, dividends, royalties, etc. Access to new borrowing Current expenditure: • Social expenditure (benefits and social services) • Staff costs • Purchase of goods and services (intermediate consumption) • Subsidies to households, businesses, and NGOs • Financial charges Capital expenditure: • Capital transfers/subsidies • Direct investment in social and economic infrastructures

Expenditure

Source: OECD 2020b, 17. Note: CIT = corporate income tax; NGO = nongovernmental organization; PIT = personal income tax; VAT = value added tax.

often subsidize the companies (Kopanyi and Awan 2020). Loans to public enterprises appear as forms of subsidies with no interest and unclear repayment terms. The OECD did not discuss a class of financial assets that are substantial in many developing countries, namely, uncollected overdue taxes and fees and other claims. Kenyan counties, especially Nairobi, inherited an enormous volume of such financial assets during devolution. And these will be hard to mobilize in the postpandemic recovery period.

Cities in developing countries, likewise Kenyan counties, own or possess a substantial volume of land, buildings, and other properties. However, they lack clear records, ownership titles, strategy, and policies that would support selection of marketable properties that can be used for supporting postpandemic recovery strategically if sold, swapped, or offered for public-private partnerships. They have vague ideas about the wealth they possess in the form of fixed assets.

Cities in developing countries show great variation in debt stocks and often have incomplete records of debt. Also, forced credits (unpaid liabilities, some long overdue for years) are often greater than the volume of formal debts (loans or bonds). Thus, debt restructuring may not appear as an option (common in developed countries), since only formal debts can be restructured in standard financial procedures. Moreover, many Kenyan counties, as discussed, are burdened with inherited overdue liabilities, some with unmanageable scale.

Revenues Preliminary data suggest that grants from higher government tiers and shared taxes remained stable in the first three quarters of the pandemic crisis in developing countries, and many central governments even disbursed extra pandemic grants to cities. However, the capacity of some national governments to further provide extra funding to local governments in developing countries may decrease as the pandemic crisis endures and continues in 2021 and beyond. This is a critical issue since OSRs are low in most developing countries. Exacerbating the problem, in many countries, local budgets depend around 90 percent on

transfers from higher government tiers. This is also the case in Kenya, where the counties’ OSR are around 10 percent, except in Nairobi and Mombasa. In Africa, local governments could experience a drop in local finances of 30–65 percent, on average, depending on the severity of the crisis (Kochanov, Hong, and Mutambatsere 2020, 2). The national government in Kenya disbursed most of its equitable shares, albeit with delays, in the 2019/20 fiscal year, which was just partially impacted by the pandemic crisis. The pandemic may impact the disbursement or volume of equitable shares in the 2020/21 fiscal year and beyond.

As for tax revenues, studies found that the pandemic crisis had minor shortterm effects on property tax revenues in developed countries, but this might change as the crisis is prolonged (Yadavalli and McFarland 2020). By contrast, tax revenues related to market factors (income, sales, business, consumption, and tourism taxes) have dropped harshly. Business and tourism taxes hit developing countries and hit Nairobi and Mombasa hard. Some user fee and charge revenues have been reduced on par with reduced consumptions in developed countries (OECD 2020b), but fee revenues have also dropped in developing countries when cities stopped collecting some user fees such as water charges during the crises (Kopanyi and Awan 2020). This deteriorated fee revenues that had already been below costs in part due to low collection rates.

Revenues from financial and physical assets have been low in developing countries, in great part because of poor asset records and management. But even in developed countries, income from physical and financial assets have been reduced and will suffer in the short term by drops in rental revenues, lost dividends from local public companies, less revenues from sales of land, lower royalty revenues resulting from decreased prices for raw material, and lower production. About two-thirds of subnational governments are anticipating a decline in revenues from assets in the United States (S&P 2020).

Experts envisage that access to loans will be a powerful tool for cities in developed countries to help ease debt limits and historic low interest rates in postpandemic recovery time (OECD 2020b). In contrast, in developing countries, cities have low capacity to access loans. Access is limited not only by regulatory debt limits that can be eased, but mainly by low creditworthiness and limited or no credit capacity. A major challenge is that some cities may turn to forced credits, that is, to accumulate further overdue bills, and in turn they may face legal actions or will be forced to sell or swap properties below market price. The case of swapping two housing estates to work out statutory debts in Mombasa resembles a forced sale case. Nevertheless, strategic use of assets to support postpandemic recovery is better than slipping into forced credit and quick sale.

Expenditures Pandemic crisis interventions have induced substantial unplanned and unbudgeted expenditures all over the world, particularly in health care, social assistance, and sanitation. National governments and international donors have provided cities with substantial amounts of pandemic grants to cover actions and expenditures in these areas. Grants also supported information technology, smart city and big data gathering, and processing tools. Local governments in surveyed developing countries spent over 10 percent of operations expenditures above the amount budgeted from their own funds (Maria et al. 2020; Kopanyi and Awan 2020; Wahba et al. 2020). But even cities in the United States have taken on unprecedented increases in unbudgeted COVID-19-related expenditures; some have tapped into emergency relief funds, while others cut non-COVID-19