The note highlights the importance ofsound intergovernmental fiscal relations, and properregulation for successful sub-national borrowing, andillustrates the potential macroeconomic hazards ofdecentralizing borrowing powers, arguing that the impact ofa possible moral hazard problem, namely, the access tofinancial markets by sub-national governments, may generateunplanned liabilities for central governments. Yet academia,and country experiences do not suggest adverse links betweendecentralized borrowing powers, and the centralgovernment's ability to maintain fiscal discipline, andmacroeconomic stability. Rather the key seems to lie in thedesign of fiscal decentralization, particularly theregulatory framework under which borrowing powers aredecentralized. The note outlines the reasons whysub-national governments require access to financialmarkets: to finance capital spending, and foster politicalaccountability, which can be achieved through directborrowing by central government, through a public financialintermediary, or, through direct borrowing. As per designingthe regulatory framework, the note suggests betterinformation systems, bankruptcy laws, and access to taxbases, in addition to separate fiscal/financial systems, andsound legislation to impose budget discipline, enablingaccess to capital markets to complement fiscal powersdevolution to regional authorities.
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