A debt policy statement, which is also known as the long-term obligation policy, can be defined as a part of a comprehensive financing policy that shows evidence of an institution's commitment to infrastructure needs via a planned schedule of expected future financing. The key objective of this statement is to assess the conduciveness of the debt management strategy to mitigate budgetary perils and facilitate long-term debt sustainability. The key objective of a debt policy statement is to develop a framework that will guide decisions pertaining management and use of debt. In order to meet this goal, the statement should, therefore, contain several key elements as explained in this paper.
First, it should state and explain the purpose of the debt. It should show that the debt funded projects will benefit all citizens and not individuals. Secondly, the statement should show that the debt is affordable and that it is the most appropriate alternative. This will be evidenced by an analysis of forecast cash flows, cost of capital, and rationale to implement budgetary ethics. In addition, it should make sure that there is integration of equity between payers of debt and the beneficiaries.
Thirdly, the statement should include risk management strategies: it should comprise of an appropriate weighting of variable and fixed rate debt, a direction for matching obligations to assets along the spectrum of duration, and a strategy to mitigate exposure and liquidity risks. Lastly, it should show the financial structure management. This will include managing debt by monitoring capital markets proactively, establishing an appropriate level of leverage versus reserve or gift, and a financial management structure.
What are the restrictions placed on state and local government debt in your neck of the woods? What are the methods used to avoid those limits? Is there a state bond bank?
Both the state and the local governments are allowed to borrow funds from the public through bonds and from commercial banks. However, this external borrowing are subject to several limits as provided for in the constitution. First there is the limit on the local government’s level of debt outstanding based on the property tax base. Although there is no uniform limit for all local governments, each one of them have set a standard that is approved by the state government. Second, there are property tax limits that specify the maximum rates that can be levied on debt service requirements, and lastly, the requirement that a proposed bond issue should be approved by citizens through a referendum.
Meeting these limits is sometimes challenging to the local governments. As a result, they exploit the limit avoidance strategies available like: suspending the sale of their slugs, which are low interest securities offered to municipals, suspending investments in the civil servants disability and retirement fund, and cutting down the issuance of long term debt and adopting cash management bills with short maturity in an attempt to gain control over the outstanding debt.
A state bond bank is an entity in the level of a state that provides debt financing to small public entities at a low cost compared to the rates prevailing in the market. These banks exist and serve hospitals, schools, municipalities and cities.
In summary, a debt policy statement should justify the need for a debt and should convince the lenders why they should invest in that project and not any other. It should have evaluated the debt limit and where necessary documented the debt limit avoidance strategies.
Reference
Advisory Commission on Intergovernmental Relations. (1961). State Constitutional and Statutory Restrictions on Local Government Debt. Columbus: McGrawHill.
