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Subnational Debt 2023: Real Emerging Market Borrowing Is Set To Ebb Despite Elevated Chinese And Indian Debt

(Editor's Note: On March 13, 2023, we corrected table 2 of this article to reflect that the debt stock of LRGs in Colombia is limited to 80% of operating revenue, not 80% of operating surplus.\line\line On March 21, 2023, we made changes to the presentation of chart 8 for clarity.)

S&P Global Ratings expects nearly half of total subnational debt in 2023 and 2024 will be from emerging markets (EMs), particularly China and India, and that this share will continue to grow even as borrowing slows throughout EMs. Still, the outsize pace of borrowing in these two countries masks significant--and in some cases, mounting--barriers to debt markets for many EM local and regional governments (LRGs), even as infrastructure needs persist.

We expect heavy infrastructure investment programs in China and India will continue to propel global borrowing volume among subnationals in 2023-2024, while other EMs will borrow primarily to refinance existing debt. All of this amounts to projected EM gross borrowing of around $1.2 trillion in 2024, or around 57% of global subnational borrowing, compared with 45% in 2019.

EM LRG Borrowing Will Remain Elevated In Nominal Terms, But Gross And Real Borrowing Are Declining

We project the gross borrowing of EM subnational governments will continue to drift down from its 2021 peak but will remain above pre-pandemic levels in nominal terms. In real terms, this decline will be even more prominent, and we expect annual gross borrowing in 2024 to be around 25% lower than in 2021 (see chart 1).

Chart 1


In many EMs, gross borrowing will be lower than we expected in our last report, given unusually strong fiscal performance in both 2021 and 2022, which led many LRGs to forgo borrowing in favor of using accumulated cash reserves. Nevertheless, still-large fiscal deficits in China and India will likely keep annual gross EM subnational borrowing above US$1.3 trillion in 2023.

Although we don't consider it our base case, a scenario of sustained high energy prices and a prolonged war in Ukraine could lead to higher-than-projected borrowing, should these factors lead to investment to rebuild infrastructure and foster energy independence from Russia. Similarly, a protracted recession could increase borrowing needs above our base case if weaker fiscal performance leads LRGs to have lower cash reserves to make needed investments.

Local EM governments often face both internal and external constraints on access to credit, and our forecast for LRGs outside China and India reflects those limitations. Generally, we foresee net borrowing (excluding refinancing) approaching zero by year-end 2024 outside of China and India as LRGs look to rein in spending to weather a period of slower growth, high inflation, and hardened credit market conditions.

Chinese And Indian LRGs Dominate Subnational Borrowing

In China, which generally accounts for around 85% of total EM LRG borrowing, we expect net borrowing to remain positive through 2024, boosted by China's promotion of an investment-led growth strategy that relies heavily on LRGs. At the same time, we expect the rate of net new borrowing among heavily indebted Chinese LRGs and their associated financing vehicles will decelerate (see chart 2) as debt burdens approach both explicit and theoretical limits to the risk tolerance of the central government. The government has slashed borrowing quotas in an effort to rein in LRG liabilities following a period of heavy countercyclical borrowing, signaling that policymakers are seeking to balance fiscal sustainability and economic growth.

We believe China's growth in 2023 and 2024 will rely less on direct investment than in previous years as the economy reopens and the housing market stabilizes. We expect gross borrowing among Chinese LRGs to be roughly flat in 2023 but decline for the 2021-2024 period (see "China Local Governments' Escalating Issuance May Finally Be Testing Liquidity," published March 1, 2022, and "The Clock Is Ticking For The Debt-Led Growth Of China Local Governments," published Feb. 21, 2023).

Indian LRGs will likely maintain their pace of net new borrowing as they finance higher spending in the wake of the pandemic. A large share of the additional costs that Indian states incurred through the pandemic have become structural, and the Reserve Bank of India provides a de facto guarantee of states' debt, which supports their access to markets despite already high indebtedness. We expect the debt burden of Indian LRGs will reach 195% of revenue in 2024--the highest share among EMs.

Chart 2


Borrowing Is Decreasing In Other EMs Despite High Infrastructure Needs

Outside China and India, we project subnational borrowing will remain broadly stable over the next two years in nominal terms, with net borrowings increasing in 2023 before dropping to nearly zero in 2024 (see chart 3). The increase in 2023 largely stems from the completion of EU-sponsored projects in European countries at the end of the EU funding cycle. In non-EU European countries, such as Serbia, borrowing may continue to increase because these countries cannot rely on EU funding to co-finance investments in infrastructure. In Pakistan, Turkiye, Nigeria, and Ukraine, weakening sovereign credit conditions, including macroeconomic and institutional instability, could further restrict LRGs' access to financing. Ultimately, this could force policymakers to choose between drawing down liquidity or forgoing investments needed for growth.

Chart 3


We expect Latin American gross borrowing to continue its declining trend, reflecting weak growth dynamics, primarily in Mexico and Argentina, that have constrained both capital expenditure and fiscal capacity. In Argentina, lack of access to the market following the default of the sovereign and most provinces constrains borrowing. And in Mexico, where many local governments have weak management and liquidity, long-term public debt reduction remains a priority at the local level, compounding a steep decline in infrastructure investment that is underpinned by poor capital execution and other structural limitations.

On the other hand, Brazilian LRGs have largely sustained gross borrowing in dollar terms over the same period. However, we expect the trend of negative net borrowing since 2015 to continue through 2024 as LRGs retire more debt than they take out.

Meanwhile, borrowing in EM Asia-Pacific (excluding China and India) has remained very low due to relatively underdeveloped domestic debt markets and low investor appetite.

In Africa, we expect Moroccan LRGs' borrowing to resume the historical trend in the coming two years, after having bottomed out in 2022, while Nigerian states will also accelerate borrowing due to sluggish economic growth and inflation dynamics. In South Africa, borrowing will remain mostly flat, despite high capital expenditure needs. We attribute this to a combination of weak financial management, historically weak capital execution, and thin domestic debt markets.

Chart 4


As inflation erodes the real purchasing power of debt proceeds, future borrowing may have to increase to meet capital investment needs. At the same time, we expect EM LRGs will be operating amid higher-for-longer interest rates, and financing will be more expensive than in the past.

Some of the biggest distortions in EMs in recent years occurred in Argentina (see chart 5), where inflation was 75% in 2022, and to a lesser degree in Brazil, India (see chart 6), Poland, and Mexico. In Argentina, borrowing in real terms since 2015 has actually declined, although debt as a share of revenue hasn't declined as quickly because Argentine provinces hold a relatively high proportion of debt denominated in foreign currency. In India, meanwhile, real borrowing has increased by roughly half the nominal increase since 2015.

Chart 6


Chart 5


Fiscal Containment And Inflation Will Keep Debt Burdens Broadly Stable In Most EMs

We expect EM LRG debt to remain contained as a percentage of revenue outside of China and India (see chart 7). In Nigeria, LRG debt as a share of revenue will hover just under 100%, while in Brazil, LRGs have been retiring debt in aggregate over the past three years, and we expect that trend to continue given strong recent and projected fiscal performance.

Chart 7


Our forecast shows most EM LRGs will have lower debt burdens as a share of revenue compared with last year's forecast (see chart 8). In many cases, this reflects a combination of stronger-than-expected revenue and reduced spending in 2021 and 2022, which has eased borrowing needs over the next two years through accumulated cash reserves.

In addition to a slower pace of new borrowing, we expect inflation in revenue will ease the debt profiles of many EM LRGs over the next two years. While inflation in the long term presents economic and financial distortions, in the short term, LRGs' fiscal positions could benefit from this effect, depending on how and when increases in prices lead to higher revenue and expenditure.

Chart 8


Rate Increases Haven't Meaningfully Constrained Debt Servicing But Could Pressure Access To Financing

EM central banks were among the earliest interest rate hikers, and S&P Global Ratings Economics expects many of them have reached or will reach peak interest rates in 2023. While it may be some time before rates start to fall, we think most EM LRGs are well positioned to absorb higher financing costs without significant pressure on their fiscal or debt profiles. Those whose debt composition includes a high share of variable-rate bank loans or shorter maturities may be more exposed to rate increases, but for the most part, debt service as a share of revenue remains low for EM LRGs (see chart 9).

Jordanian LRGs have the highest ratio of debt service payments to revenue, projected to be 36% in 2024--a function of high debt burdens compared with budget size and significant amortizations--and could face rate pressure as debt matures. Indian LRGs, meanwhile, face debt servicing costs representing 27% of total revenue. Similarly, debt service for Chinese LRGs is also high, but provinces can easily roll over most debt upon maturity at low interest rates in the domestic capital market.

Still, for those countries that finance themselves in foreign currencies, foreign exchange dynamics and a strong dollar could complicate refinancing and increase debt burdens as a share of revenue. Argentine and Turkish local governments will be most exposed, due to high shares of foreign currency debt, at 78% and 43%, respectively, along with moderately higher debt service costs than in other countries.

Chart 9


EM Subnational Debt Will Reach New Highs Even As Borrowing Capacity Remains Underutilized

Although EM LRG debt as a share of the global LRG debt stock has doubled over the past 10 years (see chart 10), this largely reflects debt intake in China and India. Still, we believe there is significant untapped borrowing capacity among other countries. For over two-thirds of the EM countries in this report, debt represents less than 30% of total revenue and debt service less than 5% of revenue. Although current debt levels and fixed costs are not the only constraints on borrowing, they signal the potential to absorb additional debt and increase public investments where they are most needed.

Chart 10


We estimate there is an additional $50 billion to $250 billion of untapped borrowing capacity among EM LRGs with the legal capacity to access capital markets (domestic or international), particularly in Mexico, Poland, Indonesia, Romania, Czech Republic, and Colombia. Along with LRG debt levels, the estimate considers:

  • The level of decentralization (how much LRG spending represents relative to total general government spending), which is associated with higher spending and debt levels for LRGs (see chart 11), and
  • The sovereign rating, which signals macroeconomic challenges and potential risks for subnational governments.

The estimate doesn't, however, fully capture all the intrinsic, systemic, and institutional obstacles to borrowing that EM LRGs face, nor the informal ways they use their balance sheets to finance operations.

Chart 11


For example, the administrative process for LRGs in Mexico to approve, contract, and register long-term debt with the national government is so onerous that many opt instead to avoid long-term borrowing entirely and rely on short-term debt, which is faster and easier to process, for capital projects. Indeed, states and municipalities in Mexico often rely on short-term payables to manage liquidity. Similarly, municipalities in South Africa use accumulated payables--particularly to state-owned energy provider Eskom--in lieu of formal financing, often resulting in overstated budgetary performance.

We see such maneuvers as a signal of constrained, and in many cases eroding, access to formal sources of credit, and we consider management among both South African and Mexican LRGs to be relatively weak by global standards, which may also deter potential investors. A handful of exceptions prove the rule: The Mexican states of Nuevo Leon and Queretaro, for example, are assigned strong credit ratings compared with national peers, bolstered by stronger and more stable management practices, and they regularly tap domestic banks for both short- and long-term financing (Mexican LRGs are prohibited by law from issuing capital markets debt).

Any holistic assessment of an LRG's capacity for debt intake ultimately must take into account creditworthiness, including the economic and institutional context, the strength of management, fiscal performance, and the influence of the sovereign. These factors may also be key constraints on access to additional debt for some EM LRGs. In Argentina, we consider the stand-alone credit profiles of several provinces to be stronger than that of the sovereign; however, their ability to sustain and service debt--particularly debt denominated in U.S. dollars--depends on their ability to access scarce dollar reserves, which in turn is constrained by the sovereign transfer and convertibility assessment. In the context of broader macroeconomic headwinds, as some EM sovereigns' creditworthiness weakens, LRGs in those jurisdictions could face additional obstacles to accessing credit.

For most EMs, capital markets debt is a relatively small share of LRG debt stock, and local capital markets have not developed to the degree that would support increased borrowing. And while we see a trend of weakening access to formal financing in places like Mexico and South Africa, access for a few EM LRGs is improving within existing debt frameworks: Nigerian states access the markets with 32% of their debt stock being external debt (primarily bank loans), while the Moroccan government now allows LRGs to borrow from international institutions. Still, while banks, multilateral lending institutions, and central governments play significant roles in extending or supporting credit to LRGs, we think overall borrowing remains low compared with the need for investment in public infrastructure.

Chart 12



Table 1

Gross Borrowing And Debt Stock Of EM LRGs
--Borrowing-- Debt stock
(Bil. $) 2017 2018 2019 2020 2021 2022e 2023f 2024f 2024f
Argentina 13.3 5.7 3.3 3.5 1.8 2.3 2.3 2.7 22.7
Bosnia and Herzegovina 1.3 0.4 0.1 1.3 1.0 0.7 1.0 0.7 7.6
Brazil 6.7 4.9 5.1 4.2 3.6 5.5 5.7 5.8 223.4
Bulgaria 0.1 0.1 0.1 0.1 0.0 0.0 0.0 0.0 0.7
China 644.8 635.4 631.5 955.2 1171.6 1100.1 1100.8 998.4 6259.9
Colombia 0.4 0.7 1.1 0.5 0.9 1.1 0.4 0.4 5.1
Croatia 0.2 0.2 0.3 0.6 0.3 0.2 0.2 0.2 1.1
Czech Republic 0.2 0.1 0.3 0.2 0.2 0.1 0.1 0.1 3.1
India 74.9 82.8 104.4 143.5 167.8 176.4 177.7 184.6 1063.0
Indonesia 0.3 0.8 0.6 1.0 1.3 1.3 0.9 0.9 4.6
Jordan 0.3 0.2 0.3 0.3 0.3 0.4 0.4 0.3 1.3
Kazakhstan 0.5 0.8 0.8 2.7 0.9 0.8 0.6 0.7 3.6
Latvia 0.2 0.3 0.6 0.1 0.3 0.3 0.2 0.2 2.3
Mexico 6.9 7.9 5.7 7.9 4.8 5.0 5.2 5.3 37.0
Morocco 0.4 0.4 0.5 0.3 0.3 0.2 0.3 0.3 3.1
Nigeria 4.1 3.9 2.3 2.5 3.0 2.1 2.6 3.1 12.1
Pakistan 0.8 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.2
Philippines 0.2 0.3 0.4 0.3 0.7 0.5 0.5 0.5 3.0
Peru 0.0 0.5 0.3 0.0 0.2 0.1 0.1 0.0 0.4
Poland 2.2 4.5 4.2 4.8 3.1 2.4 4.2 2.8 23.6
Romania 0.0 0.1 0.1 0.4 0.3 0.2 0.4 0.3 5.1
Serbia 0.0 0.1 0.1 0.0 0.1 0.1 0.1 0.1 0.4
South Africa 0.6 0.7 0.6 0.4 0.6 0.4 0.4 0.5 4.6
Thailand 0.0 0.0 0.4 0.0 0.0 0.0 0.0 0.0 1.0
Turkiye 4.7 4.3 2.0 2.6 3.1 1.8 2.7 1.9 9.2
Ukraine 0.2 0.2 0.2 0.4 0.5 0.8 0.5 0.1 1.6
Vietnam 0.0 0.0 0.0 0.0 0.2 0.2 0.2 0.2 2.6
e--Estimate. f--Forecast. Source: S&P Global Ratings.

Table 2

Restrictions On LRG Borrowing
Country Foreign currency borrowings Bonds Restrictions on debt burden Central government approval on borrowings Restrictions on deficit
Argentina Y, but no FX debt increase since December 2020 (MLI loans excluded) Y Annual DS < 15% of operating revenues net of transfers to municipalities Y, for all debt Operating expenditure growth is limited to revenue growth/inflation
Bosnia & Herzegovina Y Y N Y, all MLI funding is done via the CG N
Brazil Y Y, minor use Net consolidated debt < 200% of net revenues (for states); 150% (for munis) N N
Bulgaria Y Y, minor use Annual DS < 15% of own revenues and general subsidy N N
China N Y, only for Tier 1 CG defines annual net borrowing quota and debt stock for Tier 1 LRGs N Indirectly, via borrowing quota
Colombia Y Allowed, but nonexistent Debt stock < 80% of operating revenue; interest < 40% of operating revenues Y, for external borrowings Balanced budget
Croatia Y Allowed, but nonexistent Annual DS < 20% of revenues; annual consolidated borrowings < 2% of consolidated revenues Y, for all borrowings Balanced budget
Czech Republic Y Y Debt stock < 60% of total revenues (guideline) Y, for bonds N
India N Y N Y, via RBI for bonds LRG deficit < 3% of GDP (indicational, not enforced recently)
Indonesia N Allowed, but nonexistent Debt to GDP < 60% Y, for bonds LRG deficit < 3% of GDP
Kazakhstan N Y CG annually defines debt stock quota for LRGs Y, for all borrowings N
Latvia Y, but de facto nonexistent since 2008 Allowed, but nonexistent CG defines annual gross borrowing quota for LRGs Y Indirectly, via borrowing quota
Mexico N Y Individual net borrowing ceiling < 15% of discretionary revenues N Balanced budget
Morocco Y Allowed, but nonexistent N N Balanced budget
Nigeria Y Y Bonds are allowed when debt stock < 50% of revenues and any monthly debt service < 40% of monthly revenues Y, for external borrowings N
North Macedonia Y Allowed, but nonexistent DS < 30% of revenues; debt stock < 100% of revenues Y, for all borrowings N
Pakistan N N Bonds are allowed when debt stock < 50% of revenues Y, only budget loans are allowed N
Philippines N Allowed, but nonexistent Debt service < 20% of revenues Y, for external borrowings N
Peru Y, only CG guaranteed MLI loans Y Debt stock < 100% of revenues Y, for all borrowings Balanced budget
Poland Y Y Annual DS < operating surplus plus asset sales N N
Romania Y Y Annual DS < 30% own revenues N Balanced budget
Russia De facto N Y Debt stock < 100% of own revenues; annual DS < 20% of own revenues plus non-earmarked grants; interest < 10% of expenditures Y, for bonds Deficit < 15% of own revenues
Serbia Y Y Debt stock < 50% of revenues; Annual DS < 15% of revenues N N
South Africa Y, for special projects Y N Y, for external borrowings Balanced budget
Thailand De facto N Allowed, but nonexistent GG borrowing < 20% of annual budget and 80% of principal payment Y N
Turkiye Y Y Debt stock < 150% of revenues Y, for borrowings > 10% of revenues N
Ukraine Y Y Debt stock plus guarantees < 200% (400% for Kyiv) of development budget revenue Y, for all borrowings N
Vietnam N Y Debt stock < 90% of own revenues Y, for all borrowings Balanced budget
Y--Yes. N--No. FX--Foreign exchange. DS--Debt stock. CG--Central government. Source: S&P Global Ratings.

Related Research

This report does not constitute a rating action.

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