Municipal Bond Debt and Sustainability in a Non-Mature Financial Market: The Case of Italy

Abstract

Local government (LG) debt increased worldwide during the past decade. Yet, LGs need increased access to financing so they can maintain and expand their community’s infrastructure. Expanding an LG’s bond-related debt (while continuing to meet ongoing debt-service obligations) is essential to its sustainability. An LG must both contain its credit risk and make its risk profile available to potential investors. Credit risk determinants in mature bond markets (e.g., the U.S.) have received considerable attention while those in non-mature markets have not. This paper contributes to the sustainable development literature by (a) identifying the risk-premium drivers in non-mature markets (using the bond market for Italian LGs as an example); and (b) providing LG policymakers with guidance on formulating policies to reduce their debt cost (either directly, by targeting its determinants, or indirectly, by improving the bond market’s functioning). LGs with comparatively high financial dependency on other governments, high criminal activity, and low operating revenues incurred higher bond-related costs than LGs without these characteristics. These LGs can improve their sustainability by (a) providing transparent and understandable financial information to potential investors; (b) reducing criminal activity; and, (c) increasing the frequency of external auditing.