5. Financing African Urbanisation: Increasing the fiscal capacity of African cities

In recent decades, cities in Africa have grown by over 4% per year, almost doubling their original population between 2000 and 2015 (OECD/SWAC, 2020[6]). They are likely to see further population growth, which is estimated to reach 1.5 billion urban dwellers by 2050 (UNWPP, 2019[7]). These growth rates would be challenging for local governments anywhere in the world, let alone in the context of the limited administrative and financial capacity of Africa’s local governments. Local governments are required to provide infrastructure and services for a population in constant change and growth. Even meeting basic needs requires massive investment, involving, for example, the construction and upgrade of roads, schools, health facilities, electricity grids, water and sewage networks and waste management systems.

To be able to support the continued growth and economic development of their cities, local governments must be able to tap the wealth that their cities generate. Chapter 1 of this report shows the important role that African cities play in the economic development of their countries. It also shows how the positive impact of urbanisation on economic performance and quality of life extends beyond cities, benefitting smaller towns and rural areas. Maintaining and strengthening these economic benefits requires continued investment that local governments cannot make without further fiscal and human resources.

Beyond providing services and infrastructure to local residents, it is important for local governments to play a more active role in economic development. As discussed in Chapter 4, local governments can make a significant contribution to the economic growth of their cities if they pursue the right local economic development policies. While successful local economic policies do not only depend on the amounts that local governments can spend, the ability to make growth-enhancing investments is crucial for their effectiveness. Local governments are best placed to provide many local services and infrastructure. With their intimate knowledge of local circumstances, they are in a better position to target spending to priority areas, thus allowing public spending to address the most pressing needs (Kis-Katos and Sjharir, 2014[8]; Faguet, 2004[9]; Tiebout, 1956[10]). Yet, while local governments in Africa arguably have the greatest spending needs (Box 5.1), this chapter shows that they also have the lowest fiscal capacity2 among all local governments globally. Not only do they have low revenues and expenditures in absolute terms, they also have very low fiscal capacity by comparison with total government spending in their countries.

The arguments in favour of a strong role for local governments in infrastructure investment and public service provision do not imply that other levels of government are less important. National governments have a key role that local governments cannot play, such as stabilising the economy and redistributing income to alleviate poverty and reduce inequality (Oates, 1972[15]; Musgrave, 1959[16]). National governments are also indispensable for major infrastructure investments, like rail links between different cities or national airports. Beyond supporting projects financially, the national government plays an important role in co-ordinating different governmental actors and agencies involved in planning and funding urban investment. National governments must also ensure local governments’ compliance with legal requirements, such as enforcing standards and principles on public expenditure.

Beyond having low fiscal capacity, local governments in Africa face two further constraints by comparison with many other local governments globally. First, they are heavily reliant on transfers from the national government and have few own-source revenues. Second, with few exceptions, local governments in Africa do not have access to debt financing. This limits their potential to invest, even if investments have high social, environmental or economic returns and will lead to significantly increased tax revenues in the future.

This chapter provides an overview of the fiscal situation in Africa compared to other parts of the world. It analyses the main instruments for financing local governments that are available to strengthen the fiscal capacity of local governments. It discusses state transfers and grants, followed by the most important instruments for raising own-source revenues. The chapter concludes by presenting the potential advantages of debt financing and discusses the main bottlenecks local governments face in accessing it.

Decentralisation has been an objective in many developing countries for the past three decades. It has been defined as “the transfer of a range of powers, responsibilities and resources from national government to subnational governments, defined as separated legal entities elected by universal suffrage and having some degree of autonomy” (OECD, 2019[17]). The need to increase and improve decentralisation in Africa was mentioned in the 2014 African Charter on the Values and Principles of Decentralisation, Local Governance and Local Development3 as well as in the African Union’s Agenda 2063 (African Union Commission, 2015[2]). Donor and development partners have also supported programmes and made investments designed to strengthen local level administrations (OECD/UCLG, 2019[18]) (see Box 5.2).

Despite the longstanding attention and emphasis on decentralisation, the competencies and financial resources of local governments in Africa remain limited, particularly in a context of rapid urbanisation.

The OECD/United Cities and Local Governments (UCLG) World Observatory on Subnational Government Finance and Investment (SNG-WOFI) has compiled data on governments’ subnational revenues and expenditure for 29 African countries as well as for 106 countries in other continents. Most of Africa‘s countries are among the least fiscally decentralised states according to measures such as subnational expenditure and revenue (measured both as a percentage of national government revenues and expenditure and as a percentage of national GDP). This chapter analyses this data, but it is important to note that subnational fiscal data available on African countries is limited. More than half of the 29 African countries studied by the Observatory lack basic fiscal data; and when it is available, the data quality is generally low (OECD/UCLG, 2019[18]).

In Africa, revenues of subnational governments are 16% of national government revenues and account for only 4% of national GDP. The global average for these indicators is 25% and 8.5% respectively (Figure 5.2). In terms of expenditure, subnational governments’ spending as a percentage of national government expenditure is equally low, at 16%, in comparison with a world average of 24% (Figure 5.5) (OECD/UCLG, 2019[3]).

The lack of revenues has direct consequences on the ability of subnational governments to invest in infrastructure and services at the local and regional level. In Africa, subnational governments are, on average, responsible for 19% of all public investment. In contrast, their average share in all other global regions ranges between 36% and 41%, with the exception of North America, all of whose countries are federal countries and where subnational governments are responsible for 72% of all spending (Figure 5.4 left) (OECD/UCLG, 2019[3]).

The low level of subnational investment is not primarily due to African countries’ low income levels. While subnational investment increases as countries grow richer, it is low in Africa even when compared with other countries of similar income levels. Figure 5.4 (right) shows that subnational governments in African low-income countries are responsible for less than half as much of public investment as their counterparts in other low-income countries. While upper middle-income countries seem to depart from this pattern, this category includes only two African countries: Mauritius and South Africa.4

Two factors explain the low degree of fiscal decentralisation in Africa. First, the number of tasks and responsibilities granted to the local level is low. In fields where the local level has competencies, its responsibilities are limited. National governments often retain significant competencies in fields such as education, health, water, sewage and electricity distribution (OECD/UCLG, 2019[18]).

Most local governments are tasked with responsibilities in sectors such as the construction and maintenance of local roads, waste management, sanitation, the operation of local markets and adjoining facilities (for example slaughterhouses) as well as urban planning. In some countries, local governments are responsible for other public services that have a direct link to their jurisdiction, such as the provision of health services, primary education and utility networks (water, electricity). This is the case in Algeria, Benin, Guinea, Morocco, Namibia, Niger and Zambia. Sometimes, local governments also have competencies in economic development policies, in secondary education and vocational programmes, and in housing, as for instance in South Africa, Uganda and Zimbabwe (UCLG, 2010[12]).

Second, local governments have been granted few budgetary and fiscal powers by national governments. Even where competencies have been transferred to the local level, they have often not been accompanied by concomitant budgetary transfers. Local governments are therefore responsible for delivering services without the required capacity (whether financial or administrative). Such unfunded mandates reduce the quality of service delivery and prevent local governments from fulfilling the tasks they are responsible for.

Expenditure levels as a percentage of total public expenditure is a proxy for the real capacity local governments have to deliver on their responsibilities (UCLG, 2010[12]). Local government expenditure in Africa is low in absolute terms and as a share of total expenditure. As with public investments, it is also low in comparison with countries in the same income group (Figure 5.5 right).

The following sections discuss the main sources of financing that local governments can access. It covers transfers and grants that local governments receive from the national government, own-source revenues that local governments raise directly, and debt financing. Debt financing is often used to finance public investments, as the expected increase in tax revenues from effective public investment can be used to pay back debt without having to cut other government spending in the future.

Intergovernmental transfers are the most common tool countries use to fund local governments and other decentralised entities. They often fund local services and other statutory functions of local governments. State transfers and grants generally aim to enable local governments to carry out the tasks entrusted to them by the national government. Transfers can also reduce spatial inequality, as they usually do not depend on local tax revenues and therefore redistribute wealth across the national territory from richer to poorer regions. They can ensure a minimum quality of public service delivery and public goods provision.

On most continents, national governments’ transfers and grants are the most common method of funding subnational authorities. This is particularly the case in Africa, where 58% of subnational authorities’ revenues are obtained in this form5 (Figure 5.6).

Transfers from the national government can be funded through different means, whether tax or non-tax based. Tax-based transfers include the distribution of taxes collected exclusively by the national government, such as import and export duties, and taxes on the extraction of natural resources. Taxes collected at the local level, for example some business and property taxes, can also become transfers, if they are centralised and redistributed to local governments by the national government6 (UN-Habitat, 2015[4]). Non-tax revenues that can be redistributed to decentralised authorities include foreign aid grants, credit from public or private institutions, as well as any other licences, fees and fines that are not entrusted to the local level.

Intergovernmental transfers are often subject to a set of diverse and important conditions. Unconditional grants are grants that are not directly linked to a particular expenditure, giving local governments discretionary powers on spending decisions (UN-Habitat, 2015[4]). They can fall into two categories: equalisation and general grants. Equalisation transfers are used by national governments to redistribute income from richer regions to poorer ones, compensating for fiscal disparities within countries. Zambia’s national government, for example, redistributes 5% of the income tax according to a formula based on population and poverty levels (OECD/UCLG, 2019[24]). In contrast, general grants are allocated equally to local governments with the purpose of supporting the activity of the local government, without necessarily taking into account wealth differences between jurisdictions. These grants are based on general characteristics of the local area, such as population or territorial size.

Conditional grants, on the other hand, are transfers earmarked to fund specific local government activities. These transfers can ensure minimum standards of service in a given sector, or incentivise the investment and development of national objectives, such as the reduction of poverty or development of education of specific groups (UN-Habitat, 2015[4]). Conditional grants are often linked to evaluation criteria that ensure the budget is spent in compliance with clear objectives. Some evidence shows that projects funded through conditional grants yield overall better results than unconditional ones (Baird et al., 2013[25]). However, one potential drawback of conditional grants is the fact that they restrict local governments’ autonomy in determining spending priorities (Oates, 1972[15]; Kis-Katos and Sjharir, 2014[8]; Besley and Coate, 2003[26]). This can lead to “unwanted investments” that local governments not support (Boadway and Shah, 2007[27]).

Capital grants are a special type of conditional grant. They are allocated for the development of infrastructure, such as roads, water, sewage and sanitation systems. The national government in this case identifies infrastructure needs and allocates a fund to improve them. Sometimes, capital grants depend on a co-financing agreement, which ensures the contribution of local government or other agencies to the financing of a given project, or their compliance with certain requirements, such as the development of a programme that ensures the maintenance of the infrastructure. One example of such investments might be the construction of a mass transit system, where the national government, in collaboration with development banks or other partners, finances the construction on the condition that the local government contributes to the financing and co-ordination of the network’s operations.

Both conditional and unconditional grants require data to distribute resources across local governments. Conditional grants for education, for example, might be based on the number of students living in a city. Data requirements for equalisation grants can be complex, since allocation formulas can involve many dimensions (UCLGA, 2014[28]). Some basic equalisation grants, though, can be calculated based on statistics that are available in most countries, such as poverty levels by subnational region. Box 5.5 illustrates an example of such a transfer system.

Although systematic data on the type of grants is scarce, the existing evidence shows that conditional grants are more often used than unconditional ones (Figure 5.7) (UCLGA, 2014[28]).

Intergovernmental transfers are an effective mechanism for funding local governments, regardless of the level of administrative capacity. This financial instrument is particularly important for local governments that lack the administrative or institutional powers to raise financial means autonomously. However, this does not imply that administrative capacity is irrelevant, since it can ensure that transfers are spent efficiently and effectively. Transfers can play an important role in building local administrative capacity because they provide the resources required to do so. Evidence from Tanzania and Benin shows that transfers can have a multiplier effect on local revenues, by enhancing local governments’ tax collection capacity. They can also improve local service delivery, which encourages voluntary tax compliance (Caldeira and Rota-Graziosi, 2014[30]; Masaki, 2018[31]). This contrasts with studies of high-income countries that indicate that transfers discourage local governments from raising own-source revenues (Zhuravskaya, 2000[32]; Mogues and Benin, 2012[33]; Correa and Steiner, 1999[34]).

Functional subnational transfer systems need to meet certain key standards. First, institutional safeguards are needed to ensure the regularity and predictability of transfers. Local governments must be able to plan their long-term investments based on future revenue streams. Likewise, the provision of public services is only possible if regular funding is provided to build and maintain the administrative structures needed. Regularity and predictability also have important implications for local governments’ ability to access credit to fund infrastructure projects. Lenders are wary of the perceived risk of borrowers with unstable, unpredictable income streams.

Second, state transfers need to be transparent in the amount of transfers and the intended recipients. State transfers are often distributed through complex administrative processes, reducing the capacity to monitor and evaluate their spending. Greater transparency can improve independent oversight and reduce the scope for corrupt practices (Olken and Pande, 2012, pp. 502-504[35]).

Subnational governments in Africa often do not benefit from regular and predictable transfers. The City Enabling Environment Ratings7 provide indicators on the quality of intergovernmental transfers in Africa. Graded on a scale from 1 to 4, only two countries (of 53 surveyed) achieve the highest grade, for countries where transfers are timely, predictable, calculated according to a transparent formula, and without restrictions on their use (Figure 5.8) (UCLGA, Cities Alliance, 2018[5]). Overall, only 7 countries meet the necessary conditions to ensure the quality and effectiveness of transfers (scoring between 3 and 4 in the City Enabling Environment Ratings).

Although national government transfers are the dominant way of funding local governments, the actual amounts involved are limited (Figure 5.9). Subnational governments in Africa receive USD 159 per capita on average, against a world average of USD 1 124 per capita. Transfers in African countries are also low compared to countries at similar income levels. For example, the average per capita transfer for non-African lower middle-income countries is USD 282, compared to USD 103 per capita for corresponding African countries (OECD/UCLG, 2019[3]).

Given the limited capacity of national governments to provide grants in a sufficient and regular manner, the weak fiscal capacity of many national governments and the increasing need for investment, it is unlikely that transfers will be able to cover the funding needs of local governments in the foreseeable future. Local governments thus need to raise more own-source revenues (Paulais, 2012[36]). This capacity will also depend on the existing institutional framework, such as the clarity of the division of competencies among different levels of governments, the administrative and financial capability of municipalities and the availability of instruments to track expenditures and follow projects. A country with established local governments and whose authority is recognised by its citizens will be in a better position to raise revenues than one where the power of local governments is contested.

Several autonomous financing instruments for local governments are possible, of which own-source taxes and fees are the most common. Land-based financing is another financing mechanism that can generate additional revenue, especially in fast-growing cities where the value of land rises quickly (Box 5.6). While land-based financing has been used successfully in many emerging economies (e.g. Korea, Brazil, India and Colombia) it has so far been used only to a limited degree in Africa. This is partly due to the complex land tenure systems in many countries and to weak land databanks.

Own-source revenues offer several advantages. First, they increase the accountability of local governments relative to the local population. Local tax payments are more easily observable for residents than transfers from national governments. Moreover, with a closer link between the payment of taxes and the provision of local services, local administrations face greater scrutiny on the use of own-source revenues than on the use of transfers. Effective accountability also has feedback effects that can increase revenues, thanks to increased public trust in local governments. Citizens who are able to see and understand the impact of their taxes on local services are likely to be more willing to contribute to the public purse (Rantelangi and Majid, 2018[40]; Kassa, 2021[41]). However, accountability is only increased where local governments have effective accountability mechanisms and local residents can hold local governments to account, both through fair elections and also through participatory planning and budgeting, town meetings, oversight boards, referenda, user committees or social audits (UN-Habitat, 2015[4]).

A second benefit of own-source revenues are the incentives they offer local governments. Own-source tax revenues create powerful incentives to encourage economic development, because local economic growth will increase local tax revenues. In contrast, robust local economic performance does not affect the amount of transfers that local governments receive or, in the case of equalisation grants, may even reduce them.

Informational advantages of local governments are a third argument for own-source revenues. Local governments have a better understanding of specific economic aspects of households and businesses in their jurisdiction and identify effective methods to levy required revenues. Local officials, for example, can identify household revenues even in the absence of advanced data collection methods. This allows local governments to predict citizens’ ability to pay and to devise efficient ways of using this information to determine taxes or fees. Likewise, local governments can identify citizens who are most in need and allocate social spending accordingly (Galasso and Ravallion, 2005[42]; Galiani and Gertler, 2008[43]; Alatas et al., 2012[44]; Alderman, 2002[45]).

Own-source revenues have been shown to result in better service delivery and infrastructure development. Research in Tanzania, Zambia and Ghana (Hoffman and Gibson, 2005[46]; Otoo and Danquah, 2021[47]) has found that fiscal autonomy is positively correlated with expenditure and quality of service delivery. Angola set up independent utility providers for water supply and sanitation in 2002, and by 2010, overall access to sanitation services increased in urban areas from 59% to 86% (African Development Fund, 2007[48]; USAID, 2010[49]).

To leverage the advantages of fiscal decentralisation (enhanced accountability, economic development incentive and local knowledge) institutional changes and improved local capacities are needed. Many local governments in Africa face institutional and legal constraints that limit their ability to raise own revenues and to function autonomously, for example by denying them the power to create new taxes or fees or to set the rates of existing taxes or fees (UCLGA, 2014[28]).

National governments’ reticence towards fiscal decentralisation and autonomy is motivated by several factors. Fiscal autonomy is often perceived as a loss of political power, particularly in countries where the political leadership of national and local governments compete for power (Bahl and Bird, 2008[50]). Competition can further be aggravated in contexts with an overall low tax base and where national governments thus consider taxes as a legitimate source of revenue to meet their obligations. National governments may also be sceptical about the administrative ability of local governments to impose and collect taxes. As a result, according to the City Enabling Environment ratings, in 42% of African countries local governments do not have any power over local revenues (UCLGA, Cities Alliance, 2018[5]).

Local administrations need the administrative capacity and human resources that allow for effective deployment and management of own resources. In the case of taxation, local governments require extensive administrative knowledge and practical skills to identify the service, good or category of households to be taxed. This requires training and investment, which are essential for ensuring the tax is effective in its objective: raising local revenues.

Taxes are a key instrument local administrations can use to raise revenue, but subnational governments in Africa have weak taxation powers and have great difficulties in employing taxation (AfDB/OECD/UNDP, 2015[51]; UCLGA, 2014[28]). The continent’s subnational governments only raise 4% of the national government tax revenue (Figure 5.10) and subnational governments’ tax revenues only generate 24% of the total revenue of subnational governments, as compared with a world average of 33% (Figure 5.11, columns). Governments of cities, although they create most of the taxable wealth, benefit from only a small share of total national taxes.

Most commonly used taxes by local governments are on property, sales and various business taxes. Property taxes have a number of desirable properties related to their economic efficiency, immobile base and suitability for local use (UN-Habitat, 2016, pp. 192-215[52]). They accounted for all the tax revenue of local governments in Eswatini, Mauritania and Mauritius and for more than 80% in Morocco (OECD/AUC/ATAF, 2020[53]).

The effectiveness of taxes as instruments to fund local government depends on several conditions. In order to be equitable, taxes need to treat different groups fairly. To be efficient, taxes need to be applied in a way that does not distort economic activity. That is, they should not lead to major changes in the behaviour of individuals or firms unless this is an explicit objective of the tax (e.g. a tax on cigarettes that aims to reduce rates of smoking). Moreover, immobile tax bases should not fluctuate widely, as economic conditions change to provide a stable income. Finally, taxes need to be economic in their implementation, with low administrative and compliance costs (Evans, 2003[54]); and transparent in their enforcement and use. Clarity on what is being taxed and how the amount will be spent increases citizens’ willingness to comply and increases the accountability of local governments for delivering the public services they are committed to (Bird and Bahl, 2008, p. 9[55]). Tax revenue local governments raise should also be levied exclusively on local residents or businesses, to avoid local officials taxing a population to which they are not accountable (Bird, 2010[56]).

Developing effective local tax systems requires investment in human and technical capacity as well as political will. The most common challenges faced by local governments involve identifying the tax base, collecting taxes and enforcing payment.8

Identifying the tax base, for instance, requires information on businesses’ revenue (business tax) or on land ownership and value (property tax, land tax). Many local governments in Africa, however, face a complete lack of relevant and up-to-date data, given the widespread informality of the economy and land registries that are missing or outdated (Gordon and Li, 2009[57]; Skinner, 1991[58]). UCLG Africa’s survey of 153 cities demonstrated that an estimated 23% of cities did not have any instrument in place to address the collection of data on land property (UCLGA, 2014[28]). If they do exist, these systems are often lacking or incomplete (OECD/AUC/ATAF, 2020[53]).

Improving the ability of local governments to collect required data and track tax compliance requires investment in appropriate training and digital infrastructure. Despite the costs associated with improving the data collection systems and enforcement levels, these can pay off by expanding municipal revenues dramatically. As an example, Lagos’ administrative reforms of property tax collection since 1999 have increased its revenue fivefold, to over $1 billion in 2011 (IGC, 2018[59]). The AfDB is financing an own-revenue project in the Ivory Coast called Projet Pilote d’Appui à la Mobilisation des Revenus Propres des Communes de Côte d’Ivoire (PAMREC), which will digitise tax collection and is expected to at least double revenues after three years of implementation.

Local governments need the power to experiment with revenue collection to find equitable, efficient ways of taxation (Bird and Bahl, 2008[55]). This can be done, for example, by granting them more freedom to define the tax base (Box 5.7).

Granting more fiscal power to local governments has the additional benefit of enhancing financial responsibility, and the potential second effect of improving their financial competence (Bahl and Bird, 2008[50]). It can be achieved by incorporating local taxation into clear national frameworks, in which national governments can set tax rates ranges and determine the general direction of local taxation powers. This structure will help avoid such phenomena as double taxation, tax exportation and excessive tax competition9 (Fjeldstad, Chambas and Brun, 2014[62]). Moreover, such frameworks, and the specific regulations that structure local taxation, are also required to avoid situations in which citizens and businesses are subject to complex and confusing taxation systems that may hinder compliance and limit economic performance.

User charges and fees are an efficient way for local governments to raise revenues. In contrast to taxes, fees are charged to users of public services proportionally to their use. Thus, residents who do not use a public service generally do not have to pay fees. Payment of fees is often easier to enforce than payment of taxes. For many services, such as transportation services, it can be relatively easy to institute controls that avoid free-rider behaviour. Fees are also more transparent than taxes, because they are directly linked to the benefit they deliver. They may thus win greater public acceptance than taxes (UN-Habitat, 2015[4]).

Local governments in Africa have generally wider power over fees than over taxation, but only 3.5% of subnational governments revenues are raised in this way (Figure 5.12). Often, the inability to finance the initial investment required to provide a service or infrastructure explains the low levels of revenue linked to this instrument.

Several obstacles impede their deployment. Firstly, fees and tariffs are enforceable only if the service can be provided effectively. Often, inability to finance the initial investment required to provide a service or infrastructure explains the low levels of revenue linked to this instrument. Secondly, it can be complex to set the right level of fees to guarantee the maintenance and repayment of the investment, particularly when also considering the ability of users to pay. Thirdly, even if fee collection is usually easier than tax collection, political or administrative challenges can make it impossible for local authorities to collect fees. Difficulties in enforcing compliance is heightened if trust is low in the local government and in the way the collected revenue will be spent (Fjeldstad, 2004[63]).

Despite these limitations, fees can be an effective way to pay for investments and specifically their maintenance, in particular if combined with debt financing. To obviate the difficulties outlined above, these services are sometimes outsourced to private entities, entrusted with the delivery of the service and the collection of associated fees (Box 5.8).

Access to credit and the ability to borrow capital, especially denominated in local currency, is a key financial resource for local governments to meet the cost of infrastructure investments. Investments such as the construction of roads, transit systems, education and health facilities require large sums of capital. In absence of savings that can be used for investments, local governments can bridge this temporary gap through credit.

Capital borrowed for long-term investments can support the revenues of local governments in two ways. Directly, investments pay off financially through the immediate revenue stream they realise in fees for service. Indirectly, investments pay off financially for local governments, through the economic growth they generate and the increase in tax revenue. Investment may also pay off through higher tax revenues by increasing economic activity (enhancing the business climate with better facilities such as markets, better market connections and lower costs from, for example, a reduction in congestion due to new roads).

Debt financing plays a major role in enabling public investments in key urban infrastructure, but in Africa, local governments’ access to credit is severely limited. The UCLG Africa survey of African cities shows that only 6.5% of the 153 cities sample studied had access to credit (UCLGA, 2014[28]). Figure 5.13 shows how subnational governments’ debt makes up a small percentage of total government debt (4.4%), well below the global average.

Legal restrictions imposed by national governments and difficulties in financial structuring and perceived and actual creditworthiness are key factors that explain local governments’ low access to and infrequent use of credit to finance public investments. Only 6% of African cities are allowed by national legislation to access financial markets independently (UCLGA, Cities Alliance, 2018[5]).

Both explicit and implicit institutional constraints limit local governments’ ability to access credit. Explicit constraints generally include laws that prohibit them from accessing credit or that require prior authorisation from the national government. Implicit constraints originate in legal texts that established these authorities in the first instance, which often predate decentralisation policies and have not been updated since (UCLGA, 2014[28]). To improve local governments’ access to credit, laws and regulations that determine the workings of local governments need to be updated, creating structured institutional frameworks that allow regulated access to financial markets and private loans (BOAD, 2015[69]).

Even where local governments are allowed to use debt financing, they may not be able to access it. To obtain credit, a borrower needs to demonstrate the ability to repay the sum in full (capital) and the service fees associated with the loan (the interest rates and the fees for managing the loan) or furnish an implicit or explicit guarantee of repayment in case of default by national or international partners. Authorities can demonstrate creditworthiness through stability of income, cost-benefit analysis of the project being financed and by a clear political commitment to repay the debt (e.g. as shown by previous repayment of loans). Local governments, however, often do not have the capacity to demonstrate sufficiently stable income streams, for example because the intergovernmental transfers they rely on for repayment are not predictable or punctual. Even where local governments meet the fiscal criteria to obtain a loan, they may not be able to provide the necessary documentation, due to a lack of administrative capacity.

According to UCLG Africa (2014, p. 30[28]), up to 30% of African cities surveyed use no modern financial management instruments. Outdated registers of population, income and real property, which are essential to estimating the tax base and projecting potential future income, also limit their potential to raise money. Another risk generally linked to credit is political instability (UN-Habitat, 2015[4]). National governments need to develop consistent standards and rules, including regular audits, to facilitate access to and promote effective use of debt financing.

The most common source of credit for local governments in Africa are loans from development institutions (UCLGA, 2014[28]). National entities, such as national development banks and public investment funds specialised in financing local governments, are often responsible to allocate these loans. They are state-owned and finance themselves through sovereign debt, donors and financial markets. Table 5.1 lists some of the active bodies of this kind in Africa.

In addition to the role of loan providers, these entities are often committed to other objectives, such as building local administration capacity, supporting public bodies’ access to financial markets and promoting public-private partnership. One such institution, the Urban Development Bank (UDB) in Nigeria, has all of these competencies. Another entity, Tunisia’s Local Government Loan and Support Fund (CPSL), is also responsible for the allocation of subsidies on the national state’s behalf.

National development banks and public investment funds offer an attractive solution to funding urban development projects, thanks to the preferential terms they offer. Successful projects completed by Nigeria’s UDB include reconstruction of municipal car parks, upgrading of local markets and provision of services (Urban Development Bank, 2021[70]). In Morocco, the Municipal Equipment Fund (FEC) recently signed an agreement with the Agence Française de Développement (AFD), the French development agency, to provide resilient infrastructure (AFD, 2021[71]).

Donors and development banks can also play a role in offering credit to local governments. The municipality of Dakar, in Senegal, developed one such project in 2015, involving XOF 10 billion (EUR 15.2 million) in financing from the West African Development Bank (BOAD) and AFD, to construct urban roads and parking (BOAD, 2015[69]). To increase their capacity to support local governments, international donors have sometimes raised funds in local currency. In 2008, for example, an AFD bond issue on the regional stock exchange in Abidjan (Bourse Régionale de Valeurs Mobilières) raised USD 40.1 million that was used to finance local governments through its subsidiary PROPARCO (Paulais, 2012[36]).

Commercial banks can also help finance local governments. Such loans, however, tend to be short-term and motivated by the need to regularise budgets with punctual cash-flow issues rather than for public investment (UCLGA, 2014[28]; UCLG, 2010[12]). In some instances, longer maturities are granted for urban projects, but only for a few specific sectors and projects, such as the financing of special economic zones, power and data centres. Banks are typically risk-averse and reluctant to conclude loans with authorities that do not have reliable credit scores and evidence of financial performance. Obstacles to private lending can also be imposed by national legislation. To limit public debt and public entities’ risk of default, national governments may establish strict regulations that forbid or limit access to private credit (Bird, 2011[72]).

It is essential for investors to understand the risk of default in any given investment. Credit ratings and creditworthiness checks by independent rating agencies and other private companies can help in this regard. Cities may have difficulty, however, accessing private agencies’ rating systems because of their poor financial management systems. Self-evaluations, like the one established by the Institute for Delegated Management (Garnache and Van De Vyver, 2008, p. Annex 4[73]), are another option for demonstrating creditworthiness. Another useful alternative is offered by the Public Expenditure and Financial Accountability programme (PEFA), a system established in 2001 from donors (see Box 5.9).

The third source of credit is issuance of bonds on financial markets. Bonds usually offer longer maturities than many commercial loans, but they are not widely used by local governments in Africa. In many countries, bond markets are not well developed, and local governments have neither the capacity to meet the formal and informal requirements for accessing the bond markets or the institutional authority to issue bonds. The formal requirements can lead to capacity gaps between local administrations and large investors, in which local government officials do not fully capture the extent of the obligations they take on when issuing bonds. This is especially the case when bonds are issued in foreign jurisdictions under different legal systems.

In some cases, national governments are reluctant to grant local government the authority to issue bonds and/or restrict them from doing so. Such constraints also affect local governments that do have the capacity to comply with the formal requirements. New legislative requirements and amendments, adapted to the given context, are needed to develop bond markets and provide access to investment for local governments. Kampala’s case is particularly striking. The city received investment-grade credit ratings to issue bonds on the stock market that were later constrained by the Kampala City Act, 2010, which limits the amount of debt the city can issue to 10% of the local revenue that the local government generates annually. Without a legislative amendment that raises this cap, issuing bonds for the city is not worthwhile (Gorelick, 2018[76]).

Lagos State in Nigeria offers a successful example of bond issuance. Between 2008 and 2011, the state issued bonds to finance transport, employment zones and highways, all sectors the state identified as priorities. The bonds’ success demonstrated the availability of domestic savings in the region and the eagerness to invest. Lagos State has continued to issue domestic bonds for Nigerian investors ever since.

For local authorities to issue bonds is thus not an easy option, but if more resources are to be found to finance urbanisation, better access to this type of market for institutions that specialise in city financing needs further exploration. Tunisia’s Caisse des Prêts et des Soutiens de Collectivités Locales (Common Loan Fund) offers another instance. It only benefited once from a bond issuance, but did not continue to solicit the market. This was probably due chiefly to the availability of public resources (resources on concessional terms), which were easier to mobilise and less costly, but which continue to depend on the government.

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Notes

← 1. Most data in this chapter refers to subnational governments, which include local and regional governments, because no further breakdown is available.

← 2. Fiscal capacity is intended here to mean the ability of this level of government to raise revenue autonomously.

← 3. This international charter has been ratified by 17 of the 55 African countries. The latest, Togo and Rwanda, signed the Charter in 2019 (African Union, 2014[77]).

← 4. Neither are representative of all African countries. Mauritius is an island state, while South Africa, where 69% of public investment is devolved to subnational governments, is one of the few federal countries in Africa.

← 5. In the Subnational Governments World Observatory dataset, transfers and grants are defined as follows: “transfers to subnational governments from the national government (representing the great majority) but also from higher levels of government (state or regional governments) and from international organisations (e.g. European Union structural funds, international aid, etc.). They comprise current and capital expenditure grants (…)”. It is important to note that shared tax revenues are not included in this definition (OECD/UCLG, 2019, p. 68[18]).

← 6. Such grants are also referred to as “shared taxes”.

← 7. Since 2012, the United Cities and Local Governments of Africa (UCLG Africa) and Cities Alliance have surveyed 53 African countries to understand the institutional environments of local authorities on the continent. The City Enabling Environment Ratings “examines the institutional conditions created by the different countries in favour of the initiatives and actions of their respective local and subnational governments” (UCLGA, Cities Alliance, 2018, p. 7[5]). The ratings consider the following areas: local governance, financial autonomy, local efficiency and national institutional environment. The third and latest edition was published in 2018, and can be accessed on the UCLG Africa website. Jean Pierre Elong Mbassi’s contribution to Chapter 6 of this report also adds detail and insight on these ratings.

← 8. Taxation requires governments to specify a tax base, which may be composed, for example, of citizens’ income, the value of land, businesses’ profits or transactions that will be taxed.

← 9. Tax competition can be positive, as it incentivises local governments to ensure that public expenditure is efficient and that costs for residents are reduced. However, competition without regulation may result in a “race to the bottom”, with suboptimal delivery of services and infrastructure and laxer enforcement of standards and rules (Wilson, 1999[81]).

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