How likely are UK local authorities to follow the path of Puerto Rico?

5 Jun 17

As UK local authorities head towards economic independence, Vivien Holland asks if they run the risk of going the way of bankrupt Caribbean island Puerto Rico.  

Puerto Rico filed for the largest municipal bankruptcy in US history in early May.

A recession lasting over a decade has escalated its debts to over $70bn, plus a further estimated $49bn in pension deficits.

Around 45% of Puerto Rico’s population is in poverty and many people have already fled the region in the hope of a better economic future elsewhere.

The burden of debt has become so great, that the government has become unable to deliver essential services.

In the absence of a bail-out from the US government, bankruptcy was the only option to prevent further decline.

In the short term, it will be very hard for Puerto Ricans who remain in the country, as pensions are gone and investment in infrastructure is on hold.

In the longer term however, the move is likely to help bring debt down to a level that can be effectively managed by the government.

There is no definite process for what happens next in relation to the renegotiation of sovereign debt, but a hierarchy of creditors is currently being worked out.

Whatever ranking is established, the region’s leaders will want to ensure that essential public services are given priority.

This case is a red flag for many American states and municipalities, such as Illinois and Philadelphia that are facing similar strains, including rising pension costs, crumbling infrastructure, departing taxpayers and credit downgrades that make it more expensive to raise money.

For the UK, with ongoing austerity, is it possible that we are at risk of something similar happening to local authorities?

We have been in a period of austerity for seven years and this is likely to continue until at least 2020.

The austerity drive has hit public services hard with central government cutting funding and placing restrictions on the setting of council tax, business rates retention and potential localism.

Adding to pressures, the demand for public service such as health, social care and education has increased, whilst there remains marked inequality across areas of the UK, with pockets of both deprivation and affluence.

Cuts to funding continue to have the most detrimental impact on the poorest, those who rely more heavily on public services.

With this in mind, bankruptcy for some parts of the UK seems a potential outcome but there are several reasons why it remains unlikely.

As the responsibility for delivering many public services in the UK has been devolved to local government, funding from central government is declining.

Since 2010, the Revenue Support Grant has reduced significantly. By 2020, it will not exist. This has led to some local authorities becoming less reliant on central government for funding.

Borrowing also remains cheap as local government predominantly relies on the Public Works Loan Board, which lends at 2.5% interest, rather than through the issue of bonds, a method more commonly taken up by the corporate sector.

Therefore, the risks associated with delivering services through borrowing are lower, as is the risk of corporate creditors chasing debt repayments.

Returns on property investment are currently much higher than this rate so many local authorities are making the most of this opportunity.

While devolution has gone so far, central government is unlikely to cede complete control and is still likely to bail out local authorities if they showed signs of insolvency.

Unlike Puerto Rico, balanced budgets are a statutory obligation in the UK and continued funding cuts have prompted many local authorities to become increasingly more commercial.

Through reducing costs and focusing on generating income themselves, they are now less reliant on public funding.

This is not just making more from fees and charges, this is often achieved by purchasing land and property for investment purposes.

There are some risks associated with commercialism that could cause local authorities to default.

For example, if there is a recession and the property market crashes, the value of these assets will decline.

The National Audit Office has also identified risk in relation to investing in commercial property, with authorities’ debt servicing costs increasing as a proportion of revenue spending.

Some local authorities are also still adjusting to the idea of commercialism and the new requirement for many to act as investment portfolio managers.

Others have created trading companies that are not living up to expectations and are consequently now having to make tough decisions about their future.

As it is relatively early days for the entrepreneurial council, it remains to be seen what would happen if these risks become a reality.

What can we learn from Puerto Rico? Though extreme funding pressure, along with the increasing demand on many public services, continues to raise questions around the financial sustainability of local authorities in the UK, we are in a position to manage it.

By spreading the risk in public sector borrowing and ensuring councils continue to focus on new opportunities for income generation, it is likely that we will mitigate any risk of bankruptcy.

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