THE DETERMINANTS OF THE MUNICIPAL BONDS MARKET IN ROMANIA.

• Author: Tiron-Tudor, Adriana

1. Introduction

   The 2008 financial crisis led to various unfortunate consequences, including bursting the housing bubble, a deep recession, high unemployment rates, and adverse effects on financial stability worldwide. These circumstances made it difficult for local governments to raise funds, so the public sector became increasingly concerned by the problem of local debt. The combination of slow revenue growth and expenditure restrictions intensified the pressure on local governments (Chen et al., 2016) and forced them to find new tools to address this financial scenario (Balaguer-Coll, Prior and Tortosa-Ausina, 2016).

   In this context, the issuance of bonds became an alternative means of funding the investment projects proposed by local governments. This form of borrowing is less risky and expensive than other financing methods, such as bank loans, and can lead to economic growth in local communities. Thus, establishing and maintaining a responsible, viable borrowing environment became a widespread policy goal for local governments (Martell and Guess, 2006; Bercu, Tofan and Cigu, 2015). Bonds funded projects deliver essential public services to the communities with long term benefits as schools get built, highways paved, water and sewer systems expanded, bridges and tunnels maintained, and hospitals upgraded. Empirical studies on municipal bonds were carried mostly in the United States, where issuance of bonds by municipalities has a two-hundred-years tradition (Baber and Gore, 2008; Daniels, Diro Ejara and Vijayakumar, 2010; Reck and Wilson, 2014; Li, Tang and Jaggi, 2018). In Europe, the research interest on municipal bond markets increased especially in the post crises periods in developed markets (Padovani, Rescigno and Ceccatelli, 2018).

   The primary objective of the paper is to investigate the factors that influence the size and interest rates of Romanian municipal bond issues. This study is addressed to a broad range of readers, including theoreticians interested in public policy and public management contexts, as well as practitioners who are designing strategic plans to reduce debt levels. The study contributes to the development of knowledge by finding answers to the following research questions: (1) what are the factors determining the amount issued by municipal bonds? and (2) what factors influence the interest rates of municipal bonds?

   The originality of this paper lies in its theoretical and empirical approach. To our knowledge, it is the first study to empirically analyze the factors influencing the issuance of municipal bonds in an Eastern European country. Moreover, we reviewed economic, social, financial, and political data to assess the relationship between various variables and the issuance of bonds, as well as to explain the influence of these variables on bond interest rates. This provided an overall view of this topic.

   The main findings of our study revealed that the Romanian municipal bond market is still underdeveloped. A municipality with a large population situated in a western region with an independent mayor and relatively high levels of revenue and expenditure can be considered the prototype of the Romanian municipal bond issuer.

   This paper continues with a second section dedicated to the review of the literature concerning the level of municipal bond issuance and the cost of debt. The third section describes the research design and methodology, whereas the fourth section presents the descriptive and empirical results and is followed by the conclusions, limits and further developments section.

2. Literature review

   2.1. Theoretical aspects of the municipal bond market at the international level

   Since municipalities are often faced with a lack of resources to finance their investment projects or their ongoing activities, they frequently resort to alternative funding sources. The choice of a financing method is of great importance, so local governments must consider various aspects, such as the necessary amount, the funded activity, cost-effectiveness, flexibility, managerial and technical skills, and economic context (Eltrudis, 2018). Unfortunately, there is no ideal borrowing method, and everything depends on the context. However, the literature recommends a mixture of financing schemes.

   Financial markets represent an alternative source of financing. Local governments can attract capital through municipal bonds that are debt instruments issued by a city to raise funds to cover its budget deficit. These bonds require the issuer to pay the investors the principal amount and the interest at intervals established in the issuing prospectus (Bailey, Asenova and Hood, 2009). The municipal bond market's proper functioning is vital for the provision of public goods and services (Cestau et al., 2019). In the majority of cases, the investment projects financed by issuing bonds usually entail construction or rehabilitation of roads and water supply and sewerage systems, building or modernizing schools, repairing or developing tourist attractions, or refinancing bank loans. Such projects are intended primarily to improve the quality of life for citizens, thus leading to economic growth (Medda and Cocconcelli, 2018).

   The financial market provides the possibility to attract capital at a lower cost and for an extended period compared to bank loans, thus presenting the advantages of cost-effectiveness and equitability (Martell and Guess, 2006). However, since the issuance of municipal bonds process is quite complex and involves many parties, the differences in using this method of financing are apparent. Thus, while in the United States this method to secure funding is employed frequently by municipalities, in the rest of the world it is used less often because bank loans provide a more consistent means of financing.

   2.2. Insights into the Romanian municipal bond market

   Thus far, the literature on the Romanian municipal bond market has been scarce; Mosteanu and Lacatus (2009) highlighted the lack of empirical analysis of the municipal bond market. In 2005, Zai, Lazar and Inceu (2005) opened this research topic by comparing two financing alternatives, bank loans and municipal bonds. Over the following few years, various studies emerged and aggregated general information on municipal bonds in Romania, such as the number of issues, values, types of issuers, destinations of funds, and interest rates (Curutiu, 2006; Mosteanu and Lacatus, 2009).

   The limited development of the municipal bond sector in Romania has mainly existed due to a lack of transparency and an absence of credit ratings (Vasile and Matei, 2010; Pop and Georgescu, 2012; Constantinescu and Tanasescu, 2014). Other factors identified by Pop and Georgescu in studies from 2012 and 2016 were the low volume per offer, the relatively high nominal values, the small numbers of investors, buy-and-hold behavior, the lack of popularity of bonds, the absence of a yield curve, and poor development of credit enhancements.

   A more detailed analysis of the municipal bond market was provided by Pop and Georgescu (2016). These authors found a positive association between the outstanding quantity of municipal bonds and the issuer's economic potential as measured by population size, as well as a negative relationship between risk premiums and population size. The bonds' trading values were explained by the turnover ratios and the listing periods, whereas the risk premiums and coupon rates had no influence on these values.

   2.3. Factors determining the municipal bond amounts and the cost of debt

   The literature revealed a broad range of factors from which we extracted those considered relevant and suitable for the Romanian municipal bonds market. These factors referred to the internal and external conditions that can be more or less controlled by the municipality and are grouped in four main categories financial, economic, issuer characteristics and political.

   Financial factors refer to the municipality performance, expressed as revenues and expenditures. The levels of revenues and expenses of a municipality manifest their influence on the bond market. Income represents the source of reimbursement for municipal bonds associated with lower default risks (Reck and Wilson, 2014). This leads to an indirect influence on the cost of debt (Sherrill and Yerkes, 2018) and the level of debt (Galinski, 2015), but other studies have found that revenue directly influences debt levels (Daniels, Diro Ejara and Vijayakumar, 2010; Balaguer-Coll, Prior and Tortosa-Ausina, 2016). In addition, expenditures directly influence debt (Daniels, Diro Ejara and Vijayakumar, 2010; Balaguer-Coll, Prior and Tortosa-Ausina, 2016). However, Galinski (2015) found no association between expenditure and debt.

   Economic factors refer to the country macroeconomic indicators as gross domestic product, unemployment rate and inflation. Gross domestic product (GDP) has an indirect impact on borrowing costs (De Mello, 2001; Chen et al., 2016). For instance, Baber and Gore (2008) detected a direct influence of this factor on borrowing cost. However, other studies have found no association between these two elements (Reck and Wilson, 2014). In terms of size, an issuer with a higher GDP will issue more bonds (Chen et al., 2016). The unemployment rate is another economic measure that influences local government debt. A higher unemployment rate implies both a higher level of debt (Galinski, 2015; Greer and Denison, 2016) and a higher cost of debt (Wilson and Howard, 1984). The inflation rate increases the cost of debt (Park, 1997) but does not influence debt (Daniels, Diro Ejara and Vijayakumar, 2010); as such, the default risk in the municipal bond market can be measured with the help of inflation (Bailey, Asenova and Hood, 2009).

   Issuer characteristics are represented by social factors such as population and issuer type. In the literature, the size of an issuer has usually been measured by...