For local and regional governments (LRGs) worldwide, a high level of fiscal flexibility–that is, the extent to which a government can adjust its revenues and expenditures in case of need–can often result in more stable rating levels as governments have a greater capacity to respond to external challenges. This ability can now be synthesized using the Standard & Poor’s Fiscal Flexibility Index (FFI), outlined in a report published on Dec. 17, 2007, by Standard & Poor’s Ratings Services titled “Fiscal Flexibility Index For International Local and Regional Governments.”
The article focuses on the application of the FFI at the macro (or country) level to determine and rank the fiscal flexibility for the different layers of governments in Australia, Bulgaria, Canada, France, Germany, Italy, Mexico, New Zealand, Russia, Spain, Sweden, and Switzerland.
“In certain cases, the level of fiscal flexibility can have a marked influence on LRG ratings,” said Standard & Poor’s credit analyst Boris Kopeykin. “For example, Spain’s foral regions, Navarre and Basque Country, are both rated ‘AAA’, which is above the ‘AA’ average for Spain’s normal-status regions. This is in part because the foral regions benefit from a specific and highly beneficial financing system, which provides them with significant revenue flexibility in terms of tax regulation, collection, and tax management.”
In France, on the other hand, several reforms to the institutional framework for LRGs over the past several years have weakened LRGs’ ability to adjust taxes. At the same time, these reforms have led to an increase in spending related to personnel and social responsibilities, which present a high degree of expenditure rigidity. As a result of this gradual reduction in their ability to adjust revenues and expenditure, some French LRGs have recorded narrowing financial performances, which, combined with other factors, may have negative implications on their ratings in the near future.
“High flexibility, however, does not automatically translate into high ratings,” added Kopeykin. “Fiscal flexibility is just one of eight groups of ratings factors that we consider, and the ratings on an LRG are strongly correlated to other factors, in particular the strength of the overall institutional framework within a given country. Nevertheless, positive trends in the level of fiscal flexibility may support an improvement in the creditworthiness of an LRG, while a decrease in fiscal flexibility could place pressure on the ratings.”
