RPT-Fitch: Peru's institutional framework for subnationals is evolving

Thu Jan 9, 2014 9:06am EST

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Jan 9 (Reuters) - (The following statement was released by the rating agency)

Fitch Ratings has updated its Institutional Framework for Subnationals in Peru. The framework for local and regional governments (LRGs) is still at an early stage and evolving despite significant devolution to the local level. There is still a need to clarify the functional spending responsibilities of each tier of government.

The decentralization process in Peru commenced in 2002 and after 10 years the process is in some respects relatively advanced; the legal framework covers most aspects of the system of intergovernmental fiscal relations, and subnational governments have become important players on fiscal policy. Subnationals now concentrate a growing quantity of public expenditure decisions and they represented over 44% of total general government non-financial expenditure in 2012.

Fitch believes that the institutional framework has a number of strengths compared with its international peers, including tight control and monitoring of indebtedness by the central government and a solid level of transparency. There are a number of prudential regulations in place which limits the level of liabilities at all tiers of subnationals. These regulations are necessary in a developing institutional framework system as the local debt management capacity is still unsophisticated.

In addition, there are regular reporting requirements and high transparency in relation to subnational budget execution and debt levels. Subnationals are required to submit budget settlement data to the national Ministry of Economy and Finance. This data is published on the ministerial website. In addition, subnationals have to produce a multi-year Fiscal Management Report which needs to include the actual performance measured against target and prudential regulations and projections for the following three years.

Nevertheless, there are some weaknesses in the Peruvian subnational institutional framework, including the lack of fiscal flexibility by LRGs. The local tax base and rates are established and determined by the national government. The lack of flexibility makes subnationals wholly reliant on decisions taken at the national level with little accountability to the local population or the ability to increase fiscal revenues in case of need.

Furthermore, the equalization revenue system does not fully take into account the different costs of providing the services. In light of the limited level of devolved responsibilities this is not a major problem. However, if large responsibilities, such as the provision of health care, are devolved a failure to factor the costs of providing these services into the equalisation mechanism could lead to cost pressures, particularly in remote regions with widely dispersed populations. Also the assignment of revenue-sharing, in the form of the minin and and other royalties do not help address horizontal fiscal disparities among subnational governments because these revenues accrue exclusively to LRGs located in mining producing areas. As a result there is a wide fiscal imbalance among producing and non-producing areas.

The special report, entitled 'Institutional Framework for Peruvian subnationals', is one of a series of Fitch reports examining the institutional frameworks for subnationals in various countries which are available on the agency's website at www.fitchratings.com.

Link to Fitch Ratings' Report: Institutional Framework for Peruvian Subnationals

here

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