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The good news and the bad news of the numbers.

The April and October issues of Government Finance Review have included "Fiscal and Economic Indicators" as presented on the following page. Beginning with this issue, the Government Finance Research Center (GFRC) of the Government Finance Officers Association (GFOA) also will provide brief analyses of the numbers, commenting on both the general tone of the economy and the specific economic trends affecting government finance officers at the state and local levels. This column will focus on the general direction of the economy and the record level of state and local government debt issuance in 1992.

Direction of the Economy

A sluggish domestic economy and weak consumer confidence played significant roles in the outcome of the 1992 Presidential election. Since then, economic news has been positive, the American public is feeling better about its economic situation, and consumer confidence rose more than 20 points during the two months following the election.

In reality, the improving economic news began rolling in prior to the election. Third-quarter growth in the Gross Domestic Product (GDP) was initially reported at a 2.7 percent rate. At the time, this stronger-than-expected growth was viewed with skepticism; however, after the election third-quarter GDP growth was revised upward to 3.4 percent. The better-than-expected growth during the third and fourth quarters resulted in 1992 annual economic growth of 2.1 percent, a significant improvement over 0.8 percent in 1990 and -1.2 percent in 1991. For 1993, most forecasters place growth in the 3-5 percent range.

Another positive sign for the economy has been the lowering of interest rate levels since the presidential election. By late February the yield on the 30-year Treasury bond had fallen approximately 75 basis points. Much of this decrease was fueled by President Clinton's deficit reduction plan. Lower deficits lessen the likelihood that Congress will use the time-tested remedy of inflation to address the government's mounting deficits. The consensus view held by economists in early 1993 was an inflation rate of 1.5-4.5 percent in the years ahead.

There are many unanswered questions regarding the impact the Clinton administration's economic plans will have on state and local governments. Will short-term economic stimulus result in higher state and local government revenue growth? Will taxpayers affected by higher federal taxes be less willing to accept higher property, sales and state income taxes? Will efforts to meet infrastructure needs increase new construction expenditures by state and local governments? Will the transition from defense-dominated local/regional economies to nondefense activities result in fiscal stress for the state and local governments affected? As the details of the administration's plan are shaped in Congress and implemented in the months ahead, this column will strive to identify and analyze the indicators that might provide some insight regarding the answers to these questions.

1992: The Year of Refinancing

As illustrated in Table 2, issuance of long-term debt by state and local governments increased dramatically in 1992. The 35 percent increase from $172 billion to $233 billion resulted in an all-time record level of debt issuance in the municipal market, surpassing the previous high of $207 billion in 1985. Record-setting borrowing was fueled primarily by decade-low interest rate levels. The Bond Buyer GO 20-bond index fell 40 basis points in 1992, and The Bond Buyer revenue bond index dropped 50 basis points.

The amount of refunding issues in 1992 is also newsworthy. Taking advantage of low interest rates, state and local governments jumped into the market to refinance previously issued debt with the result that a little more than 50 percent of the long-term bonds issued in 1992 were refundings. The corresponding percentage in 1991 was only 27 percent, and the average for the previous 10 years was 26.5 percent.

There is both good and bad news associated with the record borrowing level of state and local governments. Since most refundings are undertaken to replace higher-coupon bonds with lower-coupon bonds, reduced interest rate costs and debt service payments for governments in the years ahead is the good news. These lower debt payments may result in additional funds being available for other important projects, they may allow for the avoidance of additional taxes or user fees, or they may maintain services that may have been threatened by cuts in the absence of a reduction in debt payments.

Although total long-term debt issuance increased by 35 percent in 1992, there was actually an 8 percent decrease in new-money debt issuance from $126.5 billion in 1991 to $116.2 billion in 1992. This decrease in funding for new projects represents the negative aspect of 1992 debt issuance. At a time when the cost of funds was at a low for the decade, state and local governments actually reduced for the first time in several years their use of the debt market to fund new projects.

Basic economic theory teaches that more of a commodity is purchased as its price decreases; if the price of money (interest rates) declines, the purchase of money (borrowing) should increase. Yet state and local governments borrowed less for new projects even though interest rates were lower. What explains this apparent non-economic behavior? Did governments have fewer capital projects that needed funding? Or did the lack of funds to support new money issuance account for the reduction in new money issuance at a time when the cost of money was extremely low?

As federal government mandates have mounted and state and local government revenues have been adversely affected by the recession, a general deterioration of the financial health of state and local governments has resulted. For example, Standard & Poor's reported 1,096 municipal rating downgrades and only 555 upgrades in the 1991-1992 period. The general reduction in credit quality brought on by fiscal stress explains the debt issuance behavior of state and local governments in 1992. Refundings increased dramatically because fiscal stress is alleviated by lowering debt service payments on previously issued outstanding debt.

Even when interest costs are extremely low, however, fiscal stress restricts the ability of state and local governments to issue new debt because new money debt issuance would increase their total debt burden. Hopefully, economic recovery and increased federal cooperation will allow state and local governments to take advantage of low interest rates to finance needed capital projects in the years ahead.

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J.B. KURISH, director of GFOA's Government Finance Research Center, prepared this article.
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Title Annotation:Fiscal and Economic Indicators; analysis of economic indicators
Author:Kurish, J.B.
Publication:Government Finance Review
Date:Apr 1, 1993
Words:1070
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