Negative Rates Lure Swedish Municipalities Into Debt Shortcuts

  • Interest rates on some municipal bonds negative for a year now
  • Local governments risk underestimating future costs, SKL says

As the old adage goes: If it looks too good to be true, it probably is.

Concern is growing that Swedish municipalities are loading up on too much short-term debt to take advantage of the financial alchemy that’s being turbo-fed by negative rates. And with speculation that Sweden’s central bank may expand its bond-purchase program to include municipal bonds, the lure of negative rates could grow.

“The possibility to borrow at negative rates does something with the incentive and propensity to borrow short,” said Mattias Bokenblom, head of research at Kommuninvest, the biggest issuer of municipal bonds. “When interest rates are negative you can imagine a scenario where you risk becoming a bit speed-blind, with investments becoming less well thought-through.”

About a quarter of municipal borrowing in Sweden now happens at zero or negative rates, Kommuninvest estimates. Total municipal sector borrowing is about 550 billion kronor ($65 billion), of which Kommuninvest accounts for nearly 50 percent.

Municipalities are finding it hard to turn down free cash and are trying to borrow at ever shorter maturities, where rates are lowest. The average maturity on their bonds slid to 772 days in July from 843 days in September last year, when Kommuninvest removed an earlier interest rate floor to allow negative rates.

But their increasing reliance on short-term debt is set to clash with their need to refinance long-term infrastructure investments. Borrowing for these is expected to roughly double to 1 trillion kronor in 2024, according to Kommuninvest’s latest forecast. Apart from roads and parks, local governments will need to construct housing and build new schools to make room for some of the 163,000 refugees and migrants who sought asylum in Sweden last year.

“Municipalities choose shorter maturities although they still borrow to finance the same kind of long-term investments,” Bokenblom said. “That’s a borrowing behavior that’s less desirable. It’s not good if debt maturities fall further.”

Annika Wallenskog, chief economist at SKL, the Swedish Association of Local Authorities and Regions, worries that some municipalities may not have considered what might happen when interest rates start rising again.

“The risk is that when things turn around, there will be many municipalities that need to renew their loans and some may have assumed that they won’t have any cost for that loan,” Wallenskog said. “The risk is that they haven’t factored in that interest rates will rise in the longer term.”

Kommuninvest says it’s seeing early signs of caution, with some fast-growing municipalities putting a limit on borrowing. That means Kommuninvest may reduce its borrowing forecast, according to Bokenblom. 

“What happens if you notice that the results are sinking at the same time as you have increasing investment needs?” Bokenblom said. “The investment needs are still there, but considering the economic challenges it’s possible that municipalities won’t let their balance sheets swell as much as we forecast last year.”

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