To reduce the ramp-up in local debt, the Federal Government enacted the Law of Financial Discipline of States and Municipalities in April 2016.<sup>15,16</sup> The Law introduced two key reforms altering how local governments report and manage their finances. The first was the creation of a registry— _Single Public Registry_ —where all local public bodies were required to report their contracted obligations—regardless of the type of loan, type of creditor, maturity, or financing purpose. The second reform introduced three indicators to monitor the financial health of all local governments and set debt ceilings to limit their indebtedness.<sup>17</sup> To provide enough time for the relevant entities to comply with the Law, these reforms were scheduled to come into effect several months later. As such, the alert system guidelines were published by the Ministry of Finance on March 2017. The first indicator defined in the guidelines was the ratio of _total public debt to freely disposable income_ , where freely disposable income includes federal transfers received by local governments in addition to any revenues obtained either locally or from the Budgetary Income Stabilization Fund. This indicator measures the total leverage of local governments and their overall financial sustainability. The second indicator reflects the capacity of local governments to meet the principal and interest of their obligations and was defined as the ratio of _debt service and obligations to freely disposable income_ . The third indicator, the ratio of _short-term obligations to total income_ , measures the ability of local governments to pay obligations with a maturity shorter than 12 months. Starting on April 2017, the FD Law mandated all state and municipal governments to publish these debt indicators on the website of the Ministry of Finance on a quarterly and semiannually level, respectively.<sup>18</sup>

> 15 Decree of Law of Financial Discipline of States and Municipalities, published in the Mexican Official Journal of the Federation on the 27<sup>th</sup> of April 2016.

> 16 While the FD Law was enacted in April 2016, it followed a long and uncertain process that characterizes the life cycle of most legislative bills in Mexico. More broadly, laws are initiated in one of the two chambers of congress, where they are discussed, modified, approved, and sent to the other chamber for their analysis and review. At this stage, draft laws can be approved, dismissed (and even postponed until the next period of sessions of Congress), or further modified (and sent back to the first chamber for more amendments). Using impulse response functions, we find no anticipation effects of the Law – the data suggests that changes in behavior by local governments and banks only happen after April 2016 and not before.

> 17 The Law also established procurement rules with the objective of guaranteeing that subnational debt was obtained at the lowest financial cost. One potential threat to our identification is that the establishment of procurement rules could have induced local governments with ex-ante lower debt to increase their indebtedness. However, we rule this out when examining changes in bank lending by local governments. As we discuss in in Section 4, our evidence indicates that ex-ante less-indebted local governments did not expand their bank liabilities after the Law.

> 18 Alert System Regulation, Official Journal of the Federation, March 31, 2017.

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