20 to absorb further subnational debt involves also the cost at which financing could be made available. A non-distorted cost of capital should be considered, excluding for instance implicit guarantees from the central government that would reduce interest rates as markets discount not only the repayment capacity of the subnational entity but the sovereign’s resources.

- (viii) If the assessments in step (vii) are negative, the infrastructure investment plan must be reconsidered altogether because it is not compatible with financial and/or policy considerations, and thus the process involving steps (ii) to (vii) should be repeated for a new plan that possibly envisages a reduced scale of investment projects.

- (ix) If the assessments in step (vii) are positive, instead, the infrastructure investment plan turns out to be consistent with financial and policy constraints and therefore it is possible to move forward to step (x).

- (x) Identifying the threshold values not breached by the debt path projected in step (vi) (say for variables such as the debt service-to-revenue ratio), which would constitute numerical debt limits consistent with both the achievement of infrastructure investment expenditures (step (ii)) and the opportunities and pressures associated with financial markets and political objectives (step (vii)).

While it is not realistic to calculate ‘the exact numerical value for the debt threshold’, the above efforts can help evaluate upper and lower bounds for thresholds based on expert judgment about medium-term macroeconomic scenarios, infrastructure financing needs associated with urbanization, and debt service capacity. As the steps described above indicate, the numerical thresholds are calibrated so that the budgetary and borrowing policies consistent with them (in the sense that the debt projections meet the thresholds under a baseline outlook) are also consistent with the development-driven financing needs and other financial and policy considerations. The resulting capacity to service debt must leave sufficient budget room to accommodate other expenditure demands including schools, health, and operation and maintenance of infrastructure assets.

Although local governments might not be legally allowed to borrow, they could borrow through the creation of SPVs. The above steps (i) to (x) apply regardless of whether the local governments borrow themselves or through their SPVs. As long as SPVs are not self-sufficient in finance, their debts will necessarily be contingent liabilities of the local governments. Differentiated modeling frameworks could be developed to establish specific debt limits for a subnational government’s general budget and SPVs.

The determination of debt thresholds for a representative local government can also add a constraint on the total subnational debt-to-GDP ratio, as well as quantify the risk stemming from contingent liabilities. Debt thresholds can be subject to a constraint on the total subnational debtto-GDP ratio, i.e. it is possible to calibrate the numerical thresholds so that the aggregate subnational debt as share of GDP remains below the limit monitored by the central government (as discussed in section II).

Furthermore, the medium-term macro-fiscal framework (step (i)) and the debt dynamics analysis (step (vi)) can easily incorporate random shocks to model risks associated with contingent