On June 20, Mayor Kenji Goto of Yubari, Hokkaido, solemnly told the city assembly that his city would have to undergo compulsory financial reconstruction, the equivalent of recovering from the brink of bankruptcy. The city is the second local government to fall into this status in 14 years.

Yubari’s situation has apparently prompted the Ministry of Internal Affairs and Communication to have its advisory committee consider legislation to prevent local governments from accumulating unsustainable debts to the extent that “financial reconstruction” becomes the only way out. The committee is expected to produce a report by the end of this month.

Despite the nationwide economic recovery, not all local economies are in good shape. Population decline in some areas has meant decreasing tax revenue for many local governments. And under the financial retrenchment pursued by Prime Minister Junichiro Koizumi’s administration, budget allocations from the central government to local governments, aimed at making up for the latter’s revenue shortages, have decreased by 5 trillion yen in the last three years.

Long-term accumulated debt owed by the central government and local governments is expected to reach 542 trillion yen and 233 trillion yen, respectively, by the end of March 2007. Thus it would not be surprising if some local governments go bankrupt.

Yubari’s case points to inadequacies of the current system for monitoring the financial conditions of local governments. Yubari once prospered as a coal-mining center. Its last coal mine closed in 1990. A population of 120,000 in 1960 has dwindled to 13,000. The city has tried to revive itself through tourism, including operating a ski resort and hosting an international movie festival, but it has accumulated 63.2 billion yen in debt, about 14 times its annual average budget, which comprises tax revenues and allowances from the central government.

For about 10 years the city kept taking out short-term loans from financial institutions to cover its deficits. By taking advantage of administrative loopholes in measuring its financial health, it managed to appear in the black. Now the city is expected to take 40 to 60 years to complete its financial reconstruction.

Yubari’s debt is much larger than the 3.2 billion yen owed by the town of Akaike (now Fukuchi), Fukuoka Prefecture, another coal-mining town, which became the first local government to undergo compulsory financial reconstruction in 1992. The town took 10 years to complete its financial reconstruction.

Under the current system, if a local government’s deficit tops a certain percentage of its budget, it is required to undergo compulsory financial reconstruction. The deficit criterion is 5 percent for a prefecture and 20 percent for a municipality. Since short-term loans do not appear in account settlement reports, Yubari was able to hide its excessive indebtedness. Fiscal 2004 account settlements show that 24 municipal governments nationwide had deficits. Although their deficits were lower than the 20 percent limit, experts suspect that many municipalities are in straits similar to Yubari’s.

The ministry’s advisory committee is considering having local governments report their financial conditions on a consolidated basis by taking into account not only their outstanding bonds and short-term loans but also the outstanding debts of their public corporations, third-sector entities, etc. The new method would deliver a clearer picture of each local government’s debt status. The committee will also discuss changing the debt level at which a local government should be subjected to compulsory financial reconstruction.

In the committee’s discussions, emphasis should be placed on preventing local governments from reaching the point of bankruptcy, rather than on defining the types of action for local governments whose indebtedness exceeds a certain limit.

The advisory body reportedly plans to discuss a proposal to set up a third-party committee that will call on local governments to rectify any unhealthy financial situation. Due consideration should be given to making use of and strengthening existing audit committees and external auditing. More importantly, a system must be established to make the financial conditions of local government transparent to both local residents and assembly members.

The committee also plans to discuss whether local government should be allowed to default on bonds and loans from financial institutions. But before discussing debt forgiveness, the central government should insist that local governments economize while giving them more autonomy in collecting and using revenues.

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