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84,6 per cent of the total debt of HUF 1247 billion, recorded by the local govern ment subsystem at the end of 2010, was gen erated by those local governments – Budapest, the counties and the towns with county rank – which were rated by the State Audit Office as highly risky and therefore subject to a com prehensive audit in 2011–2012.
One of the main reasons for indebtedness was that local governments did not have funds for their own contribution to EU supported investments. Therefore, longterm resources had to be found which could help local gov ernments apply for EU grants. They raised these funds by issuing foreign currencyde nominated bonds. The debt issue was a truly serious challenge to meet because most of the local governments failed to create the reserves required to repay the liabilities to financial in stitutions. The funds serving as coverage for repayment were typically not identified. It was also risky that each of the property items that belonged to the nominal assets of the local gov ernments were also offered as collateral for the loans. In the case of bonds issued, beyond the unfavourable developments of the exchange rate, preterm reconversion or conversion into Hungarian forints could also cause unexpected expenses. However, the main risk factor was exposure to the exchange rate since there was no running coverage for the liabilities due in foreign currency. Local governments did not have revenues in a foreign currency which they could use to safely repay the principal and the interest of foreign currency loans free from the volatility of exchange rates. The investments implemented from EU grants and foreign cur rency loans are typically nonproductive, so it was not possible to use the returns to generate the required funds.
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In addition to the subsequent financing of projects from EU grants, the increase in trade payables and their high level against the monthly average of nonpersonnel expenses also created additional risk. Due to the lim ited availability of funds, local governments typically considered suppliers instruments of external financing. Between 2007 and 2010, the trade payables portfolio of the local gov ernment sector grew from HUF 85 billion to HUF 105 billion, with overdue debts in creasing from HUF 26 billion to HUF 44 bil lion (by 69.2 per cent). In the same period, monthly nonpersonnel expenses rose from HUF 44 to HUF 53 billion.
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The business associations under the major ity ownership of local governments also ac cumulated significant debts, and at the same time, for lack of legislative authorisation, be fore 2011 the State Audit Office of Hungary did not have the right to audit these compa nies owned by local governments, Which in turn failed to pay sufficient attention to pre vent their business associations from becom ing indebted. In many cases, they also failed to present their own financial risks together with that of their business associations. Liability as owners—if certain conditions are met—for the debts of business associations constitutes both financial and consolidation risk, such as in the case of the Budapest Transport Compa ny (BTC). In 2011, at the initiative of the new SAO management but before the new SAO Act was enacted, the mandate of the supreme state audit authority was extended to business associations owned by local governments, and the first company to come under the micro scope of the auditors was the BTC. Assessing the financial management and audit processes of local governments up to 2010, it is important to stress that the central regulation regarding the limitation and ration alisation of debts was also unable to fulfil its function. Since the local governments took, that is, were entitled to take liabilities that exceeded their financial capacity, central debt management was inevitable because a large number of local governments going bankrupt would have caused unpredictable problems in public finances.
