Illinois is set to become the first US state to tap the Federal Reserve for emergency funding, planning to borrow $1.2bn from the US central bank to plug a financing gap created by the pandemic.

The cash-strapped government, which faces more than $130bn of unfunded pension liabilities, said it was finalising plans to pay 3.82 per cent for the one-year loan after a delay in tax collections created a budget shortfall.

Illinois recently decided against borrowing the $1.2bn from investors in the $3.9tn US municipal bond market after yields on its debt surged; in May, the state paid investors 4.88 per cent to borrow $32m for one year. Illinois is rated only one notch above junk territory by the three main US credit rating agencies.

The state said that the transaction would be finalised on Friday and it would repay its loan from the Fed by next June.

“The Federal Reserve Bank worked closely with our team to make this transaction possible through the Municipal Liquidity Facility, which is an important tool the state is using to answer the unprecedented economic challenges posed by the Covid-19 pandemic,” said Alexis Sturm, the director of the Illinois Governor’s Office of Management and Budget.

The Fed’s loan to Illinois will be its first under the Municipal Liquidity Facility, a $500bn scheme set up under the coronavirus stimulus legislation agreed by Congress and the White House in March to shield the US economy from the pandemic fallout.

The US central bank has traditionally balked at direct support for states and local governments, but officials had been growing increasingly concerned about strains in the municipal debt markets as well as the struggling finances of local authorities.

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“This was designed to be a stop gap,” said Peter Hayes, head of municipal bonds at BlackRock. “It is not a long-term fix by any means. It is meant to address the big shortfall in [states’] revenues. When you think about the big downturn in revenues that have occurred, every state is under pressure.”

The Fed’s facility, which is backed by equity from the Treasury department, is considered especially important given that talks on Capitol Hill on a government deal to provide direct aid to states and local governments are stalled; Democrats support the idea but Republicans resist it.

Donald Trump flagged his scepticism of bailouts for states in April, saying he questioned the need to help “poorly run” states governed by Democrats, such as Illinois. Jay Pritzker, the Illinois governor, retorted that his state would have posted a budget surplus in the absence of Covid-19.

“To the extent that we’re talking about the federal government providing funding for states, all states need it,” Mr Pritzker said. “Coronavirus has blown a hole in all state budgets across the country. There isn’t a single state that doesn’t need support.”

Mr Pritzker has clashed with Mr Trump on other issues in recent months, including the federal government’s coronavirus response and its handling of protests over the killing of George Floyd in Minneapolis.

Ian Rogow, co-head of municipal bond strategy at Bank of America, said Illinois would remain under financial pressure owing to its unfunded pensions and that without further aid, expected spending cuts in Illinois and other states would drag on overall US economic growth.

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“Governors, mayors and county executives across the country have said without additional aid the cuts that they will have to make will be significant and severe,” he said.



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