The Story of Indian Municipal Bond Markets So Far
If the latest experience with a pandemic has taught Indians anything, it is the need to bring reforms in local bodies which help in delivery of basic and essential services.
The first step to doing so is to increase financial autonomy of these bodies, especially in urban areas and improving the sources of their funding. Municipal bonds are handy ways to achieve this since they allow local administrations to self-finance their expenditure without depending on central revenue.
Indian municipalities are slowly beginning to come to this realisation and launch their own municipal bonds. Yesterday, Ghaziabad became the 10th Indian city to raise municipal bonds and incidentally, the first city to raise green bonds (raised to meet environmentally sound infrastructural targets).
Let’s take a look at India’s experience with municipal bonds so far.
A Brief on Municipal Bonds
As we know, the Central Government funds its projects by selling securities, bonds, treasury bills etc. State Governments raise their funds through development loans (or SDLs) which are basically sovereign securities raised via auction. Local administrations like municipalities, in comparison, have the most confined means of income. Which is why they are empowered with certain guidelines to fund their developmental projects through municipal bonds.
Municipal bonds are debt instruments issued by local bodies to raise money for capital expenditure. In effect, they are loans from investors to governments the interest on which are usually exempt from taxes making them attractive investment options. They can be classified into two types:
- General Obligation (GO) Bonds which are used for general infrastructural needs and are repaid from the general government funds or taxes (like property taxes).
- Revenue Bonds which are used to finance specific projects. These are repaid through the revenues or taxes generated from these specific projects.
Why are they lucrative? One, they are sovereign instruments and hence more credible. Two, taxation benefits. Three, reduced risk probability because again, sovereign guarantees.
What may be the shortfalls? One, comparatively low interest rates from other marketinstruments. Two, long maturity periods (usually minimum three years) that affects investor liquidity.
How Are They Regulated?
Bangalore Municipal Corporation was the first urban local body to issue municipal bonds in India back in 1997 even though the first major breakthrough came in 1998 when Ahmedabad launched the first and only public issuance. However, the market for municipal bonds remained bleak as close to ₹2,000cr ($268m) has been raised from 10 issues so far, quite modest in relation to India’s exploding urban investment needs.
In India, there is a Pooled Finance Development Fund (PFDF) scheme under which a number of municipalities can pool together to raise funds through the joint issuance of bonds. They can be issued either publicly (in the open market) or through private placement.
SEBI restructured the eligibility criteria for municipal bond issuance in 2015 to include two substantial changes:
- No negative net worth in the previous three fiscal years.
- No prior default in debt repayment in the previous year.
- No mention of municipal entities, their group companies, promoters or directors in RBI’s wilful defaulters list.
The same year, the Atal Mission for Rejuvenation of Urban Transformation (AMRUT) scheme was launched simultaneously where institutional incentives were offered to urban local bodies for participating in the bond issuance. For instance, for every ₹100cr ($13.4m) raised via bonds, the Government pays these bodies ₹13cr ($1.7m) which assists with meeting repayment targets.
In February 2019, RBI enabled Foreign Portfolio Investment (FPI) into municipal bonds too. This was meant to ease the access of debt instruments in non-residents. Minimum subscription limit per investor was also reduced to ₹10L ($13,400) from ₹25L ($33,500) aligning them with corporate bond regulations.
Behind the Nascent Growth of Municipal Bonds in India
Municipal revenue forms less than 1% of India’s GDP, an abysmally low figure compared globally.
It doesn’t help either that maintenance of healthy credit ratings, a qualifying criteria for bond issuance, is something that many municipalities are incapable of. Hard-nosed capital market investors are keen on creditworthiness, and understandably so, given the benefits that await upon tapping into the capital markets. But in the absence of reliable disclosures and accounting standards that municipalities in India practice, ease of urban financing awaits.
Another concern is with adequacy of revenues for repayment. Property taxes, which are a primary source of income for local governments in India, accounted for 0.14% of the GDP, one of the lowest among developing countries. This has partly to do with the lack of local bodies’ autonomy to frame their own tax policies. This is adding to the fact that not a large amount of tax devolution occurs from the centre to the states and further to the municipalities anyway. The pandemic has tightened revenue purses even further.
According to a World Bank report, SEBI’s guidelines on municipal bonds largely mirror those of the corporate sector, which is in a way inappropriate. By virtue of being listed on the national securities exchange, a number of procedural complications are added to subscribe municipal bonds, even if the qualifying criteria aren’t fairly difficult. But the complications, in a way, disincentivise local bodies from opting for the bond route and turn to banks and other entities instead for investments.
Road to Strengthening Our Bonds
Credit enhancement measures are the need of the hour to improve the local bodies’ profile which will in turn increase bond subscriptions. Agreed, only the Tier I and Tier II cities will come close to raising their prospects if they follow careful fiscal policies over the course of time. As for the remaining cities, sovereign guarantee is the most bankable option.
SEBI eased a few guidelines to enable municipal bond issuance for smart cities last year. One of the new norms was to allow entities other than municipalities to raise funds too. Entities like urban development authorities or city planning agencies can issue their own instruments now. This is a step in the right direction which could be further improved by making a few more structural changes.
IRDA Rules in India classify municipal bonds as “non-governmental securities” which mandate at least A+ rating to be eligible for an insurance company’s portfolio. This differential treatment of municipal bonds should be amended, especially in context of long-term investors like insurance and pension funds who would consider municipal bonds a good fit too.
As of May 2019, India’s municipal bond market is valued at about $200m which is a tiny part of the approximately $1.7trn national debt securities market. Although dwarfed at present, this number could only pick up with increasing market interest and assisted regulation. There was a time when the outstanding debt of US local governments had reached $516m. This might seem like a small figure now but back when it happened in 1870, it was considered a figure tantamount to national shame. Today, the US municipal bond market stands at $3.8trn. We can cultivate the same enduring success too.
(Originally published April 13th 2021 in transfin.in)
