Municipal Bonds in India

Municipal bonds (or “munis” for short) are debt obligations issued by states, cities, counties and other governmental entities to fund day-to-day obligations and to finance capital projects such as building schools, highways and other projects for the public good. For example, if a municipal corporation wants to establish a new metro rail link, then it can issue municipal bonds to fund the project. Institutional investors and the public are the buyers of municipal bonds. Revenue earned by the metro rail network will be used to repay the interest and principal to the investors of these bonds.

When a people purchase a municipal bond, they are actually lending money to a state or local government entity and get in return a specified amount of interest and the principal will be returned on maturity. While short term municipal bonds mature in 1-3 years, long term municipal bonds mature in a decade or more.

Background

In India, municipal bonds are in existence since 1997. Previously, cities like Ahmedabad, Bengaluru, Nashik and Madurai have issued municipal bonds. However, since 2010, there have been no new issues. Municipal bond issues are yet to gain pace in India. According to the government sources, municipal bonds were able to garner only Rs 1750 crore in India as opposed to US $ 304 billion in 1 year and South Africa’s $1.8 billion raised in a single quarter. The most important reason for the poor performance of municipal bonds in India is they are mostly privately placed with institutions and are not easily tradable.

Securities and Exchange Board of India (SEBI) has begun to work towards creating more awareness and the new rules framed by SEBI allows municipal bonds to be offered to the public, listed and traded on stock exchanges. This is expected to rekindle the appetite for municipal bonds in India.

Guidelines of SEBI

Those municipal bonds through which funds are raised for one project are known as revenue bonds. SEBI has permitted public offering of revenue bonds.

The guidelines of SEBI with respect to the municipal bonds are as follows:

• Municipalities looking forward to issue debt should not have a negative net worth in past three preceding financial years.
• Bonds should have a minimum investment rating and have a minimum tenure of 3 years,
• In case of non-receipt of minimum subscription, all of the application money to be refunded with in a time period of 12 days.
• Municipalities need to contribute at least 20% of the project cost.
• Municipalities are required to maintain full asset cover in case they are required to repay the principal amount.
• Revenues generated by the municipalities are required to be kept in a separate escrow account supervised by banks and financial institutions.

Significance

Solving problems pertaining to infrastructure requires a lot of money. Requirement of funds for addressing issues like solid waste management, water treatment etc is large. But the municipal corporations are weak in raising finances. Cities do not have required financial autonomy. 74^th constitutional amendment act has empowered local governments and cities are made to depend on the financial assistance provided by the state and central governments.

Municipal bonds help municipal corporations to directly raise funds without depending upon the support extended by government agencies and World Bank. Moreover, large institutional investors like pension funds and insurance companies are looking forward to invest in less risky avenues to invest. Municipal bonds provide avenues to tap these investments. As per CARE rating estimates, municipalities in India could manage to raise Rs 1000 to Rs 1500 crore every year by issuing municipal bonds. Municipal bonds are being successfully used by local governments in the US and China.

The municipal bonds can increase the quality of life in cities. They can act as a better alternative for investors beyond fixed deposits and small saving schemes. Municipal bonds in India also holds tax free status if it conforms to certain rules and conditions. Their interest rates will also be market linked.

As per the committee on urban infrastructure headed by Isher Judge Ahluwalia (2011), Indian cities would require Rs40 trillion at constant prices in the two decades to 2031. If the cities fail to meet this requirement, then it will not only throw the economy off the rails but also create social tensions.

Constraints and challenges

• Many municipal corporations raised huge revenue from octroi. For instance, Brihanmumbai Municipal Corporation, the richest municipal body of India has managed to earn 33% of its revenue in 2015-16 from octroi. With the advent of GST, octroi would go away. Municipalities have to look forward towards other avenues for augmenting their finance base.
• Easy availability of government funds to municipal bodies and preponderance of institutional finance.
• Lack of a secondary market to trade municipal bonds.
• Limited credit enhancements for municipal bonds affect their demand.
• Conservative approach followed by insurance and pension firms to invest in municipal bonds.
• Lack of incentives to municipal bodies to make use of debt market.
• Only very few municipal bodies exists in the country with high credit.

Way forward

There are several recommendations as way forward. Firstly, the regulatory bodies for pension funds and insurance should allow their regulated entities to invest in municipal bonds. Secondly, as transparency and clarity will be a prerequisite for investors for investing in municipal bonds, the municipal corporations have to ensure that their books of accounts are well maintained. Thirdly, Municipal bonds are not substitute for city revenue. Municipal bonds are issued based on the revenue to be generated in the future, so, the cities have to adopt stringent policies to collect local taxes, user charges, stamp duties etc. Investors will not invest their money in municipal bonds unless they are convinced about the fiscal strength of the municipal bodies. Fourthly, an agency need to be created that is willing to take some of the risk out of municipal bonds through market making, credit enhancement and underwriting. Lastly, apart from incentives like tax free status, international models like those followed in Denmark, Japan, South Africa etc can be emulated. In Japan, Japan Finance Corp. for Municipal Finance has a sovereign guarantee. In South Africa, Bank of South Africa uses its balance sheet to provide support to municipal bond issues.