Muni Bonds: The Untapped Potential For Urban Infra Needs


(This is the first of a two-part series on the need to recognize how Municipal Bonds can be used to drive India’s rapidly growing urbanization requirement. Municipal bonds can potentially serve multiple stakeholders by granting financial autonomy to Urban Local Bodies (ULBs) as well as becoming a highly effective and untapped investment opportunity.)

Urban Local Bodies (ULBs) is a broader term used for government entities responsible for setting up, maintenance, and administration of public welfare, health, regulations, and infrastructure in urban areas. Comprising of Municipal Corporations, Municipalities and City Councils – subject to size of urban sprawl – they are constitutionally empowered, at least on paper, to function as self-governing entities.

Inception of Municipal Bonds in India

Under the 12th Schedule of the Constitution, 18 functional items have been placed under the purview of ULBs including urban planning, infrastructure, drinking water, public health, and urban amenities. The resource base of ULBs consists of their own tax and non-tax revenue, grants and subsidies from central and state governments, loans from state governments, banks and also market borrowings.

However, due to the ever-rising demand for basic urban services, ULBs have been facing the issue of lack of requisite funds, resulting in a delay in project implementation.  It was the Rakesh Mohan Committee on “Commercialization of Infrastructure Projects (1996)” which recommended the development of a municipal bond market in India. The Committee pushed for private sector participation and accessing capital markets through the issue of municipal bond.

Following the recommendations, it was the Bangalore Municipal Corporation in 1997 which for the first time issued state guaranteed municipal bonds in India worth INR125 crore. Following this, other municipal corporations like that of Ahmedabad, Mumbai, Nashik and Madurai also issued these bonds. However, due to lower interest rates, non-tradability in the secondary market and virtually no tax benefits, they attracted tepid response and largely mobilized capital through institutional or private placements.

What are Municipal Bonds?

Municipal bonds are debt obligations, which are issued by ULBs to finance local infrastructure and civic projects like construction of schools, local transport, health care centres etc. They are used to mobilize capital from the market in exchange for payment of regular interest and the principal at a pre-determined maturity date.

Municipal bonds in India can be broadly classified into two categories. One is the general obligation bonds which are issued against the financial credibility of the issuing municipality. In such cases, payment to the bondholders is done using the tax revenues generated by the ULB. The other category of municipal bonds are revenue bonds, the proceeds of which are used to finance a particular revenue-generating project. Repayment of principal and the interest, in this case, is done via the revenue generated from the earmarked project.

How Can Municipal Bonds Help?

Given the pace of reforms being witnessed in the country, with the additional objective of creating more smart cities, ULB’s have increasingly been facing the heat of fund crunch.

The need to bridge the existent infrastructure gap, upgrade and maintain the existing ones, and the wide-scale urban migration exerting pressure for the creation of newer and larger facilities considerably strain the balance sheets of corporations.

The primary sources of resource mobilization i.e tax and non-tax revenues and state grants remain grossly inadequate to meet the requirement. The erstwhile Planning Commission had estimated an INR35 lakh crore fund requirement to be able to meet the current urban infrastructural needs. Interestingly, McKinsey, a management consulting firm pegged the required amount at about INR53 lakh crore. The Smart City programme introduced by the Centre, alone has an envisaged infrastructure spending to the tune of INR7 lakh crore over the next 20 years (i.e. INR35,000 crore each year).

With the overleveraged balance sheets of state government and legal bindings placed by Fiscal Responsibility and Budget Management (FRBM) Act, 2002, not much should be expected from the state governments in terms of allocating funds via grants or even loans.

Municipal Bonds, therefore, come to enjoy a critical significance in meeting the immediate challenge of urban infrastructural needs. They also share the burden of excessive dependency on state or federal grants. The 12th Finance Commission Report reveals that over the years, their dependence on “other source of revenue”, which includes grants from central and state governments; transfers from state or central finance commissions, has been increasing. As per the 13th Finance Commission, 47.1% of total municipal revenue consisted of grants from the state and centre in 2007-08. Municipal bonds will offload that share and push for more localized investments and greater public participation. This would result in an efficient assessment of local needs and push for transparent funding and ensure accountability of corporations.

International Precedents

Most developed and developing nations are focused on building local credit markets. North America and Europe have a long history of utilizing household savings for infrastructure development. The former has heavily relied on municipal bonds, while the latter established development banks. Most developing nations have used either one of these methods or their hybrid, directly or via financial intermediaries to raise capital.

Recognizing the potential that municipal bonds hold in contributing towards the development of the urban space can prove to be of great assistance to ULBs. While granting constitutional legitimacy to municipal bonds will empower ULBs to a great extent, such authority without real financial independence is futile. Concrete steps must, therefore, be taken in the right direction to ensure that ULBs possess the requisite institutional and financial autonomy.

(The article was originally published on Transfin)

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