Municipal bonds are making a welcome comeback but need mega reforms

Municipal bonds, better known as muni-bonds, are making a welcome comeback. Last week, Madhya Pradesh became the first Indian state to list its bonds on the National Stock Exchange — the response was decent as the bonds, issued by Indore Municipal Corporation, were oversubscribed 1.26 times. The corporation retained Rs 1.40  billion. That was enough for the Madhya Pradesh chief minister to declare that cities like Gwalior, Bhopal and Jabalpur will follow suit with Rs 2 billion bonds each.

The bonds issued by Indore, the business capital of MP, offered 9.25 per cent with 10-year maturity. Indications are that some more municipal corporations elsewhere in the country will also hit the market soon to fund their infrastructure development activities. That would be great given the sluggish pace of bank financing. Also, Moody's says, a deepening of the muni-bond market would improve the ability of local governments to access a reliable flow of capital and enhance accountability for their borrowing activities. And a more transparent, direct borrowing model among urban local bodies would in turn improve the central government’s oversight of local government debt.
The question is will this happen? One reason for the general pessimism about India’s muni-bond market is that such issuances had dried up after Pune raised funds in June 2017. Since then, Hyderabad has been the only other municipal corporation to tap the markets to raise Rs 2 billion in February 2018. In fact, India has seen only 30 municipal bond issues to date from 14 urban local bodies and only Rs 15 billion has been raised through such issues.

The reasons are many, the primary one being slow implementation of municipal reforms, as a result of which the ambitious plans for urban renewal in India are currently built on the quicksand of weak city finances. According to government figures, the combined revenue receipts of all the municipalities in India is estimated to be less than Rs 1.50 trillion, with less than a third coming from own resources, thus making them increasingly reliant on state and central government grants. For example, Bengaluru taxes only a quarter of its built-up area and Surat manages to collect property tax from only 11 per cent of existing structures.  

Studies have shown the declining importance of “own revenues” in the financial structure of municipalities; it is not only that the share of own revenues has dipped, their growth rates vis-à-vis other revenue constituents have also declined. As a result, municipalities in several states are at a high risk in maintaining their fiscal identity. Since stable own revenues are a pre-requisite for the creditworthiness of municipalities, municipalities have no option but to deal with hard policy issues such as collecting local taxes, user charges, stamp duties, etc as bond investors are unlikely to put money into cities unless they are convinced about their fiscal strength.

The road ahead for muni-bonds will of course be tough. For example, Crisil did a credit rating of 94 cities in 14 states as part of the cities’ preparations for issuing bonds. Only 55 of them received investment-grade ratings and the others were below investment grade. Ratings were based on multiple criteria like the cities’ social and economic profile, operating efficiency, policy framework, recent financials etc. Moody’s says this is a consequence of limited information available on the fiscal performance, debt and contingent liabilities of these municipalities. Add weak governance to that list. After all, investors need to be convinced that municipalities will have revenue streams to service the bonds. 

In 2015, the Securities and Exchange Board of India (Sebi) sought to set matters right by easing rules for the issue of such bonds, but also mandated more timely disclosure of financial information. This is important as most municipalities do not make their accounts public. But the slow implementation of the rules reflects the significant challenges that such entities face in meeting minimum disclosure standards. This should be made mandatory as proper disclosures would reinforce public scrutiny of the financial performance of municipalities improve their debt management practices, thereby helping investors overcome information barriers. Bond, or no bond, this will at least bring in fiscal discipline for the municipalities and make them accountable and answerable for their cash flows.

One solution for the poorly rated municipal corporations can be to access the bond market through pooled finance. Many civic bodies do not sell bonds because lower-rated securities have few takers. In pooled finance, several municipalities come together to issue one bond collectively, and pay back from the revenue from their projects collectively. Investors can take comfort from the fact that there is diversification of revenue sources to service debt.

For all this to happen, what is required is to take the municipalities out of the clutches of politicians by having directly elected mayors with a proper five-year tenure. Such a mayor should be the undisputed leader of the city administration, not beholden to corporators for his continuation in office.