Scaling up municipal bond issuances

Despite being one of India’s longest-running development finance pilots, India’s municipal bond (muni-bond) market has remained shallow. Since the early muni-bond issuances in the mid-1990s, there were over 20 such issuances (including a few pooled bond issuances) that collectively raised nearly Rs 1,500 crore, modest relative to India’s burgeoning urban investment needs. Even cities that did tap capital markets mostly did so in the form of one-off “testing-the-water” issuances rather than as a resource mobilisation stream to address financing gaps sustainably.

Given this backdrop, the spurt in muni-bond issuance in recent years — over Rs 1,400 crore by seven cities since 2015 — is a green shoot that needs to be nurtured a bit differently, to secure dramatically better outcomes in future, compared to what we have to show from the past. Two factors have specifically helped. 

First, there has been a concerted policy push by the government of India. Support to credit ratings of cities and interest subsidy incentives to cities issuing muni-bonds have helped. In December 2016, no less than the prime minister emphasised that at least ten cities should access the capital markets within a year’s time, reinforcing the strong policy commitment. 

Second, there have been positive moves from regulators. In 2015, the Securities Exchange Board of India (Sebi) released its “Issue and Listing of Debt Securities by Municipalities” regulations to provide specific guidance for municipal bodies seeking to tap the capital markets. Earlier this year, foreign portfolio investors (FPIs) have been allowed to invest in muni-bonds. Recent press reports suggest further measures in the offing, including removing the distinction between revenue and general obligation bonds for public issuances, changes to limits on private placements, allowing entities other than city governments (including SPVs and para-statal agencies) to issue muni-bonds, and so on.

Notwithstanding these positives, very few Indian cities still consistently meet creditworthiness thresholds that hard-nosed capital market investors look for. Of the 94 cities assigned a credit rating until December 2017, only 16 cities secured ratings above A. Three constraints underpin the credit weakness of city governments. 

First, barring exceptions, revenue reforms in Urban Local Bodies (ULBs) and civic agencies have been frustratingly slow to come by. Own source revenues are rarely buoyant. Few states have set up effective State Finance Commissions and even where these have been present, their recommendations rarely get implemented in letter and spirit.

The spurt in municipal bond offerings in recent years — over Rs 1,400 crore by seven cities since 2015 — is a green shoot that needs to be nurtured, to secure much better outcomes in future
Second, the relatively higher flow of government grants in recent years to ULBs has not been backed by commensurate institutional capacity to build infrastructure in a timely manner and to effectively deliver services. Even as cities face financial constraints to borrow to plug larger infrastructure gaps, they paradoxically end up not even utilising funds made available to them as grants. 

Third, despite initiatives on accrual accounting for over two decades, many cities have relapsed into cash-based accounting and information disclosures remains poor. Delays in audits of accounts, and poor harmonisation of accounting practices further compound information gaps, effective analysis and targeted problem-solving. 

Given that the universe of “near-to-capital market access” cities is a small consideration set, it may be worthwhile for the government of India to direct a transformation effort directed at a few relatively capable cities: 

1.Akin to countries identifying better sporting talent and taking it through a rigorous multi-year training effort for Olympic success, the central government should direct its efforts on a select shortlist of about 30 relatively more capable cities that meet minimum fiscal fitness thresholds. City-level credit ratings undertaken recently could be a useful criterion for short-listing cities. With AA being a threshold level of ratings to successfully tap capital markets in India, cities selected should ideally have a rating of A-and-above and definitely not below BBB. 

2. Short-listed cities, with the support of the central government and the respective state governments, should be extended a programmatic multi-year support for structural reforms to better their credit standing, including: (i) Fostering stable and buoyant revenues through tax reforms, rationalisation of user charges and a predictable devolution regime; (ii) shifting from static annual budgets to rolling multi-year investment plans; (iii) strengthening institutional capacity, including dedicated teams/cells for project preparation and debt management; and (iv) implementing robust financial management, accounting and information disclosure standards. 

3. Enlisting the support of state governments will be crucial. Apart from states having the decision-making power to operationalise these reforms, they will be critical to replicating this transformation effort in other cities as early benefits from this programme creates peer pressure for other cities to join the bandwagon. 

When 20 ULBs are transformed into bankable entities equipped to raise and service a modest Rs 500 crore of debt annually, the result is a Rs 10,000-crore muni-bond market. Even if five state governments raise an additional Rs 2000 crore each through pooled financing entities, a Rs 20,000 crore annual muni-bond market can possibly open up in a five-to-eight-year timeframe. The multiplier effect at this scale can be immensely transformational and will drive faster and wider replication. 

Many urban infrastructure projects have sizeable viability gaps and require complementary grant financing and financing from other sources, such as private investment, bank loans, non-profits, and development financing institutions. Muni-bonds are thus just one element of financing. However, what sets it apart is that a scaled-up muni-bond market is a sure shot marker of a relatively more efficient, transparent and accountable civic services ecosystem, something that India’s citizens truly deserve.  

The writer is Director, CRISIL Infrastructure Advisory

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