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September 04, 2019

A roadmap to scale up India’s Municipal Bond program

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. 1500 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 mobilization stream to address financing gaps sustainably.


Given this backdrop, the spurt in muni-bond issuance in recent years – over Rs. 1400 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. 


Firstly, a concerted policy push by Government of India. Support to credit ratings of cities and interest subsidy incentives to cities issuing muni-bonds has helped. In December 2016, no less than the Prime Minister emphasized that at least ten cities should access Capital Markets within a year’s time, reinforcing the strong policy commitment. 


Secondly, 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 capital markets. Earlier this year, 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 parastatal agencies to issue muni-bonds etc.


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 till December 2017, only 16 cities secured ratings above A. Three constraints underpin credit weakness of city governments.  


  • Barring exception, 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 present, their recommendations rarely get implemented in letter and spirit.
  • The relatively higher flow of government grants in recent years to ULBs have not been backed with 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. 
  • 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 harmonization 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:


  • Akin to countries identifying better sporting talent and taking them through a rigorous multi-year training effort for Olympic success, the Government of India should direct their efforts on select shortlist of about 30 relatively more capable cities that meet minimum fiscal fitness thresholds. City level credit ratings undertaken recently could a useful criteria to shortlist 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. 
  • Shortlisted cities, with support of GoI and respective State Governments, should be extended a programmatic multi-year support for structural reforms to better their credit standing including: (1) Fostering stable and buoyant revenues through tax reforms, rationalization of user charges and a predictable devolution regime, (2) Shifting from static annual budgets to rolling multi-year investment plans, (3) Strengthening institutional capacity including dedicated teams/cells for project preparation and debt management and (4) Implementing robust financial management, accounting and information disclosure standards. 
  • Enlisting the support of Since State Governments will be crucial. Apart from States having the decision-making power to operationalize these reforms, they will be critical to replicating this transformation effort in other cities as early benefits from this program creates peer pressure for other cities to join the bandwagon. 

When 20 ULBs are transformed into bankable entities equipped to raise, service a modest Rs. 500 crore of debt annually, the result is a Rs. 10,000 crore muni-bond market. Even 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 5-8 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 viz., 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.