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Why India needs a thriving Municipal bond market

Why India needs a thriving Municipal bond market

By Priya Kumari

With the increasing scale of urbanization and the agenda of developing smart cities in India, there are numerous capital intensive projects which are under progress. These are meant to serve a diverse set of purposes, including water treatment plans, public hospitals, construction of bridges and highways, sewage treatment plants, disaster management, and many more. The conventional sources of funding for the municipal bodies, like taxes and government grants are under severe stress. Therefore, municipal bonds become an increasingly important avenue to explore.

Introducing the debt instrument

Municipal bonds are debt instruments issued by municipal bodies in urban areas to raise funds from the investors in return for payment of the interest as per a specified payment cycle and the principal at maturity. They can be revenue bonds when the principal and interest are paid back using the revenues of the specific projects they were issued for. They can be general bonds where the repayment of principal and interest is guaranteed by the tax revenue of the issuer. While municipal bonds have been in existence since 1997, they were mainly available to institutional investors through private placement. The government had amended the Income Tax Act in 2001 to allow the local bodies to raise funds through taxfree bonds. Large institutional investors like pension funds can find these as less risky positions to take up.

Municipal bonds have evolved as a wonderful source of financing urban infrastructural projects. For example, Ahmedabad Municipal Corporation, in April 2002, issued a tax-free 10-year bond worth Rs. 1000 crore for water supply and sewerage infrastructure projects. To secure the interests of the investors, the SEBI announced certain guidelines in 2015 to clear the air of uncertainty about the quality of these investment avenues. These specify conditions like no default in the past 1 year, investment grade credit rating of the issuing body, a mandated guarantee from the State Government or Central Government, maintaining 100% asset cover sufficient to discharge the principal amount at all times for the debt securities issued, etc. All these conditions play a significant role in promoting municipal bonds as worthwhile investment avenues.

Analysing the need for a bond market

Going forward, India needs a well-developed municipal bond market for numerous reasons. Municipal bonds help the urban bodies to bridge funding gap. With implementation of GST, the revenues of various states are likely to take a hit. For example, BMC secures nearly 33% of its revenues through the octroi tax. In such an event, Municipal bonds will prove to be an alternative source of funding. As per the estimates of the Rating agency CARE, large municipalities could raise ₹1,000 to ₹1,500 crores every year through such bonds. Besides offering tax saving advantage, they also come up as safe positions to invest in for low risk appetite members of the public looking for products beyond the conventional fixed deposits. The demand side is constrained by the conservative sentiment of institutional investors. However, the supply side faces the heat due to a few municipal bodies with good creditworthiness and reliance on old and established methods of project financing by government entities. The urban bodies issuing municipal bonds can be incentivised through additional grants based on their creditworthiness to enable more and more issuance of such bonds.

Safeguarding the municipal bonds market, plugging the existing loopholes and increasing their penetration will go a long way in improving the efficiency of this market and thus help the government fulfil massive investment requirements for improving urban infrastructure.

References: http://www.sebi.gov.in/cms/sebi_data/boardmeeting/1427355160818a.pdf http://www.thehindu.com/business/Economy/Centretopopularisemunicipalbonds/article14628632.ece

Featured Image Source: http://www.investopedia.com/articles/investing/120816/muni-bond-returns-hurt-rates-rise-nchrx-vedtx-xmpt.asp 

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