Insights into Editorial: Using municipal bonds to bolster city finances
It is estimated that Indian cities would collectively need to invest around Rs40 trillion at constant prices in the two decades to 2031. Some 600 million Indians will be living in cities by then. The inability of cities to meet their growing needs will not only throw the economy off the rails but also create social tensions. However, Indian cities do not have the financial capability to build this infrastructure. In this context, the news that Pune is getting ready to launch the biggest Indian municipal bond issue needs to be welcomed—but with caution.
City revenue is less than 1% of gross domestic product. And the share of own revenue in city budgets has been declining consistently. The net result is that cities do not have adequate financial autonomy—a flaw that can be traced back to the landmark 74th constitutional amendment that empowered local governments. Cities depend heavily on money passed to them from either the national or the state governments.
What are Municipal Bonds?
A municipal bond is a bond issued by a local government, or their agencies. They are very popular among investors in many developed nations, especially in the U.S., where these have attracted investments totalling over $500 billion and are among preferred avenues for household savings.
Municipal Bonds in India:
With cumulative issuance of less than Rs 2,000 crore since the first issue in 1997, the municipal bonds market in India is virtually non-existent.
- In India, the Bangalore Municipal Corporation was the first municipal corporation to issue a municipal bond of Rs.125 crore with a State guarantee in 1997. However, the access to capital market commenced in January 1998, when the Ahmedabad Municipal Corporation (AMC) issued the first municipal bonds in the country without State government guarantee for financing infrastructure projects in the city. AMC raised Rs.100 crore through its public issue.
- Among others, Hyderabad, Nashik, Visakhapatnam, Chennai and Nagpur municipal authorities have issued such bonds.
Need for such bonds:
- There is massive capital investment need in municipal infrastructure and funds from programmes such as Jawaharlal Nehru National Urban Renewal Mission (JNNURM) can only partly meet the requirement. Therefore, to meet their financing needs, the municipalities have to seek recourse to other means including issuance of municipal bonds. Municipal bonds can quite obviously play a pivotal, singular role in funding this gap.
- Municipal bonds can also simultaneously deepen the long-term infrastructure financing market in India as well as redirect retail investments into liquid securities (by city residents) away from real estate and gold.
- By creating opportunities for citizens (as retail investors) to invest in tangible public causes in their cities, these bonds can also build strong bonds of trust between municipalities and citizens; bonds of trust that can galvanise citizen participation in cities at historic scale and to mutual financial benefit.
What needs to be done to jumpstart the municipal bonds market in India?
- A long-term roadmap to financial self-sufficiency of municipalities needs to be drawn up covering powers over revenues and borrowings, efficiency of revenue administration (both assessments and collections) and systematic measurement, reporting and review of revenue performance. Such a roadmap will require collaborative effort between the Centre and the states.
- There is a crying need to professionalise financial management in municipalities. The scale of funding required for public expenditure in our cities cannot be met with the human resources (both in terms of numbers and skills and competencies) that they currently possess. The revenue and finance departments of municipalities need to be urgently professionalised and made market-oriented. The Institute of Chartered Accountants of India can play a significant role here.
- There needs to be a deliberate creation and positioning of the municipal bond brand to make it popular among citizens, and a slew of enabling measures to make them attractive.
- Enabling measures such as making all municipal bond issuances tax-free, making investments in muni bonds by banks part of their priority sector lending and actively encouraging pension funds and insurance companies to participate in municipal bond issuances need to be put into place by respective regulators. These are presently crucial missing links.
- Municipalities need to produce audited balance sheets each financial year and get themselves credit-rated so that they are able to access the municipal bond market in a credible and sustained manner.
- An agency that is ready to take some of the risk out of municipal bonds—through market making, credit enhancement and underwriting should be created.
However, bonds are merely a way to collect money today based on revenue to be generated tomorrow. They are not a substitute for city revenue. So cities will still have to deal with hard policy issues such as collecting local taxes, user charges, stamp duties, etc. Bond investors are unlikely to put money into cities unless they are convinced about their fiscal strength. Some policy innovations may be needed till a proper market for bond insurance is in place.
Municipal bonds should thus be seen as only one part of a larger package to strengthen city finances. Cities need to generate more revenue as well as get more untied funds from the money collected through the new goods and services tax. And to pull this all together will require city administrations that are empowered. Having directly elected mayors is an idea whose time has arrived.