Municipal Bonds

What is Municipal Bonds?

Municipal bonds (also known as munis) are debt vehicles issued by state and local governments to finance their operations and fund municipal projects. Debt instrument may be a perplexing term, but think of municipal bonds as loans from lenders to state and local governments. In the case of municipal bonds, many of the lenders are individuals and institutions.

The attractiveness of municipal bonds to individual investors is that the income paid by these bonds is typically federal income tax-free. If you live in the state in which the bond was issued, the income paid by those bonds may be state income tax-free. The same goes for if you live in a county or municipality in which the bond was issued. (USA)

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. 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.
• 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, however, there is no provision as yet for listing and subsequent trading of muni bonds on stock exchanges in India.

However, making municipal bonds work in India is a dark-horse reform for Indian public policy.

Significance of Municipal bonds:

• Cities in India were estimated to require over Rs 40 lakh crore during 2011-2031 for capital infrastructure, whereas the aggregate annual revenues of municipalities are likely to be less than Rs 1.2 lakh crore (of which Mumbai alone accounts for Rs 30,000 crore).
• 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.
• Countries like South Africa and Vietnam are leveraging municipal bonds to fund large urban infrastructure development, with Johannesburg alone having issued bonds of $400 million (40% higher than cumulative issuances in India).
• 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.

Conclusion:

The Rs 50,000-crore Smart Cities Mission envisages creation of special purpose vehicles in cities that would raise monies from the capital markets. Sebi issued guidelines earlier this year for issuance of municipal bonds. Both of these are steps in the right direction, but do not cover the required distance. The Union finance ministry alone is capable of making municipal bonds work, because this requires serious domain expertise and leverage with states and regulatory institutions. SEBI, the RBI, the CBDT and the ICAI are all institutions that have roles to play and all of them fall under the broad umbrella of the Union Finance Ministry. The urban development ministry can only play a supporting role by facilitating appropriate provisions in urban schemes and shepherding State municipal administration departments. Though local self-government is a state subject, the Centre has a crucial role to play in addressing the infrastructure deficit in our cities, for which municipal bonds will be highly significant.