Muni Bonds are the missing piece in India’s Urban Infrastructure puzzle

‘Municipal Bonds’ or ‘Muni Bond’ was first introduced in the Indian landscape in 1997 by the Bruhat Bengaluru Municipal Corporation (BBMP). The Bengaluru urban local body raised ₹125 crore to construct city roads and drains. After this, it was expected that municipal bonds would soon emerge as a reliable source of revenue for municipalities to undertake developmental projects. Consequently, this would reduce their dependence on government grants to meet their operational requirements.

Urban Local Bodies (ULB) in India have raised ₹5,901.5 crores through the municipal bond market, out of which ₹3,840 crores was raised in 2017-21. On the other hand, the municipal bond market in the United States of America has swelled up to $4 trillion as of March 2023. It could be argued that the success of debt securities in the West is because cities there are much more prosperous and developed—meaning the presence of surplus money—which they could park in ‘Muni bonds’. In the Indian context, the lack of success of the securities issued by Indian corporations could be attributed to the lack of confidence in the municipal bond market. People generally invest in secure and profitable avenues of investment, and the poor performance and financial position of Indian local bodies give the impression that could be called anything but secure.

Since municipal bonds are a risky avenue for investment, corporations have to offer higher interest on their securities compared to the ones issued by other entities like the Government of India. Apart from that, the report titled, “Assessing the Financial Health of Indian Cities” highlights that major corporations in India are incurring losses. They are spending more than they earn. These loss-making corporations include the capital cities’ corporations such as Raipur, Shimla, Jaipur, and Chennai.

The cumulative effects of these factors render muni bonds incapable of competing against securities issued by more credit-worthy institutions, such as banks, the government of India, and other commercial entities.

DEPENDENCY ON GRANTS

A World Bank report has highlighted that India would require $840 billion to meet the demands of the increasing urban population in the next 15 years. Muni bonds could be a gamechanger in financing the infrastructure development in India. However, as per an article published by the Centre for Public Policy Research (CPPR), the government of India identified that only 35 municipal bodies in India are eligible to raise money by floating securities. Considering that India has over 5,000 urban local bodies, this small number of 35 should be unnerving for the people who are hoping to see civic bodies become self-sufficient.

The prime factor that hampers the ability of civic bodies in India on their security is their heavy dependence on government grants. Even a big corporation like the Brihanmumbai Municipal Corporation (BMC), gets more than one-fourth of its budget as government grants. In 2021-22 alone, BMC received ₹12,528 crores as government grants, an amount equivalent to 26 per cent of its ₹47,058 crore budget.

Additionally, it is essential for the municipalities not to have negative net worth if they hope to float bonds. It is a basic requirement most civic bodies might not be able to satisfy. Because of this, they could not acquire an A+ rating, another major eligibility criterion to float securities, and as per the Ministry of Housing and Urban Affairs, only 15 corporations satisfy this condition.

However, the report “Assessing the Financial Health of Indian Cities” published by the National Institute of Urban Affairs (NIUA), shows that some of the major corporations are showing negative trends. For example, during 2017-18 and 2019-20, civic bodies in Raipur, Shimla, Jaipur, and Chennai have been revenue-negative for the past three consecutive years. The report also highlights that “58% of the covered MCs with outstanding debt, had a low or even negative interest cover.”

It is important to note that this poor financial position does not dissuade the municipalities from incurring capital expenditure. More than two-thirds of the cities covered by the NIUA report spend 25-40 per cent of their total budget on capital expenditure.

BANKS AND G-SEC VS MUNI BONDS

Another major challenge before muni bonds is competition with other avenues of investments offered by financial institutions such as banks and government securities. The banking business is on the boom. As per RBI, bank deposits have swelled by 6.6 per cent, reaching ₹149.2 lakh crore in April-August 2023, and bank credit has increased to ₹124.5 lakh crore, recording a 9.1 per cent growth.

This clearly demonstrates that banks are fully capable of providing superior returns in comparison to civic bodies. For example, DCB offers a 7.75 per cent return on a term deposit of 25 to 37 months, and the Punjab & Sindh Bank offers a 7.4 per cent return. Similarly, small finance banks offer a 9 per cent return on a term deposit of 1001 days.

Similarly, as of October 2023, the Reserve Bank of India prescribed the base rate at 8.85 per cent to 10.10 per cent. The term deposit rate has been pegged at 6-7.25 per cent. This shows that even if banks stick to the rate prescribed by RBI, they would still be making a profit. If the civic body wants to make their bonds popular in the market, then they have to offer returns higher or equivalent to the ones offered by their competitors.

The issuer’s bond return is significantly impacted by their performance. Any positive or negative changes in the issuer’s performance can have a direct impact on the returns, and the performance of civic bodies in India is secret to none. This makes muni bonds a risky avenue for investment, and the higher the risk the more interest one must pay to borrow from the market. RBI’s Report on municipal finance highlights this phenomenon. It shows that municipal bodies have to pay higher interest rates on their bonds compared to the ones issued by the Government of India or any other entity for the same maturity period.

OTHER CHALLENGES

Apart from these performance issues, municipal bonds also have to grapple with the political challenge. A MoHUA report says, “In most State legislation, ULBs require approval of the State governments for bond issuance or raising debt.” This would be a difficult feat to achieve when different parties are in power in the state and in ULBs.

Apart from that, “Lack of a secondary market for municipal bonds has been a critical constraint in attracting a more extensive investor base for these securities.” In the absence of a secondary market, the investor could not sell the muni bonds if he felt the need to pull out the money he had parked in the bond.

Although municipal bonds have not met expectations, their potential remains undeniable. What we need to do is reduce the dependency on government grants, foster financial investment through greater transparency and better governance, and list municipal bonds on the stock exchange to create a secondary market essential for the healthy growth of the municipal bond market.

Criteria to float Muni Bonds:

♦ Municipality shall have surplus income as per its Income and Expenditure Statement in the immediately preceding three financial years.
♦ Municipality shall not have defaulted on the repayment of debt securities or loans.
♦ A minimum credit rating of A+ is required from at least one of the recognised credit rating agencies.