Financing of urban local bodies in India

Financing of urban local bodies in India

In recent months, there has been a discussion on developing the municipal bond market, which despite many efforts by the central government, Securities and Exchange Board of India (Sebi) and the Reserve Bank of India (RBI) has been in a nascent stage. In the context of increasing need to develop bond markets in the country, municipal bonds would play a significant role.

The need arises from manifold phases of infrastructural development and rapid urbanising underway in India. The urban population increased from eight crore in 1961 to 38 crore in 2011, and is estimated to reach 47 crore in 2021 and 70 crore by 2041. And the current levels of infrastructure, both urban and rural, are not enough to meet demands of the growing population.

In India, in 2011, 4,041 towns had urban local bodies (ULBs). In general, financial resources of urban local bodies are scarce, and unable to meet the expenditure requirements, and therefore the dependence on other two upper tiers of government is substantial. The resource base of ULBs typically consists of their own sources, state revenue, government grant, loans from state governments, and market borrowings. Over and above their own revenue, which is generally meagre, most local bodies significantly depend upon the devolution of resources and grants from the state and central governments. To meet the rising financial requirements, new sources of funding would also need to be explored. The Indian investor has yet not explored the municipal bonds market, which needs to be examined.

Nascent phases

The concept of municipal bonds is in its nascent stage in India, compared with other advanced countries like the US, where this is an important source of financing urban infrastructure. In India, 28 municipal bond issues had been made during 1997-2013, mobilising funds amounting to approximately Rs 3,000 crore with a tenor ranging between 5 and 15 years.

A noteworthy step in the history of municipal bonds in India was by the Ahmedabad Municipal Corporation, in 1998. Ahmedabad Municipal Corporation made the first municipal bond issue in India, without a state government guarantee. This involved raising Rs 100 crore from the capital market, and comprised 25% public placement and 75% private placement. Prior to this, in 1997, the then Bangalore Municipal Corporation had issued bonds guaranteed by the state government. Again, the first launch of tax-free municipal bonds was made by the Ahmedabad Municipal Corporation in 2002, for Rs 60 crore.

The value of municipal bond issuances was on a rise until 2005, but it has dropped sharply since then. The last municipal bond issue in India was in 2010 by the Greater Vishakhapatnam Municipal Corporation for Rs 30 crore.

The central government had earlier approved the Pooled Finance Development Fund Scheme in 2006. This was done mainly to benefit the ULBs, by providing credit enhancement to them, so as to access market borrowings on the basis of their credit worthiness through the State-Level-Pooled Finance Mechanism. Implementation of the Pooled Finance Mechanism requires setting up of a ‘State Pooled Finance Entity’ in every state. One of the objectives of this scheme was to facilitate development of the municipal bond market in the country. The states which have established their ‘State Pooled Finance Entity’ are Andhra Pradesh, Assam, Karnataka, Kerala, Nagaland, Odisha, Rajasthan and Tamil Nadu.

Reluctant investors

The municipal bond market in India has difficulties due to reluctant investors, unclear regulation and low credit ratings. There are constraints on the supply and demand side that limit the development of municipal bond market. The supply side constraints include small number of credit-worthy issuers, lack of financially viable projects and numerous administrative problems. Municipal credit-worthiness depends on the quality of accounting and financial management, availability of reliable financial data, and human resources available at the local government level.

The demand side constraints include lack of demand from main investors like banks, insurance companies and provident funds because municipal bonds are relatively illiquid investment and therefore exit is difficult in times of need. Finally, municipal bonds do not enjoy the status of gilt-edge and therefore risk-weight is high.

To instil confidence in the local bodies, increase volume of bonds, and lend credibility to attract investors, India could consider a National Local Body Financing Authority (NLBFA) at the national level and a State Local Body Financing Authority (SLBFA) to meet the requirements of urban local bodies. These entities would function in close coordination with the central and the state governments. First and foremost, NLBFA and SLBFA could focus on standardisation of budget making processes by the urban bodies, assess the financial requirements of feasible projects, train the relevant personnel in budget accounting and policy preparation, and tap the capital markets.

Projects chosen for development through such bond floatations should be such that they appeal to local sensibilities as local population could be the potential investors. The local authorities, who sponsor the project, being closer to the local population, would be accountable and responsible for delivery of projects.

Therefore, for the local body bond market to pick up pace in India, necessary improvements such as adopting modern accounting practices and systems for recording transactions, maintaining regular accounts in the financial accounting of urban local bodies, proper audit of accounts and annual budget-making would be necessary. A formal and standardised system of data maintenance and dissemination of information would also be helpful. Similarly, a regular system of monitoring, auditing and evaluation may also be required to instil confidence in potential investors. This is an arduous task and would take a long time, as did the development of government securities market in India. Perhaps, the Central Government could consider an empowered group of ministers to steer the municipal bonds market, similar to the successful adoption of GST in India.

(The author is the RBI Chair Professor in Economics, IIM Bangalore. Views are personal. The article draws heaving from Financing of Urban Local Bodies in India, IIM Bangalore Research Paper No. 493 by Charan Singh and Chiranjiv Singh)

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