Municipal Bonds and its Types

Context: As per the new rules, municipal bonds will now be offered not only to financial institutions but also to the public which will be listed on stock exchanges.

Analysis

  • Municipal bonds are fixed income instruments, i.e., debt securities issued by government or semi-government institutions who need funding for civic projects.
  • The market regulator has mandated that the municipal bonds must have a rating above the investment-grade for the public issue.

Types of municipal bonds There are two types of municipal bonds —general obligation bonds and revenue bonds.

  1. General obligation bonds are issued for enhancing civic amenities such as water, sanitation, garbage disposal, etc.
  2. Revenue bonds are issued for a specific purpose such as construction of a toll road or a toll bridge.
  • Repayment of interest and principal is made from the cash flow generated from the project for which it is issued.

How big is the market?

  • Municipal bonds have been in the market since 1997 (Bangalore Municipal Corporation is the first urban local body to issue municipal bonds in India).
  1. The Ahmedabad Municipal Corporation, in 1998, was the first to make a public offering.
  2. In 2017, the Pune Municipal Corporation (PMC) became the first local body in the country to issue these in nearly 15 years, raising Rs 200 crores for the Smart City project.
  3. Indore recently becoming the first city to list municipal bonds on the National Stock Exchange (NSE).
  • As these bonds were privately placed and the participants are financial institutions and pension funds, these were not tradable.
  • private placement is a sale of stock shares or bonds to pre-selected investors and institutions rather than on the open market.
  • SEBI had circulated detailed guidelines for urban local bodies (ULBs) in 2015 to raise funds by issuing municipal bonds.
  • The municipality must not have a negative net worth in each of the three previous years.
  1. The issuer (municipal corporations) should get the bonds rated by credit rating agencies.
  2. There should be no default in any kind of loan in the past one year and it must maintain full collateral/asset cover to repay the principal amount. 
  3. For revenue bond, the revenue generated from the project should be kept in a separate escrow account and financial institutions would monitor their accounts regularly.
  • In India, the share of municipal bonds in the total debt market is nonetheless insignificant; only 1 per cent of urban bodies financial needs are met through municipal bonds as opposed to 10 per cent in the US.
  • This is because the municipal bonds in the debt market have poor ratings. 
  • The municipal bond market has not garnered interest from banks, foreign portfolio investors or local investors due to a lack of adequate disclosure among Indian municipalities.
  • To rectify this, the Ministry of Housing and Urban Development is compiling a database of audited annual accounts in line with international standards for local bodies for the first time. 
  • In Smart Cities Mission (SCM), it was envisaged that Centre/State/ULB funds will meet only a part of the project cost and balance funds are expected to be mobilised from various innovative finance mechanisms such as municipal bonds with credit rating of ULBs.
  • Under the government’s smart city initiative, Special Purpose Vehicles (SPVs) have been set up at city level in the form of a limited company under the Companies Act for implementing the projects. They are promoted by the state government or union territory and the urban local body of the area.
  • The amended regulations would also permit raising funds through municipal bonds by SPVs set up for implementing smart city projects.
  • In case of private placements, the minimum subscription amount per investor was currently clocked in at Rs 25 lakh, but has now been reduced to Rs 10 lakh to align it with the regulations for corporate bonds.
  • Under the Atal Mission for Rejuvenation and Urban Transformation (AMRUT) scheme, cities have been encouraged to mobilize resources by issuing municipal bonds.
  • These are issued when a government body wants to raise funds for infra-related projects like roads, water among others.

FPIs get RBI nod to invest in municipal bonds (IE)

  • The Reserve Bank of India in April 2019 further eased norms for foreign portfolio investors (FPIs) by allowing them to invest in municipal bonds under prescribed limits to broaden access of non–resident investors to debt instruments in India.
  • The limits for investing in these municipal bonds are to be set within the limits for FPI investment in state development loans (SDLs).
  • The limits set for SDLs generally amount to 2 per cent of outstanding securities.
  • Investing in municipal bonds in India is not a popular opinion as majority municipalities are not cash rich.
  • But if FPIs start investing in these bonds, the domestic players also might find interest and also could prove to be a good income source for municipalities.
  • The central bank had in March 2019 eased norms by introducing the voluntary retention route (VRR), allowing FPI investments through the route free of regulatory norms provided they maintain a share of their investments for a fixed period.
  • In February 2019, the RBI also withdrew its April 2018 regulation, wherein no FPI was allowed an exposure of more than 20 per cent of its corporate bond portfolio to a single corporate.
  • FPIs have been investing in various debt market instruments, such as government bonds, state development loans and corporate bonds, but with prescribed limits and restrictions by the central bank.

Are municipal bonds the best/viable alternative available? What are the other sources through which SPVs can raise money for smart city projects?

  • Other than municipal bonds, there are various innovative fiscal tools, such as Value Capture Financing (VCF) that are currently being explored by state/local governments, many of which have also been in existence for a few years.
  • Some VCF methods that can be adopted or have been in place for the past few years are: land value tax, vacant land tax, fees for changing land use, betterment levy, development charges, transfer of development rights (TDRs), premium on relaxation of FSI/FAR, tax increment financing (TIF), land acquisition and development, land pooling system (LPS), among others.
  • The most recent is the government’s proposal to set up a new DFI (Development Finance Institution), to principally fill the gap in long-term finance.
  • Most urban local bodies do not have the institutional agency to raise funds, systemise accounting, and put up bankable projects.
  • In order to address this, the reforms enlisted in the 15th Finance Commission (which makes it mandatory for urban local bodies to submit audited accounts by linking them to grant disbursement) must be implemented. 

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