BANKING AND FINANCE 906

Municipal Bonds and India

Municipal Bonds have been a grand success in western countries, particularly in United States of America. Municipal
Bonds are not a so widely used instrument in India. This article focuses on Municipal Bonds in Indian market – as a
viable investment option and an instrument for raising public funds for infrastructural development of the country.
This article also discusses what are municipal bonds, their types and features, their success in western countries,
why these investment instruments are not common in India, obstacles in Indian municipal bonds market, the need and
benefits of municipal bonds in the growing and maturing Indian economy and the need of support from markets and
regulatory authorities for municipal bonds.

The capital market comprises liquidity, and flexibility in structuring

equities and debt market. Debt a portfolio, easier monitoring, long
market is a market for issuance, term reliability and decent returns.
trading and settlement in fixed They are an essential component
income securities of various of any portfolio of financial and
types. Fixed income securities real assets, in the form of pure
can be issued by a wide range of interest-bearing bonds or asset-
organisations including the Central backed mortgages or securitised
and State Governments, public instruments. Examples of Fixed
bodies, statutory corporations, income securities are Bonds
banks, institutions and corporates. (Municipal Bonds, Treasury Bonds,
Corporate bonds, etc.), Fixed
Fixed Income securities – as an Deposits, etc.
investment option – have been Fixed income securities are one
very successful in the investment of the most dynamic instruments in
world, more particularly in the the financial system; interest and
West, when it comes to retail time-value of money being the two
investor participation, since they crucial factors.
are regarded as safe, less volatile
and considered reliable, able to Bonds
generate fixed returns over a period Simply put, a bond is a debt
Anand Wadadekar of time, with less risk of default. security. According to Wikipedia,
(The author is working as a Specialist – Port- Fixed income securities offer one when we purchase a bond, we
folio Performance Measurement with a US of the most attractive investment lend money to a government,
based Asset Management Company. He can
be reached at [email protected]) opportunities in regard to their municipality, corporation, federal
safety of investments, adequate agency or other entity, known as an

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imply put, a bond income tax. In addition, munis often Working of Municipal Bonds in
is a debt security. represent investments in state the West
According to and local government projects As mentioned earlier, Municipal
Wikipedia, when that have an impact on the daily bonds are issued by states, cities,
we purchase lives, including schools, highways, and public organisations, to raise
a bond, we lend money to hospitals, housing, sewer systems funds. The methods and traces
a government, municipality, and other important public of issuing debt are governed by
corporation, federal agency projects. an extensive system of laws and
or other entity, known as an regulations, which vary by state.
issuer. In return for that Corporate Bonds Bonds bear interest at either a fixed
money, the issuer provides A corporate bond is a bond issued or variable rate, which can be sub-
us with a bond in which it by a corporation, other than a ject to a cap known as the maxi-
promises to pay a specified government or likewise. It is a mum legal limit. If a bond measure
rate of interest during the life bond that a corporation issues to is proposed in a local county
of the bond and to repay the raise money in order to expand its election, a Tax Rate Statement may
face value of the bond (the business. These are usually longer- be provided to voters, detailing best
principal) when it matures, or term debt instruments, generally estimates of the tax rate required
comes due. with a maturity date falling at least a to levy and fund the bond.
year after their issue date. The term The issuer of a municipal bond
issuer. In return for that money, "commercial paper" is sometimes receives a cash payment at the
the issuer provides us with a bond used for instruments with a shorter time of issuance in exchange for
in which it promises to pay a maturity. a promise to repay the investors
specified rate of interest during who provide the cash payment (the
the life of the bond and to repay Municipal Bonds bond holder) over time. Repayment
the face value of the bond (the A municipal bond is a bond issued periods can be as short as a few
principal) when it matures, or by a city or other local government, months (although this is rare) to 20,
comes due. In United States, or their agencies. Potential issuers 30, or 40 years, or even longer.
the types of bonds available for of municipal bonds include The issuer typically uses
investment are U.S. government cities, counties, redevelopment proceeds from a bond sale to pay
securities, municipal bonds, agencies, special-purpose districts, for capital projects or for other
corporate bonds, mortgage and school districts, public utility purposes it cannot or does not de-
asset-backed securities, federal districts, publicly owned airports sire to pay for immediately with
agency securities and foreign and seaports, and any other funds on hand. Tax regulations
government bonds. Bonds are also governmental entity (or group of governing municipal bonds
called Bills, Notes, Debt securities, governments). Municipal bonds generally require all money raised
or Debt obligations. may be general obligations of the by a bond sale to be spent on one-
issuer or secured by specified time capital projects within three
Types of Bonds revenues. Interest income received to five years of issuance. Certain
Zero-Coupon Bonds by holders of municipal bonds exceptions permit the issuance
This is a type of bond that makes is often exempt from the federal of bonds to fund other items,
no coupon (interest) payments but income tax and from the income including ongoing operations
instead is issued at a considerable tax of the state in which they are and maintenance expenses, the
discount to par value. For example, issued, although municipal bonds purchase of single-family and multi-
a zero-coupon bond with a $1,000 issued for certain purposes may family mortgages, and the funding
par value and ten years to maturity not be tax exempt. of student loans, among many
is trading at $600; you'd be paying Municipal bonds are debt other things.
$600 today for a bond that will be obligations issued by states, cities, Because of the special tax-
worth $1,000 in ten years. counties and other governmental exempt status of most municipal
entities, which use the money bonds, investors usually accept
Municipal Bonds for infrastructural development lower interest payments than on
Municipal Bonds, also known as like, building schools, highways, other types of borrowing (assuming
“munis”, (in United States) are hospitals, sewage systems,  and comparable risk). This makes the
attractive to many investors because many other projects for the public issuance of bonds an attractive
the interest income is exempt from good. source of financing to many

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BANKING AND FINANCE 908

municipal entities, as the borrowing it is one of the highest yielding debt Municipal Corporation came out
rate available in the open market instruments. The municipal bond with bonds in 1998 that were not
is frequently lower than what is market is a specialised segment backed by a similar guarantee.
available through other borrowing of the debt market. In US, most R125 crore issue of eight-year
channels. urban infrastructural projects like bonds by the Bangalore Municipal
Municipal bonds are one of water supply and sewerage are Corporation in September, 1997,
several ways states, cities and funded through issue of municipal followed by an R100 crore issue
counties can issue debt. Other bonds. Also, the secondary market of seven-year bonds by the
mechanisms include certificates for municipal bonds is active, with Ahmedabad Municipal Corporation
of participation and lease-buyback sufficient liquidity. Some municipal in January, 1998 were the two Bond
agreements. While these methods bonds are tax exempt, thereby issues by municipal corporations.
of borrowing differ in legal structure, lowering the cost of borrowing Pune Municipal Corporation (PMC)
they are similar to the municipal of the issuer. The credit rating approached CARE for a credit
bonds described in this article. mechanism of the municipal bonds rating of its proposed R2000 million
is very robust, creating a sense of General Obligation Bond issue and
The two basic types of municipal surety and confidence among the was rated CARE AA.
bonds are: investors. The Indian federation has a
three-tier structure: Government
General obligation bonds: Municipal Bond Market and India of India comprises the first tier,
Principal and interest are secured Municipal Bonds hold good the state governments and union
by full faith and credit of the issuer potential in urban infrastructural territories comprise the second,
and usually supported by either development and financing. The while the urban and rural local
the issuer’s unlimited or limited scenario seems likely to change, self-governments (local bodies)
taxing power. given more than R1 lakh crore of make up the third tier. Of the 3,682
urban infrastructure investment urban local bodies in India, 96 are
Revenue bonds: Principal and estimated over the next five years. municipal corporations while the
interest are secured by revenues In India, a beginning in this rest are municipalities. Of these
derived from tolls, charges or direction was made in the late 96, seven are in 'mega cities' with
rents from the facility built with the 1990s, but the momentum was populations in excess of 4 million,
proceeds of the bond issue. Public not maintained. The Bangalore and 28 in cities with populations
projects financed by revenue bonds Municipal Corporation was the between 1 million and 4 million.
include toll roads, bridges, airports, first municipal body to raise funds The 35 cities with populations in
water and sewage treatment by issuing bonds, backed by state excess of 1 million are likely to
facilities, hospitals and subsidised government guarantee in 1997. On experience urbanisation growth
housing. Many of these bonds the other hand, the Ahmedabad and infrastructure spending that is

A
are issued by special authorities significantly in excess of the national
municipal bond
created for that particular purpose. average, whereas the others are
is a bond issued
Most municipal notes and bonds are also likely to see robust growth.
by a city or other
issued in minimum denominations Overall economic growth will be
local government,
of $5,000 or multiples of $5,000. the key driver for urbanisation,
or their agencies.
which must be powered by strong
Potential issuers of municipal
Success in Western Countries infrastructure. Municipal bonds
bonds include cities, counties,
In the United States, it is common will be the key enabler in building
redevelopment agencies,
for the various state governments this infrastructure. With increasing
special-purpose districts,
to fund major infrastructure projects urbanisation, pushing demand for
school districts, public utility
by issuing municipal bonds (or infrastructure and the Government
districts, publicly owned
munis) by leveraging the federal, of India's thrust for infrastructure
airports and seaports, and
state and local body finances. development, a bonds-backed
any other governmental entity
The US Municipal Bond market is urban revolution seems a viable
(or group of governments).
$2.2 trillion strong and forms nearly route.
Municipal bonds may be
more than 12% of the total debt By encouraging municipal
general obligations of the
market. With more than $300 billion bodies to approach the capital
issuer or secured by specified
worth such bonds issued in 2005- market to raise funds, the efficiency
revenues.
2006, given its tax deductible nature, of these bodies could also be

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n the United the only two states to have raised Committees in India, with state
States, it is resources from the market through governments having the discretion
common for the the pooled finance route. in deciding the status of urban
various State settlements. Local expenditure
governments Why Municipal Bonds Are Not accounted for near to 50% share
to fund major infrastructure Common or Successful in India? of the estimated total (central, state
projects by issuing municipal Considering the large involvement and local) government spending in
bonds (or munis) by of the municipal corporations in the the Mumbai metropolitan area while
leveraging the federal, state infrastructure development of the in other cities; the share of local
and local body finances. The country and increasing urbanisation, expenditure in total government
US Municipal Bond market is municipal corporations have failed expenditure is close to 40%.
$2.2 trillion strong and forms to raise their own funds from the Urban population in India is
nearly more than 12% of the public. expected to account for about
total debt market. With more The first reason why Municipal 35% of its total population by
than $300 billion worth such Bonds are not common or 2011, and around 40% to 45% by
bonds issued in 2005-2006, a success in India, since the 2021. This increasing urbanisation
given its tax deductible nature, very word ‘Municipal/Municipal will add to the demand for basic
it is one of the highest yielding Corporation’ creates a sense of services such as water supply,
debt instruments. distrust among the people/investors sanitation, sewerage, solid waste
due to reasons like subtle, slothful, management, and drains, and
enhanced considerably. Revenue inefficient, bureaucracy, corruption- infrastructure such as roads,
bonds, which naturally are the most ridden, political interference, flyovers, highways, and parking
popular, will increase awareness lack of accountability, improper lots. This means that corporations
about service delivery and its management practices and lack need to make huge investments in
efficiency. of capable human resources on urban infrastructure to cope with
The concept of municipal the boards of local bodies, low increasing demand. Jawaharlal
bonds as an additional mechanism productivity, long gestation period, Nehru National Urban Renewal
for raising resources for urban erratic revenue flows, etc. Mission estimates, that India needs
infrastructure projects was first Another major reason for lack more than R1.2 trillion of investment
discussed in December 1995 of trust is lack of reliable credit in urban infrastructure over the next
at a national seminar. Later, the rating and the difficult methodology seven years (from 2007).
Rakesh Mohan Committee on the involved in the rating. Further is the Despite increasing urbanisation
Commercialisation of Infrastructure lack of information of the end use of and the consequent pressure on

M
Projects in India also discussed the funds raised through the issue
the possibility of using municipal of municipal bonds. Also there is
unicipal Bonds
bonds as a tool for raising finances a fear among investors about not
hold good
from markets. getting the investment back on
potential in urban
Internationally, Municipal maturity.
infrastructural
Bonds have played a key role in The municipal bond market in
development and
the creation of urban infrastructure India is a minuscule 0.1% of the
financing. The scenario seems
assets in United States and Canada. total corporate bond market. In the
likely to change, given more
Therefore, it was envisaged that last six years, municipalities in India
than R1 lakh crore of urban
adapting this model to the Indian have tapped the bond market only
infrastructure investment
context would open new vistas 13 times.
estimated over the next five
for attracting private capital to the years. In India, a beginning in
urban infrastructure sector. Need of Municipal Bonds
this direction was made in the
In contrast, a mere R850 crore In India, municipal bodies are
late 1990s but the momentum
($210 million) has been raised the main providers of key urban
was not maintained. The
through Municipal Bonds in India services like water supply and
Bangalore Municipal
since the first Municipal Bond sewerage. There are at present
Corporation was the first
issued by Bangalore in 1997. around 80 municipal corporations,
municipal body to raise funds
Municipal Bonds form nearly around 1770 municipal councils,
by issuing bonds, backed by
10% of the debt market in the US. around 229 Town Area Committees
state government guarantee
TamilNadu and Karnataka are and around 717 Notified Area
in 1997.

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urban services, the financial powers onsidering the Most Municipal Acts in India
and responsibilities of municipal large involvement impose restrictions on the power of
bodies have undergone negligible of the municipal municipalities to borrow funds. The
changes. This has rendered corporations in state government concerned needs
municipal bodies unable to garner the infrastructure to approve any efforts by the civic
the resources required to meet the development of the country bodies to raise debt.
demands of growing urbanisation. and increasing urbanisation, Municipalities usually borrow on
In the present scenario, with the municipal corporations have the strength of the taxes, duties and
control of fiscal deficit becoming failed to raise their own funds fees they expect to earn. However,
a critical area of economic from the public. The first state governments prescribe
management, budgetary allocations reason why Municipal Bonds other conditions regarding rate of
to municipal bodies may decrease. are not common or a success interest, repayment of principal,
Concessional funding may be a in India, since the very the interest rate on bonds, date
thing of the past. Multilateral and word ‘Municipal/Municipal of floatation, even the schedule
bilateral funding will be difficult, as Corporation’ creates a sense for loan repayment. They also
there is increasing pressure from of distrust among the people/ specify the purposes for which a
the donor countries to bring about investors. municipality can access the market,
greater accountability and market where they are typically allowed to
orientation in the projects financed These are the findings of a study raise money for construction of
by them. Municipal bodies therefore conducted by a research group at permanent ‘works’, acquisition of
need to identify new sources of the Reserve Bank of India, on urban land and buildings, and repayment
funds, such as municipal bonds, for local bodies. The study, carried of government and other debts.
financing their schemes. out by the Development Research
In India also, some measures Group, a wing of RBI’s department Need of Support from Markets
have been introduced to attract of economic analysis and policy, and Regulatory Authorities
investments in infrastructural also suggested that borrowing Shri M. Damodaran, the then
projects which include a five year restrictions on these bodies should Chairman of India’s capital market
tax holiday to BOT operators in be relaxed. Also apart from muni regulator – SEBI – said at an
infrastructure projects, tax benefits bonds, specialised municipal funds international conference held in
to financial institutions on interest and public-private partnerships Mumbai in December 2007, that it
and dividend income earned from could be looked at as ways to would work towards strengthening
financing infrastructure projects finance the creation or maintenance the municipal bond market in India
and tax benefits on investments of urban infrastructure. and emphasised the need for
in infrastructure. However, until The RBI study, which covered encouraging investors to consider
recently, municipal bodies in India 35 metropolitan municipal municipal bonds as an attractive
did not attempt to tap the capital corporations, had criticised alternative to other financial
markets. elaborate state government controls instruments.
Development of a municipal on municipal authorities that crimp SEBI should come up with
bond market in India depends latter’s ability to levy taxes and guidelines/rules for issue of
on significant improvement in user charges or to borrow funds. municipal bonds and try to create a
the credit quality of Municipal The study also suggested that market environment for investment
Corporations. municipal bodies work towards and trading in the bonds.
improving their budgeting and Credit Rating agencies also
Civic Bodies Need Easier Access accounting systems and the quality need to step up to research and
to Bond Market, Says RBI Study of disclosure of information to the rate the Municipal Bond issues.
“There’s scope to develop a public. Municipal Bonds will also create
municipal bond or muni bond “There is no source of reliable another good investment avenue
market in India because data on finances of all local bodies for people, if they are given security
municipalities and corporations in India to estimate their resource of repayment through sovereign
that govern urban local areas gaps. There is also a lack of guarantee or likewise.
in the country do not generate uniformity in classification and With growing infrastructural
enough money from taxes and utility reporting of financial data, which needs of the country, municipal
payments to fund their expenditure”. do not allow precise comparison on bonds will prove to be a good fund-
(livemint.com) various parameters,” the study said. raising instrument. n

90 THE CHARTERED ACCOUNTANT december 2011