Urban Local Bodies revamping to herald urban infrastructure | Nand L. Dhameja, Manish Dhameja & Ridhi Khatter

Rajkot Municipal Corporation (RMC) is the first civic body during 2024 to issue bonds worth Rs 100 crore. The issue got ‘AA’ rating, it also availed the incentive under the Central Government AMRUT (Atal Mission for Rejuvenation and Urban Transformation) scheme, the flagship programme to address to the infrastructure issues. The issue involved streamlining of the accounting processes and to improve revenue collection of the RMC. The bond issue was open to qualified institutional buyers (QIB) and non-QIBs registered on the NSE, such as pension funds, public sector units, trusts, and NBFCs. The funds raised are planned to be used for the eight development projects, including drinking water pipelines and sewage systems.

The paper discusses the genesis, significance and functions of urban local bodies, their finances, municipal bonds issued to finance urban infrastructure in India, and abroad, and the challenges thereof. Urban Local Bodies (ULBs), the third tier of the government, are responsible for providing essential services like water supply, sanitation, solid waste management, street lighting, public health, and transport services; there is a need to reform. and to revamp the ULBs in particular with the national objective to be a developed nation by 2047.

In that respect, the 74th Constitutional Amendment Act 1992 laid down the basis of Urban Local Bodies as:

Municipal Corporation: for areas having a population above one million, big cities having such bodies include Bangalore, Delhi, Mumbai, Kolkata;
Municipality: Nagar Palika or municipal council or municipal board having a population less than one million.

Urban Local Bodies, as per RBI Report on Municipal Finances 2022, are dependent on state and central transfers for around 35 percent of their revenues. With the introduction of GST, revenues for the ULB have been adversely affected due to the subsumption of major sources of its revenue like sales tax, octroi and local entertainment taxes in the GST structure and also the 74th Constitutional Amendment is patchy as regards their finances. For example, for the Municipal Corporation of Greater Mumbai (MCGM) its revenues have been impacted around ?7,000 crore, or 35 percent of its total revenue with the subsumption of octroi taxes in GST and also the increase in cess and surcharges by the Central Government, which need not be devolved.

To strengthened the finances of ULBs, the 6th ARC on Urban Governance and NITI Aayog made certain recommendations as to,

provide adequate sources, to raise their revenues and also to have higher devolution by the increase of the Central Devolution Fund for the recommendation of the Finance Commission;

develop capacity building programs for local government officials, urban planners and other stakeholders in urban governance;
strengthen citizen participation by involving NGOs, and civil society organisations in the ULBs functioning.

With the increased functions and the patchy finances of the ULBs arising from 74 Amendments, the ULB must reform their financial management system, improve the accounting mechanism to make it transparent so as to improve their ranking and to raise public funds.

According to Janangratha, a non-profit working on Municipal reforms, only 95 of 225 cities had investment-grade rating in 2021, while as per the earlier estimates in 2017 by the Union Ministry of Housing and Urban Affairs, only three municipalities had better rating of ‘AA+’, these included New Delhi Municipal Corporation, Navi Mumbai and Pune. In addition, a total of 94 major cities had ‘AA’ rating including municipal bodies of Ahmedabad, Vishakhapatnam, and Hyderabad.

As around 36 percent of India’s population lives in cities and by 2047 it will be more than 50 percent; and as per the World Bank estimate around $840 billion will be required to fund the bare minimum urban infrastructure over the next 15 years. No doubt, the AMRUT (Atal Mission for Rejuvenation and Urban Transformation) scheme, a flagship programme launched by the government in June 2015, and extended in October 1, 2021 provides some financial incentives for infrastructure projects, the rest of the funds are to be mobilised by both states and respective cities. The AMRUT scheme has a mission to cover 500 cities and towns with a population of over one lakh with the objective,

a). to ensure that every household has access to tap supply of water and
sewerage connection;
b). to increase the value of cities by developing greenery and well-
maintained open spaces such as parks, and
c). to reduce pollution by switching to public transport or constructing
facilities for non-motorised transport.
In that respect more cities should be encouraged to avail of the financial
assistance under the AMRUT Scheme.

The gap in the fund required for urban infrastructure could be met by the issue of bonds by the ULB, that would necessitate improved financial reforms and transparent accounting system, the project must be bankable, have investment rating, Recent issue of municipal bonds by the Rajkot city municipality was oversubscribed; it is an example for other local bodies to raise resources to finance the infrastructure projects. The issue was reserved for institutional players, while the earlier the issue by Indore municipality was subscribed by the public.

Bond issues: Types

With the opening of the economy and squeezing of the budgetary resource, ULBs use market borrowings for financing of their projects. Market borrowings can be either through intermediaries, the special purpose financial enterprises called ‘special purpose vehicles’ (SPV), or by direct market borrowing by issue of bonds. The main difference between the two is that in the former (i.e. SPV route), the intermediary would be rated and also the functioning and appraisal capabilities of the intermediary would be evaluated; whereas in the latter (i.e. direct borrowing by the municipality), the municipality would be evaluated.

The SPV route is adopted by small municipal corporations not having a strong financial balance sheet, or not having high rating; in such cases, financial institution so created, or the state government and multilateral agency raise funds from the market to finance their municipal corporations. Examples include, Bombay Metropolitan Regional Development Authority (BMRDA), Andhra Pradesh Industries Development Corporation, (APIDC), Krishna Bhagya Jal Nigam Ltd (KBJNL), Sardar Sarovar Project (SSP).

Municipal bonds can either be a coupon bond, or a discount bond. In case of coupon bond, agreed interest is paid periodically and the principal amount is paid on maturity; discount bond, on the other hand, pay only a contractual fixed amount (inclusive of interest) at maturity, there being no interest payment before maturity and as such there is no required cash outflows before maturity. Discount bonds are also known a Deep Discount Bonds. or Zero Interest bonds; bonds issued by Sardar Sarovar Projects are example of Deep Discount Bonds.

Further, bonds issued by municipalities can be categorised as ‘General Obligation Bonds’ (‘GO’), and ‘Revenue Bonds’ (‘RB’). ‘GO’ bonds are secured by the unlimited taxing power of the municipal corporation and are serviced out of the tax revenues, other revenues and assets of the corporation, these bonds are also referred to as ‘full faith’ bonds and create obligation due to the diversity of security provided. Bonds issued by APIDC, KBJNL, and SSP are examples of GO bonds. On the other hand, Revenue bonds (RB) are tied to the project, are issued for a specified project, are to be serviced from the revenue proceeds of the project; as such, such projects are to be evaluated in terms of their feasibility towards payment of interest and repayment and also meeting of operating expenses and to have higher rating. Thus, RB create local awareness regarding the project, its service and ensure the efficiency of the municipal corporation. Further, RBs are not considered as public debt of the government and are not constrained or limited to deficit financing.

Bonds issued earlier in India

Ahmedabad Municipal Corporation (AMC): AMC was the first Indian Municipality which issued tax free 10-year bonds with an interest rate of 9 percent in April 2002; the project worth Rs. 500 crore comprised of water supply, sewerage, slum development, bridge and flyover.

The AMC issued bonds for Rs. 100 crore (R 75 crore through private placement and Rs. 25 crores through public placement); the AMC was the first Asian Municipality to get a credit rating of ‘A+’ indicating adequate safety for repayment of the principal and interest. Other sources of finance for the project included internal accrual and the assistance from the World Bank. As such AMC bonds were ‘GO’ bonds, the credit rating was based on the total collection by the AMC, which comprised of revenue charges on account of services, i.e. 20 percent of the total revenues of Rs. 404 crore during 1995-96, plus property taxes and the other sources. It may be mentioned that the AMC adopted professional approach in its working, recruited chartered accountants, and had transparent working.

Tirpur Water Project and Alandur Municipal Sewerage Project in Tamil Nadue are two successful municipal projects of early nineties using bonds and public funds. In addition, other municipalities which issued bonds in the capital market included Nashik, Jalgaon, Aurangabad, Sholapur, Pune, Coimbatore. Tirpur, Hubli (Karnataka) Ludhiana, Vadodara, Jalandhar, Chandigarh, Madurai, Cochin, Nagour, of these many municipalities issued tax free bonds. Municipalities issuing taxable and tax-free bonds are contained in Exhibits I & II respectively.

One recent example is that of the Chennai Corporation Council - the Tamil Nadu civic body. The corporation has approved six types of infrastructure projects including stormwater drainage system, solid waste management system, roads and rail overbridges, bus route roads, construction of new roads, two-way flyovers and public toilets, improved energy-efficient streetlights system, restore lakes and ponds, develop new parks and upgrade existing recreational spaces to improve aesthetics.

The corporation plans to raise funds by issuing municipal bonds in accordance with SEBI Regulations, 2015, and avail of the eligible incentives under the Union Government’s scheme for issuance of the bonds. For that purpose, it is planned to appoint an agency for carrying out the credit rating of the bond issue. (Updated – The Hindu Bureau, September 27, 204)

Table I- Taxable Municipal Bonds (at end)

Table II -Tax-Free Municipal Bonds- States (at end

Municipal Bonds issue abroad.

Municipal bonds have played a vital role in building America’s infrastructure. Bonds have been a major source of financing for canals, roads, and railroads during the country’s westward expansion in the 1800s, and currently, they fund a wide range of state and local infrastructure projects, including schools, hospitals, universities, airports, bridges, highways and water and sewer systems.

Municipal bonds are issued by US state and local governments (municipalities), not-for-profit corporations and territories, examples include American Samoa, Guam, the Northern Mariana Islands, Puerto Rico, and the US Virgin Islands

It may be stated that, bond market in the US is about two-century old and bonds are an important source among states and local governments. Municipal bonds have the features of size of borrowing and the maturity periods which may extend to 20 years. In fact, the municipal market was born in the US in 1975, the New York city was the first one to issue bonds; the municipal bond market in the US is governed by the Securities Exchange Board (SEC), a 15-member Municipal Security Rule Making Board (MSRB) was established by the SEC, as an independent self-regulating agency, with the primary responsibility to develop rules governing the activities of banks, brokers and dealers in municipal securities. The bonds are made attractive by the allowing interest income as tax free, and as such the bonds are a cheaper source for municipalities. However, the use of municipal bonds as a mechanism for investing in infrastructure in the US has been subject to certain limitations as the tax law limits private sector participation in public infrastructure assets that will be financed with tax-exempt bonds.

Way forward:

As per the ICAI study (FEB, 2018) municipal bonds are not significant in the Indian debt market, out of the 94 cities which were assigned credit ratings as smart cities & AMRUT cities required additional funds, only a couple of cities have tapped the market for funds. The lack of operational efficiency reduces the creditworthiness of the municipal entities, thus making their bonds less attractive. It requires the local bodies to improve their governance and management practices; and also, the financial management reforms are required to be pursued proactively at the level of local bodies.

Further, the 15th Finance Commission (FC), emphasised the need for comprehensive reforms to unlock the full potential of municipal bonds as a source of financing. The Commission recommended as:

to account for increasing urbanization, the share of urban local bodies in the Commission grants to local bodies should be gradually increased to 40 per cent over the medium term;

State governments and municipalities need to aggressively ramp up their execution capabilities and absorptive capacities to ensure that 15th FC funds do not lie idle in the state treasury or municipal bank accounts, but are utilised to deliver infrastructure and services to citizens, by conceiving projects, floating tenders and executing works or delivering services. Besides efficient and effective process workflows, it emphasises the function of human resource numbers and capabilities.

Given 15th FC funds are not to be utilised for salaries, it becomes incumbent on state governments to aggressively build capacities through shared municipal services too.

(Authors: Dr. Nand L. Dhameja Professor Emeritus, MRIIS, Faridabad; Manish Dhameja, Senior Banker having experience in South Asia, Africa and Middle East; Dr. Ridhi Khatter, Associate Professor, MRIIS, Faridabad)

Note: Views expressed are of the authors and not the organisations to which they belong

References:

• Dhameja Nand & Dhameja Sarika, “Infrastructure Development and Financing: Including Social Infrastructure: Issues and Challenges” ( Viva Publication, 2016)
• “Municipal Bonds for Financing Urban Infrastructure in India: An Overview” The Institute of Chartered Accountants of India, (Feb, 2018)
• Chatterjee Soumya, “Municipal bonds herald way for public amenities”, (Hindustan Times, 2024, October 25, p. 8)
• “Municipal bonds are key to city finances” (Hindustan Editorial, 2024, October, 22)