RBI prods Indian civic bodies to issue municipal bonds for funding

India’s local city governments must consider issuing municipal bonds to meet their funding requirements as the demand to ramp-up infrastructure in the Asia’s third-largest economy grows, according to the nation’s central bank.

The challenge for these civic bodies, many of whom are financially weak, is to ease the resource crunch, the Reserve Bank of India said in its first report on municipal finances. “A vibrant sub-sovereign debt market catering to a robust investor appetite for municipal bonds can provide an avenue for these entities to access public funds.”

Local bodies in India are among the weakest globally as they don’t have enough autonomy to levy taxes, grant exemptions or even borrow funds, making them dependent on bank loans or federal and state governments for resources. 

While the federal government plans to borrow a record 14.3 trillion rupees ($177 billion) -- about a third of its expenditure -- this year, fund-raising through bond sales is less than 10% of municipals’ total borrowings, the report added.

The central bank suggested levying a tax on residents to pay bondholders, back the notes by earnings from a particular project or use a hybrid mechanism where revenues are used to service the debt. It also suggested pooled financing, where a common bond is issued by several municipal bodies to keep costs in check.

Some pick up in municipal bond issuance was seen a few years ago as Prime Minister Narendra Modi implemented various government programs aimed at building smart cities to upgrade water, sewer and drainage infrastructure. But it petered out gradually as there are challenges around transparency and governance of local bodies.

Credit rating too can play a vital role in attracting new investors by providing independent and credible assessment of the risk and prompt municipal bodies to undergo reforms, the RBI said. Listing of municipal bonds on stock exchanges can also boost trading in such debt and in turn develop the secondary market, it added.