Street cheers Sebi norms on municipal bonds

Gives municipalities an additional avenue to fund projects

The Securities and Exchange Board of India (Sebi) on Sunday approved new norms for issuing and listing of municipal bonds on stock exchanges. Municipal bonds are debt instruments issued by a state or municipality to finance its capital expenditure for construction of highways, bridges, schools, etc. This move will benefit municipalities in multiple ways. First, they will get an additional avenue to fund their projects. Second, the new norms will improve the disclosures provided by the municipalities. Third, the listing of these bonds will lead to a price (cost of funds) discovery for them. Fourth, the new norms have lowered the mandatory credit rating from at least A+ suggested in December 2014 to BBB- currently and will enlarge the number of municipalities eligible to issue these bonds. Overall, experts have cheered this move.

Devendra Pant, chief economist, India Ratings, says, “Municipal bonds are the need of the hour due to high investment required by the municipalities. Most cities have under invested in urban infrastructure and that could improve going forward. The norms will bring higher financial discipline in municipalities.”

Jayanta Roy, senior VP, co-head, Corporate Sector Ratings, ICRA, says, "We are quite positive about the move to encourage municipal bonds. Sometimes there are projects in municipality which are non-revenue generating, but now there will be a specific requirement for revenue generation.” Even though municipal bonds have been around for sometime, the market has remained very shallow. Roy believes the move to list and trade these bonds could help expand this market going forward. The trading of these bonds though will be based on the financial health of the municipalities, amongst other things.

As per the new norms, municipalities can only issue revenue generating bonds to the public while the general obligation bonds can be issued to institutional investors. Revenue generating bonds are the ones that earn revenues from a particular project and services the bond via these revenue. On the other hand, municipalities can fund general obligation bonds via any of its revenue streams. Even though experts differ on which of the two is more safer investment, they believe that mandatory requirement of credit rating (investment grade credit rating of BBB- or above) largely addresses this issue.

R Sivakumar, head, Fixed Income, Axis Mutual Fund, says, “It’s good to have a regulatory framework and clarity on municipal bonds. For retail investors, revenue bonds provide high safety. General obligation bonds use a municipality's entire revenues. Even if a municipality's own financial heath may not be in good shape, but some of its projects could be good. If they have revenue certainty municipal bonds could work.”

While the final norms for these bonds are likely in next 6-8 weeks, many experts believe there are enough checks in place to safeguard the interest of investors.

Experts believe there are enough checks to safeguard the interest of investors. For instance, the issuer (municipality) should not have defaulted in the previous 365 days and should have had a positive net worth for the three years preceding the issue. Further, the issuer's contribution to a project shall not be less than 20% of the cost. While the minimum tenure of these bonds is three years, listing would provide an exit route to investors and post listing, the bonds will reflect the true health of the body in question.

While its early days to stipulate on the coupon rate these could offer, experts believe it could be anywhere between the rate on government securities and bank base rates. However, Dwijendra Srivastava, chief investment officer, debt, Sundaram Mutual Fund, says: "Given that these bonds are tax-free, the interest rate cannot be on the higher side."

Adding: "Possibly, we will initially see more sophisticated investors in this market and retail investors will participate as awareness increases. Attractive returns on a post tax basis will also boost retail demand for these. In earlier cases, municipal bonds were backed by state government guarantee. It could be a similar case this time."