'Munis': Smart bonds for smart cities

India's aspiration for urban rejuvenation requires a vibrant municipal bonds market

Non-government financing for infra projects has received severe jolts in the last few years. Lending institutions have withdrawn, or are very wary. Capital markets are suspicious. Foreign interest is for operating brown-field projects; not fresh green-field investments. The non-performing assets (NPA) mountain is large for all to see; and the spate of recent bankruptcies of infra-involved companies has eroded whatever confidence still remained. All this has happened for regular, tried-and-tested infra projects, largely in power and transportation sectors.

Urban infrastructure had always been difficult to finance, even when all the above negativism had not surfaced.

So when Pune raised Rs 2 billion from the issue of municipal bonds on the Bombay Stock Exchange in June last year to fund water supply projects, it was just not that it was part of the largest municipal bond issue in this country ever. The city is looking to raise over Rs 22.64 billion in multiple tranches, and the real takeaway was that there are other major sources of funds out there to potentially fill the financing gap, and that too for staid urban infrastructure projects.

This fund raising, coupled with another by Hyderabad in February this year (also for Rs 2 billion), provides one possible answer to one of the biggest issues surrounding the government’s Smart Cities initiative — funding. It was clear from the outset that these cities could not rely on cash strapped state governments for funding the over Rs 2 trillion worth of projects. Nor are public private partnerships (PPPs) in vogue currently. Central government support would be available only up to a point. In general, the estimates as of 2011 (by the government and by McKinsey) are that Indian cities would require between $800 billion - $1.2 trillion of capital over the next couple of decades to provide basic municipal and related services to an ever burgeoning and demanding urban population.

In 2017, 94 of 500 proposed smart cities and those included under the AMRUT scheme were rated by credit rating agencies. 55 of these cities received ‘investment grade’ ratings

Globally, municipal bonds are an established and major source of funding. In the US for instance, where Municipal Bonds are lovingly called “Munis”, the current size of the municipal bond market is over $ 3.8 trillion!

In India, the municipal bond market has a history stretching back over 20 years before the Pune bond issue. Bengaluru was the first city to issue such bonds, backed by a government guarantee, in 1997. Between then and 2015 however, municipalities in India have been able to raise only $291 million, according to a report by Janaagraha Centre for Citizenship and Democracy; and have been raised by cities such as Chennai, Ahmedabad, Hyderabad and Nashik, mostly for projects related to water supply.

It was in 2015 that the Securities and Exchange Board of India (Sebi) gave a big fillip to the Munis Bond market by issuing regulations that enable municipalities to issue and list bonds. One of the biggest reasons for the lack of investor interest in municipal bonds has been the back of transparency in the functioning of urban local bodies. As the Janaagraha report points out, “Municipal bonds in India have not been able to attract potential investors due to the opacity in finances and operational outcomes”. The Sebi rules standardise eligibility norms for raising such bonds, and aim at ensuring a minimum level of transparency on the part of the city raising funds. 

In 2017, 94 of 500 proposed smart cities and those included under the AMRUT scheme (Atal Mission for Rejuvenation and Urban Transformation) were rated by credit rating agencies, a first step to enable them to approach the market. 55 of these cities received ‘investment grade’ ratings. The Central government too has offered a 2 per cent interest subsidy of the total size of a bond issue to any municipality tapping the market.

This conjunction of changes - standardising of norms for issuers, ensuring transparency in accounts, the preparation of such accounts according to accepted standards, and the credit rating of potential issuers, are major comfort factors for potential investors. While less creditworthy cities will always need government support, there is little reason why bigger and more economically dynamic cities should not be more attractive to investors and be less dependent on government finances.

But there lies the problem. Take Bengaluru for instance. There is little doubt that economically, the city is booming. But 20 years after being the first city to raise funding from a municipal bond issue, the city’s finances are in a mess. It is still dependent on government grants for half its revenues. 

Or take Pune. According to a news report in the Hindustan Times newspaper, even a year after raising Rs 2 billion through a muni bond issue, the funds remained unutilised, and still stuck in fixed deposits. Tenders for the water project for which the money was raised had to be cancelled because of charges by corporators that the bidding process was unacceptable. The fixed deposits earn the corporation less money than what it pays out in interest on the bond issue. 

While capital market reforms, the Central government subsidies and transparency in accounts are all necessary elements to get the muni bond market to take off, the real problem lies far beyond, in the deep structural problems that plague all Indian cities, whether it is in being able to raise property taxes when needed, or managing urban politics. As Indian cities begin to fix these problems, bond investors should, arguably, be far more enthusiastic.

And these smart bonds should be the obvious fountainhead for smart cities.

The author is chairman, Feedback Infra. Twitter: @Infra_VinayakCh