The Hindu Business Line : How ratings can help urban local bodies raise funds

Ever since the Jawaharlal Nehru National Urban Renewal Mission (JNNURM) was announced as an important initiative, attention has been focused increasingly on the agenda for significant reforms in the urban local bodies (ULBs) that are to play a significant part in the renewal of urban India.

Now a recent study by the Reserve Bank of India (RBI), Municipal Finance in India: An Assessment adds to the body of knowledge on the problems faced by the ULBs. Among others, it identifies low revenue levels, weak finances, inadequate capital spending, and poor administration.

Crisil’s experience in the municipal finance sector corroborates this list as the very factors that contribute heavily to the credit risks of India’s ULBs. Strong credit ratings can help urban local bodies raise funds to meet their infrastructure spending requirements.

Thus there is a need to mitigate these risks to enhance the creditworthiness of the ULBs and enable them to access bond markets. Without such access, ULBs may not be able to raise the size of funds required to revamp existing and create the new infrastructure required for urban areas to realise their full potential and sustain India’s growth story.

Urbanisation has been one of the most significant phenomena in India in recent times. By 2011, urban areas can contribute 65 per cent of India’s gross domestic product; for this to happen, however, ULBs will need to make large investments in civic infrastructure to support and sustain such economic activity. As of now, ULBs are clearly not equipped to meet the increasing infrastructure requirements.

One reason for this is, clearly, inadequate revenues and high revenue expenditure. ULBs need far greater autonomy to raise revenues; this they will get only when they are allowed to levy their own taxes and charges. It is also imperative to provide a transparent mechanism for transfer of grants.

Most importantly, however, given the limits of revenue-raising and grants, it is critical for ULBs to access debt on a scale and duration that matches the investments they need to make. For such debt to be raised, ULBs have to attain adequate credit quality, which very few have today.

Lower-rated ULBs

Out of a sample of 31 ULBs that Crisil studied, only six were found to have a high degree of creditworthiness, with the rest ranging from moderate to poor. Those ULBs with low credit quality suffer major constraints, such as limited revenue generation, high establishment expenditure, low operating surpluses, weak debt-raising capacity, inadequate infrastructure arrangements and poor quality of municipal management.

There can be no clearer endorsement of the role of stronger municipal finances and management quality in improving the credit quality of ULBs over the long term, than that made in the RBI study.

he situation also highlights the need for the Central and State governments to support the ULBs over the short term in order to enhance their creditworthiness; this will help them access the municipal bond markets to fund infrastructure growth.

Crisil believes that the municipal sector, with its limited revenues, and substantial functional responsibilities and infrastructure spending requirements, should access the capital markets through municipal bonds of a long tenure. Such bonds will allow the tenure of financing to match the long gestations of municipal projects.

Another important benefit of municipal bonds is that they lead to institutional strengthening through improved management of financial performance. The ULBs will benefit significantly from credit ratings; by benchmarking themselves against peers, these ratings will help ULBs identify the factors that constrain their ratings, and help them improve performance.

Interestingly, Crisil was the first Asian credit rating agency to assign credit ratings to municipal bond issuances, when it rated Ahmedabad Municipal Corporation’s bonds in the 1990s. It has since rated 26 other ULBs. However, municipal bond issuances have underperformed their potential, resulting in the current weak infrastructure of India’s cities.

Mitigation of risk

Most ULBs today have limited debt on their books, but paradoxically they also have limited capacity to raise debt. Although property tax constitutes their major source of revenues, inadequate reform orientation precludes them from maximising the potential of this tax. The local bodies need to urgently focus on developing their tax and non-tax revenue sources.

The ULBs’ inadequate revenue generation is partly because of the limited revenue-raising powers mandated by the municipal Acts, and low tax and non-tax collection efficiency. Unlike their counterparts in the US, urban local bodies in India cannot levy general sales, excise, and property taxes.

Even within the existing framework, though, there is great scope for ULBs to raise user charges for major services, targeting full cost recovery. The low collection efficiency reflects a weak administration and the reluctance of citizens to pay taxes because of inadequate service arrangements. There is a perception that most ULBs do not spend enough on creating or maintaining utilities and quality services.

Many ULBs are also constrained by poor quality of expenditure; establishment expenditure typically ranges between 40 per cent and 75 per cent of revenue expenditure. To break free of this vicious cycle of poor expenditure quality and poor revenue generation, the corporations or municipalities need access to funds, and strong managements that can use them well.

Prerequisite for strong ratings

Crisil believes that before accessing the municipal bond markets, ULBs would do well to follow a two-pronged strategy — improve revenues and control unproductive expenditure — so as to maintain healthy operating revenue surpluses (ORS).

An increase in such surpluses enhances a ULB’s debt-raising ability and debt servicing measures. In this regard, superior municipal management assumes utmost importance: only this can help the local bodies augment revenues, recover costs, attain collection efficiency, rationalise staffing, and curtail unproductive expenditure.

Further, the benefits of infrastructure spending can be maximised only through effective and efficient project management. Given the current status of their project administration arrangements, ULBs will, no doubt, need project management support from the Central and State governments.

JNNURM: pushing ULB agenda

The Jawaharlal Nehru National Urban Renewal Mission (JNNURM) will mark a key turning point for India’s ULBs in undertaking an ambitious change agenda. This is because the mission commits them to significant reforms, assures them of financial support to undertake infrastructure spending, mandates that they obtain credit ratings, and enables them to access the bond markets.

In this context, credit ratings can push the reforms of ULBs further, apart from simply enabling the local bodies access market funds. When these are achieved, they will result in overall improvement in the ULBs’ operational efficiency.

They will also facilitate local bodies showcase the best practices of the sector, and set benchmarks for others to follow and improve upon.

(The author is a Senior Director, CRISIL Ratings, Mumbai.)

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