Reinventing Muni bonds

The Securities and Exchange Board of India’s new regulations, which pave the way for city corporations to tap the public markets with bond issues, is welcome on several counts. The move promises to open up a new source of funding, not just for the Modi government’s pet smart cities project, but also for India’s older cities, which badly need upgrades to their decrepit road, water supply, sanitation and transport infrastructure. The Eleventh Five Year Plan estimated a total funding requirement of ₹12.7 lakh crore for this. Local bodies obviously cannot meet capital needs of this magnitude from their measly resources, made up of grants from the State and sporadic aid from multilateral agencies. Also, the financial disclosures and audits stipulated by SEBI for city bodies looking to raise municipal bonds may also lead to greater public scrutiny of their finances, ushering in much-needed transparency and accountability to their functioning.

Though several city corporations (Bengaluru, Ahmedabad, Nashik, Ludhiana, Madurai) experimented with privately placed bond issues between 1997 and 2010, the lack of regulatory clarity on their structure led to a poor response, with the issues mopping up less than ₹1,500 crore. Guidelines issued by the Centre in 2001, granting the bonds tax-free status, didn’t help either. The interest rate cap of 8 per cent, a debt service ratio of 1.25, and a minimum maturity of five years were seen as too restrictive. In contrast, SEBI’s new regulations strike a good balance between encouraging municipal bond issues and ensuring reasonably high safety for public investors in these municipal bonds. To protect retail investors, municipal bodies have been allowed to issue only revenue bonds, where monies are earmarked for a specific project. End-use of funds is to be strictly monitored by an independent agency and revenues secured through an escrow account. An investment grade rating is compulsory and the bonds have to be listed on the exchanges. Issuers also have to file a detailed prospectus with financial disclosures. These conditions, along with market-based rates and a tax-free status, could make these bonds attractive to those retail investors who shy away from riskier investments such as equities. But it is imperative that the Centre also does its bit by nudging institutional investors such as pension funds, insurance companies and mutual funds to actively invest in these bonds.

However, even the new and relaxed regulations will allow only the larger and more creditworthy city corporations to tap this route for funds. A 2012 study showed that only half of the urban local bodies in India enjoyed a credit rating of investment grade or above. Local bodies may also find it difficult to comply with the detailed disclosure requirements, similar to that of IPOs. But this is a good start and if the issue of municipal bonds incentivises even a few local bodies to clean up their act, SEBI can count it as a job well done.

COMMENT NOW