Municipalities all set to issue smart city bonds

As many as 60 municipalities may issue bonds in the next nine to 12 months to raise funds for developing smart cities

In a month or two, the Indian corporate bond market will get to see a fresh wave of municipality bonds hitting the market, an instrument which has been rarely tapped to raise funds in India even as globally it is one of the most popular fixed income instruments. 

Going by the plan of the ministry of urban development, as many as 60 municipalities across the nation may issue bonds in the next nine to 12 months to raise funds for developing smart cities. Eventually, all 100 municipalities and urban local bodies (ULB) that have been given the mandate to develop smart cities will line up their high yield bonds. The government has not yet decided if these bonds would be tax-free, and if so, whether the present cap of 8 per cent for any tax-free bond will be applicable for these bonds or not.

“The government’s focus is to reduce the cost as much as possible. The question of tax-free status or government guarantee will be discussed at a later stage, probably closer to the first issuance date,” said a source familiar with discussions. 

To make the municipalities professional enough to approach investors, the government has selected nine transaction advisories, whose work would be to “handhold” the bodies to float municipal bonds. 

The nine transaction advisories selected by the ministry are A K Capital Services, Axis Bank, Darashaw & Co. Pvt Ltd., ICICI Bank, ICRA Management Consulting Services, SBI Capital Markets, SPA Capital Advisors, SREI Infrastructure Finance and Yes Bank. 

According to sources, municipalities of Pune, Rajkot, Ahmedabad, Indore and Bhubaneshwar are at advanced stages of issuing the bonds and could file their request for proposals (RfP) within a month. The exact issue size has not been finalised yet, but people involved in the process say the bigger municipalities can easily raise Rs 500 crore each in the first tranche. Other smaller entities could be raising Rs 200-300 crore each. 

Therefore, the total number of bonds to hit the market over the next one year could raise about Rs 15-30,000 crore, considering 60 municipalities would be engaged in such fund-raising activities. The bonds will be either secured through existing assets, or will have government guarantees. 

However, for now, the smaller local bodies will not want to come in the market without getting more clarity on the bonds. It is not clear yet if foreign investors would get to invest in these bonds, but the Securities and Exchange Board of India’s (Sebi) guidelines on municipal bonds issued last year do not exclude them. The government had amended the Income Tax Act in 2001 to allow the local bodies to raise funds through tax-free bonds. 

Globally, the municipal bonds are tax free and have a huge market. In the US, the outstanding amount against the municipal-bonds is more than $3.5 trillion. Even in developing countries like Mexico, South Africa, Poland, Russia and Hungary,  municipal-bonds have a large market. 

In India though, the market is almost non-existent even as some municipalities earlier issued bonds in the market. According to the data available on NSDL website, Ahmedabad Municipal Corporation was the first to issue such bonds, raising Rs 100 crore in 2002. Since then, issuances have been few and the total issuances barely crossed Rs 1,000 crore in about 15 years. However, some unverified sources also claim the first municipal bond issue in India was raised way back in 1967.

The primary fund for the smart city mission will come from the government. The mission will be operated as a centrally-sponsored scheme and the central government will provide financial support to the extent of Rs 48,000 crore over five years, i.e. Rs 100 crore per city per year on an average. In September, Sebi had organised a conference in Mumbai for creating awareness regarding issuance of municipal bonds in India. According to the Sebi norms, the bonds issued by urban local bodies (ULBs) should be ‘investment grade’ and be backed either by tangible assets or by government guarantees. The minimum tenure of the bonds should be three years and the municipalities issuing the bonds should be net worth positive in the last three years, with no default record in the past year.

Still, there are issues around these municipalities. For example, in many such ULBs, the accounting itself is done through a single entry system, instead of the standard practice of accrual-based double entry accounting.  Also, the books of many of these ULBs are not very transparent, whereas to issue the bonds, the bodies will have to do full disclosure of finances, management, projects etc in their RfPs.    

The ministry has also issued model RfP to states/municipalities/ ULBs and these firms will bid for getting the mandate to advise the ULBs to float bonds, but the works for them are more grass route kind. Now, municipalities has to act fast to take this matter forward.

“Our main job is to handhold the municipal bodies and making it possible for them to float the bonds. This time the government is looking very serious about the whole matter and almost every week there is a meeting between us and the government officials how to go about it,” said a senior executive of one of the advisory firms shortlisted by the government. 

The advisory firms will be responsible for documentation, making the ULBs rating compliance, even accounting and auditing the urban bodies and finally marketing the bonds.  The advisors sometimes have to do prod the ULBs to do proper audit of the books so that a rating can be assigned to the ULBs, based on which the bonds will be raised. The government recently told rating agencies to assign rating to the municipalities, but the rating exercise has not started.  

According to another executive, who has worked with some of these ULBs and is in the process of advising a municipality in formation of a smart city, many ULBs, including those in the metro cities, have no accountability over their expenses and therefore resist sharing the books. 

“To be able to convince investors in giving money to these municipalities would be difficult. Therefore, many of the smaller municipalities are going for total greenfield projects inviting private parties. In normal course, it should be a public private partnetship,” said the executive requesting anonymity.   

According to the National Institute of Securities Market (NISM), Sebi’s investor education arm, raising capital from a domestic municipal bond market can start as a supplement to funding from central and state governments, borrowings from financial institutions such as LIC, HUDCO and commercial banks. The revenue generated from various sources would be cost-effective and reasonably equitable form of infrastructure financing. 

“As the market develops, there is enormous potential to scale up the level of investment much more rapidly than that can be achieved by the traditional sources of financing alone,” NISM said in a paper.