Green Shoots in Municipal Bonds Market

Indore municipal corporation has just announced a Rs. 244 crore green bond to part fund a solar power project in the city. Further, the bond will invite retail participation, bringing green bonds into the retail discourse. There is a new optimism in the air about municipal bonds.

While everyone agrees that municipal bonds is the way forward, there is also an awareness of the challenges that lie ahead. The first of the challenges is that there are few municipal issuers with high credit quality. 87% of the 44 municipal issuances so far, had AA ratings and above. These ratings were achieved with considerable credit enhancement to cater to provident funds which are by law mandated to invest in high safety instruments. In the absence of the high levels of credit enhancement, the credit ratings would be lower.

Low credit quality of municipal issuers: A status update on credit ratings awarded to AMRUT cities dated February 2020, states that 163 of the 468 cities achieved investment grade ratings (BBB- and above). This means that barely 35% of the municipalities rated were credit worthy. Further, with the onset of the Covid 19, the last two years have seen a decline in the own revenues of the urban local bodies which would have negatively impacted the credit ratings.

An analysis of the credit ratings available on the website of the rating agencies as at December end 2022, shows that there are 23 issuers with Adequate safety (A) and High safety (AA) ratings. About 15 of these issuers have not raised bonds in the last five years. Assuming an average issuance size of Rs. 100 crores, we can estimate Rs. 1500 crores of municipal bonds issuance in the near term.

Local governments have low level of own revenues: As per a recent report on the financial health of smart cities published jointly by Munify and the National Institute of Urban Affairs (NIUA), the municipal corporations of these cities are highly dependent on grants for both revenue and capital expenditure. The same point was brought out by the Report on Municipal Finances by the Reserve Bank of India- the increased reliance on transfers, and capital expenditure being funded by State and Central grants (Section II, Conclusion; page 17).

Growing own revenues is crucial to achieving attractive credit ratings.

Access to municipal financial information: The second challenge is the lack of financial management systems in the local governments. To the investors, these translate into a lack of availability of updated information on the issuers. Of the 100 smart cities, only 25 cities had both updated budgets and accounts as at October end, 20221.

Even the information available in public domain is not presented in a way that is easy to digest- budgets are published in different languages, not always coded as per the national municipal accounting manual and there is a significant variance between historical figures (Actuals) presented in these documents and those published in audited statements. There is no reconciliation statement in either the budget or the financial statements explaining the difference between these two sets of figures.

At munify.in, we have created a tech platform where municipal financial information can be quickly accessed and analysed. We hope such initiatives to build an information infrastructure for the municipal bond market, will widen the investor community.

Project execution capacity: The local governments’ ability to manage projects is also key to how municipal issuers are perceived by the market. A case in point is Pune Municipal Corporation which raised Rs. 200 cr. bonds in June 2017 for a water supply project. The implementation of the scheme was delayed and launched in 2019. For nearly two years, the bond receipts were unutilised!

Governance challenges: Such Governance related issues stem from the frequent change of Commissioners of the municipalities, who function as the chief executive of the urban local body. A Munify study indicated that out of a total 135 municipal corporations surveyed, 82 corporations had commissioners with less than 2 years tenure. Thus 60% of the corporations did not have stable senior management. Frequent change of guard at the top echelons result in a lack of consistency in policy making and execution.

A way to ringfence the projects from governance related issues is to execute them through corporate entities such as the special purpose vehicles (SPV) of smart cities and raise funds in these entities. It remains to be seen if the SPVs of smart cities will raise funds from the market as their revenue streams are yet to emerge.

Innovations in Municipal bond markets: What is not in shortage in the Indian municipal bond markets is innovation! For a nascent market that has raised only Rs. 5500 crores since the first municipal bond issue in 1997, it has seen a number of complex credit enhancements. These range from trapping specific revenues such as property tax, in escrow accounts for debt servicing, part guarantees from state governments or multi- lateral institutions. The market has also seen pooled fund structures that raise bonds for a set of small municipalities. The pooled funds attained a credit rating higher than what the individual urban local bodies would have achieved, thus paving the way for small cities to access the market.

Going forward, the market can expect to see more green bonds as cities move forward to meet their commitments to net zero carbon emissions. There is also likely to be a boom in retail participation in municipal bonds and income tax incentives are required to sustain retail investors’ interest. Online debt platforms can play a huge role in drawing retail investors to municipal bond markets.

Meanwhile, what will help is an improvement of the credit quality of the municipal issuers- specific measures such as sharing of GST revenues with local governments, a one-time recapitalisation of municipal balance sheets, a commitment to stable transfers to local governments by stage governments as recommended by state finance commissions.

The US municipal bond market is vast with over 4 trillion dollars of outstanding debt and has financial guarantee companies that elevate the credit rating of the municipal bonds. For such institutional measures to work in India, the underlying credit quality of the municipal issuers must first see an improvement!

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