Financial Musings: BMC and the Development of Municipal Bond Market

Contributed by: Gaurang S. Trivedi, CFA

Every day, your morning newspaper highlights stories of inefficiencies in the running of this great city of Mumbai. Yes, the infrastructure is inadequate for the size of Mumbaikars it supports. But more glaringly, it is the institution responsible for administration, i.e. the Brihanmumbai Municipal Corporation (BMC), which has become Mumbai’s biggest cog in the wheel. Episodes of corruption, downright apathy towards the citizenry, rampant flouting of rules and regulations established, religious fundamentalism and the decay of law and order have infringed on Mumbai’s cultural heritage and reduced the financial capital of India to a state of social ambivalence. In short, Mumbaikars have become “Comfortably Numb”.

The simple fact is the city of Mumbai spanning its western and central suburbs has become too big to be managed by a Central Authority. The quicker this is realized by politicians and citizens, the lesser will be the pain in accepting the eventual changes that will manifest. We have witnessed the fate of all central economies of the world. Sooner or later, the shortcomings of centralized management lead to inefficiencies in the allocation of resources, which culminate into resentment, civic/social unrest and call for changes in the system. Perhaps, Mumbai is just about there! Resentment and calls on the need for change are the daily rhetoric of the intelligentsia as well as the gentry. However, no solutions other than workabouts of the existing system seem to be forthcoming. I propose a radical approach – Break up the BMC! Decentralize.

Now, you may have already started to think, what does the prior musing have anything to do in a finance blog? Bear with me, as I think my proposal will bring about financial innovation that may help restore Mumbai’s status as a city able to provide not only a high standard of living but also a good quality of life. The product I recommend is by no means an “innovation” from the global availability of financial instruments. However, it is a novel product for the Indian market. Municipal Bonds may be the panacea for Mumbai! How you ask? Let me take you through my thought process.

It is important to recognize the population most of the suburbs in Mumbai support, could very easily represent a city in most developed nations. The distinguishing characteristic of each such city in the developed nations is that it has its own Municipality with its own mayor, budget and elected corporators. Why not replicate the same for our suburbs? Instead of electing corporators that represent the interest of localities in a centralized system, why can’t the citizens of a suburb elect their own mayor and corporators whose exclusive responsibility should be the growth, development, generating employment, providing law and order and thereby a high standard of living and quality of life to all the “city” residents!

In the current system, we do elect corporators, but they have limited voice in the functioning of the locality they represent. The power of decision-making rests with a central body of elected corporators, who may have no idea about the needs and preferences of the citizens living in distant suburbs. Most decision-makers may have never visited a suburb for which they may have sanctioned budgets. Such a system breeds favouritism, leads to faulty economic resource allocations, and entrenches corruption. Furthermore, the central decision makers are accessible, for all practical purposes, only through local corporators, thereby building a fence around themselves and their decisions. Transparency and accountability get buried in centralized systems.

Now think of the alternative, i.e. break-up of the “BMC. In this system, each suburb duly demarcated by its geographical jurisdiction (no different from the current scenario) will be governed by its own “Municipal Corporation”. The residents of the geographic unit (i.e. suburb) will elect their own mayor and corporators to manage the activities of the geographic unit. To make it effective, the elected representatives must necessarily be residents of the geographic unit. These elected representatives will be entrusted with the economic development and welfare of the geographic unit. As such, the process of budgeting of revenues and expenses will become more objective. Objectivity will lead to greater transparency and accountability in this system. Focus on economic development will lead to “marketing” of the geographic unit to potential businesses for setting up their operations leading to local employment. Furthermore, like any business or governmental entity, the geographic unit may tide over its budgetary imbalances via financing of such deficits.

Enter “Municipal Bonds”. Globally, Municipal Bonds are tax sheltered instruments i.e. the return provided by them is tax-free. Naturally, because of this characteristic, their coupon will also be lower than other taxable fixed income instruments. The coupon and principal of Municipal Bonds are backed by the taxing authority of the Municipality (geographic unit). All the taxes that are included in monthly maintenance charges of your residence are the sources of income for the Municipality. In exchange for this income, the Municipality will incur expenditures on the maintenance of infrastructure, marketing for attracting new businesses to set-up operations in the area, supporting municipal schools, compensation for municipal employees, and other incidental expenses to ensure smooth functioning of the municipality and provide good quality of life. By having a relatively clear knowledge of the sources of income, the budgeting (monthly, quarterly, annually) becomes relatively easy. Any shortfall, i.e. deficit, can be financed by the issue of Municipal Bonds. The cost of such financing will be usually lower than competing alternatives such as bank loans, commercial paper, etc. Moreover, the period of maturity is longer, thereby ensuring the municipality of long-term source of funds.

It is important to note here that the purpose of this treatise is not to provide a primer on Municipal Bonds. For the interested reader, insightful information on Municipal Bonds can be found here:

https://www.hjsims.com/assets/Municipal-Bonds.pdf

https://www.cfainstitute.org/learning/investor/Documents/municipal_roundtable_discussion.pdf

https://blogs.cfainstitute.org/investor/2012/12/14/book-review-the-fundamentals-of-municipal-bonds/

https://blogs.cfainstitute.org/investor/2016/12/14/municipal-bond-markets-after-the-us-presidential-election-when-the-dust-settles/

Now, you may appreciate the interconnection between the break-up of the BMC and the development of the Municipal Bond market. Yes, Municipal Bond market development can also be augured in the current centralized system, but the need for transparency and governance that will be required by the Credit Rating Agencies to grade these bonds will be a herculean task. To become part of investment portfolios, these bonds must pass the minimum investment grade barrier. This may not be attainable if the inefficiencies entrenched in the current system are continued.

The older generations of Mumbai may be tolerant of the system as they not only grew up with it but also fostered it for aspirational needs. However, the majority of the younger generation of Mumbaikars, like their counterparts in the developed world, if given the choice, would prefer a work-life balance; a result of aspirational needs of the middle-class families being met at a rapid pace. Mumbaikars, in general, are fed-up with the deterioration in quality of life wherein the daily commute for earning their keep is a grind and takes a heavy toll on health.

The breaking up of BMC into its various geographic units may perhaps be the best solution for Mumbai. It will be fortuitously associated with the development of a financial product that has the risk characteristics to suit investors and employment generation potential for the financial services industry as well as other industries interested in setting-up or growing businesses in the city. If this model is replicated pan-India level, India can have a robust Municipal bond market and help deepen its capital markets, particularly the fixed income market, a long cherished goal!

-GST