REFILE-India to boost muni market

Fri Jan 17, 2014 2:24am EST

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(Corrects dateline to January 17 from 16.)

* Country seeks funding avenue for growing cities

* Low ratings, unclear regulation pose challenge

* Potential political interference spooks investors

By Manju Dalal

SINGAPORE, Jan 17 (IFR) - India is making efforts to revive its municipal bond market to meet the mounting funding requirements of rapid urbanisation.

The market has been effectively dead. Greater Vishakhapatnam Municipal Corp issued the last muni bonds in India in 2010 for Rs300m. Total issuance has been mere Rs31bn (US$503m) since municipal bonds were first issued in 1995.

With an urban population set to grow 38% by 2026, this market in India is ill-equipped to meet the future funding needs of the country's towns and cities.

However, efforts are now under way to change this.

Last month, India's capital markets regulator formed a 20-odd member committee to look into the development of the market for municipal bonds and suggest measures to revive it.

According to sources, the central government is also closely following a World Bank report on the regulatory framework for municipal borrowing in India. This indicates the determination of the government to promote the market.

Nearly 900 million people are expected to be added to Indian cities by 2050, when the country's total population will touch around 1.7bn, according to government estimates. The Registrar General & Census Commissioner of India anticipates the urban population in the country to grow 38% to 534 million by 2026.

A vibrant market for municipal bonds can go a long way to help provide long-term funding for India's urban infrastructure requirements - as in the US, where the related market had over US$3.7trn outstanding in early 2012.

Many challenges, however, remain.

"Most municipal corporations in India have a limited understanding of bond markets. First, these bodies need to be educated on the significance of the muni bonds and, without this, nothing will work," said Atul Joshi, managing director and CEO of India Ratings & Research, the local arm of Fitch Ratings.

THOSE WHO CAN WILL NOT

As with the local corporate bond market, India's municipal market faces hurdles of low ratings, reluctant investors and unclear regulation.

The bigger and better-rated municipalities are flush with funds and, as such, are naturally reluctant to turn to the debt markets. Others, especially the lower-tier and mid-tier municipalities, have no access to bond markets and mostly rely on state-owned Housing and Urban Development Corp for their funding needs.

"Hudco may be charging anywhere above 12% from these municipalities. The funding costs will be cheaper than these levels if municipal bodies instead turn to muni bonds," said a DCM banker based in Mumbai.

Bringing smaller cities to the capital markets, however, presents a number of challenges.

"Capacity building is the biggest hurdle for the muni bond market in India. The bigger municipal bodies should be first encouraged to issue bonds so that a yield curve is created for others to follow. Right now, most bigger municipalities are cash-rich and asking them to issue muni bonds is like selling a fridge to an Eskimo," said Joshi.

Credit enhancement, tax incentives and pooled financing structures may help weaker municipalities raise funds.

Guarantees from the central government, for instance, will likely facilitate issuance and increase investor participation, but will come at a cost, likely to be around 50bp-100bp.

Pooled financings may allow a handful of weaker municipal bodies to raise money together through a special purpose vehicle. That vehicle would act as the main borrower and, with the right form of credit enhancement, could capture a higher rating than any of the municipalities involved.

Some municipal bodies, such as those in Tamil Nadu and Karnataka, have successfully experimented with pooled financing structures.

Investors may still have concerns about the ability of municipalities to increase revenues and fund themselves due to regular political interference, although the Jawaharlal Nehru National Urban Renewal Mission has partly addressed these issues.

This central government-aided, grant-based programme was launched in December 2005 to improve urban infrastructure across the country. The 65 municipal bodies under the JNNURM are rated, thus improving their chances of accessing capital.

However, of these 65 municipal bodies, only 10 are Double A rated, 10 more are Single A and 16 are Triple B. All other are rated below investment grade. This poses a hurdle in a market where large investors hardly ever buy bonds rated below Double A.

Also, most municipal bodies have preferred to issue tax-exempt bonds, but not all investors are as keen. There is an 8% cap on the coupon that tax-exempt bonds can pay, which restricts the investor base to banks. Mutual funds, pension funds, insurance companies and provident funds prefer the regular, taxable market where coupons are easily over 9%.

Various bodies including banks, municipal corporations and rating agencies have suggested that the Ministry of Urban Development needs to remove the 8% interest cap and instead provide subsidies to compensate issuers for the tax on interest payments. This way, better-rated municipal bodies will be tempted to issue more muni bonds and also achieve finer pricing. (Reporting By Manju Dalal; editing by Steve Garton and Dharsan Singh)

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