(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
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
"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
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
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
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