The concept of urban local governance has a long history in India. The first municipal corporation in India came up as early as 1687-88, when British established a corporation to govern areas in and around fort St. George in the present day Chennai city. The concept caught on and after much evolution, local governments now occupy an indispensible position in Indian governance system. The real turnaround in this episode was the 74th constitutional amendment act which dispelled all the doubts on status and legitimacy of decentralized forms of governance. The act ushered in a new era in decentralized governance by empowering urban local bodies (ULB) with constitutional status and a definite set of functional items. Most importantly, the 74th amendment act enabled ULBs to function as institutions of self government and attempted to ensure financial independence and stability of them.

While the constitution has tried to ensure financial stability of ULBs through devolution of taxes and establishment of state finance commissions, question remains whether financial inflow has been adequate to cater to the ever increasing demand for public goods. The growth in urbanisation and urban population has severely strained the local governments as demand for urban services and infrastructure development has gone up many folds. The fourteenth finance commission has noted that local bodies are not even able to meet a fraction of their expenditure on provision of basic services and are heavily dependent on the transfer of one fund or another. From the precarious state of finance of most of ULBs it is evident that the present revenue sources are not enough to plug the increasing demand for investment in urban infrastructure. Municipal bonds, a cheaper source of funding can be one way to solve this financial crunch. Municipal bonds in general refer to debt instruments issued by an institution of self government or their agencies. A widely popular debt instrument all over the world, the proceeds from municipal bonds is usually used to fund the infrastructure development or to meet day to day obligations. Countries like USA have a long history in utilizing these debt instruments to effectively fund infrastructure investment. In 2015 alone issues worth $403 billion has been made, accounting for 6.25% of total bond issuance in the country. Even developing countries like South Africa and Vietnam is actively exploring this option to fund their infrastructure development.

The idea of raising funds through municipal bonds is certainly not new to India. Bangalore Municipal Corporation was the first to raise funds through issue of bonds in 1997. These bonds, worth Rs 1.25 billion were state government backed and was privately placed. The first ULB to make a public offering was Ahmadabad Municipal Corporation in 1998 when it issued Rs.1000 million in bonds to finance its water supply project. Since then few cities like Nasik, Indore, Hyderabad, Chennai, Visakhapatnam etc. have followed the suit and have issued bonds to mobilize resources from the capital market. While few were tax free bonds there were also taxable issues. Moreover, most of them were sold not through public offering but to certain selected investors (private placement). However the market has not expanded much and the number of municipal bond issues remained dismally low. In aggregate, only Rs.13.53 billion has been issued under all categories of municipal bonds. The market has been virtually dead for the last few years with no new fresh bond issues. The pooled finance mechanism which showed promising results in early 2000s has also failed to live up to its true potential. The idea was that the state level umbrella entity could bring together smaller municipalities who lack the skill and potential to access capital market on its own. The concept proved to be a success in few states like Karnataka and Tamil Nadu who could come out with successful bond issues while most of the other states failed to do the same.


While much has been written about the potential of debt instruments in financing urban infrastructure, the efforts in this direction is yet to catch up. Though the government has stepped up its efforts with SEBI releasing a new framework for public issue of debt securities by municipalities in July 2015, the market response has been uninspiring with no new issues so far. The fourteenth finance commission also stressed the need to explore this option in its report. The issues are multifold with apprehensions about investor confidence topping the list. The doubts about self sufficiency and prudence in financial management of ULBs are strong in the investor community. ULBs also seem to accept and go by this view as most of the municipal bond issues in the past were privately placed. In contrast to this individuals hold the bulk of the municipal bonds in USA. Another feature that stands in the way of development of a healthy municipal bond market is the �lemons� issue. The credit worthy ULBs plush with internal revenues are in no need of debt financing and tend to stay clear off it while the cash strapped ones are more than eager to avail new sources of funds. This invariably increases the risk of the borrower and dampens the market confidence in municipal bonds. On the supply side, apprehensions about capacity, cost considerations, regulatory conditions and associated obligations furthers the apathy and inaction of local bodies.

Any attempt to raise funds through debt financing has to be done in such a way that financial health of ULBs should neither cloud investor outlook nor jeopardize the repayment process. Project specific financing, linking the repayment to an assured flow of revenue could be strategies to overcome this. Pooled finance mechanism was a right step in this direction and needs to be taken up more seriously. Government can also encourage its agencies like HUDCO who have a long history of association with municipalities and local self government to play an active role in the municipal debt market. They can not only guide the ULBs in the process but also contribute to deepening of municipal debt market through providing guarantees on debt, underwriting bond issues and investing in lower rated tranches of bond issues. While there is no doubt that integration with the capital markets will be a game changer in the local governance, financial stability of institutions is a prerequisite. As access to finance is only a part of the bigger picture, efforts have to be stepped up to ensure sustainability in all realms of urban finance.

–Sandeep Paul