Harun R Khan, Deputy Governor, RBI

Let me focus now an important aspect emerging needs India is rapidly urbanising, which is putting a tremendous pressure on urban infrastructure. Census data 2011 reveals that about 31 percent (377 million) of Indian population lives in urban areas and contributes 63 percent of the GDP. Going forward, the intensity of India’s urbanization will only be increasing. With the strides in the urbanisation that is being witnessed, it is projected that by 2030 urban areas will house 40 percent of the Indian population and contribute 75 percent of India’s GDP. The number of large cities which were only 5 in 1951 grew to 53 in 2011 and is expected to go to 68 in 2030. At least 2 of the Indian cities (Mumbai and Delhi) are expected to be among the five largest cities in the world by 2030.The document Smart Cities: Mission Statement & Guidelines put out in June 2015 by the Ministry of Urban Development emphasises the need for a comprehensive development of physical, institutional, social and economic infrastructure for improving the quality of life and attracting people and investments to the City, setting in motion a virtuous cycle of growth and development. Smart Cities are envisaged to be a step in that direction.

The mission announced by the Government envisaged a coverage of 100 cities during 2015-2019. Given the enormity of the vision, stakeholders, especially the Urban Local Bodies (ULBs), have a significant task on hand. Financing through municipal bonds is an alternative that the ULBs can focus on. The Municipal Bond market in India, albeit more than three decades old, is still not developed. Municipal bonds have so far played a limited role as a source of finance for funding urban infrastructure projects. In India, just 1 percent of the total ULB contribution is funded by municipal bonds as against about 10 percent in the United States.

The size of the municipal bond market today is rather limited and is distributed over a few strong municipalities of Ahmedabad, Nasik, Nagpur, etc. It is worth noting that in spite of weak finances, none of the municipal bond issues have defaulted in repayment to date. This indicates that although bond financing is feasible for ULBs there are constraints affecting both the supply as well as demand for capital.Several steps can be taken to strengthen the municipal bond markets in India. First, the regulatory and legal conditions that currently hinder the municipal borrowing in India, needs to be altered to encourage appropriate expansion of the scope of bond financing. Second, it is important to introduce flexibility in setting interest rate cap for issuance of municipal bonds by linking it to a benchmark market rate.

Issuers also need to have the option to offer long tenor bonds for implementing urban infrastructure projects with a repayment period ranging about 15- 20 years and could include variants, such as, guaranteed, non-guaranteed bonds, taxable and tax free bonds, pooled financing, etc. Treating tax free municipal bonds in the same way as other tax free instruments is necessary. Third, very often the ULBs are still considered to be riskier than the corporates with similar rating largely because the risk perception is significantly linked to financial position of their States as they depend significantly upon the devolution of resources and grant from the State Government. Therefore, the outlook for ULBs would depend upon the outlook on the financial position of the State concerned.

Fourth, ring-fencing the municipal bond funds is very essential by clearly earmarking the same for a defined project and is thus, insulated from interventions. Fifth, to gain investor confidence, municipalities need to obtain credit rating for raising funds from the market. Sixth, introduction of a bankruptcy law applicable to municipal bodies could improve investor confidence and boost demand for municipal bonds. As a backstop arrangement in the eventuality of default, there needs to be partial or full guarantee by Central/ State government. Seventh, there is need for improving transparency in accounting and budgeting and disclosure of all the material facts regarding the management, administration, financials, operations, projects, revenue generation, risk factors, etc.

Timely audit, putting in place a framework for legal remedy against defaulting ULBs and assurance against diversion of fund will have to be addressed. Eight, Pooled Finance Mechanism was initiated for small and medium sized ULBs to hedge risk for the investors and thereby avoid huge transaction costs. Finally, in order to widen the investor base, insurance companies, National Pension System, and provident funds may be allowed to invest in the rated securities of ULBs or Municipal Bodies as also Foreign Portfolio Investors and Mutual Funds. SEBI has since put out a framework for issue and listing of debt securities by municipalities.

There are demands for further fine-tuning of these regulations. Besides, concerted efforts are needed by the Central, State and the municipal bodies to address the above concerns for developing a more reliable and additional source of financing for certain infrastructure through municipal bonds. Investment bankers like SBICAP can play a very proactive role in bringing together the stakeholders.The fact that infrastructure is the life line of the economy needs no reiteration as it brings in benefits to all stakeholders in the economy, be it producers, consumers, rural households, industries and disadvantaged sections of the population through both the flow and stock impacts. Like finance, infrastructure is also a critical catalyst in accelerating growth. In order to reach the envisaged growth rates, we need to invest in robust infrastructure. There are many hurdles in financing infrastructure given its special characteristics, such as, long gestation, huge capital outlays and exposure to policy and procedural uncertainties.

Policy makers are alive to these challenges and have taken many measures, such as, facilitating bank financing to infrastructure, activating bond markets with a view to providing alternative source of funding and, opening up newer and innovative channels of financing. Financing of urban infrastructure, through municipal bonds, given our current thrust on urbanization, needs special focus.

To further strengthen this process, support from the industry is extremely critical. Industry needs to make judicious use of the new products or processes and also provide unbiased feedback to the policy makers for fine-tuning the policies. The role of investment bankers like SBICAP, which acts as bridge between the Government and the private sector in their infrastructure development efforts and provide innovative financing options through equity, debt and other hybrid instruments, is very crucial.