India’s Shallow Municipal Bond Market Held Back By Revenue And Planning Constraints

Each day, about 540 million litres of water flow from the Narmada River to the city of Indore. 

Getting this water to Indore costs the city’s local government about Rs 60 crore a year in electric costs, according to Indore Municipal Corp.’s Mayor Pushyamitra Bhargav. But that cost is likely to disappear in the next 15 to 18 months as Indore shifts its water supply mechanism over to solar electricity, he said.

To fund this solar power plant, IMC sold India's first retail green municipal bond and raised Rs 244 crore. The bond, which listed on the National Stock Exchange on Feb. 21, was oversubscribed.

"The money will be utilised in a very quick manner. In 18 months, we’ll be using more than 93% of the funds," said Divyank Singh, chief executive officer of Indore Smart City, a division of the IMC.

IMC's bond has been rated 'AA' by Indian Ratings and Research, citing the ability of the municipality to remain in revenue surplus in the medium term, supported by tax revenue, non-tax revenue, assigned revenue, and grants. IMC reported revenue surpluses of Rs 664 crore in FY22, Rs 590 crore in FY21, and Rs 583 crore in FY20, according to a December credit rating note from India Ratings.

While Indore and other municipalities like Ahmedabad and Ghaziabad are steps ahead in issuing bonds to raise funds, other municipalities in the country are held back due to a lack of planning, revenue generation, unrealistic rating expectations, and outdated accounting practices.

The size of India’s overall municipal bond market pales in comparison to countries like China, South Africa, and the United States. Indian municipal corporations raised a total of Rs 3,840 crore, or $465 million, via municipal bonds between 2017 and 2021, according to data from the Ministry of Housing and Urban Affairs. 

In comparison, the outstanding size of the U.S. municipal bond market stood at $4.0 trillion in March 2023, according to SIFMA data.

"The only thing holding back [Indian] cities right now is the capacity to convince the market there is a robust revenue scheme from the project they’re considering," Shamika Ravi, member of the economic advisory council to the Prime Minister, told BQ Prime. 

Therefore, infrastructure projects such as metro lines become an immediate candidate for funding via municipal bonds because their revenue streams are easily understood, she said. 

Another constraint is the antiquated accounting practices followed by most municipal bodies in India, which are further limited by insufficient revenue collection, an investment banker who deals in municipal bonds told BQ Prime on the condition of anonymity. Quite often, while the central government’s incentives attract municipal bodies to issue bonds, they don’t exactly know what they'd like to use the raised money for, the banker said. 

The AMRUT programme, which was started by the central government in June 2016, gives municipalities Rs 13 crore for every Rs 100 crore in bonds they sell, up to a maximum bond value of Rs 200 crore.

Another thing that keeps municipalities from selling bonds is that they want a higher credit rating. Most municipalities want ratings of 'A', 'AA' or other such top investment grade ratings, which is not possible if they’re actually performing more like a 'B' or 'BB' rated body, the investment banker said. The credit rating directly impacts the interest rate municipalities have to pay on such bonds. 

"The lack of a secondary market for municipal bonds has been a critical constraint in attracting a more extensive investor base for these securities," the Reserve Bank of India noted in a report on municipal finances in November 2022. 

Even as some cities take the lead in raising funds from the capital markets to fund infrastructure, the trajectory to bring significantly more urban bodies into this fold will likely be long drawn out. 

"You are going to see the usual suspects that will continue to do well, and in states where state capacity is a concern, the dependence on the banks will continue," Ravi said, referring to future municipal bonds in India. As state capacity builds up and infrastructure spending grows, the municipal bond market would deepen as well, she said. 

For now, Indore has set itself a target of 15 to 18 months to finish construction on the solar power plant, Bhargav told BQ Prime. Indore’s issuance made a bit of a splash, and other municipalities have also inquired about issuing bonds, according to the earlier mentioned investment banker.  

Just how well progress is being made on both fronts could indicate if the uptick in interest in municipal bonds in India will stick around for longer than in previous cycles of excitement.