Local Bodies

Municipal Bonds

Context: India’s Municipal Bond market remains nascent with around 55 issuances totalling about ₹5,000 crore since their inception in 1997.

Municipal bonds are debt instruments issued by municipal corporations and related authorities to finance public projects. Indian municipal bonds lack sovereign guarantees. Financial risks persist due to weak fiscal positions of many urban local bodies, leading to limited retail investor participation.

Relevance of the topic:

Prelims: Municipal Bonds- Features

Mains: Municipal Bonds- Bottlenecks, Steps Taken, Way Forward

What are Municipal Bonds?

Municipal bonds are debt securities issued by local governments or States.
Also known as ‘Munis’.
They are used to fund public projects such as infrastructure, schools, transportation or utilities.
Most municipal bonds are ‘General Obligation Bonds’ (GO Bonds) – their repayment is guaranteed by the tax and non tax revenues of the local body.
Tax exemption: The interest paid on municipal bonds is tax-free, as long as the buyer follows the rules set by the municipal corporation.

Municipal Bonds in India:

Bangalore Municipal Corporation issued India’s first municipal bond in 1997.
Later in 1998, Ahmedabad raised a similar bond for urban development.
As of 2024, Karnataka and Gujarat are the leading states for municipal bond issuances.
Other states like Madhya Pradesh, Uttar Pradesh, Tamil Nadu, Andhra Pradesh have also entered the market, leveraging pooled financing models to help smaller municipalities raise capital.

Regulation of Municipal Bonds in India:

Securities and Exchange Board of India (SEBI) is the market regulator for all bond issuances, including municipal bonds, in India. It plays an active role in trying to deepen the ‘munis’ market.
The ‘Issue and listing of debt securities by municipalities’ Regulations, 2015 creates a clear process for cities to issue municipal bonds.
SEBI also mandates municipalities to maintain escrow accounts to secure revenues used for bond repayment.
SEBI guidelines also emphasize transparency by mandating regular financial disclosures and audited accounts, to build investor confidence.

Steps taken to deepen Municipal Bonds in India:

The government has given various reform linked incentives to incentivize the issue of municipal bonds.
AMRUT 2.0by Ministry of Housing and Urban Affairs:
- A ULB gets an incentive of Rs. 13 crore in the first phase, for every 100 crore worth of bonds issued.
- This incentive scheme reduces the net effective cost of raising funds through municipal bonds for ULBs, making it cheaper than any other source of borrowing.
- The scheme also promotes credit rating of ULBs as a mandatory reform.
Incentive scheme of Ministry of Finance:
- Incentives are given to states depending on their categorization.
- Recently, Indore Municipal Corporation raised ₹244 crore for solar project via public issue of municipal bonds, wherein retail investors also invested in such bonds.

Present Situation of Municipal Bonds in India:

Despite all the efforts, the municipal bond market in India remains relatively small.
The cumulative issuances amounts to around $575 million with 18 bond issuances, since the inception of SMART city and AMRUT mission in 2015.
Comparison with the US: In the US, over 5000 municipal bonds have been issued so far.
- Outstanding municipal debt, as of 2024, stands at $4.1 trillion.
- 2/3^rd of the total municipal infrastructure in the US is being funded by municipal bonds.

Bottlenecks for Municipal Bonds in India:

Weak financial health:
- Lack of strong consistent revenue streams implies poor financial stability.
- Often, revenues are insufficient even to meet operation and maintenance costs of municipal services.
Poor creditworthiness:
- Financial stability is crucial for obtaining good credit ratings necessary for bond issuance.
- Only a few cities achieve investment-grade ratings (A- and above), limiting investor confidence in bond offerings.
Regulatory and procedural challenges:
- Complex & opaque approval processes by state governments for municipal bond issuance discourage cities from accessing capital markets.
- Absence of specific legal frameworks that address insolvency or debt restructuring for city governments also reduces investor confidence, in case of defaults.
Lack of transparency & inadequate financial management:
- Poor financial reporting practices & outdated accounting systems erodes investor trust.
- Delays in audits and lack of standardized reporting formats complicate the credit rating process.
- Minimal public disclosure of audited finances further discourage investor participation.
Limited market demand and investor interest
- At present, institutional investors dominate the municipal bond market in India.
- Absence of sufficient incentives like tax exemptions or attractive returns limits participation from individual investors.

Addressing these challenges will require policy interventions such as incentivizing financial reforms, improving transparency and streamlining regulatory approvals. Strengthening ULB’s financial capacities and fostering better project management practices is essential to expand the municipal bond market in India.

RBI Report on Panchayat Finances

Context: Recently, RBI released a report titled ‘Finances of Panchayati Raj Institutions’ which is based on the data of 2.58 lakh Panchayats for the years 2020-21 to 2022-23, covering about 75% of rural local bodies.

The report presents an assessment of panchayat finances and their role in India’s socio-economic development.

Fiscal source of Panchayats:

Types of Grants received by Panchayats

Fiscal issues and challenges in Panchayat finances:

Limited own source of revenue: Panchayat’s own sources of revenues are limited, mainly property taxes, fees and fines. This restricts the financial autonomy of Panchayati Raj institutions and restricts their spending ability.
Heavy dependence on grants-in-aid: Grants from higher level of governments such as Finance Commission and State Finance accounts for a total of 95% of the revenue receipts of the panchayats. Note: Grants from the Central Finance Commission has consistently increased for panchayats since the 73^rd Constitution Amendment Act.

Issues with State Finance Commission:
- This over-dependence on vertical transfers is not predictable as states continuously delay the constitution of State Finance Commission. Ministry of Panchayati Raj has highlighted that only 9 states have constituted their SFC by 2022 whereas the scheduled timing in 2019-20.
- State governments have even not adhered to its recommendation regarding devolution of financial aspect to panchayats.
Performance gap in both tax and non-tax revenues: tax portion of revenue just 1.1% of total revenue whereas non-tax is 3.3%.
Lack of fiscal prudence: the ratio of revenue to capital expenditure averaged 3.2 in 2022-23 and the ratio varied between 0.1 in Bihar and 11.5 in Tripura. Investment in capital projects was 29.6% of the total expenditure of Panchayats in 2022-23.
Distribution disparity: There are notable differences in the distribution of grants-in-aid to PRIs across states and years.

Various other challenges like inhibition of Panchayat leaders in imposing and collecting taxes, lack of devolution of taxation powers by state government, etc. also exist.

Composition of capital expenditure by panchayats:

Way Forward:

Intensification of efforts by panchayats to augment their own tax and non-tax revenue. Ex: Velpur Gram Panchayat in the Nizamabad district in Telangana effectively generated revenue from internal sources.
Timely establishment of SFCs and prudent adherence to its recommendations.
Operational changes in PRIs like transparent budgeting, fiscal discipline, e-governance, robust monitoring and evaluation process, reporting of finances in standardized formats (e-gram swaraj portal), etc.
Empowerment of local leaders and officials, active involvement of the local community to prioritise development needs, etc.

Nagaland’s municipal tightrope

Context: Recently the Neiphiu Rio-led Nagaland repealed the Nagaland Municipal Act of 2001. This led to the cancellation of the State Election Commission’s March 9 notification for holding elections to Nagaland’s 39 urban local bodies (ULBs) with 33% of the seats reserved for women. The apex court has, however, stayed the notification cancelling the civic body polls.

Why is there opposition to ULB polls?

Nagaland is arguably the only State where ULB seats are not reserved for women as mandated by clause IV of the 74th Amendment to the Constitution of India.
Most of the traditional tribal and urban organisations oppose the 33% reservation of seats for women as they argue that such reservation would violate the special provisions granted by Article 371A of the Constitution to Nagaland.
The hohos (apex tribal bodies) point out that women have traditionally not been part of decision-making bodies.

Article 371A

The Article states that no Act of Parliament would apply to the religious or social practices of the Nagas, Naga customary law and procedure, administration of civil and criminal justice involving decisions according to Naga customary law, and ownership and transfer of land and its resources.

Have such polls ever been held in Nagaland?

The first and only civic body election in Nagaland was held in 2004 without any reservation of seats for women.
The State government amended the 2001 Municipal Act in 2006 to include 33% reservation for women in line with the 74th Amendment.
This triggered widespread opposition forcing the government to indefinitely postpone the ULB polls in 2009.
Efforts to hold the elections in March 2012 met with strong protests and in September 2012, the State Assembly passed a resolution to exempt Nagaland from Article 243T of the Constitution which is related to the reservation for women.
This resolution was revoked in November 2016 and elections to the civic bodies with 33% reservation were notified a month later.
The notification led to widespread mayhem in which two people were killed in large-scale violence and arson.
This made the government declare the process to conduct an election null and void in February 2017.

Why did the government decide on ULB polls this time?

Under pressure from the Supreme Court, the Rio government laid the ground for holding ULB polls after consultations with various stakeholders, including churches, NGOs, and tribal bodies in March 2022.
The State Election Commission on March 9 notified that the polls would take place on May 16.
The tribal bodies and civil society organisations threatened to boycott the polls until the “borrowed” Municipal Act of 2001 factoring in women’s reservation is “reviewed and rewritten in complete consonance of the voice of the Naga people” so that it does not infringe upon Article 371A.
The government succumbed to public pressure and repealed the Municipal Act with immediate effect as the people “cannot be compelled” to participate in the elections.

What is the way forward?

The groups against reservation for women want a “guarantee” that the 33% quota would not violate the provisions of Article 371A.
Before “rushing to conduct” the ULB elections, they suggested that the duration of the reservation should be capped at two tenures and demanded that the post of chairperson should not be reserved for women.
The Naga Mothers’ Association (NMA) said that the State government erred in not listening to or consulting with women’s organisations before taking the decision to repeal the Municipal Act.
The Supreme Court pulled up the Nagaland government for adopting an “ingenious method” of repealing the Municipal Act to evade the undertaking given to the court for holding the polls.
The apex court also noted, “Nothing has so far emerged (with respect to Article 371A) to advance a plea that religious or social practices of Nagas or Naga customary law and procedure denies the right of equality to women insofar as the participatory process is concerned in such elections”.