Municipal Bonds

Municipal Bonds

Subject: Economy

Context:

Listing of municipal bonds in the stock exchanges can pave the way for developing the much-needed secondary market for municipal bonds in India, according to the Reserve Bank of India’s report on municipal finances.

Details of the report:

• The revenue generation capacity of municipal corporations is declining over time, dependence on the devolution of taxes and grants from the upper tiers has risen.
• The availability and quality of essential services for the urban population in India have consequently remained poor.
• The rapid rise in urban population density, calls for better urban infrastructure, and greater flow of financial resources to local governments.
• Over-reliance on property tax has constrained exploiting other avenues of funding by MCs, such as trade licences, entertainment taxes, taxes from mobile towers, solid waste user charges, water charges, and value capture financing.
• Property tax reform and development of a vibrant municipal bond market can provide a boost to the municipal finances.
  • It (urban local bodies) needs to improve collection efficiencies in respect of property tax, user charges, lease rentals, advertisement tax and parking fees
• ULBs in India are amongst the weakest globally in terms of fiscal autonomy with elaborate State government controls on their authority to levy taxes and user charges, setting of rates, granting of exemptions, and borrowing of funds as well as on the design, quantum and timing of inter-governmental transfers.
• Municipal revenues/expenditures in India have stagnated at around 1 percent of GDP for over a decade. In contrast, for 7.4 per cent of GDP in Brazil and 6 percent of GDP in South Africa.

Concept:

Municipal Bond:

• A municipal bond (muni) is a debt security issued by a state, municipality or counties to finance its capital expenditures, including the construction of highways, bridges or schools.
• A municipal bond can also be issued by a nonprofit organization, a private-sector corporation, or another public entity using the loan for public projects, such as constructing schools, hospitals, and highways.
• Through muni bonds, a municipal corporation raises money from individuals or institutions and promises to pay a specified amount of interest and returns the principal amount on a specific maturity date.
• These are mostly exempt from federal taxes and from most state and local taxes, making them especially attractive to people in high income tax brackets.
• Types:
  • A general obligation bond (GO) is issued by governmental entities and not backed by revenue from a specific project, such as a toll road. Some GO bonds are backed by dedicated property taxes; others are payable from general funds.
  • A revenue bond secures principal and interest payments through the issuer or via sales, fuel, hotel occupancy, or other taxes. When a municipality is a conduit issuer of bonds, a third party covers interest and principal payments.
• As a fixed-income security, the market price of a municipal bond fluctuates with changes in interest rates:
  •  When interest rates rise, bond prices decline; when interest rates decline, bond prices rise.
  • In addition, a bond with a longer maturity is more susceptible to interest rate changes than a bond with a shorter maturity, causing even greater changes in the municipal bond investor’s income.
• Many municipal bonds carry call provisions, allowing the issuer to redeem the bond prior to the maturity date. An issuer typically calls a bond when interest rates drop and reissues municipal bonds at a lower interest rate.
• Furthermore, the majority of municipal bonds are illiquid; an investor needing immediate cash has to sell other securities instead.
• History of Municipal Bonds Issuance in India:
  • Municipal bonds were first issued in India in 1997.
  • Between 1997 and 2010, the city corporations of Bengaluru, Ahmedabad and Nashik experimented with bond issues but barely managed to raise Rs. 1,400 crore.
  • The poor investor response was due to the fact that these bonds were not tradable and lacked regulatory clarity.
  • Securities and Exchange Board of India (SEBI)’s detailed guidelines for the issue and listing of municipal bonds in March 2015, clarified their regulatory status and rendered them safer for investors.
  • In 2017, Pune Municipal Corporation had raised Rs. 200 crore through muni bonds at an interest of 7.59% to finance its 24×7 water supply project.