Why India’s municipal bonds have few takers

Several cities including Pune, Bhopal and Ghaziabad have been issuing municipal bonds to raise money from investors to finance their civic projects, but despite Indian market regulator’s nudge, there are few takers.

This isn’t surprising, given the lack of liquidity, awareness and even weak perception about the functioning of local bodies, say experts.

Municipal bonds are non-convertible debt securities issued by a municipality or municipal corporation as a private placement or through a public offer. These bonds typically have a tenure of 4 to 10 years and a coupon of 7.15-10.23%.

But as of 30 April, 11 municipal corporations in India had raised only ₹2,683.9 crore ($320 million) through such bonds, show data from the Securities and Exchange Board of India. 

In comparison, local administrations in the US have raised about $4 trillion through municipal bonds, Pramod Rao, executive director of Sebi, said recently, urging investors to put their money in municipal bonds.

Bonds with no guarantees

Municipal corporations require funds to finance capital expenditures such as construction of highways, bridges, schools, or public utility projects. They typically receive funds from central and state governments, and in special circumstances from global firms, or borrow from financial institutions. 

These local bodies can also raise funds through municipal bonds, but the securities do not enjoy sovereign guarantees. In the absence of such government assurance, an assessment by a credit rating agency could give the papers some legitimacy, but that’s easier said than done.

Madan Sabnavis, chief economist with Bank of Baroda, said that for a municipal bond to be rated, credit rating agencies need to have access to a corporation’s balance sheet and income statement. 

But such data is usually not easily accessible, or is made available with a lag of as far as two years, said Sabnavis, who has previously worked with a credit rating agency and has been associated with sub-sovereign ratings.

“This makes it problematic when giving a rating. This is critical for raising bonds as the general perception of municipalities may not be positive for most of them,” said Sabnavis. “A rating provides comfort. Therefore only a handful have raised such bonds while most depend on devolutions from above or borrowings through loans from financial institutions.”

Also, such bonds are mostly too expensive for individual investors. Mint reported in February 2023 that municipal bonds had high face value—with denominations of ₹10 lakh—putting them out of reach of retail investors. Also, while municipal bonds are listed on the stock exchanges, they lack trading volumes.

Making municipal bonds attractive

Big municipal corporations do not need to tap bonds to finance their projects. The Municipal Corporation of Greater Mumbai, for example, is India’s richest local body with a balance sheet of ₹2 trillion. 

For such a local body with huge cash reserves, municipal bonds may not help as interest rate differentials could be high, according to P. Velsaru, former additional commissioner (projects) at the Mumbai municipal corporation and currently divisional commissioner for Konkan division.

Smaller municipalities, however, are eager to raise finances through municipal bonds. An official with a corporation in Gujarat, declining to be identified, said such bonds ensure local bodies do not have to dig into their reserves for executing projects during a shortfall.

But for bonds issued by such small local bodies to be attractive to investors, better-rated municipalities need to enter the market and establish credibility for other corporations, said Deepak Agrawal, chief investment officer at Kotak Mahindra AMC. 

Others suggested low liquidity to be a deterrent to the municipal bond market. Experts also suggested extending tax concessions on benefits accrued from municipal bond investments, while others suggested increasing awareness to make these securities attractive to investors. 

“Once there is awareness about the product, liquidity will increase and money flow in the market will increase,” said Nidhie Vora, a manager at merchant banker Resurgent India.