Municipal bond: Water sector, capital and governance

Municipal bond is an innovative financing tool that uses private sector investment in infrastructure and improves the financial sustainability at the Urban Local Body (ULB) level. Financing being a crucial issue in development, especially in relation to inclusiveness and equity, municipal bond is a response to such challenges. In addition, with the increasing debate around power relation between various hierarchies of government and hence raising question about how democratic is decision-making at the ULB level, municipal bond offers unique solution. The bond makes ULBs self-sufficient in financing, and also makes them directly accountable to the users of infrastructure. The blog reflects on the performance of municipal bond in water and sewage sector, highlighting the strong interrelation between water, flow of capital and governance.

In general, municipal bond is a debt issued by the ULB to finance capital projects such as road, railway, sewage projects etc. The tool was traditionally used in the USA and Canada. You can find articles on municipal bond in the USA even from 1970s (here). Municipal bond, in general, is exempted from tax, which makes it attractive for private sector investors within the bracket of high income tax. However, revenue generated from municipal bond may be taxable. In the context of India, municipal bond was first introduced in taxed form, and later it was tax-exempted.

In terms of financing risk, municipal bonds are preferred mode for local water and sewage projects rather than bilateral loans, as those are exposed to fluctuation in currency exchange rate. Gandy (2004) refers to municipal bonds indicating that it improves the metabolic system of ULBs. However, similar to other Public Private Partnership (PPP) projects using private financing, the risk-return balance between public and private sector actors is something to be explored in detail. Ideally the balance should be maintained so that higher revenues generated from such projects can be invested back in the same built environment for future projects, as an incentive to improve ULBs performance, and rather than the higher revenue being paid off to the private sector investors.

Based on the USA and Canada experience, Ahmedabad Municipal Corporation (AMC) first started with taxable municipal bond during late 1990s (here). The Ahmadabad Municipal Corporation (AMC) issued bonds of INR. 1000 million (USD 14.5 million) for financing a water and sewerage project of INR. 4390 million (USD 64.07 million). The use of ICT helped AMC in its earlier steps towards improving its efficiency through better tax collection measures, having computerized accounting systems etc. These initiatives helped the AMC to have a cash surplus of INR. 2,140 million (USD 31.23 million) by March 1999, from a deficit earlier.

Following AMC, other medium-size and small-size cities also issued such bonds. The uniqueness of municipal bond was that these were not backed by any kind of guarantee by the state. This facilitated power decentralization from the central government and allocated power to ULBs, and also improved the accountability of ULBs to direct users. However, the subscription depended largely on credit ratings and ULBs had to prove that they had sound financial positions with a strong revenue base, high collection efficiency etc. Question should be raised here as municipal bonds will help only the “rich” ULBs to finance their infrastructure, while it would be difficult for the new bees. Can we draw that conclusion that only rich municipalities can afford to have more efficient water and sewage projects as they would have higher credit rating and better flow of capital through municipal bond?

The next step was issuing tax-free municipal bonds. In 1999-00, the central government finance ministry allowed the ULBs to float tax free bonds and in 2000 the central government amended the Income Tax Act (vide the Finance Act 2000) indicating the interest earned from bonds entirely tax free. The AMC was the first municipality to float these tax free bonds in April 2002, where bonds were issued for INR.1000 million (USD 14.6 million) for water and sewerage projects. While on one hand, the tax free bond assure higher private sector investor participation, on the other, it raises the concern that the higher revenue generated from such bond are not being retained in the ULBs or by the public sector For .

The Ministry of finance (Budget division), Govt of India has recently published the regulations formulated by Securities and Exchange Board of India (SEBI) to both invest in and use municipal bonds in a transparent way, in their annual report 2015-16 (here). This highlights the mainstreaming of municipal bond as a financing tool. Besides the Twelfth Five Year Plan making such recommendation, current central government led urban reform on AMRUT makes reference to use of municipal bond at the State Action Annual Plan (SAAP) preparation stage.

As an innovative financing tool, municipal bond is undoubtedly a success. However, as already discussed, the risk-return balance for such private sector financing tool has to be critically examined. My other point is that, acknowledging the relation between water-flow of capital-governance (the triangle), and municipal bond being largely used in water and sewage projects, there has to be some discussion and exploration around the integration of these three dimensions. Neither financing nor governance is discussed in isolation. It is already mentioned that municipal bond has changed the way ULBs work- making them entrepreneur and allowing them to raise money from market for their own capital project. Water, being an environmental sector, and urban water system being studied in a wider context and in interdisciplinary way, there should be more discussion about the interrelation of these three dimensions.

Another perspective to look into the municipal bond is that such bonds demonstrate the evolution of the municipal structure in emerging economies. Following Ahmedabad’s example, the central government has now legitimated the municipal government’s direct borrowing from market. This makes them self-sufficient, accountable, and has changed the perception of the municipalities to entrepreneur. However, knowing that many Indian cities are facing challenges to access raw water and drinking water, and having studied how interdisciplinary and broad urban water sector is, I believe further studies can explore the relation between municipal bond and water sector. Water is, after all, central to one’s livelihood. Many countries in the other part of the world (such as France) are taking back its water sector from private companies. The issue is even more critical in the contemporary debate around climate change. Yet another perspective is to understand how does municipal bond promise to deliver just and fair development. India, currently opposing the inclusion of Right to the City clause in Habitat III report on the ground that ‘right to the city is considered as right to basic services even for the illegal immigrants’, it would be interesting to explore whether innovative tools like municipal bond can help the ULBs to deal with such critical issues.

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