The humble municipal bond may offer India a huge window of opportunity to help clean up the ailing infrastructure of the country’s vast urban landscape, says Fitch Ratings.
Already, some 285 million Indians live in 4,000 towns and cities. This number is only going to rise.
Municipalities can’t rely on their creaking, 100-year-old water pipes and sewerage systems to serve the large and growing urban communities. Investments are needed, and urgently. According to the World Bank, India will need $37 billion over the next decade to give city dwellers access to safe water and sanitation. The budgetary resources of India’s central and state governments are already stretched.
The larger Indian cities have some access to capital markets. They can borrow funds by pledging future revenue from property taxes, service charges and state grants. The Bangalore municipality sold bonds in 1997; a few others have followed suit. Smaller municipalities’ fund-raising abilities, however, are constrained by their lousy balance sheets. In the absence of sovereign guarantees—which the government nowadays is reluctant to provide—they will have to pay unaffordable junk-bond interest rates.
That’s why the Centre’s recent decision to encourage municipalities to take the structured-finance route makes a lot of sense.
Every state government will pool several municipal projects. Cash flows from these projects will go into a special bank account from which bond investors will be paid: If one project is mismanaged, others will still be generating cash.
A government-funded ratings enhancement facility will offer additional credit protection. Guarantees will be purchased from financial institutions willing to underwrite the risk of a cash-flow shortfall. Pool financing will “provide a shot in the arm for the development of India’s shallow municipal debt markets,” Fitch said in a report this week.
The concept has been borrowed from the US, where state revolving funds leverage federal grants—and state contributions—by selling bonds. The proceeds are then lent to wastewater-treatment and drinking-water projects. The revolving funds often also enhance the credit profile of municipal securities by providing guarantees.
Even in India, the model isn’t exactly new.
Pooled financing has already been tried twice in India. However, with the Centre now setting aside Rs400 crore for a Pooled Finance Development Fund, issuances are likely to gather momentum.
For there to be a breakthrough in financing of urban amenities in India, sub-national projects must be legally secure for investors, and free from political interference.
That is the main challenge.
Even in increasingly popular public-private projects, where the presence of non-government shareholders assures creditors of superior corporate governance, complacency may be fatal. In such partnerships, creditors ought to be wary of an unduly large presence of government-appointed board members. That’s because private-sector investors, who have a stake in making the project perform, can be easily outgunned by the government nominees, who have absolutely no such incentive.
They may succumb to populism and cut prices of their services, leaving the project starved for cash. A pool of debt offers protection from such mismanagement by spreading the risk over multiple projects. “The pooled finance mechanism, with its benefits of aggregation and diversification, provides a powerful answer to the vexing question of capital shortage,” Fitch said.
That doesn’t take away from the need to fundamentally revamp the way civic services are delivered in India.
Fixing civic services
India’s political rhetoric remains too focused on uplifting villages, when it ought to be preparing for massive urbanization. Cities have very little financial autonomy: Mumbai, which contributes Rs40,000 crore to the exchequer annually, gets back just Rs1,000 crore in public investment.
The revenue that municipal organizations mobilize themselves largely consists of property tax, which is a pittance; and even this isn’t collected effectively.
Then again, with a few exceptions, no Indian municipality has any public accountability. In most cases, the elected representatives are puppets, controlled by bureaucrats.
The other problem is abuse of subsidies. Ultimately, users must pay for what they get. Consumers only bear two-fifths of the cost of water in India, with taxpayers expected to pick up the rest of the tab.
In democratic India, the poor will always have a strong moral case for subsidized access to urban services. However, to ensure that the service provider is able to both meet its social obligations and maintain its assets, the cost of the handout must be recovered from other users.
Structured finance can be a force for the good in ending the drought in India’s urban investments. It won’t be a substitute for good governance. (Bloomberg)