Govt to create Rs400 cr credit backup for municipality bonds

Govt to create Rs400 cr credit backup for municipality bonds

Mumbai: Anticipating that the markets may be cool to efforts of some of the 63 municipalities that are getting ready to tap the debt markets for infrastructure funding, the ministry of urban development is creating a backup, Rs400 crore guarantee fund.

The projects are part of the Union government-sponsored Jawaharlal Nehru National Urban Renewal Mission.

The government will contribute to bond service funds of the urban local bodies from this fund, which may be either half of the amount or 10% of the total issue, whichever is lower. Details, such as the lending rate to the urban local bodies, are yet to be decided.

Debt market analysts said while the market for such instruments will certainly grow as these municipalities begin to tap the markets, many of them may not be considered creditworthy, making it difficult for them to raise money.

“Several of the urban local bodies are not in robust financial health and may find it hard get good ratings," said Akash Deep Jyoti, head of corporate and infrastructure ratings at Crisil Ltd. “In such cases, they may have to commit to higher coupon rates or carry out some financial reforms and go back for fresh ratings. But the market’s appetite for these bonds may be low."

A. Ramachandran, secretary, Union ministry of urban development,?said?the?fund will be in addition to revenues that the municipalities will be setting aside in escrow accounts. “In case the municipalities are not able to meet their repayment obligations, they will be able to tap this fund." He added that a ministry team was inspecting the financial status of these bodies to help them with the necessary financial reforms.

The 63 municipalities eligible for funding for infrastructure projects under the mission are being rated by agencies such as Crisil and Fitch Ratings. The ratings will be in place by end of this month, Ramachandran said.

The estimated demand for funds from these municipalities is around Rs46,000 crore. Under the mission, the Centre will fund up to 70% of the project cost, with the municipalities expected to raise the rest themselves.

But raising money through municipal bonds may not be as easy as it used to be two years back, said Anil Ladha, head, debt capital market, at ICICI Securities. The investors have become far more averse to risk, “so, it is difficult to predict what kind of coupon rates these instruments will carry."

The other hurdle that these bonds may face is the tax-free model, said Ladha. Though these bonds have been made tax-free, banks or insurance companies cannot avail of the full tax benefits under the amended tax laws for financial institutions. “Earlier, these institutions could have availed of the full benefits of a tax-free bond, but now under Section 14(a), tax benefits for them have dropped drastically." He added that it could still be a good diversification tool for investors such as banks, insurance firms and pension funds that are “typically long-term investors and show interest in long-term projects."

For weaker municipal bodies, the best option is that of pooled finance, said S. Nandakumar, head of public finance and infrastructure at Fitch Ratings. One option for these bodies could be to pool finances and form a trust in the form of a state-level nodal agency.

Unlike a couple of years back, there is no third-party guarantee for these pooled financed vehicles, which were earlier provided by the United States Agency for International Development.

These pooled finance vehicles are a good way of raising money for infrastructure needs as the risks are diversified for both the investor and the municipal bodies, Nandakumar said.