3 India: A Three-tier Federation First Tier: Central Government at the National LevelSecond-Tier : State Governments in 28 States & 7 Union TerritoriesThird-Tier: Numerous Rural and Urban Local BodiesRural Local Bodies 2,47,033Panchayats 2,38,662Autonomous Councils 83,410Urban Local Bodies 3,682Municipal Corporations 96Municipalities ,494Nagar Panchayats 2,092
5 Wide diversity in terms of revenue raising capabilities and economic performance OctroiProperty taxOther taxesWater / sewerageBuilding licenseVehicle/ animalsFinesInvestment incomeStamp DutyElectricity taxMotor vehicle taxState governmentOther agenciesGrowth / sustainability / predictability of key revenue heads:Octroi: Depends on consumption levels within muni. limits, and on use of industrial inouts by manufacturing units located within muni. limits. Sustainability of octroi depends on continued industrial and economic growth within city, and collection efficiency.Problems in octroi come from transport lobby, protest from consumers against adding to costs, protests from producers against eroding their local competitivenessProperty tax: % levied on ARVs of residential, industrial and commercial property. Key issues are:1) Basis of levy (flat rate, area based, mkt value based)2) how frequently are rates fixed3) how easy is it to raise rates4) collection efficiencyLitigation proneWater / sewerage charges: usually do not cover service costs. The extent of deficit is a function of:Area covered, # of connections, % of bulk consumption, income profile of usersShared / assigned taxes: passed on by concerned SG. General trend is against passing on these benefits to munis as SGs themselves are in weak position
8 Financial market is yet make a strong impact on financing subnational governments and urban infrastructures
9 Potential benefits of bond market access by the local governments: Leverage the internal resources with long term bonds for financing infrastructure;Make lumpy investments through bond issuance rather than limited pay-as-you-go financingResults in credit discipline by the city governments, by promoting fair discloser and accounting, and better management practicesMake feasible one of the vital objective of the 74th Constitution Amendment by balancing the revenue raising capabilities with expenditure responsibilities.
12 Subnational Bond Issuance in India Bonds issued by state sponsored institutionsBonds issued by ULBsUrban Development Funds
13 Issuance by State Sponsored Institutions State level Statuary Boards( such as water supply and swerage boards), state owned corporations( such as power, irrigation), state initiated SPVs,, with limited recourse to GovernmentAre the second largest issuers in Indian bond markets component of the local bond segmentsIssued as private placements, most of which are government guaranteedTaxable or tax-free, often in the form of structured issues or carrying credit enhancement features such as revenue dedication: usually known in India as “structured obligations(SO)”Have created significant fiscal risks for the state governments, as discussed
14 Noida Toll Bridge Company Limited SPV promoted by IL&FS for the Noida-Delhi toll bridge project, which include constructing a bridge across the river Yamuna on a BOOT scheme(operations started in February 2001):Equity : Rs 1016 millionFCDs : Rs 208 millionIL&FS (World Bank) : Rs 600 millionTerm loans : Rs 1075 millionDeep discount bonds : Rs 500 millionCredit rating - AAA (SO) by CAREPut option: Investors have the put option to sell the bonds to IL&FS and/or IDFC at a predetermined price at the end of 5th year and 9th year from the date of allotment.Credit enhancement mechanism: By IDFC & ILFS
15 Municipal BondsMunicipal issues are in the nature of revenue bonds, with fixed interest rate, with or without government guarantee, maturity 7-15 years, are in the form of Structured Obligations(SO), taxable or tax free
18 TamilNadu Urban Development Fund A Trust established in 1996 under the Indian Trusts Act, 1882, by GoTN, ICICI, HDFC and IL&FS with a line of credit from the World Bank, to fund urban infrastructure needs.The share holding pattern of TNUDF is GoTN (49%), ICICI (21%), and HDFC and IL&FS (15% each)Management responsibility is taken up by ICICI, the lead institution in the arrangement.ULBs, statutory boards, and joint sector projects are the eligible borrowers, with maturity varying from yearsSpecial recovery mechanisms such as escrow accounts of property tax, water charges and hypothecation of movables are generally used.
19 Pooled Financing in Tamil Nadu A State level pooled financing mechanism launched in Tamil Nadu, with the financial assistance of the USAIDFor smaller and medium sized municipalities Under the arrangement, 14 smaller ULBs, who are unable to access capital markets due to weak financial position and lack of capacity, pooled some water and sanitation projects under a special purpose vehicle (SPVs) called the Water and Sanitation Pooled Fund(WSPF), and raised about Rs 300 million from the bond market at an interest of 9.2 per cent for 15 years maturity
20 Tamil Nadu Experience is unique, needs to be replicated, in the urban and semi-urban areas of developing countries.The financing of local infrastructure met by market based funding techniques with beneficiary participation (loans and grants are blended for the poorer municipalities).Bringing to one platform a number of stakeholders: governments at the levels of central, state and municipality, multilateral donor, domestic financial institutions, and private investors;The Fund has built significant capacity by improving the financial, managerial, administrative, and technical performance of the municipalities, and has the potential of ultimately turning them into creditworthy and well functioning entities.Direct and positive environmental benefits in the urban areas through solid waste and sanitation facilities, storm drainage and water supply facilities.Established significant participatory governance, whereby City Development Strategies are undertaken through a consultative process involving elected officials, municipal officers, community and professional groups, business and industry representatives and government agencies.
21 The TNUDF has the potential to revolutionize the concept of development financing and empowering local communities, and could serve well as an effective tool towards the fulfillment of Millennium Development Goals.
22 Deepening of Subnational Capital Markets and Bonds Markets Depends much on the growth and diversity of the national bond markets, and its constituents, its institutional structure and regulatory frameworkSecurities regulations are not designed in segments; should be viewed as part of an overall system, existing alongside and complemented by established national systems of regulationsCreate the enabling environment, thereby enhancing the attractiveness of the Subnational securities, by reducing transaction costs and risks for investors
23 Environment promoting Subnational bond issuance should include.. Broadening of the issuers and investor’s baseCredit ratings of the Subnational bodiesSecurities regulations covering issuing, listing, trading, and settlementsDefined borrowing powersBankruptcy regulations with defined and enforceable debt contractsFiscal incentives such as taxation and credit enhancement such as guarantees
24 IssuersBroadening of the issuers base, through capacity building effortsFinancial restructuring of the SPVs and salutatary boards, making them creditworthyBringing medium and smaller urban areas into municipal bond marketsPromotion of pooled financing structure
25 InvestorsMost of the central and state government securities are held by the institutional investorsSubnational securities are generally seen as high yield, but more riskyAttracting more and more retail investors, and by designing customized bond structures, in order that the risk perceptions improved, wider publicity, improving transparency of local bodiesInnovative mechanisms such as embedded options, pooled financing/bond banks, specialized funds, securitization, “take-out financing” etc will strengthen this marketsBuilding capital market relationship, making investors aware of the issuer profile, familiarity with market intermediaries and regulatory environment
26 Secondary MarketsPresently the secondary market trading comprises mostly the central and state government securities.Investors in municipal bonds effectively held to maturityMunicipal issuers will benefit from listing and trading in secondary market, as this will greatly enhance trading and visibility.NSE would be the preferred exchange, has terminals in most of the Indian cities, allowing nationwide access for investors.Listing and trading requires continuing disclosure requirements for the local bond issuers.
27 Regulatory Structures Issuance of debt instruments by local bodies are governed by multiple legislationsToo many regulators, with less effective regulations
28 Regulatory Design for Local Debt Markets The Public Debt Act 1944The Securities and Exchange Board of India(SEBI) Act of 1992The Local Authorities Loan Act 1914The Companies Act 1956The Securities Contracts (Regulation) Act 1956The Depositories Act 1996Subnational bodies taking the tax exempt status come under the MUD&PA and the MOFState governments themselves regulate borrowings
29 Case for Integration of Different Regulatory Agencies for subnational issuance Case to have a single law or single window clearance for bond issuance by local bodies.State Finance Commissions (SFCs) is expected to deal with assignment of powers relating to taxes, transfers, but extremely limited role in so far as borrowing powers are concerned.
30 Borrowing PowersLocal Authorities Loans Act of 1914 is very old and have outdated provisionsEstimates of borrowing powers are made based on the annual rental value, which have not been revised for longFew States have passed laws on guarantees, but none has passed a law on capping borrowingsNecessary for a clear policy on borrowing powersIt will also bring in market discipline and fiscal stability
31 Credit RatingsMandatory rating which along with a statutory limitation on borrowing powers of Subnational bodies would bring in considerable market disciplineCredit rating is definitely not just a regulatory issue as much as a measure of market disciplineGovernment guarantee is not a substitute for important disclosure through credit ratingsSocio-political changes at the local level need to be captured by rating agenciesRating agency should monitor the ULBs as part of its surveillance during the tenor of the bondsState governments could take important initiatives in making available the credit ratings of their local bodies, something like pre-screening of the potential issuers or in the form of comparative urban indicators
32 Municipal BankruptcyThe existing framework of insolvency in India mainly relates to corporate insolvencyNot relevant insofar as enforcing secured assets of or bringing about insolvency proceedings against the ULBsNeed for laws relating to Municipal Bankruptcy:Promulgation of a law to lay down a separate insolvency process (in the nature of a fast-track recovery process) for local bodies.Constitution of separate insolvency courts to try matters pertaining to borrowings by and insolvency of, local bodies.Promulgation of a separate statute setting out the revised manner of constitution of local bodies, in order to facilitate greater transparency and responsibility in fiscal dealings
33 Fiscal IncentivesTax exemptions allowed under various sections of the Indian Income Tax Act from the following:Interest received from bondsCapital gains from bondsTax rules and rates are prone to changes every yearTax environment should be stable and predictable
34 Capacity building in capital planning process ULBs Municipal Bond Issuance ProcessProject Feasibility studyCapital planning processPrepare for DisclosureDecision to IssueCredit RatingFormation of Bond Parties (underwriter, trustee, State government guarantee)Information MemorandumAudit and Standing Committee ApprovalGOI and SEBI approvalIssuance of bondsListingUse of Funds and Follow Up
35 Enabling EnvironmentExistence of viable infrastructure projects, with definite cash flowsRegulatory framework enabling private sector participation in local projectsCash flow generating capability of projects through defined user chargesFiscal and financial capability of the city governmentsStrong accounting and disclosure standards and good corporate governanceHuman resource development, with requisite skills
36 Investment financing for urban infrastructure creation, with bond financing as one component, seems to have been more successful where the state governments and the supporting institutions have established complementarities
37 It is to be recognized that developing Subnational bond markets can be more complicated, time-taking, having both national and regional dimensions