Kochi Municipal Corporation is said to have no shortage of funds from various sources. Most recently, from lending agencies. But lending agencies are willing to lend money only because there is a state government guarantee. Since the financial management of KMC is in bad shape, more and more borrowing through lending agencies will only accentuate the fiscal crisis of the State Government of Kerala.
To mitigate the problem of excessive dependence on the State and Central Governments for funds, financial markets can be tapped through municipal bonds. Municipal bond market develops as a part of the bond market in India which is not under the control of the local governments and that which requires prudent macro-economic policies. Hence before resorting to municipal bond issues, hyper-inflation must be kept in check so that real returns are not meagre. A genuine municipal bond issue should not have a state or central government guarantee as it will create a lax attitude in the implementation of the infrastructural projects undertaken from the capital raised through the bond issue as the bond issuer is not entirely made responsible to pay back the debt. This will eventually add to the public debt at the central and state levels. It will create a situation that is similar to what has been happening over the past few years when local bodies have been raising funds through credit lending agencies hence rendering the whole argument for municipal bond issues pointless.
A city or a town issuing municipal bonds must have an efficient system of service delivery, sound institutions and good fiscal relations with the centre and the state. This implies transparent city budgets, credible accounting systems and independent audits. A reliable regulatory mechanism should be put in place. In case municipal bodies default, bankruptcy laws must be defined properly to ensure that the creditor’s claims over municipal assets are well-defined.
Appointment of credit rating agencies will help in the non-objective assessment of the creditworthiness of the various municipal bond issuers. Credit rating agencies assess the creditworthiness by analyzing the ability of municipal bodies to raise revenues through taxes and other sources, their ability to honour financial commitments, their dependence on central and state government transfers and loans, etc. To improve the credit standings, municipal tax bases should be expanded and tax rates should be rationalized. For example, the stamp duty in Kerala is a bit too high because of which there’s a high rate of default. If this rate is brought down, the rate of default should go down and there would be revenue buoyancy.
A municipal bond with a low credit rating will be priced at a higher spread than the normal central government bonds and treasury bills. Hence, a bad credit rating might incentivize corporations to raise infrastructural and bureaucratic efficiency so that their credit rating is improved and more investors invest in their municipal bonds.
To reduce the cost of debt issue, a bond insurance market can be contemplated. But it should not be a substitute for the creditworthiness of a bond issuer. Bond insurance market if formed should be brought under the purview of the Insurance Regulatory and Development Authority (IRDA) of India so that markets are not taken advantage of by certain players. For a successful bond insurance market to exist there should be a large variety of debt instruments present in the market to ensure diversity along with a reliable credit rating mechanism to respond to the investors who are conscious of the credit ratings. In the US, around 50 per cent of the municipal bond issues are insured.
Setting up a benchmark coupon rate on municipal bonds should not depend on that of the sovereign bond issues and instead should reflect the market conditions as sovereign issues are backed up by a guarantee and they’re comparatively short-term.
Municipal development funds can be set up to provide credit to municipal entities. Such an initiative was taken by the central government when it set up the Pooled Finance Development Fund.
Municipal Bonds should be made available tax free so that retail investors are incentivized.