Now FPIs can dabble in muni bonds

Apr 26, 2019

The Reserve Bank of India now allows foreign portfolio investors (FPIs) to invest in municipal bonds, popularly referred to as muni bonds.

This is a smart move to broaden access of non–resident investors to debt instruments in India, and channelize funds towards municipal bonds.

The limits for investing in these muni bonds are within the limits for FPI investment in state development loans (SDLs). The limits set for SDLs amount to 2% of outstanding securities.

According to Vinayak Chatterjee, co-founder and chairman of Feedback Infra Pvt Ltd, the current size of the “muni” market in the U.S. is $3.8 trillion, while the corresponding figure for India is less than $500 million. For Smart Cities to become a reality, there must be a very significant development of the Municipal bonds market.

In the past, capital has been raised via this route, though it is more the exception than the norm. For instance, Pune raised funds via municipal bonds in June 2017, Hyderabad was the other municipal corporation to tap the markets in February 2018, and in January 2019, the Amdavad Municipal Corporation raised Rs 200 crore by selling muni bonds.

Under SEBI (Issue and listing of Debt Securities by Municipalities) Regulations, 2015, a municipality or a Corporate Municipal Entity could make a public issue of debt securities subject to conditions.

For instance, the entity should not have negative net worth in any of three immediately preceding financial years. Municipalities having a surplus as per its Income and Expenditure Statement, in any of the three immediately preceding financial years or any other financial criteria as specified by Sebi from time to time, could issue such bonds. The municipality should not have defaulted in repayment of debt securities or loans obtained from banks or financial institutions during the last 365 days.

In a report released in May 2018, rating agency Moody’s Investors Service made some observations that were probably preventing a pick-up in issuances:

  • Lack of publicly available information on fiscal performance, debt and contingent liabilities is preventing proper credit assessment of these bodies.
  • Weak governance is a concern.
  • Accounting and disclosure standards vary widely between Indian states and between different tiers of government within the same jurisdiction.
  • With the exception of the larger capital cities that are interested in accessing the capital markets, most urban local bodies do not make their accounts public.
  • Roadblocks include restrictions on the maximum interest rates that municipal corporations can offer, and unfavourable rules regarding income tax on interest earned by bondholders.
  • A weak track record of timely project implementation and completion, which in turn weakens projected cash flows, which in turn lowers the perceived credibility of municipal bonds.

Transparency and increased public scrutiny would go a long way in urging the local bodies improve their financial prudence. It would also do away with any cloak of secrecy and strengthen the interest of investors in muni bonds.

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