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Municipal Bonds : Is India ready for more?

Listed author(s):
  • Chandrasekaran, Pravin
  • Katayama, Roy
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    In India, municipal development projects benefiting the public often get impeded by the political and institutional framework of the Central Government. In many cases in India, a major constraint is financing these projects. According to the 12th Finance Commission report most of the infrastructure initiatives have been stalled due to financial constraints. For instance, the shortfall in financing to achieve the water and sanitation sector goals in India’s Tenth Plan is estimated at INR 179 billion. Without the discretion to issue municipal bonds, municipalities are often dependent on transfers from the Government of India (GOI) since direct investment for these projects is difficult to secure. While municipal governments are responsible for public service provision, their ability to do so is often constrained by inadequate GOI appropriations and/or missing municipal bond markets. On the other hand, private investors often lack the incentives to invest in public service projects due to high risks and insufficient returns. As a result, the provision of public goods such as infrastructure projects can be delayed or cancelled. Tax-free municipal bonds provide a potential mechanism to bridge the financing gap. We have described the actual process of municipal bond process using the example of Corporation of Chennai and the desalination water project they propose to build. We present how tax incentives, transfers and private savings tie into the municipal bond framework. We believe that only a well performing municipality can be allowed to be fiscally independent and thus chose the Corporation of Chennai for analysis and go on to show what checks and balances are needed in the Indian scenario to support such a move towards sustainable financial decentralization. This policy paper analyzes four key dimensions of the expansion of the municipal bond market. Firstly, we analyze the driving forces for the evolution of a municipal bond market. Secondly, we develop an economic framework to value a municipal debt instrument and to estimate the optimal debt for the municipality to issue. In this section we also discuss the dynamics of the model and impacts of shocks and economic transfers on the municipal debt. Thirdly, we map the stakeholders and analyze the threats and benefits of a municipal bond issuance for these stakeholders. Finally, we recommend a framework for expansion of the municipal bond market while minimizing the potential for fiscal irresponsibility and uncontrolled growth of sub-national debt. We propose the creation of Special Municipal Zones based on strong credit rating, accrual based accounting systems, optimal debt to revenue collection ratios and a strong financial need of the municipalities. To support such Special Municipal Zones, we recommend several key changes in the institutional framework including creation of the Municipal Securities Board of India.

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    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 9807.

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    Date of creation: 26 Mar 2006
    Handle: RePEc:pra:mprapa:9807
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    1. Jonathan A. Rodden & Gunnar S. Eskeland (ed.), 2003. "Fiscal Decentralization and the Challenge of Hard Budget Constraints," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262182297, July.
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