Municipal bonds

27th December, 2020 Economy

Context: Vadodara corporation plans to raise money via municipal bonds.

A municipal bond is a kind of debt instrument, where investors offer loans to local governments.
They are issued by civic bodies for specific projects and usually have a 10-year tenure.
The Vadodara Municipal Corporation (VMC) will become the third Urban Local Body (ULB) in Gujarat to use this method to raise money to fund development work sanctioned under the Atal Mission for Rejuvenation and Urban Transformation (AMRUT).

The Ahmedabad experience

Ahmedabad was the first city in south Asia to launch a municipal bond of Rs 100 crore in 1998, which was completely subscribed.
It followed up with four more bonds — two Rs 100 crore ones in 2002 and 2005, a Rs 98 crore bond in 2004, and one of Rs 200 crore in 2019.
Surat Municipal Corporation was the second city in Gujarat to announce bonds in 2018, to fund a sewage treatment project worth Rs 450 crore.

Vadodara’s municipal bonds

The VMC is riding on the favourable credit ratings from two agencies for two proposed bonds of Rs 100 crore each, and expects to issue the bond at the exchange by January 2021.
The VMC General Board in its budget for 2019-20 financial year (FY), given in-principal approval for mobilisation of Rs 100 crore through issuance of Municipal Bond which was raised to Rs 200 crore in the FY 2020-21.
Under the AMRUT scheme, the VMC has got approval for its Detailed Project Report (DPR) of 14 works worth Rs 474.34 crore.
United States Treasury Department is also providing the VMC with the technical assistance and guidance for proposed Municipal Bond under the India-US Economic and Financial Partnership programme.

What is a municipal bond?

A municipal bond is a kind of debt instrument where investors offer loans to local governments.
The ULB pays the annual interest on the bonds to the investor at the decided rate.
The difference between a bank loan and a municipal bond is that any institution can secure a bond only if it has favourable credit ratings.
The bond helps raise funds from the stock market.
The bond also increases the number of investors available to the civic body, as compared to a loan from a single bank.
Bonds are issued to institutional and high networth individuals.
The face value of each instrument slot of a municipal bond if a minimum of Rs 10 lakh.
It can be subscribed to (purchased) by a single investor or multiple investors.

Why is the government pushing for municipal bonds?

Under the Atal Mission for Rejuvenation and Urban Transformation (AMRUT) scheme, urban local bodies (ULBs) are encouraged to tap the bond market.
Bonds help ensure improved credit profiles, direct transfer of funds by the Centre, transparency and efficient revenue generation.
The government also pays ULBs Rs 13 crore for every Rs 100 crore raised via bonds, subject to a ceiling of Rs 26 crore for each.

How do investors bid for the municipal bond and get paid?

Bidding takes place on an electronic trading platform after the bond is listed on the exchange.
The bidding is open to all investors and is facilitated by the transaction agent appointed by the ULB, who gets a commission of 0.10% after the money is transferred to the account of the ULB.

How do corporations facing an overall financial crunch pay investors?

The ULBs who earn approval for issuing bonds, do so after an in-depth analysis of their debt-paying capacity, based on various parameters as well as the balance sheet for the immediate preceding five years.
While credit rating firms assess the financial health of the ULBs, AA++ is considered to be the best rating — which was also given to Ahmedabad and Surat in Gujarat. The next best is the AA rating.
ULBs also share an ‘information memorandum’, which is a facsimile of the ‘share certificate’ in a stock market.
The memorandum carries details of the ULB and its financial performance.
The law firm hired by the ULB prepares this memorandum although the “due diligence report” is filed through the merchant banker with the SEBI.
One of the pre-requisites for issuing the bond is the mandatory opening of the escrow account, in which the Central government transfers all the annual incentives (Rs 13 crore per Rs 100 crore bond issued) so that the payment to be made to the investor is taken care of.

Daily News Analysis