financing municipal services - indian institute of public

Series Editors:Aasha Kapur Mehta, Pradeep Sharma

Sujata Singh, R.K.Tiwari

Financing Municipal SerFinancing Municipal SerFinancing Municipal SerFinancing Municipal SerFinancing Municipal ServicesvicesvicesvicesvicesReaching Out to Capital MarketsReaching Out to Capital MarketsReaching Out to Capital MarketsReaching Out to Capital MarketsReaching Out to Capital Markets

Om Prakash Mathur, Sanjukta Ray

2006

Market Access For Agricultural Products

AcknowledgmentsAcknowledgmentsAcknowledgmentsAcknowledgmentsAcknowledgmentsThe authors owe their gratitude to Ms. Sujatha Srikumar, then of CRISIL for her assistance in the preparationof Chapter 4 of this paper. The authors deeply appreciate the encouragement received from Dr. AshokLahiri, now Chief Economic Advisor to the Government of India in the preparation of this paper, andthank Dr. M. Govinda Rao, Director, NIPFP, for providing the needed support to its preparation. The paperwas word-processed by Ms. Usha Mathur and Ms. Rekha.

Table of ContentsTable of ContentsTable of ContentsTable of ContentsTable of Contents

1

2

3

4

5

Urban Infrastructure and Infrastructure Financing Systems: An Overview 1

Legal Framework for Municipal Borrowing 8

What Makes Some Municipalities Gain Access to Capital Marketsand Others Fail: Analysis of the Finances of Four Municipal Corporations 13

Municipal Bonds in India 22

A Framework for Evaluating the Financial Performance 32

Glossary 38

References 39


List of Tables, Charts and BoxesList of Tables, Charts and BoxesList of Tables, Charts and BoxesList of Tables, Charts and BoxesList of Tables, Charts and Boxes

1. Key Features of Tax-Free Municipal Bonds 24

2. Measuring Financial Performance 36

1 Urban Households without Access to Safe Drinking Water 2

2. Urban Demographic Pressures in Selected States 3

3. Plan Outlays on Urban Water Supply and Sanitation 5

4. Projected Gross Investment in Urban Infrastructure 6

5. Finances of the Agra Municipal Corporation (AGMC) 14

6. Measuring Performance: Agra Municipal Corporation (AGMC) 14

7. Finances of the Allahabad Municipal Corporation (AMC) 15

8. Measuring Performance: Allahabad Municipal Corporation (AMC) 16

9. Finances of the Bangalore Municipal Corporation (BMC) 17

10. Measuring Performance: Bangalore Municipal Corporation (BMC) 17

11. Finances of the Vadodara Municipal Corporation (VMC) 19

12. Measuring Performance: Vadodara Municipal Corporation (VMC) 19

13. Ratio of Own Revenues to Total Revenue Receipts 20

14. Financial Performance of Sampled Municipal Corporations 21

15. Ratio of Grants to Total Revenue Receipts 21

16. Municipal Bonds 30

17. Ratio Ranking on the Basis of Indicators 37

List of Tables

List of Charts

1. Municipal Credit Market 33

List of Boxes

AGMC Agra Municipal Corporation

AHMC Ahmedabad Municipal Corporation

AMC Allahabad Municipal Corporation

BMC Bangalore Municipal Corporation

CARE Credit Rating and Research Limited

CCF City Challenge Fund

CPHEEO Central Public Health and Environmental Engineering Organisation

GOK Government of Karnataka

GIC General Insurance Corporation of India

GOTN Government of Tamil Nadu

HMC Hyderabad Municipal Corporation

HUDCO Housing and Urban Development Corporation Limited

ICICI Industrial Credit and Investment Corporation of India

ICRA Investment Information and Credit Rating Agency Limited

IDBI Industrial Development Bank of India

IDFC Infrastructure Development Finance Company

ILFS Infrastructure Leasing and Financial Services Limited

LIC Life Insurance Corporation of India

LMC Ludhiana Municipal Corporation

IMC Indore Municipal Corporation

MIRR Madurai Inner Ring Road Project

MMC Madurai Municipal Corporation

NGMC Nagpur Municipal Corporation

NMC Nashik Municipal Corporation

PFDF Pool Finance Development Facility

SFC State Finance Commission

SPV Special Purpose Vehicles

TMC Thane Municipal Corporation

TNUDF Tamil Nadu Urban Development Fund

URIF Urban Reform Incentive Fund

VMC Vadodra Municipal Corporation

AcronymsAcronymsAcronymsAcronymsAcronyms


AcknowledgmentsAcknowledgmentsAcknowledgmentsAcknowledgmentsAcknowledgmentsThe authors owe their gratitude to Ms. Sujatha Srikumar, then of CRISIL for her assistance in the preparationof Chapter 4 of this paper. The authors deeply appreciate the encouragement received from Dr. AshokLahiri, now Chief Economic Advisor to the Government of India in the preparation of this paper, andthank Dr. M. Govinda Rao, Director, NIPFP, for providing the needed support to its preparation. The paperwas word-processed by Ms. Usha Mathur and Ms. Rekha.

Table of ContentsTable of ContentsTable of ContentsTable of ContentsTable of Contents

1

2

3

4

5

Urban Infrastructure and Infrastructure Financing Systems: An Overview 1

Legal Framework for Municipal Borrowing 8

What Makes Some Municipalities Gain Access to Capital Marketsand Others Fail: Analysis of the Finances of Four Municipal Corporations 13

Municipal Bonds in India 22

A Framework for Evaluating the Financial Performance 32

Glossary 38

References 39


List of Tables, Charts and BoxesList of Tables, Charts and BoxesList of Tables, Charts and BoxesList of Tables, Charts and BoxesList of Tables, Charts and Boxes

1. Key Features of Tax-Free Municipal Bonds 24

2. Measuring Financial Performance 36

1 Urban Households without Access to Safe Drinking Water 2

2. Urban Demographic Pressures in Selected States 3

3. Plan Outlays on Urban Water Supply and Sanitation 5

4. Projected Gross Investment in Urban Infrastructure 6

5. Finances of the Agra Municipal Corporation (AGMC) 14

6. Measuring Performance: Agra Municipal Corporation (AGMC) 14

7. Finances of the Allahabad Municipal Corporation (AMC) 15

8. Measuring Performance: Allahabad Municipal Corporation (AMC) 16

9. Finances of the Bangalore Municipal Corporation (BMC) 17

10. Measuring Performance: Bangalore Municipal Corporation (BMC) 17

11. Finances of the Vadodara Municipal Corporation (VMC) 19

12. Measuring Performance: Vadodara Municipal Corporation (VMC) 19

13. Ratio of Own Revenues to Total Revenue Receipts 20

14. Financial Performance of Sampled Municipal Corporations 21

15. Ratio of Grants to Total Revenue Receipts 21

16. Municipal Bonds 30

17. Ratio Ranking on the Basis of Indicators 37

List of Tables

List of Charts

1. Municipal Credit Market 33

List of Boxes

AGMC Agra Municipal Corporation

AHMC Ahmedabad Municipal Corporation

AMC Allahabad Municipal Corporation

BMC Bangalore Municipal Corporation

CARE Credit Rating and Research Limited

CCF City Challenge Fund

CPHEEO Central Public Health and Environmental Engineering Organisation

GOK Government of Karnataka

GIC General Insurance Corporation of India

GOTN Government of Tamil Nadu

HMC Hyderabad Municipal Corporation

HUDCO Housing and Urban Development Corporation Limited

ICICI Industrial Credit and Investment Corporation of India

ICRA Investment Information and Credit Rating Agency Limited

IDBI Industrial Development Bank of India

IDFC Infrastructure Development Finance Company

ILFS Infrastructure Leasing and Financial Services Limited

LIC Life Insurance Corporation of India

LMC Ludhiana Municipal Corporation

IMC Indore Municipal Corporation

MIRR Madurai Inner Ring Road Project

MMC Madurai Municipal Corporation

NGMC Nagpur Municipal Corporation

NMC Nashik Municipal Corporation

PFDF Pool Finance Development Facility

SFC State Finance Commission

SPV Special Purpose Vehicles

TMC Thane Municipal Corporation

TNUDF Tamil Nadu Urban Development Fund

URIF Urban Reform Incentive Fund

VMC Vadodra Municipal Corporation

AcronymsAcronymsAcronymsAcronymsAcronyms

1

Urban Infrastructure and InfrastructureUrban Infrastructure and InfrastructureUrban Infrastructure and InfrastructureUrban Infrastructure and InfrastructureUrban Infrastructure and InfrastructureFinancing Systems: An OverFinancing Systems: An OverFinancing Systems: An OverFinancing Systems: An OverFinancing Systems: An Overviewviewviewviewview

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Financing Municipal SerFinancing Municipal SerFinancing Municipal SerFinancing Municipal SerFinancing Municipal ServicesvicesvicesvicesvicesReaching Out to Capital MarketsReaching Out to Capital MarketsReaching Out to Capital MarketsReaching Out to Capital MarketsReaching Out to Capital Markets

Om Prakash Mathur, Sanjukta Ray*

* The views expressed in this paper are those of the authors and do not necessarily reflect the views of GOI, UNDP or IIPA.1 The classification of outlays shown in the Five Year Plan does not make it possible to separately estimate the outlays proposed for urban

infrastructure development. It is important to point out that even the India Infrastructure Report could not separately identify the levels of planinvestment in urban infrastructure services. Moreover, as the report indicated, in the absence of any countrywide norms of investment for suchservices as water supply, sewerage, roads, solid wastes and street lighting excepting those that were developed by the Zakaria Committee in 1963 andwhich are for all practical purposes obsolete, different agencies have put out their own estimates of investment requirements. There is a great dealof ambiguity with respect to the backlog in services except perhaps in the case of water supply.

Accelerating the flow of resources into urban infrastructureand services viz., water supply and wastewater disposal ser-vices, solid waste collection, treatment and management,citywide roads and street lighting is central to India’s eco-nomic growth and poverty reduction agenda. Current lev-els of investment, roughly placed at about 2.25 to 2.50 per-cent of total Plan outlays are low and the financial resourcerequirements are substantial. The India Infrastructure Re-port (1996) reported that the average Plan provision forurban infrastructure comprising water supply, sanitation androads was only about nine percent of the investment neededfor their provision and maintenance. Placing the annual ag-gregate investment requirements at about Rs. 282 billion forthe period 1996-2001 and another Rs. 277 billion for theperiod 2001-2006, the India Infrastructure Report observedthat the planned investment was woefully inadequate even forthe necessary operation and maintenance of core services,

let alone for financing the additional requirements of coreservices and other urban infrastructures.

Using the estimates formulated by the Central Public Healthand Environmental Engineering Organisation (CPHEEO),the Tenth Five Year Plan (2002-07) has placed the financialrequirement for 100 percent coverage of urban popula-tion with potable water and 75 percent population cover-age with sewerage and sanitation at Rs. 537.2 billion (Plan-ning Commission 2002). According to the Tenth Five YearPlan, these estimates provide at best an order of the mag-nitude of investment requirements and need to be betterassessed with information on cost of augmentation ofservice supplies and cost of pumping, treatment, mainte-nance etc. The Tenth Plan does not separately delineate theproposed plan outlays for urban infrastructure, but theseare unlikely to be noticeably higher than the outlays pro-vided in the earlier plan periods.1 The gap between what is

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Financing Municipal Services: Reaching Out to Capital Markets

2 The high population coverage of over 90 percent tends to hide several realities regarding the operations of the water system. According to the TenthFive Year Plan (Box 6.2.1), coverage may relate to the installed water capacity rather than the actual average supply. Coverage figures do not reveal theregularity or duration of supply or even whether the supply is made on a daily basis or less frequently. Coverage does not reveal the supplementarysources that the consumers put in order to secure themselves for any disruption in water supplies. For details, see Tenth Five Year Plan (pp.634-635).

provided and what is required is phenomenally large andwhen seen in the context of large infrastructure deficits,which affect the poor more than the other sections andincreasing demographic pressures on infrastructure andservices, it is evident that funding mechanisms and instru-ments that are beyond the traditional sources are neededfor financing urban infrastructure and services.

The Urban Services BacklogThe Urban Services BacklogThe Urban Services BacklogThe Urban Services BacklogThe Urban Services Backlog

Urban infrastructure and services in India are grossly inad-equate and of poor quality. According to the 54th Roundof the National Sample Survey Organisation (NSSO), al-though the proportion of urban households without ac-cess to safe drinking water is low - about nine percent,2

nearly 40 percent of them do not have a safe drinkingwater source within the premises, and 50 percent depend ona source other than tap water within the premises. (Table 1)

Inadequate coverage of the urban population is only onemanifestation of the lack of investment in the urban watersector. The NSSO has drawn special attention to the prob-lem of water scarcity, particularly during summer months,forcing households to resort to purchasing water frominformal markets together with the problem of waterquality. The 54th Round of the NSSO survey reported thatnearly 18 percent of households faced problems of un-satisfactory water quality, with several states reporting sig-nificantly higher proportions of water quality problems(Assam, 52.3%; Bihar, 34.4%; Kerala, 58.4%; and Orissa,

Table 1: Urban Households without Access to Safe Drinking Water

Year Percentage of households without access toSafe drinking Safe drinking water Tap water

water within premises within premises1981 25.87 57.00 63.901991 18.60 49.51 57.772001 9.99 39.16 50.32

Source: National Sample Survey Organisation, 54th Round, 1999.

32.5%). Conditions in respect of other urban services areequally unsatisfactory. Access to excreta disposal systemsin urban areas varies between 48 to 70 percent. Out of300 cities with a population of over 1,00,000, about 70percent have partial sewerage systems and sewage treat-ment facilities. A survey of 345 towns with a populationbetween 50,000 and 1,00,000 revealed that nearly 95 per-cent of them had no wastewater treatment facilities anddisposal of wastewater on land was the predominantmethod of disposal. Management of urban waste (about45-50 million tonnes annually) is severely stressed and iscurrently under scrutiny by the Supreme Court. A surveyconducted in 1989 showed gross deficiencies in the streetlighting system across cities and towns of different popu-lation size categories (Vaidya and Mukundan 1989). Thegrowing trend of personal vehicles has resulted in severecongestion on roads, slowing down of traffic and wors-ening atmospheric pollution. Narrow carriageways andpoor road surfaces have added enormously to congestionproblems. In smaller towns and cities, movement is ham-pered by narrow roads and constrained by the use ofcarriageways for other purposes. Poor road constructionand inadequate maintenance further hamper traffic flows.

There are also other problems which afflict the urban in-frastructure sector. In respect of urban water supply, forinstance, the Tenth Five Year Plan observes.

“The problems of the sector are manifold. Transmission anddistribution networks are old and poorly maintained. Consequently,

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physical losses are high ranging from 25 to 30 percent. Most citiesare unable to operate and maintain the existing systems to the fullcapacity. Capacity utilisation has been reported to be less than 50percent in 40 percent of the towns and less than 75 percent in afurther 20 percent of towns. There is grave danger that cities may, inmany instances, slip back to lesser levels of water supply, due to poormaintenance and depletion of sources even as the population continuesto grow. This may lead to a situation where the per capita availabilityof water by 2020 may actually decrease, unless corrective action wastaken expeditiously”.

Much of the backlog and inefficiency in service deliveryand management are attributable to insufficient investmentboth in creating new facilities and maintenance of the ex-isting systems, affecting the urban poor in a much largermeasure compared to the non-poor urban population.

Demographic Pressures on UrbanDemographic Pressures on UrbanDemographic Pressures on UrbanDemographic Pressures on UrbanDemographic Pressures on UrbanServicesServicesServicesServicesServices

Demographic pressures on urban infrastructure and ser-vices have mounted and are expected to mount further inthe coming years (See Table 2). During 1991-2001, ap-proximately 68 million persons were added to the totalurban population, which has generated fresh demand forsuch services as water supply, sewage disposal system,citywide roads and street lighting. Several states such asGujarat, Karnataka, Maharashtra, Punjab and Tamil Nadu

have registered a three to four percentage point increase intheir urban populations, which has not been accompaniedby any corresponding upgradation in the level of infra-structure and services. Moreover, these pressures are likelyto escalate at least until 2030, in which year India’s urbanpopulation will have reached at least 500 million persons.At the same time demographic pressures are mounting.Decentralisation initiatives as embodied in the 74th Consti-tution Amendment Act, 1992 have transferred responsi-bility for economic and social development, urban pov-erty alleviation and other subjects like environment andurban forestry to municipal governments. It is likely togradually involve shifting the responsibility for the localcapital budget to municipal governments. Also, as theAmendment takes root, municipal governments are ex-pected to play a greater role in setting capital investmentpriorities and on the revenue side, responsibilities for fi-nancing their own capital requirements.

Public Sector Dominance in UrbanPublic Sector Dominance in UrbanPublic Sector Dominance in UrbanPublic Sector Dominance in UrbanPublic Sector Dominance in UrbanInfrastructure FinancingInfrastructure FinancingInfrastructure FinancingInfrastructure FinancingInfrastructure Financing

Investing in urban infrastructure and services has histori-cally been a public sector activity in India. Governmentfunds are allocated to different tiers of government andentities responsible for infrastructure provision throughthe Plan processes. These funds are allocated in the form

Table 2: Urban Demographic Pressures in Selected States

State Percentage of urban to total population1991 2001

Delhi 89.93 93.01Goa 41.02 49.77Gujarat 34.40 37.35Haryana 24.79 29.00Karnataka 30.91 33.98Maharashtra 38.73 42.40Punjab 29.72 33.95Tamil Nadu 34.20 43.86All India 25.72 27.78

Source: Census of India, 2001.

Urban Infrastructure and Infrastructure Financing Systems:An Overview

4


of grants, equity or debt contributions to differentgovernmental tiers and public sector corporations such asthe Housing and Urban Development Corporation(HUDCO), departmental undertakings and the like. Thetraditional argument favouring public provision of urbanservices has hinged upon market failures due to their spe-cial characteristics like natural monopoly3, non-excludabil-ity4, externalities5, low price elasticity of demand6 andthe like.

Urban infrastructure and services, in particular, water sup-ply and sewerage and roads are capital intensive activitiesand have consequently been financed, in addition to thebudgetary provisions, by borrowings from the domesticfinance and insurance companies, specialised national-levelinstitutions such as the Life Insurance Corporation of In-dia (LIC), General Insurance Corporation of India (GIC),HUDCO, the Industrial Development Bank of India(IDBI), Industrial Credit and Investment Corporation ofIndia (ICICI), and Infrastructure Leasing and FinancialServices Limited (IL&FS), and more recently the Infra-structure Development Finance Company (IDFC). Ofthese, HUDCO has been a major provider of long-termfinance for housing and urban infrastructure. By leverag-ing central government funds and raising resources directlyfrom the capital market, HUDCO has increased its financingof urban infrastructure projects, particularly water supply,roads and other commercial projects. HUDCO’s preferredmode of financing is through the state housing boards,development authorities and municipal corporations. Allof its financing carries state government guarantees. Be-cause local government lending involves a specialised kindof financial analysis and its development lags behind lend-ing to central government and large private firms, specialisedfinancial institutions have been created to meet the financ-ing needs of local governments.

The LIC and GIC have extended term loans to parastatalagencies for urban infrastructure projects, on the basis of

state government guarantees. The role of financing andinsurance companies has thus been significant in fundingand financing urban infrastructure projects. Their lendingfor urban infrastructure and services has been characterisedby the directed credit regime under which different finan-cial institutions were mandated to invest in specific prioritysectors. The LIC, for example, was required to invest 25percent of its annual accretion of funds to social sectors,including water and sanitation. In addition, the high statu-tory liquidity ratio requirements for the banking sector alsomade funds available for priority purposes. The publiclyowned development financing institutions (DFI) largelybenefited from this regime, although as a part of financialsector reform, the directed credit regime has now beenwithdrawn.

The Infrastructure Leasing and Financial Services Limited(IL&FS) is a private entity, which has, since its establish-ment in 1987, floated special purpose vehicles (SPVs) andentered into concession agreements with state and localgovernments for building and operating infrastructureprojects on a commercial basis. The IDFC is also a privatesector initiative for financing infrastructure projects, whichis expected to link public infrastructure projects and capi-tal markets by enhancing credit, create partnerships betweenfinancing institutions and subscribe to shares and deben-tures of infrastructure companies.

The contemporary financing arrangements including pub-lic sector funding have been noted to be deficient on sev-eral counts:

Absence of rigorous project preparation and appraisalprocesses. At the borrower’s end, this has led to asituation of inappropriate incentives and the resultantinefficient utilisation of funds as well as widespreadservice inefficiencies. There is a lack of project devel-opment and management capacity at the local level. It

3 Most urban infrastructure services are natural monopolies and are characterized by declining marginal cost over a very large range of output. Forsuch services, it is economically more efficient for one producer to supply the service, and since the private sector could exploit its monopolisticsituation, the public sector has normally taken it upon itself to provide the services. (See India Infrastructure Report 1996)

4 It is difficult to exclude users from using services such as roads and public lighting systems on grounds of non-payment for services. (See IndiaInfrastructure Report 1996)

5 Many services like sanitation and solid waste disposal have significant external economies, which makes it difficult for market-based systems toprovide them in adequate quantities and quality.

6 Certain infrastructural services being basic necessities have inelastic demand, and could result in exploitative pricing unless pricing was regulated.

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is common for inter-governmental loans not to beserviced properly. Loan delinquencies are often ad-justed against state government transfers or throughrescheduling of state loans, or even writing them off.This has meant a lack of transparency and led to indif-ference on the part of local authorities to financial vi-ability issues and inadequate attention to effective tar-iff structures and cost recovery;

Inability of municipalities to contribute to project re-sources. Few municipalities are reported to have oper-ating revenue surpluses. This position has not changedeven with the implementation of the recommenda-tions of the state finance commissions (SFCs) which,in several instances, have suggested rationalisation ofthe system of devolution of resources to local bodiesand introduction of user charges on a full cost recov-ery basis along with indexation; and

Lack of control over investment decisions by munici-pal entities, even when they are saddled with debt ser-vicing and the operation and maintenance of urbanfacilities. This is especially the case with smaller munici-pal entities where investment decisions are taken bythe higher governmental tiers or the state level utilityboards.

In the context of these financing arrangements, the flowof resources for urban infrastructure has been far too small

relative to the needs. During the Ninth Plan period (1997-2002), estimates of resource flows to the sector rangedfrom Rs. 22.0 to 25.0 billion per annum, with an estimatedshare of the institutional finance in the range of 30 to 35percent (See Table 3). The Ninth Plan provision for urbanwater was Rs. 117 billion, which fell significantly short ofwhat was needed to clear the backlog and to provide forincremental urban population. Even the limited funds pro-vided under the Plan have not been utilised. This indicatesother constraints within the system, which limit the absorp-tion capacity as well as suggests a low level of priorityaccorded to this sector’s spending. The institutional capac-ity has not only constrained absorption of funds, but hasalso resulted in poor use of funds with inappropriate in-vestment and inadequate planning and project management.Compared to the resource flows into the sector, estimatesof investments needed to upgrade urban infrastructure,urban water and especially sewerage services in the com-ing years are very large.

Estimates of investment requirements clearly suggest thatthey are far in excess of the likely resource flows to thesector through traditional routes (See Table 4). Even afteraccounting for a trend-based increase in institutional finance,there will be significant shortfalls in relation to even thelower estimate of investment requirements. The shortfallshave also to be seen in the context of the state govern-ments’ deteriorating finances. All state governments are

Table 3: Plan Outlays on Urban Water Supply and Sanitation(Current prices in Rs. billion)

Plan period Total plan outlay Urban water supply % of total outlayand sanitation

First Plan (1951-56) 33.59 0.43 1.28Second Plan (1956-61) 67.69 0.44 0.65Third Plan (1961-66) 85.93 0.89 1.04Fourth Plan (1969-74) 159.32 2.82 1.77Fifth Plan (1974-79) 392.46 5.49 1.40Sixth Plan (1980-85) 976.07 17.67 1.81Seventh Plan (1985-90) 1797.42 29.66 1.65Eighth Plan (1992-97) 4334.84 59.82 1.38Ninth Plan (1997-01) 7800.00 117.00 1.50

Source: Taken from The World Bank 1999. Urban Water Supply and Sanitation pp. 133 Table No. A 6.1.


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running high fiscaldeficits and have consequently set con-tainment of fiscal deficit as a priority objective. In 2002-03, the fiscal deficit of states was 4.8 percent of their com-bined gross domestic product. An alternative route thatmany of the local government entities followed in the past,i.e., of borrowing from the financing institutions, is alsoconstrained by the rising contingent liabilities. As of 31March 2001, the state governments had accumulated con-tingent liabilities of Rs. 52.5 billion on behalf of munici-palities. Fiscal adjustments and other pressures will impelthe state governments to try and reduce deficits as well assubsidies and grants for financing of infrastructure projectsand encourage municipal governments to rely upon theirown resource raising efforts.

It is in this context that this study entitled, “Financing Mu-nicipal Services: Reaching Out to Capital Markets” haslooked at the potential of the growing capital market inthe country for financing urban infrastructure and services.Since 1997, faced with the limits of government and de-velopment bank financing of urban services, several mu-nicipal governments have raised funds directly from themarket by using credit enhancement mechanisms, like es-crowing a part of their revenue streams for redemptionof loans. Access to the capital market has meant fulfilmentby municipal corporations of several conditions. This study

takes note of such conditions and provides a frameworkfor municipalities to assess their resource raising capacity –creditworthiness as it is referred to – for tapping the ex-panding capital market for financing urban infrastructureservices.

Section 2 provides a brief account of the existing legalframework for municipal borrowing. Section 3 analysesthe finances and functioning of four municipal corpora-tions, namely, Agra, Allahabad, Bangalore and Vadodara,with a view to identifying the key differences between thosecorporations that are able to reach out to the capital mar-kets and those that continue or prefer to rely on state gov-ernment grants for financing their activities. The method-ology used here consists of developing in the first instance,indicators for assessing and evaluating the finances ofmunicipal governments and later, looking at other supple-mentary initiatives that contribute to their functioning. Thismethodology serves two purposes:

(i) It assesses the creditworthiness which is central to the ca-pacity of municipalities to be able to repay debts.

(ii) It demonstrates that debt financing of municipal ser-vices and infrastructure is also a function of variablesother than those that indicate the creditworthiness ofmunicipalities.

Table 4: Projected Gross Investment in Urban Infrastructure

Year Estimate (1) Estimate (2)Amount As % of GDP Amount As % of GDP

1995-96 75.0 0.7 68.5 0.61996-97 92.4 0.8 85.4 0.71997-98 113.8 0.9 100.5 0.81998-99 140.1 1.1 120.6 0.91999-2000 172.6 1.2 153.3 1.12000-01 212.5 1.4 189.2 1.22001-02 261.7 1.6 226.2 1.42002-03 322.3 1.8 275.5 1.52003-04 397.0 2.0 331.6 1.72004-05 488.9 2.3 402.4 1.92005-06 602.2 2.6 475.8 2.1

Source: The India Infrastructure Report, Tables 2.15 and 2.16.

(Rs. billion)

7

The measures that are used for assessing the creditworthi-ness relate to

(i) internal revenue generation,

(ii) spread and depth of tax base,

(iii) external financing of revenue and capital expenditureof municipal governments,

(iv) debt servicing capacities, and

(v) capital expansion.

Section 4 reviews the recent initiatives with capital marketfinancing of municipal infrastructure, with particular ref-erence to credit rating exercises and methodology. Thefinal Section provides a framework for municipalities toassess their performance, which constitutes the first stepforward in order to tap the capital market for financingurban infrastructure services. Basic concepts that are im-plicit in capital market financing are also discussed in thefinal section.


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Municipal government borrowing in India7 is regulated bythe Local Authorities Loans Act, 1914. This Act specifiesthe

(i) purposes for which local bodies may contract a loan,

(ii) limits on the amount of loan,

(iii) duration of loans,

(iv) security or collateral, and

(v) repayment procedures.

Subject to the limits imposed by this Act, the state govern-ments have the flexibility to determine the framework withinwhich local governments – a term used to cover all formsof local bodies including the parastatals - can borrow fromthe market. The framework which is laid out in the state-level municipal laws contains rules in respect of

(i) the nature of the funds on the security of which moneymay be borrowed;

(ii) the works for which money may be borrowed;

(iii) the manner of making applications for permission toborrow money;

(iv) the manner of raising loans,

(v) the sum to be charged against the funds, which are toform the security for the loan;

(vi) the attachment of such funds and the manner of dis-posing them; and

(vii) the accounts to be kept in respect of loans.

The four municipal corporations namely, Agra, Allahabad,Bangalore and Vadodara, which form a part of this studyand which are governed by the Uttar Pradesh MunicipalCorporation Act, 1959 (as amended by the UP Act No.12of 1994), the Karnataka Municipal Corporation Act, 1976,and the Bombay Provincial Municipal Corporation Act,1949 (as amended up to 1994) respectively contain provi-sions in respect of

Powers of a municipal corporation to borrow;

Time for repayment of money borrowed;

Limits of borrowing powers;

Maintenance and investment of sinking funds; and

Attachment of corporation fund in case of default ofrepayment of loan.8

GujaratGujaratGujaratGujaratGujarat

The Gujarat Municipalities Act, 1963 does not contain anyprovision on borrowing by municipal bodies. The BombayProvincial Municipal Corporation Act, 1949, which is ap-plicable to the municipal corporations of Gujarat, con-

Legal Framework for Municipal BorrowingLegal Framework for Municipal BorrowingLegal Framework for Municipal BorrowingLegal Framework for Municipal BorrowingLegal Framework for Municipal Borrowing

2

7 State government borrowing is regulated by Article 293 (3) of the Constitution. All state government borrowings are subject to approval by theGovernment of India, who is empowered to impose such conditions as considered necessary in this respect.

8 There are no statutes in the country that contemplate insolvency of local bodies, let alone lay down insolvency procedures.

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tains several sections that prescribe the conditions withinwhich the municipal corporations in the state may borrow.

Power of the corporation to borrow: According to Sec-tion 109, a corporation may borrow by way of debentureor otherwise any sums of money, which may be required.This loan may be taken on the security of any immovableproperty vested in it or proposed to be acquired by it orof all or any of the taxes, rates, cesses, fees and chargesauthorised by or under this Act. The money can be bor-rowed only for the following purposes:

For defraying any costs, charges or expenses incurred by it;

For discharging any loan or debt to be repaid by thecorporation;

Generally for carrying out the purposes of this actincluding the advance of loans authorized there under.

The loans can be raised provided they are with the previoussanction of the government and the amount, rate of interestand terms of the loan have been approved by the govern-ment. In case loans are raised for undertaking works, theyshould be raised only for the execution of permanent worksif the cost is spread over a few years. The period for whichthe loans may be raised should not exceed 60 years.

Section 110 authorises the municipal corporations to bor-row from any bank or banks in which surplus money atthe credit of the municipal fund or the transport fund aredeposited, against public securities in which the cash bal-ance of the corporation may be invested. The corporationmay also take credit from banks of amounts fixed by thestate government from time to time on the security oftaxes the corporation is authorised to collect.

Repayment of loans: Every loan raised is to be repaidthrough:

Payment from a sinking fund;

Equal payment of principal and interest;

By equal payment of principal;

In the case of a loan borrowed before the appointedday by annual drawings if such method was inoperation before such day;

From any sum borrowed for the purpose; and

Partly from sinking fund and partly from money bor-rowed for the purpose.

Sinking funds: The corporation is required to create asinking fund if sanctioned for repayment of loans bor-rowed on the debentures and is to pay into such sinkingfunds, sufficient sums to pay off the loan by the givendate. Sinking funds are to be invested in public securities.All interest and dividend received from this are to be paidback into the sinking fund. The sinking fund can be ap-plied for no other purpose than the repayment of the loanfor which it was created, until such a loan is wholly dis-charged. Money in two or more such funds may be con-solidated into a common fund.

All sinking funds are to be examined annually with respectto the regularity of investments and value of cash accountsheld in the funds. If any amount is found deficient in thefund, then the corporation is expected to pay the sameamount into the fund. In case of excess amount, the amountmay be transferred to the corporation fund.

Section 116 contains provisions regarding loans raised be-fore the appointed day. Section 117 states that the stategovernment may attach a municipal fund or the transportfund if a corporation defaults in repayment of loans takenfrom the government. Sections 118-125 deal with the formand effect of debentures, provisions regarding joint own-ership of debentures, issue of duplicate securities, renewalof debentures and indemnity and discharge in certain cases.The right to sue in respect of moneys secured by way ofdebentures vests with the holders.

Annual statement: Section 126 states that the Commis-sioner must prepare and submit an annual statement con-taining the following details.

Particulars of loans borrowed in previous years, whichhave not been repaid fully;

Particulars of loans borrowed in the current year;

In case of every loan for which a sinking fund is main-tained the amount of accumulation in the sinking fundat the close of the year;

Legal Framework for Municipal Borrowing

10


Particulars of loans repaid in the year; and

Particulars of securities in which the sinking funds havebeen invested.

The statement must be laid before a meeting of the cor-poration and a copy must be sent to the state governmentand to the Accountant General.

No amendments have been made in provisions on bor-rowing consequent upon the enactment of the 74th Con-stitution Amendment Act, 1992.

KarnatakaKarnatakaKarnatakaKarnatakaKarnataka

Borrowing by local governments in Karnataka is regulatedby the provisions of Section 86 of the Karnataka Munici-pal Act, 1964 under which municipal councils may bor-row either from the government or from any bank, cor-poration or person, any sum of money required for theconstruction of any work of permanent nature. The loancan be taken only when it is previously sanctioned by thestate government.

Borrowing provisions by municipal corporations of thestate are laid down in Sections 154-165 of the KarnatakaMunicipal Corporation Act, 1976.

Power of the corporation to borrow: Section 154authorises a municipal corporation to borrow by way ofdebenture or otherwise any sums of money, which maybe required. This loan may be taken on the security of thetaxes, duties, fees and dues authorised by or under this act.The money can be borrowed only for the followingpurposes.

For construction works;

For acquisition of lands and buildings;

To pay off any debt due to the government; and

To repay a loan previously raised.

The loans may be raised provided that they are with theprevious sanction of the government and the amount, rateof interest and terms of the loan have been approved bythe government. No portion of the loan may be used forany other purpose except for which it has been acquired.

The period within which the loan is required to be repaidshould not be more than 60 years. The time for repaymentof any money borrowed for discharging any previous loanis not, except with the express sanction of government, toextend beyond the unexpired portion of the period forwhich such previous loan was sanctioned.

Limit to borrowing powers: The corporation cannotborrow beyond a limit fixed by or under this Act, which isequal to 10 percent of the annual rateable value of landand buildings with the corporation.

Sections 157-159 deal with the form and effect of deben-tures and provisions regarding joint ownership of deben-tures.

Sinking funds: In accordance with the provisions of Sec-tion 160, the corporation is to maintain sinking funds forrepayment of money borrowed and debentures issued.The corporation is expected to pay by quarterly instalmentsinto such sinking funds, sufficient sums for the repaymentof borrowed funds within the period fixed for the loan.Sinking funds are to be invested in public securities, gov-ernment guaranteed securities and debentures of the cor-poration. Money in two or more sinking funds may beconsolidated into a common fund. The sinking fund shallbe applied for no purpose other than the repayment ofthe loan for which it was created, until such a loan is whollydischarged.

The trustees of the fund shall submit an annual report at theend of every year containing the following information.

The amount which has been invested during the yearin the fund;

The date of last investment made previous to the sub-mission of the statement;

The aggregate amount of securities held by them intheir hand; and

The aggregate amount, which has up to date beenapplied for discharging the loans.

Every such statement shall be laid before the council andpublished.

11

The municipal corporation has the power to consolidateall loans into a single loan and invite the holders of munici-pal debentures to exchange their debentures for scrips ofsuch a loan. The period for extinction of such a loan is notto exceed the farthest date for repayment of any of theloans so consolidated.

Payment of interest and repayment of loans is the firstcharge over all other payments due from the corporation.The government has the right to attach the corporationfund if the corporation fails to repay any loan taken fromthe government in time. An official appointed by the gov-ernment will then operate the fund.

No changes have been made to these provisions conse-quent upon the 74th Constitution Amendment Act, 1992.

Uttar PradeshUttar PradeshUttar PradeshUttar PradeshUttar Pradesh

Section 114A of the Uttar Pradesh Municipalities Act, 1916,lays down the framework for borrowing by municipalities.It states that ‘for the performance of duties and functions,whether mandatory or discretionary, municipalities may, withthe previous sanction of the state government and subjectto rules prescribed on its behalf, raise loans in the open marketor from any financial institution by issue of debentures oragainst any other security’. The Uttar Pradesh MunicipalCorporation Act, 1959, contains a chapter on borrowing(chapter VIII, sections 154-171) that defines the borrowingpowers of the corporations in the state.

Power of the corporation to borrow: According to Sec-tion 154, a corporation may borrow by way of debentureor otherwise any sums of money, which may be required.This loan may be taken on the security of any immovableproperty vested in it or proposed to be acquired by it orof all or any of the taxes, rates, cesses, fees and chargesauthorised by or under this Act. The money may be bor-rowed only for the following purposes:

For defraying any costs, charges or expenses incurredby it;

For discharging any loan or debt to be repaid by thecorporation; and

Generally for carrying out the purposes of this actincluding the advance of loans authorised thereunder.

The loans can be raised provided that they are with theprevious sanction of the government, and the amount, rateof interest and terms of the loan have been approved bythe government. In case of works, they should be raisedonly for the execution of any permanent work if its cost isspread over a term of years. The period for which theloans can be raised should not exceed 30 years. The moneyraised through such loans should be applied only for thepurpose for which it has been raised.

Section 155 authorises the corporations to borrow fromany bank or banks in which the surplus moneys at the creditof the corporation are deposited, against public securitiesin which the cash balance of the corporation may be in-vested.

Repayment of loans: Sections 156-60 deal with the re-payment of loans and the provision for sinking funds. Everyloan raised can be repaid through the following.

Payment from a sinking fund;

Equal payment of principal and interest;

From any sum borrowed for the purpose;

Partly from sinking fund and partly from money bor-rowed for the purpose; and

By other such methods including drawings as the stategovernment may specify.

Sinking funds: The corporation shall create a sinking fundif sanctioned for repayment of loans borrowed on thedebentures issued and shall pay into such sinking funds,sufficient sums to pay off the loan by the given date. Sink-ing funds shall be invested in public securities, governmentguaranteed securities and debentures of the corporation.All interest and dividend received from this shall be paidback into the sinking fund. The sinking fund shall not beapplied for any purpose other than the repayment of theloan for which it was created, until such a loan is whollydischarged. Money in two or more such funds may beconsolidated into a common fund. All sinking funds are

Legal Framework for Municipal Borrowing

12


required to be examined annually by the Examiner, LocalFund Accounts who shall ascertain the regularity of invest-ments and value of cash accounts held in it. If any amountis found deficient in the fund, then the corporation shouldpay the same amount into the fund. In case of excessamount, the amount may be transferred to the corpora-tion fund.

Sections 162-169 deal with the form and effect of deben-tures, provisions regarding joint ownership of debentures,issue of duplicate securities and renewal of debentures.The right to sue in respect of the moneys secured by thedebentures vests with the holder.

Annual statement: Section 170 states that the MukhyaNagar Adhikari must prepare and submit an annual state-ment containing the following details.

Particulars of loans borrowed in the previous years,which have not been repaid fully;

Particulars of loans borrowed in the current year;

In case of every loan for which a sinking fund is main-tained the amount of accumulation in the sinking fundat the close of the year;

Particulars of loans repaid in the year; and

Particulars of securities in which the sinking funds havebeen invested.

The state government may make rules for the procedurefor obtaining sanction of the state government for loans,establishment, investment and annual examination of thesinking fund, manner of attachment of corporation fundand printing of debentures. No amendments have beenmade in the provisions on borrowing consequent uponthe 74th Constitution Amendment Act, 1992.

Inter-state differences in provisions regulating the processof local governments to borrow are, at best, minor andrelate to the limits on borrowing, e.g., percentage of theannual rateable value of land and buildings or the periodfor which a loan may be contracted. Important to note,however, are provisions in respect of:

(i) sinking funds and investment of sinking funds into publicsecurities and government guaranteed securities, and

(ii) preparation and submission of an annual statementgiving details on loans contracted and how sinkingfunds are being maintained.9

9 In addition to the Local Authorities Loan Act, 1914, which regulates local government borrowing, there are several other relevant statutes. These are(i) Public Debt Act, 1944, which empowers the Reserve Bank of India (RBI) to regulate the primary issuance for debt securities by the central andstate governments, (ii) the Companies Act, 1956 which sets out the code of conduct for the corporate sector in relation to the issue, allotment, andtransfer of securities and (iii) Securities and Exchange Board of India (SEBI), which regulates primary issuance in capital and debt markets, other thangovernment securities and ensures sound trading practices in the secondary market through stock exchanges.

13

Agra Municipal CorporationAgra Municipal CorporationAgra Municipal CorporationAgra Municipal CorporationAgra Municipal Corporation(AGMC)(AGMC)(AGMC)(AGMC)(AGMC)

The Agra Municipal Corporation (AGMC) is governedby the provisions of the Uttar Pradesh Municipal Corpo-ration Act, 1959 (as amended by the UP Act 12 of 1994).This Act specifies the duties and powers of all municipalcorporations in Uttar Pradesh, which stand divided intoobligatory duties and discretionary duties. The AGMC’sobligatory duties comprise such duties as scavenging ofpublic streets, collection of waste and sewage, construc-tion and maintenance of drains, management and mainte-nance of waterworks necessary for water supply, streetlighting and the like, regulation and maintenance of speci-fied activities and services and such other activities as thenaming and numbering of streets and premises. In addi-tion, the municipal corporation has a large number of dis-cretionary duties, which include holding of exhibitions,promoting art and cultural events, construction of bathingghats, encouraging trade and industry, and the like.

Also defined in the Uttar Pradesh Municipal CorporationAct, 1959 are the tax powers of the municipal corporationsin the state. These powers include powers to levy taxes onland and buildings, taxes on non-motorised vehicles, boatsand animals, betterment levies, tax on deeds of transfer of

immovable property and a tax on advertisements. Thereare no statutory provisions in the Act for grants-in-aid orsharing of tax receipts, but the state government providesgrants and dispensation on several accounts for meeting therevenue account expenditure of municipal corporations. TheAGMC and other municipal corporations receive capitalgrants for creating new assets and contracts loans from fi-nancing and non-banking institutions.

The AGMC’s financial performance given in Tables 5 and6 shows that the corporation is heavily dependent on thestate government for meeting its obligations. Thus:

Grants constitute 74 to 85 percent of the corporation’srevenue receipts. The corporation’s own revenues aredistressingly low, which have ranged between 15 to 25percent of the total revenues over the five-year period.

Although the AGMC has posted a surplus on revenueaccount, the surplus is grant-generated; the fact thatthe AGMC is unable to spend the grant componenton the maintenance of services even when the overallexpenditure levels are low and maintenance of ser-vices so poor, speaks of the low level of capacity ofthe corporation.

The only redeeming feature of the corporation is thecapital expenditure component, which has shown a

What Makes Some Municipalities GainWhat Makes Some Municipalities GainWhat Makes Some Municipalities GainWhat Makes Some Municipalities GainWhat Makes Some Municipalities GainAccess to Capital Markets and Others toAccess to Capital Markets and Others toAccess to Capital Markets and Others toAccess to Capital Markets and Others toAccess to Capital Markets and Others to

Fail: Analysis of the Finances of FourFail: Analysis of the Finances of FourFail: Analysis of the Finances of FourFail: Analysis of the Finances of FourFail: Analysis of the Finances of FourMunicipal CorporationsMunicipal CorporationsMunicipal CorporationsMunicipal CorporationsMunicipal Corporations

3

14


consistently rising trend and may show an increasingsensitivity to creating new infrastructure assets.

Given its finances, the AGMC cannot be considered a sol-vent entity. It is dependent on the state government forperforming its functions and is unprepared to access thecapital market for funds. The sources of its revenue arestagnant. Figures suggest that it is a grant-financed corpo-ration. Moreover, revenue grants are far in excess of capi-tal grants and are unsystematically released.

Allahabad Municipal CorporationAllahabad Municipal CorporationAllahabad Municipal CorporationAllahabad Municipal CorporationAllahabad Municipal Corporation(AMC)(AMC)(AMC)(AMC)(AMC)

The Allahabad Municipal Corporation (AMC) is gove-rned by the provisions of the Uttar Pradesh Municipal

Corporation Act, 1959 (as amended by the UP Act 12of 1994). The UP Municipal Corporation Act lays downthe duties and powers of the municipal corporations inUttar Pradesh, which are divided into obligatory dutiesand discretionary duties. There are 46 obligatory dutiescomprising duties that are related to service provision(collection of sewage, scavenging of public streets, con-struction and maintenance of drains, management andmaintenance of waterworks necessary for water supply,street lighting etc.), regulation and maintenance of speci-fied activities and services and activities such as the erec-tion of boundary marks defining the limits of the cityand naming and numbering of streets and premises. Inaddition, there are 44 discretionary duties.10 The UttarPradesh Municipal Corporation Act, 1959 also definesthe tax powers of the municipal corporations. These

Table 5: Finances of the Agra Municipal Corporation (AGMC)

Finances (Rs. lakh) Years1995-96 1996-97 1997-98 1998-99 1999-00

Tax revenues 284.22 221.57 295.1 283.6 331.99Non-tax revenues 165.88 83.13 373.4 575.1 441.6Grants 1483.3 1637.5 1860.5 2367.5 2366.7Total revenues 1933.4 1942.2 2529.0 3226.2 3140.3Revenue account expenditure 1788.9 1873.8 2382.9 2439.9 3263.1Capital expenditure 134.4 433.5 904.2 981.6 1006.1Total expenditure 1923.3 2307.3 3287.1 3421.5 4269.2

Source: Municipal Budgets, various years.

10 Examples of discretionary duties are provision of milk to expectant mothers, encouraging music and fine arts, holding of exhibitions, grant of loansfor building purposes, construction and maintenance of bathing ghats, presentation of civic addresses, taking measures to promote trade andindustry and establishing a bank, etc.

Table 6: Measuring Performance: Agra Municipal Corporation (AGMC)

Indicators Years1995-96 1996-97 1997-98 1998-99 1999-00

Ratio of tax revenue to total revenues 0.146 0.116 0.116 0.088 0.106Ratio of grants to total revenues 0.767 0.843 0.736 0.734 0.754Revenue account surplus/deficit (Rs. lakh) 144.5 68.4 146.1 786.3 -122.8Surplus/deficit as a % revenue receipts 7.5 3.5 5.8 24.4 -24.3Capital expansion (Rs. lakh) 134.4 433.4 904.2 981.5 1006.1

Source: Estimated from the Data in Table 5.

15

comprise – similar to that of the AGMC – property tax,tax on vehicles, boats and animals, betterment tax, tax ondeeds of transfer of immovable property and tax onadvertisements. It also specifies the procedures for thelevy of a tax as well as fixing of the tax rate. These taxesand levies generate revenues for the AMC and are spenton implementing the duties as specified under the Act.Although, the Act does not provide for any transfer ofresources to municipal corporations, the Government ofUttar Pradesh provides grants and such other dispensa-tions as are called for, to enable municipal corporationscarry out their statutory duties and functions.

The finances of the AMC are shown in Table 7.

Further details of the AMC’s finances show that with theexception of one year i.e., 1998-99, the corporation hasconsistently faced a deficit, both on the revenue account asalso on overall expenditure. As a proportion of total in-come, deficits have, however, declined significantly overthe 1995-96 and 1999-2000 period, explained largely byan escalation in grants from the state government. Mea-suring the performance on the basis of the indicators, re-ferred to earlier, shows that:

Tax and non-tax revenues constitute a small propor-tion of the total revenue account receipts of the AMC.Not only has there been no improvement in the sizeand structure of the revenue base of the corporation,the ratio of tax to total revenue receipts as well as theratio of non-tax to total revenues have registered adrop in 1998-99 and 1999-2000 compared to thoseobserved in 1995-96.

The AMC earns no revenues from rents and interestswith only an insignificant amount being earned fromother non-tax sources of revenues.

Grants from the state government are the mainstay ofthe AMC. In 1995-96, grants formed 59 percent ofthe total revenues, which rose to 79 percent in 1998-99 and 77 percent in 1999-2000. High dependenceon state finances for meeting the recurrent expendi-tures, in other words, for discharging the obligatoryduties specified in the Act, is a major characteristic ofthe finances of the AMC.

Capital expenditure meant to create new stocks ofinfrastructure and services forms a small proportionof the total expenditure of the AMC. In 1999-2000,it formed just a little over one percent of the totalexpenditure, indicating that the process of creating newinfrastructure assets either rests with other agencies orhas been tardy in Allahabad. Table 8 provides thedata on indicators.

The AMC is in a state of deprivation and distress on ac-count of a reduction in grant finance and abolition of oc-troi and the consequential inability to cope with the pres-sures of adequately meeting the load of civic functions.The primary concern of the corporation is to manage thesalary component of expenditure. As a part of the initia-tive taken to computerise the Accounts Department, theAMC has been able to partly control receipts and expen-diture and monitor payment of salaries and pensions. Theoverall picture, however, is of a grant-financed, laidbackmunicipal corporation, which is starved of funds.

Table 7: Finances of the Allahabad Municipal Corporation (AMC)

Year Income (Rs. lakh) Expenditure (Rs. lakh)Revenue Capital Total Revenue Capital Total

1995/96 944.1 75.5 1019.6 2016.2 25.5 2041.71996/97 948.2 25.9 974.1 2278.9 7.9 2286.81997/98 1480.7 80.6 1561.3 2740.4 88.9 2829.41998/99 2699.2 112.0 2811.2 2515.6 20.5 2536.11999/00 2732.3 110.8 2843.1 2960.1 37.0 2997.1


What Makes Some Municipalities Gain Access to Capital Marketsand Others to Fail

16


Bangalore Municipal CorporationBangalore Municipal CorporationBangalore Municipal CorporationBangalore Municipal CorporationBangalore Municipal Corporation(BMC)(BMC)(BMC)(BMC)(BMC)

The Bangalore Municipal Corporation (BMC) is governedby the provisions of the Karnataka Municipal Corpora-tions Act, 1976, which lays down, inter-alia, the powersand functions of municipal corporations, and enumeratesthe taxes that they could levy . The powers and functionsof the corporation are divided into two parts: (i) obliga-tory, which include water and cleansing of public streetsand public places; collection, removal, treatment and dis-posal of sewage; construction, maintenance and cleaningof drains; street lighting; regulation of offensive trades;construction of public markets; laying out new streets etc.There are 31 such obligatory functions within the fold ofthe municipal corporations in Karnataka. (ii) These aresupplemented by 23 discretionary functions. Chapter Xof the Act lists out the taxes that the municipal corpora-tions in the state are empowered to levy. These includeamong others, a tax on buildings or land or both, a toll onvehicles other than motor vehicles, a tax on advertisements,a duty on transfers of property in the shape of an addi-tional stamp duty and a water rate for water supplied bythe corporations. Levy of taxes as also the fixation ofrates require the sanction of the Government.

The finances of the BMC, which serves an area of about225 sq. kilometres and a population in excess of 4.5 mil-lion, are shown in Table 9.

The table brings out several important features.

The BMC’s own revenues account for over 75 per-cent of the total revenues. Moreover, the propor-tion of their own revenues has consistently risen overthe five-year period, indicating a better and fulleruse of the potential of own tax revenues bythe BMC.

Within the own revenue component, improved per-formance is observed in non-tax revenues whoseshare in total revenues has jumped from 17 percentin 1995-96 to about 29 percent in 1999-2000.

Unlike the AGMC and AMC, the BMC has made useof debt funds for financing its activities. Capital ex-penditure (excluding loan repayment) has risen fromRs. 738 lakh in 1995-96 to Rs. 13,261.5 lakh in 1990-2000. Debt servicing (loan and interest repayment)ranges from approximately 3.4 percent in 1995-96 toabout 6.7 percent in 1999-2000. In 1998-99, it ac-counted for 10.4 percent of the total revenues. Debtservicing is still a small component of the corporation’sexpenditure.

Capital expansion in spheres where the BMC operateshas been occurring over the five-year period. From arelatively small proportion in 1995-96 (5.3%), capitalexpenditure as a proportion of total expenditure roseto nearly 33 percent in 1999-2000.

Table 8: Measuring Performance: Allahabad Municipal Corporation (AMC)


Revenue account surplus/deficit (Rs. lakh) -1072.1 -1334.8 -1259.8 +183.6 -227.7Revenue surplus/deficit as a % revenue receipts (-)113.6 (-)140.7 (-)85.1 (+)6.8 (-)8.3Ratio of tax to revenue receipts 0.18 0.20 0.20 0.12 0.15Ratio of grants to revenue receipts 0.59 0.59 0.56 0.79 0.77Ratio of own revenues to total revenues 0.41 0.41 0.44 0.21 0.23Capital expansion (Rs. lakh) 25.51 7.94 88.96 20.46 37.00

Source: Table 7.

17

The BMC’s performance measurement indices are shownin Table 10.

Three features of the BMC’s functioning, whichimpact on its performance are worth noting. First, thepreparation and maintenance of financial records and main-tenance of other forms, issuance of licenses etc., are con-ducted electronically as specified by the office of the Mu-nicipal Commissioner. Second, the BMC operates througha consolidated fund of the corporation, which consists ofall taxes, tolls and other imposts, fines, fees, penalties, pro-

ceeds of land and property transactions, interests, profits,gifts and transfers. Transactions relating to the consolidatedfund are classified into three main funds, namely:

(a) a government-type fund, which records transactionsrelating to all taxes, tolls, impositions, fines, fees, pen-alties, and public assets such as roads and bridges,

(b) a propriety-type fund, which registers commercialtransactions, maintenance of assets by levy of usercharges, maintenance of markets, levy of market fees,

Table 9: Finances of the Bangalore Municipal Corporation (BMC)


Finances (Rs. lakh) Years (Rs. lakh)1995-96 1996-97 1997-98 1998-99 1999-00

Revenue ReceiptsTax Income 6441.5 8399.0 9358.3 10557.9 13524.9Non-tax Income 2484.0 3069.6 6927.3 8111.6 7909.7Grants 5865.1 5803.0 7127.7 7567.3 6605.8Total 14790.6 17271.6 23413.3 26236.8 28040.4Capital Receipts 453.6 4725.2 36979.9 9163.4 17877.9Total Receipts 15244.2 21996.8 60393.2 35400.2 45918.3

Revenue ExpenditureInterest Payments 354.4 593.5 599.8 2523.6 1814.4Others 12481.6 13276.6 20255.9 26674.1 24958.4Total 12836.5 13870.1 20825.7 23197.6 26772.8

Capital ExpenditureLoan Repayment 156.6 199.8 699.3 211.0 54.6Others 738.5 1418.0 3633.2 4661.1 13261.5Total 895.1 1617.8 4332.5 4872.1 13316.1Total Expenditure 13731.6 15487.9 25158.2 28069.7 40089.0

Table 10: Measuring Performance: Bangalore Municipal Corporation (BMC)


Ratio of tax revenue to total revenues 0.44 0.49 0.40 0.40 0.48Ratio of non-tax component to total revenues 0.17 0.18 0.30 0.31 0.29Ratio of grants to total revenues 0.39 0.33 0.30 0.29 0.24Ratio of debt servicing to total revenues 0.034 0.034 0.025 0.096 0.064Ratio of debt servicing to total expenditure 0.039 0.042 0.028 0.108 0.067Ration of capital expansion to total expenditure 0.82 0.87 0.83 0.95 0.99

Source: Table 9.


18


creation and construction of enterprises and collec-tion of rents and profits and

(c) a fiduciary-type fund, which records transactions re-lating to trusts, gifts, transfers, including projects fundsand pension funds.

Besides, there are three sub-funds, viz., general fund, capi-tal project fund and a special revenue fund.

A third feature of the functioning of the BMC relates toperformance budgeting, which is a tool to set achievableannual targets, to provide funds and to monitor imple-mentation. As a result, the corporation’s budget nowconsists of:

(i) a statement of goals and objectives of departmentsor projects,

(ii) a quantitative estimate of the work to be accomplished,and

(iii) expected efficiency.

Prior to the reforms of accounting and budgeting sys-tems, the BMC suffered from archaic methods of docu-mentation, absence of performance standards and a lackof accountability.

VVVVVadodara Municipal Corporationadodara Municipal Corporationadodara Municipal Corporationadodara Municipal Corporationadodara Municipal Corporation(VMC)(VMC)(VMC)(VMC)(VMC)

The Vadodara Municipal Corporation (VMC) functionsin accordance with the provisions of the Bombay Provin-cial Municipal Corporation Act, 1949. Unlike other Acts,the Bombay Provincial Municipal Corporations Act, 1949addresses the issue of duties and functions under differentchapters, i.e., chapters dealing with drains and drainage,water supply, streets, building regulations, improvementschemes, municipal fire brigade, sanitary provisions, mar-kets and slaughter houses, transport undertaking, vital sta-tistics, and licenses and permits. The specific duties ofmunicipal corporations in the state, governed by this Act,are detailed out in the relevant chapters. On the other hand,taxes to be imposed under the Act are specified under thegeneral head “Municipal Taxation” and include property

taxes; special provisions relating to water and conservancytaxes and taxes on vehicles, boats and animals. The Actalso provides detailed explanations relating to the levy oftaxes, their assessment and collection procedures.

The VMC’s activities are spread over 108 sq kilometres,and relate to over 1.3 million population of which about20 percent live in slums. The VMC runs schools and hos-pitals and health centres; it also provides water supply andsewerage system.

A break up of the VMC’s finances is provided in Tables11 and 12. According to Table 11, the VMC’s total rev-enue income was placed at Rs. 19,793 lakh in 1999-2000,having risen from Rs. 11,611 lakh in 1995-96, registeringan average annual growth of over 13 percent. VMC’s rev-enue account expenditure ) was Rs. 18,595 lakh in 1999-2000, posting a revenue account surplus of Rs. 1,197.8lakh. The VMC has maintained a surplus in all the fiveyears under reference. Important features of VMC’s fi-nances are as follows.

Taxes are an extremely important source of revenuefor the VMC, although in terms of percentage, theimportance of taxes has begun to decline. In 1995-96, tax revenues comprising octroi receipts and rev-enues from taxation of land and property accountedfor 80 percent of the total revenue receipts; it increasedto 83 percent in 1996-97 and began to register a de-cline. In 1999-2000, its share, although significant,dropped to 74 percent.

The non-tax revenue component, which comprisescharges, fees, fines, rents and interest is not importantin the revenue structure of the corporation, althoughit has been registering a growth rate, which is in excessof the growth rate of the tax component of VMC’srevenues. In 1999-2000, the share of non-tax in totalrevenues was 8.3 percent as compared to 6.8 per centin 1995/96.

The VMC’s dependence on the state government formeeting the recurrent expenditures has risen slowly overthe period 1995-96 and 1999-2000. In 1999-2000,

19

grants formed 17.4 percent of the total revenues; theshare of grants in 1995-96 was 12.8 per cent.

The VMC has consistently maintained a revenue accountsurplus, although its surplus has plummeted from a highof Rs. 3378 lakh in 1997-98 to Rs. 1197.8 lakh in 1999-2000. As a proportion of total revenues, it is a major

drop, from 22 percent in 1997-98 and 25.5 percent in1996-97 to just about six percent in 1999-2000. In-deed, VMC’s finances in 1996-97 and 1997-98 weresuch that the internally generated revenues could havemet the revenue account expenditure; in 1999-2000,its own revenues are able to finance 85 percent of therevenue account expenditure.

Table 12: Measuring Performance: Vadodara Municipal Corporation (VMC)

Source: Table 11.


Revenue account surplus (+)/deficit (-) as a %of revenue receipts 12.61 25.5 22.0 10.2 6.1

Ratio of tax to total revenue income 0.80 0.84 0.76 0.74 0.74Ratio of charges, fees and fines to totalrevenue income 0.0017 0.0008 0.0007 0.0007 0.0011

Ratio of rents and interest to total revenue income 0.040 0.037 0.052 0.076 0.055Ratio of grants to total revenue income 0.13 0.11 0.14 0.14 0.17Ration of own revenue to total revenue income 0.87 0.89 0.86 0.86 0.83Ratio of debt service payment to total revenue 0.20 0.15 0.14 0.10 0.10Ratio of debt service payment to total expenditure 0.22 0.20 0.18 0.11 0.10

Table 11: Finances of the Vadodara Municipal Corporation (VMC)


Finances (Rs. lakh) Years1995-96 1996-97 1997-98 1998-99 1999-00

Revenue IncomeTax Income 9,328.9 12,343.6 11,790.4 13,173.4 14,712.5Charges, Fees and Fines, Rents and Interest 20.4 12.4 10.7 11.9 21.4Non-tax Income 470.8 544.0 803.6 1,338.6 1,081.3Grants 1,490.0 1,564.4 2,169.4 2,523.8 3,440.4Miscellaneous 301.6 272.0 553.9 659.6 558.2Total Revenue Income 11,611.8 14,736.5 15,327.9 17,707.2 19,793.8

Capital ReceiptsCapital Income 269.5 417.8 1087.0 1,899.5 2,982.1Loan Income - 106.9 106.4 428.6 2,429.2Total Income and Receipts 11,881.3 15,154.3 16,414.9 19,606.7 22,775.9

Revenue Expenditure (including of interest repayment)Revenue Expenditure 10,147.5 10,976.5 11,950.5 15,906.1 18,596.0Capital Expenditure (including of debt services) 640.9 1,135.1 1,372.6 2,902.5 5,782.8Total Revenue and Capital Expenditure 10,788.4 12,111.6 13,323.1 18,808.6 24,378.8


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An important feature of VMC’s finances is that itscapital expenditure has risen at an extraordinarily highrate over the five-year period. In 1999-2000, the sizeof capital expansion was of the order of Rs. 5,782.8lakh, which is 23.7 percent of the combined capitaland revenue expenditure of the VMC.

Like many corporations in India, the VMC wascharacterised by excessive reliance on the past, even whenthe past had lost its relevance, absence of a proper re-source allocation mechanism, a weak link between resourcerealisation and expenditure, difficulty in distinguishing rev-enue from capital expenditure and the absence of a long-term perspective. The VMC’s financial control system wasfragile and inappropriate; for instance, there was a totalabsence of financial control. The classification and analy-sis of expenditure was inappropriate and the bill move-ment system was defective.

In 1999, the VMC undertook a series of reforms toimprove its functioning. First, it divided the budget intofive parts:

(i) revenue budget,

(ii) capital budget,

(iii) loan budget,

(iv) deposit/grant budget, and

(v) advances budget.

Second, it devised an in-built model of budget and re-source allocation in the capital budget to ensure a balanced

development of the city. Third, it evolved a participatorysystem of budget formulation. Fourth, it introduced

(i) a centralised financial control system,

(ii) a proper management of cash and working capital,and management of receivables and

(iii) a broad-based reform of tax and non-tax resources.

A number of observations are possible:

The BMC’s and VMC’s performance in respect ofown revenues to total revenue receipts is far superiorto that of the AGMC and AMC. Table 14 gives theperformance level on the basis of indicators.

Non-tax revenues as a proportion of total revenuereceipts are low for all municipal corporations not-withstanding the fact that they are more elastic thanproperty taxes. Bangalore’s performance on this as-pect has consistently improved over the five-year pe-riod. Low non-tax revenues typically suggest that thereis reluctance on the part of municipal corporations tofix charges on the principle of cost recovery. Theabsence of the application of cost recovery principleis one of the most disconcerting features of the mu-nicipal finance system in the country.

The improved financial performance of the BMC andVMC is observed in the proportion of expenditurefinanced out of state grants. These proportions arelow for Bangalore and Vadodara and extremely highfor Agra and Allahabad; even when income and com-

Table 13: Ratio of Own Revenues to Total Revenue Receipts

Corporations Years1995-96 1996-97 1997-98 1998-99 1999-00

Agra 0.209 0.151 0.224 0.252 0.242Allahabad 0.407 0.407 0.438 0.214 0.233Bangalore 0.603 0.664 0.696 0.711 0.764Vadodara (1) 0.872 0.893 0.858 0.857 0.826Vadodara (2) 0.652 0.744 0.692 0.714 0.659

1. Inclusive of octroi receipts.2. Exclusive of octroi receipts.Source: Tables 5, 7, 9 and 11

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pensation for octroi is excluded from the financial in-dicators of Vadodara and Bangalore, grant financingof municipal expenditure is high. Table 15 gives a com-parison of the four sampled corporations.

The AGMC and AMC rely on grant financing of city-based infrastructure. Evidently on account of a better

Table 14: Financial Performance of Sampled Municipal Corporations

Source: Tables 5 to 12

Indicators Bangalore Vadodara Allahabad Agra1995-96 1999-00 1995-96 1999-00 1995-96 1999-00 1995-96 1999-00

Tax revenue to totalrevenue receipts (%) 43.6 48.2 80.3 74.3 18.3 15.48 13.38 10.6

Own revenues to totalrevenue receipts (%) 60.4 67.4 87.2 82.6 40.7 23.3 20.9 24.2

Transfers to totalrevenue receipts (%) 39.6 23.6 12.8 17.4 59.3 76.7 79.1 75.8

Debt servicing to totalrevenue receipts (%) 3.45 6.47 19.7 9.8 - - - -

Debt servicing to totalrevenue expenditure (%) 3.98 6.77 22.5 10.5 - - - -

Debt servicing to revenuesurplus/ deficit (%) 26.32 143.14 1.6 1.6 - - - -

Capital expenditure tototal expenditure 5.40 33.08 5.94 23.7 12.49 1.2 4.1 23.6(revenue and capital) (%)

credit performance, VMC and BMC have made use ofinstitutional lending for financing infrastructure services. Atthe same time, debt financing as an instrument for financ-ing urban infrastructure and services is still at an infant stageeven with such municipal corporations as Bangaloreand Vadodara.


Table 15: Ratio of Grants to Total Revenue Receipts

Corporations 1995-96 1996-97 1997-98 1998-99 1999-00Agra 0.791 0.849 0.776 0.748 0.758Allahabad 0.590 0.590 0.560 0.770 0.770Bangalore 0.396 0.336 0.304 0.288 0.235Vadodara 0.128 0.106 0.141 0.142 0.174

Source: Tables 5, 7, 9 and 11

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A key development in the sphere of infrastructure financ-ing in India has been the emergence of a municipal bondmarket. The bond market in India has grown significantlyin recent years, in items of issuers and investors, instru-ments, trading volume and market awareness. The centralgovernment issues treasury bills, zero-coupon bonds, float-ing rate bonds and inflation-indexed bonds. For publicsector companies, the main issues comprise taxable andtax-free bonds, while the private sector companies issuebonds and debentures, zero-coupon bonds and floatingrate bonds. At sub-national levels, the state-level publicenterprises issue government-guaranteed bonds.

The concept of municipal bonds as an instrument forraising resources for urban infrastructure projects, whichhad been playing a crucial role in creating urban infra-structure projects in the United States of America (USA)and Canada was initially outlined in a seminar held in 1995and subsequently elaborated on by an Expert Group onthe Commercialisation of Infrastructure Projects, knownas the India Infrastructure Report. This report noted thaturban infrastructure services are provided by local levelagencies. Funds have generally been in the form of loansand grants from the central and state governments. TheUrban Local Bodies (ULBs) own resources have beeninsufficient even to meet the operation and maintenancerequirements of these services. Since most urban infra-structure services have been treated as public services andthe concept of cost recovery has never been consideredrelevant, a commercial approach to these services has notbeen developed. Even if the facilities were fundedby loans, the repayment of loans was generally book

adjustments or paid out of grants made by state govern-ments. Even when user charges are levied, the price perunit is too low to cover even the variable cost of provid-ing the service.

The fact that infrastructure services do not pay for them-selves and the government continues to subsidise the ben-eficiaries has resulted in low availability of funds. Withincreasing requirements, this has meant deficiency in vol-umes as well as quality of service. Consequently, a parallel,unorganised sector for provision of many of these ser-vices has developed, resulting in high prices and qualita-tively deficient services. From a societal point of view,these are expensive solutions. It is high time that a commercialapproach is adopted.

In this context, the Credit Rating Information Services ofIndia Ltd. (CRISIL), a credit rating agency in India, draw-ing upon the experiences of its partner, the Standard andPoor’s Rating Services of USA, undertook an exploratoryexercise to evaluate the credit quality of municipal entitiesin India, with a view to explore the feasibility of expand-ing the horizons of its rating operations. It involved theAhmedabad Municipal Corporation (AHMC) and othermunicipal corporations in formulating what it called, aframework for municipal credit evaluation and laid outthe groundwork for credit rating of municipalities andproject-specific debt issues. CRISIL studied the financesand operations of the AHMC, and assigned an “A+” creditrating to the proposed Rs. 1 billion bond issue, indicating acredit risk profile in the adequate safety category. Since then,the bond market in India has seen a noticeable growth in

Municipal Bonds in IndiaMunicipal Bonds in IndiaMunicipal Bonds in IndiaMunicipal Bonds in IndiaMunicipal Bonds in India

4

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terms of issuers and investors, instruments and volume oftransactions.

Following the example of the AHMC, a number of mu-nicipal entities and parastatals have since accessed capitalmarket funds, with the back-up of CRISIL and two creditrating agencies namely, the Investment Information andCredit Rating Agency (ICRA Ltd.); and Credit Analysisand Research Limited (CARE) who have developed theirown criteria and systems for evaluating the creditworthi-ness of municipalities. The fiscal incentives offered by theGovernment of India in the form of tax exemptions toeligible issuers, defined in the Ministry of UrbanDevelopment’s Guidelines for Issue of Tax Free Munici-pal Bonds (2001), have given a further stimulus to themunicipal bond market. The guidelines stipulate that theissuers are to maintain a debt service coverage ratio of atleast 1.25 throughout the tenure of the bond. This over-collateralisation and the provision of a debt servicereserve account serve as measures to reduce risk toinvestors. Key features of the tax-free bonds arecontained in Chart 1.

The nine municipal corporations which have accessed thecapital market have thus far been able to raise Rs. 6185million, by issuing bonds. An important feature of mu-nicipal bonds is that with the exception of bonds issuedby the BMC and Indore Municipal Corporation, otherbonds have been issued without a state government or abank guarantee. Traditionally, lenders to entities in the in-frastructure sector have sought a state or a sovereign guar-antee as an important security mechanism. The fact thatmunicipal entities have begun to raise resources in the capi-tal market on the strength of their own credit standing andcredit enhancements based on escrowing of the cash flowsindicates a growing acceptance in India of municipal bondsas an instrument for raising resources for financing infra-structure projects. Municipal bonds in India are a securitised

debt instrument, providing future revenue flows from theproject as collateral.

At the heart of any credit system is a revenue stream thatthe borrower does not use for day-to-day operations.Borrowing for investment purposes is equivalent to capi-talising an income or revenue stream. The borrower re-ceives funds today to pay for project construction. In re-turn, he signs away the right to an annual revenue flow inthe future in favour of the lender. The more certain andpredictable is the revenue stream, the greater is the securityfor a loan.

Credit Rating for Debt FinancingCredit Rating for Debt FinancingCredit Rating for Debt FinancingCredit Rating for Debt FinancingCredit Rating for Debt Financing

A credit rating11 is an independent opinion on the futureability, legal obligation and moral commitment of a bor-rower to meet its financial obligations of interest and prin-cipal in full and in a timely manner. Rating is important toissuers for two key reasons:

(i) investors are reluctant to buy bonds if they are notrated; in several countries, the central government doesnot permit sub-sovereigns to sell unrated bonds,12

(ii) the rating often serves, particularly in countries whereinterest regimes are allowed to operate freely, to de-termine the interest rate at which sub-sovereigns canissue debt in the capital market.

The riskier the ability of a borrower to service debt pay-ments, the higher the interest rate sub-sovereigns have to pay.

Credit rating is mandatory for debt instruments with amaturity exceeding 18 months. The three major credit rat-ing agencies, viz., CRISIL, ICRA and CARE together withtheir partners (Standard and Poor’s, Moody, and Fitch Rat-ings) serve the Indian market in terms of rating bonds anddebentures and other papers. The frameworks that theyuse are outlined below.

11 Credit ratings are an assessment of the ability and willingness of a borrower to make full and timely payments; opinions as to the credit quality ofthe issuer throughout the life of the bond. Credit ratings are not recommendations to buy, sell or hold a security; opinions about the general qualityof a government or statements about the quality of life in a community; opinions about the correctness of a government’s policy decision ( WorldBank, 1999).

12 A recent Presidential Decree in Russia requires regional governments to obtain ratings from international credit rating agencies before borrowingfrom the foreign market.

Municipal Bonds in India

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Credit Rating Information Service ofCredit Rating Information Service ofCredit Rating Information Service ofCredit Rating Information Service ofCredit Rating Information Service ofIndia Ltd. (CRISIL)India Ltd. (CRISIL)India Ltd. (CRISIL)India Ltd. (CRISIL)India Ltd. (CRISIL)

Legal and Administrative FrameworkThe legal and administrative framework for accessing thecapital market is defined in or drawn from the relevant

provisions of state municipal laws, which lay down thelegal and administrative status of a municipality. The lawsalso outline the obligatory and discretionary functions of amunicipality. A clear, unambiguous legal and administra-tive framework and fiscal linkages with the higher tiers ofgovernment and budgeting and auditing procedures are a

Chart 1: Key Features of Tax-Free Municipal Bonds

Eligible Issuers

Use of Funds

Requirements(a) Project Development

(b) Financial Viability

(c) Other Conditions

(d) Project Account and Monitoring

Investment, Maturity and Buy-Back

Ceiling on Amount

Credit RatingLegal and Administrative Requirements

Local self governments, other local authorities or publicsector companies* duly constituted under an Act ofParliament or state legislature; other local authoritiesconstituted under relevant state government statuteslike water supply and sewerage board; and groups oflocal authorities through a financial intermediary.Capital investments in urban infrastructure namely,potable water supply; sewerage or sanitation; drainage;solid waste management; roads, bridges and flyovers;and urban transport if it is a statutory municipalfunction.Project development consisting of an approvedinvestment plan including phasing and a financing plan;benchmarks for commencement and completionincluding the milestone dates for the proposedcomponents of the project; completion of the process ofpre-qualification of bidders; initiation of the process ofland acquisition and other statutory clearances.Financially viable i.e., generation of a stream ofrevenues sufficient to finance the project; creation of anESCROW account for debt servicing, appointment of anindependent trustee for monitoring the Escrow account.Conformity with laws governing borrowing; maintenanceof a Debt Service Coverage Ratio (DSCR)** of 1.25through the tenure of the tax-free municipal bond.Maintenance of a separate account as alsoestablishment of a separate Project ImplementationCell.Minimum maturity of five years, with the option for buy-back arrangements of the face value of the bonds.Maximum amount of tax-free bonds as a % of totalproject cost will be 33.3% or Rs. 50 crore whichever islower; debt-equity ratio not to exceed 3:1; contributionof 20% of project cost from internal resources or grants.Mandatory to obtain an investment grade rating.Adherence to guidelines issued by the Securities andExchange Board of India (SEBI).

Note:* Public sector company means any corporation established by or under any Central, State or Provincial Act or a government company as defined in Section 617 of theCompanies Act, 1956.** Debt Service Coverage Ratio (DSCR) is defined as the ratio of net income after meeting all obligations and liabilities of the issuer (except the long-term debt obligations)to long-term debt servicing obligations.Source: Inferred from Tax Free Municipal Bonds Section 10(15)(iii) of the Income Tax Act. 2001

Key Features

25

prerequisite in any exercise involving its rating. It is used toshed light on the process that is involved in taking impor-tant decisions as also on the transparency and responsive-ness of a municipality on important spheres of its func-tioning. Emphasis is also placed on the system of inter-governmental grants.

The legal and administrative framework comprises an evalu-ation of the borrowing powers and the administrative re-quirements for mobilising funds from the capital market.The limits imposed on borrowing are taken as an impor-tant consideration in credit enhancement of bond ratings.It includes ceilings on debt levels and the manner in whichsinking fund balances are transferred and monitored.

Economic Base

The economic base of the area that the municipality is re-sponsible for is a robust indicator of the citizens’ capacityto bear escalation in tax rates and user charges. The eco-nomic base is thus analysed with respect to the level ofindustrial and commercial activity, income levels, numbersof vehicles registered, number of telephone lines (includ-ing cellular phones) penetration, bank deposits, propertydevelopment, and other indicators, which point to the ex-isting and potential level of economic activities. The analy-sis focuses on the capacity of the city to contribute to themunicipal revenue-raising base.

Municipal Finances

An in-depth analysis of municipal finances, as detailed inthe revenue and capital account transactions, forms anintegral part of the credit rating exercise. As a part ofthe analysis, receipts and expenditures are assessed; thedebt profile of the municipality and its accounting policiesare considered as key inputs to the analysis. In the firststage of analysis, the overall surplus or deficit on revenueaccount is assessed; an overall surplus, if it is on accountof postponing critical capital and revenue expenditure isnot necessarily a positive feature of the financial analysis.The composition of revenues in terms of relativeproportion of tax and non-tax revenues is studied. In theabsence of cost recovery for services that are provided

by municipalities, the quantum and proportion of taxrevenues assume importance in assessing their fiscalautonomy.

Non-tax based revenues, which comprise user charges andincome from municipal properties are analysed as a dis-tinct component of revenue receipts. Revenue receiptsfrom user charges are specifically examined, which high-light consumer categories, past and existing rates and thebasis of levying charges (flat rate or consumption-related).Another critical aspect is the level of state transfers (sharedtaxes and grants or compensations) in relation to revenuereceipts, which indicates the dependence of a municipalityon state resources.

The level and stability of capital receipts as well as theirjudicial deployment towards capacity building is assessedas a part of the financial analysis. A track record of con-sistent, rising developmental capital expenditure is viewedpositively as it builds the economic infrastructure andthereby, improves the level of civic services that are pro-vided in the service area.

Assessment of Existing Operations

Understanding the existing operations of a municipalitythrough a study of the range of services provided by itand comparing it with its obligatory and discretionary ser-vices as defined in the relevant statutes is important to arating exercise. To assess the operating efficiency, an in-depth analysis is undertaken of its core activities includingwater provision (area and population coverage, per capitawater supply and treatment capacity), sewerage (coverageand sewerage treatment capacity) and primary educationand health services (number of schools, hospitals, etc.). Alow level of current service levels indicates pressure on themunicipality to increase spending. The organisational ar-rangement of a municipality is also evaluated with respectto its capacity to be able to augment service levels, revenueincomes and expenditures, etc. Also examined are the pro-posed levels of service enhancement by analysing projectsin works, their completion schedules and alternative insti-tutional arrangements like privatisation.


26


Managerial Assessment

Experience with municipal bond ratings suggests that thefinancial health of a municipality is, to a significant extent,linked to the initiatives taken by its management to en-hance the resource base and improve the level of munici-pal services. It is, therefore, considered important to analysethe organisational structure, administrative systems andprocedures, project management skills as well as the levelof control exercised on expenditure, the ability to managepolitical forces and the initiatives taken to enhance resourcesand improve collection mechanisms.

Project-Specific Issues

In respect of project-specific bonds, the existing level ofservices, the improvements envisaged from the project, theproject costs, means of funding the project, and the effectof debt funding on the debt service coverage ratio of theconcerned municipality are comprehensively examined.

Criteria for Rating Municipalities:Criteria for Rating Municipalities:Criteria for Rating Municipalities:Criteria for Rating Municipalities:Criteria for Rating Municipalities:CARE’CARE’CARE’CARE’CARE’s Methodologys Methodologys Methodologys Methodologys Methodology

The CARE considers parameters such as the fiscal profileof bond-issuing municipal body, profile of the projectbeing financed and its related risk factors, revenue streamsassigned for repayment of bonds, the level of local gov-ernment autonomy and the administrative capability of localgovernment, amongst other factors. It evaluates the legalset-up within which the local body operates including thepower to raise debt, responsibility to repay debt, powerto authorise specific issues, revenue raising powers, pend-ing litigations affecting the status of debt and inter-gov-ernmental fiscal structure. While evaluating the fiscal pro-file, financial parameters such as the composition of rev-enue and expenditures, revenue surplus or deficit, marginof surplus or deficit, availability of general revenues tomeet short-term delays in debt servicing of project-linkeddebt instruments, availability of financial resources to meetunforeseen contingencies and quantum of state budgetarysupport and the nature of operating expenses are exam-ined. It also studies the debt specific factors such as thedelays in past loan repayments, current debt burden, debt

service coverage ratio, degree of reliance on short termborrowings, maturity profile and state government approv-als for borrowings.

When the bond proceeds are to be used to finance a newproject, viability of the new project in terms of the consti-tution of the project as a special purpose vehicle (SPV) oras a departmental project, sources and allocation of fundsfor the project being financed and analysis of major projectrelated revenues and expenditures are assessed.

Also evaluated are factors such as the state of the localeconomy, local employment characteristics, demograph-ics, development indicators, and prioritisation of expendi-ture across projects. It looks at the administrative and legalissues, such as organisational structure, management infor-mation system, tax billing, collection and enforcementmechanism, ability to implement plans and degree of au-tonomy given to the local body. CARE’s methodologycarefully analyses the linkages between the above-statedfactors, while assigning an appropriate rating to the debtinstrument.

ICRAICRAICRAICRAICRA’’’’’s Rating Methodology fors Rating Methodology fors Rating Methodology fors Rating Methodology fors Rating Methodology forIssuance of Municipal BondsIssuance of Municipal BondsIssuance of Municipal BondsIssuance of Municipal BondsIssuance of Municipal Bonds

ICRA has assessed a number of municipal entities in termsof assigning credit rating for bond issues. Although thecriteria for evaluating bond issues by ICRA are not pub-lished, a study of the rating rationale gives an indication ofthe underlying rating philosophy and broad criteria.

ICRA looks at the overall profile of the issuer in terms ofthe area that it services together with its demographic andsocio-economic profile. It conducts a detailed assessmentof the financial performance of municipalities in terms ofthe organisation of accounts, past revenue and expendi-ture profiles, revenue surplus or deficit, past capital expen-diture schedule, liquidity position and debt profile. Alsostudied are major revenue heads in terms of trends andcomposition and expenditure patterns of key operatingdepartments. It also appraises the ongoing and proposedprojects from the point of improvements in service deliv-ery and funding arrangements.

27

The analytical methodology used by Standard and Poor’sfocuses on the range of economic system and administra-tive factors, budgetary performance and flexibility, and thefinancial position of the rating entity. It evaluates sover-eign-related factors as, in its view, the credit standing ofsovereign governments has a significant impact on the creditprofile of sub-national and local governments. While evalu-ating local governments, Standard and Poor’s examines theparameters affecting the local economy, which include eco-nomic structure, growth prospects and demographic pro-file of population. It assesses the system structure andmanagement in terms of inter-governmental linkages, sta-bility and supportiveness of the higher levels of govern-ment, revenue and expenditure balance, and managementsystems and policies. In evaluating the financial perfor-mance, it analyses the revenue sources and flexibility therein,expenditure trends, liquidity, debt burden and off-balancesheet liabilities.

A Profile of Municipal BondsA Profile of Municipal BondsA Profile of Municipal BondsA Profile of Municipal BondsA Profile of Municipal Bonds

Bangalore City Corporation (BCC)

Bangalore Mahanagarpalika issued the first municipal bondin India for Rs. 125 crore with a seven-year maturity and acoupon rate of 13 percent. The purpose of issuing bondswas to raise capital for developing roads, drains and streetlighting in Bangalore. The Rs. 125 crore bond programmeof BCC was awarded “A+(SO)” (pronounced A plusstructured obligation), based on a credit mechanism in theform of an unconditional guarantee by the Governmentof Karnataka (GOK) to meet the debt servicing obliga-tions on the rated bonds. Therefore, the rating reflects theability of the GOK to service the debt obligations on therated bonds. The principal and interest payments are se-cured by way of structured payment mechanisms, i.e., col-lection and deposit of property tax and state governmentgrants to an escrow account, which is to be used to paybond holders and supervised by bond issue the KarnatakaState Finance Corporation.

The decision of the BCC to seek a state government guar-antee for accessing the capital markets was guided by thenon-availability of other credit enhancement instruments.

Replicability of this form of credit enhancement on a largescale is questionable, given the relatively weak credit pro-file of many state governments and their large contingentliabilities on account of the already outstanding guarantees.

Ahmedabad Municipal Corporation (AHMC)

The AHMC issued bonds of Rs. 100 crore at 14 percentinterest, payable semi-annually. Designed as a structuredobligation, the issue secured a credit rating of “AA(SO)”(pronounced “Double AA Structured Obligation” – HighSafety), rating based on escrowing of octroi collectionsfrom ten designated collection centres for servicing theobligation on the bond issue. The repayment mechanisminvolved the collection and deposit of octroi receipts fromidentified check-posts during the lien period, into a centraloctroi collection account in a designated bank, specificallyopened for this purpose. During the lien period, the req-uisite funds (interest and principal payments) are requiredto be transferred directly from the AHMC’s central octroicollection account to a designated bank account. Trusteesare authorised to operate the escrow account till the finalredemption of the bonds. The lien period varies between180 days for interest payment and 360 days for paymentof principal amount. A key point to note is that the es-crow structure provides for prioritisation of cash flowsfor payment to bondholders, which reduces the risk ofmisallocation of revenue streams for other expendituresprior to debt servicing. In effect, this bond issue has takenthe form of a superior debt issue, where payment to bond-holders is given priority over payment to other creditors.

The credit enhancement structure is different from theconcept of pure revenue bonds, which are a typical fea-ture in the United States. The structure of this bond issueprovides for dedicating other revenue streams of theAHMC for meeting debt-servicing obligations in the eventof octroi abolition or insufficiency of octroi revenues.Therefore, this structure is a blend between a general obli-gation bond and a revenue bond.

Nashik Municipal Corporation (NMC)

The NMC raised Rs. 100 crore at 14.75 percent interest tofinance projects such as water supply and underground


28


sewerage, flyovers, bridges and truck terminals. CRISILhas given these bonds, an “AA (SO)” rating, which is basedon the escrowing of octroi revenues from three pre-de-termined octroi collection centres for debt servicing un-der the supervision of a Trustee. The rating was subse-quently downgraded to “AA-”, the stand-alone rating ofNMC due to the non-implementation of the proposedcredit enhancement, but upon completion of documentsrelating to credit enhancement, the original level of “AA(SO)” was restored.

The change in credit rating even when credit enhancementvia escrowing of octroi collection was not crucial on ac-count of the high stand-alone credit rating of NMC, com-bined with such covenants as the maintenance of pre-speci-fied debt servicing coverage ratios are examples of prob-lems that are characteristic of countries where municipalbond markets are in an early stage of evolution.

Ludhiana Municipal Corporation (LMC)

The Rs. 10 crore term loan programme of the LMC wasawarded in June 1999, a “LAA-(SO)” (pronounced Ldouble A minus structured obligation), indicating high safety.The credit enhancement used in this case involved trans-ferring the entire water and sewerage charges into a no-lien escrow account, till the amount collected in the ac-count was sufficient to cover the two succeeding paymentobligations (interest and principal) of the term loan.

The credit enhancement is similar to that used in the AMCand NMC, where escrowing of revenues streams formsthe basis for enhancing the rating. The key difference lies inthe earmarking of non-tax revenues such as water andsewerage charges to partly finance a water supply and sew-erage project.

Nagpur Municipal Corporation (NGMC)

The Rs. 50 crore bond programme of NGMC has beenawarded a “LAA-(SO)” rating, a rating which carries highsafety. The rating is based on a specified structure, whichrequires the NGMC to escrow cash flows from propertytax and water charge collections for servicing the bond-

holders. The NGMC is required under the arrangementto pay equal annual instalments collateralised into a no-lienescrow account from property tax collections over the ten-ure of the instrument. The inflow into the escrow accountis to be invested in approved securities. Interest earned oninvestments is to be reinvested into this account. Watercharges collected are also to be escrowed into a secondno-lien escrow account for meeting the recurring interestliability. Arranged by the State Bank of India Capital Mar-kets Ltd., the issue carries a maturity of seven years, with aput-and-call option at the end of five years, and a redemp-tion option at the end of five, six, and seven years.

The rating of this issue takes into account the NGMC’spast performance, which has been consistently good andcharacterised by low debt levels and other managementinitiatives for improving tariffs. The rating draws comfortfrom the structure, which is based on a stable revenue streamof property tax and water charges. If the Governmentof Maharashtra (GOM) abolishes octroi, NGMC’s finan-cial position would be adversely affected; however, underthis scenario, it is expected that GOM will compensate themunicipal corporation with alternative sources of revenues.

Madurai Municipal Corporation (MMC)

MMC issued bonds amounting to Rs. 30 crore by way ofprivate placement at 12.25 percent interest without a guar-antee. The bonds are in the form of secured redeemableand non-convertible debentures and are taxable. A ratingof “LA+(SO)” (LA plus structured obligation) was as-signed to this bond issue; the bond amount is to be usedfor a two-lane inner ring road and to refinance the thenhigh cost loan from the Tamil Nadu Urban DevelopmentFund (TNUDF). The rating indicates adequate safety.

The rating is not for general obligation of the MMC, butis specific to the bond issue, the redemption of which isbacked by the toll collections from the Madurai Inner RingRoad Project (MIRR). The rating factors have accountedfor the structured payment mechanism, which has isolatedthe toll collections by means of a no-lien escrow account.The rating also factors in the credit strength provided by

29

the commitment of the Government of Tamil Nadu(GOTN) to meet out any shortfall in the repayment ofprincipal and interest due thereon during the tenure of thebond.

Hyderabad Municipal Corporation (HMC)

The Rs. 82.5 crore bond programme of the HMC wasawarded an “AA+(SO)” (pronounced double A plus struc-tured obligation), indicating high safety with regard to timelypayment of interest and principal on rated bonds. Thepurpose was to partly fund the corporation’s plans to in-vest Rs. 247.5 crore in various development projects.

This bond issue carries a two-level credit enhancementmechanism, comprising escrow cover and cash collateral.The bond issue has a tenure of seven years comprisingsemi-annual interest and principal repayments, with theprincipal repayment commencing at the end of the fifthyear from the date of the issue. The escrow, coveringinterest payment up to year five, comprises receipts fromprofessional taxes, advertisement revenues, stamp duty rev-enues, town planning revenues and non-residential prop-erty tax revenues. Interest and principal repayments, whichfall beyond year five are covered through a cash collateralof Rs. 78 crore, currently available from the accrued rev-enue surplus. The State Bank of Hyderabad is the Trusteefor this issue.

In this structure, the corporation is able to enhance creditrating of the bond issue while at the same time, retainingthe past revenue surpluses. This structure is possible to bereplicated by those corporations, which have created sub-stantial revenue surpluses.

Indore Municipal Corporation (IMC)

The IMC issued non-convertible redeemable bonds ofRs. 10 crore at 11.5 percent payable annually. The bondswere issued through private placement with guaranteefrom the state government. The proceeds are to be utilisedfor improving city roads. The bonds are redeemable inthree instalments of 30 percent, 30 percent and 40 per-cent, payable at the end of five, six, and seven years.

Tamil Nadu Urban Development Fund (TNUDF)

The Tamil Nadu Urban Development Fund (TNUDF)has been awarded a “LAA+(SO)” (L double A plus struc-tured obligation) rating for Rs. 110.05 crore long-term debtprogramme. The TNUDF is a pilot venture, designed toinvolve the private sector in funding infrastructure devel-opment. This rating indicates high safety. The instrumenthas a structured payment mechanism, which requires theTNUDF to maintain a bond service fund (BSF) equiva-lent to one year’s principal and interest payment as collat-eral throughout the currency of the bond. The rating fac-tors are based on mechanisms instituted by TNUDF, whichhas resulted in high collection efficiency, zero non-perform-ing assets, continued support of the Government of TamilNadu in the form of guarantees and set-off mechanisms,well-established systems and procedures, insignificant as-set-liability mismatch, and a comfortable liquidity providedby its surplus funds.

Thane Municipal Corporation (TMC)

The AA (SO) rating on TMC’s bond programme indicat-ing high safety with regard to the timely payment of theinterest and principal obligations on the rated instruments.The rating assigned reflects the corporation’s strong stand-alone credit quality and the strength of the credit enhance-ment mechanism provided for the instrument structurethrough an escrow of octroi collections. TMC’s stand alonecredit profile receives significant comfort from its clearlydefined revenue raising powers and borrowing powersunder the provisions of the BPMC Act 1949 and its ser-vice area coverage of a relatively high-income populationin close proximity to Mumbai. TMC’s revenue sourcesare well diversified with octroi contributing 58 percent ofthe revenue income combined with property tax andwater tax.13

The quantum of municipal bonds issued (Rs. 6,185 mil-lion) thus far is a small fraction of the total debt marketin the country and can at best be called an initial attemptto tap the potential of the growing debt market in thecountry (See Table 16). It underlines the importance of

13 Details on the interest payable and the projects for which these funds will be used are not available at the time of preparing this study report.


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Table 16: Municipal Bonds

City Amount Placement Guarantee Interest Escrow Purpose Rating(in Rs. million)

Ahmedabad 1000 Public & No 14% AA-(SO)Private

Bangalore 1250 Private State 13% A-(SO)government

Ludhiana 100 Private No 13.5% to LAA-(SO)14%

Nagpur 500 Private No 13% LAA-(SO)

Nashik 1000 Private No 14.75% AA-(SO)

Indore 100 Private Yes 13% A(SO)

Madurai 300 Private No 12.25% LA+(SO)

Ahmedabad 1000 Private No 9% AA (SO)(tax free)

Hyderabad 825 Private No 8.5% LAA+(SO)(tax free) AA+(SO)

Tamil Nadu 110 Private * 9.20%(pooledfinancing)14

Source: Compiled from Bond Issuance Brochures.* The USAID provided a backup guarantee of 50 percent of the bond’s principal through its Development Credit Authority.

Octroi from10 octroicollectionpointsStategovernmentgrants andproperty taxWater &seweragetaxes andchargesProperty taxand waterchargesOctroi fromfour octroicollectionpointsImprovementof city roadsToll taxcollection

Propertytaxes of twozones

Non-residentialpropertytaxes,advertisem-ent tax,professiontax, etc.Monthlypaymentsequal toone-ninth oftheir annualpayments.

Watersupply andsanitationprojectCity roads,streetdrains

Watersupply andsanitationprojectWatersupplyprojectA (SO)

City roadprojectWatersupply andsanitationprojectRoadconstruct-ion andwideningWatersupply andsanitationprojects in14 ULBs

14 Pool finance facility is meant for smaller municipalities who individually do not have the capacity to raise funds in the capital market. They pooltheir requirements and make use of an intermediary to raise funds from the capital market.

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market-based financing of municipal infrastructure.Access to the capital markets fosters commercially vi-able urban infrastructure projects and improves gov-ernance and accountability on the part of municipali-ties. A distinctive feature of municipal bonds in India

is rooted in the financial strength and fiscal disciplineof borrowing municipalities – in the taxes they raise,cash balances they keep, user charges they are able toput into practice and toll collections as credit supportmechanisms.


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Capital market access is a useful, if not an indispensable,instrument for financing the investment needs of munici-pal governments in growing economies. It has gainedimportance in recent years in view of the:

(i) continually rising population pressures on cities andtowns and their consequential impact on the demandfor municipal services and infrastructure,

(ii) inability of the higher tiers of government to providegrants for financing services and

(iii) greater decentralisation of spending decisions to mu-nicipal governments.

The capital market allows a municipal government to un-dertake a capital investment programme, which wouldotherwise not be possible. It promotes inter-generationalequity by making the future generations who are expectedto benefit from capital works pay for them.

An important decision that municipal governments areusually faced with is from where to borrow for financ-ing infrastructure projects: banks, financing institutionsand specialised municipal bank or the market. In West-ern Europe, specialised municipal banks supply muchof the municipal credit in the form of long-term bankloans. In the USA and Canada, municipalities sell bondsfor raising resources. The difference between the Eu-ropean and US systems, which use bank loans and bondsrespectively, are rooted in financial sector intermedia-tion. A bank carries out the intermediation function by

mobilising savings, appraising and extending loans andmonitoring loans and the financial condition of bor-rowers. The bond market represents a kind of dis-in-termediation. Municipal government bonds are solddirectly to household savers and to financial institutions.The monitoring of municipal financial condition is per-formed by specialized credit institutions. Unlike bankcredit where relations between a bank and municipalityare important (often called relationship banking), mu-nicipal bonds constitute a form of direct access to thecapital market. They represent a less personal connec-tion between a borrower and lender. A bond is inher-ently more decentralised.

An important aspect of bond markets is the disclosure ofmunicipal finance information in order to function effec-tively and be accountable. Developed financial systemsmaking use of bonds have extensive public disclosurerequirements that issuers must comply with. Unlike in thecase of bank credit where a bank develops a comprehen-sive relationship with the borrower, a municipal bondmarket relies on a network of institutions and services forcarrying out activities that form an integral part of the pro-cess of issuing bonds. These include, among others, deci-sions on where to obtain the advisory services or technicalassistance on project design and how to manage internalpayment systems. It presupposes that these specialised tasksare possible to be performed in the economy where mu-nicipalities may be located.15

A Framework for Evaluating theA Framework for Evaluating theA Framework for Evaluating theA Framework for Evaluating theA Framework for Evaluating theFinancial PerformanceFinancial PerformanceFinancial PerformanceFinancial PerformanceFinancial Performance

5

15 These activities entail substantial costs. It is often argued that these costs (e.g. legal cost, fee for underwriting etc.) may be unaffordable for smallermunicipalities.

33

Market-based municipal lending helps to increase the effi-ciency and productivity of investments. The critical mea-sure of efficiency and creditworthiness is a municipality’sability and willingness to repay its debts. From this per-spective, it is important for municipal authorities to bor-row as long as they are in a position to repay their debtswith a safety margin.16

Credit rating of a municipality is a specialised task, whichin the contemporary financial market is to be performed

by recognised credit rating agencies. As shown in the ear-lier section, it may involve a detailed assessment of theeconomic base of the city that a municipality is responsiblefor together with its growth profile and prospects of out-standing debts, financial operations, revenue and expendi-ture flexibility and government’s administrative and legalstructures. It may need to consider the sovereign or statu-tory ceilings as well. What follows in the next section isa framework that lays down how a municipality may

16 There is abundant literature on when a debt may turn excessive. Excessive local debt would normally imply that the rate of return on projectsfinanced by borrowed funds is lower than projects in the rest of the economy.

The figure below provides an overview of a country’spotential for municipal credit market development at apoint in time. Along the vertical or y-axis is arrayed thestability and adequacy of the municipal finance system.This measures potential demand for municipal borrowing.Along the horizontal axis is shown the degree of financialsector development. This measures the economy’sability to assemble savings and to use financialintermediaries to supply investment financing in the formof credits. An example of a few countries may be seenbelow, using qualitative judgments as to their conditionsin 1996.

Strategies for developing municipal credit markets shouldbegin with an assessment of where a particular countrystands. In the lower left quadrant are countries whereany kind of municipal credit market development ispremature. Kenya, for example, is plagued by amunicipal system that leaves municipalities highly

Box 1: Municipal Credit Market

dependent upon central government transfers. Transferpolicy is not spelt out in law. Central authoritiesdetermine the transfer amounts by non-transparentcriteria, and often end up transferring less than has beenpromised. The different levels of government are alsotrapped in interlocking debts. Bulgaria is another countrywhere municipal lending of any kind would seem to bepremature.

For countries in the middle range, there are options.Traditionally, they have used municipal developmentfunds to meet local governments’ credit needs (e.g.,Brazil). Other countries are in the midst of taking thefirst step toward establishing a municipal developmentfund, with external support. Countries in the upper rightquadrant face a transitional decision. They are ready tointegrate municipal lending into the general, private-sector credit market, but must decide whether and howthey will make the transition.

Stab

ility

and

Ade

quac

y of

Mun

icip

al F

inan

ce º South Africa(former white)

º Chile

º Colombia

º Poland

º Philippines

º Brazil

º Romaniaº South Africa

(Former black)

º Bulgaria

º Kenya

Financial Sector Development

A Framework for Evaluating the Financial Performance

Source: G. Peterson. 2001

34


evaluate its own performance, with reference to debts, fi-nancial operations and revenue and expenditure flexibility,in order to decide if it is ready to seek a credit rating foraccessing the capital market.

Evaluating the FinancialEvaluating the FinancialEvaluating the FinancialEvaluating the FinancialEvaluating the FinancialPerformancePerformancePerformancePerformancePerformance

For a municipal government to be able to raise resourcesin the capital market, it needs a thorough investigation ofthe legal and statutory framework, which regulates its func-tioning, economy-wide performance and growth patterns,financial strengths and weaknesses of the entity itself andthe debt repayment capacity. Such an investigation formsa part of a formal exercise that is undertaken by a creditrating organisation. However, a decision to enter the capi-tal market needs to be preceded by an in-house evaluationof the financial performance, which would indicate itspreparedness for raising market funds. What follows is aframework for evaluating the financial performance of amunicipality, which must begin with an in-depth examina-tion of its budget. A municipal budget consists of (i) anoperating budget comprising current revenues and oper-ating expenditures, (ii) a capital budget comprising assetsales, investment grants from state governments and pro-ceeds from borrowings and bond issues and (iii) fund fi-nancing. The constituents of the budget are as under:

Operating budget:= Current revenues i.e.,

Own sources +Shared revenues +Operating transfers from state governments

(-) Current expenditure.= Operative surplus or deficit.17

Capital budget.= Operating surplus +

Asset sales +Investment grants from state government +

Borrowed funds including bond issues (-)Investment + debt services

Fund financing (Special funds)

Earmarked streams of revenues set aside to fi-nance debt service on specific capital projects.

Current expenditure comprises payment of salaries andwages, expenditure on administrative functions and oper-ating and maintenance costs of service delivery, whereascurrent revenues have standard revenue sources, such astax revenues, receipts from fees, charges, fines and interestincome from investments. Capital account inflows arecategorised on the basis of sources of revenue. Accrualfrom borrowings, grants allocated for capital expenditureand sale receipts of assets constitute capital receipts, whilecapital investments include debt servicing and investmenton infrastructure and services.

Operating Budget: Current Revenue

Tax Revenues

Property taxes including taxes such as a house tax, watertax, sewerage tax and other clubbed taxes such as light-ing and connection fees in respect of the above andother taxes comprising octroi or entry tax revenues,but not any compensation in lieu of octroi abolition.

Taxes on animals and non-motorised vehicles, theatretaxes, and advertisement taxes.

Shared taxes, which include taxes that are collected bythe state, but shared between the state and municipali-ties, taxes on entertainment, profession tax, educationcess and surcharge on stamp duty.

Non-Tax Revenues

Fees and charges, which include fees levied for ser-vices as distinct from taxes, fines and license fees lev-ied by municipalities for granting permission for con-struction of buildings and running of businesses andtrades.

17 Strictly speaking, municipal governments may not post any deficit, as all municipalities are required by law to balance their budgets.

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Income from municipal properties, viz., rent or leaseincome from properties owned by municipalities.Profit on sale of municipal land is the realisation fromthe sale, net of the cost at which land was acquired. Ifthe initial acquisition cost of land is not recorded, theentire proceeds for sale is recorded as capital incomefor that year.

Miscellaneous income, which includes income fromcommunity events, sale of scrap, etc.

Grants and Transfers

Revenue grants from the state government, which ac-crue in the form of general or specific-purpose grant,compensatory grant and transfers under different rev-enue-sharing arrangements.

Capital Budget: Income Component

Investment consisting of capital grants under specificschemes, (e.g., Swarna Jayanti) or service-specificprojects;

Loans including those from the state government, na-tional-level lending institutions such as HUDCO, loansfrom LIC and municipal bonds; and

Others.

Operating Budget: Current Expenditures

Current expenditures are possible to be reviewed in sev-eral ways.

Establishment: (salary and wages, pensions, gratuity,and other retirement benefits, and such expendituresas on uniforms, etc.);

Administrative and general expenditure;

Interest and finance charges: (interest on loans, intereston debentures and bonds, bank charges and other fi-nance charges);

Grants, contributions and subsidies (outflows);

Provisions and write-offs (provision for doubtful re-ceivable discount and remissions, and revenues writ-ten off);

Repair and maintenance;

Depreciation;

Miscellaneous expenses (losses on account of the saleof plants and contingent expenditures).

Department-Wise Expenditures

Expenditure is possible to be analysed for each depart-ment: expenditure on the operation and functioning ofthe municipal council; general administration; finance andaudit; law department; public relations and vigilance de-partment and election, collection of taxes and revenuedepartment; public works and land and buildings; watersupply; public health and medical services; sanitation andsolid waste management; burial and cremation; publicamenities like street lighting, parking lots, bus stops andpublic conveniences; slaughter houses; and family welfare,and social services and welfare of weaker sections.

Debt-Related Payments

Repayment of debt by municipalities may occur throughtwo modes, viz., direct repayment by municipalities orthrough a sinking fund. Under the sinking fund mode, themunicipalities make an annual contribution to a sinkingfund, specifically aimed at future debt repayments. Pay-ment to debt holders is done from the sinking fund. Theannual contribution to and payments from the sinking fundusually vary and are shown separately. In addition, munici-palities typically have an outstanding balance in the sinkingfund. Thus, the debt parameters are based on the value ofdebt, net of the balance in the sinking fund, as it gives abetter picture of the indebtedness of municipalities. Forcoverage parameters such as debt service credit ratio(DSCR), the overall surplus of a municipality is adjustedfor sinking fund payments, by deducting the annual contri-bution to sinking fund.

Capital Expenditure

Capital expenditure consists of the repayment of loans; re-fund of deposits to contractors; acquisition and purchaseof fixed assets (land, buildings, roads and bridges, flyovers,sewerage and drainage, waterways, plants and machinery,


36


vehicles, office and other equipment, furniture and fixturesand other fixed assets; capital work-in-progress) and invest-ments e.g., provident fund and pension fund investment.

Current LiabilitiesAdvance and Deposits

The net values (amount received-amount given) of ad-vances and deposits are classified separately. Although cash-based, accounts followed by municipalities classify suchinflows as revenues, these are, in effect, an increase in cur-rent liabilities.

Current AssetsCash and Bank Balances

Cash and bank balances are used for the opening and clos-ing balance. This is used as a check by comparing thedifference between the two against the cash inflows ofmunicipalities. The cash inflows comprise the overall sur-plus and deficit on both the revenue and capital accountand net inflows due to advances and deposits.

Total Outstanding Debt

Values as per municipal accounts statement are taken andused to compute parameters measuring indebtedness.

Municipal Financial IndicatorsMunicipal Financial IndicatorsMunicipal Financial IndicatorsMunicipal Financial IndicatorsMunicipal Financial Indicators

The financial performance of municipalities is measuredthrough various indicators. A summary of indicators usedfor evaluating the creditworthiness of municipal entities isgiven in Chart 2. These indicators reflect the operationalefficiency of municipalities as well as the conduciveness ofthe legal framework under which their operate.

Ranking of the ratios into

(a) favourable,

(b) good,

(c) moderate, and

(d) poor

helps to determine the performance of a municipality.(See Table 17)

Implications of Municipal Bond forImplications of Municipal Bond forImplications of Municipal Bond forImplications of Municipal Bond forImplications of Municipal Bond forthe Urban Reform Agendathe Urban Reform Agendathe Urban Reform Agendathe Urban Reform Agendathe Urban Reform Agenda

The emergence of the municipal bond market in the countryrepresents an important breakthrough in channelising re-

Chart 2: Measuring Financial Performance

Ratio IndicatorOperating revenue surplus / revenue receipts Operating efficiency and surplus on the revenueaccount prior to debt servicing.Revenue surplus / revenue receipts Margin for municipal entities, considers cash flowsafter interest and principal repayment.Debt servicing credit ratio Debt repayment liability through operating surpluses.Operating revenue surplus / interest costs Interest repayment liability through operatingsurpluses.Capital expenditure / total expenditure Expenditure on improvement of services anddevelopment of infrastructure to total expenditure.Operating revenue surplus / debts Time frame within which debt is repayable out of ownaccruals.Revenue receipts / debts Level of indebtedness.Capital grants + revenue surplus / capital expenditure Level of capital expenditure supported by non-debtrelated inflows.Own tax revenues / revenue receipts Level of fiscal autonomy.Revenue grants / revenue receipts Level of dependence on the state government grants.Establishment expenditure / revenue expenditure Proportion of revenue expenditure required to meetwages and salaries.

37

sources to the urban infrastructure sector. While the num-ber of municipal bond issuances in the country is a smallfraction of the total bond market, the demonstration ef-fect of these successful issues holds an important place inthe urban sector reform agenda. The municipal bond ex-perience does not merely relate to developing additionalsources of finance for investment in the urban sector. Thevery fact that more than 40 municipalities have subjectedthemselves to credit rating demonstrates an increasing ac-ceptance of the need for independent evaluation and moni-toring. Many municipalities have used the credit rating pro-cess as an important benchmarking tool to evaluate theirperformance. This process fosters a competitive spiritamongst local governments, which gives a positive signalfor the urban reform agenda.

Accessing the capital market through municipal bondsimposes market rigour and sets performance targets formunicipalities. Municipal governments in such cases arerequired to share more information periodically with alarger financial community, which encourages transpar-ency and places additional focus on internally develop-

Table 17: Ratio Ranking on the Basis of Indicators

Indicators Favourable Good Moderate PoorOperating revenue surplus / revenue receipts >50% >35% >15% <15%Revenue surplus / revenue receipts >40% >25% >10% <10%Debt service credit ratio >4 x 2-4 x 1-2 x <1 xInterest coverage >6 x 3-6 x 1.5-3 x <1.5 xCapital expenditure / total expenditure >40% >20% >10% <10%(inclusive of debt servicing)Operating revenue surplus / debt >50% >25% >10% <10%Revenue receipts / debt >2.5 >1.5 >1.0 >1.0Capital grants + revenue surplus / capital expenditure >0.75 >0.5 >0.25 <0.25Own tax / revenue receipts >70% >50% >25% <25%Revenue grants / revenue receipts <10% <25% <50% >50%Establishment expenditure / revenue expenditure <40% <60% <75% >75%Cost recovery: water >75% >50% >25% <25%Collection efficiency: property tax >75% >50% >30% <30%

Source: Sujata Srikumar 2000. Rating of Municipal Bonds. Mimeo. Unpublished.

ing and maintaining management information systems.Financial covenants imposed at the time of issuing thebonds serves an important check against financial im-prudence. While the regulatory system of clearances byhigher levels of government on local government bor-rowings serve as an administrative check on controllingthe debt burden, capital market based tools such aschanges in credit rating and varying yields on bondsprovide more effective warning signals on risingfinancial risks.

As the municipal bond markets develop further, the desireto participate in the market itself would turn out to be astrong incentive to improve and maintain their creditwor-thiness. The proposed policy decision of the Ministry ofUrban Development to set up a City Challenge Fund toprovide incentives to municipalities and other local entitiesto improve their governance through creditworthiness is astep in the right direction and needs to be further deep-ened with appropriate provisions in the existing statutes toenable municipalities to undertake credit performanceexercises on a regular basis .


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GlossarGlossarGlossarGlossarGlossaryyyyy

Accrual accounting: A method of accounting in whichrevenue is recognised when earned and expenses arerecognised when incurred without regard to the timing ofcash receipts and expenditures.

Bond rating: An appraisal by a recognised financialorganisation of the soundness of a bond as an investment.

Cash accounting: A method of accounting in which changesin the condition of a municipality (or organisation) arerecognised only in response to the payment or receipt of cash.

Coupon rate: The interest rate that is paid to the bond-holders. The amount of interest is determined by multi-plying the coupon rate by the par value of the bond.

Credit enhancement: A guarantee provided by a thirdparty to pay the interest and principal on a bond if theissuer is unable to make the required payment. The mostcommon types of credit enhancements are letters of creditissued by commercial banks and insurance provided bybond insurance companies.

Debt capacity: The total amount of debt a municipality(or organisation) can prudently support given its earnings,expenditures and equity base.

Debt policy: A policy that establishes the guidelines forthe use of debt by an issuer. The policy covers the maxi-mum amount of debt that can be issued, the types ofdebt, the purposes for which debt can be issued and thedebt maturity schedule.

Debt-to-assets ratio: A measure of financial leverage,defined as debt divided by total assets.

Debt-to-equity ratio: A measure of financial leverage,defined as debt divided by shareholder’s equity.

Debt service payment: The sum of interest and the prin-cipal amount of bonds scheduled to mature in a givenyear.

General obligation bond: A type of bond that is backedby revenue sources that is limited as to the sources or themaximum amount of the tax.

Maturity date: The date at which the issuer is obliged torepay the principal amount of the bond to the bondholder.

Revenue bond: A bond issued for either project or en-terprise financings, secured by the revenues generated bythe facility being financed.

Sinking fund: A fund of cash set aside for the paymentof a future obligation.

Unlimited-tax, general obligation bond: A bondthat is secured by the full faith, credit, and taxing powerof the issuer. The issuer pledges to levy taxes or chargesat whatever amount is necessary to repay the bonds.

Variable rate (or floating rate) bond: A bond whosecoupon rate can change over the life of the bond issue.The variable rate is generally linked to the level of an inter-est rate index.

39

ReferencesReferencesReferencesReferencesReferences

Aronson, J. Richard and Schwartz, Eli 1996. Management Policies inLocal Government Finance. Washington D.C.: International CityManagement Association.

Expert Group on the Commercialisation of Infrastructure Projects1996. The India Infrastructure Report: Policy Imperatives for Growthand Welfare, 1-3, New Delhi.

Higgins, Robert C. 2001. Analysis for Financial Management. NewYork: McGraw-Hill.

Organisation for Economic Cooperation and Development 1997.Emerging Bond Markets in the Dynamic Asian Economies, Paris.

Peterson, George and Ferguson, Bruce 1991. Municipal CreditInitiatives, (Mimeo), The World Bank, Washington D.C.

Planning Commission 2002. Tenth Five Year Plan (2002-2007),Government of India New Delhi.

Standard and Poor’s. 1996. Municipal Finance Criteria, New York.The World Bank 1999. Credit Ratings and Bond Issuing at the

Subnational Level, Washington D.C.

The World Bank 1999. Urban Water Supply and Sanitation. NewDelhi: Allied Publishers.

The World Bank (undated). Confronting Rapid Urbanization: Lessonsfrom Five Countries: The Experiences of Brazil, Canada, China,Korea and Malaysia and their relevance to India.

Vaidya, Chetan and Mukundan, K. 1989. Delivery and Financing ofUrban Services, Operations Research Group, Vadodara.

About the Series EditorsAbout the Series EditorsAbout the Series EditorsAbout the Series EditorsAbout the Series Editors

Aasha Kapur Mehta is Professor of Economics at the Indian Institute of Public Administration, New Delhi and leads theChronic Poverty Research Centre’s work in India. She has a Masters from Delhi School of Economics, an M.Phil fromJawaharlal Nehru University and a PhD from Iowa State University, USA. She has been teaching since 1975, initially ata college of Delhi University and then at IIPA since 1986. She is a Fulbright scholar and a McNamara fellow. Her areaof research is now entirely focused on poverty reduction and equity related issues.

Pradeep Sharma is an Assistant Resident Representative and heads the Public Policy and Local Governance Unit inthe India Country Office of United Nations Development Programme (UNDP). A post-graduate from University of EastAnglia (UK) and Doctorate from Jawaharlal Nehru University, he has held several advisory positions in the Governmentof India and has taught economic policy at LBS National Academy of Administration, Mussoorie. He has severalpublications to his credit.

Sujata Singh is an Associate Professor at the Indian Institute of Public Administration. She completed her doctoralstudies in Public Administration and Public Policy at Auburn University, USA. Her primary research interests are in thearea of Comparative and Development Administration, Public Policy Analysis, Organizational Theory and Evaluation ofRural Development Programmes.

R.K. Tiwari is Senior Consultant, Centre for Public Policy and Governance, Institute of Applied Manpower Research,Delhi. He was formerly Professor of Public Administration at the Indian Institute of Public Administration (IIPA), NewDelhi. He received his education at Gwalior, Allahabad and Delhi. He has undertaken a number of research studies inDevelopment Administration, Rural Development, Personnel Administration, Tribal Development, Human Rights andPublic Policy. He has conducted consultancy assignments for the Department of Posts and in the Ministry of RuralDevelopment, Government of India; and for the Government of Orissa and the Narmada Planning Agency, Governmentof Madhya Pradesh. He has published several books.

financing municipal services - indian institute of public

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