Municipal Bonds in India: A Rising Financing Avenue Amidst Challenges

Municipal Bond Issuance Set to Cross ₹1,500 Crore in FY2025- 26

India's municipal bond market is poised for substantial growth, with issuances expected to surpass ₹1,500 crore in the Financial Year (FY) 2025-26. According to a recent report by ICRA, this surge is primarily driven by the Indian government's concerted push toward alternative financing mechanisms for Urban Local Bodies (ULBs). Additionally, an increasing focus on Environmental, Social, and Governance (ESG) initiativeswill likelyo boost the issuance of green and pooled bonds.

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A Transformational Growth in the Municipal Bond Market

The municipal bond market in India has gained significant traction in recent years, particularly after FY2018. Since then, the total funds raised through municipal bonds have exceeded ₹2,600 crore, a stark contrast to the period between FY1998 and FY2005, when less than ₹1,000 crore was raised. This growth trajectory highlights the effectiveness of fiscal incentives introduced by the Government of India (GoI).

Regulatory Interventions and Incentives Drive Market Expansion

Key regulatory and fiscal measures have been pivotal in expanding the municipal bond market. In 2015, the Securities and Exchange Board of India (SEBI) issued the "Issue and Listing of Debt Securities by Municipalities" regulations, which clearly defined the status of municipal bonds and helped garner investor interest. Further, in FY2018, the GoI launched an incentive scheme, offering a financial incentive of ₹13 crore for every ₹100-crore bond issuance, significantly motivating ULBs to explore this financing option.

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Challenges Hindering the Municipal Bond Market's Growth

Despite the positive momentum, several structural challenges continue to impede the municipal bond market's full potential. These include:

• High dependency of ULBs on government grants.
• Lack of adequate and timely financial disclosures.
• Limited liquidity and absence of a robust secondary market.
• High compliance requirements.
• The weak credit quality of many ULBs, makes market access difficult.

Structured Payment Mechanisms Enhancing Credit Ratings

A notable aspect of municipal bond issuances since FY2018 is the adoption of strong structured payment mechanisms. These frameworks have significantly enhanced the credit ratings of municipal bonds, ensuring that all issuances receive at least an AA rating, irrespective of the varying financial health of the underlying ULBs. In the future, most upcoming issuances are expected to follow similar structured financing models to maintain investor confidence.

Future Outlook: Strengthening the Bond Market for Sustainable Growth

Since FY2018, approximately 17 municipal bonds worth about ₹2,600 crore have been issued, with an average issuance size of ₹150 crore. While the outlook remains positive, the key to sustaining this momentum lies in improving the intrinsic credit quality of ULBs, fostering a more transparent financial disclosure system, and enhancing market liquidity. Addressing these challenges will be crucial in developing India's more vibrant and resilient municipal bond market in India.

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