Contract clauses of penalties and liquidated damages are bound to be pressed, leading to arbitration and legal battles.
In 2017, the Pune Municipal Corporation (PMC) was widely commended for raising an amount of ₹2 billion through municipal bonds. The money was to part-fund its ambitious 24x7 water supply project (total cost ₹29 billion) that would enable the urban local body (ULB) to provide potable water to its citizens equitably and uninterruptedly throughout the city. This required the installation of 1,600 km of pipeline network and the addition of 103 water tanks spread over the city so that water pressures and distribution could be evenly managed. Some 300,000 water metres were also to be installed with a view to promote water conservation and water charges as per usage. The scheme was designed to cover additional geographical areas that had been merged within the municipal limits. The PMC set 2021 as the deadline for project completion.
In order to raise bonds, PMC had moved to the double-entry accounting system and had got itself credit rated by CARE and India Ratings. Both gave it a rating of AA+ stamping approval to the ULB’s credit worthiness. The bond is a revenue bond with a tenure of 10 years and carries a six-monthly interest rate of 7.59 per cent. All three roles of advisor, arranger and merchant banker are being performed by SBI Caps, who are also the trustee of the Escrow Account mandated with regard to repayment arrangement.
The revenues flowing out of property tax are pledged in the repayment arrangement and the bond has been listed on the Stock Exchange. The investors are the Bank of Maharashtra and ICICI Prudential. While the Government of Maharashtra approved the raising of the bond, it did not provide state guarantee, something that the lenders insist if the municipal credit worthiness appears unsound. The bonds also had no tax exemption provided by the Government of India (GoI) for income earned on municipal securities. Nor were the interest rates subsidised. In the case of PMC, however, these factors were no deterrent and the issue got oversubscribed six times. This exhibits the confidence level of the investors in the ability of the PMC to discharge its liabilities accruing from the bond. It must be added, however, that this is no reflection on the overall municipal finances of the PMC except that the market believed that given the size of the municipal budget, the PMC should have no problem repaying ₹2 billion.
This is not the first time that municipal corporations have raised bonds. More than two decades ago, Ahmedabad had gone to the market and successfully raised money through municipal bonds and a few others followed this path of innovation. The bond initiative in India drew inspiration from the ULBs of the United States where the use of capital markets to finance investments in urban infrastructure has been a century old practice. It is estimated that about 60 percent of the urban local bodies in the US numbering several thousands have gone to the market to seek funds. As per a Federal Reserve report of 2018, the size of the US municipal bond market is up to $3.853 trillion. However, while the US example was sought to be emulated, this did not become a normal practice in India. There followed an interlude of one-and-a-half decades before the use of bonds was revisited by PMC.
A successful exercise of this kind should enthuse other municipal corporations in the country to attempt to raise money through bonds. This is an attractive alternate source of sizeable funds for infrastructure projects. To begin with, they would need to get themselves credit rated by a professional agency with established credentials whose estimates carry weight with investors. However, this is not possible unless ULBs resolve to set their house in order. They would need to introduce accompanying reforms in municipal finance, in accounting practices, in tariffs and in governance.
Of the reforms, the accounting reform in regard to issuance of bonds is the most significant. Here, ULBs would be required to move from the traditional single-entry cash-based accounting system to double-entry accrual-based accounting system. The primary objective of financial reporting is to elicit information on the financial performance of a municipal body and the soundness of its financial position. The single-entry cash-based accounting system leaves a lot of gaps in their record of financial information, rendering its accuracy suspect.
What has recently been reported, however, about the municipal bonds of PMC does not inspire confidence. It has come to light that the municipal corporation has had to park the money it borrowed in fixed deposits and savings accounts. It has till date earned ₹20.73 crore in interest from part of the money invested. In the process, however, it has paid ₹30.36 crore in interest to the lenders. These facts recently came to light through a reply to a question raised in the General Body of the PMC. It must also be added that PMC received an amount of ₹26 crore as a stimulus from GoI that has also been placed in a fixed deposit.
What has been revealed is that the PMC’s inability to spend money arose out of its unpreparedness in terms of implementing the water supply project and its premature withdrawal of bond money. The public criticism that this may be partly on account of administrative one-upmanship among ULBs appears to be partly true. This is also on account of the municipal processes that are long-drawn, requiring approvals at various stages. These do not take into account the mounting pressures on a municipal body to deliver services to ever-increasing numbers of people and expanding areas.
Additionally, the operationalisation of a project invariably leads to discoveries of implementational difficulties that were not factored in. In this present case, it was brought to light by the water meter manufacturing firm that the meters were being improperly installed and that they would have to be re-installed correctly. The installing company in turn complained that concretised roads were a hindrance to proper installation. These and other roadblocks have already delayed the project and it is clear that the PMC will not be able to achieve the deadline. In such a situation, contract clauses of penalties and liquidated damages are bound to be pressed, leading to arbitration and legal battles.
The point of significance is that cities cannot borrow and make that money sit in deposits and pay interest on them. In effect, this will become an additional tax burden on the citizens who would ultimately have to pay from their pockets. Due diligence prior to raising money is of the utmost importance. This requires a lot of preparatory work in the field and on the table before a contract is drawn. Defaults committed at this stage will come to haunt the operationalisation of the project, leading to delays and cost escalation. Readers may notice that in every municipal aspect that we discuss, municipal capacity, issues of urban governance and municipal processes continue to stare us in the face, crying out for reforms.
The views expressed above belong to the author(s). ORF research and analyses now available on Telegram! Click here to access our curated content — blogs, longforms and interviews.
Dr. Ramanath Jha is Distinguished Fellow at Observer Research Foundation, Mumbai. He works on urbanisation — urban sustainability, urban governance and urban planning. Dr. Jha belongs ...
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