India's Municipal Bond Market: A New Era of Fiscal Innovations and Challenges

Municipal bond issuances in India are projected to surpass Rs 1,500 crore in FY2025-26, driven by government initiatives. Green bonds are expected to see a rise due to ESG focus. Despite growth aided by fiscal incentives, challenges like lack of financial disclosures and weak ULB credit quality persist.

The Indian municipal bond market is set to witness a substantial leap, with issuances anticipated to raise over Rs 1,500 crore in FY2025-26, according to a report by ICRA. This surge is primarily propelled by the government's vigorous push towards municipal financing.

The report underscores the growing prevalence of Green and pooled bonds, attributed to an increased emphasis on Environmental, Social, and Governance (ESG) initiatives. Such developments aim to enhance the credit profile of Urban Local Bodies (ULBs), a significant facet in this transformative phase.

Since FY2018, the municipal bond market has seen impressive traction, largely due to fiscal incentives introduced by the Indian government. Between FY2018 and now, municipal bonds have collectively amassed Rs 2,600 crore—an impressive jump from the sub-Rs 1,000 crore recorded between FY1998-FY2005.

In part, the market's growth is credited to regulatory measures, notably the 2015 SEBI regulations, which defined and formalized municipal bonds, invigorating investor interest. The government's 2018 incentive, offering around Rs 13 crore for every Rs 100 crore bond issuance, further accelerated the market's growth, urging ULBs to adopt this funding route.

Despite these advances, the market confronts significant hurdles, including ULBs' heavy reliance on government grants, a lack of timely financial disclosures, and the absence of a secondary bond market. Compliance hurdles and the weak credit quality of ULBs further complicate market dynamics.

Municipal bonds have, however, enjoyed robust structured payment mechanisms, which have been pivotal in elevating their credit ratings to AA. These mechanisms enable issuances despite the varying credit quality of ULB issuers, and future issuances are expected to adhere to these structures.

ICRA's report highlights that maintaining momentum will require tackling issues like improving ULBs' credit quality and enhancing financial transparency, critical for sustaining healthy market expansion.

(With inputs from agencies.)