As per recent media reports, Pune Municipal Corporation (PMC) has to return the bond proceeds to investors at the completion of the issue period, i.e. 10 years. This does not sound unusual, bonds are for fixed periods and are to be repaid. What is unusual, is that the project for which the money was raised, was stalled and therefore the money could not fulfill the objective. This is unusual for our Indian ears, we are used to the discourse of our Urban Local Bodies (ULBs) not having enough funds to take up infrastructure projects.
Though we are familiar with stalled projects, as for many government sponsored projects, there are funds allocated, but remain unused, since the projects are delayed or sometimes do not see light of the day.
But this case is different, because the money was raised from the capital market, where there is due diligence at multiple levels. There are stringent guidelines from SEBI, there are credit rating requirements, and investors have their own wisdom. A successful bond issue has to pass all these tests to finally result in money for the project. If a project fails to take off in spite of meeting all these requirements and crossing all the hurdles, the issue is deep and requires reflection.
Let me try to unpack this for us:
Why did PMC raise funds: For a 24X7 water supply project (capex on reservoirs, pipelines, metering) as part of SMART Cities/AMRUT initiatives.
How were the funds collected: PMC issued municipal bonds to raise Re. 200 crores in 2017, with a tenure of 10 years and a coupon rate of 7.59%.
What went wrong: As per media reports there were delays in land acquisition and issues with contracting that did not allow the water supply project to be taken up.
What did PMC do with the funds: The funds were deposited in a fixed deposit with a bank, earning interest.
Why couldn’t PMC use the funds for another project: SEBI guidelines prohibit the use of funds for any other purpose other than what is stated at the time of issue. There is a provision to amend the purpose later, but it requires a long and complicated process, making it almost impossible to change the use. Attempt to change the purpose of issue might lead to downgrading of credit rating. This is prudential, drawing boundaries against the possibilities of misappropriation of funds by issuers and keeping them accountable towards the investors.
Who lost/gained what:
Investors: Investors had subscribed to the bond for the return offered, and PMC has not defaulted on any payments. The bond issue process requires the ULB to maintain an escrow account and PMC has been able to pay the semi annual interest on time. No Effect.
PMC: PMC has earned interest on the fixed deposit and an interest subsidy of 2% (Interest subvention for 5 years) from the central government. Though the actual numbers for interest earned and bond liability are not available, it can safely be assumed that PMC has enough elbow room to repay the bond principal and interest. However, the project was envisioned with the objective of service delivery, and welfare enhancement, which could not be achieved.
Central Government: The central government provided a 2% interest subsidy for five years for the bond issue. Public funds used for this subsidy carry a clear opportunity cost: resources allocated to one project could have supported other priorities. When the project itself does not materialize, the intended welfare gains are not realized, making the subsidy an inefficient use of public funds.
Citizens of Pune: They were deprived of the welfare gains the project was meant to deliver — the true social cost.
Lesson learnt:
The issuance had got a AA+ rating from the rating agencies, they must have done the project readiness check, along with the due diligence on the financial status and capability of the bond issuing municipality. These are detailed processes and involve thorough documentation. In spite of producing all the documents indicating project readiness, to avail an investment rate grading, PMC could not do the project. In corporate world, a similar issue would lead to questions raised by the Board. The executioners would be answerable under the corporate governance framework. The Board of governors will raise these questions in the best interest of the company and its stakeholders.
Are we ready to ask the tough questions and accept the discipline that markets demand? If ULBs are not empowered to take decisions and clear regulatory and operational hurdles to ensure that projects actually happen, should their ability to issue bonds be reconsidered? And ultimately, who is asking these questions in the interest of investors, citizens, and other stakeholders?
Thing I liked here was how you looked at different stakeholder, what they want and did they got it. I do have a few comments
1. When we are looking at "citizens of pune" as a different catagory, we need not include in PMC "goal was service delivery and enhancement of welfare". Purpose of a system is what it does. https://en.wikipedia.org/wiki/The_purpose_of_a_system_is_what_it_does and every beaurocratic organisation exists for perpetuation of itself. It would mean comfort and security of tenured salary of it's members. If "incentives create outcomes", and "culture eats strategy for breakfast" then there is no alignment between service delivery and tenure of PMC babus & welfare enhancement and their salaries.
2. Central government one will force us to think long term. I found myself asking, is it one of the earlier instances of where gov is providing the money and independence to cities for the first time in our living memory of history? Considering this was mostly counter elite musing (those without power of votes, asking for it and getting it) I would be kind of happy with the outcome. I want normalisation of the focus on decentralisation. Even if there are execution failures due to inertia of the past, I would be ready to see beyond one deal towards big picture.
3. You have called the citizens of pune suffering from "true social cost" where they are deprived of the welfare gains. Biased one like me would call this perspective as selective and do it's own selective analysis thusly: Citizens were already suffering from it so it is not the bond issuance or the larger policy of decentralization that hurt the people in the first place. If you say "If ULBs are not empowered to take decisions and clear regulatory and operational hurdles to ensure that projects actually happen.." why the next question to follow is whether we should reconsider the bond funding of munis rather than more power should be given to the local level rather than central level. One is always perplexed how it is the cabinet in delhi that is giving the approval for metro line and highway extension.
*My own personal bias would be towards 1. Starting new udipur sized cities 2. village focus rather than cities. 3. Creating new states based on geography so the number rises to 115 approx. 4. A return of monarchy but these are aside and not part of discussion here.
It is true that our ULBs are probably not ready for what a competitive market demands. I believe that governments cannot function in the same way markets do, because they cater to a different set of needs, which can often lead to delays in execution.
I would still support the issuance of municipal bonds, because it will help ULBs understand which sectors can attract market investments and which need to be funded through own-source revenues or centrally sponsored schemes. This is a fairly new area for ULBs in India, and only through experience will they learn to manage their finances better. It is after that that they will begin to take greater accountability.
From my experience working with ULBs and SPVs, many of them prefer not to use their own money, partly to avoid direct accountability. That ultimately does not serve citizens well either.
I think more issuances of municipal bonds by ULBs over 2-3 years will:
1. Give ULBs a better understanding on how to manage finances to repay their loans
2. Encourage markets to diversify their investments into the public sector (CSR and aid industries have learnt to do that now overs years of experience)
3. Tighten the policy processes as per the efficiency of markets (might happen)
Just adding a recent article published on our blog, Nagar Niti on this topic: https://nagarniti.substack.com/p/ravivar-roundup-budget-edition