Accessing the Capital Market

1. Accessing the Capital Market Why Capital/Debt Market? Market Access by ULGs Municipal Bond Market Municipal Credit Rating The Road Ahead

2. Accessing the Capital/Debt Market � Why? Urban infrastructure requires long-term funds at a reasonable cost Lack of long-term funds is main constraint Capital/debt markets are emerging as perennial and sustainable source of funds for ULGs Capital market tap household savings, which can provide long-term funds Needs only a fiscal instrument appropriate in terms of risk, liquidity and returns

3. Accessing the Capital/Debt Market � Introduction (continued) Capital markets in developing countries are under-developed or play a minor role because of absence of appropriate public policy on infrastructure financing Entails paradigm shift in municipal fiscal management practices Entails innovative debt-servicing, debt management and asset management practices Also needs an innovative risk mitigation mechanism Facilitates and sustains PPP initiatives

4. Development of Debt Market Govt. securities dominated the debt market from the 1960s to the 1990s Three components of debt market Government securities Public sector undertaking securities Corporate sector Securities Several new securities emerging Deep discount bonds, securitised debt, public sector infrastructure bonds, government index bonds, corporate floating rate bonds, municipal bonds and institutional tax-free bonds Emergence of fourth segment - Municipal Bond Market

5. Development of Debt Market Strategies based on U S Model

6. Municipal Debt Financing Concept still nebulous in developing countries Market borrowings can accentuate an ULG�s fiscal stress � one needs to be careful Municipal debt financing depends on ULG�s Financial health Fiscal and financial autonomy Debt-absorption capacity Debt management and monitoring ability But why and how municipal bodies should resort to debt financing

7. Market access by ULGs Municipal infrastructure requires long-term funds that an active debt market alone can provide ULGs in developing countries increasingly accessing the debt market Direct access by ULG Through intermediary (pooled finance) By project entities such as special purpose vehicles

8. Market Access by ULGs Supportive Systems/Arrangements Credit Rating System Credit Enhancing Mechanisms Debt service reserve funds Over-collateralisation of cash flows Flow of funds structure Bond insurance or financial guarantees from private insurance companies Letters of credit from banks Tax-free status to municipal bonds

9. Market Access by ULGs Some Questions Public debt management by ULGs raises several questions: What factors should govern local government bond issues or market borrowings? How do we integrate them into the active debt market? What should be their risk weights? How should debt liability issues in the event of default be addressed? Should such bonds be restricted to urban local bodies?

10. Market Access by ULGs Debt Servicing Capacity Assessment Basis or foundation of market access Two ways to assess Quick self-assessment by ULG Detailed assessment by credit rating agency Three methods for assessing debt-servicing capacity Debt ceiling approach Credit rating approach Loan appraisal approach Cash flow approach Balance sheet approach

11. Quick self-assessment of debt carrying (servicing) capacity Determine current account surplus (CAS) Project potential CAS in future Estimate relative increase in CAS Project population growth Estimate total CAS by multiplying incremental CAS with projected population Determine level of direct cost recovery Multiply CAS by cost recovery multiplier Use NPV to equalise amortised loan repayment and debt servicing capacity

12. Market Access by ULGs � Exercise 1 Q1. Which debt instruments can be applied to access the capital market in your context. Q2. What steps need to be taken to promote these instruments. Q3. Assess a town�s debt-carrying capacity as per Illustration 2 and suggest an action plan for the same.

13. Municipal Bond Market Municipal bonds emerging as a popular instrument to access the capital market Developing countries have introduced them since 1990, taking a cue from the US and European markets Three types of bonds (typology of bonds) Revenue bonds General obligation bonds Double barrelled bonds

14. Pre-requisites of Municipal Bonds Streamlining legal provisions and regulations on direct market borrowings. Leveraging fiscal transfers for market borrowing Encouraging public-private partnerships and joint-ventures for implementing projects Improving the local government�s project development and implementation capacity Enabling the flow of long-term funds to the urban infrastructure sector through monetary and fiscal reforms and concessions, and Improving public awareness about market-based financing mechanisms For example, the Government of India has issued guidelines specifying the various steps that municipal governments need to take to access the market For example, the Government of India has issued guidelines specifying the various steps that municipal governments need to take to access the market

15. Market-Based Financing StrategiesKey Pre-Prerequisite Credit profile � improving it through efficient investment plan and adequate debt servicing capacity � Credit rating Risk mitigation � Contracting mechanism Inter-municipal co-operation - Pool finance Concessions and incentives Efficient and flexible regulatory structure Regional intermediaries to promote market-based financing

16. Municipal Bond Market � Exercise 2 Q1. Is there a market for municipal bonds in your context? Identify four driving forces and four constraints in this regard. Q2. Identify the pre-requisites needed to issue municipal bonds in your context.

17. Municipal Credit Rating Most crucial requisite for accessing the capital market Essentially done to protect interests of lender or investors Examines ULG�s creditworthiness, future plans and capacity to service debt Identifies fiscal weaknesses, paves way for corrective actions Depends on various credit enhancement mechanisms

18. Municipal Credit Rating (continued) Parameters considered for rating Economic base of the service area Municipal finance Municipal government�s scope and operations Management quality Sector and project-specific assessment Debt profile Legal and administrative framework

19. Indicators for Credit Ratings