Soon, more cities will be able to tap the debt market to access funds for vital urban renewal projects. The urban development ministry is working on a fresh blueprint for municipal bonds? structure and investment pattern and has begun holding discussions with the Reserve Bank of India and Securities Exchange Board of India on the issue.

The focus of the new guidelines will be enabling municipal corporations to issue taxable bonds. The existing guidelines for the issue of tax-free bonds will be given a fresh look as well. While a few cities have already issued municipal bonds in recent years, fresh consultations with industry and financial institutions have indicated that there?s a greater appetite for taxable bonds than tax-free bonds. ?Taxable bonds are preferred by investors as they give a higher interest rate than the tax-free bonds,? an official said.

The interest rate on tax-free municipal bonds is capped at 8%. But in the case of taxable bonds, the interest rate is linked to the market. Currently, the rate on taxable bonds is around 11.5% and could go up further if market rates rise.

Apart from latent investor interest in taxable bonds, municipal bodies have another reason to consider taxable bond issues. There is a ceiling on the amount of tax-free municipal bonds that can be issued for a single project. So an urban corporation can only issue tax-free bonds up to 50% of the project cost or Rs 300 crore, whichever is lower.

?Since the appetite of the market for tax free bonds is limited and there are more regulatory constraints for investing in them, taxable bonds are often advisable,? Chetan Vaidya, director, National Institute of Urban Affairs.

Vaidya had worked with the United States Agency for International Development (USAID), which had assisted a number of states in preparing bond structures through the late nineties under its Financial Institutions Reform and Expansion ? Debt ( FIRE -D) project .

The urban development ministry, which is the nodal ministry for the Jawaharlal Nehru National Urban Renewal Mission (JNNURM), had initiated a credit rating exercise for a number of urban local bodies. The exercise undertaken by the four credit-rating agencies?Crisil, ICRA, CARE and Fitch ? has been completed for 22 urban centre in North India.

The results are far from comforting, though. Only one urban local body (ULB) ?the Chandigarh Municipal Corporation bagged an A+ rating, while eight others managed an investment grade rating of BBB-.

The ministry is hoping to finalise the blueprint for bond issuances soon after it gets the views of Sebi and RBI on the matter. But it doesn?t see any bond issues to take off in the immediate future, given the current tizzy in global financial markets. ?These bonds will be introduced at later date when urban local bodies are financially sounder and the market conditions are more stable,? an official explained.

Municipal bonds are now being considered a good source of financing given the large investment required under the JNNURM. It is estimated that the 63 mission cities require Rs 3,35,000 crore to cater to the basic infrastructure needs during a seven-year period. Of this, the ULBs in these 63 cities would have to invest around Rs 98,000 crore on their own.

Taking into account the investment requirements of all the 5,161 urban centres across the country, a capital investment of around Rs 800,000 crores was required according to estimates.

Many cities have already forayed into this financing mode. The Ahmedabad Municipal Corporation (AMC) was the first ULB to access the capital market in January 1998 when it issued Rs 100 crore in bonds. This was used to partly fund a Rs 439 crore water supply and sewerage project. After that, eight more cities including Ludhiana , Madurai , Nashik, Nagpur have issued such bonds, amounting to Rs 445 crore.

Tax-free bonds came into vogue from 2002 when the AMC issued a tax-free 10-year bond with an annual interest rate of 9% worth Rs 100 crore. About Rs 649.5 crore of tax free bonds have been issued so far by a number of ULBs.