Recommended by the First State Finance Commission

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TABLE 5.7 Share ofMunicipalities in State’s Resources as Recommended by the First State Finance Commission

State Recommended share

Andhra Pradesh 39.24% ofstate tax and nontax revenue for all local bodies. Assam 2% ofstate tax for local bodies, both rural and urban. (The share ofurban local bodies has not been specified.) Himachal Pradesh An amount equal to Rs 1.2 billion as grants in lieu ofoctroi for 1996/97, rising to Rs 1.79 billion in 2000/01 and centrally sponsored scheme grants to accrue to municipalities. Karnataka 5.4% ofthe total nonloan gross own-source revenue receipts for meeting plan and nonplan requirements. Kerala 1% ofstate revenues (excluding from certain sources) transferred to local bodies as nonstatutory nonplan grants distributed between the rural and urban local bodies in proportion to their population. Madhya Pradesh 8.67% ofthe tax and nontax revenues ofstate government. Maharashtra 25% to 100% ofentertainment taxes collected from municipalities ofdifferent grades, 25% ofvehicle taxes, and 10% ofprofession taxes. Manipur Maintenance grant equal to Rs 8.83 million to accrue to municipalities in 1996/97. (The amount varies in subsequent years.) Orissa Projected transfer (grant) to urban local bodies between 1998/99 and 2004/05 ofRs 17.95 billion. (The deficit ofRs 13.78 billion between the estimated income and expenditure and an additional requirement ofRs 3.81 billion for improvement ofcore civic services should be met by the 11th Central Finance Commission.) Punjab 20% ofnet proceeds for five taxes—stamp duty, motor vehicle tax, electricity duty, entertainment tax, and cinematography shows—to be transferred to municipalities. (The projected gap ofRs 3.22 billion should be met by the Central Finance Commission.) Rajasthan 2.18% ofnet proceeds ofstate taxes. (The division ofthese proceeds between rural and urban should be in the ratio of3.4:1.) Tamil Nadu 8% ofthe state’s net tax revenue in 1997/98; gradually increasing in successive years to 9%, 10%, and 11%, reaching 12% in 2001/02. (The division ofthis amount between rural and urban should be on the basis ofpopulation as shown in the last census.) Uttar Pradesh 7% ofnet proceeds ofthe state’s total tax revenue. West Bengal 16% ofnet proceeds ofall taxes collected by the state. Such funds should be released to the districts. These proceeds should be divided between urban and rural based on population.

Source: Reports ofthe State Finance Commission.

192 Om Prakash Mathur

loans,(e) the sum to be charged against the funds that form the security for the loan,(f) the attachment ofsuch funds and their disposition,and (g) the accounts to be kept about loans.

The state government formulates rules and procedures for obtaining the sanction ofthe state government for loans;establishing,investing,and annually examining the sinking fund;attaching corporation funds;and printing debentures.No amendments have been made to the provisions on borrowing since 1992.

Interstate differences in provisions regulating the process oflocalgovernments to borrow are,at best,minor and relate to the limits on borrowing— for example,the percentage ofthe annual ratable value ofland and buildings or the period for which a loan may be contracted.Important to note,however,are provisions on sinking funds and investment ofsinking funds into public securities and government-guaranteed securities,as well as provisions on preparation and submission ofan annual statement ofdetails on loans contracted and the maintenance ofsinking funds.18

Under subsection (1) ofthe 1914 act,local bodies are permitted to borrow (a) to carry out any works that they are legally authorized to carry out, (b) to grant reliefand establish and maintain reliefworks in times offamine and scarcity,(c) to prevent outbreaks and spread ofdangerous epidemic diseases,and (d) to repay money previously borrowed in accordance with the law.

Several state governments have stipulated guidelines for local government borrowing,such as the period oflocal borrowing,which is not to exceed 30 years;interest offered by the municipal bodies,which is to be in tune with the interest on government securities;and adequate provision for debt servicing.Such guidelines may also state that municipal borrowings should have the legal sanction ofstate governments and that municipal corporations and port trusts are allowed to issue securities.

Generally,municipal corporations are allowed to borrow from the market.Such loans are based on the annual ratable value (ARV) ofland and buildings assessable for property taxes.However,all market borrowing requires the approval ofthe state government.In a few municipal corporations,the total market borrowing,including all outstanding debt,is limited to a fixed percentage ofthe value ofthe immovable municipal properties and assets,as prescribed in the municipal corporation acts.In some others,the annual borrowing limit is fixed as a percentage ofthe ARV ofthe property. In the Mumbai municipal corporation,the total market debt limit,including all outstanding debt and balances,is prescribed at three times the ARV for the general-purpose budget,slum improvement budget,and education

Local Government Organization and Finance: Urban India 193

budget and two times the ARV for the water and sewerage budget.The total outstanding debt ofthe Mumbai municipal corporation,therefore,is not to exceed eight times the ARV.

Until the mid-1990s,municipal governments raised loans primarily from financing institutions and specialized institutions such as the Housing and Urban Development Corporation,with guarantees provided by the state governments.In 1996,Credit Rating Information Services ofIndia Ltd. (CRISIL),drawing on the experiences ofits U.S.partner,Standard and Poor’s Rating Services,undertook an exploratory exercise to evaluate the credit quality ofmunicipal entities.The goal was to explore the feasibility of expanding the horizons ofits rating operations and to determine the capacities ofmunicipalities to borrow from the nascent but growing capital market.It engaged the Ahmedabad municipal corporation (AMC) and other municipal corporations in formulating what it called a framework for municipal credit evaluation.It also laid the groundwork for rating the credit ofmunicipalities and project-specific debt issues.CRISIL studied the finances and operations ofAMC and assigned an A+ credit rating to the proposed Rs 1 billion bond issue,indicating a credit risk profile in the adequate safety category.Since then,the bond market in India has seen a noticeable growth in issuers and investors,instruments,and volume oftransactions.

Following the example ofAMC,a number ofmunicipal entities and parastatals have accessed capital market funds,with the backing ofCRISIL and two credit rating agencies—the Investment Information and Credit Rating Agency and Credit Analysis and Research Limited.These two agencies developed their own criteria and systems for evaluating the creditworthiness ofmunicipalities.The fiscal incentives offered by the government of India in the form oftax exemptions for eligible issuers,defined in the Ministry ofUrban Development’s guidelines for issue oftax-free municipal bonds,have further stimulated the municipal bond market.The guidelines stipulate that the issuers are to maintain a debt-service coverage ratio ofat least 1.25 throughout the tenure ofthe bond.This overcollateralization and the provision ofa debt-service reserve account reduce risk to investors.Key features ofthe tax-free bonds are laid out in table 5.8.

The nine municipal corporations that have accessed the capital market have thus far been able to raise Rs 6.185 billion by issuing bonds.An important feature ofmunicipal bonds is that,except for those issued by the Bangalore Municipal Corporation and Indore Municipal Corporation,they have been issued without a state government or bank guarantee.Traditionally,lenders to entities in the infrastructure sector have sought a state or sovereign guarantee as an important security mechanism.The fact that municipal