Urban development ministry seeks PMO support to make municipal bonds tax-free

The urban development ministry has sought the intervention of Prime Minister’s Office to resolve a standoff with the finance ministry over issuance of municipal bonds, seen as the primary revenue source for most big-ticket urban reforms, including Smart Cities Mission.

The two ministries have locked horns over providing tax-free status for municipal bonds. The urban development ministry argues that tax-free status will help urban bodies save 1-1.5% on interest costs and encourage them to take up the laborious process.

The finance ministry, however, has resisted the demand, saying this could disrupt the bond market and lead to potential revenue loss of Rs 180 crore per annum, government sources said.

Now, the urban development ministry has written to PMO saying that several cities under the Smart Cities Mission are ready to issue municipal bonds, but finance ministry’s objections are stalling the process.

Ministry officials said that if local bodies issue bonds without tax-free status, they raise money at a rate of 8-8.5%. This would not be attractive enough considering banks offer loans to local bodies for urban development projects at 8.4-8.5%, they said.

“With hardly any difference in the rate of interest, the local bodies do not have much incentive to go through the laborious 45-step process of issuing municipal bonds. But in case of tax-free status it means raising money at 7% rate of interest,” a senior urban development official told ET.

The ministry, on its part, is encouraging local bodies to issue municipal bonds because the 45-step process also means simultaneous urban reforms.

As per ministry statistics, Pune and Ahmedabad are ready to issue bonds. Of the 60 smart cities, 35 cities have completed credit ratings (a requirement to issue bonds) and 21 have been found to have investment grade rating.

In its representation to PMO the ministry also claimed that the fears over bond market disruption is unfounded.

“The envisaged issuance of municipal bonds in 2017-18 fiscal is about Rs 6,000 crore and Rs 10,000 crore overall. The entire bond market is worth Rs 4 lakh crore. So there would be only small ripples and not disruption in the market,” it said in its pitch to the PMO.

“Also, the projects for which commercial and infrastructure bonds are issued are very different from those being funded by municipal bonds revenue,” it said. It is hopeful of PMO’s support after PM Narendra Modi’s recent emphasis on boosting municipal bond market.

While market regulator Sebi has made changes in relevant regulations to allow municipalities having surplus in their books to issue bonds, the tax-free status is stuck with finance ministry.

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