Financing of municipal projects

By IMRAN MALIK
 

Dated: September 03, 2007

The Punjab government proposes to issue municipal bonds to raise Rs6 billion during the next financial year.

The provincial authorities at the post-budget press conference on June 16 said huge funds were required for implementing infrastructure projects. For first phase of the Lahore Rapid Mass Transit System, the government would raise $1.4 billion from ADB, $1 billion from the market and the project would be completed on a built-operate-transfer (BOT) basis.

The proposed launching of municipal bonds for financing infrastructure projects is a positive development. However, the investors would look at the city government performance and may agree to finance the municipal bonds after imposing conditions including high margins over KIBOR, requiring city governments to engage experts for capacity building and repayment guarantees by the government. The raising of funds through municipal bonds will not be easy but it is considered imperative that weaknesses in the system are overcome.

While the execution of projects, under devolution, is with the city and district governments, they are dependent heavily upon the federal/provincial governments for funds. Delays in the receipt of funds cause problems in implementing projects. Audit reports on different projects periodically quoted in the national press show inefficiency, misuse or wastage in many projects. This reflects on the capacity of some of these city and district governments to plan and execute such projects. Capacity building of city governments has to come up side by side with the planning for fresh financial resources.

Due to neglect, infrastructure in big cities particularly Karachi, Lahore, Peshawar, Quetta, Hyderabad and Rawalpindi is in bad shape, the revamp and expansion of which needs big amount of money. All these cities (as well as other cities and towns) need large financial resources for their development projects in areas such as roads, water, sewerage, transport and sanitation. Most municipal projects require rupee funds for implementation. Such projects should logically be funded from resources raised from local taxes, from government grants or local borrowings. Projects requiring import of machinery or other essential foreign inputs may be considered for financing through borrowing in foreign currency from local banks or in special cases, through borrowings from the World Bank, ADB or other IFIs.

For implementing mega infrastructure projects, identified and proposed in federal/provincial and city government budgets, the relevant authorities are understood to be considering raising funds through different sources such as borrowings from international financing institutions (IFIs) or inviting investors on BOT basis. The authorities carefully decide on the source, quantum and currency of fresh borrowings for new infrastructure projects preferably in the light of experience from infrastructure projects either under construction or completed.

In case of infrastructure projects, promising cost recovery through user charges, BOT option should be the last resort. BOT projects are generally costlier, more difficult to negotiate and take more time for implementation. Moreover, the city government officers might not be adequately equipped for tackling the BOT process.

If the BOT projects are negotiated prudently, users of the facilities are likely to be obliged to pay high charges/fees. The government and the SBP might look into the situation as BOT financing has the potential for increasing the city government’s as well as the country’s debt stock and the benefits of such funding may not in some cases reach the people.

Mega cities, with active support and guidance of the government, might be able to raise municipal bonds from local debt market. Municipal Sukuk could also be considered as these cities have the ownership of physical assets for the purpose of the Sukuk transaction. Karachi and Lahore appear to have the capability to mobilise funds through issue of municipal bonds. The government may have to consider extending guarantees and allowing tax incentives for the safety of investors and to keep the cost of borrowing low.

Like Wapda’s and Civil Aviation bonds, the process of designing, structuring and issue of municipal bonds and seeking of government approvals including tax exemptions on profit and repayment guarantees, would require lot of spadework and convincing at various levels in the government.

The city governments shall also have to take seriously measures to remove weaknesses possibly through extensive training and technical inputs.The city governments have to demonstrate to investors that their operations are stable and that they have regular resources inflow to pay profit and to finally redeem the debt securities on time. The city governments may have also to engage an institution that has the successful experience of market making and issuance of special bonds offered for public subscription.

Once the arrangements are in place, city governments may be assured of reasonable supply of relatively cheap funds for carrying out priority projects of social and economic value for people residing within the limits of the city government. Once the ordinary investor is assured of the safety of the principal amount and the promise of reasonable return, he would like to invest in municipal bonds. Presently, small depositors are not getting a fair return from the commercial banks.

Medium-size cities/towns also need loans with longer maturity but lower cost as development projects are set up more on social and environmental considerations and less due to cash generation capability. Commercial banks may avoid financing such projects due to questions about creditworthiness of these cities/ towns and the uncertainties about repayments. Being small in size, the DFIs extending financing to local authorities may not be able to raise funds through issue of municipal bonds. A specialised institution, namely a municipal bank can guide such cities/towns and make available finances for priority projects.

In Pakistan, the need for providing loans to the local authorities was realised quite early. The charter of both IDBP and NDFC (since merged with NBP) allowed provision of loans to the local authorities. It is another matter that municipalities did not receive due attention.

The NBP and the DFIs are allowed to start financing municipal projects. These institutions, along with the State Bank, may also join hands to promote a municipal bank.

Development projects are needed more in areas such as waste management, sanitation, sewerage, drinking water, schools and health facilities. The World Bank has helped in setting up the Punjab Municipal Development Fund, which is active in areas such as capacity-building and training. However, the impact so far appears limited.

Presently, what we need is a full-fledged municipal bank providing all sort of financing and technical assistance to local authorities. Such a bank can assist cities/towns by imposing conditionalities for compliance, monitoring physical progress in the execution of development projects.

A municipal bank might be a DFI-cum-scheduled bank licensed by the SBP for providing specialised services to local authorities including development agencies. Its core businesses might include financing of viable projects appraising, financing and monitoring the projects of city/district governments; mobilising local and foreign financial resources including deposits and credit lines and technical grants from various institutions.

Set up on sound lines with adequate paid-up capital, the municipal bank can work without any subsidy. It may, however, be argued that a municipal bank organised on provincial basis would attract more participation by the stakeholders and the provincial/districts governments, with more harmony and cohesion among the prospective investors as well as the beneficiaries. National or provincial status may be decided after careful consideration of relevant facts.

(The writer is President/CEO of First Credit and Investment Bank Limited.  The article represents his personal views)