Solving municipal distress in India
In recent years, Indian municipal bodies have increasingly gained access to public debt markets. During the four-year period from 2017 to August 2021, nine municipal companies issued bonds totaling Rs 3,000 crore. In contrast, during the previous two decades, ten municipal bodies had issued bonds totaling less than half that amount. This is generally a positive development. Tapping into financial markets increases the resources available to cities for essential services and development. Like companies that access public procurement, municipal bodies that submit to market discipline are subject to higher standards of transparency and local governance. A key element missing from this story, however, is the lack of clarity on the rights of municipal creditors in the event of a default by a municipal borrower. In a chapter published in the 2021 annual publication of the Insolvency and Bankruptcy Board of India titled Five-year Insolvency and Bankruptcy Code, 2016, we argue that the time has come for policymakers in India to develop a reorganization framework for financially troubled municipal bodies. We assess the potential of a formal bankruptcy regime as a model for such a framework.
The arguments in favor of a framework for municipal reorganization
We put forward three arguments. We start by demonstrating the weakness of municipal finances in India. For example, during the decade starting in 2007-08, municipal revenues stagnated at 1% of GDP, which is significantly lower than that of peer countries. Municipal bodies (Urban Local Organizations or ULBs) are disproportionately dependent on state governments for grants and loans. They have been shown to have consistently underinvested in capital infrastructure. The pandemic has exacerbated weak municipal finances in India. The size of the municipal debt market is therefore likely to grow as municipalities seek additional resources.
Second, we argue that the current legal regime in India offers no scope for collective action against defaulting on municipal debts or clarity on the treatment of creditors (bondholders, banks and financial institutions, lenders. government, employees and vendors) in the event of a loan. the insolvency of the municipal body.
At one end of the spectrum, this creates the possibility of an aggressive sale of public assets, owned and operated by ULB for the benefit of the public, by “powerful” ULB creditors. At the other end of the spectrum, this deprives the system of the benefits of early recognition of financial distress in ULBs. It minimizes the possibility of saving ULB operations through a mutually negotiated and court-supervised reorganization exercise. The increasing levels of municipal borrowing on public markets and the impact of the Covid-19 pandemic reinforce these concerns.
Third, the standard reorganization framework applicable to private borrowers does not apply to ULBs as they provide public goods, and most of their assets are presumably for public use. Several countries have adopted differently designed reorganization frameworks to resolve ailing municipal bodies. We highlight the main features of such a framework, namely Chapter 9 of the US Bankruptcy Code. Certainly, Chapter 9 has its detractors. However, with over 100 municipal entities using Chapter 9 for their resolution, it has proven to be a viable municipal bankruptcy scheme. It is a rules-based process, but flexible enough to be able to resolve the complex issues of government financial distress, which inevitably combine important business concerns with essential social welfare necessities. At the very least, it helps formulate a number of threshold and critical questions that should be part of any discussion of reorganizing struggling municipal entities.
Main legal and institutional challenges
We conclude by highlighting some key legal and institutional challenges to the idea of a municipal bankruptcy law in India.
First, while bankruptcy and insolvency are on the Constitution’s concurrent list, municipal governance is inherently a state matter. Union legislation on municipal bankruptcies will raise complex questions of federalism and will require provisions allowing states to retain their autonomy in applying a union bankruptcy law to their ULBs. What could be the institutional tools to preserve this autonomy?
Second, the US experience suggests a proactive role for the courts in administering municipal bankruptcy.
If so, this would be a fundamental departure from the design of the Insolvency and Bankruptcy Code, 2016, which seeks to minimize court intervention in insolvency proceedings and provides for the appointment insolvency professionals to manage the debtor’s transactions. Likewise, the extent of the relief that the process can legitimately provide in the context of ULB bankruptcy proceedings will have to be examined. Can a resolution plan for a ULB contemplate an increase in taxes? Can it provide for the sale of the public domain belonging to the ULB? How to do it without encroaching on the decisions which are the prerogative of a municipal legislature or the power of the State?
Passing municipal bankruptcy law will require resolution of these issues and protracted negotiations with states, as will the enactment of the GST framework. However, this should not deter decision makers from initiating the process. The gains from a clear framework of municipal bankruptcy, in the face of the severe impacts of the Covid-19 pandemic and the deteriorating condition of Indian cities, should provide motivation to do so. The fact that municipal bonds are poised to become an important asset held by Indian households adds an additional imperative and responsibility to ensure that there is a framework in place to deal with municipal financial difficulties in India.
This article was originally published as ‘Resolving Municipal Distress In India’, by Adam Feibelman and Bhargavi Zaveri-Shah, The Leap Blog, October 24, 2021.
Adam Feibelman is Professor of Law and Director of the Center on Law and Economics at Tulane Law School. Bhargavi Zaveri-Shah is a doctoral student at the National University of Singapore.
The opinions expressed here are those of the authors and do not necessarily represent those of BloombergQuint or its editorial team.