Why India’s Municipal Bonds Need Founding Rigour, Climate Reset

The recent Union Budget 2026-27 has done what years of policy nudges could not: it has put municipal bonds firmly in the spotlight. The promise of a ₹1 billion incentive for issuances above ₹10 billion is an unambiguous signal to our largest cities to tap the capital markets.

On paper, it is a dream move to fund our urban future.

The numbers from ratings agencies confirm the green shoots: 2025-26 is on track to see issuances of nearly ₹20 billion, a jump from the cumulative ~₹55 billion-₹60 billion raised in the entire history of the market prior to this year. News reports say issues are getting fully subscribed, offering yields of 8.00-8.50% that are attractive enough to draw institutional attention.

But as someone who published the 2017 Guidance on the use of Municipal Bonds for PPP projects after exhaustive study, deliberations and consultations, I would caution that the renewed enthusiasm, while welcome, rests on foundations that may be weaker than they appear.

Are we building on the right principles, or are we merely adding a glittery new incentive to a structure whose original, carefully laid pillars have been quietly eroded? More importantly, is this structure ready for the climate storm that is already gathering on our horizon and for hard truths about our cities’ balance sheets?

The snowballing need for huge amounts of infrastructure financing is what makes this issue so urgent. Consider the scale of investment required for just one city: Mumbai’s Brihanmumbai Municipal Corporation’s 2025-26 budget allocates ₹439.59 billion for capital expenditure — more than the cumulative total of all municipal bonds ever issued in India.

The projects being funded range from coastal roads to massive link roads and stormwater drainage upgrades, the kind of long-gestation, high-cost assets that bank loans, with their shorter tenors and restrictive covenants, cannot easily finance. While a thriving, functional bond market is a non-negotiable need for our urban future, the current market size is dangerously undersized for the task at hand.

A) The Background (and how we lost the plot)

The Forgotten Rigour of 2017

The 2017 Guidance was not just a desk exercise but the product of extensive study. This included the learnings from the experience in other jurisdictions, as in the deep and mature US municipal bond market, which at ~$4 trillion accounts for about 14% of US GDP and 7% of its overall bond market. 

We consulted a wide range of stakeholders: ministries, state governments, urban local bodies, the banking sector and capital market regulators (RBI and SEBI, respectively), banks, insurance companies, potential long-term institutional investors, infrastructure and PPP developers. The core principles we laid out are immutable for a reason: they stipulate that accessing the bond market should not be a fundraising gimmick but a governance reform contract. An urban local body has to demonstrate creditworthiness, ring-fence stable project revenues, and commit to financial discipline before it embarks on the exercise.

We chose the Pune Municipal Corporation issuance as the pilot case. It was meticulously prepared — this was not just about preparing a prospectus but ensuring that the urban local bodies had in place a committed administrative set-up and state support. With careful capacity building over 15-18 months, the municipal staffers who would have to manage this new instrument and the related political establishment were familiarised with the process and the procedures. We took technical support from the US government for setting up accounting standards. The result? A successful issue which was oversubscribed, including by established sovereign wealth funds and other global institutional investors known for their rigorous due diligence, all placing their faith in an Indian municipality.

This was, unfortunately, followed by the chaos of demonetisation. The timing was tragic as its fallout affected the revenue models of some of the projects to be financed by the first tranche of bond-funding. 

The general economic upheaval also weakened the momentum built by the Pune model.

When the focus returned, the approach shifted: in its bid to reignite the market quickly, the ministry introduced tax breaks on bond interest. I was, and remain, against this.

The 2017 Guidance was built on the idea that market discipline, not fiscal sops, would force urban local bodies to become creditworthy. Tax breaks, as subsidies, remove the incentive for fundamental reform as we reward the act of issuance, not the long, hard work of becoming a credible borrower.

Today’s Market: Green Shoots, Same Old Snags, and New Data

So, where do we stand in 2026? The data shows undeniable green shoots, but dig deeper and we find the structural problems we had addressed in the Guidance remain stubbornly in place. The process is still a nightmare for urban local bodies:

• Cumbersome Due Diligence: A 5-6 month ordeal with reports of merchant bankers demanding documents that do not exist for bodies with pre-British-era origins.
• High Costs: At 8.00-8.50%, bond coupons are often higher than bank loans. The only thing making them viable for many urban local bodies, particularly smaller and first-time issuers, is the 2% interest subvention provided under the AMRUT scheme, which meaningfully reduces the effective cost of borrowing as long as it lasts. The government is, reportedly, considering raising the ₹260 million cap on this subvention, but the fundamental concern remains: we are using subsidies to mask an underlying cost disadvantage, rather than fixing the structural issues that make bonds more expensive than bank loans in the first place.
• Poor Liquidity: With a secondary market trading value of just ₹1.75 billion in all of 2025, a journal recently noted that these are buy-and-hold instruments, not part of a dynamic market-one ratings agency estimated that the municipal bond market accounts for only about 0.06% of India’s total outstanding corporate bonds.
  

More issuances without solving the fundamental issues of urban local bodies autonomy, accounting standards, and market depth have meant that we have only made it financially tolerable for a handful of better-off cities to jump through the hoops.

The Hidden Vulnerabilities in Our Leading Cities

There is a deeper layer of risk that the current discourse ignores. To understand it, we need to look closely at the balance sheets of the cities leading the charge. Let us do a quick analysis of Mumbai and Pune, as a sample:

Mumbai: Of unquestionable mammoth size, India’s richest urban local body is often held up as the model. The numbers are staggering. The BMC has a balance sheet size of over ₹2.00 trillion and annual revenues of ₹378.91 billion. However, a closer look reveals hidden vulnerabilities. Mumbai’s fiscal might is not primarily built on its own revenue sources. Its property tax collection of ₹61.98 billion in 2024-25 is impressive but is dwarfed by the ₹143.98 billion it receives annually from the state government as compensation for the abolition of octroi- a grant whose continued flow is a political and policy decision, not an immutable right. This makes the primary revenue stream vulnerable to state-level fiscal stress.

The BMC’s 2025-26 budget allocates massive sums to infrastructure: ₹59.07 billion for the Coastal Road, ₹51.00 billion for roads, ₹19.58 billion for the Goregaon-Mulund Link Road. Much of this has been, and will continue to be, financed through bonds. The critical question, which the current incentive structure ignores, is: what is the total outstanding debt service obligation on the BMC’s balance sheet? With a budgeted revenue surplus of a mere ₹606.5 million for 2025-26, the margin for error is razor-thin. Is there an over-reliance on future issuances (and future incentives) to simply roll over the debt?

Pune presents a different, but equally important, cautionary tale.

The city has seen a dramatic shift in its revenue composition. For the second consecutive year, revenue from building permissions has surpassed property tax collections. The 2025-26 budget targets this trend to continue for a third year, but this is a structural red flag. Revenue from building permissions is deeply cyclical and volatile. It is tied to the real estate market’s health, which can flip overnight. An urban local body that issues bonds backed by an escrow of its “total revenue” (which is increasingly dependent on this volatile stream) is building its debt repayment capacity on sand. The 2017 Guidance’s principle of ring-fencing stable revenue streams like property tax was designed precisely to avoid this kind of risk.

B) Learning from Others—What the World Teaches Us

The experience of other economies, both developed and emerging, reveals both cautionary tales and replicable successes. Before examining specific examples, it is worth stepping back to ask: what are the underlying principles that have made municipal bond markets work elsewhere? And how might those principles, embedded in the Guidance, inform our own path forward?

The Fundamental Preconditions for a Thriving Municipal Bond Market

Across jurisdictions that have successfully developed municipal bond markets, three preconditions consistently emerge:

First, fiscal autonomy and creditworthiness at the local level. Municipal bonds are ultimately claims on the future revenues of a city. If a city does not have meaningful control over its own revenue sources—if it depends heavily on discretionary transfers from higher levels of government—then its bonds are only as strong as the political commitment to keep those transfers flowing. This is precisely the vulnerability we see in Mumbai’s reliance on octroi compensation.

Second, standardised financial reporting and disclosure. Investors cannot price what they cannot see. The most successful municipal bond markets have developed uniform accounting standards that allow for meaningful comparison across issuers. This was one of the core recommendations of the 2017 Guidance, but its implementation remains incomplete.

Third, a diverse and deep investor base. Municipal bonds need buyers not just at issuance but in the secondary market. This requires institutional investors- the pension funds, insurance companies, mutual funds- with long-duration liabilities that match the long-term nature of infrastructure assets. It also requires retail participation to build political constituencies for market discipline.

A fourth factor, more recent but no less critical, emerges from the US experience. It offers a stark warning about what happens when climate risk is ignored.

The US has the world’s deepest and most mature municipal bond market. But in recent years, insurers in high-risk regions have begun to withdraw, unwilling to underwrite properties that face mounting threats from wildfires, hurricanes, and floods. This is not merely an insurance problem. 

When insurers flee, property values decline. When property values decline, the local property tax base - often the primary revenue stream backing municipal bonds - is eroded. And when the tax base shrinks, the creditworthiness of the issuing municipality is called into question.

The dynamic is now directly affecting bond valuations. Rating agencies have started to factor climate risk into their assessments, downgrading issuers not just after disaster strikes but in anticipation of future threats. This is the climate-debt doom loop in action: climate risk translates into fiscal stress, which translates into higher borrowing costs, which leaves less money for adaptation, which increases future climate risk.

The lesson for India is not that we should copy the US model. The lesson is that we cannot afford to wait until climate risk is priced into our bonds by crises. We need to build resilience into the framework from the outset, while we still have the luxury of foresight.

Emerging Market Experiences: What Works in Contexts Like Ours

If the US offers a warning, the experience of other emerging economies offers practical insights into what works when starting from a position similar to India’s.

Several themes recur across successful cases:

• Patient, sustained technical assistance is non-negotiable. In multiple instances where sub-national entities have successfully accessed capital markets, the process was measured in years, not months. External partners provided hands-on support for financial structuring, governance systems, and investor communications. This was precisely the approach we took with Pune, and it worked.
  
• Catalytic capital can unlock private investment. A relatively small amount of well-targeted grant funding or credit enhancement can crowd in much larger volumes of private capital. The key is to use public funds not as a substitute for market discipline but as a bridge to it.
  
• Aggregation mechanisms matter. Many individual municipalities are too small to access markets efficiently on their own. Structures that pool multiple issuers or projects can achieve the scale needed to attract institutional investors while diversifying risk.
  
• Domestic institutional investors are natural partners. They also reassure and draw in foreign institutional investors seeking steady yields. Pension funds and insurance companies have long-duration liabilities that align perfectly with infrastructure bonds. In successful cases, these investors have been engaged early in the process, helping to shape structures that meet their needs.
  
  

Bringing it back to India, what does this mean for us? Three implications stand out:

First, it means that the 2017 Guidance was right in its fundamentals. The emphasis on creditworthiness, on stable revenue streams, on capacity building, on a pipeline of ring-fenced projects, on accounting transparency - these were not merely a listing of optional extras. They are the essential foundation upon which any durable municipal bond market is built. The mistake was in allowing short-term incentives to substitute for long-term discipline and in easing the requirements.

Second, it means that we cannot simply transplant models from elsewhere. The US market is too different in scale and maturity to serve as a template. The emerging market successes are instructive but not directly replicable. Our task is to extract the underlying principles and adapt them to Indian conditions.

Third, and most important, it means that we must build climate resilience into the foundation, not bolt it on later. The US is now grappling with the fiscal consequences of climate risk after decades of ignoring it. We have not just the opportunity but the obligation to include this in the framework to anticipate such challenges from the start.

C) The Missing Chapter—Climate and Resilience

The structural problems we identified in section (A) - weak revenue streams, poor disclosures, volatile collateral - are precisely the vulnerabilities that climate risk will amplify. Addressing them requires not just returning to the 2017 principles, but adding new ones.

This brings us to a critical shortcoming in our current approach. The 2017 Guidance, for all its foresight, could not anticipate the speed at which climate risk would transition from an environmental concern to a core financial variable.

The financial logic is now inescapable: a climate event - a flood, a cyclone, a prolonged heatwave - would not only cause physical damage but would immediately disrupt both property tax collections (if properties are damaged) and, in cities like Pune, building permission revenues (as construction can halt). Climate resilience, therefore, is not an add-on; it is core to the financial logic of a bond’s repayment capacity.

This is where we need a formal addendum to the 2017 Guidance. A new chapter on Climate Resilience and Municipal Financial Risk would mandate:

• Explicit Climate Disclosure: Just as the original Guidance mandated financial disclosures, any urban local body seeking to issue a bond should have to assess and report on its physical climate risks and model how a climate event would affect its proposed repayment streams. This is not about penalizing vulnerable cities; it is about creating transparency so that investors can make informed decisions.
  
• Categorise Revenue by Volatility: The framework should mandate that bonds of a certain tenor or size are backed by ring-fenced, stable revenues (like property tax) rather than volatile ones (like building permissions). This would force urban local bodies to be honest about the security they are offering.
• Climate Stress Testing: Require urban local bodies to model how a one-in-100-year climate event would impact their ability to service debt, and disclose those stress test results to investors.
  
• Ensure a Constructive Role for Insurers: Insurance companies are the real experts in pricing physical risk. Rather than waiting for them to retreat, as they have in the US, we need to bring them into the conversation early. For bonds funding infrastructure in climate-vulnerable zones, issuers could voluntarily seek insurance partners to validate risk assessments and, where appropriate, structure parametric insurance products that provide automatic payouts when, say, rainfall exceeds a certain threshold. This would protect the urban local bodies’s cash flow during flood events and enhance investor confidence. The key is to make this optional, not mandatory—a tool for the most ambitious issuers, not a burden for all.
  
• Innovative Structures for Resilience Infrastructure: A persistent challenge is in how to finance non-revenue-generating resilience infrastructure, like sea walls, improved drainage, and mangrove restoration, that protects a city’s tax base but does not create a direct income stream for debt servicing. The new Guidance should explicitly recognize this challenge and provide examples of how it has been addressed elsewhere, whether through state-level credit enhancements, pooled financing mechanisms, or blended finance structures that combine public and philanthropic capital.
  
• Require Cumulative Debt Disclosure: We need full disclosure of urban local bodies’ cumulative debt service obligation from all past and proposed issuances. Investors and rating agencies must be able to see the full picture of a city’s liabilities, not just the terms of the latest bond.
  

A Resilient Reset
The Urban Challenge Fund and the new budget incentives can be a shot in the arm, but just throwing money at the problem is not a prudent strategy. It risks creating a new wave of debt, of profligate issuance driven by short-term incentives, that ignores both the hard lessons of the past and the challenges of the future.

A return to the foundational principles of the 2017 Guidance is unavoidable and accessing the bond market must remain a privilege earned through fiscal discipline, governance reform, and capacity building. But we must also accept that the 2017 Guidance is incomplete.

The new data from our largest cities reveals risks we did not need to confront a decade ago. Mumbai’s balance sheet, while massive, is now burdened with cumulative debt from years of issuances, its repayment relying on a state grant and a perilously thin surplus. Pune’s revenue, once anchored by stable property tax, is now increasingly dependent on the volatile whims of the real estate sector. These are not arguments against bonds; they are arguments for a smarter, more resilient framework.

The global experience offers us both a warning and a set of principles. From the US, we learn that climate risk, once ignored, becomes a fiscal crisis that insurers flee and investors price into bond spreads. From successful emerging market cases, we learn that patient technical assistance, catalytic capital, and aggregation mechanisms can work even in challenging contexts. We need to adapt these lessons to our own circumstances, not copy them as is - India’s path forward is not to invent a new model from scratch but to update the model we built in 2017.

The updated model would, in sum:

•  Mandate climate risk disclosure and stress testing for all issuers.
  
• Categorise revenue streams by volatility and require that bonds be backed by ring-fenced, stable revenues.
  
• Require detailed disclosure of urban local bodies’ cumulative debt service obligation.
  
• Provide best-practice examples for financing non-revenue-generating resilience infrastructure.
  
• Explore a framework for constructive, voluntary engagement with the insurance sector to price physical risk and keep insurers at the table as partners.
  

The lessons from experience, now starkly illustrated by the numbers from our own cities, underline the need to plan for the financing of urban infrastructure projects through an approach defined not just by economic growth, but by the ability to make it resilient.