Please note: The following Deal Description is an excerpt from Habeck, Odo. Matsukawa, Tomoko. Review of Risk Mitigation Instruments for Infrastructure Financing and Recent Trends and Developments. Washington, D.C.: World Bank and PPIAF. 2007. To access the Full Report on the PPIAF website, please click here. For additional related reports and information, please visit the websites of PPIAF and the World Bank’s Guarantee Program.

8. India: Tamil Nadu Pooled Financing for Water /Sanitation

Country / India
Sector / Water/Sanitation
RMI Type / PCG (local currency)
RMI Providers / Gov’t. of Tamil Nadu, USAID
RMI Beneficiary / Debt (bond investors)
RMI Coverage / 50% of principal and interest outstanding;
up to US$3.2 million
Borrower / Water and Sanitation Pooled Finance – 13 small and medium municipalities
Debt Amount / US$6.4 million
(304.1 million India Rupees)
Maturity / 15 years
Principal
Repayment / equal annual principal payments and starting year 1
Interest Payment / 9.2% per annum
Rating / AA (local) Fitch
Financial Closure / 2002

The U.S. Agency for International Development (USAID) utilized its Development Credit Authority (DCA) to support a pooled municipal bond issue that financed water and sanitation infrastructure improvements for smaller cities located in the Indian state of Tamil Nadu. USAID not only provided market access to these urban local bodies (ULBs), but helped develop the municipal capital market by introducing a new institutional option to Indian investors. USAID’s partial guarantee, combined with other risk mitigation measures and the credit quality of the ULBs, resulted in a local AA Fitch rating, which was sufficient to attract Indian institutional investors.

A constraint to the expansion of the municipal bond market in India had been a lack of investor interest in long-term debt. Prior to this transaction, the term of municipal bonds had been confined to a maximum of seven years. Municipal bonds with longer tenors had been perceived as too risky for the market and thus unable to receive favorable pricing. Measures to increase the term of municipal bonds and measures to initiate their trading on the secondary market were needed to further develop the municipal bond market in India.

In addition to investor obstacles, there are high transaction costs for local governments interested in accessing capital directly from the market, making it affordable for only the largest municipal issuers. Pooling arrangements at state or regional levels allow small and medium size cities to aggregate their financing needs and diversify credit risk, which serve to attract investors, as well as spread the transaction costs among a number of borrowers. Additional risk mitigants included both ULBs and the Tamil Nadu State government (GoTN) pre-funding escrow accounts dedicated to bond investors, and USAID providing a guarantee to replenish 50% of the amount drawn from the Debt Service Reserve Fund (DSRF), up to an amount equal to one-half of the bond principal.

Tamil Nadu’s Municipal Urban Development Fund (TNUDF), a legally registered trust, issued the bonds. TNUDF is the successor organization to the World Bank-supported Municipal Urban Development Fund. The TNUDF trust is managed by a private entity, Tamil Nadu Urban Development Infrastructure Financial Ltd. (TNUIFSL), whose ownership is 51% private, including the largest private shareholder and manager of TNUIFSL, ICICI Bank. The state government owns 49% of the company.

The escrow accounts were funded by the ULBs from general revenues and prior to bond issuance, in an amount equal to one-year’s worth of their respective loan obligation to TNUDF. These funds were held in secure, short-term fixed deposits in the name of the ULB and available to cover debt service payment shortfalls. The ULB’s Current Account will be used to replenish draws on the escrow accounts.

The GoTN funded the DSRF at a level equal to 1.6 times of annuity payments (or comparable market negotiated level). Like the ULB-funded escrows, the debt service reserve is held in short-term fixed deposit investments or other liquid instruments in the name of the Fund. If drawn upon to make annuity payments to bondholders, GoTN will replenish it through either a government order or by diverting ULB transfer payments. USAID guarantees 50% of DSRF repayments and is triggered when the DSRF is exhausted and has not been replenished by the GoTN within 90 days.

Critical to the success of this transaction and another pooled municipal financing in the state of Karnataka and also supported by USAID, was a relatively stable regulatory framework and transparent ULB budgets. These factors were positively influenced by long-term and intensive USAID technical assistance.

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