The key purpose of a municipal bond is to raise funds in the market to finance municipal infrastructure. To address the above challenge, municipalities and sub-sovereign entities need to improve their financial management as per commercial standards to earn the confidence of market investors for investing in financial instruments such as municipal bonds. A World Bank study found that only a small percentage of the 500 largest cities in developing countries could be deemed creditworthy—about 4 per cent in international financial markets and 20 per cent in local markets.1
With the aim of piloting the issuance of municipal bonds and subnational debt financing in Bangladesh and Nepal, a municipal credit rating methodology was developed by UNCDF. The credit quality, diversity, and concentration of loans of municipalities are essentially the credit quality of the municipalities who are the underlying and eventual obligors to potential investors in municipal bonds, both institutional and individual. This will help in achieving SDG 11, target 11.3 on enhancing inclusive and sustainable urbanization. This will also help in strengthening domestic resource mobilization, including through international support to developing countries, to improve domestic capacity for tax and other revenue collection (SDG 17, target 17.1) and mobilizing additional financial resources for developing countries from multiple sources (Target 17.3). Similarly, this would also facilitate in achieving IPoA Priority 7 in Mobilizing financial resources for development and capacity-building while facilitating Priority 8 - Good governance at all levels.
Using the methodology, credit ratings were assigned to ten A-grade municipalities in Bangladesh and five municipalities in Nepal. In Bangladesh, nine of the ten municipalities received an investment grade from a commercial credit rating agency. In Nepal, the assessment was used as a baseline for the five pilot municipalities to internalize their areas of strengths and gaps to build on to attract investments from financial institutions in future.
While developing the credit rating assessment methodology, a participatory process was followed in both countries. In Bangladesh, the finance executives and engineers of municipalities and local partner Bangladesh Municipal Development Fund were trained on municipal creditworthiness and credit rating methodology. Following the training, the trained personnel supported the process of developing a municipal credit rating methodology and actual credit rating of municipalities was done. In Nepal, the UNCDF and the Town Development Fund oriented 10 municipalities on alternative sources of finance and on credit rating assessments of subnational governments, following which five pilot municipalities shared their expression of interest to partake in the credit rating scoring assessment.
Drawing on the lessons and process followed in Bangladesh on municipal credit rating, UNCDF Nepal partnered with the Town Development Fund, used the methodology applied in Bangladesh and contextualized it to fit the assessment of municipalities in Nepal. The respective offices of South-South cooperation in the countries were informed of the good practice replicated in two countries. The credit rating scoring assessment process has helped provide evidence-based assessment of the financial strength of municipalities and identify gaps that municipalities need to address to access long-term debt required to finance municipal infrastructures in Nepal. The process has also supported the Town Development Fund and UNCDF to orient and sensitize municipalities to broaden the scope beyond grants for municipal investment finance.
The practice was innovative because municipalities of Bangladesh and Nepal were rated and assessed for their creditworthiness for market financing. Banks like Standard Chartered and CITI NA showed interest for the first time in investing in municipal infrastructure. They expressed interest in issuing municipal bonds as one of the new financial products. While national large-scale infrastructures are being financed by loans, supplier credit and bonds, municipal credit rating will open opportunities for municipal infrastructure financing by international private sector investors. This will create an advantage for graduating LDCs in attracting foreign private investment in municipal infrastructure financing.
The government of Bangladesh in its National Urban Development Policy has included bonds as one of the financing tools for municipal infrastructure, which will require a credit rating. The Bangladesh Securities and Exchange Commission has permitted one city corporation to issue a project-specific municipal bond and UNCDF is in discussion with that city corporation to offer the credit rating support for the bond and the municipality. In Nepal, technical assistance is being provided to support pilot municipalities in strengthening areas identified in the municipal credit rating scoring assessment and extend support to the Town Development Fund to leverage funds from the market to finance municipal infrastructure.
To further promote South-South cooperation in the LDCs, UNCDF, through its global Municipal Investment Finance programme, has already started applying the municipal credit rating process and tools in Uganda and Tanzania. UNCDF is facilitating the knowledge exchange between these countries and applying the lessons learned from Asia to Africa including:
- Municipal credit rating has some common elements but needs to be locally contextualized.
- Contribution and participation of the municipalities and key institutions such as municipal development banks that finance municipalities are essential to build ownership.
The participatory approach has made municipalities aware of financial processes and products available in the market. They have understood that dependency on municipal tax or inter-government fiscal transfer cannot ensure financing for service infrastructures. When investable resources are available in the market, preparing and building capacity to capture those resources can be helpful for them to face the challenge of post-LDC graduation and achieve the SDGs. Thus, a change in mindset of subnational governments has taken place on alternative sources of financing for municipal investments and areas to build on to access such funds to achieve SDGs at the local level.