Budget Incentives to Push Large Urban Local Bodies to Access Debt Capital Markets: India Ratings

India Ratings and Research said the 2026-27 Union Budget is set to strengthen supply-side dynamics in India’s municipal bond market, with enhanced financial incentives expected to deepen market participation and encourage greater use of capital markets for urban infrastructure funding.

In a note, India Ratings said the revised incentive framework should promote stronger financial and operational discipline among urban local bodies, while improving the attractiveness of bond issuances relative to traditional funding sources. Anuradha Basumatari, Director – Public Finance at the rating agency, said the medium-term outlook for municipal bond activity remains strong, even though larger single-ticket issuances are likely to materialise only gradually.

Urban local bodies have historically faced financing constraints that limited infrastructure creation and service delivery. Since the introduction of municipal bond guidelines in 2015 and the launch of AMRUT-linked incentives in 2021, bond market access has improved, though overall volumes remain modest. As of February 2, 2026, 21 urban local bodies have collectively undertaken 28 municipal bond issuances aggregating ₹40.35 billion since 2017-18, with outstanding bonds of ₹35.85 billion.

Issuance momentum has picked up in 2025-26, with bonds worth ₹12.51 billion raised in the first ten months, surpassing the previous annual peak of ₹9.90 billion recorded in 2018-19. India Ratings expects this trend to continue, with several large urban local bodies, including Nashik Municipal Corporation through a green bond, actively preparing to access the market.

The FY27 budget introduces a new incentive of ₹1 billion for each municipal bond issuance exceeding ₹10 billion. India Ratings expects this to encourage large urban local bodies to tap debt capital markets for sizeable urban infrastructure projects, while reinforcing governance and fiscal discipline. Existing AMRUT incentives will continue, supporting smaller and mid-sized issuers and ensuring a broader participation base.

The incentive framework is further complemented by the 16th Finance Commission’s recommendations, which include ₹2.32 trillion in basic grants and ₹290.16 billion in performance-linked grants for urban local bodies over FY27–FY31. A special infrastructure grant of ₹561 billion for select million-plus cities is expected to support large wastewater and urban resilience projects, creating additional funding opportunities through a mix of grants, internal accruals and market borrowings.

Despite the supportive backdrop, India Ratings noted that Urban local bodies are still testing the market, with most issuance sizes capped around ₹2 billion. Coupon rates over FY18–10MFY26 ranged between 7.15% and 10.23%, with an average spread of about 142 basis points over the 10-year government bond yield. India Ratings said large-scale issuances will emerge over time as urban local bodies build project pipelines, secure approvals and structure sustainable financing models.