Over the past three decades, urban policy has steadily pushed municipalities toward market-based financing, asking Urban Local Bodies (ULBs) to raise capital through municipal bonds instead of depending solely on grants and transfers. Yet the conditions that make markets trust borrowers, including stable revenues, audited accounts, predictable governance, and fiscal autonomy, remain deeply uneven across Indian cities.
Into this credibility gap has stepped an unlikely instrument: the escrow account.
Originally a technical mechanism of commercial law, escrow has become central to India’s municipal finance architecture because it solves a narrow but critical problem. It assures investors that a specific revenue stream will be ring-fenced and protected for debt repayment even if the municipality itself is fiscally weak. In effect, escrow substitutes institutional trust with contractual protection.
That substitution has helped India slowly revive municipal bond markets. It has also exposed a deeper structural problem. Escrow can protect creditors from municipal weakness, yet it cannot repair the underlying weaknesses that made such protection necessary in the first place.
Building Markets Without Fiscal Capacity
The 74th Constitutional Amendment of 1992 grants constitutional status to municipalities and Article 243X empowers state legislatures to authorise municipalities to levy taxes and borrow funds. In practice, however, states transferred responsibilities without equivalent fiscal capacity. Most ULBs remained dependent on conditional and unpredictable intergovernmental transfers.
From the mid-1990s onward, policy increasingly attempted to address this imbalance through market participation. The Jawaharlal Nehru National Urban Renewal Mission (JNNURM) linked urban grants to financial reforms. The 14th Finance Commission tied performance grants to audited accounts. The Securities and Exchange Board of India’s (SEBI) 2015 municipal bond regulations formalised access to capital markets, while the Atal Mission for Rejuvenation and Urban Transformation (AMRUT) 2.0 introduced incentives for bond issuance. The Union Budget 2026 further proposed a ₹100 crore incentive for single bond issuances exceeding ₹1,000 crore.
Across governments and policy regimes, the direction has remained consistent. Indian cities are expected to finance a larger share of urban infrastructure through own-source revenues and market borrowing.
The difficulty is that markets demand predictability, and most municipalities do not yet offer it. AMRUT’s credit-rating exercise showed the scale of the challenge: only 162 of 468 cities received investment-grade ratings. Many municipalities continue to suffer from weak accounting systems, politically constrained taxation, irregular disclosures, and heavy state interference. Urban finance systems remain fragile even as policy increasingly assumes market readiness.
Why Escrow Became Central
This is where escrow accounts acquired outsized importance.
An escrow arrangement ring-fences a designated revenue stream, such as property tax receipts or user charges, and commits it exclusively toward servicing debt obligations. Investors are therefore insulated from broader municipal fiscal instability because repayment is tied to a protected cash flow instead of the municipality’s general finances.
The landmark example remains Ahmedabad Municipal Corporation’s 1998 bond issuance, the first municipal bond in India issued without a state guarantee. The success of that issuance did not rest on escrow alone. Ahmedabad had already built credibility through computerised property tax systems, professional management, budget surpluses, and relatively transparent public financial disclosures. Escrow worked because it converted administrative discipline into a protected revenue commitment.
That distinction matters. Escrow did not create credibility from nothing. It formalised credibility that had already been built administratively.
Over time, municipal bond issuance in India evolved in phases, including an initial expansion between 1997 and 2005, a slowdown during the grant-heavy JNNURM years, and a partial revival after 2017. Throughout these phases, one pattern remained clear: municipal bonds have largely remained episodic instruments used by a small number of better-governed cities rather than a broad-based financing mechanism for urban India.
SEBI’s 2015 regulations attempted to formalise this market by requiring audited accounts, investment-grade ratings, and stronger disclosure standards. Escrow-linked safeguards through project-specific accounts and third-party monitoring further strengthened investor protection.
These reforms improved market confidence, but they also exposed the limits of escrow-driven finance.
The Limits of Escrow-Led Urban Finance
Escrow works by isolating one healthy revenue stream from a wider ecosystem of fiscal weakness. That makes it effective as a credit enhancement tool, while leaving its governance role relatively limited.
An escrow-backed bond is only as reliable as the revenue stream being escrowed. In earlier years, municipalities frequently relied on octroi revenues. Once the Goods and Services Tax (GST) subsumed octroi in 2017, that revenue base disappeared. Property tax has consequently become the most important remaining local revenue source, but property tax collection remains highly uneven across municipalities.
This creates a structural paradox in India’s urban finance system. The municipalities most capable of credibly escrowing revenues, such as Ahmedabad, Pune, or Indore, are often the least dependent on bond markets because they already possess stronger fiscal systems. Meanwhile, weaker municipalities struggle to access markets precisely because they lack stable revenues that investors are willing to trust.
Escrow therefore does not resolve municipal asymmetry. It simply makes the asymmetry more visible.
There is another limitation. SEBI regulates bond issuance and disclosure standards, but it does not oversee the municipality’s broader fiscal health. A city may continue servicing escrow-backed bonds even while accumulating unpaid liabilities elsewhere in its budget. In effect, escrow can create protected creditor enclaves within otherwise fragile municipal finances instead of strengthening municipal finances as a whole.
This is why regulatory sophistication alone cannot deepen municipal bond markets. India’s urban finance challenge is fundamentally institutional.
Escrow as Governance Reform
The more productive way to think about escrow is as a governance discipline rather than solely as a debt-servicing instrument.
An escrow account is, at its core, a commitment device. It reduces discretion, creates documented obligations, ring-fences commitments, and limits the ability of political authorities to divert funds arbitrarily. Applied more broadly, escrow mechanisms could help municipalities improve payment discipline, contractual credibility, and financial transparency even before entering bond markets.
That matters because municipal creditworthiness develops gradually through administrative behaviour and financial consistency. Markets respond to repeated evidence of reliability, including stable revenues, predictable obligations, audited accounts, and timely payments.
Instead of treating escrow as a last-mile compliance requirement for market borrowing, states could encourage municipalities to use escrow-linked systems across large contracts and infrastructure payments. Over time, this would help municipalities build the operational track record that investors and rating agencies actually evaluate.
In this sense, escrow is most useful as part of a longer sequencing strategy for municipal reform rather than as a standalone financing innovation.
Building Fiscal Credibility Before Market Expansion
If escrow is to evolve from a narrow credit-enhancement tool into a broader governance discipline, reforms must focus on administrative credibility as much as market access.
First, state governments should encourage or mandate escrow-linked payment systems for large municipal contracts, especially infrastructure projects with recurring liabilities. This would improve payment discipline and reduce the persistent accumulation of unpaid vendor liabilities and sundry creditors that weaken municipal balance sheets.
Second, SEBI and the Ministry of Housing and Urban Affairs should jointly establish structured preparation frameworks for municipalities seeking bond-market access. Many ULBs fail because they lack the financial history, disclosure practices, and escrow discipline that investors require.
Third, the question of municipal fiscal autonomy can no longer be postponed. The GST regime substantially narrowed local taxation space, making property tax the last major own-source revenue instrument available to municipalities. Unless cities are given stronger and more predictable revenue powers, attempts to deepen municipal bond markets will remain limited to a small group of administratively stronger cities.
India’s urban infrastructure demands are expanding far faster than public grants can sustain. Municipal borrowing will inevitably become more important in financing transport, water systems, sanitation, and urban services. But capital markets cannot substitute for fiscal foundations. Investors ultimately lend to institutions they believe can sustain obligations over time.
Escrow can help build that trust incrementally. It can improve discipline, strengthen credibility, and create enforceable financial commitments. But escrow alone cannot solve India’s urban finance problem because the deeper challenge lies in the slow and unfinished task of building fiscally credible cities.