A municipal bond or muni bond is a debt instrument issued by municipal corporations or associated bodies in India. These local governmental bodies utilise the funds raised through these bonds to finance projects for socio-economic development through building bridges, schools, hospitals, providing proper amenities to households, et al.
Such bonds come with a maturity period of three years, whereby municipal corporations provide returns on these bonds either from property and professional tax collected or from revenues generated from specific projects or both.
The Securities and Exchange Board of India (SEBI) revised the guidelines related to the issuance of municipal bonds in 2015 in an attempt to enable ULBs or local government bodies to raise finances from such sources. Following this measure, different cities have capitalised on the new guidelines to fund initiatives such as Atal Mission for Rejuvenation and Urbanisation Transformation (AMRUT) and Smart Cities Mission.
As per data released by the Government of India, floated municipal bonds with eight cities in India are worth Rs. 3,200 Crore as of Financial Year 2018 – 19.
What are the SEBI Guidelines on Municipal Bonds?
The new guidelines as mandated by SEBI are –
- The municipal body should not have a history of defaulting at repayments of loans or debt instruments acquired from financial institutions in the past year.
- It should possess positive net worth in all the three years preceding the issuance of municipal bonds.
- Such municipal entity, its Group Company or directors, and promoters shall not be mentioned in the willful defaulters’ list published by the Reserve Bank of India.
Municipal bonds having a credit rating of BBB and higher as declared by top credit rating agencies in India (e.g. CRISIL) can be issued to the public. These ratings have been assigned in an attempt to substantiate and popularise these bonds’ credibility and to incite investors’ confidence in them.
However, it might be so that after these bonds are issued in the market and subsequently traded in the secondary market, i.e. stock exchange, their credibility might falter due to the concerned municipality’s waning financial performance. This might lead to a decrease in such bond prices. On the other hand, if a municipal corporation performs well after such issuance, its bond prices shall appreciate.
Types of Municipal Bonds in India?
There are primarily two types of municipal bonds in India, categorised as per their usage. These are –
- General Obligation Bonds
As the name suggests, General Obligation Bonds are issued to raise finances for general projects such as improving the infrastructure of a region. Repayment of the bond, along with interest, is processed through revenue generated from different projects and taxes.
- Revenue Bonds
Revenue bonds, on the other hand, are issued to raise finance for specific projects, such as the construction of a particular building. Repayment of such bonds (principal and accrued interest) shall be paid through revenues explicitly generated from the declared projects.
Revenue generation from projects which are financed with revenue bonds shall be deposited in an escrow account. Concerned financial institutions monitor this account.
Who Should Consider Municipal Bonds?
Municipal bonds are ranked as per their credit ratings before issuance to the public, hence making it a secure investment option for individuals seeking to dilute the risk-factor associated with their investment portfolio.
Other than that, several municipal bonds come with considerably higher interest rates when compared to other fixed-income financial instruments. For instance, municipal bonds issued by Pune came with a coupon rate of 7.5%, whereas the Andhra Pradesh Capital Region Development Authority offered an interest rate of 8.9% on their municipal bond funds
Hence, entities seeking to appreciate their capital while also enjoying the guarantee of repayment shall also invest in these financial instruments.
What are the Advantages of Municipal Bonds?
There are multiple advantages of investing in municipal bonds which include –
Municipal bonds that are issued to the public are rated by renowned agencies such as CRISIL, which allows investors transparency regarding the credibility of the investment option.
- Tax benefits
In India, municipal bonds are exempted from taxation if the investor conforms to certain stipulated rules. In addition to such conformation, interest rates generated on such investment tools are also exempt from taxation policy.
- Minimal risk
Municipal bonds are issued by municipal authorities, implying involvement of minimal risk with these securities.
What are the Disadvantages of Municipal Bonds?
The disadvantages of municipal bonds are enumerated below –
- Long maturity period
Municipal bonds come with a lock-in period of three years, imposing a burden on the liquidity requirements of investors. Nonetheless, selling such securities prematurely in the secondary market can be challenging if the bonds are issued by an unpopular municipal corporation. It is because, in such cases, entities are uncertain about its credibility and yielding capacity.
- Low-interest rates
Even though interest rates on municipal bonds, in some cases, are higher than other debt instruments, these rates are considerably low when compared to returns from market-linked financial instruments such as equity shares.
Entities looking to invest in best municipal bonds should consider different variables such as their risk-appetite, investment objectives, investment portfolio etc. in tandem with a municipal body’s credibility and a bonds’ credit rating to ascertain its liquidity and repayment.