What are Municipal Bonds?
Municipal bonds are also known as ‘muni bonds’. It is a debt instrument that municipal corporations and other associated bodies in India issue them. Whenever the local government body wants to raise funds, they issue these bonds. These bonds come with a fixed maturity period and investors earn a fixed interest rate on them. Also, there are short-term bonds that have a maturity between one to three years and long-term bonds have a maturity of up to ten years. The municipal corporations provide returns on these bonds either from property tax or professional tax collected or other specific projects’ revenues.
In the year 2015, the Securities and Exchange Board of India (SEBI) circulated guidelines for urban local bodies or local government bodies to raise funds by issuing these bonds.
Why are Municipal Bonds Issued in India?
The local government body issue these bonds when they want to raise funds for projects such as
- Railway stations
- Hospitals and so on.
The government issues these bonds for socio-economic development purposes, providing amenities to households or other public projects.
SEBI Guidelines for Municipal Bonds in India
The following are SEBI guidelines for issuing municipal bonds in India –
- The municipal body shall not have a negative net worth in all the three years preceding the issuance of these bonds.
- The municipality must have no default in repayment of debt securities or loans acquired from banks or financial institutions in the past year.
- Such municipality, its group company, promoters or directors shall not be mentioned in the wilful defaulter’s list published by the Reserve Bank of India (RBI). Also, such an entity or person should not default any payment of interest or principal amount regarding debt instruments issued to the public.
It is mandatory for the credit rating for these bonds. They must have a rating above the investment grade for the public issue. The motive for assigning a credit rating is an attempt to substantiate and popularise these bonds’ credibility and build investors’ confidence in them.
However, after these bonds are issued and subsequently traded in the secondary market, i.e. stock exchange. The credibility might change due to the concerned municipality’s financial performance. Also, this may lead to a fall in bond prices. On the contrary, the bond price might appreciate if the municipal corporation performs well after the issue.
Types of Municipal Bonds in India
The most prevalent forms of municipal bonds in India are –
General Obligation Bonds
The municipal corporation issues these bonds to generate finance for various projects. These projects aim to improve the existing infrastructure within the region. After the bonds mature, the repayment and interest are paid from the revenue generated from the various projects and taxation.
These bonds focus on generating funds from specific upcoming projects like financing the construction of a new building. After the bonds mature, the bondholders receive the repayment and interest from the revenue generated explicitly from these specific projects. After these specific projects generate funds that aid the revenue bonds, the funds are deposited in the escrow account. Financial institutions are responsible for monitoring this account.
Advantages and Disadvantages of Investing in Municipal Bonds
The following are the advantages of investing in municipal bonds –
- Transparent: The credit rating agencies like CRISIL rate these bonds. This gives investors transparency regarding their credibility.
- Risk: Municipal authorities issue these bonds, which implies a minimal risk of these securities.
The following are the disadvantages of investing in municipal bonds –
- Long Maturity: These bonds have a lock-in period of three years which imposes the burden of liquidity on investors. However, selling them prematurely in the secondary market can be challenging if an unpopular municipal corporation issues them. Therefore, there is uncertainty about their credibility and yielding capacity.
- Low Return: These bonds have returns that are lower than what market-linked instruments generate.
Who Should Invest in Municipal Bonds?
Municipal bonds are ranked as per their credit rating before issuing to the public. Therefore, a highly rated bond can be a safe investment option. It is suitable for investors with low-risk tolerance levels as they prefer security from their investment. Also, investors can purchase municipal bonds to dilute the risk factor in their investment portfolio.
Moreover, these bonds offer higher interest rates than other debt instruments. Investors seeking capital appreciation can consider investing in these bonds. However, these bonds fluctuate based on the interest rate movement.
Frequently Asked Questions
A highly rated municipal bond is a safe investment option in comparison to other debt investment options. The reason is that the chance of default is minimal. In other words, these bonds are not entirely risk-free as the issuer may fail to make the interest payments or the principal on maturity.
The cities like Pune, Hyderabad, Indore, Amravati, Bhopal, Visakhapatnam, Ahmedabad, Surat, Ghaziabad and Lucknow have issued these bonds in India.
Investing in these bonds is a good way to protect your capital and generate interest simultaneously. A high credit-rated bond can be a safe investment. However, you must be aware that there is a risk of default in any bond investment.
The interest rate offered by municipal bonds is generally 8% which is higher than other debt instruments. However, these are long-term bonds with ten years. But if you purchase them from the secondary market, the yield may range between 7.25%-8%. For instance, the municipal bonds were offered at 8.1% in Lucknow and 8.5% in Ghaziabad.
In India, you can purchase municipal bonds from dealers, banks, brokerage firms and in a few cases, directly from the municipality. These bonds are tradable in both primary and secondary markets. In the primary market, you can purchase during the offer period. However, these bonds are released in higher denominations. The secondary market allows you to invest in these bonds already issued in markets through your Demat account. However, the bond price may vary as it includes a markup, i.e. the dealer’s cost plus profit.
Bonds are less riskier than stocks. However, this does not mean that you cannot lose your money owning these bonds. The bond prices decline when the interest rate rises or when the issuer’s credit rating downgrades. Sometimes even inflation can erode the returns on bonds. Therefore, you must consider these factors before investing and also consider the issuer’s credit rating before investing in these bonds.