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Decoding Municipal Bonds in India

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Published Date: 07 Feb 2024Updated Date: 19 Sep 20246 mins readBy MOFSL

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Introduction:

There are different types of bonds in India. Some are issued by companies, some by the government, and then municipal bonds. All three types of bonds vary in risk and returns, so it is essential to understand what each offers. Today, we are zooming in on municipal bonds. Municipal bonds are issued to fund community projects and offer you a chance to support local development while earning potential returns. This article will explain what makes municipal bonds unique, their risks, and whether they can fit into your portfolio.

What is a municipal bond?

A municipal bond, often called a muni bond, is a type of debt security issued by state and local governments in India. The Securities and Exchange Board of India (SEBI) laid out comprehensive guidelines in 2015, enabling urban local bodies to raise funds through the issuance of municipal bonds. Municipal bonds fund various public projects, including constructing bridges, schools, roads, toll facilities, and hospitals. Municipal bonds are considered a low-risk investment option with a fixed maturity date and interest rate.

Municipal bonds have been present in India since 1997, with the Bangalore Municipal Corporation being the pioneer in issuing such bonds among urban local bodies in the country. Municipal bonds in India with a credit rating of BBB or higher, as determined by leading credit rating agencies such as Credit Rating Information Services of India Limited (CRISIL), are eligible for issuance to the public.

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For a municipality in India to issue municipal bonds, it must fulfil specific eligibility criteria by SEBI. These include:

Positive net worth: The municipality should not have a negative net worth in each of the three preceding years.
No defaults: There should be no default in the repayment of debt securities and loans obtained from banks or non-banking financial companies in the previous year.
No enlistment as wilful defaulters: The municipality, its promoters, and directors must not be listed as wilful defaulters by the Reserve Bank of India (RBI). Additionally, there should be no default history in paying interest and repaying principal amounts concerning debt instruments.

Types of Municipal Bonds in India

There are two main types of municipal bonds in India, as categorised below:

General obligation bonds: General Obligation Bonds are issued to raise finances for general projects to enhance a region's overall infrastructure. As the name implies, these bonds are not tied to a specific project. The repayment of these bonds, including principal and interest, is funded through revenues generated from various projects and taxes. These bonds are versatile as they help you contribute to the comprehensive development of the community.
Revenue bonds: In contrast, revenue bonds are issued for financing specific projects, such as the construction of a particular building, school, or bridge. These bonds help you contribute to distinct projects and causes you may want to support. The repayment mechanism for revenue bonds differs from that of general obligation bonds. The repayment of both principal and accrued interest of revenue bonds depends on the revenue explicitly generated by the projects for which the bonds were issued.

To ensure the earmarked funds are utilised as intended, revenue generated from these projects is diligently deposited into an escrow account. These funds are then monitored to ensure transparency and compliance with the bond's intended purpose.

Advantages of municipal bonds

Here are some benefits of municipal bonds:

Municipal bonds issued to the public undergo thorough rating processes by reputable agencies like CRISIL. This ensures transparency and provides you with a clear understanding of the credibility of the bond and its issuer.
In India, municipal bonds enjoy a tax-free status, which makes them an ideal asset for tax diversification.
Since municipal authorities issue these bonds, they generally involve minimal risk.

Disadvantages of municipal bonds

Here are some disadvantages of municipal bonds:

Municipal bonds offer generally lower returns when compared to other market-linked financial instruments like stocks.
Like any other issuers, municipalities can face financial challenges like credit risk. This refers to the possibility that the municipality may default on its bond payments.

To sum it up

Municipal bonds allow you to contribute to the community while enjoying potential returns. They are transparent, have minimal risk, and provide tax benefits. Given all of these benefits, municipal bonds can be a practical addition to your investment portfolio. However, it is crucial to weigh their pros against potential lower returns and credit risks.