Municipal Bonds: Invest Smart, Earn Returns, and Build the Nation

Every individual invests with the aim of earning returns. However, imagine an investment vehicle that gives you returns while also aiding the country's development. Municipal bonds are one such instrument.

Municipal bonds, which are slowly gaining traction in India, help local governments raise funds for public projects such as building roads, bridges, schools, hospitals and sanitation systems. For investors, such bonds offer the chance to earn potential returns in the form of interest payments, with the principal repaid at maturity.

Municipal bonds can be issued by municipal bodies, urban local governments etc. They are considered relatively stable investments with the potential for steady returns. However, like any investment, they come with risks and limitations.

In this article, we will understand municipal bonds in detail, covering their definition, types, advantages and disadvantages.

• Table of contents

1. Understanding of municipal bonds
2. Prominent municipal bonds types
3. Who can invest in municipal bonds?
4. SEBI guidelines on municipal bonds
5. Why you should invest in municipal bonds
6. Limitations of municipal bonds

Understanding of municipal bonds

Municipal bonds are debt securities issued by municipal corporations and local government bodies to raise funds for infrastructure projects. When an investor purchases a municipal bond, they lend money to the issuing authority. In return, the issuer commits to pay interest periodically and repay the principal amount at maturity.

These bonds are considered lower risk compared to corporate bonds. However, their returns may be lower than that of equities and other higher-risk investments.

In 2015, the Securities and Exchange Board of India (SEBI) introduced the Issue and Listing of Municipal Debt Securities) Regulations, 2015, which put in place a framework for the public issue of such bonds and their listing and trading. And in 2023, NSE Indices launched Nifty India Municipal Bond, India’s first ever bond index.

Since then, various cities have used this opportunity to fund projects like the Atal Mission for Rejuvenation and Urban Transformation (AMRUT) and the Smart Cities Mission.

Prominent municipal bonds types

General obligation bonds (GO bonds)

General Obligation Bonds are used to raise money for public projects like improving infrastructure. The government repays these bonds, along with interest, using money collected from various projects and taxes. These bonds usually attract conservative investors as they offer lower returns than revenue bonds.

Revenue bonds

These bonds are backed by the revenue generated from a specific project, such as toll roads, bridges or public utilities. They are slightly riskier than GO bonds because their repayment depends on the project’s success. However, these bonds offer better returns than General Obligation Bonds.

Who can invest in municipal bonds?

Municipal bonds may be suitable for:

Income-oriented investors: These bonds may be suitable for individuals looking for a potentially steady income stream through interest payments from the underlying securities.

Risk-averse investors: Investors who prefer relative stability over returns can fund municipal bonds suitable because they are generally considered low-risk. Issued by local government bodies, these bonds have a lower chance of default compared to corporate bonds. Their stability makes them a preferred choice for those looking to prioritise capital preservation while earning moderate returns.

Tax-efficient investors: Individuals in higher tax brackets often invest in municipal bonds to take advantage of tax-free interest income. Many municipal bonds offer tax exemptions at the state and federal levels, helping investors reduce their overall tax burden while maximising their earnings.

Long-term investors: Institutional investors like insurance companies and pension funds prefer municipal bonds for their long-term stability. These bonds help them achieve consistent growth while ensuring capital preservation.

SEBI guidelines on municipal bonds

SEBI has set clear rules for municipal bonds to ensure transparency and investor confidence.

• No recent defaults: The local government or urban body issuing the bond must not have defaulted on any loan repayment in the past year (365 days) before issuing the bond.
• Positive net worth: The issuing entity must have had a positive net worth for at least three years before launching the bond.
• No fraud history: The entity, its leaders and promoters must not be involved in financial malpractice, such as being labelled ‘willful defaulters’.
• Minimum credit rating: The bond must have been rated investment grade or higher by a SEBI-approved rating agency to ensure credibility and investor trust.

Why you should invest in municipal bonds

Creditworthiness

These bonds are rated by top credit rating agencies like CRISIL, giving investors a clear idea of their reliability and risk level. A high rating means lower chances of default.

Low risk

Since municipal bonds are issued by local government bodies, they are generally considered safer than corporate bonds, making them ideal for conservative investors.

Tax benefits

Many municipal bonds come with tax exemptions, allowing investors to earn interest income without paying taxes on it.

Portfolio diversification

Investing in municipal bonds can help mitigate overall investment risk by balancing high-risk assets like stocks with lower risk fixed-income securities.

Limitations of municipal bonds

Liquidity

In India, municipal bonds typically have a maturity period of 3 to 10 years. Selling them before maturity in the secondary market can be difficult, especially if the bonds are issued by smaller or less-known municipal bodies. This makes them less liquid and may affect investor confidence.

Lower returns

Compared to market-linked investments like stocks or mutual funds, municipal bonds offer relatively lower returns. Since their interest rates are fixed, they do not provide strong protection against inflation and eroding purchasing power, which can reduce their attractiveness over time.

Market sensitivity

The value of municipal bonds fluctuates based on interest rate changes. If interest rates go up, the price of existing bonds usually falls, which can lead to lower returns for investors.

Conclusion

Municipal bonds are an effective investment vehicle for those seeking stability, tax benefits and reasonable returns while supporting infrastructure projects. However, they are not entirely risk-free and investors should evaluate their financial goals before investing. By understanding the various types, advantages and potential risks, investors can make informed decisions about municipal bonds.

FAQs:

How do I buy municipal bonds?

Municipal bonds can be purchased through stock exchanges, brokerage firms and financial institutions that facilitate bond trading.

Do municipal bonds pay monthly?

The interest repayment schedule depends on the bond issuer but semi-annual payments are more common.

Are municipal bonds good?

Municipal bonds can be suitable for investors seeking stable, tax-efficient returns but may not be ideal for those looking for high-growth investments.

Who buys a municipal bond?

Municipal bonds are typically purchased by risk-averse investors, retirees or institutional investors.

Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.