Investing in municipal bonds? Here's all you need to know

Funding any public projects is always challenging, especially if the central government is financially stretched. However, to bridge that gap, local or state governments issued municipal bonds to fund public projects.

Municipal bonds have existed in India since 1997. Bangalore Municipal Corporation is India’s first municipal corporation to issue municipal bonds. Municipal bonds sank in popularity following their initial investor appeal and failed to raise the required capital. To reintroduce municipal bonds, the market regulator Sebi issued guidelines for their issuance in 2015.

What are municipal bonds?

The bond is issued by a municipal corporation, as the name implies. A municipal corporation is a legal organisation established by Article 243Q of the Indian Constitution to manage the local government.

The corporation is primarily responsible for local issues such as waste management, playground maintenance, street lighting, and water supply. Typically, the money necessary to conduct these tasks are allocated by either the central and state governments.

On the other hand, municipal corporations frequently struggle for appropriate funding due to the growing need for improved infrastructure and the stretched nature of government finances. As a result, municipal bonds enable local governments to meet their financial obligations while also providing increased services to citizens.

Purchasing municipal bonds is a simple process. Municipal bonds can be purchased in India through bond dealers, banks, brokerage firms, and in a few instances directly from municipalities. Municipal bonds are traded on both the primary and secondary markets. The primary market is where new bonds are issued, whereas the secondary market is mostly utilised to trade existing bonds. Further being under the bond category it is issued on a public or private basis, and on basis of that, an investor invests.

Factors to consider

> Whether the state government guarantees the bonds will vary depending on the bond issued, the overall response is no. Generally, the state government has no clear commitment that it will reimburse creditors if the municipal corporation defaults on payments.

> That said, investors must bear in mind an implied guarantee by a state government will not allow its municipal corporation to default on its debt obligations. Thus, while municipal bonds are not as safe as state-government borrowings, they are deemed sufficiently safe. This is reflected in their credit ratings, which are AA, one notch below the highest, AAA. Further, the investors should carefully review the placement paperwork for all municipal bonds to determine the level of security provided by the state governments.

> Unlike municipal bonds issued in other nations, municipal bond interest is not tax-free in India. Investors in the highest tax bracket must take post-tax returns into account when making investment decisions.