This article seeks to help readers better navigate the world of municipal bonds.
Defining Municipal Bonds
Municipal bonds (or muni) are debt instruments that are issued on behalf of municipal corporations or bodies associated with them across the country. Funds raised via municipal bonds are channeled towards financing projects aimed at the socio-economic development of the municipality in question. This could range from developing and enhancing schools and hospitals to creating bridges and providing superior amenities to the public in general.
Municipal bonds can be purchased with a maturity period that amounts to three years following which the issuing municipal corporation is obligated to provide returns to the bondholders via property and professional tax gathered or via revenue generated from certain projects. On occasion, it can be a combination of both events.
2015 witnessed the Securities and Exchange Board of India (or SEBI) revise the previously imposed guidelines pertaining to the issuance of municipal bonds. This was done such that urban local bodies (ULBs) or local government bodies could generate finances via these avenues. Shortly after, varied cities have taken advantage of these new guidelines such that they could have varied initiatives be funded. These initiatives have ranged from the Smart Cities Mission to the Atal Mission for Rejuvenation and Urban Transformation (or AMRUT) scheme in Lucknow.
Thus far, cities ranging from Amaravati to Visakhapatnam have taken advantage of and raised municipal bonds ranging from INR 2000 Crores to INR 80 Crores respectively.
SEBI Guidelines Governing Municipal Bonds
As per the new guidelines set forth by the SEBI, municipal bonds are expected to follow through with the following stipulations.
Municipal bodies that issue municipal bonds must not have a history of defaulting the repayments they owe their bondholders. Moreover, this defaulting attitude should not extend towards any debt instruments they might have gained via financial institutions over a year either.
Prior to issuing municipal bonds, municipal bodies are expected to retain a positive net worth for all three years that precede this issuance.
A municipal entity in addition to its group companies or those in charge, such as the company’s directors and promoters must not find their name listed under the wilful defaulters’ list as published by the Reserve Bank of India.
Understanding Credit Ratings that Govern Municipal Bonds
Municipal bonds that have a credit rating amounting to BBB or higher as set forth by the country’s leading credit rating agencies (such as CRISIL) are entitled to be issued to the public. These ratings have been brought forth such that there is greater popularity pertaining to the varied bonds in existence’s credibility and to substantiate the same. The confidence an investor instills in the same also increases with the aid of these ratings.
Once these bonds have been issued in the market and have been traded via the stock exchange, it isn’t out of the ordinary for their credibility to falter with reference to the municipality in question to its financial performance. Should the municipal corporation perform positively following the issuance of their bonds, the price of the same should reflect this and appreciate. Conversely, should their performance wane, their bonds will reflect a decline in their performance.
Types of Municipal Bonds in India
The prevailing forms of municipal bonds that are favored across the country include the following.
General Obligation Bonds – These bonds are issued by municipal corporations such that finances can be generated for varied projects aimed at improving the existing infrastructure that prevails within a certain region. Once these bonds mature, the repayment and interest issued to bondholders are processed via revenue created from varied projects in addition to the process of taxation.
Revenue Bonds – These bonds are focused on generating funds for specified projects that might be upcoming such as financing the construction of a new building. Once these bonds mature, the repayment and interest issued to bondholders are processed via revenue explicitly generated via the projects declared in the bonds. The revenue generated via projects which are funded with the aid of revenue bonds is deposited into an escrow account. Financial institutions concerned with the same are responsible for monitoring this account.
Examining the Advantages and Disadvantages of Municipal Bonds
There are a wide range of pros and cons associated with investing in municipal bonds each of which have been touched upon briefly below.
Advantages of Municipal Bonds
Municipal bonds are rated by leading credit rating agencies including CRISIL which provide investors with transparency such that they can make wise investment decisions.
By investing in municipal bonds, investors are free of the obligation of paying taxes provided they abide by certain rules outlined. Additionally, interest rates developed via municipal bonds are also free of taxation.
Owing to the fact that these bonds are issued by municipal authorities, there are minimal risks associated with these investments.
Disadvantages of Municipal Bonds
Those who invest in municipal bonds are required to stand by the lock-in period which is 3 years which can affect the liquidity required by some investors. Moreover, selling these securities prior to their maturity via the secondary market can be a difficult process should the bonds be issued by a municipal corporation that isn’t popular. This is owed in part to the fact that entities are then unsure about the credibility of the municipality in question in addition to their yield capabilities.
While the interest rate applicable to municipal bonds may in some scenarios be higher than other debt instruments, this interest rate may still fall below other rates applicable to market-linked financial instruments.
Those who seek to invest in municipal bonds must first consider their capacity for risk in addition to the objectives that govern their investments and the landscape of their financial portfolios. These factors must be considered against a municipal body’s credibility and their bonds’ credit rating in order to determine whether their level of liquidity and method of repayment is a viable bet.