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What are municipal bonds?

8 Mins 19 May 2023 0 COMMENT

There are investment options to match different risk appetites, financial goals, and preferences. Bonds are a type of debt security that provides investors with investment stability and low-risk growth. However, as with any investment, bonds can also be subject to some risk. Therefore, it is essential to understand these instruments and learn how they function. This article will explore the basics of municipal bonds in India, including ’their meaning, features, benefits, risks, and types.

What is a municipal bond?

Municipal bonds are a form of debt securities issued by state and local governments in India. Also known as muni bonds, these securities are issued to finance public projects, such as roads, bridges, schools, tolls, and hospitals. Municipal bonds have a fixed maturity date and interest rate, which makes them a low-risk investment option. 

To get a better idea of the meaning of municipal bonds, it is essential to know how they work. Municipal bonds are like loans. When the local government bodies need funds, they issue bonds calling investors to invest in them. People who invest in bonds lend money to the local government. The government, in return, repays the money with interest. This helps investors grow financially. 

Types of municipal bonds in India

In India, investors can choose from several types of municipal bonds. Here are some of the most popular municipal bonds in India:

  • General obligation bonds: These bonds are issued with the intent to improve existing infrastructure within a locality. They are backed by the creditworthiness of the issuing municipality.
  • Revenue bonds: These bonds are issued for designated new projects like a new building or bridge. They are backed by the revenue generated by the project for which the bond was issued. The bondholders are paid from the revenue stream created by the project alone.

Benefits of investing in municipal bonds 

  • Tax-exempt income: One of the primary benefits of municipal bonds is that they enjoy a tax-free status that helps maximise earnings. Municipal bonds can be an attractive investment option for investors in higher tax brackets.
  • Diversification: Municipal bonds can benefit investors, as they are not directly correlated with the stock market or other asset classes. Investing in municipal bonds can help investors reduce their overall portfolio risk and volatility.
  • Steady income: Municipal bonds typically offer a fixed rate of interest and a predictable income stream, which can be attractive to investors seeking stable income.

Disadvantages of investing in municipal bonds

  • Low returns: Municipal bonds may offer lower returns than other types of investments, like corporate bonds and other asset classes like equity, gold, etc. 
  • Risk: Municipal bonds may carry an interest rate, credit and liquidity risks. Therefore, it is essential to factor these in. 

SEBI guidelines on municipal bonds

The Securities and Exchange Board of India (SEBI) has issued specific guidelines regarding municipal bonds. Here are some guidelines that bond issuers must follow to meet the eligibility criteria:

  • Before issuing the bond, the municipality should not have had a negative net worth in the three previous years.
  • The municipality should not have any default in the repayment of debt securities and loans availed from a bank or a Non-Banking Financial Company (NBFC) in the year before issuing the bond.
  • The group companies, promoters, and directors should not be enlisted in the wilful defaulters’ list published by the Reserve Bank of India (RBI). 
  • The municipality should not have any history of default in the payment of interest and the repayment of principal concerning debt instruments.

Conclusion

Municipal bonds can be a suitable investment option for investors depending on their investment objectives, risk tolerance, and tax situation. They are generally considered low-risk investments, as they are backed by the creditworthiness of the issuing municipality. This makes them a suitable option for investors looking for a stable and predictable income stream with low risk. Municipal bonds are also a convenient option for retirees looking for a steady income stream to supplement their retirement income. However, investors should carefully consider their financial goals and risk appetite before investing in municipal bonds and consult a financial advisor if necessary.

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