Invest in municipal bonds? All you want to know in 5 brief points
AROUND 60 municipal corporations are set to issue bonds for smart cities soon. As per the new rules, municipal bonds will now be offered not only to financial institutions but also to the public which will be listed on stock exchanges.
Municipal bonds and types
Municipal bonds, also known as munis, are fixed income instruments, i.e., debt securities issued by government or semi-government institutions who need funding for civic projects. Normally, they are issued and redeemed at par and carry a fixed interest rate.
Types of municipal bonds
There are two types of municipal bonds —general obligation bonds and revenue bonds. General obligation bonds are issued for enhancing civic amenities such as water, sanitation, garbage disposal, etc. Revenue bonds are issued for a specific purpose such as construction of a toll road or a toll bridge. Repayment of interest and principal is made from the cash flow generated from the project for which it is issued.
How big is the market?
Municipal bonds have been in the market since 1997. As these bonds are privately placed and the participants are financial institutions and pension funds, these were not tradable. Nine municipal corporations have accessed the bond market and mobilised R1,353 crore. There are more than 80,000 issuers of muni bonds in the US and the cumulative bond market is estimated at $3.7 trillion, while in China it is at around $187 billion. As per CARE ratings, the largest municipalties with investment grade have the potential to raise R1,000-1,500 crore every year over a five-year period in the Indian market.
Mechanics
The Securities and Exchange Board of India (Sebi) has placed several conditions to safeguard the interest of the bondholders. The issuer (municipal corporations) should get the bonds rated by credit rating agencies and make upfront There should be no default in any kind of loan in the past one year and it must maintain full collateral. For revenue bond, the revenue generated from the project should be kept in a separate escrow account and financial institutions would monitor their accounts regularly.
Investor perspective
Municipal bonds enjoy tax-free status since 2001 (subject to certain conditions). Interest rates are based on the prevailing market rates. However, winning investors’ confidence is not easy. Many urban local bodies do not maintain their books of accounts properly and transparency is a matter of concern. Investors must note that municipal bonds are not risk free. Do the required homework to ascertain whether municipal bonds are appropriate for you. Consider default, interest rate and liquidity risks. However, if your risk appetite suits, municipal bonds are a great way to see steady tax-free income with marginal risk.