Municipal corporations and urban local Governments in India normally issue debt securities which are commonly known as “Munis” or Municipal Bonds, intending to raise finance for socio-economic development and infrastructural development like building schools, bridges, hospitals etc.
Municipal Corporations have limited resources as they have no authority to collect taxes on property, tolls, water, and other services, like Central and State Governments. They can only arrange funds via these Bonds, but the other 2 tiers of Government have the options of Treasury Bills, SDLs (State Development Loans) and other securities.
History of Municipal Bonds
In 1997, Bengaluru became the first local government to issue Municipal Bonds, which was then followed by Ahmedabad in 1998. And by the year 2000, nine other municipalities had also raised a total of Rs. 1200 crores through municipal bonds. However, despite these early successes, municipal bonds failed to gain widespread popularity due to a lack of regulatory clarity and the fact that they were not easily tradable.
Another reason that caused a sudden halt to their journey happened in the year 2005 when Jawaharlal Nehru National Urban Renewal Mission (JNNURM) was introduced. This initiative, initiated by the Government of India under the Ministry of Urban Development, aimed at the extensive modernization of cities and identified a total of 63 cities for the program. The JNNURM envisioned a substantial investment of approximately Rs. 16,000 crores over a span of seven years, from 2005 to 2012.
In 2015, SEBI (Security Exchange Board of India) stated detailed guidelines for issuing and listing Municipal Bonds, which will help in its regulatory status and make it safer for the investor. Here are some of them: –
- No instances of debt repayment default in the past year.
- The Net-worth has shown positive growth for 3 years prior to the issuance.
- Such municipal entities, promoters, or directors should not be mentioned in the wilful defaulters’ list of RBI.
- The issuer shall obtain a credit rating from at least one credit rating agency registered with the Board.
- The issuer shall make an application for listing to one or more recognised stock exchanges in the manner specified by the Board, failure to which shall lead to a refund of all monies within 7 days
Current Scenario
- India’s first Municipal Bond for retail investors started in February 2023. The Indore Municipal Corporation launched a public offering of green municipal bonds valued at Rs. 244 crores. These bonds are rated, listed, taxable, secured, redeemable, and non-convertible, with a face value of Rs. 1,000 each and a minimum application of Rs. 10,000. Indore Municipal Corp. is the first Municipal to be listed on the NSE. The issue was oversubscribed 5-8 times across different categories (retail, institutional, corporate, HNI). On 3rd May 2023, the closing price was Rs. 254.50/-
- In February 2023, the first Municipal Index was launched by NSE. This bond index will have 28 municipal bonds issued by 10 issuers as its constituents. The bonds in the index have a credit rating of AA category.
- Currently, Rs. 2184 crores are outstanding in Municipal Bonds, making it less than 1% of the total Indian Bond market (Rs. 190 trillion).
What are the types of Municipal Bonds?
There are majorly two categories of Municipal Bonds that are listed below: –
- General Obligation Bonds
General Obligation Bonds, as the name clarifies, are issued in order to raise finances for general projects like improvising the infrastructure of any region. The repayment of the bond, including the interest, is funded through the revenue generated from various projects and taxes.
- Revenue Bonds
Revenue Bonds are issued to allocate finance for particular projects like the construction of a building. The repayment of these bonds (both the principal amount and accrued interest) will be made using revenues specifically generated from the respective projects. The revenue generated from projects financed by revenue bonds will be deposited into an escrow account, which will be monitored by financial institutions.
Risk and Returns in Municipal Bonds
According to the SEBI guidelines, the credit rating given by the Credit Rating Agency holds the utmost importance. This piece of information is mentioned in the offer document or placement memorandum. It assists in mitigating the risk and enables investors to make well-informed decisions. Currently, the yield on the NSE Municipal Bond Index is 8.79%. The coupon rate for these bonds typically falls within the range of 7-9%, although it may vary depending on the specific issue and tenure.
| Average Coupon Rate and Maturity Pattern of Municipal Bonds | |||||
| (Per cent) | |||||
| Year of Issuance | 5 years | 7 years | 10 years | 12 years | 15 years |
| 2021 | 8.1 (6.2) | ||||
| 2020 | 8.5 (6.1) | ||||
| 2019 | 8.7 (6.7) | 10.2 (6.9) | |||
| 2018 | 9.4 (7.7) | ||||
| 2017 | 7.6 (6.7) | 8.3 (7.1) | |||
| 2004 | 5.2 (5.9) | ||||
| 2002 | 9.2 (7.6) | ||||
| 2000 | 11.9 (10.4) | ||||
| 1997 | 13.0 | ||||
| Note: Values in parentheses are comparable Government bond yields of similar maturity. Source: MoHUA (cityfinance.in). | |||||
Municipal Bonds differ from G-securities as they lack a Sovereign Guarantee, but they must adhere to SEBI guidelines that mandate obtaining a credit rating report from independent agencies. Although the risk associated with Municipal Bonds is higher compared to Central/State government counterparts, it is worth noting that no previous bond issues have experienced payment defaults. The credit rating report plays a crucial role in enabling investors to make informed decisions. Municipal Corporations have implemented a structured payment mechanism where coupon and principal repayments are facilitated through an escrow account. To ensure timely payments, the municipal corporation periodically transfers a fixed amount of money from its revenues into the escrow account. This setup provides a level of assurance that the bonds will be serviced on time.
Current Status of Municipal Bonds in the Global Market
The US Municipal Bond Market is a massive industry with an outstanding value of almost $4 trillion. This market has a long history, dating back more than 200 years to 1812, when the first municipal bond was issued for a canal development in New York. With almost 45,000 – 50,000 issues, the market has grown significantly over the years.
One of the major advantages of investing in municipal Bonds is that the interest income earned from it is exempted from the Federal Tax. Retail investors are the backbone of this market, specifically, that holds about three–quarters of nearly $ 4 trillion in outstanding Bonds.
Other countries, including Sweden, New Zealand, and Finland, have well-developed municipal bond markets. Meanwhile, China and South Africa are emerging economies for municipal bonds. The popularity of these bonds among investors can be attributed to their relatively low risk and stable income, making them a valuable addition to many investment portfolios.
Opportunity for an Investor
The available funds in the Municipal Bonds are less than 1% of the total fixed-income market (Rs. 190 trillion). The Municipal Corporation required funds as the population of India is constantly migrating to cities, and the number of people shifting is increasing with every passing year, impacting infrastructural and hygiene systems. The urban facilities in India face ongoing challenges and require continuous development and financing for improvement. Municipal bonds present a win-win situation for residents, corporations, and investors seeking transparent and low-risk investment opportunities.
The 3-year lock-in period may discourage some of investors, but it still holds considerable potential for cautious investors. Previously, municipal bonds were privately placed with a minimum investment requirement of Rs. 10 lakhs, excluding retail investors. However, since the Indore Municipal Green Bond issuance and listing on the NSE in February 2023, retail investors have become new participants in municipal bond investments. The listing on an exchange provides an avenue for easy exits, increasing investor confidence and making municipal bonds an increasingly popular choice.
The major significant differentiator between the popular Munis Abroad and the Indian Municipal Bonds is the one and only tax benefit. The investors of Indian Municipal Bonds do not enjoy the exclusive feature of tax exemption like the foreign investors. The lack of tax benefits for domestic investors is a significant obstacle that prevents many potential investors from participating. However, if appropriate regulatory changes are implemented to extend tax benefits to domestic participants, it is expected that the popularity of these bonds will experience a significant surge.
Conclusion
In conclusion, municipal bonds offer a promising opportunity for middle-class investors with limited disposable income. These bonds not only have the potential to uplift the image and development of cities but also provide a reliable and guaranteed source of returns for prudent investors. Given the appealing prospect of guaranteed returns, retail investors are expected to warmly embrace this new avenue as a means to invest their funds. With their participation, municipal bonds can contribute to the growth of cities and serve as a valuable addition to diverse investment portfolios.
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