What you need to know about municipal bonds that offer over 8% interest

Learn about the types of bonds, risks parameters, and tax benefits that you can enjoy.

Whenever a municipality or urban local body (ULB) embarks on a large-scale developmental or maintenance project, it does so by raising funds via municipal bonds. The local administration has to follow specific guidelines as laid down by SEBI to raise money via the public route. These bonds have a mandatory rating above investment grade and offer an attractive rate of return. 

Here are some key factors to consider if you are planning on investing in municipal bonds.

• Types of bonds: There are two types of municipal bonds issued in India – General Obligation Bonds (GOB) and Revenue Bonds. GOBs are issued for financing general development projects such as roadways, bridges, hospitals, and other socioeconomic activities. Revenue Bonds are tied to specific projects such as highways or electrification projects. The repayment of such bonds is done exclusively through the revenue generated by the project.
   
• Returns: Interest rates differ from one issuing authority to another. Presently, one can purchase bonds from the municipal corporations of Ghaziabad, Pune, Lucknow, Bhopal, Indore, Hyderabad, and Ahmedabad, among others, with yields ranging from 7.5% to 8.5%. 
   
• Tenure: As per SEBI’s mandate the municipal bonds should have a minimum tenure of three years. However, some Revenue Bonds can have a maturity as high as 10 years depending on the project.
   
• Risk: All municipalities have to undergo a mandatory credit rating exercise before they are permitted to issue bonds. Presently, 55 ULBs across the country have a rating of BBB, which is the baseline investment grade. Most of the bonds listed post 2017 carry an AA grade, making them a safe investment option.
   
• Taxation: Interest earned on these bonds is usually tax-free on maturity. However, you will have to check the bond prospectus to understand the tax status. If the bond is sold after one year but before maturity, the returns will be taxed at 10% without indexation.

Related: Banking/PSU and corporate bond mutual funds: Are they 100% risk-free?

Should you invest in municipal bonds? 

Given the current interest rate market, the 8%+ return on these bonds is significantly higher compared to the average return of 5.5% available on bank deposits and other traditional options. 

These bonds also have a low investment risk, considering they are issued by some major cities that have a robust cashflow mechanism in place from sources such as property taxes, municipal fees, advertisement revenue, professional tax, stamp duty, etc. that account for almost 60% of the ULB’s revenue, thereby minimising the risk of default on the loan.

Related: Dummy’s guide to investing in government bonds or G-Secs

Municipal bonds can be a good avenue to diversify the debt portfolio for investors who are keen to hold them till maturity. In addition to the tax implications, the investment can be relatively illiquid in the secondary market even if the holder wishes to exit at a discount.

Conduct adequate due diligence on the ULB’s credibility and the bond’s credit rating to ascertain if fits with your risk appetite and investment objectives. 8 Key differences between bonds and debentures