What are municipal bonds, and why do investors prefer them over corp bonds?

Municipal bonds are primarily issued to raise money for financing infrastructure projects like building parks, libraries, schools, police departments and community centres

The Centre has identified over 30 cities with good ratings in the municipal bond market. While Surat and Visakhapatnam will likely issue these bonds soon, Chennai could become the first megacity to do so in 2023.

In February, the Indore Municipal Corporation became the first Indian city to introduce the public issue of municipal bonds to raise Rs 244 crore.

What are municipal bonds?

Municipal bonds are issued by civic bodies to finance the needs of urban infrastructure projects. These are similar to corporate bonds but are used by civic bodies like states, counties, transit authorities, school districts and hospitals.

These bonds are primarily issued to finance infrastructure projects like building parks, libraries, schools, police departments and community centres. The bonds issued by Indore municipal corporation were to be used in building a solar power project.

Advantages of municipal bonds

These bonds raise money from individuals as well as institutions and promise a specific interest along with the return of the principal amount on maturity. Investors prefer municipal bonds as they offer a higher coupon rate than conventional PSU bonds.

Moreover, the issue sizes of these bonds are smaller, making it easier for common people to invest.

The municipal bonds are also tax-exempt, and the returns from these are not subject to taxes. It makes these bonds a subject of interest for high-net-worth individuals. 

How do municipalities pay back the investors?

Different municipalities have different methods of ensuring repayment. Tier 1 municipalities usually have surplus cash and can easily meet their obligation.

The tier 2 municipalities keep aside a part of their internal cash receivables to meet the obligation in future.

Do municipal bonds carry any risk?

These bonds are not backed by the Centre, and the municipal authorities may default on the repayment. However, these bonds are a much safer alternative to corporate bonds.