A wise method to diversify your fixed-income portfolio is by investing in bonds. Bond interest can be used as a secondary source of income. They can be an excellent option if you have a low-risk tolerance, implying you want to take only a little risk with your investments. They also provide easy-to-predict income while protecting your cash. One such type of investment is Municipal Bonds. Let us understand how Municipal Bond works.
What are Municipal Bonds?
A Municipal Bond is a type of debt instrument issued by a Government entity (such as a state, municipality, or district) or a non-profit organization or an allied agency that is participating in public initiatives for the development of essential infrastructure such as airports, roads, schools, bridges, etc.
Municipal Bonds’ regulatory status was clarified and made safer for investors by the thorough guidelines issued by the Securities and Exchange Board of India (SEBI) in March 2015 for issuing and listing them.
How do Municipal Bonds work?
Let us try to understand how Municipal Bonds work. Municipal Bonds are available in India from dealers, banks, brokerage houses, and sometimes directly from the municipality. There are primary and secondary markets where these bonds can be traded.
Municipal corporations produce yields on these bonds by collecting property and professional taxes, generating income from particular projects, or doing both, and these have a few-year maturity period.
Importance of Municipal Bonds
Let’s understand why Municipal Bonds are important.
- In order to upgrade aging infrastructure, big cities need the municipal bond market to expand.
- Urban local bodies (ULBs) can use them to raise money for budget initiatives since property taxes are the sole significant source of municipal income.
- Municipal Bonds provide more investment choices to Indian fixed-income investors.
Advantages of Municipal Bonds
Below mentioned are some of the advantages of Municipal Bonds.
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Upgrading public infrastructure
Municipal corporations are encouraged to fund new projects and upgrade public infrastructure by raising money from capital markets, which also motivates them to develop sound financial practices and governance principles.
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Socio-economic development
The government issues these bonds to fund public projects, household amenities, and socio-economic development.
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Improving credibility
Municipal Bonds in India are rated by renowned rating agencies, which gives credibility to investment options.
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Minimizing risk
Since local authorities backed by the government issue Municipal Bonds, there is less risk associated with these securities.
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Availing taxation benefits
Municipal Bonds are exempted from most state and local taxes, which helps in attracting attention to those in high-income tax categories.
Limitations of Municipal Bonds
Though Municipal Bonds are advantageous, there exist some limitations. For example, returns on these bonds are less than those of market-linked securities. And bonds have a lock-in period of more than three years, which burdens investors’ liquidity.
Types of Municipal Bonds in India
Following are the types of Municipal Bonds based on usage.
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General Obligation Bond
Generally speaking, these bonds are issued to raise money for general initiatives like enhancing a region’s infrastructure. Bond repayment and interest are paid using money collected through taxes and proceeds from various enterprises.
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Revenue Bond
Revenue Bonds are issued to raise money for certain projects, such as the construction of a specific building. Principal and interest on such bonds must be repaid, along with accrued interest, through expressly created funds from the projects that were publicly announced.
Who needs to think about Municipal Bonds?
Those who desire security from their investments and have low-risk tolerance should consider it. Also, investors can buy Municipal Bonds to diversify their portfolio.
Recent developments in Municipal Bonds
NSE’s index services subsidiary, NSE Indices Limited, launched India’s first-ever Municipal Bond Index called Nifty India Municipal Bond Index in 2023. It has investment-grade credit ratings and monitors the work of municipal bonds issued by Indian municipal corporations across maturities.
The index is expected to serve as a reference index followed by passive funds in the form of Exchange Traded Funds (ETFs), index funds, structured products, and a benchmark for asset managers.
Conclusion
Municipal Bonds give investors a means to receive interest payments from state and municipal governments that are tax-free, and it also aids in funding public works initiatives like building roads, schools, and other infrastructure. Municipal Bonds can be chosen as the best option for diversifying portfolios with reliable income.
Disclaimer
- This blog is exclusively for educational purposes
- Investments in the securities market are subject to market risks; read all the related documents carefully before investing
