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Municipal Bonds : Definition, How They Work & Taxability

Updated on: Jan 13th, 2022


4 min read

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The administration in India has the following three levels; the Central Government of India, State Government, and Local Municipal Body. The State and Central Governments raise funds for their developmental works through the taxes they collect from individuals. This includes both direct and indirect taxes.

How are funds raised for developmental works?

Apart from the taxes, the Central Government funds its projects through the sale of securities, bonds and treasury bills. The State Governments are empowered to raise funds through developmental loans. These loans are bonds which are market sold. Local municipal bodies form the weakest layer in the administration of the country in terms of financing capabilities. The local authorities are empowered by specific guidelines to raise funds for their developmental projects by issuing municipal bonds.

What are Municipal Bonds?

Municipal bonds are also referred to as ‘muni bonds’. The urban local government and agencies issue these bonds. Municipal bonds are issued when a government body wants to raise funds for projects such as infra-related, roads, airports, railway stations, schools, and so on. The Securities and Exchange Board of India (SEBI) circulated detailed guidelines in 2015 for the urban local bodies to raise funds by issuing municipal bonds.

Municipal Bonds in India

Municipal bonds exist in India since the year 1997. Bangalore Municipal Corporation is the first urban local body to issue municipal bonds in India. Ahmedabad followed Bangalore in the succeeding years. The municipal bonds lost the ground after the initial investors’ attraction it received and failed to raise the desired amount of funds. To revive the municipal bonds, the market watchdog SEBI came up with guidelines for the issue of municipal bonds in 2015.

SEBI Guidelines

A municipality should meet the following eligibility criteria to issue municipal bonds in India:

  • The municipality must not have a negative net worth in each of the three previous years.
  • The municipality must have no default in the repayment of debt securities and loans availed from the banks or non-banking financial companies in the last year.
  • The municipality, promoter and directors must not be enlisted in the wilful defaulters published by the Reserve Bank of India (RBI). The municipality should have no record of default in the payment of interest and repayment of principal with respect to debt instruments.

Grade of the municipal bonds

The market regulator has mandated that the municipal bonds must have a rating above the investment-grade for the public issue. The bonds must come with a maturity period of three years and financial institutions like banks must be delegates as a fiscal bureau.

Taxability of municipal bonds

The municipal bonds in India enjoy tax-free status if the investors adhere to rules, and the interest rate depends on how the markets fair. Bonds can be issued on public or the private basis. The SEBI let urban local bodies raise money for the developmental works by issuing revenue bonds. Revenue bonds are those bonds from whose revenue is used for one specific project. The revenues generated from the project is used to pay out the bond investors.

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