Home / Money / Personal Finance /  Look at liquidity when investing in municipal bonds

Recently, the Lucknow Municipal Corp. issued bonds with a coupon rate of 8.5%. Given the attractive interest rates, the bonds received bids worth 450 crore, which indicates high investor interest. Nine municipalities, including that of Ahmedabad, Pune and Indore, have raised municipal bonds recently and many more have lined up to do so, said Pratapsingh Nathani, chairman and managing director, Beacon Trusteeship Ltd, a debenture trustee firm.

He said the municipal bond market saw a flurry of activity after Sebi’s amendment to bond issuing and listing guidelines for municipalities last year. Given the high interest rate, should you invest?

Main features

These bonds are issued by municipal corporations to fund specific projects. The bonds generally have a tenure of 10 years. The minimum lot size is generally 10 lakh. As per Sebi guidelines, the bonds have to be rated by at least one credit rating agency.

The bonds are issued through private placements and are generally dominated by institutional investors like banks and mutual funds. Retail investors need to apply through registered arrangers (Sebi-registered intermediaries). “They can invest in the primary issue through their broker who can combine applications from various clients and invest in these bonds through electronic bidding platforms. After the bonds are listed, the broker will transfer the bonds to the respective clients, " said Dalal.

“The issues have to be listed on the exchange, but as the issue size is generally not high, there is very less liquidity in the secondary market, which makes it difficult to invest in these bonds through the secondary market," said Nathani.

Interest is generally paid annually and is fully taxable. The capital gains in case the bonds are sold in the secondary market after one year will be considered as long term and taxed at the rate of 10% without indexation. If they are sold before one year, they will be added to the income and taxed as per slab.

Risk and return

The interest rates are certainly attractive. “The risk is relatively low. However, the bonds don’t have any explicit guarantee. There is an implicit guarantee as it is assumed that the state government will repay in case the municipal corporation faces any cash flow issues," Vikram Dalal, managing director, Synergies Capital.

But another factor to consider is liquidity. “Retail investors should stay away from these bonds due to the paucity of liquidity, irrespective of the tenure or the security structure," said Nathani. “However, long-term investors who want them to hold till maturity can invest part of their debt corpus in these bonds," said Dalal.

When investing in a fixed-income instrument, don’t just go by the interest rates. Look at the risk and liquidity too.

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