A bet on urban India: How municipal bonds are slowly gaining traction

We look at benefits, risks, investment process, and expected returns of municipal bonds in detail.

What are benefits?

Municipalities are formed under the State Government Act, and their bonds are secured instruments created in favour of a Sebi-registered debenture trustee. Municipal bonds are considered as safe instruments, typically backed by at least four to five credit enhancement layers.

“Additionally, some ULBs provide extra cash liquidity support and state government backup. Due to these credit enhancement layers, most of these bonds receive a credit rating of at least ‘AA,’ denoting a very high degree of safety and a very low probability of default. No municipal bond issued since 2015 has defaulted to date,” said Aditi Mittal, co-founder of IndiaBonds.

However, in case any ULB defaults and fails to repay, investors have the option to seek recourse through legally enforceable transaction documents.

“In the event of a default, the trustee can invoke the security on behalf of investors and initiate recovery proceedings in accordance with the prescribed regulatory framework. This mechanism ensures a structured process for protecting investor interests,” said Suresh Darak, Founder, Bondbazaar.

What are the risks involved?

Globally, municipal bonds are considered relatively safer than other forms of state-sponsored borrowing because they are backed by direct cash flow rather than state grants. As servicing is linked to these local cash flow, both credit and political risk are relatively lower.

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Credit is a major risk associated with municipal bonds. “If there is a decline in revenue of the ULB (such as tax collections, government grants, etc.), it may impact their debt-servicing capacity and credit rating. However, to mitigate such risks, various security or credit enhancement layers are built into the bond structure, which reduces the risk of default to almost negligible. Further, there is sufficient escrow cover for the investors, which acts as the first layer of security,” said IndiaBond’s Aditi Mittal.

Many ULBs operate under budget deficits and lack stable revenue sources. Audits by the Comptroller and Auditor General (CAG) have revealed that urban local bodies (ULBs) across states are struggling with weak financial management, generating only 32 percent of their revenue from internal sources.

Another key risk is liquidity. “The lack of a developed secondary market for municipal bonds in India significantly limits their liquidity, making it difficult to sell them before maturity. Low trading volumes discourage institutional and retail participation,” said Nikhil Aggarwal, Founder & CEO, Grip Invest.

There is also a high risk related to project implementation which can affect the municipality's ability to meet bond obligations.

Further, changes in leadership, inconsistent policies, and delays in project execution can adversely affect bond performance.

“Local governments’ fiscal and financial management, including their power to levy taxes, duties, charges, and fees, often remain under the control of State governments, leading to dependence and potential political influence,” said Aggarwal.

All about municipal bonds in India

Minimum investment amount

The minimum investment amount for municipal bonds has traditionally been high (Rs 10 lakh), but recent regulatory changes have reduced it. As of 2025, the minimum face value for privately placed municipal bonds is Rs 10,000.

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Can retail investors participate?

“Since municipal bonds are generally issued on a private placement basis, retail investors may participate in these bonds in the secondary market on the stock exchanges through online bond platform providers and other market participants,” said Aditi Mittal from IndiaBonds.

How can one invest in municipal bonds?

Individual investors can purchase municipal bonds through a brokerage account. Bonds are listed on stock exchanges (NSE and BSE), and transactions can be conducted via online platforms (OBPP) or brokers. “Some banks may offer access to bond issues or related products,” said Nikhil Aggarwal.

How many municipal bonds are listed?

India’s municipal bond market still is nascent with around 55 issuances, totalling about Rs 5,000 crore since inception in 1997.

As per Sebi statistics, since June 2017, a total of 37 municipal bonds have been listed in India, issued by 18 municipalities, with a cumulative issuance amount of Rs 2,833 crore. Going forward, ICRA estimates that more than 10 issuances combined in financial year 2025-26 would raise funds in excess of around Rs 1,500 crore.

Is it okay to sell municipal bonds before maturity?

Liquidity is limited in the municipal bonds before maturity in India due to an underdeveloped secondary market for these instruments.

While it is technically possible to sell purchased bonds on the secondary market, low trading volumes and minimal liquidity can make it challenging to find buyers, or to execute trades quickly. The price at which a bond is sold before maturity can also be higher or lower than its face value, depending on changes in interest rates and the issuer's creditworthiness, potentially resulting in capital gains or losses.

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What should be the return expectations?

Municipal bonds generally offer higher returns compared to similarly rated fixed deposits as well as tax-free bonds.

Municipal bonds typically offer 1.5 percent to 2 percent higher returns than fixed deposits, along with the flexibility to exit anytime, offering superior liquidity.

“Additionally, investors may benefit from capital gains if interest rates decline or demand for the bonds increases after purchase. However, municipal bonds are not directly comparable to tax-free bonds, as the tax treatment and structure differ significantly,” said Bondbazaar’s Suresh Darak.