Municipal bonds 

A municipal bond is a bond issued by a state or local government to raise funds for public projects, such as schools, roads, sewers, hospitals, or other community needs.
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Instrument Category

  • Bond Issuance

Other ınstruments ın the same Category

Green, social, sustainable and sustainability-linked bonds (GSSS bonds)
Sukuk (Bonds) 
Project bonds

Relevant case study

Municipal Bonds for Large-Scale Urban Infrastructure Projects in Gujarat, India

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Description

A municipal bond is a bond issued by a state or local government (including cities, towns, villages, counties, etc.) to raise funds for public projects, such as schools, roads, sewers, hospitals, or other community needs. The municipal entity (the ‘issuer’ or ‘borrower’) sells a bond to receive a loan from investors (‘bondholders’) and uses the proceeds to finance a project with a public benefit. Maturities of municipal bonds range from two-months to 30 years or more, with longer maturities reflecting the useful life of public assets.

Enabling Conditions and Key Considerations 

  • Existing legal framework to borrow. Laws and procedures to issue municipal bonds must be established prior to bond issuance. The framework and procedures should detail how debt can be secured, the type of security a municipality can use, the currency the bond can be denominated in, and remedies to protect lenders in the event of a default.
  • Positive credit rating. A favourable credit rating enhances the attractiveness of a municipal bond. It signals to potential investors that the bond issuer has a commendable track record of meeting its obligations, is in good financial health, and maintains strong governance practices.
  • Clear use of bond proceeds. Well-defined and necessary projects, such as infrastructure development, schools, hospitals, etc. can help demonstrate the municipality’s commitment to use bond proceeds for beneficial purposes and can enhance investor interest. The objectives and outcomes of the project would need to be established clearly.
  • Conduct market due diligence. Conducting market due diligence before issuing municipal bonds is a prudent practice to gauge demand. Establishing a precedent, such as by issuing a central government bond, can provide valuable insights into market demand. Additionally, the due diligence exercise can also help identify instances where a local government have attempted to issue a bond but failed due to bureaucratic challenges.
  • Incentives to increase attractiveness of bonds. Use of bond guarantees can help improve the attractiveness of the bond to investors by lowering the perceived risks. Deductions and tax exemptions for income from municipal bonds can also be an incentive to improve the attractiveness of the municipal bond.

Potential Challenges

  • Limited local government experience. The local government may have limited experience in navigating the complexities of bond dealings. Municipal bond issuances are not without risks, particularly the government’s inability to pay their interest and principal debt obligations as they become due under contract. If these risks are not properly anticipated or managed appropriately, the issuance of a bond can affect the local government’s finances in the future.
  • Regulatory uncertainty. Absence of clear guidelines on bond issuance for municipal corporations, or potential regulatory changes on the ability for local governments to raise debt and borrow funds, will impact the proper planning and issuance of the bond.
  • High costs of issuance. Issuance of municipal bonds requires supporting costs to be borne by the local government that issues them. Such as management fees, fees for guarantees, legal consulting, financial advisory, rating agency, due diligence fees. The government also needs to allocate a budget for the management of the bond funds.
  • Policies limiting foreign market participation. Policies mandating debt (bond) issuance exclusively in local currency may diverge from market preferences for bonds denominated in non-local currencies.

Potential Benefits

  • Municipal bonds provide long-term financing option. Municipal bonds provide local governments with a long-term financing option for infrastructure projects by aligning the repayment schedule with the useful life of the asset being finance, thus avoiding the need for short-term funding solutions.
  • Ability to raise capital for large-scale projects. Municipal bonds allow local governments to raise capital to fund vital infrastructure projects that may be challenging to finance only through direct transfers from the national budget.
  • Bond proceeds can be used to fund a variety of projects. Municipal bonds can be issued to raise funds for a variety of projects that help address critical community needs, such as schools, public transportation, roads and bridges, hospitals, water, and waste management systems.

Sources/Additional Information

Case Study

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