Why in News ?
- The Finance Ministry has allowed municipal bonds to be used as eligible collateral in repo and reverse repo transactions, as per a notification under the Securities and Exchange Board of India (SEBI) Act, 1992.
- This move effectively creates a new investible asset class and aims to deepen India’s municipal bond market.
Relevance
- GS-3 (Economy): Financial markets, urban infrastructure financing, fiscal decentralization.
- GS-2 (Governance): Strengthening local governance and municipal accountability.
- GS-1 (Urbanization): Financing challenges of rapidly urbanizing India.
Concept Basics: What are Municipal Bonds
- Definition: Debt instruments issued by Urban Local Bodies (ULBs) to raise funds for infrastructure projects (e.g., water supply, sanitation, urban mobility).
- Types:
- General Obligation Bonds: Backed by the issuer’s credit and taxing power.
- Revenue Bonds: Secured by specific revenue streams (e.g., tolls, user charges).
- Legal Framework in India:
- SEBI’s 2015 Regulations – Issue and Listing of Debt Securities by Municipalities.
- Requires credit rating, financial disclosure, and no default record in previous 365 days.
Significance of Allowing Repo Eligibility
Liquidity and Depth
- Before: Municipal bonds were largely illiquid, held mainly by long-term investors (pension funds, ESG investors).
- Now: Can be used for short-term borrowing/lending, attracting banks, mutual funds, insurers, etc.
- Enhances market depth, price discovery, and liquidity.
Broader Investor Base
- Expands participation from institutional investors who prefer liquid securities.
- Improves credit visibility and market confidence in ULBs.
Infrastructure Financing
- Enables cash-strapped municipalities to fund urban infrastructure (water, waste, transport, green projects) through market borrowings rather than dependence on grants.
Fiscal Decentralization
- Strengthens financial autonomy of urban local bodies, consistent with the 74th Constitutional Amendment and Atmanirbhar Bharat’s decentralisation goals.
Inclusion in Money Market Ecosystem
- Puts municipal bonds on par with sovereign and corporate bonds for short-term liquidity operations.
Challenges & Constraints
| Challenge | Explanation |
| Low Credit Quality of ULBs | Most municipalities have weak balance sheets, limited revenue sources (property tax collection <0.2% of GDP). |
| Lack of Disclosure & Transparency | Many ULBs don’t maintain audited accounts or meet SEBI disclosure norms. |
| Limited Investor Appetite | Past issuances (₹3,300 crore as of Sep 2025) are minuscule compared to central/state issuances (₹20–25 lakh crore annually). |
| Risk of Default | Despite being “secured”, weak governance and revenue unpredictability raise credit risk. |
| Capacity Gaps | Small/medium ULBs lack technical capacity to issue or manage bonds effectively. |
Data & Trends
- First modern municipal bond: Ahmedabad, 1998.
- Total raised till 2025: ~₹3,300 crore (SEBI).
- Top issuers: Pune, Hyderabad, Indore, Surat, Ahmedabad, and Lucknow.
- GoI incentive: ₹13 crore for every ₹100 crore bond issue (since FY18).
- Credit Costs: Gradual moderation in H2FY26 as repayment trends improve (Kotak Mahindra Bank).
Global Context
| Country | Model / Lesson |
| United States | $4 trillion municipal bond market; deeply liquid; backed by local tax revenues and often insured; key to financing schools, roads, and hospitals. |
| Japan | Local government bonds supported by strong fiscal discipline and transparent credit data. |
| Brazil | Uses municipal debt for urban transport and housing, supported by fiscal transfer guarantees. |
| South Africa | Johannesburg pioneered local government bonds (2004) to fund urban infrastructure; backed by robust local governance frameworks. |
Learning for India:
Need for robust credit rating system, disclosure norms, and municipal finance reform to emulate mature bond ecosystems.
Policy & Institutional Enablers
- SEBI 2015 Regulations – standardised issuance process.
- 15th Finance Commission – recommended incentives for municipal bond issuances.
- AMRUT 2.0 and National Urban Infrastructure Fund (NUIF) – facilitate city-level creditworthiness enhancement.
- Smart Cities Mission – encourages credit rating of cities.
- RBI & SEBI Coordination – repo eligibility links bond market to central liquidity mechanisms.
Way Forward
- Credit Enhancement Mechanisms: State guarantees, pooled finance models (like Tamil Nadu Urban Development Fund).
- Transparency Reforms: Mandatory annual financial disclosures of ULBs.
- Digital Municipal Market Infrastructure: Centralized municipal bond exchange portal for real-time trading.
- Capacity Building: Training local officials on project finance and bond issuance.
- Green & Social Bonds: Promote ESG-focused municipal instruments to attract sustainable finance.
