Aditya Roy/AI-Generated Image
Summary: Your savings account isn’t growing. FDs aren’t keeping up with inflation. But now, some Indian cities are offering something new — and investors are paying attention. Is this a smarter way to earn tax-free returns… or are there risks involved, at least for now? Let’s find out.
Savings account giving you peanuts? Fixed deposits not keeping up with inflation? You’re not alone. After a series of repo rate cuts by the RBI in 2025, most major banks have slashed savings interest rates to as low as 2.5–2.75 per cent. Fixed deposit rates have also slipped.
As interest rates decline across traditional avenues, a contender is quietly emerging from India’s urban growth story: municipal bonds.
What are municipal bonds?
Think of them as loans you give to a city. Urban local bodies (ULBs) like municipal corporations borrow money from investors by issuing these bonds, promising to repay with interest.
The funds are typically used for public infrastructure projects like water supply, sanitation, roads and housing.
These are not new. Bengaluru floated India’s first municipal bonds in 1997, followed by Ahmedabad in 1998. But for years, they were the domain of institutional investors. That changed in 2018, when Indore Municipal Corporation became the first to list on the NSE, targeting retail investors.
Now, other cities are stepping up.
Chennai’s bond issue
In May, Chennai Corporation listed its municipal bonds on the National Stock Exchange, raising Rs 230 crore. The offer was oversubscribed 4.2 times, proof of growing investor interest. The bonds offered a return of 7.97 per cent, more than many fixed deposits and savings accounts today.
And this is just the beginning. Rating agency ICRA estimates over Rs 1,500 crore will be raised through more than 10 municipal bond issuances in FY26.
Promise of tax-free and higher returns?
Municipal bonds can yield higher returns than fixed deposits (FDs). Currently, the coupon rate of municipal bonds range from 7.97 per cent (Greater Chennai) to 10.23 per cent (Greater Hyderabad).
Municipal bonds usually don’t carry an explicit guarantee from state governments. So, if a municipal body defaults, the state isn’t legally required to bail it out. However, many of these bonds are supported by the Infrastructure Development Fund (IDF) — a state-backed reserve that steps in to cover any shortfall in interest or principal payments. This backstop, while not a legal guarantee, helps bolster confidence and is one reason why bonds from cities like Chennai, Indore, Pune and Pimpri-Chinchwad enjoy strong AA+ credit ratings.
Moreover, to even qualify for issuing such bonds, a municipal corporation must show a positive net worth for three consecutive years, a basic financial filter that offers some assurance of repayment capacity.
And here’s another sweetener: most municipal bonds in India offer tax-free returns under Section 10 of the Income Tax Act.
What are the risks?
1. Low liquidity
The biggest challenge right now is getting out when you want. The secondary market for municipal bonds is still in its infancy. Trading volumes are extremely low — average daily turnover is barely over Rs 1 crore, as per India Municipal Bonds website. That means if you decide to sell your bond before maturity, you may struggle to find a buyer at the right price, or any buyer at all. This makes municipal bonds a less flexible investment compared to, say, mutual funds or listed corporate bonds.
2. Limited transparency
Unlike listed companies, municipal bond disclosures are patchy. Detailed project-level updates, city-level financial health, or repayment status can be hard to come by. This makes it difficult for retail investors to evaluate the true risks of the project they’re funding.
3. Credit risk still exists
While some municipal bonds are rated AA+, most of them are AA rated, signalling that not all cities have the same financial strength or discipline. If the issuing urban local body struggles with revenue generation or budget management, timely repayments can be at risk.
4. Don’t just check coupon rate
Investors often look at the coupon rate (the interest paid on the bond) and assume that’s the effective return. But if you’re buying a bond on the exchange (secondary market), the yield-to-maturity (YTM) is what really matters. That considers the purchase price, remaining term, and future cash flows. A bond trading at a premium could deliver far less than the coupon rate suggests.
5. Interest rate risk
If you plan to sell before maturity, rising interest rates can hurt you. Bond prices fall when interest rates rise, and municipal bonds are no exception. You could end up booking a capital loss, even if the bond offers a high coupon. Conversely, falling interest rates can boost the bond’s price, but only if you’re able to sell — which brings us back to the liquidity issue.
To sum up, municipal bonds may offer attractive, tax-free coupon rates, but the reality isn’t so simple. With poor liquidity (difficulty in selling the bonds), patchy disclosures and not-very-high credit rating, they remain a niche product in a still-developing market.
For most investors, well-managed debt mutual funds offer a far better mix of liquidity, transparency, diversification, and higher exposure to safer, AAA-rated instruments.
And if you’re a retiree seeking regular income, it’s hard to beat the Senior Citizens’ Savings Scheme (SCSS). Backed by the government, SCSS is not only safe and predictable but also offers a compelling interest rate of 8.2 per cent, as of July 23, 2025.
Want smarter debt options?
Let our experts help you discover top-rated debt mutual funds tailored to your goals.
Explore Value Research Fund Advisor Today
This article was originally published on July 23, 2025.
Ask Value Research 
New episodes every Friday 
New Process Alert 
Seems like you've uploaded a wrong QR code. Please upload the QR code downloaded from MF Central platform.
