Municipal bonds have become a matter of renewed interest with the announcement of a new incentive scheme by the Finance Minister in the Union Budget for the year 2026-27. Finance Minister Nirmala Sitharaman said, “To encourage the issuance of municipal bonds of higher value by large cities, I propose an incentive of ₹100 crore (₹1 billion) for a single bond issuance of more than ₹1000 crore (₹10 billion).” This is in addition to the current scheme under the Atal Mission for Rejuvenation and Urban Transformation (AMRUT), which incentivises issuances of up to ₹2 billion and supports smaller and medium towns.

This is a welcome initiative, probably prompted by the fact that even after 28 years of the existence of municipal bonds in India, the instrument is still in its nascent stage. In contrast, municipal bonds are a major instrument in the U.S. The question is: Will this incentive scheme work? Is it a lack of incentive structure or larger structural issues that are responsible for its minuscule role?

Municipal bonds are debt securities issued by cities and other local governmental entities to finance capital projects such as water systems, roads, or sewer networks. By purchasing these bonds, investors lend money to the issuer in exchange for periodic interest payments and the return of the principal at maturity. Broadly, municipal bonds fall into two categories: general obligation bonds, which are backed by the issuer’s overall financial strength, and revenue bonds, which are repaid from revenues generated by specific projects, such as highway tolls or lease fees. In recent years, specialised instruments such as green, blue, and solar bonds have also emerged to finance environmental and climate-related initiatives.

A Reserve Bank of India (RBI) report on municipal finances, released in 2024, highlighted the importance of municipal bonds, noting that they provide an additional source of financing for urban infrastructure projects, especially given the congenial financial markets. Furthermore, the introduction of green bonds by some MCs signals a commitment to sustainable development and climate resilience, it noted.

With rapid urbanisation, demand for high-quality, reliable public services in cities is growing rapidly, and these requirements are expected to increase further in the coming years. Municipal corporations (MCs) are responsible for providing public services in their jurisdictions, including water supply, sanitation, roads, street lighting, public parks, and fire services. At the same time, increasing urbanisation contributes to biodiversity loss, increased material consumption, and climate change. The policy goal is therefore to move towards sustainable cities, which requires not only decarbonisation across sectors but also support for people in adaptation. Financing these climate-resilient urban systems will require stronger municipal finances and new sources of funding.

Incentives increased numbers, not scale

Bengaluru Municipal Corporation was the first to issue a municipal bond in 1997, raising ₹1.25 billion. This was followed by the Ahmedabad Municipal Corporation, which issued a ₹1 billion bond in 1998. Since then, up to January 2026, 64 bond issues (49 bond issues by municipal bodies and 15 by urban parastatals) have been issued by 25 municipal bodies and 7 parastatals, raising a total of ₹83.39 billion (₹53.21 billion by municipal bodies and ₹30.18 billion by urban parastatals). The highest amount raised through municipal bonds occurred in 2025, when nine municipal bodies together raised ₹10 billion. Ahmedabad has issued bonds six times, followed by Nashik four times, and Chennai and Hyderabad three times each.

However, the journey of municipal bonds in India has not always been on an upward trajectory. After a few initial issuances, the launch of the Jawaharlal Nehru National Urban Renewal Mission (JNNURM) in 2005 made sizable capital grants available to municipal bodies, and the issuance of municipal bonds largely stopped. In 2017-18, the Government of India introduced a one-time demand-side incentive under the AMRUT scheme: ₹130 million for every ₹1 billion in bonds, with a maximum incentive of ₹260 million for a municipal body issuing bonds. To avail this incentive, 21 municipal bodies issued 29 bonds worth ₹42.4 billion.

If one compares the 29 bonds worth ₹42.4 billion issued by 21 municipal bodies since 2017 with the earlier 20 bond issues worth ₹108.2 billion by 10 municipal bodies during 1997–2017, it appears that the incentive has worked.

But in reality, when the number of municipal bodies and their potential to issue bonds are taken into account, the picture looks different. Only 25 municipal bodies to date (since 1997) have raised funds through bonds, out of 36 municipal bodies that received “A” and above credit ratings, and another 128 municipal bodies that received investment-grade “B” band ratings, when 470 municipal bodies were credit-rated under AMRUT in 2018.

Each of the 29 bonds issued has been of ₹2,000 million or less (with an average size of ₹1,462 million), except for two bonds, for which municipal bodies retained the amount from oversubscription. This indicates that the bonds were issued mainly to claim the incentive. In 15 of the 21 municipal bodies, the amount raised was 5% or less of their borrowing capacity and less than 20% of their annual capital expenditure (CAPEX).

If the need for urban infrastructure investment of these municipal bodies is taken into account, then funds raised through municipal bonds will be less than 2%.

The remaining six municipal bodies, which raised bonds of ₹250 million to ₹500 million, could also have raised bonds of larger amounts.

Thus, incentives worked to some extent, resulting in a greater number of bond issues than in earlier periods, but showed no correlation between funds raised through bonds and the financial capacity or investment needs of the municipal bodies. A well-intentioned initiative, in practice, failed!

Fixing the fundamentals

Though the new incentive is a welcome initiative, it may have even less success than the existing scheme unless the underlying causes and constraints are addressed. Under the proposed incentive, if a municipal body issues bonds of ₹10,000 million or more, it will receive an incentive of ₹1,000 million per bond issue. In India, however, there are hardly 12 to 15 municipal bodies capable of issuing bonds of ₹10,000 million and, more importantly, capable of absorbing such amounts for capital expenditure in a year.

It has also been proposed to continue the earlier incentive scheme of ₹260 million for ₹2,000 million bonds. However, issues of creditworthiness, capital absorption capacity, and willingness to leverage will persist. Fewer than 40 municipal bodies have an “A” grade credit rating, and many of them lack the capacity to absorb capital infusion of ₹2,000 million over and above the grants they receive annually. As seen earlier, some municipal bodies may issue bonds mainly to claim the incentive without a clear correlation with their financial capacity or development needs.

Incentives are desirable, but they are not a solution for the healthy growth of municipal bonds as a financing instrument for urban infrastructure. In recent years, several steps have been taken, including regulatory measures, the creation of a municipal bond information repository, an online course by the Securities and Exchange Board of India (SEBI), a municipal bond index by the National Stock Exchange, higher FPI limits, and tax exemptions for sovereign wealth funds. However, far-reaching demand-side and supply-side reforms are still needed to address the underlying constraints.

First and foremost is the financial health of municipal bodies. The lack of adequate funding sources and autonomy to raise resources remains a major constraint. Bonds are instruments that must be repaid with interest, and therefore require sufficient own-source revenue and a revenue surplus (revenue exceeding expenditure). However, municipal bodies’ own-source revenue typically ranges from 20% to 50%, and most lack adequate revenue surpluses. Unless financial health improves through stronger revenue powers, greater fiscal autonomy, and stricter accountability for resource use, incentives alone will not work.

There is also a need to improve long-term development planning and project management capacity. Weak planning and execution reduce the appetite for municipal bonds, as many municipal bodies struggle even to spend the capital grants they receive and often face time and cost overruns. In several cases, bond proceeds remained unused for long periods, forcing municipal bodies to park funds in bank deposits, earning lower interest than the cost of borrowing.

Improving accounting systems, financial management, auditing, and financial disclosure is equally important. These systems strengthen creditworthiness and build investor confidence, yet only a handful of municipal bodies currently maintain robust financial reporting systems. Clear regulations for investment recovery in the event of default are also needed to strengthen investor protection, as such provisions are largely absent from municipal legislation. Granting government security status to municipal bonds could further enable greater participation by insurance and pension funds.

Finally, a strong financial and development accountability framework for municipal bodies is essential. Providing new funding sources, autonomy, and incentives will not, in itself, lead to greater municipal bond issuance unless state governments regularly monitor and evaluate performance through an independent, consistent framework. Barring a few exceptions, municipal bodies in India are still not optimising their resources or performance.

Incentives to encourage municipal bond issuance are a welcome step. However, municipal bonds in India face deeper structural issues that need to be addressed; otherwise, even well-intentioned incentives may fail or create distortions.

The author is a freelance consultant and visiting professor in urban finance and governance.

Banner image: A road in Ahmedabad, Gujarat. (AP Photo/Ajit Solanki)

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Kundan Pandey Editor

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Cities and TownsClimate ChangeClimate Change AdaptationEnvironmental EconomicsEnvironmental PoliticsGovernanceSustainabilityIndia

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