1

Background note

The Financing of Urban Infrastructure

Issues and Challenges

Prof. om Prakash Mathur, Senior Fellow and Chair, Urban Studies, Institute of Social Sciences, New Delhi. Assistance of Abbas Haider Naqvi, Akanksha Laroiya and Samyukta Varikoti in the preparation of the statistical evidence for this paper is gratefully acknowledged.

(View expressed here are personal.)

about the author

aBstractExtraordinarily important changes have taken place in the mode of financing urban infrastructure the world over, India being no exception. A broad range of financing instruments and financing arrangements are under various stages of application and experimentation to support investment in urban infrastructural services. Notwithstanding these developments, investment deficits continue to be phenomenally large. India, according to one estimate, will need to invest Rs. 39.2 lakh crore to eliminate the current infrastructure deficit and meet the infrastructure needs of the incremental urban population over a period of 20 years. The current level of infrastructure spending in India is estimated at US $17 per capita as against US $134 per capita needed to sustain its growth momentum and other macroeconomic development goals.

What impedes the flow of investments in urban infrastructure ? Does urban infrastructure as a sector rank low in the order of public investment priorities ? Or, is it an issue of the rate of return on infrastructure investments? Are there regulatory and structural issues that hamper the tapping up of the potential of financing infrastructure services such as the capital and land markets ? This paper attempts to address such questions.

The Financing of Urban Infrastructure Issues and Challenges

urban development:technological solutions and governance challenges

19-20 April 2018, Ahmedabad

1. oVerVIeWThe importance of urban infrastructure in the context of world’s urban transition has, in recent years, grown exponentially and led to a proliferation of research and studies on its role in the development process. A review of the recent studies suggests that urban infrastructure and its various dimensions such as access, adequacy, pricing, planning, delivery systems, financing, and management form an integral part of most national urban policies and urban sector interventions. In India, which is the focus of this paper, all urban sector initiatives focus on the augmentation of infrastructural facilities; these initiatives manifest on the ground in the building up of infrastructural services such as water, wastewater disposal services, solid waste management, urban roads and mobility, parks and play grounds, and safety protocols such as street lighting. Other policy aspects such as governance, capacity building, and spatial planning while unquestionably relevant, do not enjoy the same level of precedence.

Most studies underline the importance of urban infrastructure in terms of its link with economic growth, poverty reduction and quality of life, suggesting that any lag or deficit in infrastructural services and the investment that may be needed could hurt or slow down the growth process. The Mckinsey Global Institute (MGI: 2016) estimates that infrastructure typically has a rate of return of 20 per cent meaning that a $ 1 of investment could, in the long run, boost GDP by 20 cents by raising productivity, adding that GDP impacts could be higher for countries that have large infrastructural deficits. Other studies while acknowledging that economic growth is constrained by infrastructure bottlenecks and rank infrastructure as a top priority for the emerging economies are, however, less assertive about the quantitative dimensions of its growth linkages.

Studies refer to several developments that have brought about significant changes in the way urban infrastructure is understood, conceptualized, planned, financed, and managed. Firstly, the traditional notion that urban infrastructure services are ‘natural monopolies’, and are characterized by externalities, or have low price elasticity of demand and therefore, are better suited to be delivered by one producer, has substantially weakened. The process of “unbundling” of the infrastructure sector as suggested and amplified in the NCAER’s India Infrastructure Report (1996) has made it possible for the private sector to finance and manage those activities.

4

Thus, there is a far greater flexibility and space for urban infrastructural services to be planned, financed, and managed outside of the public sector framework.

Secondly, partly as a result of this conceptual shift and partly as a result of the extraordinarily important advances in the global architecture of finance, important developments have taken place in the mode of financing urban infrastructure, worldwide and in India. New instruments of financing such as the use of debt finance, land leasing and land value capture, monetization of public assets, conversion of land rights into infrastructure assets, derivatives, and Ola-Uber type of financing are under various stages of application and experimentation in the emerging and developing economics. Multiple forms of institutional arrangements such as the public-private partnership, franchises, joint ventures, concessions, urban development funds, special purpose vehicles (SPVs), and philanthropies, have emerged to support investment in urban infrastructure. Financial innovations with a view to impart efficiency in resource generation have been brought about in the form of Constitutional changes wherein fiscal transfers to municipalities can be withheld if they fail to effectively collect taxes (Brazil), issuance of tax free municipal bonds and regulations for listing of debt securities by municipalities which, inter-alia, include establishment of corporate municipal entities (India), and of establishing city-level Urban Development and Investment Companies for mobilizing finance for new infrastructure (China), to cite a few examples.

Notwithstanding these developments and the importance that has come to be placed on urban infrastructure and its financing, infrastructure gaps are phenomenally large across countries. According to the Asian Development Bank (ADB : 2017), over 400 million Asians lack electricity, roughly 30 million have no access to safe drinking water, and 1.5 million lack basic sanitation. In many countries, the ADB report states, power outages constrain economic growth and city traffic congestion costs them large sums in lost productivity, wasted fuel and human stress. It estimates that Asia will need to invest $ 22.6 trillion over 2016-2030, or about $1.5 trillion per year to provide infrastructure access (transport, power, water supply and sanitation and telecommunication) to its fast-increasing urban population. Inclusion of climate change and adaptation costs to the portfolio of services will raise the investment requirements to US $ 26.2 trillion, or 5.9 per cent of Asia’s projected GDP. In India while access of urban population to tap water within premises and basic sanitation has significantly improved, registering an annual average growth of roughly 4.5 to 5 per cent in coverage over the 1991-2011 decades, 38 per cent urban households are still without access to tap water from a treated source, and 18-19 per cent of households are without access to latrine facilities within premises (2011-12), and there are significant gaps in storm water drainage and in facilities for processing solid and liquid waste. According to the CPCB, only about 18 per cent of the total waste is processed, and installed treatment capacity of sewage generation is 38 per cent of the total sewage generation. Even in metropolitan cities, sewage treatment capacity lags considerably. Electricity consumption per capita is just about 26 per cent of the global average.

Two estimates of investment required to eliminate the current infrastructure deficit and the new demand that will emanate from the urbanization trends have been made in India in recent years. According to the High-Powered Expert Committee (HPEC: 2011), India will need to invest Rs.39.2 lakh crore at 2009-10 prices in services such as water supply, liquid and solid waste disposal and management, sewerage, storm water drains, city-wide roads and urban mobility, and street lighting to meet the current infrastructure deficit and the new demand over a period

of 20 years (2012-2031). The Mckinsey Global Institute (MGI : 2010) estimates that the annual level of per capita capital spending in urban infrastructure in India is just about US $ 17 and it will need to invest US $ 1.2 trillion in urban infrastructure, equivalent of US $ 134 per capita or almost eight times the current level of spending for sustaining its growth momentum and other macroeconomic developmental goals. Further examination of the budgetary provisions which continue to be the principal source of financing urban development and urban infrastructure - other sources still being in an incipient stage – places the annual spending at Rs. 36,946 crore ( Central government), Rs 43,129 crore (State governments), and Rs. 91,253 crore (Municipal governments). Municipal governments spending includes state government assignments, devolution and shared revenues and Finance Commission grants. In aggregate these account for just about 1.5 per cent of the country’s GDP, and irrespective of the yardstick that may be used for assessing adequacy these levels are grossly insufficient in relation to the requirements of this key sector of the Indian economy.

Several questions arise : What explains the continuing deficit in urban infrastructure? What impedes the flow of investment in urban infrastructure ? Does urban infrastructure as a sector rank low in the order of the public investment priorities ? Or, is it an issue of the rate of return on infrastructure investment ? Is this sector, for its distinctive attributes such as the low price elasticity, perceived to be risky for investment? Are there regulatory and structural issues that hamper the tapping up of the potential of sources such as the capital market and the land market ? Or, are there statutory or other forms of limitations for the borrowers such as the municipalities to effectively use their tax and non-tax powers ?

This paper attempts to address these questions. The paper has kept in view the context of the process of India’s urbanization which, although moderate by international standards, has important implications for the financing of urban infrastructure. One is the staggering scale of India’s urbanization. Between 2015 and 2030, it is expected to add 170 million people to its present urban population base. The projection that 20 to 30 per cent of this increase may be accounted for by “ Census towns” which are devoid of any kind of urban services adds an important dimension to the estimation of investment requirements for urban infrastructure. Second, India’s urbanization is taking place at a relatively low level of per capita income where even the high GDP growth rates of over 7.5 per cent may not be able to generate enough savings for meeting the varied infrastructural and other needs of an emerging economy. It places India in a position where its GDP growth rate and urbanization may on the one hand, generate higher demands on infrastructural services and on the other hand, be faced with limited fiscal space for effectively responding to the higher demand.

Thirdly, the development of urban infrastructure is shared between the three governmental tiers, their extended arms such as the development authorities, infrastructure corporations, and the private sector which make it difficult to make any assessment of the sector in terms of what is invested, the terms on which investments are made, and what additional capacities are added on an annual, or bi-annual, or even on a quinquennial basis. In this context, the paper whose main purpose is to gain better understanding of the complexities implicit in financing urban infrastructural services, looks at the existing approaches to urban infrastructure financing, attempts to identity the key impediments to investment flows and puts forward a few options that might open up the sector to accelerated investments. It draws attention to the emerging challenges to the sector in the light of the demographic, economic, and technological developments

and international benchmarks contained in the Sustainable Development Goals (SDG) and the New Urban Agenda.

Divided into four sections this paper begins with setting out a brief introduction to India’s urbanization and how its different facets such as the scale, composition, and distribution might impact the strategy of planning and financing urban infrastructure. It is followed by some facts on the state of the urban infrastructural services. Section three discusses the approach to urban infrastructural financing, the centrality of the budgetary support as the main financing source, and the continuing marginality of the other financing sources. The role of municipal governments in the development and financing of infrastructural services is analysed in some details. The concluding section underlines the key issues and lessons and discusses what options are available for accelerating investments into urban infrastructure.

2. urBanIZatIon and urBan InFrastructureWith an estimated population of 377 million and growing at an annual exponential growth rate (AEGR) of 2.76 per cent (2001-2011), urbanization occupies an important place in the Indian economy. The NITI Aayog’s three year Action Agenda recognizes urbanization as “an integral part of economic development”, while the Economic Survey 2016-17 sees it as one of the forces that will “define the trajectory of the Indian development”. Urbanization has demonstrated strong linkages with economic growth; according to the Central Statistical Organization (CSO), the urban share of the country’s GDP is 52.6 per cent (2011-12), and has witnessed a secular increase over time.

Three features of India’s urbanization that have a direct link with and impact on urban infrastructure need to be recognized at the outset. One is the scale of urban population growth. The decade 2001-2011 added an average of over 9 million persons annually to the country’s urban population base. The estimates of the United Nations indicate the annual increment to increase to 10-12 million even under conditions of an expected dip in the AEGR; more significantly, a greater part of the future increase in population will take place in the urban areas (Table 1). Rural population is projected to decline in absolute numbers from 2030 onwards. Two: although driven by a combination of three factors, natural increase, rural-urban migration and reclassification of rural settlements into urban, it is the reclassification that, prime facia, constitutes a major challenge in terms of infrastructure provision, financing, and management. These settlements happen to be devoid of urban infrastructural services. Third, close to 42-43 per cent of the 2011 urban population live in cities with over one million population; between 2001 and 2011, the population of metropolitan cities increased from 78 million to about 160 million, in part as a result of the aforementioned factors and partly an account of what is known as a “size class jumping” phenomenon, signaling yet another challenge for both assessing the infrastructure requirements of such cities as well as their financial requirements (Table 2) .

table 1: trends in India’s urbanization

Year Population (million) % urban aegr 2001-2011

1991 215.8 24.4 NO

2001 286.1 27.8 2.74

2011 377.1 31.4 2.76

Source: Census of India (various issues).

7

table 2: Basis statistics on India’s urbanization

Urban population, 2011 (million) 377.12 Projected urban population (million) 2015 428.52030 605.8AEGR (2001-2011) 2.76 per centPopulation of cities with over 1 million, 2011 (million) 159.6Per cent of the total urban population 42.2 per centPopulation share in net urban population increase (2001-2011) National increase 46.0Rural-urban migration 22.8Census towns 31.2

Sources: Census of India and United Nations, World Urbanization Prospects, 2011 (Various issues).

Development of urban infrastructure is an activity that is concomitant to the process of urbanization. As a result, urban infrastructure has historically been an integral part of the central government’s urban initiatives, earlier in initiatives such as the Environmental Improvement of Urban Slums (EIUS), Integrated Development of Small and Medium Towns (IDSMT), and JNNURM, and currently in Missions such as the Smart Cities, AMRUT, HRIDAY, and Swachh Bharat (Table 3).

table 3: Infrastructure components of central government Mission Mission / Initiative Infrastructure

Smart City Water supply, sanitation and waste management, urban mobility and public transport, health and education , electricity, affordable housing, robust IT and digitization

AMRUT Water supply, sewerage facilities and septage management , storm water drains, green spaces, parks and recreation centre’s, parking spaces and pedestrians non-motorized public transport

HRIDAY Sanitation toilets, drinking water facilities, solid waste management, traffic management, street furniture, public transport and parking

Housing for ALL (Urban) Civic amenities and infrastructure

Swachh Bharat Mission Urban households toilets, community toilets, public toilets and urinals, solid waste management

References : Mission statement and guidelinesMinistry of Urban DevelopmentMinistry of Housing and Urban AffairsMinistry of Housing and Urban Poverty Alleviation

While a few of these initiatives (IDSMT and JNNURM) have been formally evaluated, there have been no studies of the impact of these initiatives and missions on the stock of infrastructural services or the extent to which these initiatives have impacted the access of urban households to

8

services, adequacy of services, distribution of services among different income groups, or their pricing. The data as contained in the various issues of the Census of India, the National Sample Survey Organization (NSSO), and the Central Pollution Control Board (CPCB) show that the key services such as water, sanitation, and waste water disposal services are deficient in terms of their access and adequacy (Table 3). The Census of India, for instance, shows of urban households do not have tap water within premises and per cent do not have access to treated water, and per cent of households are without access to latrine facilities within premises (2011). There are significant gaps in storm water drainage and in facilities for processing solid and liquid waste. According to the CPCB, only about 18 per cent of the total waste is processed and installed treatment capacity of sewage generation is 38 per cent of the total waste generation. Even in metropolitan cities sewage treatment capacity lags considerably. Electricity consumption per capita (25 Kwh/month) is just about 26 per cent of the global average. The database provides little information on the qualitative aspects of services such as water quality, quality of treated sewage, number of houses of water supply, water losses etc. and the like (Table 4).

table 4: status of urban Infrastructural services (all India)

Water • Per cent of urban households having tap water within premises 62• Per cent of urban households having tap water from a treated source 62sanitation• Per cent of urban households to latrine within premises 81Waste• Per cent of solid waste treated (Class 1 and Class 2 cities) 23• Per cent of sewage treated 31electricity• Per cent of urban households having electricity 93• Per capita electricity consumption, kwl 25roads• Urban road length/1000 persons 12

Thus, while the economic and social significance of such services is recognized, there is a complete lack of any grip on how inadequate services affect the urban quality of life or growth, or poverty reduction.

3. aPProacH to FInancIng InFrastructureMost discussions on financing urban infrastructure centre around four questions: (i) how much is invested in urban infrastructure? (ii) who invests? (iii) what are the key sources and financing instruments? and (iv) are the investment levels adequate or proportionate to the demand? There is a notable paucity of data on these crucial questions not just in India but across countries. The Asian Development Bank (ADB) in its report Meeting Asia’s Infrastructure Needs notes: “How much has Asia invested in infrastructure? It is surprisingly difficult to answer.....countries typically do not publish aggregate investment figures, and how they report infrastructure-related data

9

varies widely” (2017: pp 17). In the case of India, the task is tenous as the development of urban infrastructure is shared between the three tiers of governments, their extended arms such as the development authorities, infrastructure corporations, and the private sector making any assessment of the sector in terms of what is invested, the terms on which investments are made, and what additional capacities get added on an annual, or bi-annual, as the quinquennial basis extremely difficult. Again, as the ADB notes: “Government budgets would seem the obvious source for infrastructure investment by the public sector, encompassing not only national and sub-national governments, but also public sector corporations (or SOEs). But not all economies publish budget data on investments by sub-national governments and investments by SOEs are typically excluded. Similarly, private sector investments might not be published or even available”. (pp. 17)

It is in the context that this section puts together the budgetary provisions and expenditures for urban development and urban infrastructure attributable to the central government, state governments, and municipalities on urban development and infrastructure to highlight firstly, the continuing primacy of the public sector in financing urban infrastructure and secondly, to demonstrate the gross insufficiency of the investment levels. The role of municipal governments in the development, financing and maintenance of infrastructural services such as water supply, wastewater disposal services, solid waste management, local roads, and street lighting is especially analysed. As this section would indicate, significant changes have taken place in the role of municipalities post-1992 Constitutional amendment with a view to empower them and enable them play a mainstream role in the Indian economic system. Several important reforms have been brought in to complement the agenda contained in the amendment.

Budgetary Provisions for Urban Development and Urban InfrastructureThere are four channels that are responsible for bulk of the urban development and infrastructure financing. These are the budgetary provisions from the fiscal resources of the various tiers of government, borrowings which include issuance of bonds and formal bank and non-bank lending, land-based financing and private financing. Direct budgetary provisions on urban infrastructure include spending of the Central, state, and municipal levels (including their extended arms).

A large part of infrastructure development takes place at sub-state, municipal levels, with these entities being directly responsible for the provision of services, and is discussed in detail in a separate sub-section. Budgetary provisions for urban development are compiled from the Central budgets and state budgets, and a consolidated statement of budgetary spending levels of municipal governments from the reports of the Finance Commissions. There are given in Table 5, showing that the Central government’s spending on urban development (urban infrastructure and other linked activities was Rs. 36946 crore in 2016-17, that of state government at Rs 43,129 crore, and that of the municipal governments at Rs. 91,253 crore in 2012-13. These account for 1.24 per cent of the GDP. An important feature of the spending levels is a rise in the central government provision for urban development and a fall in the share of the municipalities own resources.

10

table 5: Budgetary Provisions for urban development

tier of government amount (rs. crore) % of gdP

Central government (2016-17) 36,946 0.26

State governments (2014-15) 43,129 0.28

Municipal governments (2012-13) 91,253 1.07

The Role of Municipalities in Urban DevelopmentLocal governments, the constitution and powers of municipal corporations, improvement trusts and provision of public health and sanitation, communications and roads, water, land, works and buildings - commonly described as local infrastructure and services - are a State subject under the Constitution. The 1992 Constitutional amendment together with the 12th Schedule expands the list, and explicitly incorporates functions such as urban planning and town planning, regulation of land use, slum improvement, and urban poverty alleviation into the Constitution. State governments determine the level of priority that need to be assigned to either the “local governments” or “the municipalities” and to the aforementioned services vis-a-vis other sectors and developmental priorities. State governments also define the role of urbanization in their development strategies.

The Constitution of India does not lay down the revenue base for municipalities. The power to determine their revenue base – be it the tax authority, tax base, tax rate setting, local tax autonomy, or even the grant-in-aid and other form of assistance rests with the state government. Within this framework the state governments specify the taxes that municipalities can levy which historically have comprised taxes on land and buildings, taxes on advertisements other than advertisements published in the newspapers, taxes on professions, trades, calling and employment, and taxes on entertainment. In addition, there are charges, fees and fines forming the non-tax revenue base of municipalities.

Transfers from the higher to lower tiers of government and revenue – sharing arrangements are perhaps the most important feature of public finance and instrumental in making local financial adjustments. An important feature of transfers to municipalities in India is its discretionary nature. Unlike the Constitutional provision that lays down the revenue sharing arrangement between the Central government and states, there exists no statutory provision in state municipal laws that define the conditions under which transfers should take place from the states to municipalities. Since local governments is a state subject and spending responsibilities and taxation powers are determined by state governments, it is assumed that the state governments have the obligation of bridging the gap between what the municipalities are able to raise by way of taxes, charges, levies etc. and what they need to implement their spending responsibilities, with the proviso that such a gap is worked out on normative considerations and not attributable to inefficiencies and fiscal profligacy.

It is important to point out that while the municipal revenue base in India is controlled and regulated by state governments even though it may fulfil the criteria for the determination of a local tax base, for example the principle of residency and benefit taxation, low mobility, and stability over the period of business cycle, the states determine the choice of tax rates, exemption policy etc. Absence of autonomy in matters relating to tax rate setting is one of the key features of the functioning of municipal governments.

11

As urbanization has moved forward in response to both the endogenous factors as well as on account of exogenous developments such as free trade, globalization, cross border movement of capital and the like which have directly impacted a string of cities across India, the Central government has begun to take important initiatives to enable cities assume larger roles in the country’s development process. The urban sector Missions such as the Smart Cities, AMRUT, HRIDAY, and Swachh Bharat are a response to the expanding role of cities and urbanization in the country.

The role of municipalities has undergone a major shift as a result of both the Constitutional amendment and other exogenous factors, evidenced specifically in the fiscal relations between the municipalities, the state governments and the Central government. Five features of the changes are important to underline here:

• It provides for a quinquennial review of the financial position of municipalities;• It recognizes the need for and provides for a revenue-sharing arrangement between the

municipalities and state governments;• It gives options to municipalities to explore and experiment with measures that would improve

their finances;• It recognizes that municipalities are not just the responsibility of state governments – the

Central government has an important stake in financing activities that are intrinsically local; and • Municipalities have a claim on the divisible pool of the Central government resources with

many of the functions enumerated in Schedule 12 having been drawn from the concurrent list of the Constitution.

Over the past decades, these provisions have been implemented in various degrees by the Central and state governments. While a review of the impact of these provisions on the finances of municipalities is called for, this paper focuses on the shifts that have taken place in the fiscal portfolio of municipalities, and the effect of these changes in their revenue structure and base. One of the paradigm shifts in the system of municipal finance is portrayed in Table 6:

table 6: Municipal Finance: a Paradigm shift

From to

• Rents to form the basis for estimating annual rateable value and property taxation

• Negotiated intergovernmental transfers• Grant financing for municipal

infrastructure• Finances of municipalities determined

largely by the higher governmental tiers

• Municipal provision of services• Subsidised prices of basic municipal

services on grounds of their public good characteristics and externalities

• Land treated as fixed assets

• Area characteristics or capital valuation to form the basis for property taxation

• Rule or formula-based intergovernmental transfers

• Debt financing of municipal infrastructure

• Incentive funds of municipal governments to undertake reform for improving finances and financing

• Public-private partnership in the provision of municipal services

• Application of the principle of cost recovery for pricing municipal infrastructure and resources

• Land value capture

12

The fiscal role of municipalies in India’s macroeconomic framework has rarely been systematically analysed. What the municipalities spend and what they generate from the revenue-raising powers given to them under the state-level statutes, have been historically studied in a narrow, local context, and in the the state context since the adoption of the 74th Constitutional Amendment. In 2012-13, the size of the municipal sector in terms of the revenue raised was estimated at Rs. 49,913 crore with a tax revenue component of Rs. 30,912 crore. The following tables gives the revenue structure of all municipalities for 2012-13 and the change that has occurred between 2007-08 and 2012-13.

table 7: revenue structure of Municipal governments, 2012-13

structure amount % to the % of gdP (rs. crore) total 2007-08 2012-13

Own source revenues 49,913 51.6 0.60 0.53

State government grants, transfers and assignments 37,580 38.9 0.38 0.40

Government of India transfers 5,387 5.6 0.08 0.05

Finance Commission transfers 3,760 3.9 0.02 0.04

Total 96,640 100.0 1.08 1.02

Over the 2007-08 to 2012-13 period, the size of the municipal sector registered a decline in the share of “own resources” in the total, and aggregated revenues of all municipalities as also as a per cent of the country’s GDP. Two other facts are important to underline:

• As a proportion of GDP, the overall revenues of municipalities including the state government grants, shared revenues, and assignments, and central governments and Finance Commission grants declined between 2007-08 and 2012-13;

• Likewise, the share of municipalities in the total tax revenue, i.e. taxes raised by the central and state governments also declined. In fact, a decline in the municipal tax share is observed over a longer time frame.

Two comments on the aggregate performance seem necessary. First, the municipal sector in India in terms of what the municipalities generate and what they spend is tiny, and represents in a sense the intergovernmental distribution of fiscal powers between the three tiers under which they have access to relatively less buoyant and less elastic sources of income. This conclusion holds even under the assumption that inefficiencies in tax and non-tax collection may be higher in municipalities compared to the other two levels. Second, although municipal revenue expenditures that serve as a proxy for service levels have shown a marginal improvement, these are grossly insufficient to maintaining services even at minimum levels, let alone the levels indicated by the Zakaria Committee or by the HPEC under the service level benchmarks.

role of debt Financing in urban servicesIn theory, municipalities have several options for financing urban infrastructure facilities which besides own taxes, user charges and grants-in-aid include borrowings from the banks and financial intermediaries and mobilization of funds from the capital market. Yet, lending for

13

urban infrastructure in India has been limited. Interestingly, while commercial banks lending for infrastructure has risen, they have not considered urban infrastructure as one of their priority sectors. Even the non-banking companies like the NBFCs barely lend for core urban infrastructure such as water, sanitation, drainage etc. In several countries especially the West European countries, the institution of Municipal development Banks has played an important part in extending credit financing and a host of linked services to municipalities for financing services. Many countries have set up Municipal Development Funds with initial capitalization from the Central government and often supported by the international lending agencies.

Municipal bonds have emerged as an important source of financing urban infrastructure. The USA has a sophisticated municipal bond market, accounting for over 15 per cent of the GDP. In India, municipal bond is of a recent origin even though it has had the benefit of the Local Authorities. Loans Act, 1914 which lay down the framework under which a “local authority” can borrow. According to the Act, local authorities can borrow against the security of their funds subject to the specified conditions.

Municipal bond financing commenced in India in 1997 with the Bangalore Municipal Corporation issuing bonds of Rs. 125 crore with a state government guarantee. The first issue without a state government guarantee was floated by the Ahmedabad Municipal Corporation (AMC) for a sum of Rs. 100 crore for a 8 year period; state government grants to the AMC and property tax revenue were escrowed for the redemption of the bonds. Since then, 22 bonds have been issued with a total bond value of Rs. 1353 crore.

table 8: Municipal Bonds in India 1997-2016

Bond amount raised (rs. crore)

Taxable bonds 445

Tax-free bond 649

Pool finance 259

Total 1,353

Sources: Securities Exchange Board of India, 2015.

Two important features of this mode of financing need to be noted. One relates to the insertion of Clause (vii) to Section 10(15) of the Income Tax Act, 1961, exempting the interest income on bonds from payment of income tax. This clause, however, places a limit on the interest payable by the issuer to 8 per cent. The second feature of this mode of financing relates to “escrowing” of the future streams of municipal revenues for redemption of loans. Traditionally, lenders to municipal entities have sought a sovereign guarantee as a basic security mechanism. The few years of experience with the use of municipal bonds for financing urban infrastructure is that it has been limited. Studies looking into its limited use and impact point out several reasons which are important in identifying how those limitations and constraints can be overcome.

• Grant financing under Central government Missions and initiatives affect the incentive of municipalities to raise resources via bonds;

• Low level of credit rating of municipalities, and• Absence of alternatives to “escrowing” as collaterals. Public finance analysts have pointed

14

out to the short run implications of escrowing, in some cases, as much as 40-50 per cent of municipalities revenue resources that may otherwise be available for the delivery of services. It is also important to point out that the 1914 Act does not allow any immovable property to secure a loan nor does it allow for attachment of immovable property for redemption of loan. A World Bank study notes that using a municipal asset for creating a security against a loan to municipal governments is a difficult undertaking as e.g., a water treatment plant as a mortgage is of little commercial value other lender. Supply side constraints that impact the municipal bond market have also been observed.

Public – Private PartnershipThe purpose of public –private partnership is to finance public services and to enhance the operational efficiency in the provisioning of public services or a combination of the two. International experience in the developing countries indicates that the role of the private sector as a source of finance for core urban infrastructure ( water, sanitation, solid waste and drainage) requiring “lumpy” investments, has been limited to an account of the risks associated with tariff structure, the difficulties in using either marginal cost pricing or striking a balance between the cost and price of services. Many urban sector projects, as the evidence shows, have been subjected to contract renegotiation.

In India, several small-scale public – private projects have been negotiated; more recently, the private sector has shown a preference for projects that are aimed at improving operational efficiency which reduces the risks associated with tariff and other regulatory mechanism and for which public funding is available via the budgetary sources, government guarantees and the like.

4. BrIdgIng tHe InVestMent gaP : Issues, cHaLLenges and oPtIonsIndia annually invests approximately Rs. 1,75,000-2,00,000 crore for the development of urban water supply, wastewater disposal services, solid waste management, roads and other ancillary infrastructure. Forming just about 1.5-1.7 per cent of the country’s GDP compared with the Asia’s average of 5.7 per cent, it grossly falls short of requirements and explains the persistence of huge infrastructure shortages across cities and towns despite infrastructure development being central to Mission such as the Smart Cities and AMRUT. It is evident that this pace of infrastructure financing will not be able to either bridge the existing gap or meet the continuing increase in the demand for infrastructural services. While successive plans and the Niti Aayog’s three year Action Plan underline the importance of urbanization to the Indian economy, financial provisions are not proportionate to the importance embodied in the public policies , nor is it clear if additional fiscal space is available to finance urban infrastructure demanded by urbanization and economic growth, or how much budget expenditure are necessary to addressing infrastructure needs stemming from urbanization .

Public financing continues to be the principal mode of financing urban infrastructure. Municipal bond market has not shown any vibrancy and is encountering on the demand aside issues of collaterals and of statutory liquidity ratio on the supply side. Private sector participation in urban infrastructure development in thus far anecdotal, even as public policies recognize its potential that it has in the context of the current approach to urbanization.

What then are the options ? International practices focus on developing sound project pipelines to secure a flow of financing institutional investors, elimination: of regulatory impediments,

15

review of risk characteristics and development of adequate responses, and promotion of credit enhancement among others. For India, where the gaps are substantial and credit markets for urban infrastructure still in an early stages of development, there are several imperatives for opening up of the sector urban infrastructure to accelerated investments, one being an explicit recognition that the current levels are significantly lower compared to what are needed, and importantly, higher allocation are necessary for growth, poverty reduction, and basic quality of life. Secondly, urban infrastructure is as much an issue of private finance as of public finance even if the current role of private finance may be anecdotal.

Thirdly, given the primate role of municipal governments in urban infrastructure development, their fiscal empowerment is a necessary condition for accelerating investment in urban infrastructure. For this imperative to be taken forward, it is essential to –

• bring in some form of fiscal responsibility at the level of municipalities. Brazilian experience of a Constitutional amendment which provides for a withholding of grant –in –aid for municipalities in case they fail to raise revenues may serve as a case in point.

• reform the existing practices of credit rating in ways that formula- based transfers and compensatory grants are treated as a part of own revenues rather than as transfer.

• alternatives to ‘ escrowing’ as a collateral are essential to instil confidence among investors in municipal bonds. The current position where municipal assets can not be put as collateral has a dampening effect on the debt market.

• Private finance is not meant to neutralize the inefficiencies of the public sector institutions, nor is it a substitute for public finance. For private finance to serve as a viable source of finance, it is essential to impart efficiency in the use of public finance.

• A strong database on urban infrastructural development is essential to determining the investment policy for infrastructure development. Several countries have developed comprehensive physical reporting system which make it possible to track urban infrastructure along various dimensions.

The importance of land as a source of financing urban development has been underlined internationally and in India. The example of China which has made use of land leasing to finance its urban infrastructure has been widely used to underline the potential of land. Also, a number of land-based instruments such as development charges, betterment levis, land leasing, land monetization, tax increment have been cited as possible instruments for raising resources and using them for infrastructure development. Land leasing has enabled municipalities in China gain control over a revenue source which is within their control. India has also made use of the land-based resources for real estate development ; their use for infrastructure development has, however been limited.

referencesAsian Development Bank. 2017. Meeting Asia’s Infrastructure Needs. Manila.Briceno-Garmendia, Cecilia et.al. Undated. “Infrastructure Services in Developing Countries : Access , Quality Costs

and policy Reform”. The World Bank. Washington D.C.Cao, Chengxin and Zhirong Jerry Zhau. 2011. Funding China’s Urban Infrastructure: Revenue Structure and Financing

Approach. University of Minnesota. Minneapolis. USA.City of London . 2010. Indian Infrastructure : Going Beyond the Sound bytes. The Council of EU Chamber of Commerce

16

in India. Mumbai.Fang, Chuanglin and Danlin Yu. 2016. China’s New Urbanization : Development Paths, Blueprints and Patterns.

Springer and Sciences Press Ltd, Beijing.Global Environmental Facility and UNEP. 2014. Sustainable Urbanization Policy Brief. Report to the 5th GEF Assembly.

Mexico.Government of India, 2018. Economic Survey, 2017-18. New Delhi .Government of India. Ministry of Urban Development and Poverty Alleviation. 2001. Guidelines for the Issue of Tax

Free Bonds. New Delhi.Government of Ontario. 1997. Municipal Property Assessment Corporation Act 1997.Henckel, Timo and Warbick, Mckibbin. 2010. The Economics of Infrastructure in a Globalized World: Issues, Lessons

and Future Challenges. Brookings. Washington D. C.Infrastructure Development Finance Company Ltd. 2012 Evolving Perspectives in the Development of Indian

Infrastructure. Orient Blackswan Private Ltd. New Delhi.Kohli, Harinder S et.al.2017 Asia 2050 : Realising the Asian Century . Asian Development Bank. Manila.Mathur, Om Prakash and Sandeep Thakur. 2004. India’s Municipal sector: A study for the Twelfth Finance Commission.

National Institute of Public Finance and Policy. New Delhi.Mathur, Om Prakash, 2012. Intergovernmental Transfers in Local government Finance : A Report to UN-Habitat, Nairobi. Mathur, Om Prakash. 2006 . “ Urban Finance” in IDFC. India Infrastructure Report. New Delhi. Mathur, Om Prakash. 2014. “ India : Decentralization and Municipal Finance”, a paper prepared for the World Bank’s

Leveraging Urbanization in South Asia. 2015.Mckinsey Global Institute. 2016. Bridging Global Infrastructure Gaps. Mckinsy Global Institute. 2010. India’s urban awakening, Building inclusive cities, sustaining economic growth.Ministry of Housing and Urban Affairs. 2017. Guidelines for Swachh Bharat Mission. Urban (Revised). New DelhiMinistry of Urban Development, 2015. Government of India. Smart City: Mission Statement and Guidelines. New Delhi.Atal Mission for Rejuvenation and Urban Transformation : Mission Statement and Guidelines. New Delhi.HRIDAY: Heritage City Development and Augmentation Yojna : Guidelines. New Delhi.Ministry of Urban Development. 2011. Report on India Urban Infrastructure and Services. New Delhi. Mohanty P K, 2016. Financing Cities in India : Municipal Reforms , Fiscal Accountability and Urban infrastructure.

Sage Publication India Pvt. Ltd., New Delhi.National Council of Applied Economic Research. 1996. Expert Group on the Commercialisation of Infrastructure

projects. Published on behalf of the Ministry of Finance, Government of India, New Delhi.Niti Aayog. 2017 Three Year Action Agenda 2017-18 to 2019-20. Government of India, New Delhi Nowlan, David M. undated . “Local Taxation as an Instrumental of Policy “. Paper presented at a York University

Workshop on the Changing Metropolitan Metropolis. University of Toronto. TorontoPeterson, George and Patricia Clarke Annez. 2007 Financing Cities: Fiscal Responsibilities and Urban Infrastructure in

Brazil, China, India, Poland and South Africa, Sage Publication India Pvt.Ltd, New Delhi.Reserve Bank of India. State Finance: A study of Budgets Several issues. MumbaiSecurities Exchange Board of India 2015. “Issue and Listing of Debt Securities by Municipality” Regulations.Serageldin, Ismail. 1994. Water supply, Sanitation and Environmental Sustainability. The World Bank, Washington D.C.Smolka, Martin O. 2013. “ Implementing Value Capture in Latin America : Policies and Tools for Urban Development.

Lincoln Institute of Land Policy . Cambridge.Sridhar, Kata Seetharam and Om Prakash Mathur 2009. Costs and Challenges of Local Urban Services : Evidence

from Indian Cities. Oxford University Press. New Delhi.Su, Ming and Quanhou Zhao. Undated. “The Fiscal Framework and Urban Infrastructure Finance in China”. The

Research Institute for Fiscal Science. Ministry of Finance. Beijing. The World Bank. 2004. Reforming Infrastructure: Privatization , Regulation, and Competition. Washington D.C.The World Bank. 2011. Developing a Regulatory Framework for Municipal Borrowing in India. Washington D.C.United Nation Centre for Human Settlement. 2015. “Municipal Finance”. Habitat III Issue Paper. Nairobi.Yoshino, Naoyuki and Peter Morgan. 2017. Central and Local Government Relations in Asia. ADB Institute. Tokyo.

18