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Financing Growth of Indian Cities

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India is rapidly urbanising, with increasing urbanisation rates.  From a 30 per cent urban India in 2011, which is about 340 million people living in Indian cities, it is expected that we would have 600 million people in urban India (40 per cent urbanisation) contributing to over 70 per cent of Indian GDP in the next 20 years. It has now been quite clearly established that cities are engines of economic growth and not a matter of debate whether urbanisation is to be supported or not. Urbanisation is a natural process of economic agglomeration which will happen with economic growth, and it is then a question of quality of cities, which is of concern.

The focus of inclusive growth cannot any more be on rural India as urban poor are probably worse off than rural poor in India. Across Indian cities, the quality of life is declining and basic urban services like water, waste management, city roads, and urban transport are far below basic levels. Various policy papers, high powered or empowered committees churn out reports on urban infrastructure investment requirements, financing gaps with some possible solutions but some basic questions remain unanswered as how all these would be done and financed.

As per some latest published estimates, around $1.2-trillion investment in urban infrastructure and services is required over the next 20 years for catching up on infrastructure investment backlog and for new urban infrastructure investments to support the urbanisation process. While there are concerns on policy, governance, and planning issues in Indian cities, there is also the need to figure out how urban infrastructure and services investments would be financed. If we carry on with the present approach to developing urban infrastructure constrained by the state of municipal finances, and sometimes supported central programs, it would not be possible to meet even a major fraction of the required investment. This means that the quality of life in Indian cities would decline further instead of improving. Some cities across the world have demonstrated that such decline can be reversed over a period of 10 years but these need careful policy and institutional actions which need to be implemented at the urban local body levels.

On the subject of financing urban infrastructure and municipal services, the usual approach which we see from some economic and policy “think thanks”  and urban departments of the government is a prescription that talks about public private partnerships, commercial  borrowing and  municipal bonds. While these approaches are desirable for bridging the urban infrastructure financing gaps, it needs to be recognized that these are only ‘instruments’ which would be successful only if the underlying key issues are resolved. Public private partnerships could improve the quality of operation and maintenance in urban servicers in addition to enabling private investment in urban infrastructure. 

Assuming that these instruments and approaches would work; some have gone further to suggest and experiment with incremental innovations such as pooled financing (which is getting a number of smaller municipalities to come together for borrowing), urban infrastructure funds, credit rating of municipalities and guarantees. A few of these initiatives have also been supported by multilateral and bi-lateral institutions, case studies have been developed and a few pilot successes demonstrated (if at all) again and again over the last decade. While all of these efforts may be laudable, some of the core underlying issues remain unaddressed. Let me explain this with some examples. 

A municipality can borrow from banks or by way of issuing bonds only if they are capable of repaying them and the lender or the bond investor is convinced of the same. It is now been over 15 years since the initial set of municipal bonds were issues by some reasonably larger municipalities and since them the total mobilization by way of municipal bonds has only been around  Rs 1,200 crore, when the five-year plan requirements are of the order of  Rs 1.2 lakh crore.  

The reason is simple; most municipalities are not creditworthy enough to access commercial finance. There is need to strengthen municipal finances in India. Credit rating of municipalities can possibly provide an indication of the how creditworthy the municipality is, which only serves a limited purpose of giving a number to the what we already know about the bad state of municipal finances (with a few exceptions). PPPs in urban infrastructure have seen limited success for the same reason-weak and uncertain municipal finances. Urban infrastructure financing is the process by which cities can obtain the right mix of funding for continued investments in urban infrastructure and services so that residents can have access to better basic urban services.

Meeting the challenge of financing our huge urban infrastructure needs possibly requires a different line of thinking and strengthening of municipal governance and finances lie at the heart of this approach. It also needs to be appreciated that we are unlikely to see completely commercialised cities (except possibly a few very large ones, which could possibly generate adequate revenues to fund both operating expenses and capital expenditure from own sources. Urban infrastructure needs to be financed by a mix of public expenditure, grants, commercial borrowings, development financing and with some infrastructure being amenable to PPPs – which could be private investment with commercial revenue models and limited viability gap funding. Some of the possible fiscal and financial approaches to improving the state of municipal finances in India could include some of the following
  • Monetising urban land and capturing indirect value from urban infrastructure provisioning;
  •  Increasing property taxes which seem to be the mainstay of urban local body finances;
  • Attempting cost reflective pricing for all urban services, may be with targeted subsidies  for urban poor;
  • Ensuring certainty in timing and amount of government grant devolutions; 
  • Equitable or proportionate sharing of all tax revenues between the state and urban local bodies.
  • Creating urban regulatory institutions which provide an oversight on the quality of urban       services and provide for appropriate economic regulation. 

Only with gradual improvement in municipal finances across the board can we expect to see increasing urban infrastructure investments and improvement in quality of urban services. This could then be followed by municipalities accessing commercial bank financing, bond markets; effectively use focused urban infrastructure funds set up with mixed capital and only then Indian cities could be the driver of sustainable growth in India.

(The author is president and CEO, financial advisory division, Feedback Infrastructure Services. The views expressed here are personal).