Urban Infrastructure in India
In the post 1990s era in India, the urban areas in the country have been in focus with cities being named as “the engines of economic growth”. This has been highlighted by various national missions and programs that the central government has launched in the preceding two decades to build urban infrastructure and bring in reforms in delivery of public services like public sector participation, attracting private investments in urban sectors like housing, transport, water supply, solid waste management, etc.
In the budget speech for FY 2023-24 urban infrastructure and the reforms for financing urban infrastructure projects featured prominently, it was mentioned that – “states and cities will be encouraged to undertake urban planning reforms and actions to transform our cities into ‘sustainable cities of tomorrow’. This means efficient use of land resources, adequate resources for urban infrastructure, transit-oriented development, enhanced availability and affordability of urban land, and opportunities for all”.
Adding that – “Through property tax governance reforms and ring-fencing user charges on urban infrastructure, cities will be incentivised to improve their creditworthiness for municipal bonds. Urban Infrastructure Development Fund (UIDF) will be established through use of priority sector lending shortfall. This will be managed by the National Housing Bank, and will be used by public agencies to create urban infrastructure in cities. States will be encouraged to leverage resources from the grants of the 15th Finance Commission, as well as existing schemes, to adopt appropriate user charges while accessing the UIDF. We expect to make available Rs 10,000 crore per annum for this purpose.”
Interestingly a few months earlier, in November 2022, the World Bank came out with a report on urban infrastructure financing in India, the report was titled Financing India’s Urban Infrastructure Needs: Constraints to Commercial Financing and Prospects for Policy Action. In the context of rapidly urbanising Indian cities, the need for increasing investments in urban infrastructure, the gaps in resources to finance these investments to increase the economic growth rate and living conditions in India’s urban centres. What is interesting that some of the recommendations made by the report are similar to the announcements mentioned in the budget speech like the formation of the infrastructure development fund, municipal bonds, improving creditworthiness through urban local body (ULB) resources, increasing user charges, etc.
Let’s quickly go through the main points of the World Bank report which tries to underscore the importance of financing these urban infrastructure investments from private sources to cover this financing gap including through municipal borrowing and Public Private Partnerships (PPPs). The bank has been arguing for the use of PPPs and private investments in infrastructure projects generally and specifically in urban infrastructure for several years.
The World Bank Report on Urban Infrastructure
The report aims to identify the key constraints and provide policy proposals for the state and central government and cities to address them. It also presents an updated estimates of infrastructure investment needs and analyses recent trends in capital investment and commercial financing for urban infrastructure. The scope of private financing considered in the report include – municipal borrowing/ debt financing and municipal PPPs.
It estimates that India’s cities require an estimated capital investment of USD 840 billion in urban infrastructure and municipal services till 2036. This is equivalent to 1.18 percent of estimated gross domestic product. It says that over half of these investment needs, almost USD 450 billion are in basic municipal services (i.e. water supply, sewerage, municipal solid waste management, storm water drainage, urban roads and street lighting) while the rest USD 300 billion are for mass transit projects.
It further says that these needs are significantly higher than the current levels of investment. The total capital expenditure in urban infrastructure averaged 0.6 Percent of GDP in 2011 – 2018 period. While most investment has been in basic municipal services (around 0.48 Percent of GDP), investments in metro rail infrastructure has seen strong growth.
Urban Infrastructure Financing
Discussing urban infrastructure financing the report mentions that – private commercial financing plays a very minor role in financing urban infrastructure, it is financed by intergovernmental fiscal transfers, as tied grants. It observed that the fiscal transfers from states have increased substantially over FY 2011-18. The share of ULBs’ revenue surpluses utilised to fund capital expenditure has substantially declined, accounting for 15% of total capital expenditure and halving in share of GDP terms.
Further it states that – non-guaranteed commercial financing accounted for only 5% of total capital expenditure in urban infrastructure in FY11-18. This includes debt financing by ULBs (municipal bonds and loans) and PPPs. Commercial financing has been roughly equally split between PPPs and debt. Loans from the Housing and Urban Development Corporation Ltd (HUDCO) has total capital expenditure of 8%, are guaranteed by states and not considered commercial market-based financing.
The report says that – the overall funding base to raise substantial commercial for urban infrastructure in India appears to be low at present, due to weak fiscal performance of cities, due to low Own Source Revenue (OSR) and service charges relative to economic base and low absorptive capacity for execution.
It further argues that – low service charges for municipal services undermine financial sustainability and viability. Policy decisions to keep tariffs and service charges below levels required for cost recovery and financial sustainability are contributing to low revenue. ULBs and utilities are generally unable to recover operations and maintenance (O&M) costs of providing services such as water supply and sewerage, let alone capital costs.
It notes that – in ULBs absorptive and implementation capacity for urban infrastructure delivery is low. ULBs across India have generally not been able to fully spend their budgeted capital expenditure in recent years, with some large ULBs having extremely low capital budget execution rates. Mentioning a review of 10 large ULBs from across the country it says that they were able to spend only two-thirds of their cumulative capital budget over the three recent FYs.
In the context of slow performance by ULBs on several flagship government urban missions the report points to constraints on implementation capacity. ULBs across India have executed only about one-fifth of the cumulative cost of approved projects under Smart Cities Mission (SCM) and Atal Mission for Rejuvenation and Urban Transformation (AMRUT) since the start of these missions. Resulting in budget surpluses due to increasing fiscal transfers which are not being used to finance capital expenditure.
In terms of the geographical concentration the funding base to leverage higher private financing is concentrated in a few municipal corporations in states like Gujarat, Karnataka, Maharashtra, and Tamil Nadu, accounting for over two-thirds of total OSR and revenue surplus of all ULBs nationwide.
Focusing on urban infrastructure financing through private investments the report says that – total annual issuances of commercial debt financing for ULBs, including loans and bonds, was muted in the period FY11-18, ranging between USD 156–311 million of annual issuances. On the other hand, loans from HUDCO, guaranteed by state governments, have accounted for a much larger share of capital expenditure.
It contended that – municipal bonds are very small relative to commercial loans, being less than one-tenth of total commercial debt raised by ULBs in this period. Only five cities have issued bonds in the last 4 years, despite 28 municipal corporations securing investment grade credit ratings under AMRUT and substantial incentives available from GoI.
Public Private Partnerships
Continuing on the issue of private financing the report discusses about Public Private Partnerships (PPPs) in urban infrastructure projects. It says that the PPP transactions for urban infrastructure have seen a marked decline in the last decade both in monetary value and transaction volume. Only one-third of all PPP investments awarded since 2000 came in the last decade. Municipal Solid Waste Management projects had the highest share in the last decade.
The report confirms that – PPPs in urban infrastructure have needed sizable funding support, as capital grants from state governments and central government as viability gap funding and others. City agencies have been unable to expand the resource and funding base to support private financing. This is because user charges for water supply, sewerage networks, and bus services are highly subsidised and do not recover even O&M costs. These revenues are also used to fund debt service costs for municipal borrowing.
Even in urban services where the end-user is distinctly identifiable and can be charged for the service, PPP potential is constrained by the existing revenue structure undermining their viability for private investors. In addition, PPPs have not fully accounted for risk-sharing or risk-transfer mechanisms for project risks. The report mentions example of several PPPs in Tamil Nadu facing operational issues due to unanticipated demand shocks and technical and legal challenges requiring restructuring and coming into public ownership.
The report argues that – the primary constraints preventing higher volume of private financing for urban infrastructure in India are on the demand side such as the policy and political economy decisions impacting revenue levels and funding base for private financing; weak absorptive and implementation capacity of city agencies for capital expenditure; and the restrictive inter-governmental framework which reduces accountability and incentives for city agencies to invest more ambitiously in infrastructure. The other constraint that the report mentions is the state mechanisms regulating the financing of these projects and constraints on financial markets and weak financial management.
The report summarises that, the persistently low level of private financing in urban infrastructure is primarily a fiscal and institutional problem. Private financing will remain constrained until these fiscal and institutional challenges are overcome, with cities developing the absorptive capacities and related incentives to invest more aggressively in urban infrastructure; and policy decisions are taken to increase taxes and user-charges to required levels so that the private financing required for infrastructure can be funded and repaid.
To overcome these challenges the report recommends several measures at multiple levels – national, state and city level –
In the form of structural reforms to address financial and institutional constraints –
- Fiscal transfer system (at both national and state levels) move to a more stable, formula-based, and unconditional fiscal transfer regime, a well-designed conditional transfers can also improve outcomes.
- Cities’ fiscal base and creditworthiness will be improved by addressing revenue constraints through increasing property taxes, user fees and service charges from the current low bases substantially in real terms.
- Increasing the service delivery mandates of city agencies will improve their accountability and incentives consistent with principles of the 74th Constitutional Amendment Act and devolution of water and sewerage functions may be a starting point.
- Further as part of targeted actions the report recommends a group of large, financially endowed cities raising private financing as they have a relatively strong revenue base which is not currently being fully leveraged.
State-level actions to address constraints on demand for financing and the regulatory environment are given as –
- Improving cities’ absorptive capacity with multi-year capital investment and financial planning, building a pipeline of investment projects, and operationalising these plans.
- Improving capacity of ULBs to develop and implement bankable projects and complex PPP transactions through TA and advisory to strengthen institutional capacity and creditworthiness of ULBs
- Program of performance-based fiscal transfers to improve absorptive and institutional capacity of ULBs, linking performance-based fiscal transfers to institutional results rather than specific projects.
- Improving cities’ fiduciary and public financial management quality and OSR performance through implementing accounting, auditing, and financial disclosure standards for ULBs and availability and consistency of reliable financial data; improving capacity of ULBs to collect revenue from assigned sources.
Revising regulatory environment to create more conducive conditions for municipal borrowing and PPP activity –
- Revising rules and procedures governing ULB access to private finance and borrowing.
- Improving procedures to provide dispute resolution with investors and deal with potential defaults by ULB on borrowing and support for dispute resolution between city agencies and investors/creditors
- State-controlled FIs to transition from concessional financiers to facilitate private financing.
Central Government-level actions to support ambitious reform agenda and incremental progress –
- To provide facilitation, technical assistance, capacity building and removing market frictions
- Establishing a structure such as a ‘Cities Investment Support Unit’ to focus on infrastructure finance with regulatory reform, transaction preparation and implementation for private financing including borrowing and PPP transactions.
- Information dissemination, convening, sharing strategies with prospective financiers to build relationship between investors and borrowers based on long term infrastructure and financial plans
- Building business case for urban investment through dialogues, to expose FIs/investors to the market potential for financing urban infrastructure, union government’s policy and available revenue streams to support infrastructure financing.
- Building and expanding data systems and information disclosures on urban financing, to support the development of an ecosystem of private investment which includes data, analysis and research on municipal finance trends.
What’s Changed in Past Two Decades?
As mentioned earlier urban infrastructure and the reforms for financing urban infrastructure projects were mentioned in the union budget speech. The urban areas have seen a few national missions being implemented to improve the state of infrastructure as well as bring in conditionalities with funds for reforms to privatise delivery of services and implementation of projects by the ULBs. Private sector participation through PPPs and private investments in urban projects have been advocated in urban projects for the past several years including by institutions like the World Bank.
The development of urban infrastructure comes with reform measures that have been proposed in the urban areas such as – increasing taxes and user charges on residents like property tax to fund these projects through private financing. The push for raising funds through municipal bonds is also featured in the speech, though it is not a new idea. Financing urban infrastructure through municipal bonds has also been floated for quite some years now without much success. As the report mentioned several city corporations have tried to raise funds through this route however the amounts have been miniscule. Also the inadequate credit ratings of several municipal bodies makes it difficult for them to raise money from the commercial markets.
PPPs have also been discussed in the World Bank report and has been advocated by the bank and other financial institutions to be used for infrastructure construction and service delivery for several years as part of the larger model to bring in private companies in public welfare services. Over a period of last two decades PPP projects have not been produce the desired results as suggested by its proponents in different sectors in urban services. There are very few examples of successful PPP project operating in the country without any public support. The World Bank report has also recognised that PPPs have been operating with support from the public agencies in the form of loans, grants, subsidies and increasing user charges to finance these projects and over a period of years the interest in PPPs has declined as the data also suggests. Risk allocation between public and private agencies has been a contentious issue in PPP projects since private sector wishes the public sector to take on majority of risks like investments, tariffs, social and environmental impacts, guarantees, etc leaving it free to earn risk free profits.
This has been seen in several PPP water and sewerage projects across the country. Some of these projects have been supported by the World Bank and other public agencies, however these projects have not been able to provide the desired results and have been either stalled or operated with public support presently.
The argument about the potential to increase user charges and other taxes to improve the economic base and creditworthiness of the city corporations and hence raise the private financing for infrastructure projects. However, this crucially misses the very important point about the prevailing economic conditions of the larger sections of the population, especially in the post covid years. An indication of the situation is that a large section of the population in India is availing of the food support provided by the union government. The unemployment rates are at an all-time high and the real wages have not increased in a long time. A majority of the population of the urban poor and marginalised section works in the unorganised sector without sufficient social security measures. Further increasing charges and taxes in urban areas for public services would lead to increased economic burden and distress to these sections.
Looking back a few years, the World Bank Water Sector Strategy for Urban Water Supply and Sanitation published in 1999 came up with the similar recommendations for reforms in the water sector. These include private sector participation and tariff increases to improve the delivery of services and cost recovery of services delivered. So these measures proposed in this new report are not too new in terms the policy directions that the bank has been providing to reform the urban services in the developing countries. It needs to be said that these are not new mechanisms and have been in discussion for several years.
However, implementation of private projects and reforms in the Indian context in urban areas have not been a success over a period of the past couple of decades. The previous missions like Jawaharlal Nehru National Urban Renewal Mission (JNNURM), Urban Infrastructure Development Scheme for Small and Medium Towns (UIDSSMT), Smart Cities Mission and Atal Mission for Rejuvenation and Urban Transformation (AMRUT) have attempted to implement these measures without much success. These missions had mandates to implement privatised PPP projects with reforms in hundreds of large and medium cities included in these missions. The lack of success of these missions shows that there needs to be a change in the national policies to implement urban projects and their financing, however it seems that the lessons from the past experiences have not been learnt.
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