Small Steps

Government’s recent measures for financing smart cities

One of the most critical aspects of the Smart Cities Mission is the mobilisation of funds for the planned projects. Based on the estimates of the High Powered Expert Committee on Investment, the requirement for financing smart cities is as much as Rs 350 billion annually for the next two decades.

Factors such as fiscal limitations of the government at both the central and state levels, the poor financial health of most urban local bodies (ULBs) in the country, and the problems associated with the public-private partnership (PPP) model reflect the need to depart from regular financing models and graduate to the formulation of innovative funding solutions. Until some headway is made in this direction, the private sector (which has the potential to be a game changer) will not be interested in investing its funds in this space.

Confidence building is one way the government can undertake the task at hand. Recently, in a bid to “crowd in” investments from the private sector, the centre revealed the progress on the credit rating of ULBs of those cities that have been included in the Smart Cities Mission as well as the Atal Mission for Rejuvenation and Urban Transformation (AMRUT). The idea is to grade the ULBs in terms of their financials, so that efforts of raising funds from the market through bond issuances garner investor interest.

A total of 94 cities were accorded credit ratings. Of these, 55 received investment grade ratings. Of the total 20 ratings that range from AAA to D, ULBs that have a grade of BBB- and above are investment grade. Cities that are ranked below this level are required to undertake the necessary interventions to improve their financial standing. Credit ratings are assigned based on assets and liabilities of the ULBs, their revenue streams, resources available for capital investments, and accounting and governance practices. It is pertinent to note that in addition to the credit rating of ULBs, ratings for individual projects (for which resources are to be mobilised) too have a significant impact on the channelisation of funds.

Another noteworthy step has been the introduction of the value capture financing (VCF) model by the Ministry of Urban Development in February 2017. It is planned that VCF will be an integral part of the detailed project report of all central government projects. The globally used model is based on the government’s right to claim a part of the increase in asset value resulting from its investment decisions. In other words, government investment towards developing public infrastructure often leads to rapid economic development in those areas, resulting in high land prices. A VCF framework opens a channel for the government to tap into this increment through various means such as the imposition of additional taxes, development charges, etc. and in turn utilise the funds thus raised to finance future projects.

In sum

The fund requirement for the Smart Cities Mission is large and while the government is extending financial support through various schemes such as AMRUT (which converge with the mission), it has limited fiscal capacity. In light of this, private participation is an absolute must. However, the poor uptake of the PPP model may have a significant impact on the financing for the mission. While the Kelkar Committee has recommended ways to fix the model, it may take a while before this is actually done. The recent credit rating exercise is expected to increase some investor confidence, and is likely to translate into fund flow. VCF is another laudable step that is expected to pay off and open up new avenues for capital recycling. That said, a host of factors will have a bearing on the bankability of projects. The cost of funds, financial design of projects, and contractual clauses will need to be meticulously incorporated into project conceptualisation. Often, problems in these areas are overlooked in the appraisal process and this leads to capital being locked in and further prevents fresh investment.

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