Mounting Needs

Investment requirements for smart city projects

The implementation of the Smart Cities Mission (SCM) entails massive fund re-quirements. India’s per capita government spending in urban areas is only $17 and reflects the inadequacy in funding due to low property tax coverage and the inability of urban local bodies (ULBs) to generate revenues. In this backdrop, the SCM is being operated as a centrally sponsored mission.

A sum of Rs 480 billion has been allocated to the SCM by the central government. Central grants are to the tune of Rs 1 billion per city per year for a period of five years with matching grants from the state and city governments. Meanwhile, convergence with other programmes such as the Atal Mission for Rejuvenation and Urban Transformation (AMRUT) will ensure additional funding availability. Most smart cities (area based) will also be AMRUT cities (project based). At the planning stage itself, cities are to seek convergence with other programmes – AMRUT, the Swachh Bharat Mission, the National Heritage City Development and Augmentation Yojana, Digital India, Skill Development, Housing for All, etc.

Besides, the National Investment and Infrastructure Fund (NIIF) has been set up by the government to supplement infrastructure financing in the country. The initial authorised corpus of the fund is about $3 billion (Rs 200 billion) and may be raised as per the discretion of the Ministry of Finance. Funds under the NIIF have not yet been disbursed for the SCM.

Other funding options include public private partnerships (PPPs), value capture financing, user fees/charges, taxes, etc. Further, the possibility of issuing municipal bonds is being explored in the states of Gujarat, Tamil Nadu, Karnataka, Telangana and Andhra Pradesh. However, creditworthiness is a challenge in many municipalities. Almost all municipal acts in the country impose restrictions on the power of cities to borrow funds, in terms of balancing their budgets and seeking the permission of the state government prior to borrowing. These permissions are project based and are granted on an ad hoc basis. Recently, given the huge financing needs of smart cities, the Department of Economic Affairs has taken up a project for assessing the creditworthiness and bond-readiness of cities such as Chennai, Indore and Bhubaneswar.

Between 77 and 87 per cent of funding in all smart cities is allocated to area-based development, leaving very little funds for pan-city projects. A funding assistance to the tune of $500 million has been secured from the World Bank and about $1 billion from the Asian Development Bank (ADB). The assistance will be put to use for smart city projects by 2020. However, the exact modalities of financing are currently being worked out.

Potential funding avenues

Established by the BRICS (Brazil, Russia, India, China and South Africa) countries and headquartered in Shanghai, the New Development Bank has started financing infrastructure and sustainable development projects. India and 56 other countries have joined the Asian Infrastructure Investment Bank (AIIB), which is in the process of getting operational with support of $50 billion from China. Further, apart from the World Bank and ADB, the government can procure funds from other agencies such as the AIIB, the Japan International Cooperation Agency (JICA), Agence Française de Développement (AFD) and Germany’s GIZ and KfW among others.

According to the Department of Industrial Policy and Promotion, between January and June 2016, India surpassed the US and China as the biggest foreign direct investment destination, garnering $31 billion in investments compared to $28 billion attracted by China and $27 billion by the US.

Meanwhile, 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, investment by the government towards developing public infrastructure often leads to rapid economic development in those areas, resulting in higher 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.

Challenges and the road ahead

Fiscal limitations of the central and state governments coupled with the poor financial health of ULBs and the inherent issues associated with the PPP model have motivated states to explore new and innovative funding avenues. The need for new sources is further magnified due to limited private sector interest in the segment.

The recent credit rating exercise is expected to increase 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. w

Based on a presentation by Dr Debolina Kundu, Associate Professor, National Institute of Urban Affairs, at a recent India Infrastructure conference

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