By Debashish Biswas, Partner, and Vivek Mittal, Executive Director, Deloitte Touche Tohmatsu India LLP
Three distinct but interrelated trends shape today’s Indian growth story. First, we recently surpassed China and took over as the most populous country in the world. About 66 per cent of this population is young and below the age of 35. This group is characterised by high aspirations and a demand for improved civic services and quality of life. Second, we are witnessing rapid urbanisation. As of 2022, around 36 per cent of our country is urban in character and it is predicted that by 2035, over 43 per cent of India will be urban, housing close to 675 million people. Also, between 2019 and 2035, 17 of the 20 fastest growing cities in the world are expected to be in India. Third, our economic growth will be driven by cities. Currently, around 63 per cent of India’s economic growth comes from urban areas. This is slated to further increase to 75 per cent by 2030. This means more people will migrate to cities in search of better lives and greater aspirations. Consequently, there is an onus on urban policymakers and local governments to provide improved civic amenities and state-of-the-art urban infrastructure. The important question to ask is whether the Indian urban local bodies (ULBs) have the economic and financial muscle to support this transition.
State of ULB finances
A look at the finances of ULBs in India reveals certain fault lines, both in terms of quantum of financing and a structure. From a revenue perspective, a recent Reserve Bank of India report highlighted that the municipal revenue in India hovers at about 1 per cent of the GDP, whereas in other emerging economies such as Brazil and South Africa, the figure stands at 7.4 per cent and 6 per cent respectively. It also points out that over the last decade, growth of own source revenues for Indian ULBs has reduced and their dependence on state support has increased. Also, the tax collection bucket is dominated by property taxes, which account for close to 50 per cent of all taxes.
From an expenditure perspective, the World Bank estimates that Indian cities would need around $840 billion or $108 per capita per year between 2021 and 2036 to finance their urban infrastructure and basic service needs. Of this, around $450 billion will be required to finance basic civic services, which fall under the direct purview of ULBs. However, between 2011 and 2018, the total capital expenditure for the urban sector fell significantly short, estimated at $85 billion or $24 per capita per year.
Addressing the gaps
These trends highlight two important challenges. First, there exists a huge infrastructure financing deficit. Second, the current fiscal fundamentals of the ULBs are not sound and require attention. Therefore, there is a need to rethink municipal finance as a policy subject, augment existing revenue streams, tap new and innovative mechanisms to fund urban infrastructure, undertake municipal reforms to strengthen financing processes. Some of the efforts that can be taken in this direction are:
Estimate the medium-term and long-term financing requirements: Every ULB must quantify the infrastructure requirement in its city for the medium and long term and accordingly create a robust resource requirement estimate. Often, ULBs lack a long-term investment plan and a list of priority projects, which leaves room for ad hoc project pipeline creation and misallocation of resources. Hence, a sector-wise identification of priority projects along with their financing requirements must be undertaken by ULBs. This will also provide a longer window for the city to mobilise finances for the conceptualised projects.
Augment existing revenue streams: Municipalities can augment their existing revenue streams through various means, such as the rationalisation of taxes and user charges, introduction of new user charges such as parking fees and use of technology to boost tax collection. Many cities like Ahmedabad have incentivised property tax payers by offering rebate and discounts on early payments. Also, creating an auto increase mechanism for taxes and charges is important to ensure sustainable growth in own source revenues. For example, Tamil Nadu has recently amended its Tamil Nadu Urban Local Bodies Act, 1998 to mandate an annual automatic increase in property tax rates in line with the state GSDP. Other states such as Karnataka, Kerala and Odisha have provisions in their ULB acts to hike property taxes on a periodic basis.
Reduce property tax dependency: Another area where ULBs must channellise efforts is shifting their dependence on property taxes. For example, charges on advertisements/ hoardings and fees on parking can be sustainable revenue sources. Cities can clearly demarcate permissible hoardings into three categories – private properties, vacant lands and government properties – establishing rules and fixing charges for each category. Given that cities are growing rapidly, both vertically and horizontally, income from advertisements and hoardings can be a steady and large source of revenue. Similarly, on-street parking management systems offer significant potential. For example, in 2020, the Greater Chennai Corporation Commissioner estimated Rs 12 billion as potential revenue from parking charges. Another high potential source is user charges on waste collection. Even small ULBs such as the Vengurla Municipal Council, with about 5,000 households, generates Rs 170,000 per month through user charges and selling recycled waste.
Tap new and innovative financing mechanisms: ULBs need to look beyond the usual sources of income such as taxes and user charges. There is a need to tap new, less explored, but viable sources of funding. These include municipal bonds, value capture financing (VCF) tools and public-private partnership (PPP) models for developmental projects. Leveraging the capital markets by floating municipal bonds has proven to be an attractive financing channel. One successful example is the Vadodara Municipal Corporation, which raised Rs 1 billion with the lowest coupon rate of 7.15 per cent in the history of municipal bond issues in the country. Another landmark bond issuance was Indore Municipal Corporation’s green bond, which aimed to raise capital to build a solar plant. It was oversubscribed by 5.9 times and raised Rs 7.2 billion. Other cities that have successfully raised money through bonds are Pune, Hyderabad, Lucknow, Ahmedabad, Bhopal and Surat. The process of issuing bonds requires ULBs to implement several accounting and revenue reforms, which can serve as positive externalities.
VCF tools, such as betterment levy, are another potential source to fund developmental projects and raise revenue. The San Francisco case is a good example in this regard. The city levies an “impact fee” on new development projects to provide public services and augment infrastructure. The idea is to offset the burden of new developments on large infrastructure projects such as the transit system. Another source of revenue for ULBs is monetising vacant lands. Typically, ULBs and other state government departments own land parcels across the city in various sizes. These vacant lands can be developed into different types of facilities, such as pure parking, commercial and parking facilities and sports complexes, on a PPP basis with a revenue sharing model in place.
Municipal manpower reforms: Adequate and skilled manpower is essential for managing city finances. ULBs must be viewed as a microcosm of the larger economy and their finances must be handled by qualified professionals with experience in the urban and public finance sector. A municipal cadre must be created at the state level, where recruitment can be done through the respective state recruitment boards. Given the dynamic urban landscape, specific trainings and onboarding for this cadre must be provided in line with the ongoing developments in the urban sector including methods of financial bookkeeping, global best practices for revenue augmentation, principles of public finance, accounting and credit assessments. Also, regular upskilling programmes must be institutionalised for the existing revenue and finance staff of the ULBs.
In sum
Our cities are undergoing unprecedented transformations economically, socially and culturally. The next few decades of India’s growth narrative will revolve around cities. This means, more people, more opportunities, and more aspirations and expectations for better infrastructure and quality of life in cities. This also entails that ULBs governing our cities must address these increased expectations, create better infrastructure and ensure ease of living.
To this end, it is essential to rethink the traditional approach to municipal finances. We need a more proactive yet streamlined management of municipal revenue and finances, not just to meet urban aspirations but also to ensure sustainable urban growth.
