India’s urban infrastructure sector faces a critical challenge due to a persistent shortfall in revenue levels compared to the growing needs of its expanding cities. Despite the high investment needed for the development and maintenance of urban infrastructure, available resources remain insufficient.
As per CRISIL, overall capital expenditure in the sector is around Rs 20 trillion, to be incurred by both the centre and states over fiscal years 2020-25. Of this, over half of the investment requirement, worth Rs 37 trillion ($450 billion) during the period 2021-36, is for basic urban/municipal services. However, between 2012 and 2018, investments in the sector accounted for just 0.6 per cent of the GDP. Additionally, since 2018, the trend has continued with similar spending patterns.
Functioning and financing needs of municipal bodies
Funding urban infrastructure in India presents a unique challenge where a one-size-fits-all approach cannot be applied to municipal corporations. This is primarily due to the fact that all local governments in the country do not perform the same functions. Further, the urban infrastructure sector is a state subject under the constitution, with the institutional framework varying across policymaking bodies.
For instance, in Delhi, the water supply and sewerage services are managed by a dedicated body, the Delhi Jal Board. The same is the case with Hyderabad, Bengaluru and Chennai, with their own dedicated bodies. A key service provided by all local bodies is solid waste management. In contrast, in Rajasthan, water supply responsibilities are under the Public Health Engineering Department, while sewerage management has been passed on to the local bodies. Similarly, some cities in Gujarat and Maharashtra operate city bus services, although urban transportation remains a discretionary rather than an obligatory function for these bodies. Furthermore, some cities in Maharashtra and Gujarat extend healthcare facilities as well.
Multiple bodies, including municipal corporations, state town planning departments, public works departments and redevelopment authorities, engage in urban planning responsibilities. The scale of investment required for development depends on various services provided by these entities. In line with this, municipalities investing in large-scale infrastructure can explore funding options like municipal bonds. However, this is not always ideal.
With a few exceptions, most local governments in India are accountable to state governments and require approval for critical decisions such as revisions in tariffs or expenditure approvals. However, this governance structure is not uniform across all states.
Challenges in revenue generation 
Indian municipal bodies face a significant challenge in revenue generation. These bodies currently generate revenue of Rs 4,624 per capita on basic urban services, excluding urban transport. However, as per CRISIL, the required revenue to adequately meet these needs is around Rs 9,700 per capita. Consequently, this shortfall of sufficient revenue translates into a lack of borrowing capacity for local bodies.
Additionally, municipal bodies lack revenue sources linked to economic activity across cities, resulting in minimal growth in their revenue streams. Previously, octroi duties were a significant revenue source. However, with the implementation of the goods and services tax (GST), these were phased out and made unconstitutional. As a result, cities now primarily depend on central and state governments to meet expenditure obligations. Meanwhile, their own revenue sources remain underutilised.
Property tax revenue should ideally account for 0.6 per cent of the GDP of any fast developing economy. However, for India, this stands at merely 0.15 per cent. In absolute terms, total property tax collection in India is approximately Rs 300 billion per year, far below the potential Rs 1.2 trillion it should achieve.
Unlike utilities such as water and electricity, which can be disconnected due to non-payment for service, solid waste management is a necessary service to prevent public health hazards. These services are heavily dependent on taxes. However, low property tax collection in Indian cities has historically resulted in inadequate funding for solid waste management services. As a result, this has adversely impacted capital investments.
With overall property tax collections at around 0.34 per cent of GDP, Maharashtra has performed relatively well; however, this also falls short of the ideal benchmark of 0.6 per cent. This is followed by Telangana and Karnataka (0.21 per cent), Chhattisgarh (0.16 per cent) and Madhya Pradesh (0.15 per cent).
Trends in bond issuances
Between 1997 and 2005, cities actively utilised municipal bonds, supported by octroi revenues that provided a stable financial base for these issuances. However, with the introduction of the Jawaharlal Nehru National Urban Renewal Mission in 2005, the funding model shifted, with greater reliance on grants from the central and state governments, reducing the need for cities to borrow. Following this, municipal bond issuances gradually declined.
Fast forward to 2015-16, the interest in municipal bonds resurfaced. However, the progress has been modest since 2017, with total funds raised amounting to approximately Rs 24 billion. Raising funds through bonds requires more than just creditworthiness; it also demands a substantial revenue surplus to raise the money and invest in pent-up and upcoming demand for future infrastructure development.
Key recommendations for the uptake of municipal financing
A key requirement for local governments is to ensure they cover their operations and maintenance (O&M) expenditure. Further, this expenditure needs to align with best asset management practices. For instance, if the O&M cost of an asset is estimated at 8 per cent of its capital cost, spending below this threshold will compromise its lifespan.
Another key recommendation is the structural reform in the form of sharing GST revenues to enhance the investment capacity of city governments, as GST is a reliable funding source. Currently, the revenue base of city governments is only sufficient to cover O&M expenses, even if all revenue sources are optimised, leaving them unable to fund capital expenditures. In this case, revenue sharing can provide financial support.
In the near term, to meet the growing demand and obligations for urban infrastructure, revenue streams across municipal bodies must increase. Property tax rates should be enhanced such that they reach approximately 0.6 per cent of GDP, while other taxes should contribute around 0.1 per cent. Non-tax revenues, such as user charges, currently at 0.18 per cent of GDP, need to rise to 0.5 per cent. Transfers from the central and state governments, which currently stand at 0.12 per cent and 0.33 per cent of GDP, respectively, must remain stable. Additionally, introducing a GST revenue-sharing mechanism at 0.25 per cent of GDP, together with other efforts, can potentially elevate municipal revenues to 1.9 per cent of GDP.
Although this target remains lower than the 3-4 per cent in other developing countries, it represents a crucial first step. Implementing these measures would increase municipal revenues from Rs 1.5 trillion in 2018 to an estimated Rs 5.17 trillion in the future. This shift would move municipal revenues closer to a level that aligns with the scale and responsibilities of local governments, enabling them to meet their infrastructure needs better.
The way forward
The sector’s overall investment requirement is projected at $840 billion. To meet this, annual investments must double in size, reaching approximately 1.18 per cent of GDP by 2036. Going forward, a positive outlook for urban infrastructure funding lies in the adoption of strategic measures to enhance municipal revenue streams. Net, net, by aligning O&M expenditure with sound asset management practices, introducing revenue-sharing mechanisms and targeting an increase in property taxes, non-tax revenues, and central and state transfers, municipal revenues can grow significantly, enabling cities to meet their infrastructure needs more effectively in the near future.
