Fix municipal balance sheets to fund urban infrastructure
India’s urban infrastructure is estimated to require Rs40 trillion of investments between 2011 and 2031, but municipal revenues account for less than Rs1.2 trillion today
The Smart Cities Mission will cover 100 smart cities with an outlay of Rs.50,000 crore from the central government and a matching amount from states and cities. This would amount to Rs.200 crore per year per city. The mission guidelines suggest that this outlay will not meet full project costs, and additional funds are expected to be mobilised from sources such as public private partnerships (PPP), innovative financing mechanisms like municipal bonds and tax increment financing, plain vanilla borrowings, etc.
The government of India has undertaken measures to create a facilitative environment for additional funding of Smart City projects. The Securities Exchange Board of India (Sebi) has issued regulations for issuance of municipal bonds, the Kelkar committee has submitted a report on PPPs and the 14th Finance Commission has listed several recommendations on how additional resources can be mobilised by municipalities. The Smart Cities Mission along with the above measures is certainly a positive step and will undoubtedly result in at least a few successes if not many. But the relevant question is not whether it is positive or not, or whether anecdotal successes in the form of signature projects will or will not get done under the Smart Cities Mission. What is critical to question is whether the Smart Cities Mission and allied policy measures will have a transformative impact. Does the Mission set our cities on a new trajectory which will lead to sustained transformation in quality of life? The answer is no.
There are principally four underlying policy drivers of our cities, what we can refer to as city-systems. They are spatial planning and design, municipal finance and staffing, quality of political leadership in a city and transparency, accountability and citizen participation. Local governments being a state subject under the Constitution, these city-systems will need to be put in place by state governments. Municipal finance however is an exception, and this is where the Smart Cities Mission should have done more to become a transformative intervention.
We need to recognize that municipal finance is an integral component of the public finance system of the country, and an increasingly crucial one at that. India’s urban infrastructure is estimated to require Rs.40 trillion of investments in a 20-year period from 2011 to 2031.
Today, municipal revenues at less than Rs.1.2 trillion account for approximately 1% of the country’s GDP as against 6%+ in Brazil, South Africa, etc. Of this Rs.1.2 trillion, own revenues of municipalities are estimated at less than a third, with a large chunk of municipal revenues coming from central and state government grants. Sustainable financing of urban infrastructure is therefore a problem that is yet to be prioritized and solved, and merits a place in the national fiscal consciousness. The central government alone can catalyse reforms in this sector at scale, given the technical expertise required and parallels that can be drawn from other areas of reform like corporate and securities laws and regulations.
Take for example how publicly listed companies in India raise adequate capital from investors to meet their capital requirements and are in turn accountable to them for their financial and operational performance. On the one hand, there is a functioning, reasonably well-regulated capital market that exists where different market participants interact. On the other hand, there are robust regulations and market practices around credit rating, financial reporting and independent audits that serve as a bedrock of trust between market participants. The Companies Act, Sebi regulations and guidelines of the Institute of Chartered Accountants of India have extensive provisions on how balance sheets of companies need to be drawn up (detailed formats prescribed under the Act and accounting standards issued by Institute of Chartered Accountants of India), at what frequency they need to be published (quarterly), who needs to audit them (independent Chartered Accountants) and by what time frames (within six months of close of financial year etc.), how adverse audit observations need to be responded to, what are the consequences for delays in financial reporting, financial misstatements, etc. These laws and regulations on financial reporting serve as safety harnesses and are the mainstay of corporate governance in the country.
Contrast this with the state of municipal financial governance in India. A large majority of the 4000+ municipalities in India do not have balance sheets, as many of them continue to follow cash basis of accounting. In several states, municipal laws don’t even mandate audit of annual accounts. Municipalities have not carried out physical verification of their assets and inventories for decades. Their audit is generally carried out by the Department of Local Fund Audit, a division of the State Finance Department or a Chief Auditor, neither of whom is a professional organization and often severely short staffed. Municipal laws do not have consequences for delays in completing audit of annual accounts, leave alone consequences for audit qualifications. They also don’t provide for any uniform accounting standards to be followed, rendering municipal accounts largely incomparable across states and sometimes even within the same state.
The poor credit rating of municipalities, the tepid or even non-existent municipal bond market and the inability of municipalities to raise revenues on the strength of their own balance sheet can all be directly traced to poor financial governance. Total municipal bond issuances in India in two decades have been less than Rs.2,000 crore. Municipalities that have been credit rated have done so not on the basis of an active capital market for urban infrastructure but to check the box of reforms under Jawaharlal Nehru National Urban Renewal Mission or Smart Cities Mission, etc. The lack of documentation and control over fixed assets, especially land and buildings, incomplete records in respect of overdue receivables, analysis of return on assets, etc. have led to financial squalor.
This is where the Smart Cities Mission could have potentially played a transformative role by putting in place a framework for municipal financial rejuvenation, especially in respect of raising capital from the market, which is purportedly a thrust area for the Mission. Empaneling two groups of independent chartered accountants to prepare and audit municipal balance sheets would jump-start sound financial governance in municipalities by creating a pan-India municipal fiscal landscape. This would throw up a wide range of opportunities for financing infrastructure and also make a strong case for systematic fiscal decentralisation from states to municipalities; the latter has been a long overdue reform. Recent experience of empanelment of chartered accountants in Rajasthan suggests that at a cost of no more than Rs.100 crore a year all 4,000+ municipalities in India can have their balance sheets audited by independent chartered accountants. This is a very high return on investment from public policy and infrastructure financing standpoints.
By creating SPVs (special purpose vehicle) and ring-fencing them both financially and administratively, the Smart Cities Mission has bypassed the fundamental need of institutional strengthening of municipalities, particularly on financial management. We need to prepare, audit and fix municipal balance sheets to sustainably finance urban infrastructure in India’s cities and towns. There are no smarter ways around this.
Srikanth Viswanathan is coordinator, advocacy and reforms, at Janaagraha Centre for Citizenship and Democracy.