Illustration: Jayachandran/Mint
Illustration: Jayachandran/Mint

Improving city finances is a must for India’s future

A strong municipal bond market should be seen as one part of a larger policy, which includes directly giving cities a slice of GST collections

Indore is the third city to raise money through municipal bonds in recent months. Its issue was preceded by similar offerings from Pune and Hyderabad. The very fact that each municipal bond attracts so much media attention shows what a rarity it is in India. The two decades since Ahmedabad raised money from the bond market have seen more discussion than action.

Indian cities do not have the financial muscle to build the infrastructure needed for them to sustain as engines of job creation. A committee headed by Isher Judge Ahluwalia had estimated in 2011 that Indian cities would have to invest a cumulative 40 trillion at constant prices over the next two decades, at the end of which around 600 million Indians could be urban. Meanwhile, city revenue is less than 1% of gross domestic product (GDP). The share of their own revenue in annual budgets has been slipping consistently, making cities dependent on the whims of state and national governments for their infrastructure financing.

Municipal bonds are one obvious solution. However, they are not a magic wand. There are three cautionary points that are worth pondering over.

First, any bond eventually has to be repaid through cash flows, so urban governments should not think that issuing debt to investors in some way releases them from the core task of strengthening their own revenue base.

Second, there have to be credible commitments to investors that the money raised will not be diverted for other uses, as was done by several state governments in the 1990s, a fudge that destroyed investor confidence in bond finance for state government projects.

Third, many of the (admittedly inefficient) levies such as octroi that cities depended on for money have been removed in the new goods and services tax (GST) system. There is absolutely no reason to shed tears on the death of such levies, but India needs to move to a situation where cities, and the third level of government more generally, get a direct share of GST collections rather than routing these through state governments.

This newspaper has earlier argued that India may need policies to reduce the risk in municipal bonds till the market matures. Credit rating is already done, but there may be need for an agency to do market making, credit enhancement and underwriting. Just providing tax breaks may not be enough. For example, the Japan Finance Corporation for Municipal Finance has been provided with a sovereign guarantee. The Development Bank of South Africa uses its balance sheet to support municipal bond issues. Denmark has an agency that takes some of the risk out of pooled finance by creating a mechanism to protect bondholders in case one city in the pool defaults. (Some cities in Tamil Nadu and Kerala have experimented with joint bond issues.)

Such institutional innovations will be needed in a country like India where cities are not financially strong. A strong municipal bond market should be seen as a part of a larger policy mix to improve the state of cities. We have already mentioned two other parts—the need to directly give cities a slice of GST collections as well as other ways of boosting city finances, such as reform of property taxes and user charges.

All this should be seen against the larger challenge of empowering city governments, with financial power complementing political power. Cities need directly elected mayors who have political incentives to use money wisely. The landmark 74th amendment to the Constitution is more than 25 years old now. By officially recognizing city governments as part of the federal structure, it legally empowers local governments, though there has not been enough institutional backing in terms of financial power or political autonomy to make the amendment work in the true sense of the term.

B.R. Ambedkar lucidly argued why cities will determine the future of India. Millions are voting with their feet in support. Urban development in recent years has been chaotic, but welcome nevertheless.

Cities are not only engines of economic growth but also offer an escape from social oppression. The future of India is profoundly linked to the future of its cities. That future will continue to be compromised as long as cities have neither the financial nor political ability to chart their own course. Municipal bonds are just one part of the broader task.

How can Indian cities strengthen their revenue base? Tell us at views@livemint.com

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