India’s rapid urbanisation is a well-documented story. Depending on how one counts urbanisation, Indian has between a-third and-a-half of its population already living in high-density areas. The trend towards urbanisation will continue as the economy moves towards becoming more connected with global ecosystems in manufacturing and services. According to various estimates, urban India contributes to ~70% of India’s GDP. The poor quality of India’s urban infrastructure means that the need to invest in it is well recognised.
Indian cities will have to improve their rankings in the surveys of the best cities in the world. Current rankings are largely driven by poor infrastructure of travel, water and sanitation, and air quality. The High-Powered Expert Committee for Estimating the Investment Requirements for Urban Infrastructure Services estimated the investment required to finance urban infrastructure and services at Rs 39.2 trillion during 2011-2031.
Private experts have also estimated these numbers: McKinsey (2018) noted that India’s cities would require $1.2 trillion (~Rs 85 trillion) in capital funding over the next 20 years to keep up with the demands of their growing populations. The National Infrastructure Pipeline (NIP) envisages Rs 19 trillion of investments in urban India over a five-year period till FY25.
In China, urban local bodies (ULBs) have relied on land sales to generate ‘incomes’ which have been reinvested in other projects. While Indian ULBs have some land and buildings of their own, a large part of the land in the cities and towns is either private or owned by agencies of the central government (Railways, Defence, etc) or the state government. Investments by ULBs will require large upfront capex, for which, the ULBs in India do not have the assets to sell and recycle. Such capex can be financed by taking on debt, i.e., by leveraging cashflows of the ULB. Capital investment financed out of such debt is expected to lead to higher and more-evenly distributed growth: the increased economic pie can eventually be used to repay the debt.
Many municipalities in the recent years have raised funds from the market—however, the overall fund-raise has been only ~Rs 40 billion, a small fraction of what is required and can be enabled by the market. Accessing the market for urban financing will require: (a) ULBs to have predictable revenue streams, (b) capacity building, and (c) innovation in financial products to attract investors.
Predictable ULB revenues
Revenues or inflows for the ULBs comprise tax and non-tax sources. Taxes include those on property and vehicles or levied by the local body on goods. User charges for services like water, fire, permissions, etc, account for the non-tax sources. ULBs also get some income from rentals of its properties.
For the top-35 municipalities in FY19, the primary revenue balance (the difference between revenue receipts and revenue expenditure) was negative Rs 487 billion. ULBs received revenue share and grants of Rs 656 billion and capex grants amounted to Rs 577 billion, totalling to Rs 1.2 trillion. These 35 municipalities spent Rs 836 billion on capex, or less than half-a-percent of India’s Rs 200 trillion GDP.
UBLs are, hence, dependent on devolution and grants from the Centre and respective states. These grants and devolutions are sometimes committed, but in most cases, are discretionary or tied to specific projects. Converting grants that Centre and the states give to ULBs to committed devolutions will allow for better leveraging.
If, for example, the above annual Rs 1.2 trillion is committed as a predictable and committed devolution, this amount can then be leveraged 7-10X to allow for a capex of Rs 8-12 trillion in the cities over the next few years. These numbers are illustrative, but tie-in well with the requirements under the NIP.
ULBs need to get their accounting and financial reporting in order so that external investors have higher confidence in their numbers and prospects. A rigorous and timely system of accounting will also lead to the identification of new revenue sources, plugging of leakages in current sources, improvement of collections, optimisation of their assets, etc.
There are concerns on the political stability of the ULBs and their dependencies on two other tiers of the government, which may have different political dispensations: creating cash flow streams that are not impacted by significant political changes will generate confidence on the ability to service debt.
Currently, the market is shallow with few investors participating, and those who come in, tend to hold the bonds issued by ULBs to maturity. Creating a wider pool of investors will require having a predictable and large pool of supply of bonds and an active secondary market. This will generate interest amongst various long-term fund managers in insurance, pension funds, mutual funds, and others. One way in which the municipal debt can be analysed and tracked is if such issuances become part of an ETF like ‘Bharat Bond’ ETF that currently is only for central government and PSU debt.
Creating innovative products
Structuring debt issued by ULBs requires considerable skill. While 35 ULBs have been rated AA and above, only a few have been able to access the market due to the challenges outlined above. Structuring debt will require addressing concerns on availability, predictability, and fulsomeness of the cashflows to meet debt obligations. Many ULBs have escrowed their expected collection of property taxes to give comfort to the investors.
Multiple ULBs can come together to pool their resources to reach out to the market—this will create a larger issuance and give investors comfort over the combined credit risk. Having a credit guarantee fund could allay some of the concerns. Innovation is also required in pooling together a wider variety of state and municipal bond issues and creating appropriate tranches with suitable risk-return trade-offs.
Unlocking urban financing is the key to getting the urban investment story kick-started: it will significantly improve the ‘ease of living’.
Author is with National Investment and Infrastructure Fund (NIIF). Views are personal