MC Explains | Indian municipalities and their finances

The Reserve Bank of India (RBI) recently released its Report on Municipal Finances (RMF). The RBI has itself called RMF a “first of its kind” report; it’s the first analysis that aims to bridge the gap in public understanding of municipal finances.

RBI has published the report “with the objective of making it a regular annual publication.” This explainer helps understand the findings of the report and its significance for Indian economy.

What are municipal corporations?

In 1992, the 73rd and 74th Amendments of the Constitution added third layer of governance in India. Apart from governments at the central and state levels, the amendments added governments at the local level. The local-level governments were of two types – urban local governments for urban areas and panchayati raj institutions for rural areas. Further, urban local governments were divided into three types: municipal corporations, municipal councils and Nagar panchayats. Municipal corporations are for larger urban locations whereas municipal councils and Nagar Panchayats are for smaller locations and transition areas.
The constitution has also listed 18 functions of MCs as shown in the table below.

What do we mean by municipal finances?

Municipal finances mean the budget of the urban local government which comprises receipts and expenditure. The RBI report analysed the budgets of 201 MCs. The latest data we have is for 2019-20, which is also marked as budgeted. The union and most state governments have presented the budgeted estimate for 2022-23. The revenue receipts are in the range of 0.6 to 0.7 percent of Gross Domestic Product (GDP) for three years. Within revenue receipts, transfer from state governments makes up the highest share.

The share of own tax revenues is around 31-34 percent and share of property tax is around 14 percent of the total receipts. The octroi/local body tax has been subsumed in the Goods and Services Tax (GST) which has made property tax an even more prominent source of revenue for urban bodies. Even so, Indian municipalities collect lower property taxes compared to other countries due to inefficient administration and poor governance.

In case of expenditure, total expenditure is 0.7 to 1.05 percent of GDP, which is higher than revenue receipts. Within expenditure, share of revenue expenditure has declined from 70 percent in 2017-18 to 58 percent in 2019-20. Within revenue expenditure, share of salaries has declined from 26 percent to 21 percent of revenue expenditure. Share of capital expenditure has risen from 30 percent to 42 percent.

The union and state governments manage higher expenditure by borrowing from banks or issuing bonds. This option is highly limited for municipal corporations as their borrowing is just 0.05 percent of GDP or just 6 percent of revenue receipts. Within borrowings, nearly 80 percent of the borrowings come from banks and state governments. The bond market comprises just 10 percent of the total borrowings, making it a largely untapped opportunity.

How do different municipalities rank in finances?
The municipal corporations in Delhi, Gujarat and Maharashtra collect the highest share of own tax revenue whereas the smaller states of Sikkim, Assam and Goa collect the least share of own tax revenue. The higher share of own tax revenues enables the municipal corporations of Delhi, Gujarat and Maharashtra to budget higher revenue expenditure compared to other counterparts. The municipal corporations in the states of Sikkim, Assam and Goa have both lower revenue and capital expenditure compared to counterparts in other states. In terms of borrowing, Municipalities in Telangna, Bihar and Maharashtra borrow the highest.

How do India’s municipalities compare with rest of the world?
The research shows that municipalities dependent on grants from higher tiers of government are more vulnerable and inefficient. In some developed countries such as Switzerland and New Zealand, municipalities generate a higher share of around 80-90 percent from own taxes and non-tax revenue. There are other developed countries such as the United Kingdom and Italy whose municipalities rely more on grants from the state. Within emerging economies, China and South Africa generate around 60-70 percent of receipts from own taxes and non-tax revenue. The share of own tax and non-tax revenue in India’s municipal corporations is around 40 percent, which is on the lower side.

What is the overall assessment of the RMF?

Despite the importance of urban local bodies in provision of public services, little attention has been paid to their functioning and even less to their finances. We saw the importance of local bodies during the pandemic, when most cities in India struggled to provide basic healthcare services. RMF shows that nearly all the municipal corporations in India are struggling financially and highly dependent on support from state and central governments. There is tremendous scope for development of a municipal bond market in India that could become an alternative source of funding. The RMF team has done a remarkable job of preparing and releasing the report as most of these entities do not keep proper records. The report has kickstarted the much-needed discussion on municipalities and their finances.