How 'smart' cities can transform into 'sustainable' cities through municipal bonds

She lauds Indore’s initiative to issue green bonds to focus on sustainability issues. Before this, Ghaziabad has issued a green bond in 2021 for setting up a water treatment plant.

When it comes to local governance, the Indore urban local body has been setting records. In India’s Municipal Performance Index, Indore emerged as the highest-ranked municipal corporation in 2020. The city has maintained a top position in the cleanliness survey for consecutive six years.

The city received a special mention in a recently published report by the Reserve Bank of India for being the first municipal corporation to list on the National Stock Exchange (NSE) in 2018.

Focused on municipal finance, the report appeared on November 10, 2022 and gives a glimpse of ULB’s financial health.

The rapid growth of urbanisation in India has not been accompanied by a corresponding increase in urban infrastructure, says the RBI report on municipal finances.

The increasing urbanisation is putting pressure on the infrastructure. There is an increasing demand for affordable housing, integrated transport systems, and basic infrastructure like water, and electricity along with schools, hospitals, etc. The COVID-19 pandemic has also exposed the lack of preparedness of Indian cities which now need to be prepared for managing future disasters. Simultaneously, there is added burden due to climate change. Rise in sea level, cyclones, flooding, and heat waves warrant climate adaptation and risk mitigation plans, says the RBI paper.

In this scenario, the three-tier local governments need significant capital to prepare their infrastructure for future challenges.

To estimate the required capital, the government of India constituted a high-power expert committee that gave its report in 2011. The committee estimated that urban infrastructure (eight sectors) will need Rs. 31 trillion in 20 years from 2012 to 2031 (estimated at 2009-10 prices). Those sectors include water supply, sewerage, solid waste management, urban roads, storm water drains, urban transport, traffic support infrastructure, and street lighting.

This estimated investment however, has not been revised in the last decade, says Janaagraha’s Aggarwal, adding that currently, urban local bodies do not have the financial capacity to meet citizens’ needs. They are heavily dependent on state and federal grants that are unpredictable and insufficient. The capital expenditure of cities has grown manifold in the last decade or so, she says.

The RBI paper also reiterates the same, “Due to limited sources of revenue generation, municipal corporations in India are largely dependent on grants from the Central and State governments for meeting their expenditure needs.”

Acharya’s study reveals that “now the ULBs are heavily dependent on grants given by the centre and states.”

The grants for these local bodies are decided by the recommendations of the Central Finance Commission (CFC) from time to time. The State Finance Commissions (SFC) also recommend grants from the consolidated fund of states to supplement the municipalities’ resources. Both the CFCs and SFCs are constituted every five years and recommend grants for municipalities from the Consolidated Fund of India and States. However, it is not a guarantee that the ULBs get the entire amount of the recommended grant. There are some suggested guidelines from both the union and state governments that need to be followed to be eligible.

The latest Finance Commission (Fifteenth FC) for the year 2021 to 2026, recommends Rs. 1.2 trillion for five years in way of grants to local governments. It says, “To cater to the growing urbanisation needs, a total of Rs. 1,21,055 crore is recommended for urban local bodies for the period 2021-26.” Before this, the Fourteenth FC recommended Rs. 871.44 billion to ULBs for five years from 2015 to 2020 which included Rs. 697.15 billion as a basic grant and Rs. 174.29 billion as a performance grant. Apart from these CFC grants, states also devolve grants to ULBs, however, these grants are minimal.

As per the RBI paper, the local rural and urban bodies received less than 90% of the recommended grants during thirteenth and fourteenth plan period. Being dependent on grants also affects ULBs’ financial autonomy, says the RBI report which goes on to explore possible ways through which municipalities can generate resources. It discusses bond issuance as a tool too.

The potential of financing through bonds

In the last few years, there has been a push from the centre for local governments to use bonds to mobilise capital from the market. In her budget speech, the union finance minister Nirmala Sitharaman said, “States and cities will be encouraged to undertake urban planning reforms and actions to transform our cities into ‘sustainable cities of tomorrow.’ This means efficient use of land resources, adequate resources for urban infrastructure, transit-oriented development, enhanced availability and affordability of urban land, and opportunities for all.” For this, cities will be incentivised to improve their creditworthiness for municipal bonds, she added.

However, there is a resurgence of municipal bonds since 2017 with nine MCs raising around Rs 38.40 billion during 2017-21, the paper informed.

The Ministry of Housing & Urban Affairs also provides incentives to ULBs for the issuance of municipal bonds.

Though there is an exclusive emphasis on issuance bonds, experts feel that this is still a distant dream. Namita Aggarwal says that revenue mobilisation through bonds is at a very nascent stage. Re-issuance of municipal bonds have been very limited. It means cities that have gone for municipal bond issuance have only done it as a one-time activity to raise money, and not as a sustainable form of funding for their infrastructure projects.

The larger million-plus cities can look for mobilising finance through this tool. “But it does not look to me as a major source of funding given the current status of smaller municipalities. The cities lag on many fronts. They do not have their strong revenue source and also there are no predictable grants from the states. There is a lack of trust in the market regarding the repayment capacities of MCs. Trust needs to be built first, for the market to be able to see that this is a good investment,” she adds.

She lists several hurdles including the gap between market expectations and what MCs are offering. Cities lack financial literacy and cannot take this forward. They are heavily dependent on state capacities and privately hired advisors to guide them in the overall process of bond issuance. “Cities should have their own set of bankable projects that they have created and have inherent revenue potential. And to fund those projects, they should go to market. Right now, what is happening is the opposite of this. Cities are going to the market because this is a new thing to do. They are going into the market first and thinking about the project later,” she added.

Due to poor planning and programme budgeting; and varying accounting practices followed by ULBs across states, the level of fiscal transparency is very low and hence the chance of mobilising resources from market through issuing bonds would be bleak, said Nilachala Acharya.

The RBI paper also underlines this fact by saying that municipal laws do not prescribe any uniform accounting standard to be followed, rendering municipal accounts largely incomparable across states and even within a state.

The Comptroller & Auditor General (CAG) of India constituted a task force on accounting format for ULBs in 2002. The task force recommended an accrual accounting system for municipalities to ensure the correct, complete, and timely recording of municipal transactions. It is also supposed to help in producing accurate and relevant financial reports. Following this, the central government formulated the National Municipal Accounts Manual (NMAM) in 2004. As a next step, state governments were supposed to implement NMAM, however, only nine states (of the fourteen states for which information pertaining to adoption of state municipal accounts manual is available in the CAG reports) have approved it, as per the RBI paper.

Now, the central government is relying on the credit rating of MCs and has included it in the reform agenda of the Smart Cities and AMRUT programme. Of the 94 cities that have been assigned credit ratings in 2018, 59% received a rating of investment grade or above, highlighting the under-utilised potential for bond financing by Indian municipalities, concludes the RBI paper.