Financing smart cities in India

Fri, 2019-02-15 14:22 -- SCC India Staff

Financing

With the current funding structure or guidelines laid down by the Centre, each selected city, for the period of four to five years, will receive Rs 5 billion and an equally matching amount will be contributed by the State Governments. This means the State Governments and Centre are required to shell out or make an arrangement for Rs 1 trillion collectively towards the selected 100 cities. That apart, municipal corporations will contribute Rs 200 billion. Considering these huge numbers, the Centre and state governments may be in a much better position in terms of their revenue streams, but with an eye-popping Rs 1 trillion to contribute, the ULBs have a mammoth task ahead.

In this funding pattern, the Centre and State Governments, with 46 per cent of the contribution, remain the major shareholders in the Smart Cities Mission, followed by convergence from various Centre-driven schemes like AMRUT, Housing for All, etc, which comes to around 21 per cent, PPP with 20 per cent, equity funds with 4 per cent, ULBs 1 per cent and 8 per cent from other sources. Here, with 67 per cent, Central Government grants and schemes remain the top contributor. Thus, the dependence of selected smart cities on these grants can certainly jeopardize their envisaged plans if not released on time.

In the next five years, special purpose vehicle (SPVs) will spend Rs 1,642 billion on projects conceived under area-based development (ABD) and Rs 389 billion on pan-city development. The question is, though, how are these funds likely to be mobilized? For instance, the selected ULBs carrying out the SCM are solely dependent on revenue streams such as property tax, building licence fees and other land-based levies such as betterment levy, valorization, impact fee, exaction, stamp duty, hawker or vendor fee, PPP and advertisement fees. However, moving away from archaic ways of traditional funding, cities are now vying for credit ratings for mobilization of resources through municipal bonds, crowd and pooled funding, etc, reflecting on their keenness to think and act differently.

Let’s bond together
In India, the municipal bond market is largely untapped. Over the past 15 years, only a handful of municipal corporations have managed to raise funds from bond issues to the tune of a mere Rs 15 billion.

However, the game has changed with the advent of smart cities in India. In the past two years, Pune Municipal Corporation (PMC) and Greater Hyderabad Municipal Corporation (GHMC) have successfully raised Rs 4 billion. PMC will use its funds for a 24x7 water supply project, whereas GHMC will use the funds for a strategic road development project. In December 2018, the Greater Visakhapatnam Municipal Corporation (GVMC) successfully raised Rs 800 million to part-financing the development of sewerage system and supply of treated water to various industries in Visakhapatnam. It is also worth mentioning the recently issued municipal bonds by Ahmedabad Municipal Corporation (AMC). The Rs 1 billion bond was oversubscribed 10 times within minutes, creating history in the overall municipal bonds market in India.

Meanwhile, to raise funds through municipal bonds, one needs capacity augmentation of ULBs. As Prakash Gaur, CEO, Andhra Pradesh Urban Infrastructure Asset Management (APUIAML), explains,“The ratings span 20 levels from AAA to D, with BBB-being investment-grade rating; cities rated below BBB-have to get better ratings to attract investors.” He further adds: “Considering the long gestation period of urban projects, it is always beneficial to opt for bond funding than using one’s own resources as the duration is 10 years with a guaranteed return on investment for investors.”

Commenting on the recent success of municipal bonds, Ashish Sable, Senior Vice-President & Group Head, Debt Capital Markets, SBI Capital Markets, says, “I think the process of raising funds through municipal bonds will make ULBs accountable to be transparent. This will compel the ULBs to meet the investors’ requirement in terms of disclosure, discipline, etc.”

Although municipalities have tremendous potential for growth, except for a few large municipalities, the growth of smaller municipalities, ULBs and towns has been muted. According to reports, till now only 55 of the 94 cities had investment-grade ratings. Ratings are based on multiple criteria, like the cities’ social and economic profile, operating efficiency, policy framework, recent financial, etc.

So why is it necessary for ULBs to opt for municipal bonds? According to M Hari Narayanan, Commissioner, Greater Visakhapatnam Municipal Corporation, municipal bonds give a higher rate on investments compared to banks and bring in a lot of financial discipline in the ULB as it needs to get its account audited on a regular basis and has to show substantial cash flow or revenue streams to the rating agencies.

Around Rs 7,000 billion is required for urban development over a period of 20 years, i.e., around Rs 350 billion per year. But does India have enough instruments to fund this kind of capex? Let’s do a fact check. The Government of India borrows around Rs 6,500 billion from bond markets; however, India’s corporate bond market is equal to what the Government is borrowing. In fact, it is much bigger. To cite an example: Pune and Hyderabad have issued their bond at 7.57 per cent and 8.9 per cent, respectively, which is far better than the Central Government’s borrowing rate.