Sustainable financing of cities: 4 success factors from India’s Smart City Mission experience

Most cities in developing countries still struggle with limited financial resources, which remains one of their major challenges.

In India, most cities rely on revenue from property taxes, but as they continue to be inadequate due to political sensitivities over increasing rates, the dependency shifts to grant financing from federal and/or provincial governments.

Out of these earnings, a large part usually goes towards meeting salary and other operational expenses. As a result, capital expenditure for developing or upgrading critical urban infrastructure (roads, water transmission/distribution networks, transport facilities, affordable housing), and digital infrastructure (Integrated Command Control Centre, Intelligent Transport Management System), becomes constrained.

But some models, such as the India Smart City Mission, offer good examples of successfully mobilising external resources through alternate financial structures and instruments like public-private partnerships (PPPs) and municipal bonds.

One of the key objectives of the India Smart City Mission (SCM) experience, launched by the Indian government in 2015, was to enable cities to overcome capital expenditure constraints by co-funding infrastructure projects in 100 cities. Priority cities and projects were selected based on a Smart City Challenge, which required participant cities to develop a specific plan to improve the quality of life for citizens.

The SCM experience has indeed been an eye-opener and a game-changer. In addition to diverse infrastructure projects being taken up for implementation, several cities have successfully mobilized external resources through innovative PPPs and instruments like municipal bonds.

Over 200 PPP projects have been undertaken across more than 50 Indian cities in diverse areas like multi-modal transit hubs, common mobility cards, smart poles and street lighting, public bike sharing, rooftop solar, energy-efficient lighting, waste to energy, and public utilities (water ATMs). Similarly, as many as 12 cities have issued municipal bonds totalling more than 35 billion rupees ($424 million) as part of the SCM initiative.

The following factors emerged as the key underlying enablers for cities successfully mobilizing external resources:

1. Identification of suitable sectors and projects: Specific sectors (like water, urban transport, solid waste etc.) for resource mobilization were selected based on potential investor expectations. Subsequently, projects within these sectors were selected based on a robust assessment of the underlying risks and returns. These sectors and projects differed from city to city, given the competitive advantages of the particular local body.

2. Extensive preparatory activities: The design of SCM enabled the cities to fund preparatory activities through government grants. In the case of PPP projects, for example, activities like appointing specialist advisors for feasibility studies, detailed project report preparation, and structuring of the transaction and bid process management for selecting the private partner received due attention. Project risks were distributed between the government and private sector through objective and transparent contracts, with the government bearing early-stage risks around the land, right of way etc. and innovative structures like escrow accounts for capturing high-quality revenues being proposed as required. For municipal bonds, activities like identifying the underlying asset or project, updating financial statements for the urban local body, structuring and credit rating of the instrument, appointing merchant bankers and other specialists etc. were undertaken as part of SCM.

3. Commitment and initiative of key decision-makers and stakeholders: All successful cities had extensive support from key stakeholders in the provincial government as well as the elected city government, with a dedicated team of city officials driving the entire exercise in a time-bound manner, with support from external subject matter experts as required.

4. Supportive regulatory environment: While successful PPP contracts had well-defined and time-bound dispute resolution mechanisms like arbitration, the listing guidelines for municipal bonds were simplified through measures like allowing individual city utilities/agencies to issue bonds, reducing lot size for application allotment, removal of onerous conditions like preparing detailed project reports, having a separate monitoring agency etc. as a pre-requisite for the listing of bonds.

There are a couple of areas that could further enhance the value proposition and attractiveness of some of these resource-mobilization options.

First, aligning the resource-mobilization strategy with the green agenda should help. For both PPPs and municipal bonds, if a strategy is developed involving projects in areas like water recycling, urban afforestation etc., it may be possible to attract climate-specific investor groups with lower return expectations. While this would include getting the project accredited or appraised through the appropriate climate certification agency, it should facilitate broader adoption and make the financing more cost-effective alongside environmental benefits.

Second, with multiple cities now having functional digital technology platforms for capturing transaction data across various city functions like property and other tax payment, licensing and permits etc., specific PPPs supporting business models around the transaction data (suitably anonymized) could be another potential game changer.