India’s urban population has grown by 32% from 2001 to 2011 as compared to 18% growth in total population of the country.[1] As per Census 2011, 31% of the country’s population (377 million people) live in cities, and contribute to 63% of the country’s GDP.[2] The urban population is projected to grow up to 600 million by 2031.2 With increasing urban population, the need for providing better infrastructure and services in cities is increasing.[3] The government has introduced several schemes to address different urban issues. These include the Atal Mission for Rejuvenation and Urban Transformation (AMRUT), Smart Cities Mission, Heritage City Development and Augmentation Yojana (HRIDAY), Pradhan Mantri Awas Yojana – Housing for All (Urban) (PMAY-U), and Swachh Bharat Mission (Urban).
Last week the Ministry of Urban Development released the next batch of winners under the Smart Cities Mission.[4] This takes the number of smart cities to 90. The government has also announced a few policies and released data indicators to help with the implementation of the urban schemes. In light of all this, we discuss how the new schemes are changing the mandate of urban development, the fiscal challenge of implementing such schemes, and the policies that are trying to address some of these challenges.
Urbanisation in India
The Jawaharlal Nehru National Urban Renewal Mission (JnNURM), launched in 2005, was one of the first urban development schemes implemented by the central government. Under JnNURM, the central government specified certain mandatory and optional reforms for cities, and provided assistance to the state governments and cities that were linked to the implementation of these reforms. JnNURM focused on improving urban infrastructure and service delivery, community participation, and accountability of city governments towards citizens.
In comparison, the new urban schemes move beyond the mandate that was set by JnNURM. While AMRUT captures most of the objectives under JnNURM, the other schemes seek to address issues around sanitation (through Swachh Bharat), affordable housing (through PMAY-U), and technology innovation (through Smart Cities). Further, the new schemes seek to decentralize the planning process to the city and state level, by giving them more decision making powers.2 So, while earlier, majority of the funding came from the central and state governments, now, a significant share of the funding needs to be raised by the cities themselves.
For example, under the Smart Cities Mission, the total cost of projects proposed by the 60 smart cities (winners from the earlier rounds) is Rs 1.3 lakh crore.[5] About 42% of this amount will come from central and state funding towards the Mission, and the rest will be raised by the cities.[6]
The new schemes suggest that cities may raise these funds through: (i) their own resources such as collection of user fees, land monetization, property taxes, etc., (ii) finance mechanisms such as municipal bonds, (iii) leveraging borrowings from financial institutions, and (iv) the private sector through Public Private Partnerships (PPPs).[7]
In 2011, an Expert Committee on Indian Urban Infrastructure and Services (HPEC) had projected that creation of the required urban infrastructure would translate into an investment of Rs 97,500 crore to Rs 1,95,000 crore annually.[8] The current urban schemes are investing around Rs 32,500 crore annually.
Financial capacity of cities
Currently, the different sources of revenue that municipal corporations have access to include: (i) tax revenue (property tax, tax on electricity, toll tax, entertainment tax), (ii) non-tax revenue (user charges, building permission fees, sale and hire charges), (iii) grants-in-aid (from state and central governments), and (iv) debt (loans borrowed from financial institutions and banks, and municipal bonds).
While cities are now required to raise more financing for urban projects, they do not have the required fiscal and technical capacity.8,[9] The HPEC had observed that cities in India are among the weakest in the world, both in terms of capacity to raise resources and financial autonomy. Even though cities have been getting higher allocations from the centre and states, their own tax bases are narrow.8 Further, several taxes that cities can levy are still mandated by the state government. Because of their poor governance and financial situation, cities also find it difficult to access external financing.8,7
In order to help cities improve their finances, the government has introduced a few policies, and released a few indicators. Some of these are discussed below:
Policy proposals and data indicators
Value Capture Financing (VCF): The VCF policy framework was introduced by the Ministry of Urban Development in February 2017.[10] VCF is a principle that states that people benefiting from public investments in infrastructure should pay for it. Currently when governments invest in roads, airports and industries in an area, private property owners in that area benefit from it. However, governments recover only a limited value from such investments, constraining their ability to make further public investments elsewhere. VCF helps in capturing a part of the increment in the value of land due to such investments, and use it to fund new infrastructure projects.
The different instruments of VCF include: land value tax, fee for changing land use, betterment levy, development charges, transfer of development rights, and land pooling systems.10 For example, Karnataka uses certain value capture methods to fund its mass transit projects. The Mumbai Metropolitan Region Development Authority (MMRDA), and City and Industrial Development Corporation Limited (CIDCO) have used betterment levy (tax levied on land that has gained in value because of public infrastructure investments) to finance infrastructure projects.
Municipal bonds: Municipal bonds are bonds issued by urban local bodies (municipal corporations or entities owned by municipal bodies) to raise money for financing specific projects such as infrastructure projects. The Securities and Exchange Board of India regulations (2015) regarding municipal bonds provide that, to issue such bonds, municipalities must: (i) not have negative net worth in any of the three preceding financial years, and (ii) not have defaulted in any loan repayments in the last one year.[11] Therefore, a city’s performance in the bond market depends on its fiscal performance. One of the ways to determine a city’s financial health is through credit ratings.
Credit rating of cities: In September 2016, the Ministry of Urban Development started assigning cities with credit ratings.[12] These credit ratings were assigned based on assets and liabilities of the cities, revenue streams, resources available for capital investments, accounting practices, and other governance practices.
Of the total 20 ratings ranging from AAA to D, BBB– is the ‘Investment Grade’ rating and cities rated below BBB– need to undertake necessary interventions to improve their ratings for obtaining positive response to the Municipal Bonds to be issued. By March 2017, 94 cities were assigned credit ratings, 55 of which got ‘investment grade’ ratings.[13]
Credit ratings indicate what projects might be more lucrative for investments. This, in turn, helps investors decide where to invest and determine the terms of such investments (based on the expected returns).
Earlier this month, the Pune Municipal Corporation raised Rs 200 crore through the sale of municipal bonds, to finance water supply projects under the Smart Cities Mission.[14] The city had received an AA+ credit rating (second highest rating) in the recent credit rankings assigned by the central government.
Other than credit ratings, the Ministry of Urban Development has also come up with other data indicators around cities such as the Swachh Bharat rankings, and the City Liveability Index (measuring mobility, access to healthcare and education, employment opportunities, etc). These rankings seek to foster a sense of competition across cities, and also help them map their performances year on year.
Some financing mechanisms, such as municipal bonds, have been around in India for the last two decades, but cities haven’t been able to make much use of them. It remains to be seen whether the introduction of indicators such as credit ratings helps the municipal bond market take off. While these mechanisms may improve the finances of cities, the question is would more funding solve the cities’ problems. Or would it require municipal government to take a different approach to problem solving.
[1] Census of India, 2011.
[2] Mission Statement and Guidelines, Smart Cities, Ministry of Urban Development, June 2015, http://smartcities.gov.in/writereaddata/SmartCityGuidelines.pdf.
[3] Report on Indian Urban Infrastructure and Services, March, 2011, The High Powered Expert Committee for estimating the investment requirements for urban infrastructure services, http://icrier.org/pdf/FinalReport-hpec.pdf.
[4] “30 more smart cities announced; takes the total to 90 so far”, Press Information Bureau, Ministry of Urban Development, June 23, 2017.
[5] Smart Cities Mission, Ministry of Urban Development, last accessed on June 30, 2017, http://smartcities.gov.in/content/.
[6] Smart City Plans, Last accessed in June 2017.
[7] “Financing of Smart Cities”, Smart Cities Mission, Ministry of Urban Development, http://smartcities.gov.in/upload/uploadfiles/files/Financing%20of%20Smart%20Cities.pdf.
[8] “Report on Indian Urban Infrastructure and Services”, March, 2011, The High Powered Expert Committee for estimating the investment requirements for urban infrastructure services, http://icrier.org/pdf/FinalReport-hpec.pdf.
[9] Fourteenth Finance Commission, Ministry of Finance, February 2015, http://finmin.nic.in/14fincomm/14fcrengVol1.pdf.
[10] Value Capture Finance Policy Framework, Ministry of Urban Development, February 2017, http://smartcities.gov.in/upload/5901982d9e461VCFPolicyFrameworkFINAL.pdf.
[11] Securities and Exchange Board of India (Issue and Listing of Debt Securities by Municipalities) Regulations, 2015, Securities and Exchange Board of India, July 15, 2015, http://www.sebi.gov.in/sebi_data/attachdocs/1436964571729.pdf.
[12] “Credit rating of cities under urban reforms begins”, Press Information Bureau, Ministry of Urban Development, September 6, 2016.
[13] “Credit Rating of Urban Local Bodies gain Momentum”, Press Information Bureau, Ministry of Urban Development, March 26, 2017.
[14] “Pune civic body raises Rs200 crore via municipal bonds”, LiveMint, June 19, 2017, http://www.livemint.com/Money/JOOzaSTKnC6k1EZGeFh8LJ/Pune-civic-body-raises-Rs200-crore-via-municipal-bonds.html.
Finances of the Railways were presented along with the Union Budget on February 1, 2018 (the Railways Budget was merged with the Union Budget last year). In the current Budget Session, Lok Sabha is scheduled to discuss the allocation to the Ministry of Railways. In light of this, we discuss Railways’ finances, and issues that the transporter has been facing with regard to financing.
What are the different sources of revenue for Railways?
Indian Railways has three primary sources of revenue: (i) its own internal resources (revenue from freight and passenger traffic, leasing of railway land, etc.), (ii) budgetary support from the central government, and (iii) extra budgetary resources (such as market borrowings, institutional financing).
Railways’ internal revenue for 2018-19 is estimated at Rs 2,01,090 crore which is 7% higher than the revised estimates of 2017-18. Majority of this revenue comes from traffic (both freight and passenger), and is estimated at Rs 2,00,840 crore. In the last few years, Railways has been struggling to run its transportation business, and generate its own revenue. The growth rate of Railways’ earnings from its core business of running freight and passenger trains has been declining. This is due to a decline in the growth of both freight and passenger traffic (see Figure 1). Railways is also slowly losing traffic share to other modes of transport such as roads and airlines. The share of Railways in total freight traffic has declined from 89% in 1950-51 to 30% in 2011-12.
The Committee on Restructuring Railways (2015) had observed that raising revenue for Railways is a challenge because: (i) investment is made in projects that do not have traffic and hence do not generate revenue, (ii) the efficiency improvements do not result in increasing revenue, and (iii) delays in projects results in cost escalation, which makes it difficult to recover costs. Railways also provides passenger fares that are heavily subsidised, which results in the passenger business facing losses of around Rs 33,000 crore in a year (in 2014-15). Passenger fares are also cross-subsidised by charging higher rates for freight. The consequence is that freight rates have been increasing which has resulted in freight traffic moving towards roads.
Figure 2 shows the trends in capital outlay over the last decade. A decline in internal revenue generation has meant that Railways funds its capital expenditure through budgetary support from the central government and external borrowings. While the support from central government has mostly remained consistent, Railways’ borrowings have been increasing. Various committees have noted that an increased reliance on borrowings will further exacerbate the financial situation of Railways.
The total proposed capital outlay (or capital expenditure) for 2018-19 is Rs 1,48,528 crore which is a 24% increase from the 2017-18 revised estimates (Rs 1,20,000 crore). Majority of this capital expenditure will be financed through borrowings (55%), followed by the budgetary support from the central government (37%). Railways will fund only 8% of its capital expenditure from its own internal resources.
How can Railways raise more money?
The Committee on Restructuring Railways had suggested that Railways can raise more revenue through private participation in the following ways: (i) service and management contracts, (ii) leasing to and from the private sector, (iii) joint ventures, and (iv) private ownership. However, private participation in Railways has been muted as compared to other sectors such as roads, and airports.
One of the key reasons for the failure of private participation in Railways is that policy making, the regulatory function, and operations are all vested within the same organisation, that is, the Ministry of Railways. Railways’ monopoly also discourages private sector entry into the market. The Committee on Restructuring Railways had recommended that the three roles must be separated from each other. It had also recommended setting up an independent regulator for the sector. The regulator will monitor whether tariffs are market determined and competitive.
Where does Railways spend its money?
The total expenditure for 2018-19 is projected at Rs 1,88,100 crore, which is 4% higher than 2017-18. Staff wages and pension together comprise more than half of the Railways’ expenditure. For 2018-19, the expenditure on staff is estimated at Rs 76,452 crore. Allocation to the Pension Fund is estimated at Rs 47,600 crore. These constitute about 66% of the Railways’ expenditure in 2018-19.
Railways’ primary expenditure, which is towards the payment of salaries and pension, has been gradually increasing (with a jump of around 15% each year in 2016-17 and 2017-18 due to implementation of the Seventh Pay Commission recommendations). Further, the pension bill is expected to increase further in the years to come, as about 40% of the Railways staff was above the age of 50 years in 2016-17.
The Committee on Restructuring Railways (2015) had observed that the expenditure on staff is extremely high and unmanageable. This expense is not under the control of Railways and keeps increasing with each Pay Commission revision. It has also been observed that employee costs (including pensions) is one of the key components that reduces Railways’ ability to generate surplus, and allocate resources towards operations.
What is the allocation towards depreciation of assets?
Railways maintains a Depreciation Reserve Fund (DRF) to finance the costs of new assets replacing the old ones. In 2018-19, appropriation to the DRF is estimated at Rs 500 crore, 90% lower than 2017-18 (Rs 5,000 crore). In the last few years, appropriation to the DRF has decreased significantly from Rs 7,775 crore in 2014-15 to Rs 5,000 crore last year. Provisioning Rs 500 crore towards depreciation might be an extremely small amount considering the scale of infrastructure managed by the Indian Railways, and the requirement to replace old assets to ensure safety.
The Standing Committee on Railways (2015) had observed that appropriation to the DRF is the residual amount after appropriation to the Pension Fund, instead of the actual requirement for maintenance of assets. Under-provisioning for the DRF has also been observed as one of the reasons behind the decline in track renewals, and procurement of wagons and coaches.
Is there any provision towards safety?
Last year, the Rashtriya Rail Sanraksha Kosh was created to provide for passenger safety. It was to have a corpus of one lakh crore rupees over a period of five years (Rs 20,000 crore per year). The central government was to provide a seed amount of Rs 1,000 crore, and the remaining amount would be raised by the Railways from their own revenues or other sources.
As per the revised estimates of 2017-18, no money was allocated towards this fund. In 2018-19, Rs 5,000 crore has been allocated for it. With the Railways struggling to meet its expenditure and declining internal revenues, it is unclear how Railways will fund the remaining amount of Rs 95,000 crore for the Rail Sanraksha Kosh.
What happened to the dividend that was waived off last year?
Railways used to pay a return on the budgetary support it received from the government every year, known as dividend. The rate of this dividend was about 5% in 2015-16. From 2016-17, the requirement of paying dividend was waived off. The last dividend amount paid was Rs 8,722 crore in 2015-16.
The Standing Committee on Railways (2017) had noted that part of the benefit from dividend is being utilised to meet the shortfall in the traffic earnings of Railways. This defeats the purpose of removing the dividend liabilities since they are not being utilised in creating assets or increasing the net revenue of Railways.
