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Urban Governance and Finance in India

TL;DR: In this article, the authors identify some key reforms required to realize both the constitutional intent to encourage citizen participation in urban governance and the economic and politically desirable goal of ensuring greater accountability of urban governments.
Abstract: Over 330 million people live in India’s cities; 35 cities have a population of over a million and three (Mumbai, Delhi and Kolkata) of the 10 largest metropolises in the world are in India. India’s cities are large, economically important, and growing. However, neither urban infrastructure nor the level of urban public services is adequate for current needs, let alone to meet growing demands. Dealing with this problem is a formidable challenge. Not only must adequate finance for the provision of services be found but it is critical to ensure that the money spent results in desired outputs and outcomes. To do so, local governance structures also need to be reformed and strengthened. This paper attempts to point the way towards some possible solutions by analyzing urban governance and finance in India in the context of lessons drawn from fiscal federalism theory and experiences of governance institutions and financing systems both in India and around the world. No one system of urban governance is likely to work equally well for all urban local bodies. However, the paper identifies some key reforms required to realize both the constitutional intent to encourage citizen participation in urban governance and the economic and politically desirable goal of ensuring greater accountability of urban governments. For example, the paper draws attention to existing ambiguities in the assignment system and underlines the need to undertake activity mapping to ensure clarity as well as to make independent agencies significantly accountable to elected governments in urban areas.The paper also discusses a variety of ways of augmenting the resources of the municipal bodies in the country including essential reforms in the property tax system and adequate exploitation of user charges and fees for various services delivered as well as ways of strengthening and improving central and state transfers to urban local governments. With respect to financing urban infrastructure, development charges should be used more effectively. More should also be done to utilize public lands more effectively. In addition, to a considerable extent capital expenditure requirements will have to be financed through borrowing so further development of the municipal bond market is important, as is more and more effective use of public private partnerships in some areas.

Summary (3 min read)

Introduction

  • Over 330 million people live in India’s cities; 35 cities have a population of over a million and three (Mumbai, Delhi, and Kolkata) of the 10 largest metropolises in the world are in India.
  • Neither urban infrastructure nor the level of urban public services is adequate for current needs, let alone to meet growing demands.
  • The paper identifies some key reforms required to realise both the constitutional intent to encourage citizen participation in urban governance and the economic and politically desirable goal of ensuring greater accountability of urban governments.
  • With respect to financing urban infrastructure, development charges should be used more effectively.
  • JEL Codes: R51, H70 Keywords: India, urban public finance, urban governance, intergovernmental fiscal relations, property tax, metropolitan areas, infrastructure finance Urban Governance and Finance in India.

I. Cities as Centres of Economic Dynamism: Role of Governance and Finance

  • Urbanisation and development are inseparably linked in part because cities are the leading edge of economic dynamism in every country.
  • Financing urban infrastructure and services adequately is thus a formidable challenge.
  • Nonetheless, this examination of Indian reality in the context of both theory and international experience with local governance and finance suggests, the authors think, some clear directions for possible reforms to increase the dynamism of India’s cities and realise more fully their potential as engines of national growth.
  • The traditional theory of fiscal federalism demonstrates the welfare gains from fiscal decentralisation by matching public service provision with the varied preferences of the people living in different jurisdictions.

III. Models of Urban Governance and Governance Systems in India

  • As the theories of fiscal federalism reviewed in the previous section demonstrate, to be economically dynamic, cities need the right governmental structure.
  • At the same time, economies of scale and minimising coordination costs in providing such services often require a larger governmental jurisdiction, as does efficient raising of revenue.
  • If India’s larger cities are to have effective urban governance structures, similar steps need to be taken by all State governments to make the Commissioners in municipal corporations and municipalities primarily responsible and accountable to the respective municipal bodies.
  • In general, State governments are reluctant to devolve functions to the local governments on the grounds that they do not have the capacity to undertake them.
  • Municipalities across the country have been vested with a long list of functions by the State governments under their respective municipal legislations relating to public health, welfare, safety, regulation and developmental activities.

V. Financing Urban Services: User Charges and Local Taxation

  • As emphasised earlier, an important rule of sound fiscal decentralisation is that finances should follow functions (Bahl, 2002).
  • Municipal spending is so low both because of problems in mobilising own revenues and the inadequacy of transfers from central and State governments.
  • Some important lessons from the Bangalore experiment in the reform of property tax must be noted.

VI. Financing Urban Services: Intergovernmental Transfers

  • In principle, municipal governments should raise revenues to finance local public services from their residents.
  • In many cases, the SFCs appointed did not have the expertise to undertake the technical exercises required to estimate the requirements of the municipalities.
  • As mentioned earlier, this ambitious programme is designed to augment urban infrastructure and services and is linked to a reform agenda that includes doing away with urban land ceiling act and rent control act as well as reforms in property tax etc.
  • As mentioned earlier, the grants under the scheme are linked to reforms both at the State and at municipal level.
  • In any case, not that much has yet happened since states have so far been reluctant to undertake reforms and avail the assistance.

VII. Financing Urban Infrastructure

  • As mentioned above, reforms in user charges, property tax, and the transfer system as well as perhaps additional funding through a ‘local’ surcharge on the GST can do much to bring about significant improvement in the resources required for basic urban public services and maintenance expenditures.
  • States are reluctant to guarantee municipal bonds because their fiscal responsibility legislation requires them to limit their committed liabilities to half a per cent of Gross State Domestic Product (GSDP) and their fiscal deficit at 3 per cent of GSDP.7.
  • When the development of infrastructure by the municipal body increases the capital value of such land, any gains realised through sale should be shared with the municipal body that has increased the urban infrastructure and services in the area.
  • There are many services such as water supply sewerage, solid waste management, recreational facilities, rain water harvesting, and urban transportation where public-private partnerships are eminently feasible, in principle.
  • Privatising the design, construction, and operation of urban infrastructure may have many merits if done properly, but it is neither a panacea, nor free.

VIII. Concluding Remarks

  • World over, cities are the central drivers of growth: they are the leading edge of economic dynamism.
  • Thus, good policies, efficient and responsive local governance systems and sound arrangements to finance public services are critical elements in sustainable urban development.
  • Lack of clarity in the assignment system is not only between the states and urban local bodies; there are also confusing areas of concurrence between urban local bodies and independent agencies delivering various services.
  • The paper discusses a variety of ways for augmenting the resources of the municipal bodies in the country including essential reforms in the property tax system and adequate exploitation of user charges and fees for various services delivered.
  • Reform of urban governance and finance are critical not only to improving the quality of life of the people living in urban areas but also to ensure that cities, and especially the large metropolitan areas, become the drivers of economic growth in the country.

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Urban Governance and Finance in India
M. Govinda Rao and Richard M. Bird
Working Paper No. 2010-68
April 2010
National Institute of Public Finance and Policy
New Delhi
http://www.nipfp.org.in

3
Urban Governance and Finance in India
M. Govinda Rao
*
and
Richard M. Bird
**
Abstract
Over 330 million people live in India’s cities; 35 cities have a population of over a
million and three (Mumbai, Delhi, and Kolkata) of the 10 largest metropolises in the world
are in India. India’s cities are large, economically important, and growing. However,
neither urban infrastructure nor the level of urban public services is adequate for current
needs, let alone to meet growing demands. Dealing with this problem is a formidable
challenge. Not only must adequate finance for the provision of services be found but it is
critical to ensure that the money spent results in desired outputs and outcomes. To do so,
local governance structures also need to be reformed and strengthened. This paper
attempts to point the way towards some possible solutions by analysing urban
governance and finance in India in the context of lessons drawn from fiscal federalism
theory and experiences of governance institutions and financing systems both in India
and around the world.
No one system of urban governance is likely to work equally well for all urban
local bodies. However, the paper identifies some key reforms required to realise both the
constitutional intent to encourage citizen participation in urban governance and the
economic and politically desirable goal of ensuring greater accountability of urban
governments. For example, the paper draws attention to existing ambiguities in the
assignment system and underlines the need to undertake activity mapping to ensure
clarity as well as to make independent agencies significantly accountable to elected
governments in urban areas.
*
Director, National Institute of Public Finance and Policy, New Delhi, Email:
mgr@nipfp.org.in;mgr@vsnl.com
**
Professor Emeritus of Economics, University of Toronto, Toronto, Canada

4
The paper also discusses a variety of ways of augmenting the resources of the
municipal bodies in the country including essential reforms in the property tax system and
adequate exploitation of user charges and fees for various services delivered as well as
ways of strengthening and improving Central and State transfers to urban local
governments. With respect to financing urban infrastructure, development charges should
be used more effectively. More should also be done to utilise public lands more
effectively. In addition, to a considerable extent capital expenditure requirements will
have to be financed through borrowing so further development of the municipal bond
market is important, as is more and more effective use of public private partnerships in
some areas.
JEL Codes: R51, H70
Keywords: India, urban public finance, urban governance, intergovernmental fiscal
relations, property tax, metropolitan areas, infrastructure finance

5
Urban Governance and Finance in India
I. Cities as Centres of Economic Dynamism: Role of Governance and
Finance
Urbanisation and development are inseparably linked in part because cities are
the leading edge of economic dynamism in every country. The concentration of
enterprises and people from various walks of life in cities facilitates productive interaction
and the exchange of ideas and creates a climate for creative activity and enterprise
development that leads to innovation and productivity. Cities generate externalities that
facilitate transactions, production, and distribution activities and serve as centres of
entrepot trade. Large cities in particular may achieve the critical mass required to attain
high degrees of specialisation in labour, knowledge and businesses, services,
infrastructure, institutions and media, all of which increase economic dynamism (Bird and
Slack, 2007).
However, the extent to which cities succeed in realising their potential to
galvanise innovation and accelerate growth depends to a considerable extent on whether
they succeed in providing not only adequate urban public services but also good policies,
high-quality institutions, and the tolerant and open social environment needed to facilitate
creative social and economic interaction. Achieving agglomeration economies in cities
requires the sustained provision of a wide range of urban public services that underpin
both private sector activities and the well-being of the urban population such as water,
sewers, garbage collection and disposal, drainage systems, police and fire protection,
and transportation. In a world where international economic competition is linked to
dynamic urban centres, cities that wish to attract the ‘knowledge workers’ who are
increasingly the drivers of growth also need policies to accommodate diverse cultures
(including outsiders) as well as such ‘quality of life’ factors as high quality schools and
healthcare facilities, social and cultural activities, recreational opportunities, and safe and
strong neighbourhoods. Moreover, cities must also accommodate all those who make the
city work, including new migrants and others who work in construction and other essential
activities and often need affordable housing and in many cases some social assistance.
Finally, underlying all this, a ‘good’ city also needs a political and governance system that
responds to the requirements and needs of its people swiftly without entailing heavy
transaction costs.
Good policies, good local governance systems, and sound arrangements to
finance public services are critical elements in sustainable urban development and shape
the nature and quality of public services provided as well as the structure of incentives
and accountability. Open multicultural policies support cosmopolitanism and attract both
capital and labour; in contrast, restrictive policies create insecurity and prevent efficient
migration. Cities, to be competitive, need both to provide quality public services in
adequate quantities and to be responsive to the requirements of people and businesses.
To do so, they not only require adequate sources of finance but also effective
participatory mechanisms that elicit the preferences of people and provide the services
that meet these preferences. The governance system should also foster accountability
by ensuring that, by and large, urban residents themselves pay for the public services

6
they receive (except to the extent that urban services provide significant external
benefits outside the urban area itself).
In India, over 330 million people live in urban areas distributed over 5,165 cities.
Urban population has grown at an annual rate of 2.7 per cent and, even though overall
population growth is expected to decelerate, the urban population is likely to continue to
grow at about 2.5 per cent until 2031 (Ramanathan and Dasgupta, 2009). In 2005, there
were 96 municipal corporations, 1494 municipalities and 2092 Nagar Panchayats in 2005
(India, 2004). Over a million people lived in each of 35 cities, and of the 10 largest
metropolises in the world, three (Mumbai, Delhi and Kolkata) are in India. The urban
sector presently contributes about two-thirds of GDP and this share is likely to increase to
75 per cent by 2021 (India, 2008). India’s cities are thus already large, economically
important, and growing. Ensuring that they can meet the challenges they face will not be
easy.
Demands for better infrastructure and better public services in India’s urbanised
areas are large and growing. In contrast, the resources now available to urban local
governments are clearly inadequate, falling short even of the norms (adjusted for
inflation) set long ago by the Zakaria Committee (India, 1963). Mohanty et al (2007), for
example, found that on average for the period 1999-2000 to 2003-04 actual spending in
30 large municipal corporations in India was only about 24 per cent of the requirements
established by the Zakaria Committee almost half a century earlier. While there was
considerable variability in the sample, the extent of under spending on urban services
was over 75 per cent in 17 municipal corporations, and indeed over 50 per cent in all of
them except for three -- Pune (31.6 per cent), Nagpur (30.8 per cent), and Nasik (35.5
per cent). At the other extreme, spending in the Patna Municipal Corporation was
estimated to be only 5.6 per cent of the normative requirement, and the shortfall was over
90 per cent in almost all municipal corporations in the poorest States of Uttar Pradesh
and Bihar.
Financing urban infrastructure and services adequately is thus a formidable
challenge. The infrastructure deficit in urban areas is not only large but growing. Recent
analysis by the Planning Commission shows that 34 per cent of urban households do not
have water taps within their premises, 26 per cent of them do not have toilets, 70 per cent
of waste is not treated before disposal, and untreated sewerage and unregulated
discharge from industries is a major source of water pollution. In total, according to the
draft Eleventh Five Year Plan document, only 63 per cent of the urban population had
access to sewerage and sanitation facilities in 2004. Urban transportation problems are
similarly acute. Public transportation is congested and inefficient, and even those who
can afford private transportation on average travel only a kilometer in 15 minutes owing
to road congestion. Housing too is problematic, with almost 21 per cent of the urban
population living in squatter settlements.
Such problems are likely to worsen in the near future with continued urban
growth. As both, education and skill levels of the population and manufacturing and
service sectors expand, migration to urban areas will continue, resulting in a continued
high urban population growth rate even as the fertility rate in urban areas declines.
Ramanathan and Dasgupta (2009) estimate cumulative capital investment requirements
for providing services at 2007 prices for the period 2006-2031 at Rs. 71,251 billion and
O&M requirements at Rs. 10,031 billion. This works out to an annual average of Rs.

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Abstract: vogue. Both in the industrialized and in the developing world, nations are turning to devolution to improve the per- formance of their public sectors. In the United States, the central government has turned back significant portions of federal authority to the states for a wide range of major programs, including wel- fare, Medicaid, legal services, housing, and job training. The hope is that state and local governments, being closer to the people, will be more responsive to the particular preferences of their con- stituencies and will be able to find new and better ways to provide these ser- vices. In the United Kingdom, both Scot- land and Wales have opted under the Blair government for their own regional parliaments. And in Italy the movement toward decentralization has gone so far as to encompass a serious proposal for the separation of the nation into two in- dependent countries. In the developing world, we likewise see widespread inter- est in fiscal decentralization with the ob- jective of breaking the grip of central planning that, in the view of many, has failed to bring these nations onto a path of self-sustaining growth. But the proper goal of restructuring the public sector cannot simply be de- centralization. The public sector in nearly all countries consists of several different levels. The basic issue is one of aligning responsibilities and fiscal in- struments with the proper levels of gov- ernment. As Alexis de Toqueville ob- served more than a centuty ago, "The federal system was created with the in- tention of combining the different ad- vantages which result from the magni- tude and the littleness of nations" (1980, v. I, p. 163). But to realize these "dif- ferent advantages," we need to under- stand which functions and instruments are best centralized and which are best placed in the sphere of decentralized levels of government. This is the sub- ject matter of fiscal federalism. As a subfield of public finance, fiscal feder- alism addresses the vertical structure of the public sector. It explores, both in normative and positive terms, the roles of the different levels of government and the ways in which they relate to one another through such instruments as intergovernmental grants.2

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Frequently Asked Questions (2)
Q1. What are the contributions in "Urban governance and finance in india" ?

This paper attempts to point the way towards some possible solutions by analysing urban governance and finance in India in the context of lessons drawn from fiscal federalism theory and experiences of governance institutions and financing systems both in India and around the world. However, the paper identifies some key reforms required to realise both the constitutional intent to encourage citizen participation in urban governance and the economic and politically desirable goal of ensuring greater accountability of urban governments. For example, the paper draws attention to existing ambiguities in the assignment system and underlines the need to undertake activity mapping to ensure clarity as well as to make independent agencies significantly accountable to elected governments in urban areas. 

It also suggests that one possibility that should be considered is for the largest cities to be accorded independent status similar to the States in part to insulate them from localised and parochial biases. The paper also suggests that consideration should be given to the possibility of empowering metropolitan governments to piggyback on the GST when it comes into existence: even a 1 per cent surcharge on this base could generate one and a half to twice the amount of revenue that is being collected from the property tax at present. In addition, to a considerable extent capital expenditure requirements will have to be financed through borrowing.