The biggest barrier so far in implementing smart city projects around the world has been access to finance and uncertainties introduced by new operating models.
The word ´smart city´ has captured the imagination of the world and India is no exception. But realizing the ambitious goal of Prime Minister Modi to develop 100 smart cities across the country will prove to be a socioeconomic and financial challenge. The biggest barrier so far in implementing smart city projects around the world has been access to finance and uncertainties introduced by new operating models. Cities in Asia often have fewer options for raising funds than their European or North American counterparts. For instance, even in China with its huge infra¡structure investments, financing smart city projects is becoming difficult. India is a different animal and the challenges in infrastructure financing so far have been Asset-Liability Mismatch, underdeveloped debt markets, risk concentration, regulatory constraints, etc.
Portland´s iconic Brewery Blocks redevelopment has been selected as a winner in the 2014 Urban Land Institute Global Awards for Excellence competition, widely recognised as the land use industry´s most influential recognition programme. The city´s brewery blocks smart development project was pegged at around $300 million and the city contributed just $8 million. The remaining $292 million came from private sources, producing a 36:1 private-to-public investment ratio. The project increased property tax revenue for Portland by $1.3 million and the value of the land shot up by 490 per cent.
The above example is just a sample of how smart projects are getting funded around the world.
Fortunately for India, there is growing knowledge on financing models available now-right from debt markets, Public-Private Partnerships, equity investments to advanced financial models like financing through cloud securitisation, tax increments, crowd sourcing, venture capital, etc. But the key to success of any of the above models has much to do with leveraging the right option based on the unique risk and rewards of a particular environment.
The Municipal Bonds or ´muni bonds´, are very popular among investors in many developed nations, especially the United States, where muni bonds have attracted investments totalling over $500 billion and are among preferred avenues for household savings. But in India municipal bonds have not picked up mainly because of lack of interest amongst investors, the sorry state of finances of many urban local bodies (ULBs), bureaucratic hurdles and regulation, etc.
The Indian government is looking to finance smart cities through the PPP route. But India is still at the ´bottom rung´ of the PPP maturity ladder. Currently the need is to ensure clear political support, a proper legal and regulatory structure, a robust procurement framework that can be understood by both procurers and bidders, and a credible project timetable.
To make PPPs successful, India can look at countries like Brazil and Russia, its BRIC colleagues. Brazil in its successful transportation project based on PPP has introduced performance parameters, easing predetermined investment targets of different service levels. This kept the project heuristic and ensured less risk to the private partner. Likewise Russia in its PPP project for transportation focused on developing right project design while building its own capacity. A practical legal framework ensured success of the project.
There is hope around the corner in the form of FDI. Developing a smart city requires significant real estate investment. Currently with recent amendments, 100 per cent FDI is allowed in greenfield projects with a minimum size of development (20,000 sq m) and a lock-in restriction on equity repatriation. Also with the new ordinance on land acquisition brought into play by the Modi government, there will be traction in smart development.
It´s good news that global pension funds´ long-term capital is finally finding its way into India, where about $35 billion worth of private operating assets were created in the past decade. The availability of these assets, known as ´brownfield´ in industry parlance, is set to grow further on the back of the government´s emphasis on infrastructure. Pension funds can also serve as an alternate source of finance for infrastructural projects if the regulatory issues are addressed appropriately.
They could provide long-term streams of income, consistency, predictable cash flow, low default rates, and societal benefits. India should look in this direction.
Recently the world started experimenting with innovative business models such as finance through cloud, etc. The emergence of cloud-based services such as Software as a Service (SaaS), Platform as a Service (PaaS), Infrastructure as a Service (IaaS) and City as a Service (CaaS) offers a cost-effective and scalable infrastructure for the delivery of new services, as well as important financial advantages-notably, shifting investment costs from capital expenditures to operating expenditures. Another opportunity for cities to maximize the value of their assets is to open up data resources to third-party developers.
Although the return on investment may be attractive, complexities often make it challenging for cities to kick-start their Smart City projects.
If Davos corridors echoed a positive sentment about India, among many things it was about Real Estate Investment Trusts or REITs. The proposed instrument is said to be a ´booster rocket´ for investments coming into India and realty players are waiting just as ´smart city´ hopefuls in India.
India and the municipal bonds market
The capital market is a major source of financing for municipalities in the US. However, they have evolved rules and regulations to support investors in financing their municipalities that we may find difficult to emulate. For instance, in the US, municipalities can be declared bankrupt and investors can force actions on the municipalities that would be considered completely unacceptable in our country. Given our socio-economc-political context, such a dispensation will also not be warranted. Our institution has been working with a number of banks in putting together a Pooled Municipal Debt Obligation (PMDO) facility that is designed to provide financing to commercially structured and bankable projects in municipalities. Over the past few years, we have developed significant expertise in handling such projects and in assisting in their seamless implementation. Increasing the footprint of initiatives such as the PMDO, will provide the basis for deepening and strengthening the municipal financing system in the country and position the sector for the capital market eventually.