Smart Cities: Financing Challenges

In the next five years, special purpose vehicles (SPVs) will be spending around Rs.1,631 billion on projects conceived under area-based development and Rs.388 billion on pan-city development. But the question is how these funds are likely to be mobilised. <br />
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In the month of April (this year), the government completed 1,000 days since its announcement on Smart Cities Mission (SCM). As on today, out of 100 cities identified, the government has selected 99 smart cities with a staggering investment of Rs 204 billion. That said, outlay for each city ranges from Rs 10 billion to Rs 25 billion, and in some cases, it is around Rs 3 billion. Now, with such enormous amount of investments, it is important to understand the funding sources available to match the required demand.&nbsp;&nbsp; <br />
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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 that the state governments and Centre are required to shell out or make an arrangement for whopping Rs 990 billion collectively towards the selected 99 cities. <br />
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That apart, urban local bodies (ULBs) will be contributing a gigantic Rs 198 billion. Considering these whopping figures, at least the Centre and state governments are in much better position in terms of their revenue streams, but with an eye-popping Rs 198 billion to contribute, ULBs have a mammoth task ahead to achieve. <br />
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If we look closely at the funding pattern, the central and state government (s) (with 46 per cent of contribution) remains to be the major shareholder in SCM, followed by convergence from various Centre-driven schemes like AMRUT, Housing for All, etc., which comes to around 21 per cent, public-private partnership (PPP) with 20 per cent, equity funds with 4 per cent, ULBs contribution 1 per cent and other sources is 8 per cent. The figure speaks for themselves; with 67 per cent central government grants and schemes remains to be the top contributor. That means, the dependence of selected smart cities on these grants can certainly jeopardise cities envisaged plans, if not released on time. Worth to mention, with 20 per cent of the total smart cities outlay to be funded through PPP projects worth Rs 440 billion, as on today only 50 projects worth Rs 52 billion have been implemented.<br />
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INFRASTRUCTURE TODAY dug deeply to understand the financing challenges of these future smart cities likely to face and managed to provide solutions to the decision makers to act upon.<br />
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<span style="font-weight: bold;">Fact check</span><br />
Since the launch of the Smart Cities Mission (SCM), Rs 99.39 billion has been released by the Government of India. Against this, 753 projects worth Rs 245.11 billion have been completed or started work on-ground. Further, about 287 projects worth Rs 142.96 billion are in tendering stage and the works on-ground is expected to start very soon. The government claims this is one of the fastest progress demonstrated in the urban sector considering the scale and novelty of the mission.<br />
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Moreover, the progress depends on the date of the selection of the smart city. After selection, it takes around 18 months in setting up an special purpose vehicle (SPV), procuring project management consultant (PMC) firm, hiring human resources, preparing detailed project reports (DPRs) and then call for tenders. For cities selected in Round 1 (January 2016), where 18 months have lapsed, about 51 per cent of the projects have either been tendered or are under implementation. In round 2 and 3, nearly all the cities have set up their respective SPVs.<br />
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<span style="font-weight: bold;">Big plans, but limited sources</span><br />
In the next five years, SPVs will be spending Rs 1,631 billion on projects conceived under area-based development and Rs 388 billion on pan-city development. But the question is how these funds are likely to be mobilised. <br />
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For instance, these selected ULBs, which are carrying out the SCM, are solely dependent on revenue sources, including property tax, building licence fees, and other land-based levies such as betterment levy, valorisation, impact fee, exaction, stamp duty, hawker or vendor fee, PPP and advertisement fee.<br />
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<span style="font-weight: bold;">Th Harikumar Singh, Municipal Commissioner, Imphal Municipal Corporation</span>, is a worried man in this case. Imphal was selected in the fast track round and is struggling to get the required finance for the envisaged projects. ‘We are concerned about funding, as the state is looking for investments on a PPP mode,’ avers Singh.<br />
Singh is not the only municipal corporation concerned about the funding. <br />
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INFRASTRUCTURE TODAY spoke to various municipal commissioners and SPV CEOs during the SM@RT URBANATION 2018 expo in Hyderabad last month, and ironically, everyone echoed their worries on funding, with some suggesting the Smart Cities Council India (SCCI) to take the lead in solving this issue.<br />
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That said, despite limited resources, experts in the fraternity believes that these ULBs can sail through the funding storm with improvising their strategies than just being dependent on primary source of revenue.<br />
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<span style="font-weight: bold;">Funding options</span><br />
Although smart cities have been provided dedicated seed money from the Centre and the state, with some to be generated from their own budget, but the financial requirement still remains huge as smart city plan has to benefit the entire city and not just limited to the area identified for development. However, moving away from archaic ways of urban governance, cities are now vying for credit ratings for mobilisation of resources through municipal bonds, crowd funding, etc., reflecting on their keenness to think and act differently.<br />
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<span style="font-weight: bold;">Vijay Agrawal, Executive Director, Equirus Capital,</span> has a point to make. ‘Since an SPV does not have the capacity to pay interests if the fund is raised from equity markets, they can opt for deep discount bonds.’ He adds: ‘It’s a type of a structured bond wherein for the first 7-10 years, SPVs do not have an obligation to pay any interests to its investors and post 10 years start the guaranteed redemption.'<br />
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With this, an SPV cash flow matches with bond redemption with premium so investor returns are guaranteed and a SPV also has enough cash flow to make the projects sustainable. The funds raised through this route can be utilised in IoT-enabled infrastructure, which do not put pressure on users as charges can be designed in a way will recover the operation and maintenance cost, capex cost and return for the investors.<br />
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<span style="font-weight: bold;">Anindya Mallick, Partner with Deloitte,</span> suggests municipal corporations to leverage floor space index or floor area ratio to monetise for the benefit of the corporations. The other source (according to Mallick) could be from international multilateral agencies, national infrastructure investment fund (NIIF), which is looking to bring in sovereign and global pension funds to India.<br />
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Another funding option that can be looked upon is crowd funding. Crowd funding is a method of raising capital through the efforts of family, friends and investors. The pool of individuals participating in the fund-raising can be formed via social media, government portals and other platforms for extensive exposure and reach. Crowd funding has emerged as an alternative form of finance far removed from the avenues of the conventional financial system. At present, Amaravati, the greenfield capital of Andhra Pradesh, is the only city in India that is raising funds digitally.<br />
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The crowd-funding initiative, ‘My Brick, My Amaravati’ was launched in October 2015 by the state government, and is gaining momentum now. This could be the first such exercise in India wherein Indian citizens along with expats will contribute in a fund-raising initiative. Under the ‘My Brick, My Amaravati’ initiative, a person is allowed to buy a digital brick for Rs 10 and his or her name is engraved on it. It is kept in a repository forever. And the donor gets a certificate of commendation from <span style="font-weight: bold;">Andhra Pradesh Chief Minister N Chandrababu Naidu,</span> which reads: ‘Every brick matters and every effort is valued. Your gesture will go a long way in realising Amaravati as a true people’s capital.'<br />
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Plans are also afoot for stepping up this donations campaign for the capital by the cash-strapped state government, which has not been able to gain any significant special assistance from the Centre until now for the project. Andhra Pradesh has received only Rs 856 crore so far from the Centre for the building of Amaravati.<br />
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<span style="font-weight: bold;">Asset monetisation</span><br />
The SPV needs to identify bankable projects to attract private investment. The challenge is to mitigate funding as well as keep it self-sufficient to generate revenue from various available sources for sustainability. Currently, SPVs are in comfortable position. Reason, assured funds from both the State and Centre for launching projects. However, as soon as the first few billion spent on envisaged projects, SPV becomes paranoid where the rest of the money will come from. <br />
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In such cases, Bhopal Smart City has set an example. But to an extent, the state government is also equally supportive. <span style="font-weight: bold;">Chandramauli Shukla, CEO of Bhopal Smart City, </span>said that the SPV has been lucky enough to receive 342 acre land from state government, which, if developed and marketed properly, can monetise around Rs 60 to 70 billion.<br />
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<span style="font-weight: bold;">Prakash Gaur, CEO, Andhra Pradesh Urban Infrastructure Asset Management (APUIAML), </span>explains the next-gen financial reforms, where the authorities need to look beyond their comfort zones. APUIAML, in a joint venture with IL&amp;FS, plans to raise CAT 2 fund, which is quite similar to NIIF. Interestingly, six months ago, this entity has raised Rs 50 billion for the urban development work in Andhra Pradesh including four smart cities. <br />
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<span style="font-weight: bold;">T Ravinder Reddy, Partner, Grant Thornton India</span> is of the opinion that monetisation of several projects is possible in cities where there is a lot of commercial sense to that particular project, but the same may not be applicable to a different city elsewhere. For instance, a city can monetise projects such as smart poles, which are erected in public areas. These poles can be commercially exploited with additional services like Wi-Fi, surveillance, solar panels, etc. Reddy added: ‘A lot of telecom companies are interested in doing such projects because that is the revenue generation asset and entity for them. And they are going to monetise it and make it profitable and share the revenue with SPV as well. Such projects are popular.’ <br />
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But, are such projects popular in all cities? Reddy says, ‘Maybe not. Cities with commercial sense will taste the success of monetising such projects, unlike rural hinterland or tier 2 or 3 cities. Because it will be difficult to find buyers in those places.'<br />
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<span style="font-weight: bold;">Current trends </span><br />
Apart from asset monetisation, other revenue sources for urban centres are user charges for specific services, taxes and non-tax revenues, grants, loans and other receipts. According to the report titled ‘Municipal Finance: Funding Urban Development in India’ by JLL India, it is estimated that as much as Rs 250 million can be raised annually through advertising fees by municipal bodies of metropolitan cities of India.<br />
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Advertising fees are trending as a key instrument for revenue augmentation in the urban centres of India. The advertising fee or revenue collected through the leasing of advertisement rights on assets owned by various government agencies have the potential to be a game changer in the near future. It is to be noted that many Indian cities are now focusing on developing, planning and expanding this opportunity to assets that present an advertisement fee opportunity including public convenience facilities, lamp posts, public parks an open spaces, and government buildings.<br />
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The report notes that metropolitan cities (population of 1 million and over) have a potential to attract average revenues of over Rs 250 million per year through out-of-home advertising. Cities that have a population of up to 1 million, revenue from out-of-home advertising is estimated in the range of Rs 7.5 million to Rs 10 million per annum.<br />
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For smaller municipalities and town panchayats, the estimated revenue generation potential through advertising is estimated in the range of Rs 1 million to Rs 2.5 million per annum. Mega cities have an even higher potential of generating revenue through advertisements revenue and tax and can be in the range of Rs 750 million to Rs 1 billion depending on the availability of space in their assets, the report says.<br />
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<span style="font-weight: bold;">Need for municipal finance</span><br />
In India, the municipal bond market is largely untapped. Over the last 14 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. Last June, however, the Pune Municipal Corporation (PMC) became the first city to issue bonds after a long gap. Bonds worth Rs 2 billion were issue to fund PMC’s 24 x 7 water supply project. Then again, in February 2018, the Greater Hyderabad Municipal Corporation (GHMC) also issued bonds worth Rs 2 billion for its Strategic Road Development Project (SRDP).<br />
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<span style="font-weight: bold;">Dr B Janardhan Reddy, Municipal Commissioner, GHMC</span>, is visibly happy with the success of their second municipal bond. He said: ‘Going forward, we will be raising Rs 10 billion for SRDP.'<br />
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Recently, there have been spates of news reports, indicating that many more cities are planning to issue bonds. As we speak, over 140 cities have applied for credit rating with the Security Exchange Board of India (SEBI). <br />
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The Ministry of Housing and Urban Affairs has auctioned a credit rating system – one of the transformational reforms under which 500 cities and towns have been given credit ratings to ensure investments. <br />
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But before hitting the market, <span style="font-weight: bold;">Mehali Patel, Associate Director, CRISIL Risk and Infrastructure, </span>advices municipal corporations to strengthen the revenue stream than its dependence on property tax to repay its investors. ‘ULBs need <br />
to buckle up for creating dependable revenue sources, property being the key source today, but we all know about the issues related to it,’ she says.<br />
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Meanwhile, to raise the funds through municipal bonds, there is a need for capacity augmentation on ULBs. 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. Only 55 of the 94 cities had investment grade ratings. Ratings were based on multiple criteria like the cities’ social and economic profile, operating efficiency, policy framework, recent financials, etc.<br />
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While none of the cities got the highest rating of AAA, three cities – Pune, Navi Mumbai and NDMC (New Delhi Municipal Corporation) – got the second highest rating of AA. GHMC, Ahmedabad and Visakhapatnam got the next best rating of AA, and four other cities were rated AA-. Overall, only 10 cities were rated in the AA band. And only 14 came under the next ‘A’ band.<br />
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On municipal bonds, <span style="font-weight: bold;">Nalini Atul, Joint Managing Director, Karnataka Urban Infrastructure Development and Finance Corporation (KUIDFC),</span> has a different take. According to him, if a SPV is getting funds at a cheaper rate than that of municipal bonds, it is wise to not opt for it. This is mainly because it creates an additional responsibility or obligation on SPV to repay its investors. <br />
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<span style="font-weight: bold;">Countering Atul’s view, Ashish Sable, Sr Vice President &amp; Group Head, Debt Capital Markets, SBI Capital Markets</span>, says, ‘I think the process of raising funds through municipal bonds will make ULBs accountable for being transparent. This will compel the ULBs to meet the investors’ requirement in terms of disclosure, discipline, etc.’ <br />
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Further, Sable explained why it s necessary for ULBs to opt for municipal bonds. <br />
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According to him, Rs 7,000 billion is required for urban development over the period of 20 years, i.e., around Rs 350 billion per year. So do we have enough instruments to fund this kind of capex? Let’s do the fact check. The Government of India borrows around Rs 6,500 billion from bond market however, India’s corporate bond market is as equal to what the Indian government is borrowing. In fact, it is much bigger. To make his case strong, he cites examples of Pune and Hyderabad. ‘These two ULBs have issued their bond at 7.57 per cent and 8.9 per cent, respectively. Even central government may not been able to borrow at this rate.'<br />
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That said, municipalities have tremendous potential for growth. However, except for a few large municipalities, the growth of smaller municipalities, ULBs and towns has been muted. In order to strengthen the former and improve the latter, it is important to find revolutionary ways to pool finance. In this case, the Tadipatri Municipal Corporation has shown the way to others. Since the corporation was mainly dependent on grants from state and central, Tadipatri has managed to create a pool of fixed deposit worth Rs 270 million. <br />
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Says the Corporation’s Municipal Commissioner, S Siva Rama Krishna, ‘We have generated funds by converting all the vacant sites into shopping complex.’ That said, the corporation is generating an income of Rs 1 billion from the shopping complex and has introduced usage charges on garbage collection. In addition, the corporation is receiving a sum of Rs 30 million per annum from solid waste management.<br />
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<span style="font-weight: bold;">Way Forward</span><br />
To mitigate the funding issues for smart cities, projects should be planned in such a way that they accelerate the pace of growth of tax revenues of various government departments, spur the city’s economy and sustainably enhance the paying capacity of citizens.<br />
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Value capture financing (VCF), land value improvement tax and tax increment financing (TIF) should be envisaged in planning the finance. Once planned, projects are successfully implemented, considering the bankability of the projects, there can be a stake sale either through a private placement or through an initial public offering (IPO) at a significant premium. There is also scope for raising funds for projects that have attained commercial production. This should help cover cost overruns, if any, or if the envisaged capital or revenue inflows do not materialise on time or are not adequate. Hence, adequate development for bettering the lives of citizens and improving the availability of infrastructure becomes a prime need to increase the revenue potential.<br />
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That said, a solid financial structure is essential for the success of cities in meeting the growing needs of urbanisation. SCM was the first initiative by the government that linked not only all the government schemes (such as AMRUT, Affordable Housing under PMAY, National Heritage City Development and Augmentation Yojana (HRIDAY), Swachh Bharat Mission, Skill India, Make in India, Non-Motorized Transport (NMT), Multimodal Integration, Lastmile Connectivity Options and Green Mobility Schemes) but also all the funding mechanisms that are available through convergence. It is not just the urban landscape that will change, but also the way ULBs manage the funding to balance the city’s economy. <br />
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This will change the landscape of cities to prepare itself in this new era of city competition to become a leading global city. Projects that implement pooling all the financing options available, monitored under a single SPV under a fixed timeframe with the intervention of technology will definitely set a benchmark for how future cities would manage their finances. The same technique should be replicated across all other ULBs to optimise the benefits.<br />
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<span style="font-weight: bold;">- RAHUL KAMAT</span><br />