Fiscally Challenged Indian CIties

India is undergoing an extraordinary phase of urbanization. Over the next three decades, its urban population is expected to double, increasing from 400 million to 800 million. This surge presents a unique opportunity to transform urban spaces but simultaneously poses immense financial and structural challenges. According to a recent World Bank report, India will require a staggering ₹70 lakh crore by 2036 to meet its urban infrastructure needs. However, the current investment levels, pegged at approximately ₹1.3 lakh crore annually, fall significantly short of the required ₹4.6 lakh crore per year. This mismatch highlights the urgent need for reform and innovation in urban infrastructure financing.

Why Are Municipal Finances Struggling?

Municipal finances are central to urban infrastructure development, yet their contribution to India’s GDP has stagnated at just 1% over two decades. While municipalities account for 45% of urban investments, the remaining 55% is managed by parastatal agencies, reflecting the limited financial autonomy of local urban bodies. Although central and state government transfers to municipalities have increased from 37% to 44%, municipalities remain underfunded and unable to meet their responsibilities.

Declining Self-Sufficiency: Municipalities’ own revenue sources have decreased from 51% to 43%, highlighting a growing reliance on external transfers. This decline underscores a need for greater fiscal autonomy and innovation in revenue generation.
Low Property Tax Collection: Property tax, a critical revenue source, generates a mere ₹25,000 crore annually, or just 0.15% of GDP. Major cities such as Bengaluru and Jaipur collect only 5%-20% of their potential revenues, exposing inefficiencies in tax assessment and collection systems.
Inefficient Cost Recovery: Municipalities recover only 20%-50% of the costs of urban services. This chronic gap between service delivery expenses and revenues exacerbates fiscal deficits.
Underutilization of Funds: Many municipalities fail to fully utilize allocated resources. For instance, 23% of municipal revenues remain unspent, and cities like Hyderabad and Chennai utilized just 50% of their capital expenditure budgets in 2018-19.

These challenges are compounded by the limited capacity of Urban Local Bodies (ULBs) to design, implement, and manage large-scale infrastructure projects, further stalling urban development.

How Has Public-Private Partnership (PPP) Performance Declined?

Public-Private Partnerships (PPPs) once held promise for urban infrastructure financing in India. However, investments in PPP projects have plummeted, dropping from ₹8,353 crore in 2012 to just ₹467 crore by 2018. Several factors contribute to this decline:

Limited Viability: The commercial success of PPP projects often hinges on project-specific revenues or government support for viability gaps. Without such mechanisms, these projects lose attractiveness for private investors.
Regional Disparities: Municipal bodies in smaller cities lack the expertise and resources to create Special Purpose Vehicles (SPVs) or design comprehensive PPP frameworks, resulting in less than 10% of PPP projects originating from smaller cities.

The absence of robust financial and administrative frameworks in many ULBs makes it difficult to attract private investments, deepening the divide between urban centers and smaller cities.

What Long-Term Reforms Are Needed to Revive Municipal Finances?

Empowering municipal governments and enhancing their financial independence are essential for addressing India’s urban infrastructure challenges. Long-term reforms should focus on structural changes that strengthen local governance and revenue generation.

Strengthening State Finance Commissions (SFCs): Many states fail to constitute or effectively implement the recommendations of SFCs, delaying resource allocation to local bodies. Addressing this gap is critical for equitable fiscal devolution.
Promoting Municipal Bonds: Municipal bonds have shown promise in cities like Pune, where the Pune Municipal Corporation raised ₹2 billion in 2017 to fund a water supply project. Fiscal transparency and robust accounting practices, as demonstrated by cities like Mumbai, can significantly improve municipalities’ creditworthiness.
Modernizing Tax Systems: Property tax systems require urgent modernization. Leveraging tools like GIS mapping, automated valuation methods, and transparent collection processes can help municipalities maximize revenue from this key source.

Decentralization efforts must also focus on empowering ULBs to manage their own resources, reducing dependency on state and central transfers.

What Medium-Term Interventions Can Address Immediate Challenges?

While long-term reforms take time to yield results, medium-term measures can address immediate gaps and accelerate progress in urban infrastructure development.

Improving Project Preparation: Poorly prepared projects often fail to secure funding or meet sustainability criteria. By decoupling project preparation from financial assistance, municipalities can design better projects that are socially, economically, and environmentally viable.
Expanding Digital Public Infrastructure (DPI): Outdated service delivery practices in Indian cities hinder efficiency. DPI solutions can enhance the management of public utilities and urban transport systems.
Capturing Land Value in Transport Projects: Urban transport accounts for 50% of India’s urban infrastructure needs. Integrating transit projects like metro and rail systems with urban development can unlock land value near transit hubs, generating additional revenue.

These interventions can bridge existing gaps while laying the groundwork for sustainable urbanization.

How Can Private and Community Partnerships Drive Innovation?

Innovative collaborations between municipal bodies, private stakeholders, and communities can unlock additional resources for urban infrastructure. Examples like the New Delhi Municipal Corporation’s (NDMC) PPP sanitation projects and Chennai’s Villivakkam Tank restoration showcase the potential of partnerships to create sustainable urban spaces.

Leveraging Private Expertise: PPP models can be used effectively for services like sanitation, where private entities build and maintain infrastructure while generating revenue from commercial activities.
Building Capacity in Smaller Cities: Smaller municipalities often face resource and knowledge gaps. Vocational training programs and capacity-building initiatives can equip ULBs with the skills needed to plan and execute complex projects.

Community participation, coupled with private sector expertise, can address resource limitations while ensuring projects align with local needs.

What is the Role of Fiscal Devolution in Strengthening ULBs?

Despite constitutional provisions under the 73rd and 74th Amendments, fiscal devolution to local bodies remains inadequate. Local governments account for less than 7% of total government expenditure, leaving them fiscally constrained. This lack of autonomy forces ULBs to depend heavily on state and central transfers, undermining their ability to address urban challenges effectively.

Resource Constraints in SFCs: Many states fail to provide updated fiscal data and adequate infrastructure to SFCs, delaying their recommendations. Even when recommendations are made, states often ignore or partially implement them.
Dependence on External Revenue: Over 50% of municipal corporations in India rely on external sources for revenue expenditure. States like Bihar and Uttar Pradesh particularly struggle, with own-source revenue (OSR) accounting for less than one-third of their expenditures.

To break this cycle of dependency, municipalities must mobilize their own revenue through property tax reforms, rationalized user charges, and diversified revenue streams.

What Lies Ahead for India’s Urban Future?

India’s urban transformation hinges on its ability to address financial and structural challenges with urgency. The path forward requires a combination of long-term structural reforms, medium-term interventions, and innovative financing mechanisms. By promoting collaboration between all levels of government, leveraging digital tools, and embracing fiscal transparency, India can create cities that are inclusive, sustainable, and economically vibrant.

As the urban population grows to 800 million, the stakes for timely action have never been higher. Addressing gaps in governance, financing, and planning is not just a necessity—it is an imperative for securing India’s urban future.