9
Jan

Municipal Finance – Funds

By Vishnu Prasad, IFMR Finance Foundation

As part of our series on Municipal Finance, this blog post discusses the present state of municipal finances by taking an in-depth look at municipal revenue and expenditure in India.

Municipal Revenue

According to the Thirteenth Finance Commission, in 2007-08, municipal revenue constituted 0.94% of GDP (at market prices) in India. This is well below that of other emerging economies like Brazil and South Africa, where corresponding figures are 5% and 6% respectively.

The main sources of municipal revenues can be boxed under the following categories:

  1. Tax revenues
  2. Non-tax revenues
  3. Assigned (shared) revenue
  4. Grants-in-aid
  5. Loans
  6. Other receipts.

Broadly, they can be categorized as own revenue (tax revenue and non-tax revenue) and other revenue (shared revenue, grants-in-aid, loans and other receipts). Table 1 lists out sources of revenue under each revenue head.

Figure 1 below shows the flow of funds (mentioned in Table 1) to ULBs from Government of India, State Governments and citizens.

Figure 2 shows the components of municipal revenue for 2007-08. Own tax and own non-tax (non-tax revenue) comprise 52.94% of total municipal revenue. Assignments, devolutions and grants-in-aid from the state government form 71% of other revenue.

Figure 3 shows the share of own revenue and other revenue in total revenue for the period 2002-03 to 2007-08. The share of own revenue has been declining over the time period; from 63.48% in 2002-03 to 54.94% in 2007-08.

Municipal Expenditure

Municipal expenditure can be classified into two categories: capital expenditure and revenue expenditure.

Further, revenue expenditure comprises:

  1. Establishment expenditure
  2. Administrative expenditure,
  3. Operations and maintenance expenditure, and
  4. Interest payments on loans

Capital expenditure comprises:

  1. Expenditure on capital formation and
  2. Principal repayment.

Figure 4 shows that revenue expenditure makes up the bulk (60.46%) of India’s municipal expenditure despite its falling share in total expenditure over time. Mohanty (2007) also finds that establishment and administrative expenditure make up 36% of total expenditure in a study of 35 Municipal Corporations. Figure 3 shows that the share of capital expenditure in total expenditure has increased from 27.45% in 2002-03 to 39.54% in 2007-08, while the share of revenue expenditure has decreased from 72.55% to 60.46% during the same time period.

Current State of Municipal Finance

Mohanty (2007) finds that municipal corporations in India are characterized by sound fiscal health and high levels of under-spending. This is due to statutory obligations that restrict expenditure of ULBs to resources available and limit the access of ULBs to debt. The study finds that the level of under-spending on core services (as compared to the norms set by the Zakaria Committee) is 76%. Reasons for under-spending by ULBs can be divided into exogenous and endogenous reasons. Exogenous reasons include over-dependence of ULBs on upper tiers of government for resources and inadequate delegation of revenue raising powers to ULBs.

The Report on Indian Urban Infrastructure and Services (2011) points out that the 74th Constitutional Amendment Act did not create for a separate ‛municipal finance list’ to match the municipal functions listed, hence making an ‛incomplete devolution’ package. Endogenous reasons include inefficient tax administration, low cost recovery and poor quality expenditure. The Report also projects that investment requirement on urban infrastructure over the next 20 years is Rs. 39.2 lakh crores.

As Figure 3 shows, there is a declining trend in share of own revenue in total revenue. As the Report notes, “The overall average does not convey the gravity of the situation in many municipal bodies where ULBs are virtually reduced to becoming state government departments since even the salaries are paid by state governments.” Mohanty (2007) points out that there is high positive correlation between under-spending and dependency ratios (share of grants a Municipal Corporation receives in relation to total expenditure). High dependency ratios and declining own revenue shares have been an impediment to ULBs accessing municipal debt markets. Till date, there have been 22 bond issues (Taxable-9, Tax-free-11 and Pooled bonds-2) in India, mostly met with partial success. These bonds have been able to raise Rs. 1224 crores. Small and medium ULBs are unable to access the municipal debt markets due to their weak balance sheets and high cost of transactions. Tamil Nadu and Karnataka have issued pooled bonds by combining many ULBs.

Jawaharlal Nehru National Urban Renewal Mission (JNNURM) was launched in December 2005 with the aim to encourage reforms and expedite the planned development of identified cities. The Mission consists of four programs- Scheme for Urban Infrastructure and Governance (UIG) and the Scheme for Basic Services to the Urban Poor (BSUP) for funding basic urban services and urban infrastructure in identified cities and Urban Infrastructure Development Scheme for Small and Medium Towns (UIDSSMT) and the Integrated Housing and Slum Development Programme (IHSDP) covering non-Mission cities and towns with the aim of providing basic entitlements and services to all including the urban poor. As of December 2010, the Mission had released funds equal to Rs. 28650 crores. Funding for the project is conditional on a set of mandatory reforms, accompanied by a set of optional reforms. However, JNNURM faced a trade-off between creating a moral hazard (by disbursing money to ULBs that had not undertaken reforms) and letting important infrastructure projects languish. Consequently, most ULBs have not undertaken even the mandatory reforms and the moral hazard has dis-incentivised ULBs from accessing debt markets for funding.

References

  1. Ahluwalia, Isher Judge. Report on Indian Urban Infrastructure and Services. High Powered Expert Committee (HPEC) for estimating the investment requirements for urban infrastructure services. March 2011
  2. Mohanty, P.K et al. Municipal Finance in India: An Assessment. Development Research Group,Reserve Bank of India. December 2007
  3. Report of the Thirteenth Finance Commission (2010-2015). Finance Commission, India. December 2009