Land as a source of financing urban infrastructure

By Aditi Balachander and Anand Sahasranaman, IFMR Finance Foundation

At a fundamental level, it can be argued that internal revenue sources are the most critical funding levers available to a municipality because without effective, predictable generation of internal revenues, it will be impossible to attract new, external sources of funding. External sources, whether in the form of bank loans, bonds or other capital market instruments, will be available to municipalities only on the basis of the internal revenues they generate now and are expected to generate in the future. Additionally, the internal revenue generation of a municipality is but a reflection of the quality of its governance, and the transparency and accountability of its administration. Any assessment of the internal financing capability of a municipality is, therefore, a judgment on its governance standards. A better governed municipality implies better information availability, better assessment capability and better collection efficiencies that are then reflected in the quantum of revenues generated through internal funding levers. Therefore, any attempt to substantially improve the infrastructure provision scenario in India will need to begin by giving a significant thrust to improving the assessment, enforcement and collection of internal revenue levers.

While the generation of internal revenue is critical for a city, the use of land as a source of financing urban infrastructure can be a very useful supplementary mechanism. Traditionally, urban infrastructure has been financed by savings of local government, grants from higher levels of government and capital borrowings. However, at a time when government budgets are hard pressed and large-scale borrowings are hard to come by, land-based financing presents an important option for local infrastructure finance. By leveraging the sensitivity of land values to urban economic growth and the principle that benefits of infrastructure are capitalized into land values, land-based financing instruments have come to play a key role in complementing other sources of capital finance.

Land-based financing introduces significant advantages to infrastructure financing decisions, reducing dependence on debt and its associated fiscal risks. It has the advantage of generating revenues upfront, sometimes before the infrastructure is undertaken, making it easier to finance infrastructure projects that call for massive investments. The scale of land-based financing is also much larger in magnitude when compared to other sources of urban capital finance. Further, mobilizing finance from land transactions strengthens efficiency of urban land markets and rationalizes the pattern of urban development by sending out price signals to the market.

While land-based financing holds the potential for closing the infrastructure financing gap and supporting the sustainable development of cities, its role is restricted as an instrument of capital finance. It is not a permanent and recurring source of revenue as land sales cannot continue indefinitely. Thus, revenues from land financing should ideally not be used to finance operating expenses and must be directed only to the capital budget. Further, we need to keep in mind that the volatility inherent in land markets could simply reflect an asset bubble and world-wide economic conditions. Thus, extrapolating past trends to prepare future investment plans could be risky. Also, the magnitude of revenues raised from land financing breeds the risks of favoritism, corruption and abuse of government power if land-based transactions lack transparency and accountability.

Land financing has been widely used to finance urban transportation projects or the infrastructure required to service new urban developments. It has been less frequently employed to finance investment in existing basic infrastructure services such as repair or upgrading of water supply, waste-water collection, or solid waste removal. The fact that water supply and other basic services agencies do not own excess land that can be sold or developed explains the lack of land-based financing in these areas. A possible solution would be to establish a consolidated capital budget that could automatically allocate part of the land finance proceeds for the delivery of basic services. Also, when governments are responsible for providing the entire range of infrastructure services, employing land financing to pay for particular investment projects frees up funds for investment in basic services. This calls for special measures to be taken to make land-based financing support investment in existing infrastructure services.

Categorising land-based financing instruments

Land-based financing instruments can be broadly classified under three categories: developer exactions (including impact fees), value capture (betterment levies, land sales) and land asset management (including private investment in public infrastructure). The following table discusses the working of land financing instruments and recounts select cases of their employment.

  • http://www.prassrinivasan.blogspot.com Pras

    All of the above lists one-time payments and capital play. This has the detrimental effect of higher prices for infrastructure that affects the city’s economy due to higher upfront capital payments. The property taxes collected rarely reflect earnings values of the property but a registered value.

    It may be worthwhile for corporations to consider integrating an element of revenue flows into their infrastructure plans. These will provide cash flows to service debt/capital plus surpluses to redeploy. And linked to overall economic growth – so there is a direct stake in the corporation making the city successful in income terms (that can’t be fudged so easily) rather than capital value terms (that create bubbles).

    Examples of these (just suggesting):
    i) The Corporation takes up an equity stake in commercial developments based on land price at time of transfer to developer. Downstream sales will thus contribute earnings to the corporation.
    ii) Specific area based taxes for newer developments. E g if road, water/sewage and electricity footprint is expanded – this is a geography footprint. All the property in that area benefits from it in terms of prices etc. A small fee (calibrated to not kill profitability) will contribute a steady income to the city corporation. Won’t affect older areas.

    The sale of assets on capital value creates an incentive for land owners (viz., govt) to work towards higher values. This pushes up prices or worse still cost of living, as accompanying services become expensive for residents. This directly proliferates “slum living” and overconstruction in areas outside city control.