Financing Indian cities : opportunities and constraints in an Nth best world

This paper examines international experience with mobilizing funding for both capital and recurrent costs for municipal infrastructure with a view to identifying areas where India could improve its system of financing infrastructure in cities. Based on international data, the analysis shows that there is indeed a wide range of models for funding municipal infrastructure across a group even as relatively homogeneous as the European Union. Although a number of different models operate in countries with very good services, important features of India’s municipal finance system stand out. The spending per capita is exceptionally low, even when compared with local governments with few functions. The real estate sector generates meager tax revenues, but transfers from higher levels of government are also meager. Turning to cost recovery models for services, the paper examines international evidence on cost recovery. In practice, a surprisingly large number of countries, including high-income countries, subsidize basic municipal services, particularly in water supply and sanitation. Analysis shows that these subsidies often have perverse distributional effects. Likewise, pricing schemes designed to skew subsidies to low-income households often have unintended distributional effects. Again, evidence from urban India suggests that cost recovery is exceptionally low, not only in absolute terms but relative to the experience of other low and middle-income countries. The paper concludes with a discussion of some of the measures that should be considered for improving finances in Indian cities, includingland monetization and capital grants systems designed specifically for reaching secondary cities and towns.