Why are municipal corporations struggling in India?

A recent Reserve Bank of India (RBI) report has suggested that municipal corporations in India are struggling financially. Urban local bodies like Municipal Corporations, Municipal Councils and Nagar Panchayats received constitutional status from the 74th Amendment Act which institutionalized local governance in India. However, even after so many decades of having local government bodies, the growth of infrastructure has lagged behind the growth of cities. The reason is a classic mismatch between responsibilities and powers. Over all these decades, municipal revenues have been stagnant at 1% of GDP as compared to Brazil where it stands at 7.4% and South Africa at 6%. Although these local bodies have responsibilities such as healthcare, education, housing, transport, etc. they do not have any financial autonomy to carry them out. The issue with the finances is that local bodies have no control over revenues, they are heavily reliant on grants from the state, and there is no formal access to capital markets. The Urban Local Bodies have three major categories of revenues – 1) Tax revenue e.g. property tax, entertainment tax 2) Non-tax revenue e.g. charges for various citizen services 3) Transfers from the state government. The local bodies also receive donations, however, major infrastructure changes are financed by borrowings from banks and other lenders. The tax revenue and user charge although collected by the local bodies, the rates of these charges and taxes are decided by the state government, leaving no control over the same. Property tax makes up the majority of the tax revenue, however, problems like non-registration, property undervaluation, litigations on property disputes, etc. lead to heavy leakages. When Octroi and Local Body Taxes were subsumed into GST, the autonomy was further reduced. Similar to how the Central Financial Commission lays down guidelines for tax sharing between the Centre and States, a State Financial Commission (SFC) decides the tax devolution and which or what portion of taxes is assigned to the local governments. The grants received from the State Governments form a large portion of the receipts of the local bodies, however, the flow of these funds has never been steady or predictable. Transfers make up 52% of the total revenue for Karnataka, 46% of Kerala, 35% of Gujarat and 27% of Maharashtra. The commissions take around 32 months to submit their reports to the state governments who in turn take another 11 months to table these reports. These long delays create cash flow problems especially when they form such a huge chunk of revenues. Meanwhile, the lack of options to borrow from the markets hurts even further. The Central and State Governments usually run deficit budgets and finance the deficits by borrowing from the markets. As much as 61% and 85% of the Central and State Government deficit is catered through borrowings. However, municipal corporations have a balanced or surplus budget by law, and they cannot outrun their expenses over revenue. Gross municipal borrowing in India is less than 0.05% of GDP. All borrowings need approval from the state government and can take up to 6 months for approval. These bodies are allowed to issue bonds and raise money, however, the lack of a stable source of revenue, prohibits them from raising money. Banks do not lend money for a longer duration, and the loans are limited to a 5-7 year tenure which is not sufficient for long-term infrastructure projects. Over the years, instead of empowering the local authorities, the Governments have created parallel authorities to solve these problems e.g. development authority, transport authority, water and sanitation, etc. India’s largest bond ever was issued by the ‘Andhra Pradesh Capital Region Development Authority which is not a local body but a parallel authority. The problem of financing for local bodies can be solved by Pooled Financing methods, however, the Governments haven’t shown much interest in the past. A State Pooled Finance Entity can be created to borrow on behalf of all participating municipal corporations which can be served by pooling the revenue stream from the respective projects or revenues of the participating local bodies. These funds can also be guaranteed by the State Governments which can lower the risk for investors and therefore, attract more funding. The Tamil Nadu Urban Development Fund issued bonds on behalf of 14 municipalities in 2003 through a Water and Sanitation Pooled Fund where the municipalities had pledged 10% of their revenue to service the debt and the state pledged to fulfil the shortfall. However, since 2018, only 94 cities have been given credit ratings which is a pain point for investors. Most local bodies do not publish their financials for public viewing and also do not follow a universal accounting system for comparability as in the case of corporates that follow the same set of accounting standards and report under the same reporting standards. Besides, local bodies have also failed to utilize the benefits of technology, as the revenue leakages can be easily plugged and governance can be improved with the help of technology. Over-reliance on state government grants, absence of stable revenue, no access to formal markets, delays in the issue of funds, absence of credit ratings, failure to leverage technology and absence of sufficient power have together contributed towards the failure of the local bodies and has led them to financial distress.