unconventional financing

Unconventional Methods of Financing Urban Development: The Role of Public-Private Partnership (PPP) Mukul G.Asher* And Deepa Vasudevan** September 8, 2008 Ver 1 * Professor, Lee Kuan Yew School of Public Policy, National University of Singapore, email at sppasher@nus.edu.sg **Freelance Researcher, email at deepavasu@hotmail.com Abstract The demand for urban infrastructure and amenities in India far exceeds the limited conventional financial resources of local governments. As a result, skills in accessing unconventional financing sources (such as municipal bond markets and using state assets more productively) have become essential. This will require the Urban Local Bodies (ULBs) to learn to initiate and sustain Public Private Partnerships (PPPs). This chapter discusses common PPP modes in municipalities, and the risks and challenges in implementing them. The introduction of private capital or managerial expertise through a PPP does not guarantee success in itself; it has to be supported by transparent and equitable risk allocation between partners. The governance structures of the ULBs will need to become more accountable and performance-oriented. Increased urbanization and rising incomes are increasingly leading to demand for better quality of urban services and amenities. Those who meet this demand are likely to reap rich electoral dividends. Key words: urbanization, public private partnerships, municipal finance, India JEL Classification: H42, H7, L33 2 1. Introduction The role of public and private sectors has evolved historically, resulting in shifting economic boundaries of the state and the market. The current phase of globalization has brought about two significant changes in the analysis of public finances. First, the state and the market (more loosely, public and private sectors) are increasingly regarded as playing complementary rather than mutually exclusive roles in undertaking various activities of the government. This has lent a more technocratic and managerial orientation to the organization and financing of various areas of government operations. Second, public finance activities are no longer confined primarily to the domestic sector, but involve international dimensions (Figure 1). While this development has increased the options for addressing government tasks (such as provision of infrastructure, or meeting health and education challenges), it has also created the need for greater coordination with multiple domestic and international agencies both in the public and private sectors. The co-ordination and facilitation roles therefore have become more important, requiring personal networking and other soft skills. It is in the above context that this chapter explores the role of unconventional sources in financing India’s urban development1. The chapter argues that to access such financing on a sustainable basis, both public and private sectors need to be skilled in initiating and sustaining Public Private Partnerships (PPPs). The term Public Private Partnership is commonly used to refer to a wide range of collaborations between national and sub-national governments, and the private sector, in order to supply infrastructure or deliver certain services that have traditionally been provided exclusively by the government. As in the case of private goods and services; new technologies, organizational and financing innovations have made it possible to undertake more elaborate division of labour between different parts of the value chain involving government services. 3 The word “partnership” is critical in PPP as it implies that each party must bring resources of real economic value to the project or activity on a sustainable basis. Both parties, therefore, must have attitudes of learning organizations. These resources may be in the form of money, land, regulatory facilitation, technical expertise, and management know-how. In some PPPs between urban local bodies and private parties, there may not be any exchange of finances per se, but the private party could add economic value by providing expertise in performing tasks such as: rationalizing municipal accounting and budgeting systems; mapping cities for better property tax administration; maintaining parks; or advising on solid waste management and rain harvesting. Thus PPPs should not be evaluated on the basis of monetary inputs alone; rather, their success should be assessed by overall resource cost savings and contributions to desired outcomes or objectives of the partnership. Though developing economies have the most potential to benefit from PPPs, the trend towards such partnerships is global. A recent study of PPPs in Europe found that between 1990 and 2005, more than a thousand partnerships had been signed in the European Union alone, representing an investment of almost 200 billion euros2. In India, PPPs are also being regarded as an instrument for addressing the gap between provision of sufficient urban services and availability of financing through conventional sources of finance. Various public policy outcomes, notably, law and order, public health, old age pensions and poverty reduction may be produced and/or financed jointly by public and private sectors3. The rest of the chapter is organized as follows. Section 2 discusses urbanization trends in India and its implications for urban management. Section 3 describes the conventional and unconventional sources of finance available to municipalities in India. It is argued that there is an overwhelming need for urban governments to become adept at accessing unconventional sources of finance as even major reforms in the conventional financing 4 sources will leave major gaps between the demand and supply of urban infrastructure and amenities. Section 4 discusses various PPP modes applicable to India’s municipal sector and their challenges. The final section provides concluding observations. 2. Urbanization Trends India is a rapidly urbanizing country. The Census of India 2001 showed that out of the total population of 1.03 billion, about 286 million, or 28% lived in urban areas. In absolute terms, the urban population has risen almost five-fold from its level in 1951, rising faster than the growth in total population (Table 1). The post-economic reform period has witnessed a large increase in the number of areas defined as urban. In 2001, there were 5161 areas classified as towns or urban agglomerations4, which represented an increase of 37% over the number in 1991. Thirty five urban agglomerations have million-plus populations. The largest metropolises in India- Kolkata, Mumbai, Delhi, Chennai, Hyderabad and Bangalore- are among the fifty largest urban agglomerations of the world5. The urban transformation of India is projected to continue in the future. Estimates by the United Nations predict that by 2010, about 30 per cent of the population will be urban, and this proportion will exceed 50 per cent by 2045. By that time, more than 700 million people are expected to live in urban areas. The economic importance of urban areas will also grow. The contribution of urban sector to India’s GDP has increased from 29% in 1950–51 to about 62% at present; and is expected to go up to 75% by 20216. There are two striking features of India’s urban transformation that are relevant to understanding its consequences. First, an increasing concentration of population is observed in towns with populations of one lakh or more, commonly known as Class I cities. Within this category, the relatively greater economic opportunities available in cities with a million plus population- the Metropolitan cities- draw the majority of urban residents. Almost 38% of the total urban population of India, or 108 million people, lived in metropolitan cities in 2001. A similar trend is observed in other developing countries. Of all 5 urban residents in Class I cities in the developing world, the largest proportion, or about 36% lived in cities with populations of 1-5 million, and over half lived in cities with sizes of 1-10 million7. Second, it is estimated that urban natural growth has contributed about 60% to the total growth in urban population in India8. During 1901-2001, urban population in India increased by 68 million, of which only 20 million was on account of rural-urban migration9. Urbanization of this nature cannot be controlled through restrictive migration policies or by incentivizing agriculture. Instead, it has to be accepted as an inevitable consequence of economic growth and its outcomes must be optimized by creating world class cities where a good quality of life is available to all residents, who in turn contribute significantly to the growth and development of the country. Yet the economic development of cities is neither automatic nor a natural corollary of growth in urban population. It is conditional upon the availability of urban infrastructure that provides access to basic standards of living (water supply, sanitation, solid waste management, power, hospitals, schools); facilitates industrial development and services growth (communication, transport, roads, railway links, airports); and additionally, caters to the non-essential recreational needs of urban residents (leisure areas, theatres, parks, sports centres, town centres). The quality of urban infrastructure and delivery of civic services in India is poor as compared to global standards, even in the larger cities. The Eleventh Plan steering document highlighted several stark gaps in the availability of basic urban facilities. It was noted that 43% of households in urban areas either had no latrines or no connection to a septic tank or sewerage. Only 41% of urban households had sole access to their principal source of drinking water; 59% were sharing a public source. Systems for removal of household waste were so poor that 71% of urban households reportedly removed it themselves, and only 14% of waste removal was conducted by Local Authorities. Road networks of metropolitan cities suffered from poor maintenance, poor traffic management 6 and poor enforcement of regulations on parking and encroachments on right-of-way. As a result traffic was observed to be slow moving and road capacity low10. There are wide variations in the availability of infrastructure and services between cities. Smaller cities with limited resources tend to have lesser institutional capabilities to deliver urban services or to build urban infrastructure. Sustaining high growth will therefore require substantial expenditure on physical and social infrastructure, and in urban amenities. It will also require a change in mindset that recognizes that India no longer lives in her villages. Policy makers need to view efficient urban development and management as a critical pre-requisite to sustainable growth. It must be recognized that the impact of urbanization has to be factored into the formulation of developmental policies. Estimations of urban investment requirements vary depending on the definition of infrastructure and the period of projection. The eleventh plan estimated that total funds required for implementation of Eleventh Five Year Plan targets in respect of urban water supply, sewerage and sanitation, drainage and solid waste management was Rs.1,27,025 crore, and total financial requirement for urban transport was R.1,32,590 crore11 (at 200607 prices) over the entire plan period. This translates into an investment requirement of 0.9% of GDP over the plan period12. Estimates of the Jawaharlal Nehru National Urban Renewal Mission (JNNURM) indicate that over a seven-year period commencing in 2005-06, Urban Local Bodies in 63 selected cities would require total investment (basic infrastructure and services) of Rs. 1,20,536 crore, equivalent to an annual funding requirement of Rs. 17,219 crore.13 A recent study by the Reserve Bank of India calculated that urban investment over the period 2003-04 to 2013-14 would need to be Rs.6, 28,210 crore, equivalent to an annual average of Rs. 62,821 crore at 2004-05 prices14. 7 Differing methodologies and results of investment requirements do not undermine the fact that India would need large investments to provide a decent standard of living to its urban residents. The onus of urban development and management is largely upon Urban Local Bodies (ULBs), which includes municipal corporations, municipalities and Nagar Panchayats15. According to the Report of the Twelfth Finance Commission, India has 3,723 Urban Local Bodies (ULBs), of which 109 are Municipal Corporations, 1432 are municipalities and 2182 are classified as Nagar Panchayats. The number of ULBs varies across states depending on the number and characteristics of urban agglomerations. India has yet to make full use of the provisions of the 74th Constitutional Amendment, passed in 1993, which was expected to strengthen finances of ULBs. As a result most urban bodies do not have the financial resources to build up urban infrastructure to provide adequate basic services to residents. Their fiscal powers are limited, and the practice of levying user charges to recover project costs is practically non-existent. There are large inefficiencies in tax collection, record maintenance and accounting and budgeting. Since the adoption of the Fiscal Responsibility and Budget Management Act, 2003 (FRBM), central and state governments have been forced to reduce their deficits in accordance with the mandated norms. Imposition of fiscal discipline is likely to reduce loans and grants to urban bodies in the future. There is increasing consensus that unconventional financing methods will be needed to mobilize capital of the scale required to set up world class cities. 3. Sources of Financing Municipal finances account for a very small part of central and state government revenues and expenditure. The share of municipal revenue in total government revenue was about 2.3 per cent; and the share of municipal expenditure in the combined expenditure of State and Central Governments accounts was about 2.2 percent in 200102. Both ratios show a declining trend (Table 2). 8 Total revenue of the municipal sector accounts for about 0.75 per cent of GDP of the country; and total expenditure of the municipal sector accounts for about 0.79 per cent of the GDP. The revenue significance of municipalities is low by international standards: the ratio stands at 4.5% for Poland, 5% for Brazil and 6% for South Africa16. The relative insignificance of municipal revenues and expenditures in the country’s GDP can be considered as the outcome of distortions in inter-governmental allocation of functions and fiscal powers between the three tiers of government (centre, state, local) under which the municipalities have access to relatively less buoyant and less elastic sources of revenue17. 3.1 Conventional Sources of Finance Municipalities have conventionally relied on a combination of internal and external sources of finance (Table 3). Internal sources include taxes; non-tax components such as user charges and fees, and taxes that are levied and collected by state governments but assigned to local bodies. Property tax is the most significant source of own-tax levy for municipalities. External sources of revenue mainly include grants and loans provided by the central and state governments, financial institutions and bilateral and multilateral funding agencies, as well as bonds issued in the capital market. Local bodies are not financially self-sufficient because their major revenues sources (such as property tax) are inadequate to fund their expenditures. Between 1998-99 and 2002-03, the proportion of own revenue in total revenue of ULBs declined from 59.69 percent to 58.44 percent. Using their own revenues, ULBs would have been able to finance only 52.3 percent of total expenditures in 2002-0318. The lack of financial autonomy has resulted from the imbalance between low taxation powers and huge responsibility to provide urban amenities to its growing population. Inefficiencies in collection and administration of taxes and user charges by local bodies have compounded the problem. Thus ULBs are 9 heavily dependent on State Governments for grants or shared taxes or funding under development schemes. Several researchers (Pethe and Karnik, 2004; Vaidya and Vaidya, 2002; Mohanty et al, 2007; Mukhopadhyay, 2006; Mathur, 2006; Mohanty, 2003) have documented the ways in which conventional sources of finance can be used to generate additional revenue. The current trend towards extending municipal boundaries (such as in Bangalore and Ahmedabad) can help rationalize property tax structures. Simple innovations such as greater involvement of tax payers, rather than implementation of a sophisticated valuation system, can yield greater efficiencies in property tax revenues (such as in Hyderabad19). User charges have to be set on the basis of economic principles; and facilities should be priced in such a way that at least operation and maintenance expenditures are recovered through fees and charges. For instance, the new airports in Bangalore and Hyderabad charge user development fees from passengers using the terminal facilities; and the Ministry of Civil Aviation has approved the levy of user fees by Ahmedabad and Thiruvananthapuram airports also. The fees will enable the Airports Authority of India (AAI) to recover some part of the ongoing investment on the development of new terminal facilities at the two airports. These reforms require leadership that is committed and politically capable of pushing reforms through, and the support of administrators who can actually implement the reforms at local levels. 3.2 Unconventional Sources of Finance Most urban bodies have substantial assets, such as land and real estate, which can be utilized more productively to generate additional revenue. If these assets are systematically surveyed, mapped, documented, registered and exploited, they could finance a substantial part of their investment on infrastructure and services development. It has been suggested that the problem with developing countries is not lack of assets or entrepreneurship. The problem is the lack of easy access to an integrated formal property 10 system that could legally ascertain the economic potential of their assets so that they could be used to produce, secure, or guarantee greater value in the market20. Innovations that unlock the value of municipal assets in general and property assets in particular, will be key to increasing municipal revenue. Commercial utilization of land through construction of offices, shopping malls and commercial complexes can generate lease income. Rental incomes can be particularly lucrative in metropolitan cities such as Delhi and Mumbai21. Construction in metropolitan cities is often limited by laws that limit Floor Space Index in each area. ULBs can develop a "Floor Space Index (FSI) Bank" to overcome this problem. FSI banks could be used for selling FSI in excess of that stipulated within an area, and the premiums earned could be used for developing city infrastructure. Alternately, owners could transfer some portion of their land for public use in return for higher FSI. The concept of Transferable Development Rights (TDR) is also potentially revenue generating. ULBs could pay for land through TDRs rather than acquisition money, which would entitle the owner to construct and develop another plot, or simply transfer this right to another buyer. The Karnataka State Government permitted the Bruhat Bangalore Mahanagara Palike (BBMP)22 to grant TDRs to property owners and leaseholders in February 2005. By 2007, BBMP had identified 45 important roads for widening with acquisition of land under the TDR scheme23. The scheme permitted an additional floor area ratio (FAR) to owners whose lands were acquired for road widening. BBMP could acquire land without paying compensation and the owners could either undertake construction or sell the TDR to builders in specified zones. Greater development of municipal bond markets would enhance ULB access to capital markets. The municipal debt market in India has grown considerably since the first issue in 1998, but several constraints remain unaddressed24. Municipalities have collectively mobilized Rs. 1200 crore or $280 million through bond issues. Since municipal bonds 11 need to be rated by a credit rating agency, their issuance is likely to indirectly bring about regulation and discipline in municipal finances. However, only the larger and welladministered municipalities are currently in a position to access municipal bond markets. For the remainder, prior accounting and budgeting reforms, and implementation of the Model Municipal Law (MML) guidelines would be necessary25. The development of commercially viable urban projects that can recover costs through user charges and other revenues is likely to facilitate mobilization of public capital. In that sense, the induction of expert private partners through PPPs would greatly increase the viability of an urban project. A credit instrument called a Structured Debt Obligation (SDO), in which debt repayment obligations are given priority and kept independent of the overall financial position of the borrower, could be an alternate financing option for ULBs. SDOs are similar to municipal bonds but a trustee monitors debt servicing and the borrowing agency does not have access to the pledged resources until the loan is re-paid26. Economies of scope can be created by using the expertise of an existing financial institution for designing and floating SDOs. Innovative taxation, even within the limited scope of fiscal powers of ULBs, has been very successful. The Pune Municipal Corporation in Maharashtra levies a street tax that finances improved traffic management and public transportation. The fee is collected with property tax and is five percent of annual ratable value.27 The Pune Mahanagar Parivahan Mahamandal Limited (PMPML) - a public transport body- entered into an innovative asset mobilization agreement with a Malaysian company. PMPML agreed to give advertising rights at its 2600 bus shelters and on all its busses for fifteen years in return for 2300 air conditioned buses28. Innovations in property tax administration could be the first step in property tax reform. In 1997-98, the Chennai Municipal Corporation introduced a computerized information system that allowed better monitoring of collections; and just this simple reform 12 increased its property tax revenue by 50 percent. In 2001-02, the Indore Municipal Corporation conducted a physical survey of properties in all wards to identify unregistered properties and add them to the property database. The number of registered properties registered increased from 135,000 before the survey to 236,000 in 200329. The earning of emission credits, for example, through better solid waste management, or more efficient municipal power generation, is a globally relevant option that saves resources as well as the environment. The Brihanmumbai Municipal Corporation (BMC) has recently proposed the replacement of its street lamps by light emitting diode (LED) bulbs to create carbon credits. The use of LED bulbs, which have longer lives and lower maintenance costs, is also expected to reduce power consumption by about 85 percent and reduce carbon emissions by 40 percent30. Local governments also have untapped human resources in the form of business and financial management expertise, organizational experience in urban management, extensive networks, and underutilized or inefficiently utilized capacity. The challenge is to use these opportunities creatively to generate revenue. Local governments can build on their strengths to leverage private investment through partnerships with the private sector and community groups. International networking can bring expertise that can potentially lead to better service delivery, as well as make domestic ULBs adept at international benchmarking. Greater coordination with higher government units may result in more productive use of State and Central government assets (e.g. areas around railway station, sea-ports, airports, highways, etc.). An illustration of efficient use of government land is provided by the proposal for redevelopment of the Chatrapati Shivaji Terminus (CST) in Mumbai. CST is spread across 26 hectares of land in Mumbai’s business district. Technical studies indicated that even after taking into account existing structures and their potential expansion to accommodate rising passenger traffic, considerable vacant land is likely to available for development. A PPP proposal to lease vacant land to private parties for 13 redevelopment of CST into a world class terminus with entertainment, parcel handling and storage, shopping and parking facilities is under consideration. The accessing of unconventional sources of finance by ULBs on a sustainable and viable basis often requires the use of PPP modes. PPPs can directly facilitate additional revenue by providing services at more economic rates; or they can unlock resources indirectly by strengthening government systems for more efficient service delivery in the future. For instance, private partners can offer expertise in strengthening budgeting and administrative systems, or adopting e-governance systems, which would benefit local government efficiencies beyond the term of the PPP contract. 4. PPP modes in the municipal sector and their challenges PPP arrangements have the potential to deliver urban infrastructure and services, as well as to facilitate unconventional financing by municipalities. However, PPP agreements have inherent challenges, which need to be addressed before they can be used effectively. This section discusses common PPP modes in municipalities, and the risks and difficulties in implementing them. For the municipal sector in India, three areas of PPPs are relevant. The three areas are: • • • Basic infrastructure (roads, footpaths and walkways, water and sanitation in public spaces) Social sector (education, health, amenities and services for the elderly) Municipal management and Policy Implementation (accounting and budgeting systems, street lightings system, policy advice regarding solid waste management, water harvesting, noise and other pollution, designing literacy, cleanliness and civic responsibility campaigns, etc.). This area provides particularly fruitful opportunities for PPPs designed to translate negative externalities into marketable goods. 14 In each of the above three areas, customization will be required with respect to the financing mix used; the manner in which different risks of PPP are shared among the contracting parties; and the composition of total economic resources involving monetary, physical assets, expertise and managerial know-how. A PPP contract can be arranged in various ways. The design of the PPP agreement would depend on the type of work or service to be delivered, and the requirements of the ULB. Table 4 summarizes the general characteristics of the common types of PPP agreements in terms of the scope of responsibilities of the private partner. The options include service contracts; management contracts, Design-Building/Construction-Operation (DBO) contracts; lease; variants of the build-operate-transfer (BOT) and build-own-operatetransfer (BOOT) contract, concessions including fee concession. The contracting municipality should opt for a PPP arrangement that matches its needs. Given that urban services have traditionally been in the nature of public goods, the introduction of private enterprise may harm local sensitivities. Hence local governments may need to carry out an assessment of its own physical, financial and managerial capital; examine the nature of sector for which PPP is being sought; and give adequate weightage to political considerations and labour market implications of private partnership. For instance, if a municipality seeks to allocate limited responsibilities to its private sector partner without transferring asset ownership, then a service contract would serve the purpose. A management contract is ideal where private parties are needed only for providing management expertise. Lease arrangements are appropriate where governments have financial resources to create infrastructure but need the private sector to operate and manage it. When the private sector is required to bring in capital in addition to the responsibility of operation/temporary ownership, then the PPP should be designed as BOT or BOOT arrangement. 15 Majority of PPP contracts in India have been of the BOT/BOOT variety. Roads, railways and ports are sectors with the maximum PPP arrangements. Though PPP agreements in heavy infrastructure sectors are the most visible parts of public-private partnerships in India, increasingly, several ULBs are using PPP arrangements in areas such as solid waste management, water and sanitation, sewerage and urban transport. The Jamshedpur Utilities and Services Company (JUSCO) a wholly owned subsidiary of the Tata Steels formed in 2003, has a management contract for providing operations and maintenance of water supply and sewerage services for Jamshedpur city. Service contracts for street sweeping are extensively used in Hyderabad and Chennai. The Corporation of Chennai is the only ULB that has used the services of MNCs in a PPP agreement: in 2000, it awarded the French company Veolia a 7 year contract for sweeping, transportation, and community bin maintenance. Bangalore has entered into two kinds of PPP service contracts for solid waste management. The first involves collection of primary waste from the doorstep and its transportation to the disposal site through small contractors- an arrangement that has cut costs by 50 per cent of what it would cost to undertake the task departmentally. The second contract involves the treatment and disposal of waste in return for through payment of tipping fees to expert agencies31. The Alandur Municipality in Tamil Nadu built an underground sewerage system in Alandur on a BOQ (Bill of Quantities) basis, and a sewerage treatment plant (STP) under BOT (Build, Operate and Transfer) basis with private sector participation. The Alandur Sewerage Project (ASP) that presents a unique case in the area of public-private partnership in the urban sanitation sector. Beside the construction responsibility, the contractor also has undertaken operation and maintenance of the sewerage system for a period of five years from the date of completion of the construction, on a fixed fee basis. The collection of tariff and provision of new connections during the O&M phase would be undertaken by the municipality directly32. 16 The supply of bulk water in areas around Vishakapatnam is provided through a PPP arrangement implemented on a BOT basis. The project, which commenced its services in 2004, is expected to catalyse industrial development around Vishakapatnam city. In the city of Navi Mumbai, which is managed by the Navi Mumbai Municipal Corporation (NMMC), three core municipal services—water supply, wastewater services and solid waste management—are currently managed by the private sector on performance- based service contracts33. The above cases illustrate the multiplicity of PPP agreements that are already in place for the development and management of urban services. Private partnership has a large role to play in other urban infrastructure services such as public transport including intra-city metro rail, bus transport and even ropeways in hilly areas34. However, successful utilization of PPP models requires that the project is appropriately defined to allocate risks and rewards equitably between private and public sector partners. Designing PPP models with appropriate risk sharing is the most challenging aspect of PPP arrangements. Project parameters need to be defined clearly to delineate areas of responsibility and to allocate risks in accordance with the capacity of the partners. Identification, evaluation and mitigation of the risks in a project is a core part of project management. Project risk refers to an event or a possibility of an event which may cause the actual project circumstances to differ from those assumed when assessing the project cost and benefits. Risk assessment and sharing is critical both to project profitability (private sector objective) as well as efficiency in delivering promised public goods (ULB objective). From the perspective of a private partner, the risk-balance in a PPP is inherently skewed, because the government’s role as a regulator and law maker grant it the power to change the contract rules to the detriment of the private party. Thus the private sector would be incentivized to enter into a PPP only if risk valuation and sharing was fair and adequate35. The following categories of risk may be identified in PPPs: 17 • • • • Construction/Completion Risk: Delay in construction, cost overrun, quality and performance failures, increasing operation costs Revenue/ Demand Risk: Change in demand, change of tariffs, cost increases for resources Commercial Risk: Delayed or cancelled payment, fluctuations in exchange rate, interest rate fluctuations Country Risk: Expropriation, breach of contract, war, cancellation of concessions, import/export restrictions, taxation risks, no refund of profits Excessive transfer of risk to private sector may discourage PPP arrangements; yet inadequate risk transfer to the private sector nullifies the very purpose of involving private sector capital. Innovative financial instruments may need to be used to strike a balance. For instance, the PPP concession agreement between Dockland Light Railways (DLR) and a private construction contractor named Woolwich Arsenal Rail Enterprises (WARE) for the expansion of the highly automated and driverless railway system in the Dockland area of East London was designed such that the entire construction risk was borne by the private contractor, and most of the financial risk by the local authority. The rationale was that the construction contractor was more likely to be able to control risks during the construction period; and since the local authority could resort to fare hikes if necessary, it was better placed to bear the risk of default in syndicated bank loans by WARE36. The literature suggests that demand risk is the most common cause of failure of PPP projects. There is a tendency on the part of the private sector partner to overestimate the potential demand for services, and accordingly overprice the services. Conventional assessment of PPP projects is often biased towards the cost-benefit ratio at the construction stage. Assigning adequate weightage to the risk of decline in demand over the operations stage of the project will address demand risk more effectively37. 18 Private participants may be willing to shoulder the majority or all project risks in return for high expected payoffs over the period of project operation. The acceptance of excessive risk may be justified by the probability of high demand and cash flows from the delivered services. An illustration of such a project is the Western Freeway Sea Link, which proposes to create a high speed all-weather link between the business district in south Mumbai and the business district in Bandra–Kurla and the Mumbai airport. The traffic on this corridor is expected to be high because current north-south links in Mumbai are very congested. Consequently, the Maharashtra State Road Development Corporation (MSRDC) has received a good response with many bidders interested in constructing the second phase of the project38. The PPP model is the DBFO (Design, Build, Finance, and Operate) model, where the private sector partner will be required to design, construct, finance, operate and maintain the project39. MSRDC is expected to facilitate and liaise with other government agencies for clearances, permits and finances, but will not share significantly in the project risk. The private partner will effectively bear all projects risks (supply, operation, infrastructure, environmental, market, political, force majeure, forex, funding/interest, engineering, completion, syndication, and legal), and toll revenues will be the only significant source of income40. It is apparent that returns from the project are projected to be high enough to ensure financial viability. The selection of an appropriate PPP model is critical to the successful implementation of urban development projects. Models that function in a particular urban area may not be as successful in another city with a different population, or if the ULB has insufficient political backing. The inability to ‘transplant’ models has been observed in the area of urban solid waste management. Outsourcing of solid waste management to private operators is widely practiced by ULBs. The PPPs are usually of the nature of service contracts; in which the private partner is paid for services rendered, but not required to assume commercial risks. In Gandhinagar, Gujarat, the ULB fixed user charges and contracted with a private agency for door-to-door garbage collection. The initiative was not very successful because most of the consumers were public officials who did not wish 19 to pay user charges, and the ULB did not have the political backing to take action against them. However, in Shimla, a similar model was successful because the ULB modified its bye-laws to allow it to disconnect water supply and electricity services of defaulting customers41. Market risks beyond the control of the private operator may need to be shared by the local authority. For instance, traffic on toll roads depends on exogenous factors such as state of connecting roads in terms of quality and congestion and overall economic conditions during a period of time. Mechanisms that guarantee compensation for negative externalities that are not due to operational inefficiencies of the contractor may be needed to attract PPPs. If the viability of a PPP depends on user charges, then it is necessary to clearly establish willingness to pay on the part of end-users of services. This is particularly relevant in areas such as water and sanitation, where user charges have traditionally been nonexistent or nominal. Municipalities may need to underwrite this risk, or at least assist in cost recovery. For instance, ‘Willingness to Pay Survey’ was conducted in Alandur municipality to assess the acceptability of the Alandur sewerage project by the residents of the town, as well as their willingness to pay for the service. The survey indicated that about 97% of the people of Alandur wished to have the sewer connection, and would not be reluctant to pay a reasonable amount for provision of the service. The findings of this survey were an important part of the feasibility studies conducted before undertaking the Alandur sewerage project42. Table 5 lists some risks in PPPs and common mitigation techniques employed by contractors. Effective risk mitigation requires investment in technical, market, financial and political feasibility studies which study project risks extensively. This is necessary even to attract private sector bidders to an urban development project. However, the infusion of capital or expertise by a private partner does not guarantee success in itself; it has to be supported by transparent and equitable risk allocation between partners. 20 5. Concluding Remarks This paper has argued that as India urbanizes, providing adequate urban infrastructure and amenities has become an important national priority. This requires not only reforming conventional municipal revenue sources such as property tax and user charges, but also significantly enhancing capacities of ULBs to obtain financing from unconventional sources. These, however, require the ULBs to become more adept at initiating and sustaining PPPs. The key elements of a successful public private partnership are accountability of participating authorities and continuity of policy stance. Policy makers and leaders need to adopt a CEO-mindset by visualizing themselves as chiefs of towns and cities; and being accountable for targets. Effective risk allocation and unambiguous specification of responsibilities will lead to better delivery of services. Policy initiatives need continuity of purpose and commitment if they are to fructify into tangible outcomes. It is often observed that when an implementing officer in a local authority moves away, then the initiatives introduced under his leadership tend to be sidetracked. The governance structure of the ULBs needs to be made more accountable and performance-oriented. Increased urbanization and rising incomes are increasingly leading to demand for better quality of urban services and amenities. Those who meet this demand are likely to reap rich electoral dividends. 21 Table 1 India: Urbanization Trends Year 1951 1961 1971 1981 1991 2001 Total population (crore) 36.11 43.92 54.81 68.33 84.63 102.86 No. of Towns and UAs 2843 2365 2590 3378 3768 5161 Urban Population (crore) 6.24 7.89 10.91 15.95 21.76 28.61 Share of Urban Population to Total Population (%) 17.3 18.0 19.9 23.3 25.7 27.8 Decadal Growth of Urban Population (%) 41.4 26.4 38.2 46.1 36.4 31.3 Note: UA: Urban Agglomerations Source: Census of India 2001 Table 2: Year Municipal Revenue and Expenditure in India: Selected Years Municipal Revenue Rs crore As % of GDP As % of state and central revenue Municipal Expenditure Rs.crore As % of GDP As % of state and central expenditure 1998-99 1999-00 2000-01 2001-02 11515 13173 14581 151490 0.72 0.75 0.77 0.73 2.5 2.5 2.4 2.3 12035 14452 15743 15914 0.75 0.82 0.83 0.76 2.21 2.36 2.34 2.15 Source: Adapted from Table 13 and 14, Chapter 4 , Mohanty et al(2007) Table 3: Conventional Sources of Municipal Finance in India Revenue Sources of Revenue Head/Category Property Tax, Octroi (now only applied in few cities such as Mumbai), Tax Revenue Advertisement Tax, Tax on Animals, Vacant Land Tax, Tax on Carriages and Carts User Charges, Municipal Fees, and Hire Charges, Lease Amounts Non-Tax Revenue Sundry receipts, Law charges costs recovered, Lapsed deposits, Fees, Other receipts Fines and Forfeitures, Rent on Tools and Plants, Miscellaneous Sales 22 etc. Entertainment Tax, Surcharge on Stamp duty, Profession Tax, Motor Assigned (Shared) revenue Vehicles Tax Grants-in-aid Plan Grants made available through planned transfers from upper tier of Government under various projects, programmes and schemes (ii) Non-Plan grants made available to compensate against the loss of income and some specific transfers Loans borrowed by the local authorities for capital works etc. – HUDCO, LIC, State and Central Governments, Banks and Municipal Bonds (i) Loans Source: Mohanty et al (2007) Table 4: Type Characteristics of Common PPP agreements Responsibilities of Private Partner Provides a defined service Manages activities like operations and maintenance Undertakes Design, Construction and Operation Carries out operations and maintenance (but public partner makes new investments ) Builds the project, operates and owns it Similar to BOO, with additional clause of subsequent transfer of ownership to public partner Undertakes construction, operation and maintenance 1 Service Contract Management 2 Contract 3 DBO 4 Long term Lease 5 BOO 6 BOOT 7 Concession Source: Authors 23 Risk Type 1 Technology Performance Table 5: Typical PPP Risk Allocation Description Allocation Mitigation Existing technology unproven in terms of revenue service Customer willingness to pay for service unknown Traffic and revenue below projections Competing/alternative projects Excessive capital maintenance Insufficient revenues to fund ongoing O&M Private Warranties 2 Revenues Public Private and Investment grade Revenue studies accepted by rating agencies Adequate debt coverage ratios Adequate reserves Credit enhancement, Insurance Toll adjustment flexibility Careful budgeting processes and O&M controls Non-compete protections 3 Completion Cost and overruns Schedule Private (Construction Contractor) and Public Use of fixed price / guaranteed maximum contract Adequate contingency funds Force majeure insurance Design and construction management/over sight by Public Partners (which may be outsourced) Financially viable Private Partners 4 O&M Costs Excessive costs of operation Private (O&M contractor) Non-recourse financing Minimum guarantees 24 Excessive capital maintenance expenditures Unpredictability of costs and Public Toll adjustment flexibility Credit enhancement, insurance Careful budgeting processes Capital asset replacement assurances Warranties, incentives, and penalties Financially viable Private Partners Use of fixed price/ guaranteed maximum pricing, with escalations and adjustments over time and Persuasive and Supported arguments for Project Early regulatory agency involvement Public relations and citizen/policymaker education campaign Community engagement and buy-in strategy 5 Political Uncertainties on public policy and change in law Regulatory uncertainties Funding support Public Private Source: US Federal Highway Administration (FHWA) Public-Private Partnership (PPP), downloaded on August 28, 2008 from http://www.fhwa.dot.gov/ppp/faq_3.pdf 25 Figure 1 Source: UNDP(2006). Downloaded on August 20, 2008, from http://www.newpublicfinance.com/overview/english_new.pdf 26 References Akintoye, A., Beck, M. and Hardcastle, C. (2003), Public-Private Partnerships: Managing Risks and Opportunities, New York: Wiley-Blackwell. Chattopadhyay, Soumyadip. (2006), “Municipal Bond Market for Financial Urban Infrastructure”, Economic and Political Weekly, June 30, Vol41, No.26, PP 2787-2802 De Soto, Hernando (2001), “The http://www.cato.org/pub_display.php?pub_id=5181 Mystery of Capital”, Government of Gujarat (2007), “Inclusive development through Partnership and Reforms: Urban Management in Gujarat 2001-2006”, Gujarat Urban Development Company. Government of India (2006), “Report of the Steering Committee on Urban Development for Eleventh Five Year Plan (2007-12)”, Planning Commission, New Delhi. Downloaded on June 15, 2008 from http://planningcommission.nic.in/plans/planrel/11thf.htm Government of India (2007), “Consultation Paper on Projections of investment in infrastructure during the Eleventh Plan”, Planning Commission, New Delhi. Downloaded on June 15, 2008, from http://infrastructure.gov.in/pdf/Inv_Projection2.pdf Government of India (2007a), Second Administrative Reforms Commission, Sixth Report, Local Governance: An Inspiring Journey into the Future , Department of Administrative Reforms and Public Grievances, Ministry of Personnel, Public Grievances & Pensions, Chairperson: Shri Verrappa Moily Harvey, F. (2006), “Carbon: Hot Air Balloons as a Tradeable Commodity”, Financial Times, May 30. Accessed at: http://www.wbcsd.org/plugins/DocSearch/details.asp?type=DocDet&ObjectId=MTkzMT Y India Infrastructure Report 2002, 3iNetwork, Oxford University Press, New Delhi, 2001 Mathur, Mukesh. (2001), “Alandur Sewerage Project: A Unique Experiment of Public Participation in Project Financing” in India Infrastructure Report 2002, 3iNetwork, Oxford University Press, New Delhi, 2001 Mathur, O.P. (2006), “Urban Finance” in India Infrastructure Report 2006, pp. 82-105. Mohanty, P.K. (2003), “Innovative Urban Development Financing Practises: A Case Study of Hyderabad City, India”, Paper Prepared for the International Development Department of the School of Public Policy, University of Birmingham under EngKar Research Project 8070., November 2003. Downloaded on August 21, 2008 from http://www.municipal-finance.org/downloads/Hyderabad.pdf 27 Mohanty, P.K., Misra, B.M., Goyal, R. and Jeromi, P.D. (2007), Municipal Finance in India: An Assessment, Development Research Group Study No. 26, Department of Economic Analysis and Policy, Reserve bank of India, Mumbai. Montgomery, M. (2008), “The Urban Transformation of the Developing World”, Science, Vol.319, February 8, pp 761-63 Mukhopadhaya, P. (2006), “Whither Urban Renewal?”, Economic and Political Weekly, March 11, pp. 879-884. Pethe, A. (2004), “On Urban Infrastructure Development”, Working Paper No. 7, Dr. Vibhooti Shukla Unit in Urban Economics and Regional Development, Department of Economics, University of Mumbai. Pethe, A. and Karnik, A. (2004), “Infrastructure Financing in the Time of Revenue Crunch: Exploring the Avenues for Urban Local Bodies”, Working Paper No. 10, Dr. Vibhooti Shukla Unit in Urban Economics and Regional Development, Department of Economics, University of Mumbai. United Nations Development Programme (UNDP) (2006), The New Public Finance: Responding to Global Challenges, UNDP: Oxford University Press. Electronic access: http://www.newpublicfinance.com Vaidya, C. and Vaidya, H. (2002), “Management Innovations for Municipal Resource Mobilization in India”, India Infrastructure, 4, 11, pp. 57-59. Vaidya, C. and Vaidya, H.(2008), “Creative Financing of Urban Infrastructure in India through Market-based Financing and Public-Private Partnership Options”, Mimeo ENDNOTES The terms ‘Urban Local Bodies (ULBs)’, ‘urban bodies’ and ‘municipalities’ will be used interchangeably for the rest of the chapter to refer to the set of organizations responsible for local governance and civic services in urban areas. 2 Source: A primer on Public-Private Partnerships, By Francois Michel, Downloaded on August 21, 2008 from http://blog-pfm.imf.org/pfmblog/2008/02/a-primer-on-pub.html 3 UNDP(2006). Downloaded on August 20, 2008, from http://www.newpublicfinance.com/overview/english_new.pdf 4 “Urban agglomeration is a continuous urban spread constituting a town and its adjoining urban outgrowths (OGs), or two or more physical contiguous towns together and any adjoining urban outgrowths of such towns. Examples of Outgrowth are railway colonies, university campuses, port area, military camps etc. that may have come up near a statutory town or city but within the revenue limits of a village or villages contiguous to the town or city”, Source: Census of India , 2001. Downloaded on August 28, 2008 from www.censusindia.gov.in/Metadata/Metada.htm 1 28 Source: Government of India(2007a), Chapter 5: Urban Governance, Table 5.12, Sec5.1.3.4. It is pointed out that as recently as 1975, none of the Indian cities made it to the top ten cities of the world. But by 2005, Delhi, Kolkata and Mumbai were among the top ten metropolises by population. 6 Chapter 11, Vol III, Eleventh Five Year Plan 2007-12, Planning Commission, Government of India. Downloaded on August 21, 2008 from http://planningcommission.nic.in/plans/planrel/fiveyr/11th/11_v3/11v3_ch11.pdf 7 Source: Montgomery (2008). Data refers to the year 2000. 8 Source: Montgomery (2008). 9 Mukhopadhyay (2006) points out that this is in striking contrast to China, where migration from rural to urban areas has accounted for as much as 90% of the increase in urban population. Consequently, strict controls on fertility rate and migration into cities were effective in controlling the pace of urbanization in China. 10 Source: Report of the Steering Committee on Urban Development for Eleventh Five Year Plan (200712), Govt. of India, Planning Commission. 11 Source: Report of the Steering Committee on Urban Development for Eleventh Five Year Plan (20072012), Government of India, Planning Commission, New Delhi. Downloaded on June 15, 2008 from http://planningcommission.nic.in/aboutus/committee/strgrp11/str11_hud1.pdf 12 This is arrived at as follows. First, GDP at market prices is projected for each year of the plan period assuming a 9% target growth rate. Next, total investment required, Rs.2,59,615 crore (urban services plus transport) is divided by total GDP during 2007-08 to 2011-2012- the actual five-year period of the eleventh plan- Rs. 2,69,13,485 crore , to obtain the figure of 0.9%. All numbers are in 2006-07 prices. Source: Tables1 and 3, Consultation Paper on Projections of investment in infrastructure during the eleventh plan, Planning Commission, Government of India, October 2007. Downloaded on June 15, 2008, from http://infrastructure.gov.in/ 13 Source: The Jawaharlal Nehru National Urban Renewal Mission, Ministry of Urban Development, Government of India. Downloaded on June 15, 2008 from http://jnnurm.nic.in/nurmudweb/toolkit/Overview.pdf 14 The study analyzed the finances of 35 Municipal Corporations over the period 1999-00 to 2003-04 to estimate resource requirement for basic civic amenities (water supply, sewerage, roads, solid waste management and street lighting) and for the provision of mass urban transport systems as well as road infrastructure. Source: Mohanty et al (2007), Chapter 5 15 The criteria for specifying the type of Municipality include population of the area, density of the population therein, revenue generated for local administration, the percentage of employment in nonagricultural activities, the economic importance or such other factors as may be deemed fit by the Governor of the State (Article 243Q of the Constitution of India). 16 Mohanty et al (2007) 17 Mathur(2006). He points out that this conclusion holds even under the assumption that inefficiencies in tax collection at the municipal level may be higher when compared to the other two levels. 18 Government of India(2007a), Chapter 5: Urban Governance, Table 5.12, P.102 19 Mohanty(2003) has documented the success of property tax reform in Hyderabad. Self-assessment of Property Tax scheme was introduced by the Hyderabad Municipal Corporation during 1999-2000. About 130,000 people filed self assessment returns within 4 months of its introduction. Property tax collection increased by over 40%, rising from Rs.58 crores in 1998-1999 to Rs.82 crores in 1999-2000, though the effective tax rate went down by almost two-thirds. The increase has been attributed to the correction of long-standing inequities in the property tax system and better record-keeping. 20 De Soto(2001). He points out that in developed countries, assets lead a “ parallel life as capital outside the physical world. They can be used to put in motion more production by securing the interests of other parties as "collateral" for a mortgage, for example, or by assuring the supply of other forms of credit and public utilities”. 21 Pethe(2004) points out that the development of “Palika Bazaar” in New Delhi, as a commercial and shopping complex has successfully earned revenues for the municipality 22 Which was then known as Bangalore Mahanagara Palike(BMP). See http://www.bmponline.org/engdept/program-of-works/madivala/TDR-website%2001.pdf for details of TDR scheme. 5 29 Action Taken Report for the Year 2007-08, Bruhat Bangalore Mahanagara Palike, March 2008. Downloaded on August 20, 2008 from http://www.bmponline.org/accountdept/Action%20Taken%20Report%20on%202007%20-%202008%20Budget.pdf 24 The Indian Municipal bond market is tiny when compared to a developed market such as the US. In 2007, the US municipal bond market had $2.3 trillion bonds outstanding sold by over 60,000 issuers. 25 Vaidya and Vaidya (2008) and Chattopadhyay (2006) discuss municipal bond markets in some detail 26 Pethe and Karnik, 2004 27 Source: Vaidya and Vaidya, 2002 28 Source: “PMPML slaps Malaysian firm with notice”, DNA , August 31, 2008, P.3 29 Mathur(2006) 30 Source: “BMC has bright idea to earn carbon credits”, DNA, August 1, 2008, P.3 31 Usnani, P.U., “Solid Waste Management”, Chapter 8, India Infrastructure Report 2006. Downloaded on August 21, 2008 from http://3inetwork.org/reports/IIR2006/Solid_Waste.pdf 32 Mathur, Mukesh (2001), “Alandur Sewerage Project: A success story of Public- private partnership arrangements. Downloaded on August 21, 2008, from www.developmentfunds.org/pubs/Alandur%20Sewerage%20Project.doc 33 Zérah, Marie–Hélène, “Urban Water and Waste Water”, Chapter 7, India Infrastrucure Report 2006. Downloaded on August 21, 2008 from http://3inetwork.org/reports/IIR2006/Urban%20Water.pdf 34 Chapter 6: Commercial and Urban Infrastructure, India Infrastructure Report 2008, containes case studies of urban transport and infrastructure that have used PPPs. Downloaded on August 22, 2008 from http://www.3inetwork.org/reports/IIR2008/Chap%206.pdf 35 Source: “Management and treatment of risks in PPP projects”, Background presentation to the Panel Discussion on Risk Sharing by Srinivas Sampath , Commonwealth Secretariat, UK at the ADB Institute, Tokyo, November 22, 2007. Downloaded on August 26, 2008 from http://www.adbi.org/files/2007.11.19.cpp.risk.presentation.pdf 36 Rastogi, Anupam and Shreemoyee Patra,2008, “The Dockland Light Rail Project Model— An Innovative Financing Model by a Sub-national Government”, Chapter 6, Section 6.3, India Infrastructure Report 2008, downloaded on August 21, 2008 from http://www.3inetwork.org/reports/IIR2008/Chap%206.pdf 37 The experience of UK reveals that PPPs often outperform traditional public sector procurement processes during the design and construction phases, and thus appear to yield higher value for money using the conventional Public Sector Comparison index. Source: Chapter 2, India Infrastructure Report 2008, downloaded on August 21, 2008 from http://www.3inetwork.org/reports/IIR2008/Chap%202.pdf 38 The second phase of this link will connect Bandra to Haji Ali. The bids are expected to be received till the mid-October and construction will commence either from May or October 2009. Source: “Tata and Ambanis among bidders for sealink”, article in DNA Daily News and Analysis, Monday, August 25, 2008. Downloaded on August 25, 2008 from http://www.dnaindia.com/report.asp?newsid=1185499 39 MSRDC has provided details of the project on its website http://www.msrdc.org/Projects/Wfslp.aspx 40 Other sources of revenue like advertising are not likely to constitute a sizeable percentage of the cash flows in view of the large capital expenditure involved in the project 41 Agrawal,V.S. and Gupta, N. (2008), “Models for Solid Waste Management in India”, in Chapter 7, Section 7.3, India Infrastructure Report 2008, downloaded on August 21, 2008 from http://3inetwork.org/reports/IIR2008/Chap%207.pdf 42 See Mathur (2001) for a detailed note on the Alandur Sewerage project 23 30