Mid-Term Exam - URP0509

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    Urban Management & Urban Governance

    1 | P a g eAvinash Y. Kumar

    URP0509

    School of Planning

    CEPT University

    SUB: URBAN MANAGEMENT AND URBAN GOVERNANCESemester Three, 2009-2011

    Faculty: Prof. Anjana Vyas / Dr. Dinesh Mehta

    Mid-Term Examination

    Date: 8th Oct 2010

    1. Critically examine the State Municipal Finance System in India.

    Ans.

    The State level Municipal Finance system could be viewed as as macro- scale of viewing the situation

    of Municipal administration in terms of the financial aspect. As per the 74th

    CAA 1992 which

    identified enormous responsibilities for the urban local governments. Besides the 18 items listed as

    municipal responsibilities in the Twelfth Schedule of the Constitution, the Legislature of a State, by

    law, can assign any tasks relating to:

    (i) The preparation of plans for economic development and social justice; and

    (ii) The implementation of schemes as may be entrusted to them.

    For strengthening the finances of urban local governments, two positive features were provided in

    the 73rd and 74th Amendments to the Constitution:

    a. A provision for the constitution of State Finance Commissions (SFCs) every five years (Article

    243-I as per the 73rdAmendment) and (b) amendment of Article 280 of the Indian

    b. Constitution by inserting section 3(C) which requires the Central Finance Commission (CFC)

    to suggest measures needed to augment the consolidated fund of the states to supplementthe resources of municipalities devolved on the basis of the respective SFC

    recommendations.

    However, the progress in the implementation of SFC recommendations in several states has not

    been very encouraging. The CFC has also grappled in making recommendations of resource transfer

    to local governments in states. However, in the absence of authentic data, successive CFCs have

    made recommendations for the transfers of funds for local bodies on ad hoc basis.

    The following illustration gives us a picture of the Fiscal dependency of ULBs in the State Municipal

    Finance Framework.

    Municipal Corporations; Municipalities; Town Area Committees; Notified Area Committees

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    Municipal corporations - from the ULBs mentioned above, usually exercise a good degree of fiscal

    autonomy and powers as they have a larger population and tax base, and deal with state

    governments directly. Municipalities with smaller jurisdictions have to deal with the state

    governments through the district collectors. As the revenue collectionand sharing procedure differs

    by state government, exploring these intergovernmental fiscal relationships, procedures, and

    mechanisms may provide important insights into the limited access of ULBs to resources. In India,

    ULBs are 3rd

    tier administrative divisions, responsible for providing basic infrastructure and services

    in cities and towns.

    Meanwhile, state governments have made municipal laws grounded in the 74th CAA of 1992, and

    each state has varying degrees of conformity with the legislation in terms of what are obligatory or

    discretionary functions of municipal bodies within each state.

    These differences tend to create certain deviations from the principles of efficient allocation of

    resources across different levels of the governmental administration functions; i.e., under the theory

    of fiscal federalism, certain roles and functions are better placed in the lower tiers of government

    while some can be more efficiently delivered by higher levels of government. Thus, it is equally

    important to study whether:

    i. Service provision and revenue generation and collection remain within the same jurisdiction,

    ii. Efficient resources are allocated according to the economic principles of municipal financing.

    Typical Structure at State Level

    Source: Urban (Municipal)Management Structure in India presentation: Prof. Ravikanth Joshi

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    Urb

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    2 Des ribes

    stemofmuni ip l go

    ern n ein Indi andissues asso iated withit

    Ans

    The sys

    e !"

    # $ % c % & al gove ' $ ance in India is broadly de"

    ined under the provisions of the landmark

    74th

    Constitution Amendment Act of1992 whichestablished the following threecategories of urban

    local bodies (

    Nagar nigam (Muni) ipalCorporation)

    Nagar palika (Muni0 ipalit1

    )

    Nagar panchayat (Cit2

    Coun3 il)

    As per the provisions of this Act, it was re 4 uired that municipal areasshall be declared having regard

    to the population of the area, the density of population therein, the revenue generated for local

    administration, the percentage of employment in non-agricultural activities, the economic

    importance or such other factors as may bespecified by thestate government by public notification

    for this purpose 5

    In 1992, a major step towards the decentralization and empowerment of local governments in India

    took place with the enactment of74th Constitutional Amendment Act. The Amendment calls for

    greater responsibilities and authorities for local governments by recognizing it as a third tier

    government. Some of the important aspects include 6

    Planning for economic and social development and role of municipal government in

    implementation of urban poverty alleviation projects

    Increased responsibility for urban planning at the district and metropolitan levels

    Greater authority to mobilize and using of resources

    This Act further provides that thereshall be7

    i. A Nagar Pan8 hayat for transitional areas i.e. an area in transition from rural to urban,

    ii. A Muni9 ipalCoun9 il for a smaller Urban area and

    iii. AMuni@ ipalCorporation for a larger urban area (Mathur 1999b).

    Most stateshave amended their municipal laws in conformity with the CAA. However, variations are

    found in the definition ofsmall and large urban areas, as well as in transitional areas.

    As per Census of India 1991, there are3255 Urban Local Bodies (ULB)s in thecountry A classified into

    four major categories of

    MuniB ipal corporations

    Municipalities

    (i.e. - Municipal council, municipal board, municipal committee)

    Town area committees

    Notified area committees

    RepresentatiC

    eBodies

    Partially NominatedBodies

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    The municipal bodies of India arevested with a long list of functions delegated to them by thestate

    governments under the municipal legislation. These functions broadly relate to public health,

    welfare, regulatory functions, public safety, public infrastructure works, and development activities.

    The12th

    Schedule of Constitution (Article 243 w) provides an illustrative list of18 functions that may

    beentrusted to the municipalities. Besides thesame traditional core functions of municipalities, it

    also includes development functions for e.g. - likeplanning for Economic development and Social

    justice. Somestateshave amended their municipal laws to add additional functions in the list of

    municipal functions assuggested in the twelfthschedule.

    There is a lot of difference in the assignment ofobliF G torH

    and I iP

    Q retionarH

    functions to the

    municipal bodies among thestates. Whilesomestates find certain functions as obligatory, these are

    discretionary functions in other states.

    It needs to be noted that among all urban local governments, municipal corporationsenjoy a greater

    degree of fiscal autonomy and functions although the specific fiscal and functional powers vary

    across the states, these local governmentshave larger populations, a more diversified economic

    base, and deal with

    th

    e state governments directly. On th

    e oth

    erh

    and, municipalitiesh

    ave lessautonomy, smaller jurisdictions and have to deal with the state governments through the

    Directorate of Municipalities or through thecollector of a district. These local bodies aresubject to

    detailed supervisorycontrol and guidance by thestate governments.

    In terms offiscal federalism, functions whose benefits largelyconfine to municipal jurisdictions and may

    be termed as theessentially municipal functions. For valid reasons, certain functions ofhigher authorities

    are appropriate to beentrusted with the Municipalities as if under principal-agent contracts and may be

    called agency functions that need to be financed by intergovernmental revenues. Thus instead of

    continuing the traditional distinction between obligatory and discretionary functions the municipal

    responsibilities may be grouped into essentiallymuniR iS

    al, jointand agencyfunctions.

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    3. ElaboratetheprocessofFinancialAnalysis; Financial Forecasting andpreparationofFinancial

    Operating Plan

    Ans.

    Financial Analysis refers to an assessment of theviability, stability andprofitabilityof a business

    undertaking, sub-business or project or in thiscase that of the functioning of an ULB. It makes use

    of information taken from financial statements and other reports. Using the inferences of a financing

    analysis, the undertakers of the project can:

    Continue or discontinue its main operation or part of its businessV

    Make or purchasecertain materials in the manufacture of its product;

    Ac W uire or rent/leasecertain machineries and e W uipment in the production of its goods;

    Issuestocks or negotiate for a bank loan to increase its working capital;

    Make decisions regarding investing or lending capital;

    Other decisions that allow management to make an informed selection on various

    alternatives in theconduct of its business.

    During thecourse of this analysis, we would wish to assess the following for the ULBs:

    Profitability: its ability to earn income and sustain growth in bothshort-term and long-term.

    A company's degree of profitability is usually based on the incomestatement, which reports

    on thecompany's results of operations;

    Solvency: its ability to pay its obligation to creditors and other third parties in the long-term;

    Liquidity: its ability to maintain positivecash flow, whilesatisfying immediate obligations;

    (Both2 and 3 are based on thecompany'sbalancesheet, which indicates the financial condition of a

    business as of a given point in time.)

    Stability: the firm's ability to remain in business in the long run, without having to sustain

    significant losses in theconduct of its business. Assessing a company'sstability re X uires the

    use of the income statement and the balance sheet, as well as other financial and non-

    financial indicators.

    Financial analysts often compare financial ratios (ofsolvency, profitability, growth, etc.):

    PastPerformance - Acrosshistorical time periods for the same firm (the last 5 years for

    eY

    ample),

    Future Performance - Using historical figures and certain mathematical and statistical

    techniques, including present and future values, This e

    trapolation method is the main

    source of errors in financial analysis as past statistics can be poor predictors of future

    prospects.

    Coma

    arativePerformance- Comparison between similar firms.

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    These ratios arecalculated by dividing a (group of) account balance(s), taken from the balancesheet

    and / or the incomestatement, by another, for ed

    ample :

    Netincome /equity = return on equity (ROE)

    Netincome /totalassets = return on assets (ROA)

    Stock price /earnings pershare = P/Eratio

    Comparing financial ratios is merely one way ofconducting financial analysis.

    Sources ofFinancial Information at the level of ULBs:

    ULBleveli. Budget documents

    ii. Annual reports

    iii. Periodic publications

    Stateleveli. Budget documents

    ii. Financial intermediary

    iii. Periodic publications

    iv. Grant disbursing agencyv. Financecommission reports

    vi. Department of Economics and Statistics

    A FinancialOperating Plan is a multi-year forecast of finances(FinancialForecast) of the local

    body for the medium-term. The forecasts are generally based on past trends. One of the

    important salient features of an FOP is that the forecastsconsider capital investment plans for

    the term of CDP alongside taking into account all outstanding dues, including debt and non-debt

    liabilities.

    The process of developing an FOP could beee

    plained as follows:

    i. Developing an Account Database for past 5 years for the ULB in question and

    subsequently identifying growth trends.

    ii. Identifying Project shelves for eachsector by developing priorities.

    iii. Undertaking the projection ofrevenue as well ascapitalaccounts (this would consider

    past trends).

    iv. Defining improvement scenarios in the revenue and ef

    penditure trends considering

    reform agenda.

    v. All the above steps would followed by taking into consideration all thescenarios over

    the projected accounts model and selecting the most appropriate one wherein all debts

    areservices, alongside increasing servicecharges in infrastructure delivery by the ULBs.

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    4. What are financial resources of Municipal bodies in India? Explain in detail

    Ans.

    Municipal finance constitutes only a small share of Indias federal finance structure. The

    following illustration is an overview of the components of Municipal Finance:

    The revenue base of MCs can be broadly categorized into:

    a. Tax revenues,

    b. Non-tax revenues,

    c. Assigned (shared) revenue,

    d. Grants-in-aid,

    e. Loans and

    f. Other receipts.

    Share of own resources in the total resources is very good indicator of self-sufficiency of

    municipal finance. Own revenue of municipal corporations constitutes about 80 percent of their

    total revenue (Source: Municipal Finance ASCIg World Bankg WSP). This means that they get

    comparatively fewer transfers or grants-in-aid in percentage terms. A higher share of revenue

    from own sources for municipal bodies does not mean that they are raising sufficient resources

    for their expenditures.

    Note: The following table lists out revenuesources under each major revenue head. It may be mentioned

    that composition as well as relative importance of revenue sources of MCs varies across the States.

    Source: Municipal Resources presentation: Prof. Ravikanth Joshi

    Municipal Finance Components:

    Revenue Sources of Municipal Corporations in India 1998-2002

    Source: Budgets of Municipal Corporations

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    Apart from their own revenue sources, i.e., tax and non-tax revenue sources, the MCs depend upon

    grants from State Governments. These grants are primarily intended to compensate for the

    mismatch of functions and finance. Most of the MCs receive financial support in the form of revenue

    grants from State Governments to meet current expenses. Similarly, capital grants are also provided

    for meeting project related expenditure. Table 20 shows the composition of grants-in-aid in selected

    MCs. In addition to own revenues, shared revenues, user charges & fees and grants-in-aid, loans also

    constitute an important source of municipal revenues in some ULBs.

    The above illustration is an overview of the various Revenue Sources for ULBs in India.

    A higher share of revenue from own sources for municipal bodies does not mean that they are

    raising sufficient resources for their expenditures. We have already observed that most of them are

    in revenue deficit.

    Revenue Sources of Municipal Corporations in India 1998-2002

    Source: Municipal Resources presentation: Prof. Ravikanth Joshi

    Source: Budgets of Municipal Corporations

    Components of Revenue of Municipal Corporations 2000 04

    (As average % of Aggregate Total Revenue)

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    Municipalities, because they are larger and metropolitan in character, are able to generate revenue

    from their own resources, but nagar panchayats, which are based in transitional cities that haveyet

    to attain an urban character and economic base, are not able to get sizable revenue from their own

    resources.

    As for tax revenue, property tax is the main source of revenue. It accounts for more than 50 percent

    of tax revenue and about 25 percent of the revenue from own sources. Next in order of importance

    are the water tax (or water charge) and theconservancy tax (based on the assessed valuation of

    the property in the district).

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    5. What are the issues associated with Municipal Finance in India. Narrate with examples

    Ans.

    As per the Report of the Twelfth Finance Commission, India has 3,723 ULBs, of which 109 are

    MCs, 1432 are municipalities and 2182 are Nagar Panchayats.

    Under the constitutional scheme of fiscal federalism, funds from the Central Government are

    devolved to the State Governments. Following the recommendations of the State Finance

    Commissions (SFCs) and taking into account the devolutions made by the Central Finance

    Commission (CFC), the State Governments are required to devolve resources to their local bodies.

    However, due to endemic resource constraints, they have not been in a position to allocate adequate

    resources (Municipal Finance) to their ULBs. This is further compounded by the fact that even the

    existing sources of revenues are not adequately exploited by many of the ULBs. The above factors

    have led to rising fiscal gaps in these institutions, with resources drastically falling short of the

    requirements to meet the backlog. To address the fiscal stress, some ULBs began to resorting to

    borrowings from institutions such as State Government guarantees, financiah

    institutions, bani

    s,

    open marketandexternah

    lendingagencies (World Bank & theAsian Development Bank).

    This has implications for both Central and State finances, as it reflects the dependency of the ULBs

    and consequently, the provision of local public services on the policies and programmes of the

    Central and State Governments.

    The revenue base of ULBs can be broadly categorized into:

    a. Tax revenues,

    b. Non-tax revenues,

    c. Assigned (shared) revenue,

    d. Grants-in-aid,

    e. Loans and

    f. Other receipts.

    Fiscal Dependency of Local Bodies

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    Theexpenditure incurred by the ULBscan be broadlycategorized into:

    a. Revenueexpenditurei. Establishment expenditure,

    ii. Administrativeexpenditure,

    iii. Operations and maintenanceexpenditure,

    iv. Interest payments on loans

    b. Capitalexpenditure.

    i. Expenditure on capital formation

    ii. Principal repayment.

    A comparison of municipal spending with these norms, after revising them to the current period,

    would reveal the level of under spending by the ULBs. There are a host of factors whichcould be

    responsible for the level of under-spending, which can be divided into two broad categories.

    Exogenousfactors:Those that are not within thecontrol ofconcerned ULB (They includedelegation

    of revenue powers).

    Endogenousfactors:Those that have to do with the ULBsp

    own operations. (They includerevenue

    (tax) administration, cost recovery and quality of expenditure.)

    Issues concerningMunicipal Financein India

    The following write up is an illustration of the few enlisted issuesconcerning Municipal Finance in

    India:

    i. There is mismatch between functions and finances of ULBs, which primarily explains the

    vertical imbalance. i.e. - Out of 18 functions to be performed by the municipal bodies in

    India less than halfhave a corresponding financing source. There are no commensurate

    resources with these institutions to discharge development functions such as poverty

    alleviation as per 12th

    Schedule of CAA. Thus, vertical imbalance isconstitutionally in-built.

    ii. There is need for reforms in thestructure of fiscal federalism, including revenue assignment

    and inter-governmental transfers through the Central and StateFinance Commissions.

    iii. There is a need for function-finance mapping to ensure that each function to be performed

    by the ULBs is backed by a corresponding financing source. The revenue instruments

    assigned to a tier of government should match, as far as possible, the expenditure

    requirements to induce fiscal responsibility.

    iv. Under-spending in civic services is evidently linked to certain exogenous and endogenous

    factors.

    Thesize of the municipal fiscal sector in India isverysmall as in terms of both revenue and

    expenditure the urban local bodies account for little above2 per cent of thecombined revenue

    and expenditure of Central Government, StateGovernments and ULBs. This is in contrast to the

    situation obtaining in advanced countries, where local bodies normally account for 20-35 per

    cent of the total government expenditure.

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    v. ULBs have low outstanding debt and debt sustainability parameters such as interest

    coverage and debt coverage ratiossuggest that these bodieshave considerablescope for

    debt financing of their expenditure needs.

    vi. The patterns of urban public finance in India are based on the model of Anglo-Saxon

    countries like United Kingdom and Australia, which have an elaborate system of

    intergovernmental transfers. In addition to own and shared revenues, grants-in-aid

    received from the concerned State Governments constitute a major resource of ULBs.

    However, the fiscal position of the States themselves has been weak with high level of

    deficits and outstanding liabilities. Hence, the State Governments have not been in a

    position to providesufficient funds to their ULBs as per the recommendations of theSFCs.

    vii. Further, most of them arecommitted to reducing deficit, as per their newlyenacted Fiscal

    Responsibility and Budget Management Acts. Need for empowering ULBs with own taxes

    and non-taxes and th

    e intergovernmental transfer system, especially transfers from Statesto ULBs, need restructuring. Present system in States isad hoc, withvery little incentive to

    ULBs to prompt efforts for bridging the fiscal gap and rendering performance.

    viii. There is a need to sufficiently increase the income of ULBs from all sources. Because, a low

    level of investment would mean poor services, wherebycitizens are unhappy and unwilling

    to pay for thespecificservice. Assuch there erupts an unwillingness to charge and hence

    subsequently a low income. In order to thus improve the income of ULBs, it would require

    the following:

    Ch

    arge wh

    erever it is possible Earn through market based operations

    ix. Control expenditure in maximum possible ways

    x. Improvecost efficiency (productivity)continuously

    System and HR reforms

    Harnessing alternativesources of financing

    xi. Create mechanism to flow private and social resources for financing urban infrastructure

    that isharnessing alternative resources.

    xii.Th

    ere is also a need for alternative sources of financingdue to: Inadequacy ofconventional sources.

    Bridging of resource gap.

    Improving the financial and project management capabilities.

    Inculcating financial discipline.

    Attaining objectives of accountability, transparency and efficiency.

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    References

    i. P. K. Mohanty, B. M. Misra, Rajan Goyal, P. D. Jeromi; Municipal Finance in India: An Assessment;

    DevelopmentResearch Group

    ii. Dr Ravikant Joshi;Municipal Finance;WorldBank, ASCI, WSP.

    iii. Prof. Ravikanth Joshi;Municipal Resources presentation.

    iv. Wikipedia

    v. India: India Municipal Finance Study Technical Assistance Report;Asian DevelopmentBank.

    vi. Reserve Bank of India Press Release; www.rbi.org.in