Below post is cross-posted from our Financing Small Cities Blog.
By Anand Sahasranaman, IFMR Finance Foundation
Given the magnitude of investments and expertise needed for sustainable development of urban infrastructure in India, it is essential that there be substantial private sector involvement. This post explores how there has been a greater thrust towards private funding models post-1990 and what how policy can incentivize cities to move further in this direction.
Evolution of urban infrastructure financing in India
Prior to 1990, urban infrastructure in Indian cities was financed largely through government grants and Plan funds of central and state governments. Decisions on local infrastructure investments were made by state and central governments. Because of the disconnect between local needs and infrastructure plans drawn up at higher levels of government, these infrastructure investments made were without any clear understanding of local demand. In the absence of inputs on both the nature and extent of local demands, the infrastructure that was built ended up being inadequate, of poor quality and often unrelated to people’s needs.
In addition to these direct government levers of grants and Plan funds, cities were also allowed to access debt from the Housing and Urban Development Corporation (HUDCO), which was directed by the central government to lend to cities. These borrowings from HUDCO were guaranteed by state governments, thereby de-risking the investment for HUDCO by ensuring that the lender was exposed to the state government’s risk and not the particular project’s risk. By design, such an arrangement ensured that the credit discipline that is associated with prudent, commercial lending programs was missing here. The incentives of the lender were completely skewed by disconnecting the lending from the project risk, and the incentive of the city to structure a viable project was also skewed by the knowledge that the ultimate risk of default lay with the state government. This financing structure fundamentally lent itself to the design of sub-optimal, unsustainable projects.
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