Financing of Smart Cities

Part 3

Smart Cities: Smarter Solutions for better tomorrow

Financing Requirement

Financing Requirement India’s ambitious 100 smart cities development plan offers an unprecedented investment and economic growth opportunity that will require focused effort. It is estimated that investments of about USD 1.2 trillion will be required over the next 20 years to build smart cities in India.Financing Options Smart city projects require substantial financial investment and financing remains one of the greatest challenges facing such initiatives. Some of the funding options that can be leveraged for smart city development are -

Internal Sources of financing

Internal Sources of financing 1. Land based financing instruments- This is widely accepted financing model used by public authorities across the globe to finance smart city projects, and is gaining recognition among Indian authorities as well. I. Tax Increment Financing is a method that finances debt in anticipation of future tax revenues. TIFs allow cities to fund smart city projects with borrowed funds with a promise of repay those funds back with additional tax revenues generated from the increased property value in the area around the development. The repayment comes solely from revenue generated through new taxes from within the new development area. This tool has been used effectively in US and Canada.

Internal Sources of financing

Under this form of financing, cities designate a TIF area for capital improvements and then earmark any future growth in property taxes to pay for investments in infrastructure and other economic development initiatives. In most cases, cities consider TIF projects a viable option because the proposed development of the area is anticipated to spark an increase in property values. For example, in Chicago, 10% of all property taxes were earmarked for TIF purposes, and TIF districts covered more than 25% of the city’s geographic area.

Internal Sources of financing

Impact Fees can be levied based on the impact that buildings have on urban infrastructure. These can be charged at the time of giving building permission - separate rates for residential and commercial buildings. FSI (Floor Space Index) Charges beyond a certain minimum which can be claimed as a right attracts additional charges, which can be used for funding smart city projects. Conversion charges collected can also be utilized towards funding smart city projects. These are collected at the time of land use conversion, that is, from rural to urban use and from residential to commercial use. Exactions are types of impact fees that require developers to pay for the impact their new development has on the community.

Internal Sources of financing

2. Municipal Bonds - Since the central and state governments support may not suffice the overall funding requirement for smart city projects, the urban local bodies (ULBs) can target to contribute by raising funds through the issue of municipal bonds. While the current size of the municipal bond market is limited and is distributed over a few strong municipalities of Ahmedabad, Nasik and Nagpur, it is expected to emerge as an important source of finance in the future time period. RBI and SEBI have taken several steps to strengthen the municipal bond markets. RBI has even suggested that insurance companies, National Pension System, and provident funds may be allowed to invest in the rated securities of ULBs.

Internal Sources of financing

Municipal bonds / General obligation bonds have been used in the past for funding smart city projects. Under this scheme, the issuing entity, typically the local government / municipal body backs the issuance of the bonds, this means, that the jurisdiction leverages its tax revenues to repay the bond buyers plus interest. Bond ratings agencies such as Standard & Poor’s, Moody’s and Fitch evaluate and grade the risk of the bonds in terms of the fiscal health of the issuing jurisdiction. This rating influences the interest rate the jurisdiction will have to pay on the bonds (e.g., the cost of borrowing). The returns to investors are not as aggressive as other types of bonds reflecting the lower risk of default.Example where the instrument was leveraged- In 2006, the state of California leveraged USD 68 Bn in GO bonds under its strategic growth plan initiative to fund the state infrastructure- transportation, education, water and health infrastructures

Internal Sources of financing

3. User Fees, User Charges and Asset Based Taxes- These are some additional options that can be leveraged to cover the costs associated with growth. User Fees - User Fees allows local jurisdictions to fund smart city projects. Under this system, the municipalities collect use fees to cover the cost incurred towards funding enhancements to city infrastructure aimed at improving the quality of life. In other words, levying user fees involves assigning project costs to project beneficiaries. Parking charges / fees is an important instrument of revenue enhancement through user charges for local governments.

Internal Sources of financing

On-Bill financing is an effective tool to drive adoption of new technologies among customers who are reluctant to pay high upfront costs. On-bill financing allows the local utility to decide the best upgrade package that can be reasonably financed. The utility then oversees the upgrades and customers are assessed a fixed monthly charge on their utility bills to pay for the upgrade. Different forms of charges such as – Utility Charges, Highway Toll Charges, Sewerage Charges, Sanitation Charges, and Real Estate Property Taxes could be imposed to leverage funds for smart city initiatives. However, they need to be explored further to understand their potential benefit / impact.

Internal Sources of financing

4. Other financing options aimed at enhancing the resource base for smart city development include Betterment Tax, Advertisement tax, Entertainment tax, Octroi and Intra-State Entry Taxes, and Professional tax. However, they need to be explored further to understand their potential benefit / impact

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