Governance structures :
A crucial prerequisite
By Hemant Sahai
& Nilesh Chandra,
A smart city can be only as “smart” as its infrastructure permits. A smart city must offer efficient and effective services and infrastructure to encourage and allow economic activity that can compete with the rest of the world. Creating world-class infrastructure within smart cities will require creative financing and execution solutions.
India’s ambitious 100 smart cities development plan presents an unprecedented investment and economic growth opportunity and will require focused effort. While significant institutional financial support is available, the figures pale in comparison with the aggregate capital investment required.
The Indian government in its 2014-15 budget allocated US$1.2 billion in investment towards the smart cities initiative, to be followed by `1 trillion (US$15 billion) over five years. In addition, an average of `1 billion per smart city per year will be contributed by a centrally sponsored scheme, state governments and urban local bodies (ULBs), largely by way of viability gap funding support. The government has also prepared a blueprint for financing the smart cities by pooled finances from national and state-level agencies and ULBs and schemes to attract investment in forms of bonds, etc. International partners too have committed financial support. However, as an estimated US$1 trillion in financing is needed for these smart cities, it is now accepted that most of the infrastructure will have to be built on the public-private partnership (PPP) model.
Investors and developers of PPP infrastructure projects in India have faced challenges in the past, leading to an uncertain market for project financing. While drafting PPP models for smart city infrastructure development, debt and equity financing challenges need to be addressed. HSA is working with diverse domestic and international institutions on developing innovative concession and financing structures and particularly on de-risking developers from government and project development risk. Recent regulatory changes by the Reserve Bank of India on take-out financing and longer debt tenors have helped significantly and have attracted long-term pension funds into the sector.
The current liquidity crunch of private and public sector commercial banks for financing the debt in PPP infrastructure projects needs to be addressed by creating long-term sources of financing such as insurance, pension funds, bonds and public schemes. To stimulate financing from public capital, the specific issues arising out of the inadequate regulatory regime need to be resolved and credit rating, credibility, transparency and accountability of the government needs to be improved. Restructuring, refinancing and take-out financing schemes for existing debt will also assist in creation of funds for the commercial banks and in turn, enable such banks to participate in development of new projects.
The blueprint for financing infrastructure for smart cities may also include adopting economic models such as purpose bonds, which are paid off on achievement of a specific goal, e.g. in construction, and may attract small and medium-scale investors. The model must be crafted so that financial institutions see it as a bankable option.
In India, equity financing in PPP models has largely been contributed through promoters’ funds which, coupled with stringent lock-in provisions, has proved to be self-limiting. Equity lock-in provisions have blocked promoters’ funds not just during the construction phase but significantly beyond that, including a lock-in of tapered equity for the entire residual tenor of the concession. Fortunately, there is an increasing recognition by public authorities that different classes of capital and investors with different risk appetites can each contribute in financing infrastructure development.
Land monetization, a widely accepted financing model used by public authorities across the globe to finance infrastructure projects, is gaining recognition among Indian authorities. Private developers’ initial investments can be monetized by allowing change in land use, sale or lease of residential and commercial space, higher floor area index, collection of user fees, etc. Capping real estate development ensures that it cross-subsidizes the main infrastructure project, rather than degenerating into a mere real estate project with the main project suffering as a consequence.
Land pooling and land readjustment schemes may also help optimize the value of the available land. Land monetization requires a proper regulatory framework to ensure land value is dictated by use, accessibility, infrastructure and service provisions, to prevent speculative development that jeopardizes the main project. Further, lack of transparency in financial and land transactions may deter public participation in land monetization schemes. While land monetization may be a significant source of financing for brownfield smart cities, a long-term strategy would be required for greenfield projects, which would need a significant amount of prior investment in basic urban infrastructure.
An appropriate PPP model, addressing financing challenges and including provisions for unique and innovative modes of financing of smart cities will play vital role in ensuring financing of the smart cities.