India is witnessing rapid pace of urbanisation. The need for measures to make our cities more liveable has been felt badly in the past decade. The investment required to improve urban infrastructure and service delivery in India in the coming years is huge.

According to the 2011 ‘Report on Indian Urban Infrastructure and Services’, the aggregate investment (for providing eight basic services) up to 2031 would be to the order of '39.2 lakh crore. Recognising this need, successive governments have rolled out urban renewal programmes with large budget outlays. The erstwhile Jawaharlal Nehru National Urban Renewal Mission (JnNURM), the 100 Smart Cities Mission, and the Atal Mission for Rejuvenation and Urban Transformation (AMRUT) are all schemes aimed at improving India’s urban centres on a mission mode. In addition, the government is giving a huge impetus to alternative innovative sources of funding through public-private partnerships for infrastructure development, municipal bonds and so on.

The state of urban local body finances

While ever-increasing budget outlays and improved access to alternative funding are expected to fuel the future growth of India’s cities, the question that arises is whether our corporations and municipalities have internal systems in place to access and manage funds of the magnitude required. The dismal state of finances of India’s urban local bodies has been the topic of many debates and discussions over the past few years.

While on one side, there is an acute shortage of financial resources vis-à- vis the requirement, on the other there is a lack of transparency and accountability in the management of such resources. The common problems are unscientific budgeting, mismanagement of funds, delays in finalisation of accounts, pending audits, low realisation of taxes, and over-reliance on cash inflows from the state government.
Needless to mention, the poor state of financial management affects the overall quality of governance and is a primary reason for the urban mess that we find ourselves in.

Steps taken

The first step towards solving a problem is to recognise the problem in hand. The good news is that the problem of the poor state of city government finances is now an accepted fact in government circles. Schemes like JnNURM and Urban Infrastructure Development Scheme for Small and Medium Towns (UIDSSMT) tried to address this issue by linking access to scheme grants by urban local bodies to implementation of accounting reforms. This to a certain extent was instrumental in Indian municipalities taking up migration to accrual based accounting. However, the implementation remained incomplete in most places. In other places where accounting reforms were indeed implemented, the process took an unreasonably long time and there is very little evidence to suggest that the implementation actually helped improve financial management and in turn governance. The government subsequently realised that tying grant release to reform implementation often results in a lose-lose situation (neither reforms get implemented nor infrastructure gets developed) and hence shifted to an incentive-based approach. This shift in approach is reflected in the fact that the AMRUT scheme sets apart 10 percent of the budget for incentivising reform implementation. Double entry accounting is one of such reforms identified.

Financial reforms: underlying issues

Unlike investments in public infrastructure or in improving service delivery, the issue with financial reforms is that the linkage between the investment and the returns is not easily established. Hence, there is no inherent incentive for policy makers at the local government to actively undertake financial reforms. Another issue is that financial reforms have all along been narrowly interpreted to mean reform of the accounting system without realising that accounting reforms are only a means to an end and not an end in itself. Reform of the financial management system in order to produce tangible outcomes must encompass budgeting, asset management, debt management, working capital management, service delivery costing, financial analysis for decision making, and audit - internal as well as external. This has rarely been the case with financial reform exercises in India’s corporations and municipalities. As a consequence, even after many years of reform and after spending significant amounts, most of our upcoming smart cities are still a long way from calling themselves financially smart.

The path to a financially smart city

A financially smart city is not necessarily the city having abundant financial resources. In fact, the best of innovation happens when resources are short. A financially smart city is one which prioritises budgets democratically, realises revenues in a timely manner, creates and preserves its assets, leverages debt effectively, diligently monitors execution vis-à-vis budgets, monitors service delivery costs, and shares financial information with citizens in a transparent manner. Financial smartness is not such a vague concept after all. Parameters for financial smartness can actually be defined, measured, and monitored.

PFMA assessment

A corporation or municipality that intends to become a financially smart city requires a way to be able to assess the performance of its financial management system. Such assessment must be undertaken before as well as after the local body has trod the financial reforms path. Such an assessment is typically known as a Public Financial Management and Accountability Assessment, in other words, a PFMA Assessment.

PFMA assessment of urban local bodies – Need of the hour

PFMA assessments have been conducted at the local body level in India in the past. However, such assessments have been few and far between. Even where baseline assessments have been undertaken, follow-on assessments have not happened to assess the actual improvement or decline in performance. With the initial list of 100 Smart Cities now declared, it is the right time for the government to initiate PFMA assessments in these 100 cities prior to releasing funds under the scheme. While on one hand, a baseline assessment will highlight significant inherent risks in the finances of these cities, on the other, it sets the stage for a follow-on assessment after a few years to assess actual performance.

After the initial 100 cities are covered, PFMA assessments can be extended to cover more cities and smaller towns. In future, a PFMA assessment can be made a prerequisite for selecting local and state governments for performance-linked grants. The cost of conducting a PFMA assessment is insignificant compared to the money allotted for infrastructure development and service delivery improvements.
India may choose to adopt the PEFA framework or develop its own framework for PFMA assessment at the local body level. What is important is that a common framework is used across the country and applied consistently from one assessment to another.

Conclusion

Neither the central government, the state government, or for that matter the bond market is large enough to fully fund India’s future urban growth. While on one hand, funding will be perennially short, on the other funders will continue to face challenges of finding safe, credit-worthy investment opportunities. Systems need to be established that facilitate channeling of scarce resources to players who can use them efficiently and produce measurable, long-lasting results. In the absence of robust financial management systems at the grassroots level, any amount of investment would yield mediocre outcomes. In this connection, PFMA assessments can go a long way in providing assurance to government and investors alike on the efficient, effective use of scarce financial resources in providing a better quality of life in India’s cities.

Rao is executive director of Management and Governance Consulting, Bengaluru.

(The column appears in the September 16-30, 2016 issue)