Financial Times

Opinion: Funding India's urban infrastructure

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India’s urban population will soar from nearly 340 million in 2008 to 590 million in 2030. With such an unprecedented increase in urbanization, India will need to build an urban infrastructure that keeps pace with this change. India's record to date, however, has not been promising, and access to basic services in cities is poor. Without adequate funding, the risk is that the quality of life in urban India will deteriorate, gridlock may compromise productivity, and investors could decide that India’s cities are too chaotic for their businesses to thrive.

While India needs to move decisively to improve the way it governs and plans cities, the bedrock of any improvement will have to be a very large investment program. In per capita terms, India's annual capital spending on urban infrastructure of $17 is only 14 percent of China's $116 and less than 6 percent of New York’s $292. New research by the McKinsey Global Institute (MGI) concludes that urban India needs to spend the equivalent of $134 per capita per year in the period to 2030—almost eight times what it invests now. Overall, India needs to inject an additional $1200 billion of capital spending into its cities between now and 2030.

Tier 1 cities (with populations of more than 4 million) require capital spending of $288 per capita per annum, and Tier 2 cities (populations between 1 million and 4 million) $133 per capita per annum, while the requirement in Tier 3 and 4 cities (populations of less than 1 million) is $96 per capita per annum. The bigger need for investment in India's Tier 1 and 2 cities is mainly due to their much greater demand for mass-transit systems and affordable housing.

Only by initiating such an aggressive investment program will India be able to provide 150 liters per capita of water supply, provide full coverage and treatment of sewage and waste management, move toward a public-transit-led mobility system (including 8,400 kilometers of metros and subways), and help facilitate the construction of 38 million affordable houses for the poorest people living in cities.

So can India realistically find such enormous sums? The answer is that doing so will be challenging but possible as long as India taps the kinds of revenue streams that are part of the everyday life of well-run cities around the world, which have consistently used four sources of funding to drive investments: monetization of land assets, property taxes and user charges that reflect costs, debt and public-private partnerships, and transparent, formula-based government support. To date, India has underleveraged these avenues.

It is highly unusual, for example, for Indian cities to monetize land assets, yet MGI estimates that India could generate up to $27 billion a year (or $58 per capita per annum) this way. India could systematically increase floor area ratios (FAR) around central business districts and linked transport corridors and then charge a development fee linked to property rates. In Mumbai, for instance, a FAR increase from 1.3 to 4 in key commercial centers could fetch the government 4,000 to 5,000 rupees per square foot. And cities could generate significant funds through the auction of greenfield sites and charge impact fees on all new infrastructure developments on a per-square-foot basis.

India could generate another $50 billion a year ($112 per capita)—a fivefold increase from today's level—by using property taxes and user charges more extensively. To date, low tariffs (adopted for populist reasons), poor assessment methods, and noncompliance have hindered India's ability to generate revenue from these sources. Today, India collects only an estimated 0.04 to 0.08 percent of property values as property taxes&mdashone of the lowest rates in the world. In the case of user charges, India needs to recover a lot more.

India's cities need to make use of debt and private capital with the potential to raise up to $12 billion a year or $26 per capita from these sources. Poor financial structuring in the past has rendered these types of revenue unviable, and they have contributed less than 5 percent to the funding of urban investment.

Using these three sources of funding, India's Tier 1 and 2 cities can meet 80 to 85 percent of their funding requirements. The rest has to come from state and central governments—another area that India continues to neglect at its peril. Today, local governments bear the majority of the burden of urban spending with very little support coming from the higher tiers of government. Given that India’s cities generate almost 70 percent of the taxes, if they were to retain an 18 to 20 percent share of goods and services taxes (China allows its cities to keep 25 percent of value-added taxes), they would see the injection of an additional $10.4 billion per year, or an average of $43 per capita.

All these revenue sources are standard fare in other cities, and there is no reason why India cannot put the appropriate framework in place to access them. Indeed, India needs to act decisively if it is to head off even more egregious strains on its cities as they expand over the next 20 years.

This piece is the second in a Financial Times series on India's urban challenge. Subsequent pieces will focus on funding and infrastructure as well as how urbanization in India and China compares.

Shirish Sankhe is a director of McKinsey based in Mumbai, and Richard Dobbs is a director of MGI and a director of McKinsey based in Seoul.

This article originally ran in The Financial Times.