Financing urban infrastructure projects

Value

capture

method

Typically used in land development, Urban Development Authorities across the country raise
considerable revenues from land by selling after minimal or even no development of the land. From
the seller's perspective, this is an inefficient method since the major portion of the value of an
undeveloped land is embedded in the future revenue streams arising from its development. In other
words,

the

seller

exits

at

the

lower

end

of

the

value

chain.

The developer, in turn garners a windfall after full commercial development of the land. He benefits
from both the land value shooting up and from the incoming revenue streams, whose NPV is in most
cases many times more than the land value itself. The seller of the land (government agency) loses
out

from

partaking

share

in

this

future

revenue

streams.

The seller can maximize his returns by an arrangement wherein the land gets leased to the
developer for a fixed period at an annual rental value and a share in the future revenues streams (a
developement premium). Another model is where the developer transfers a portion of the
developed

commercial

Tax

or

residential

Increment

built-up

Financing

area.

(TIF)

TIF is a mechanism that allows municipalities to earmark the increased tax revenues from property
value growth, due to land re-development or renewal, within a designated area suffering from blight
(a TIF district) in order to finance development in that same area. It dedicates the increased property
tax and other revenues from redevelopment to finance debt issued to pay for the project. It is
therefore a method of using future gains in taxes to finance the current improvements that will
create

those

gains.

Re-development benefits the municipality by creating more taxable property (and hence tax
revenues) and by increasing the values of land held by it. Vacant land, if any, can in turn be
leveraged

to

earn

more

revenues

and

property

tax.

After a municipality designates a TIF, local government units are barred from collecting taxes on the
areas property value growth. They can tax only the "frozen" property value and properties, as it
stood when the TIF was designated. The tax revenue from growth the tax increment accrues
instead to the TIF, to be spent on loan repayment, capital improvements, developer and rent

subsidies, job training, and other expenditures meant to spur new development. The value of this
new development is taxed, the taxes ploughed back into the TIF, and the TIF revenues spent on
creating

still

more

development.

TIF is a popular method of financing investments in poorer areas, since it does not involve any
immediate increase in property taxes and also beacause it mandates the spending of money raised
from

the

area

Pooled

in

that

area

Finance

itself.

Development

It is an approach under which an appropriate mix of urban infrastructure projects are bundled
together, and the bundle is then posited before the debt MARKET. The projects should be chosen so
as to diversify away and mitigate the individual project risks. This can be achieved by choosing
projects with robust enough cash flows, which imparts an element of credit protection against
revenue

shortfall

in

the

other

projects.

This method of financing is typically used to leverage investments into smaller municipalities, whose
credit worthiness is often suspect, by mixing them with projects from more credit worthy and larger
municipalities. It can also be used to finance projects with smaller revenue streams, by bundling
them

with

those

having

larger

revenue

streams.

Pooled Finance Development FUNDS (PFDF), set up by governments, can also provide ratings
enhancement facility by functioning as a Credit Rating Enhancement FUND (CREF) and raise the
credit worthiness of the bond offerings (to finance a bundle of projects) to investment grade.

Credit

Enhancement

Facility

Given the virgin nature of debt market for urban infrastructure, it is natural that lenders have
apprehensions about the riskiness of their investments. In order to facilitate the development of this
market, it may be necessary to increase the credit worthiness of these investments by providing
additional layers of credit protection. Such additional protection would make the project investment
grade,

and

thereby

lower

the

cost

of

capital.

Such credit enhancement can be provided directly through a guarantee fund, or by purchasing
guarantees from financing institutions willing to underwrite the risk of a cash-flow shortfall. All this
additional layers of credit protection, over and above the Project cash flows, is meant to mitigate the

risks, lower the cost of capital and thereby encourage the growth of a debt market in urban
infrastructure

projects.

Venture

financing

model

This approach uses a higher equity share to leverage debt at lower cost, on the condition that the
equity holder can progressively withdraw his equity. In other words, the equity is used to "crowd in"
lower cost debt. Under this model, the project commits to achieve certain operational and
commercial benchmarks in its performance, within a specified time schedule, thereby demonstrating
its ability to counter its commercial and operational risks. Once the project stabilizes and the
revenues streams get established, it becomes possible to attract debt at lower cost. The equity
investor can then progressively exit with a handsome return. The equity can then be invested in
newer

projects.

This arrangement is similar to the venture financing or angel investing model, in which promising
ideas and projects are financed by providing seed capital. The venture capitalist or angel investor,
exits with a handsome profit once the project becomes established as a success. There can be
institutions

that

specialize

in

Impact

making

such

investments.

fee

financing

Major infrastructure investments results in increased land and rental values in the area. Since the
land owners do not contribute anything to this increase, it is only appropriate that they are priced
for this unearned increment. The gains accruing to the landlord from the positive externality arising
from the investment, is partially internalized by way of an impact fee. This impact fee can be by way
of

higher

property

tax,

higher

Tradable

building

permission

fee,

or

direct

infrastructure

levy.

assets

The infrastructure assets can be created by short term debt or financed by government. An
appropriate pool of such infrastructure assets can then be bundled together, securitized and sold off
as a tradable financial product. Their price and true cost of capital will be determined by the market.
These tradebale assets would be similar to the infrastructure funds that are floated in the debt
market

to

raise

capital

for

creating

specific

infrastructure

project

assets.

The O&M of the assets can then be auctioned off to franchisees by competitive bidding, thereby
helping

consumers

get

the

best

deal

in

service

pricing.

Viability

gap

funding

or

bridge

financing

This approach is suitable when an investment is financially unviable, since the investment costs are
too large to be compensated (or repaid) by the relatively smaller revenue streams. In such projects,
the government does the bridge financing required to make the project financially viable, most often
as a grant. This amount can be offset against the subsidy provided by the government, by way of
lower

tariffs

on

Government

water

or

sewerage

guaranteed

systems.

debt

In major projects, where the SPV accesses the debt market, the cost of capital is invariably higher
than if the debt was raised by the government or any of its agencies. In emerging MARKETS like
urban infrastructure, no private entity, however established and credible, will be able to convince
lenders that it has adequately addressed the issue of construction, commercial and operational risks.
This inability to signal convincingly enough to lenders will translate into higher cost of capital for the
project, thereby saddling the project with often unsustainable debt service burdens, under the
weight

of

which

it

fails.

The portion of such government raised debt, can vary depending on the type of project and its
financial viability. This debt can become a junior debt tranche, to senior debt raised in the regular
debt markets.
Land as a source of financing urban infrastructure
At a fundamental level, it can be argued that internal revenue sources are the most critical funding l
available to a municipality because without effective, predictable generation of internal revenues, it
will be impossible to attract new, external sources of funding. External sources, whether in the form
of bank loans, bonds or other capital MARKET instruments, will be available to municipalities only
on the basis of the internal revenues they generate now and are expected to generate in the
future. Additionally, the internal revenue generation of a municipality is but a reflection of the
quality of its governance, and the transparency and accountability of its administration. Any
assessment of the internal financing capability of a municipality is, therefore, a judgment on its
governance standards. A better governed municipality implies better information availability, better
assessment capability and better collection efficiencies that are then reflected in the quantum of
revenues generated through internal funding levers. Therefore, any attempt to substantially

improve the infrastructure provision scenario in India will need to begin by giving a significant
thrust to improving the assessment, enforcement and collection of internal revenue levers.
While the generation of internal revenue is critical for a city, the use of land as a source of financing
urban infrastructure can be a very useful supplementary mechanism. Traditionally, urban
infrastructure has been financed by savings of local government, grants from higher levels of
government and capital borrowings. However, at a time when government budgets are hard pressed
and large-scale borrowings are hard to come by, land-based financing presents an important option
for local infrastructure finance. By leveraging the sensitivity of land values to urban economic growth
and the principle that benefits of infrastructure are capitalized into land values, land-based financing
instruments have come to play a key role in complementing other sources of capital finance.
Land-based financing introduces significant advantages to infrastructure financing decisions,
reducing dependence on debt and its associated fiscal risks. It has the advantage of generating
revenues upfront, sometimes before the infrastructure is undertaken, making it easier to finance
infrastructure projects that call for massive investments. The scale of land-based financing is also
much larger in magnitude when compared to other sources of urban capital finance. Further,
mobilizing finance from land transactions strengthens efficiency of urban land MARKETS and
rationalizes the pattern of urban development by sending out price signals to the market.
While land-based financing holds the potential for closing the infrastructure financing gap and
supporting the sustainable development of cities, its role is restricted as an instrument of capital
finance. It is not a permanent and recurring source of revenue as land sales cannot continue
indefinitely. Thus, revenues from land financing should ideally not be used to finance operating
expenses and must be directed only to the capital budget. Further, we need to keep in mind that the
volatility inherent in land MARKETScould simply reflect an asset bubble and world-wide economic
conditions. Thus, extrapolating past trends to prepare future INVESTMENT plans could be risky. Also,
the magnitude of revenues raised from land financing breeds the risks of favoritism, corruption and
abuse of government power if land-based transactions lack transparency and accountability.
Land financing has been widely used to finance urban transportation projects or the infrastructure
required to service new urban developments. It has been less frequently employed to finance
investment in existing basic infrastructure services such as repair or upgrading of water supply,
waste-water collection, or solid waste removal. The fact that water supply and other basic services
agencies do not own excess land that can be sold or developed explains the lack of land-based
financing in these areas. A possible solution would be to establish a consolidated capital budget that
could automatically allocate part of the land finance proceeds for the delivery of basic services. Also,

when governments are responsible for providing the entire range of infrastructure services,
employing land financing to pay for particular investment projects frees up FUNDS for investment in
basic services. This calls for special measures to be taken to make land-based financing support
investment in existing infrastructure services.
Categorising land-based financing instruments
Land-based financing instruments can be broadly classified under three categories: developer
exactions (including impact fees), value capture (betterment levies, land sales) and land asset
management (including private investment in public infrastructure). The following table discusses
the working of land financing instruments and recounts select cases of their employment.

All of the above lists one-time payments and capital play. This has the detrimental effect of higher
prices for infrastructure that affects the city's economy due to higher upfront capital payments. The
property taxes collected rarely reflect earnings values of the property but a registered value.
It may be worthwhile for corporations to consider integrating an element of revenue flows into their
infrastructure plans. These will provide cash flows to service debt/capital plus surpluses to redeploy.
And linked to overall economic growth - so there is a direct stake in the corporation making the city
successful in income terms (that can't be fudged so easily) rather than capital value terms (that
create bubbles).
Examples

of

these:

i) The Corporation takes up an equity stake in commercial developments based on land price at time
of transfer to developer. Downstream sales will thus contribute earnings to the corporation.
ii) Specific area based taxes for newer developments. E g if road, water/sewage and electricity
footprint is expanded - this is a geography footprint. All the property in that area benefits from it in

terms of prices etc. A small fee (calibrated to not kill profitability) will contribute a steady income to
the city corporation. Won't affect older areas.
The sale of assets on capital value creates an incentive for land owners (viz., govt) to work towards
higher values. This pushes up prices or worse still cost of living, as accompanying services become
expensive for residents. This directly proliferates "slum living" and overconstruction in areas outside
city control
Pooled Bonds Method
As per the estimates of the Ministry of Urban Development the Urban Local Bodies (ULBs) in India
require cumulative capital investments of Rs.39.2 lakh crore over the next 20 years in order to
address prevailing urban infrastructure and service gaps1. The Jawaharlal Nehru National Urban
Renewal Mission (JNNURM) provides assistance to ULBs in the states to the extent of 35-90% of the
cost of projects being approved under this mission. However, ULBs face constraints in meeting the
remaining part of the cost of such projects in view of their limited financial resources and the
absence of a domestic market for long term municipal debt. Grants from the State Government and
loans from the State nodal agency are currently being provided to partially bridge this gap.
However, with an estimated Rs.1 lakh crore worth of projects having been sanctioned since the
inception of the JNNURM, this alternative is also reaching its limits.
The challenge before the Government of India is to find the resources to fund the massive
infrastructure requirements of the urban sector. Even if the Government were to somehow mobilize
its share of funding, it is inconceivable how ULBs, particularly the small and medium towns, could
bring in their contribution under the existing arrangement without taking recourse to a substantial
increase in property tax, which is the principal source of ULBs own revenue, or a manifold increase
in tariffs for services, both of which are politically sensitive options.
On the other hand, thanks to a healthy growth rate in the GDP and the high domestic savings rate of
our economy, there is enormous opportunity to tap the financial market for meeting ULBs funding
requirements. However the market for municipal bonds in India is almost non-existent, unlike in
countries such as the US where this is the principal mode of financing urban infrastructure.
Retail investors and their proxies, viz. mutual, pension and insurance funds have been the main
subscribers to such pooled municipal bonds as they have traditionally looked at long term
investments with tax-free returns.
The basic premise behind the pooled bond structure is that by combining program equity with a pool
of loans, the risk of a single borrower loan default causing a bond default is reduced. The more the

size and diversification of a pool increases, even with the inclusion of smaller and less creditworthy
borrowers, and the more the concentration of the largest participants decreases, the more the
default risk spread, thereby improving the creditworthiness of the pool and lowering the cost of
funds. The structure provides four key benefits:
1. Each individual borrower has access to the capital market at a much lower interest rate than it
would otherwise get if it borrowed on its own.
2. Transaction costs are spread among participants, providing a further efficiency
3. Resources once used to fund grants can instead be used to make subsidized loans, spreading the
resources to a larger group of beneficiaries.
4. Bonds used to finance loans can receive higher ratings than those of the underlying borrowers
due to pool diversity and program equity.
India presents a similar opportunity to tap into the growing pension, insurance and provident funds
to fund urban infrastructure. To avail of it, however, certain structural issues need to be addressed
first. To begin with, it has to be realized that debt financing is a more efficient mode of capital
delivery to urban sector projects as it brings an element of discipline. With an obligation to repay,
ULBs are compelled to judiciously plan, design and execute projects that can maximize revenues,
while minimizing O&M costs in a sustained manner throughout the asset life span.
Therefore, GOI needs to proactively develop the municipal bond market.
Having identified the principal players who may have an appetite for such instruments, it may
engage with them to understand their concerns. The recent experience with tax-free pooled bonds,
especially under the Pooled Finance Development Fund (PFDF) Scheme, should be closely studied to
address market concerns and the concept modified so as to attract more investors.
A schematic diagram of the pooled bond structure as exists at present is given below:

However the scheme must be open to taxable bonds, without any cap on the coupon rate, in line
with market expectations. Others include declaring such bonds as either SLR equivalent paper or
qualifying under priority sector norms in order to encourage banks to participate. There are certain
other suggestions relating to taxation and interest subvention that also require to be looked into.
Accessing External Financing A Possible Approach

1. The core idea is to create a Fund structure where GOI and State funds under JNNURM are
used as a combination of equity and junior debt to leverage and access funds from the
capital market, rather than be deployed as grants into the ULB projects.
2. The focus here is to use GOI/State funds to create a vehicle for raising external resources to
meet the financing gaps for ULB projects in a sustainable manner.
3.

A key benefit in creating such a vehicle will be to ensure that public resources are more
effectively used for creating urban infrastructure

within the country, besides

the

establishment of financial intermediaries that encourage the injection of external capital to

finance urban infrastructure.
4. The proposed approach would complement JNNURM by building on the initial experience of
the Pooled Finance Development Scheme of MoUD and deepen the Municipal Bond market
in India.
5. While, in the past, Municipal Bond schemes have tended to focus on providing a tax-free
status, experience in Tamil Nadu and elsewhere shows that it may be useful to instead
provide flexibility of raising resources instead through taxable bonds with no cap on coupon
rate.
6.

However, in order to limit the interest burden on ULBs, it is proposed to reduce the
effective cost of financing even with the relatively higher cost of the external financing
component, by providing interest subvention.

7. Under the proposed structure, the SPFE (an SPV) would float taxable (or tax-free, as the
need may be) pooled bonds to raise the counterpart funding for a pool of ULB projects being
found eligible for assistance under JNNURM.
8. Each issue of bonds would be collateralized by a suitable Debt Service Reserve Fund (DSRF)
as determined by the rating agency so as to target a minimum rating, say AA. Such DSRF
may be provided by the GOI/State as equity to the SPV. The interest earning on the DSRF
corpus could be used to provide interest subvention on the ULB loan from the SPV that
would be raising external debt at market rate through the bond issue.
9. Since the tenor of the pooled municipal bond would be decided based on marketability,
typically in the range of 5-10 years, or with put/call option at suitable interval, whereas loans
to ULBs may be necessarily of longer duration, say 7-20 years, asset-liability mismatch would
have to be handled by the SPV either through its internal resources, including equity, or
through securitization of its assets.
10. For the purpose of building the pooled municipal bond market, the GOI/State could
underwrite the initial few bond issues till the SPV establishes itself or the market matures.

Alternatively, in the beginning, issues could have a senior debt (bond proceeds) and junior
debt (GOI/State contribution), in order to provide greater comfort to investors.
11. Bond issue proceeds would be on-lent to the ULBs participating in the pool at concessional
terms, including soft rate of interest (through interest subvention using the earnings of the
DSRF) and long tenor. Alternatively, the SPFE could in turn utilize the proceeds to subscribe
to bonds issued by such ULBs.
12. Repayments by ULBs would be routed through an escrow account and in case of default, this
would trigger an appropriate release from the DSRF to ensure timely payment to
bondholders. Erosion of DSRF would be replenished by suitable intercept by the SPFE of the
releases of the State Finance Commission devolution grants.

In case these credit

enhancement measures do not suffice, third party guarantee by the State Government,
could be resorted to.
13. The SPV at the state level may be created jointly by GOI, State and select financial
institutions such as IIFCL and IDFC that are mandated to invest in urban infrastructure. The
SPV would be managed on behalf of the stakeholders by a financial intermediary, which
may be in the nature of a PPP with GOI/State holding not more than 49% equity so as to give
it a private fund manager status, which would enable it to attract talent from the market.
14. The SPV could float a dedicated issue for a group of ULBs in a state, pooling together their
requirements for identified projects. These could either be developed projects awaiting
financial closure or projects already pre-financed by other entities during the construction
phase.
15. The SPV can kick start a consistent and a regular stream of issues to raise capital periodically
and such issuance can follow appraisal of existing / proposed shelf of projects including an
analysis of project viability and debt servicing / financial strength of the sponsoring ULBs.
As repayments from earlier bond issues start coming back from ULBs and bond instalments
are paid, the equivalent portion of DSRF could be freed up, and go towards strengthening
the next bond issue. This would further collateralize the pooled bonds and improve the
issue and the SPFEs rating and consequently reduce the cost of borrowing from the market.
At some point of time, the SPFE may become sufficiently capitalized so that GOI/State may
not need to provide any support, except targeted capital grants for hardship communities.
16. A range of project pooling, structuring and payment security options, such as those
suggested above, need to be examined and developed to manage and mitigate risks and
meet debt servicing and rating expectations of potential investors for such issuances.

17. Needless to say, this would also require the financial intermediary (SPV) to have project
structuring and appraisal skills as well as capabilities in financing and raising funds from
capital markets.
However, pooled financing offers certain challenges, as enumerated below:

Need for legislative sanction in order to give statutory footing to SPFEs, on the lines of SRFs
in the United States would be necessary. Similarly, environmental legislation on the lines of
the Clean Water Act and the Safe Drinking Water Act would compel ULBs to hasten the
creation of water and sanitation infrastructure, which would provide the right impetus to
the pooled bond mechanism by unleashing demand for funds.

Development of a sound programme structure for the pooled financing mechanism, which
would address issues such as whether the SPFE would sub loan to ULBs or subscribe to the
latters bonds; whether the GOI/State contribution would be the equity piece for the DSRF
or would constitute junior debt, etc.

Implementation tools need to be developed, which would include toolkits and standardized
documents for bond issues, loan agreements, project covenants, project monitoring and so
on.

Capacity building at National, State and ULB level, so that implementation agencies are
equipped to handle the transition to such new forms of market financing.

The rich

experience of entities in the US, notably the SRFs, bond banks, underwriters and rating
agencies, could be tapped in the initial phase.

Education of all stakeholders, such as investors, underwriters, rating agencies, lawyers, etc.
about the pooled financing mechanism as it is a nascent market; this could take the form of
conferences, newsletters and publicity material.

Support, especially at the policy level, for establishing SPFEs in States (something that has
not yet materialized, except in a couple States) and rolling out the pooled bond programme.

Loan tracking system and customer service support will be crucial to the sustenance of the
model.

A separate Grant Fund to be set up to handle hardship grants / viability gap funding and to
be administered at the SPFE level on rational principles.

Project Development is critical to any such programme and for this, investments by the SPFE
through a dedicated Fund may be required.

Innovative instruments like bridge financing (to insulate investors from construction risk)
and take out financing (to handle asset liability mismatch) may have to be explored.

Sustaining Debt Unlocking Land Value

The most critical but neglected area in the urban finance sector is the debt sustainability of ULBs.
Given the limitations in exploiting traditional revenue modes such as taxes, fees and tariffs, if ULBs
are to cumulatively absorb on an average Rs.1 lakh crore every year, most of it in the form of debt,
and if there are serious impediments in structuring successful PPPs in infrastructure creation and
service delivery (as has been the experience so far), then we need to look at other options to
generate revenue, such as by unlocking the value of land.
Since most ULBs have very limited commercially exploitable lands, and since sale of family silver is
not a sustainable proposition, a more feasible way of appropriating
value resulting from better infrastructure and service delivery is by imposition of betterment levy on
lands situated in areas that benefit out of investments in urban infrastructure. This has to be made a
pre-condition for accessing GOI assistance and can become part of the mandatory JNNURM reform
agenda.
Such betterment levy may ideally be linked to the area guideline value / circle rate and guided by the
capital cost of the optimal infrastructure and the economically feasible maximum tax rate. Such levy
may be, for obvious reasons, deducted from capital gains calculations. It may be collected as a onetime recoupment by the ULB at the time of seeking planning permission by the owner of the land.
Additionally, it may have a recurring component (say 2% of the one-time betterment levy)
collectable every year for maintaining the assets created from all occupiers of the lands that benefit
from the creation of infrastructure in the area.
The other way of unlocking the intrinsic value of land is to apply the tools of town planning, on the
lines of the Gujarat Town Planning Schemes. Typically zonal Detailed Development Plans (DDP)
should follow the Master Plan of any city. The DDP is basically a land use zoning plan on a micro
level, which also spells out the infrastructure requirements that need to be planned

for.

Unfortunately the City Development Plans (CDPs) that are currently being prepared by cities, with
the help of consultants, as a pre-condition for accessing finance under JNNURM are

largely

investment plans that do not explore the possibility of raising revenues from land through re-zoning
or re-development.

Microfinance
When developing city-wide infrastructure, one cannot simply assume that the whole city benefits.
Many times technical designs only provide infrastructure upgrades for households that already have
access to services. Other times, infrastructure expansion only includes main or secondary lines, but
not distribution networks within neighborhoods. This is fine for new housing developments for
middle- and high-income residents or government projects where the builders pay for the
distribution networks, but it is problematic for retrofitting older neighborhoods and servicing the
poor. Currently, 33% of Indias urban population lives in slums, and India has more slum dwellers
than any other country in the world. Cities can no longer pursue urban development, infrastructure
improvements, or economic growth without also including slums. To do so would ignore a third of
the cities population.
Urban slums grow because Indian cities attract all types of people aspiring to take advantage of new
economic opportunities. However, the growth of infrastructure and housing has failed to keep up
with population growth. With an inadequate supply of acceptable quality, affordable housing and
land, people live in miserable conditions without basic services or secure tenure.
There is a common belief that slum dwellers cannot afford to pay for proper infrastructure services.
However, successful pilot projects around the country have contradicted this belief. In Dewas,
Madhya Pradesh and Thane, Maharashtra, for example, the FIRE (D) Program focused on orienting
city-wide projects to extend networks into the slums. Infrastructure extension into slums is a
marginal increase to the cost of a large capital project, and paying for it can be financed like any
other part of a network improvement. In Bhubaneswar, Orissa, the FIRE (D) Program is
demonstrating that household access to water and sanitation services can be expanded within
slums, partially using a microfinance model. In the Gyannagar slum of Bhubaneswar, the FIRE (D)
Program introduced microfinance and attained full sanitation coverage, with 95% of the households
opting for household water connections and toilets. Encouraging households to invest in on-plot
work and legal connections helps ensure long-term sustainability of infrastructure systems because
slum dwellers become regular paying customers.
slums develop without the provision of infrastructure within the neighborhood. Slums frequently
develop on land that is not formally part of the city and its service delivery area. As a result, there is
no formal mechanism to expand infrastructure to these areas. This situation is complicated by the
fact that slum households have difficulty paying for high utility connection fees as well as for the

necessary costs of pipes, taps, meters, and other household-level items. Most also lack the formal
documentation that many utilities require for household connections.
From an affordability perspective, slum dwellers have difficulty paying the full cost of extending the
distribution network into their neighborhood. However, microfinance has enabled slum dwellers to
pay modest connection fees for a house connection with home improvement loans. Slum dwellers
are often willing to invest in on-plot work, since the household directly benefits from improved
services and appreciated property value. Ankuram Sangamam Porum (ASP), a microfinance
institution (MFI) in Andhra Pradesh, conducted a survey in 2004 that showed that 79% of households
were interested in home improvement loans, and 18% of the MFIs borrowers reporting that they
used part of their business loans for housing anyway.
Microfinance for Household Water Connections and Toilets
Most households in the pilot did not have enough money saved to cover the full toilet costs upfront, and therefore opted for MFI financing. For the most part, Bharat Integrated Social Welfare
Agency (BISWA), the MFI, wanted the pilot to fit its typical loan parameters. The loan carried 20%
annual interest, repaid monthly in 24 constant installments. Closing costs included 2.5% of the
principal for loan processing, Rs. 15 (US$0.33) for bonding any group loans, and Rs. 120 (US$2.60) for
stationary costs of the documents. These closing costs were financed as part of the loan.
Mandatory savings of Rs. 50 (US$1.10) per month, prior to and during the course of the loan, served
as loan collateral. Low-cost life and health insurance for each household also served as collateral and
became mandatory parts of the pilot project.
Each borrower had to be a member of a community self-help group (SHG) through which s/he
deposited his/her monthly savings in a non-interest-bearing bank account. Except for emergencies,
SHG members did not have access to the savings until after their loan repayment. With these loan
terms (which comply with Reserve Bank of India [RBI] rules and are competitive relative to other
MFIs in India), the average monthly costs for each typical option .
Home improvement lending in urban areas became a new market for the local MFI. It had lent for
toilet construction in rural areas, but primarily for pit latrines under the Government of India
Community Led Toilet Scheme. MSDF facilitated the MFIs entry into this new sector by paying for
planning and community mobilization costs. The FIRE (D) Program helped develop the right pilot
design, focusing on household affordability: the combined analysis of (1) borrower capacity to pay,
(2) borrower willingness to pay, (3) lending terms, and (4) cost of home improvements.

In addition to loan repayment (associated with each construction option listed above), households
have to pay several other ongoing costs. At the minimum, households have to be able to
comfortably
afford the water and sewer tariffs to use the services. The project team incorporated these ongoing
costs into the affordability analysis to help determine the borrowing capacity for each household
Households have to be able to afford these ongoing expenditures to participate in the project. It
would not be sustainable to build a toilet or provide a water connection if the beneficiary could not
pay the monthly water and sewer tariffs.
Together, the water and sewer tariffs, insurance, and mandatory monthly savings for loan collateral
is Rs.155/month (US$3.50). Although this appears small, the amount is in excess of all routine
household expenditures prior to this project, as well as the new loan.
Affordability Strategies
It is essential that the monthly payment capacity of each household matches the microfinancing
terms of the desired water/sanitation option. Affordability analysis is a fundamental part of
reviewing the credit risk of each household. The analysis partially stems from household surveys and
partly from discussions with the SHGs to understand how much financing they are comfortable with.
The primary parameters include:

Household income and types of jobs

Use of loan (whether it will increase household income or decrease monthly expenditures)

Current savings and expenditures patterns

Terms of loan product offered by the MFI

Individual versus group loan structure (whether the SHG shares the liability jointly for all
member loans)

If a household desires a particular option but cannot afford it, then an alternative strategy needs to
be implemented. In the pilot project, more than one household could share a single
connection/toilet, or a household could join a livelihood enhancement program (operated by the
MFI and the citys Slum Improvement Office) to help boost income before taking a loan. For the
poorest households in the pilot project, community toilets (operated as a microenterprise) offered
the lowest-cost option for proper sanitation. For small monthly installments of approximately Rs. 30
(US$0.66), households gained access to toilet facilities maintained by one of the community SHGs.
The community toilets are connected to the water and sewer lines and have electricity. Locks
prevent nonmembers from using them. A grant from MSDF paid for building the community toilet. In

the pilot project, most of the households were ultimately able to finance their access to water and
sanitation through micro-loans
The Future of Microfinance for Infrastructure
India has a huge market for water/sanitation microfinance specifically and for home improvement
more generally. The market potential represents 45% of total Asian and African demand, based
on the 2008 survey by the Gates Foundation of 38 countries in those regions.
That portion equals approximately Rs. 270 billion (US$5.4 billion) in loans and 56 million borrowers.
Although the market for water/sanitation microfinance is enormous, serious limitations constrain
the sectors immediate growth.
Relatively few microfinance organizations work in the home improvement sector, of which toilet,
bath, and water tap/piping upgrades are a part. Although several Indian MFIs are entering the
market, only Ahmedabads Self-Employed Womens Association (SEWA) is well established in urban
lending. In fact, unlike other countries, urban lending is underrepresented in Indian microfinance.
The added complexity of urban settings might be one explanation for relatively low market
penetration. Also, the origin of microfinance in India is very rural based. Historically, the primary
driver for microfinance has been the joint liability, savings group model that focuses on womens
empowerment. MFIs have worked with women to form self-help and savings groups, which then
borrow as a single entity. The group shares both asset creation (and benefits of the asset) and the
loan liabilities. This makes sense from the gender and microenterprise perspectives, because MFIs
have focused on improving livelihoods of women. The approach also fits well into RBI regulations
that prevent MFIs from mobilizing deposits and savings
RBI regulations do not permit MFIs to function as depository banks, and they are prohibited from
offering savings accounts to members. Instead, SHGs deposit their savings in other commercial or
state banks. For small-scale lending, savings is the safest form of collateral tying the borrower and
institution together. Saving deposits are also the cheapest way for MFIs (as well as commercial
banks) to raise capital for lending. Without this tool, MFIs in India have to rely on a limited supply of
grants and very expensive commercial capital. In the water/sanitation sector, MFIs have to pay 15%
20% interest for capital from domestic banks, and the debt has to be repaid over short terms. In
addition, domestic banks require significant fixed deposits before lending to MFIs. This really
constrains the size and terms of loans that MFIs can offer its borrowers, it increases the interest
rates that MFIs charge borrowers, and it limits the growth rate of the sector overall.Supplying larger

home improvements loans with longer repayment periods will be difficult for most MFIs in India
right now due to how their own capital is structured.
For this reason, MFIs are reluctant to change their lending models, even though the traditional
model is not completely appropriate for the new sector (i.e., joint liability is not as appropriate for
individual asset creation and ownership).
The Government of Indias lending programs add further complexity. For example, the Interest
Subsidy for the Urban Poor8 provides loans at 5% interest, well below market rates. Unfortunately,
this interest subsidy is designed to flow through state-owned banks that do not work well with lowincome communities. Compared with MFIs, state banks do not have community mobilizers that
work hand-in-hand with slum households in designing interventions and ensuring repayment.
Where MFIs have high (95%+) repayment rates, state banks experience much higher default rates
among the poor. This experience reinforces negative attitudes toward the poor and makes the banks
reluctant to participate.
In this difficult regulatory environment, it is unlikely that MFIs can scale up lending for large slum
upgrading programs. Building on the experience from the Bhubaneswar pilot project, the FIRE (D)
Program has proposed a revolving fund for the poor, which can be established by cities through a
states urban infrastructure fund (UIF) (see Article 6.6). These funds can be used to capitalize MFIs
for specific types of slum improvement lending, thereby increasing MFI capital for water/sanitation
lending and reducing interest rates for the poor.
Unlocking land values
The installation of infrastructure (e.g., roads, water, sewer, and electricity) increases the value of the
land in the vicinity of the infrastructure investment. Unused land owned by local governments or
state government has a market value that can be put to use to accomplish development objectives
highlighted in a city development plan (CDP). Converting land values into resources needed to pay
for infrastructure is an important alternative to using debt financing and is being used in rapidly
growing cities like Bangalore, Mumbai, and Pune.
There are a number of different ways to convert land values into infrastructure investment.

Betterment levies are a one-time tax on the increased value of private land that benefit from
service improvements as a result of public infrastructure investment.

Developer land sales recover the cost of infrastructure installed by the developer (public or
private) by adding those costs to the price of the land offered for sale.

Sale of public land adjacent to an infrastructure project enables the government to capture
the increase in land value resulting from a project.

Sale of development rights is a way for government to raise money for infrastructure by
selling developers the permission to develop their private property to a higher level than
would otherwise be allowed due to zoning or building regulations.

Developer extractions or impact fees are mechanisms to directly shift the cost of
infrastructure from the government to the private sector developer whose project stands to
benefit from a public investment.

Sale of underutilized public land is a way for government to convert underutilized or unused
land assets into cash for investment in infrastructure.

Betterment levies
Betterment levies are an easily understood means of taxing the financial gains of property owners
who benefit from the installation of infrastructure, though they have proven difficult to implement
in most developing countries. The value of a property in an area that is deemed to have benefitted
from infrastructure improvements is assessed and compared with the assessed value of the same
property before the introduction of the improvements. The increase in value is then subject to a
one-time betterment levy at a fixed rate (as much as 50%60% in some cities). The tax revenue is
then used to pay off the financing that was initially used to fund the infrastructure. This has the
advantage of providing a means of taxing existing properties that benefit from infrastructure
improvements (rather than just new properties as in the case of developer extractions and impact
fees). However, betterment levies are complex to administer and require carefully maintained and
frequently reassessed property value registers. It also requires significant consensus building among
the public at large, so that they realize the link between the betterment levies and improved
infrastructure (connection charges can partially capture new investments if designed correctly). For
this reason, only a few developing cities have chosen to employ betterment levies significantly (e.g.,
the Ahmedabad town planning scheme).
Developer land sales.
Another simple way to use land to finance infrastructure is for a property developer (government or
private) to add the cost of the infrastructure to the price of the land or buildings sold. Commercial or
residential property development projects that are destined for sale to the public can be required to
provide the local government with all necessary onsite infrastructure as a condition for permitting
their construction. That way, the developer will build the cost of the onsite infrastructure into the
price of the property sold at the end of its project, and the local government will acquire completed

infrastructure without having to finance it. If the property development project is large enough, the
required onsite infrastructure may include schools, clinics, and police/fire stations in addition to
roads, water, sewer, electricity, and telecom.

Sale of public land adjacent to an infrastructure project

A variant on the sale of government land involves the sale of excess land that the state or local
government acquired to implement a specific infrastructure project. For example, there may be
excess government-acquired land available along the right-of-way of new roads or adjacent to a
public transportation terminal or a bus/rail transit station.
The land is acquired in order to build the infrastructure improvement, but after construction, not all
of the acquired land is needed for operation of the infrastructure/service. The land adjacent to the
infrastructure improvement will have increased substantially in value compared to its market value
at the time it was acquired by the state or local government for the project. Depending on the
amount of excess land owned by the state or local government and the per unit increase in value, a
public sale or development of the excess land may bring in enough money to pay for the entire
infrastructure improvement project. This mechanism was considered for use in Bangalore, where
excess land owned by the state government adjacent to the newly developed airport could have
been sold at market rates to generate enough capital to build a new access road from the city to the
airport. And it has been used very successfully in Delhi to fund a portion of the new metro rail. This
mechanism has the advantage of linking the proceeds from land sale to a specific infrastructure
project so that the chances of the funds being diverted are minimized. Its disadvantage is that it
does not generate funding in advance of project implementation, so other funding (usually debt
financing) has to be mobilized to acquire enough land and build the infrastructure before benefiting
from land sales.
Sale of development rights
A more complex approach to capturing land value for development of infrastructure is to sell
development rights. Where development controls, such as the floor area ratio (FAR) or restrictive
zoning, are enforced by local governments or state government, the opportunity exists for
permitting developers in a specific area to exceed established restrictions in return for a payment
that is used to finance infrastructure in the area. This is the approach being used to mobilize funding
for the redevelopment of Dharavi slum in Mumbai, as well as redevelopment projects in other Indian
cities. Dharavi landowners pay a substantial fee to the Mumbai Metropolitan Redevelopment

Authority (MMRDA) in return for permission to build high-rise buildings that would not normally
conform to the FAR. MMRDA (and the developers themselves) use the funds derived from the sale
of development rights to construct infrastructure in Dharavi at a level that will accommodate the
projected demand from the increased development. The private developers have to calculate
whether they can recoup the large fee paid to MMRDA from the sale or lease of the additional floor
area they are allowed to develop.
In other cities like Pune, development rights are made transferable so that the owner of land in an
area designated for infrastructure improvements can buy development rights based on his land
holding in that area, but use or sell the development rights to increase the intensity of development
on a different land holding elsewhere in the city (often only in designated development areas where
authorities are able to accommodate higher levels of development). While this can be an effective
way to mobilize substantial amounts of capital for infrastructure, it requires detailed and up-to-date
knowledge of land markets and land values by a local government, a state government, or other
authorities. It also requires a sophisticated monitoring system in cases where developers agree to
build the improved infrastructure (e.g., low-income housing) to ensure that the targeted
beneficiaries actually receive the agreed-upon benefit
Sales of development rights can be used strategically by local governments during periods of rapid
growth. But the mechanism should only be considered a temporary way to advance development
objectives. Over the long term, overly restrictive zoning laws prevent private sector development in
cities (i.e., development that responds to market demand). In the face of rapid growth, the
government needs to find all ways possible to facilitate quality construction. By restricting formal
development, builders consequently resort to illegal and haphazard construction, which is difficult to
guard against after the fact.
Developer extractions or impactfees. However, a property development project also increases the
burden on infrastructure beyond the boundaries of the project itself (e.g., the supply of water to the
neighborhood under construction). To pass on the cost of the necessary offsite infrastructure
improvements to the project beneficiaries, the developer can be charged an extraction or impact fee
as a one-time charge based on the cost of the infrastructure improvements necessitated by its
project. The developer then builds this cost into its property sales price. All of these mechanisms
have the effect of shifting the cost of infrastructure improvement from the state or local
government to the property developer, and creating a strong linkage between the beneficiaries of
the infrastructure improvements and the people who pay for it. However, these types of

infrastructure financing can be complex to administer and can lead to special deals and other
corrupt practices unless they are managed in a highly transparent manner.
Sale of underutilized public land
The most straightforward way to convert land value to funding for infrastructure is to sell
government land. A local or state government may already own underutilized properties, which,
because of their location, have a significant value to private developers. To determine if this is the
case, the local or state government first needs to identify all of its land holdings (including land with
buildings) and how each of the land parcels is being used.
Next, the list of land holdings needs to be analyzed to determine if particular parcels are
underutilized or no longer essential to the government. These parcels should then be examined to
estimate their potential value if offered in the market. The FIRE (D) Program assisted Indore
Municipal Corporation in carrying out this asset identification and valuation work with a real estate
agency, as part of its broader resource mobilization effort. If the appropriate officials in the local or
state government approve the sale of specific parcels, they can then be offered to the market in
some form of competitive sale. The proceeds of the sale should be placed in a special account
(preferably an escrow account) dedicated to funding infrastructure improvements. This mechanism
has the advantage of providing funding for infrastructure projects without the government going
into debt. Its disadvantage is that the funding is not necessarily closely linked to a specific
infrastructure project, and there is always the temptation for cash-short governments to use the
funds to support the annual operating budget rather than capital investment in infrastructure. This
would be a mistake because the sale of land and other assets is limited to what government owns,
and therefore should be considered as one of the main financing tool