Exploring the Financial Resources of Local Bodies in India

Local bodies in India sit at the frontline of everyday governance. They light our streets, collect our waste, maintain our drains, run primary schools, and build the rural roads that connect villages to markets. Yet for all this responsibility, most Panchayats and Municipalities operate on shoestring budgets. Understanding where their money comes from, why the flow is often inadequate, and what reforms can help is essential to grasping why decentralisation in India still feels like a half-finished project.

Why the financial health of local bodies matters 🔗

The 73rd and 74th Constitutional Amendments of 1992 gave Panchayats and Municipalities constitutional status and assigned them a wide range of functions. But functions without funds are a recipe for failure. When a Gram Panchayat cannot afford to repair a hand pump, or a Municipality cannot clear its drains before the monsoon, citizens lose faith in the very institutions that are supposed to be closest to them.

The scale of the mismatch is striking. Analysis based on RBI data shows that Municipal Corporations generate only about 0.6% of GDP in revenue, compared with 14.6% by State governments and 9.2% by the Centre. Financial transfers to municipal governments are pegged at just 0.45% of GDP, far below countries like Brazil, Indonesia and the Philippines where similar transfers range from 1.6% to 5.4% of GDP. This gap explains why essential services remain patchy even in our biggest cities.

The constitutional foundation: Article 243-H and beyond 🔗

The financial architecture of rural local bodies rests on a cluster of constitutional provisions. Article 243H authorises State Legislatures to empower Panchayats to levy, collect and appropriate taxes, duties, tolls and fees; to assign them certain state-collected taxes; to provide grants-in-aid from the Consolidated Fund of the State; and to create Panchayat funds for crediting money received.

For Urban Local Bodies, Article 243-X performs a parallel function. Together with Article 243-I (establishing State Finance Commissions) and Article 280(3)(bb) (which directs the Central Finance Commission to recommend measures to augment state resources for local bodies), these provisions form the backbone of fiscal decentralisation in the country.

The reality, however, is more complicated. The Constitution empowers States to devolve financial powers, but it does not compel a specific level of devolution. Legal commentaries on Article 243H note that although it provides for financial empowerment, its realisation varies widely across states, with challenges such as limited tax bases in rural areas, heavy dependence on grants, delays in fund transfers, and weak financial management expertise.

Why the design feels incomplete 🔗

The framers of the 73rd Amendment left the actual devolution of taxation powers to State Legislatures. This was meant to respect federalism, but in practice it has produced uneven outcomes. Some states have genuinely empowered their Panchayats, while others have retained tight control over purse strings. The result is a patchwork where local autonomy depends heavily on the political will of the state government of the day.

The four pillars of local body finances 🔗

Revenue for local bodies in India flows through four broad channels. Each pillar has its own strengths and weaknesses, and the balance between them shapes the financial health of the institution.

Tax revenue 🔗

Taxes are the most autonomous source of revenue because they are collected directly by the local body. The most important among these is the property tax, often described as the workhorse of urban finance. Other tax sources include taxes on professions, trades, vehicles, advertisements, and entertainment, though these vary by state. Data from the RBI Report on Municipal Finances (2024) indicates that property tax contributes more than 16% of total revenue and over 60% of own tax revenue of Municipal Corporations. Yet the contribution of property tax to India’s GDP stands at just 0.15%, compared to 1.7% in advanced economies.

Non-tax revenue 🔗

This includes user charges for services like water supply, sewerage, solid waste management, rentals from municipal property, fees for trade licenses, building plan approvals, and parking. User charges are economically efficient because they link payment to service, but political resistance and weak billing systems keep collections far below potential.

Grants-in-aid 🔗

Grants come from both the State and Central governments and are often the single largest source of funds, particularly for smaller local bodies. The Fifteenth Finance Commission allocated Rs. 2,36,805 crore for the period FY 2021-26 to Panchayats across all three tiers, Traditional Local Bodies and Sixth Schedule areas in 28 States. These grants are split into Tied Grants, which must be used for drinking water, rainwater harvesting, water recycling and sanitation, and Untied Grants, which can be used for felt needs under the 29 subjects in the Eleventh Schedule, except for salaries and other establishment costs.

Borrowings 🔗

For larger infrastructure projects, local bodies can raise debt through bank loans, loans from specialised institutions like HUDCO, or municipal bonds. Borrowing is a relatively new frontier for most Indian municipalities, and while it holds enormous promise, uptake remains uneven.

The property tax puzzle 🔗

Property tax ought to be the reliable bedrock of local finance. It is rooted in an immovable base, difficult to evade, and grows naturally with urbanisation. Yet Indian cities consistently underperform. A World Bank study on property taxation in India identifies four interlinked reasons for the low yield: undervaluation of properties, incomplete property registers, policy inadequacy, and weak administration. The Second Administrative Reforms Commission had estimated that only about 60-70% of properties actually appear on municipal rolls.

Per capita property tax collections vary wildly across states. Figures for 2017-18 ranged from about Rs. 63 in Bihar to Rs. 1,911 in Gujarat. Metros like Delhi continue to grapple with exemptions for central government properties, unauthorised colonies outside the tax net, and weak collection machinery.

Reform pathways 🔗

There is, however, a clear template for reform. Bangalore’s move to the Unit Area Method of valuation, combined with self-assessment and digital systems, significantly increased both the number of assessed properties and revenue. GIS-based mapping, digital door numbering, online payment portals, and linkage of property records with utility databases have helped several cities expand their rolls. Recent reporting shows that while digital portals and reforms are pushing collections forward, systemic weaknesses in compliance and political hesitation continue to hold back revenue growth.

User fees and the resistance problem 🔗

Charging for services is one of the simplest ways to raise revenue while also curbing wasteful use. Water tariffs, sewerage charges and solid waste management fees can cover a substantial part of operational costs. Yet most Indian local bodies recover only a fraction of their service costs. The resistance is partly political, as elected representatives are reluctant to raise tariffs, and partly administrative, as billing is inaccurate and collection weak. Reports point to states like Maharashtra, Gujarat, Rajasthan and Tripura that have experimented with better-structured user charges as examples worth learning from.

The role of State Finance Commissions 🔗

Article 243-I requires every state to set up a State Finance Commission (SFC) every five years to review the financial position of Panchayats and Municipalities and to recommend principles for the distribution of state taxes, grants-in-aid, and measures to improve their fiscal health. The SFC is meant to be the bridge between state resources and local needs, ensuring predictable and equitable transfers.

In practice, SFCs have had a mixed record. Many states have delayed their constitution, failed to act on their recommendations, or treated them as advisory at best. Strengthening SFCs, ensuring timely constitution, providing them with adequate research capacity, and making implementation of their recommendations binding through state legislation, could transform the financial landscape of local bodies.

Exploring market borrowings and municipal bonds 🔗

For ambitious infrastructure projects, grants and taxes alone cannot meet the bill. This is where market borrowings come in. Bangalore Municipal Corporation issued India’s first municipal bond in 1997, followed by Ahmedabad in 1998, and then a long gap before cities like Pune, Indore, Hyderabad, Lucknow and Ghaziabad re-entered the market after 2015.

The regulatory framework received a boost with SEBI’s Issue and Listing of Municipal Debt Securities Regulations, 2015. Under AMRUT, the central government offered incentives of up to Rs. 13 crore for every Rs. 100 crore raised through bonds in the first phase. Ghaziabad’s Rs. 150 crore green municipal bond in 2021 to fund a tertiary sewage treatment plant opened a new sustainability-focused chapter.

Yet the scale remains modest. As of April 2025, there were only 18 outstanding municipal bonds issued by 13 ULBs, with total SEBI-regulated issuances between 2017 and 2025 amounting to just Rs. 2,833.90 crore. Total ULB borrowings from financial institutions stood at around Rs. 3,364 crore as per the RBI’s November 2024 report, less than 0.05% of GDP. The Union Budget 2025-26 has proposed an Urban Challenge Fund of Rs. 1 lakh crore, under which cities will need to raise at least 50% of project costs through municipal bonds, bank borrowings or PPPs. This is designed to nudge ULBs towards self-reliance.

Why most cities cannot borrow 🔗

Market access requires investment-grade credit ratings, audited accrual-based accounts, and predictable revenue streams. Most small and medium-sized ULBs lack all three. Of the 223 cities rated by agencies like CRISIL by 2021, only 95 received investment grade ratings. Bond issuance has remained concentrated in a handful of financially strong cities like Pune, Ahmedabad and Indore, while weaker cities remain locked out.

Structural reforms on the horizon 🔗

A credible reform agenda for local body finances would rest on several pillars. Rationalising property tax through accurate valuation, periodic revision of rates, GIS-based mapping, and digital payment systems is the first priority. Improving user fee collection through transparent billing, tiered tariffs and performance-linked contracts for service delivery would address the non-tax side. Strengthening State Finance Commissions, making their recommendations binding, and ensuring timely devolution are critical on the transfers side.

On borrowings, shifting from cash-based to accrual-based double-entry accounting, pooled financing arrangements for smaller cities, credit enhancement mechanisms, and tax exemptions for retail investors in municipal bonds can expand the market. Equally important is capacity building, as many local bodies simply lack officers trained in modern municipal finance, project appraisal and contract management.

The road ahead 🔗

Strengthening the financial base of local bodies is not just a technical matter. It is a political choice about how much trust we are willing to place in grassroots institutions. States that have walked the talk on devolution have seen better service delivery, stronger civic engagement, and more accountable governance. Those that have held back have ended up with weakened Panchayats and Municipalities that struggle to deliver even basic services.

The broader lesson is that constitutional design alone is not enough. Article 243-H gave Panchayats the potential for financial empowerment; Article 243-X did the same for Municipalities. Turning that potential into reality requires sustained effort on multiple fronts, from tax administration and user charges to transparent accounts and market borrowings. The cost of inaction is visible in every overflowing drain, every unlit street, and every unpaved village road.

What do you think? Should states be constitutionally compelled to devolve a minimum share of their revenues to local bodies, or is such rigidity at odds with the spirit of Indian federalism? And if smaller local bodies cannot realistically tap bond markets, what alternative models of sustainable self-financing could work for them?

References

1. https://competitiveness.in/municipal-fiscal-reforms-crucial-for-addressing-urban-governance-challengesmoving-beyond-dependence/
2. https://www.pib.gov.in/PressReleaseIframePage.aspx?PRID=1911562
3. https://www.gktoday.in/article-243h/
4. https://www.etvbharat.com/en/!opinion/making-the-property-tax-work-in-indian-cities-enn24120703100
5. https://openknowledge.worldbank.org/server/api/core/bitstreams/c5df42d0-1f82-54b3-b856-fb90511016f2/content
6. https://www.business-standard.com/finance/news/why-india-s-cities-can-t-crack-property-tax-even-after-digital-push-125120900894_1.html
7. https://theiashub.com/free-resources/mains-marks-booster/state-finance-commission-in-india
8. https://vajiramandravi.com/current-affairs/municipal-bonds-in-india/
9. https://www.nism.ac.in/urban-infrastructure-financing-in-india-challenges-and-solutions-for-a-deeper-municipal-bond-market