Strengthening Financial Resources for Urban Local Bodies: Key Reforms and Strategies

Urban Local Bodies (ULBs) are the backbone of city governance, responsible for everything from clean water and sanitation to roads, street lighting, and solid waste management. Yet most of them run on shoestring budgets, unable to match the scale of services their growing cities demand. With over half of municipal corporations generating less than half their revenue independently, the need for deep financial reform is no longer a matter of debate, it is a fiscal emergency. Strengthening ULB finances requires a coordinated push across tax revenues, user charges, intergovernmental transfers, land monetisation, and access to debt capital.

Why municipal finances need urgent strengthening 🔗

Indian cities contribute a major share of national output but operate on a disproportionately small financial base. Cities account for roughly 67 percent of GDP and 90 percent of government revenue, yet municipal revenues have stagnated at around 1 percent of GDP for over two decades. Compare this with Brazil, where ULB revenues hover around 7 percent of GDP, and the funding gap becomes obvious. This mismatch starves cities of the capital they need to fund water supply networks, public transport, drainage, affordable housing, and climate-resilient infrastructure.

The problem is structural. The 74th Constitutional Amendment recognised ULBs as the third tier of governance but did not provide them with a dedicated finance list. As a result, the revenue powers of municipalities continue to be determined by state governments, and the base of local taxes remains limited and inflexible. Reforms, therefore, must attack this on multiple fronts simultaneously.

Boosting own tax revenues 🔗

Own-source tax revenues are the most important pillar of municipal financial independence. When a city relies largely on its own taxes, it gains both fiscal autonomy and the political accountability that comes from asking citizens directly for funds. Property tax is by far the most significant of these.

Revising property tax regularly 🔗

Property tax reform is the single biggest lever available. Property tax collection in India remains dismally low, with some estimates pegging it at just around 0.15 percent of GDP, far below global benchmarks. Reasons include outdated valuation methods based on Annual Rental Value, incomplete tax rolls, generous exemptions, and weak political will to revise rates. Property tax is an important source of own revenues for ULBs, capturing a share of the unearned increase in property values that occurs when municipalities invest in infrastructure. Yet without periodic revisions of guideline values and rates, cities effectively give this wealth away.

Municipalities need automatic, formula-based revisions linked to property price indices, along with a move from ARV-based taxation to capital value-based systems. Equally important is bringing all taxable properties into the net. Vacant land, often held speculatively, is grossly under-taxed in Indian cities despite the fact that in many Latin American countries, vacant land is taxed at rates higher than built-up property to discourage speculation.

Improving collection systems 🔗

Raising rates is pointless without collection. Here, technology has become a game-changer. Digital door numbering, GIS mapping, and computerised billing have shown spectacular results where implemented. Select Indian cities have quadrupled property tax revenue within a few years by combining regulatory reform, geo-referenced digital property maps, and IT-based tax administration. Andhra Pradesh’s experience with digital door numbering alone produced a 25 percent increase in property tax coverage and a 30 percent jump in collection efficiency. A state-level Municipal Revenue Board that handles back-office valuation and administration for smaller ULBs can further professionalise the system without overwhelming tiny municipalities.

Increasing non-tax revenues through realistic user charges 🔗

Non-tax revenue, primarily user charges for water, sewerage, solid waste, parking, and market fees, is the second major lever. The fundamental problem is that cost recovery on urban utility projects in India is very low compared to other large middle-income countries, with municipal revenue stuck at 1 percent of GDP since 2002. Water tariffs rarely cover even the operation and maintenance costs of supply, let alone capital costs.

Reform requires a two-step approach. First, user charges must be rationalised so that they reflect the actual cost of service delivery, with telescopic tariff structures that protect the poor while charging commercial and high-consumption users appropriately. Second, billing cycles need to be frequent and collection automated. Universal metering of water connections, digital payment gateways, and linking service disconnection to non-payment are essential. Without genuine price signals, services remain underfunded and wasteful consumption is encouraged.

Reforming state and central transfers 🔗

Even with aggressive own-revenue mobilisation, ULBs will continue to depend on transfers from higher levels of government. The design of these transfers matters enormously.

A more predictable transfer framework 🔗

Finance Commission grants provide the most stable transfer stream. The 16th Finance Commission, chaired by Arvind Panagariya, submitted its report covering 2026-27 to 2030-31 and has proposed enhanced financial support for Urban Local Governments, marking a significant push towards strengthening urban governance. Untied funds allow ULGs to allocate resources according to local priorities rather than being confined to centrally prescribed schemes, while the remaining tied grants focus on essential urban services such as sanitation, solid-waste management, and water. Structural reform requires moving towards a more formula-based, unconditional transfer regime so that cities can plan multi-year capital investments.

Performance-linked and reform-linked grants 🔗

Transfers that reward reform produce measurable change. The 16th FC continues this approach by retaining reform-linked eligibility conditions including timely ULG elections, publication of audited accounts, constitution of State Finance Commissions, and tabling of action-taken reports. Twenty percent of grants are now contingent on meeting revenue targets, particularly growth in own source revenue. Reforms of this kind push ULBs to become credible fiscal institutions rather than passive recipients of grants.

Modernising municipal financial management 🔗

Even well-designed revenues collapse without sound financial management. Most ULBs still use cash-based single-entry accounting, which offers little visibility into long-term liabilities, unfunded pensions, or asset depreciation. To further strengthen India’s urban local bodies in their financial management, the central government developed guidelines for moving to a double entry accrual-based accounting system through the introduction of a National Municipal Accounts Manual.

Key reforms include the full adoption of accrual-based double-entry accounting, timely publication of audited annual accounts, medium-term fiscal planning covering at least three to five years, and dedicated finance cadres staffed by trained chartered accountants and financial analysts. Without these foundations, cities cannot produce the reliable data that credit rating agencies and investors require.

Leveraging land value through monetisation 🔗

Urban land is perhaps the most underused asset on municipal balance sheets. As cities grow, public investment in metro lines, flyovers, parks, and arterial roads causes land values along those corridors to rise sharply. Land value capture (LVC) is the principle that a portion of this unearned increase in value should be recovered by the public body that created it.

Instruments for land-based financing 🔗

Several tools exist to operationalise this principle. Land value capture mechanisms include betterment levies, Transferable Development Rights, Tax Increment Financing, and impact fees, and these have been used in projects such as the redevelopment of Delhi’s Connaught Place, Mumbai’s Dharavi, and Hyderabad’s Old City. A betterment levy is a one-time charge on landowners whose property values rise due to public investment. Transferable Development Rights allow landowners in protected or constrained zones to sell their unused development rights to builders in designated high-density areas, generating revenue without direct public expenditure. Tax Increment Financing earmarks future incremental property tax revenues from a redevelopment zone to service debt raised for the initial infrastructure investment.

Monetising public land holdings 🔗

Many municipalities sit on significant parcels of underutilised public land. Long-term leasing, rather than outright sale, can generate recurring revenue while preserving public ownership. The Chinese experience is instructive, cities there financed much of their urban infrastructure through land leasing after the 1994 fiscal reforms directed 95 percent of such proceeds to local governments. Care must be taken, however, to avoid the pitfalls that critics point out, where short-term fiscal gains from land monetisation often outweigh considerations of long-term public interest such as affordable mobility, environmental sustainability, and heritage conservation. Transparent bidding, public participation, and clear master plans are essential safeguards.

Incentivising revenue mobilisation 🔗

Behavioural incentives matter as much as policy design. The Revenue Mobilisation Incentive Fund (RMIF) is a mechanism that rewards ULBs for improving their own-source revenue performance. Historically, two-thirds of such incentive funds have been recommended for municipal corporations showing more than 15 percent increase and municipalities showing more than 12.5 percent increase in own-source income over the preceding year. This kind of positive reinforcement encourages continuous improvement rather than one-time bursts of reform.

The Government of India’s Urban Reforms Incentive Fund from 2002, though limited in scale, pioneered the idea of reform-linked central grants. The lessons from that experience informed the larger JNNURM programme and, more recently, the Urban Challenge Fund. The Urban Challenge Fund adopts a market-linked approach where central assistance is capped at 25 percent of project costs, while at least 50 percent is expected to be mobilised through municipal bonds, bank loans, and public-private partnerships, ensuring fiscal discipline and long-term sustainability. A well-funded, predictable RMIF at both central and state levels can institutionalise the incentive structure.

Deploying debt capital for infrastructure 🔗

No city in the world has built modern infrastructure purely from current revenues. Long-lived assets like metros, sewerage networks, and trunk water lines need long-term debt financing, matched to the useful life of the asset and the stream of benefits it produces.

Municipal bonds and pooled finance 🔗

Municipal bonds allow cities to raise funds directly from capital markets, giving them access to a far larger pool of resources than grants or loans. The Union Budget for 2023-24 emphasised the need for strengthening urban civic bodies to improve their finances and creditworthiness and help them raise funds through municipal bonds, with incentives for governance reforms for property tax and segregating a portion of user charges on urban infrastructure. Since Pune’s pioneering bond issuance in 2017, several large cities including Ahmedabad, Hyderabad, Indore, and Lucknow have successfully tapped the bond market.

Yet the bond market remains concentrated among a handful of financially strong cities. For smaller municipalities, pooled finance mechanisms, where several ULBs bundle their borrowing requirements to attract institutional investors, offer a realistic route. Credit enhancement through partial guarantees, such as the Credit Repayment Guarantee Sub-Scheme for Tier-II and Tier-III cities, helps bridge the creditworthiness gap.

Dedicated urban infrastructure lending 🔗

Institutional lending windows complement market borrowing. The Urban Infrastructure Development Fund aims to supplement State Government efforts through loans to Tier 2 and Tier 3 cities with populations between 50,000 and 9,99,999, providing a stable and predictable source of financing for urban infrastructure. Such dedicated funds give smaller cities access to long-tenor debt at affordable rates, a crucial missing piece of the urban finance puzzle.

Putting it all together 🔗

No single measure will transform municipal finances. What is needed is a parallel, coordinated effort: regular property tax revisions backed by GIS-based collection systems, realistic user charges, formula-driven and predictable transfers, accrual accounting and medium-term fiscal planning, aggressive land value capture, a well-funded RMIF to incentivise performance, and open access to municipal bonds and pooled debt. Only this combination can shift Indian cities from chronic grant-dependence to a sustainable, investment-ready model of urban governance.

What do you think? Should states move decisively towards formula-based, unconditional transfers to ULBs, or is reform-linked conditionality still necessary to drive performance? And how can smaller cities build the creditworthiness to tap capital markets without being left permanently dependent on grants?

References

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