India: Smart Cities – Project Funding By Multilateral Agencies

Last Updated: 29 September 2016
Article by Soumya Kanti De Mallik

The central government's Smart Cities Mission is an ambitious project, which envisages various city-level projects, in areas such as low-cost housing, renewable energy and public transit. The sheer magnitude and size of the project brings to mind implementation and finance.

The first phase of the mission has been rolled out, with the central government disbursing the first tranche of `1.94 billion (US$29 million) to many selected cities. However, the present financial assistance from the central government, state governments and urban local bodies (ULBs) will aggregate to only a fraction of the total estimated cost.

To bridge this gap, the mission contemplates financing through various sources, including multilateral agencies. Such financing may be easier and cheaper than other funding options. The fact that it works for long-term infrastructure projects is well demonstrated by Delhi Metro, which successfully raised a major portion of its funding through the Japan International Cooperation Agency (JICA). Also, as the Smart Cities Mission is not aimed at developing tier 1 or metropolitan cities, but at financing tier 2 or tier 3 cities, with the probability that these may eventually develop into business cities, banks may see the projects as a risky or not-so-attractive proposition. Considering these factors, financing by multilateral agencies is likely to emerge as a major source of funding.

The World Bank, the Asian Development Bank and Agence Française de Développement have already made financial commitments to the mission. However, executing a facility commitment is only the first step and each project special purpose vehicle (SPV) will still need to satisfy the conditions precedent to drawdown. Strict terms may be imposed on the SPV, ULBs and the state governments, for disbursal of the loan tranches.

Disbursement of loans may be subject to stringent screening processes, diligence and scrutiny. Many projects may not pass the test unless the SPV is able to identify clear project milestones, time lines to achieve those milestones and risk allocation. The risk of milestones not achieved, or of unforeseen eventualities, also raises the necessity of procuring adequate insurance for each phase of the project. Whether this has been ensured has not been made public by the government.

Loans from multilateral agencies come with stipulations as to permitted end-use, and end-use compliance certificates are also required to be provided to the lender, periodically. Hence, use of proceeds will need to be monitored closely. The borrower is also required to strictly comply with anti-corruption norms and managing these adequately will be a Herculean task, in the Indian context.

Smart cities projects are still untested waters, and require long-term financing with greater risk for returns. While the exact details of the financing terms secured from the multilateral agencies mentioned above have not been made publically available, it is likely that financial covenants/guarantees will be required.

In the instance of Delhi Metro, the guarantee for the funding from JICA was provided by the central government. If guarantees are required, the central government may be the only body competent to provide such guarantees. However, to ensure transparency and accountability, the central government should lay down strict guidelines, which SPVs will be required to comply with, in lieu of these guarantees. The entire process should be well structured and not ad hoc.

All multilateral agencies, as part of their standard facility documentation, require detailed environmental impact assessments (EIAs) and also include covenants for compliance with environmental protection norms and standards, throughout the project. While it may be easier to produce a satisfactory EIA at the beginning of a project, continued compliance will be required during implementation. Non-compliance may jeopardize further drawdowns or may even be an event of default under the facility, leading to the facility being recalled. It is about time that projects focus on environmental detail, in addition to technical and commercial aspects.

An understanding of the municipal legal framework, operation of ULBs and state governments, and functioning of the SPV, will help any international agency to appreciate the ground realities, and structure the facility documents accordingly. However, the SPVs also need to tailor their implementation programmes to address funding concerns.

Urban Development Minister Venkaiah Naidu aptly summarized the issue when he said that money from the governments and ULBs will act only as "seed money" for each smart city and cities will have to "be creative in raising the required finance". Thus, he highlighted the fact that smart cities will need a smart approach to financing.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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