The Finances ofMunicipalities:An Assessment

Local Government Organization and Finance: Urban India 195

entities have begun to raise resources in the capital market on the strength oftheir own credit standing and credit enhancements based on escrowing ofcash flows indicates a growing acceptance in India ofmunicipal bonds as an instrument for raising resources for financing infrastructure projects. Municipal bonds in India are securitized debt instruments,providing future revenue flows from the project as collateral.

At the heart ofany credit system is a revenue stream that the borrower does not use for day-to-day operations.Borrowing for investment purposes is equivalent to capitalizing an income or revenue stream.The borrower receives funds today to pay for project construction.In return,he or she signs away the right to an annual revenue flow in the future in favor ofthe lender.The more certain and predictable the revenue stream is,the greater is the security for a loan.

The emergence ofa municipal bond market represents an important breakthrough in channeling resources to the urban infrastructure sector. Although municipal bond issuances make up a small fraction ofthe total bond market,the demonstration effect ofthese successful issues is important for the urban sector reform agenda.The experience does not merely relate to developing additional sources offinance for investment in the sector.The very fact that more than 40 municipalities have subjected themselves to credit ratings demonstrates an increasing acceptance ofthe need for independent evaluation and monitoring.Many municipalities have used the credit rating process as an important benchmarking tool to evaluate their performance.This process fosters a competitive spirit among local governments,a positive signal for the urban reform agenda.

The Finances ofMunicipalities: An Assessment

Assessing the performance ofmunicipalities is a complex activity.Municipalities are recognized as the third tier ofgovernment under the constitution,but their functions,powers,and responsibilities and the degree of autonomy that they are permitted to exercise are determined by state governments.As we noted earlier,there are important interstate differences in municipal functions,powers,and responsibilities and in thestate-municipal fiscal relationships.Many municipalities have a larger role in the national and regional economic affairs that affect their revenue base and expenditure patterns.With this framework,we analyze here the performance ofmunicipalities and seek explanations for why municipalities in some states perform differently than those in others.We assume that the performance values reflect the effect ofthe 74th amendment,as well as ofarticle 280(3)(a) and