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Infra Project Financing: Capitalising on value creation

Urban local bodies can use value capture financing as an infra funding tool by tapping the appreciation in land value resulting from such projects

August 19, 2017 2:31:49 am
urban infrastructure , smart cities mission, Urban Transformation, Infra Project Financing As per the 13th Finance Commission report, ULBs’ own sources of revenue met only half of their total expenditure and a whopping 82 per cent of their revenue expenditure in fiscal 2008.

By Brijgopal Ladda

Lack of adequate municipal revenues is throttling development of urban infrastructure in the country, despite the bevy of schemes rolled out by the Centre such as the Smart Cities Mission, the Swachh Bharat Mission, and the Atal Mission for Rejuvenation and Urban Transformation.

VCF, a low-hanging fruit

Value capture financing (VCF) works on the conviction that public policy and infrastructure projects typically lead to improvement in the quality of housing, jobs access and transportation, yield other social benefits, and lead to the emergence of important commercial, cultural, institutional, or residential developments in the influence area. This, in turn, leads to an appreciation in land value in the neighbourhood.

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Given this, VCF seeks a share of the enhancement in value for the municipal body, as the appreciation has resulted from positive externalities other than the land/property owner’s investments. It comprises a range of funding instruments or tools that ‘capture,’ ‘recover’ or ‘share’ a portion of the extra value of land and buildings resulting from public investments and policy initiatives in the influence area.

For all that, VCF is not necessarily a new tax; it could just as well be a manner of computation of existing levies that captures a portion of incremental property value.

The VCF process comprises 4 key steps:

* Value creation: Public regulations, policies and investments lead to creation of value

* Value realisation by private owners: For instance, the investment made by a developer fetches a bigger monetary value when he sells housing units along a metro corridor planned by the government than he would have without the project

* Value capture: It involves the government and private owners agree to a sharing mechanism for the value captured

* Value recycle: The resources collected are ploughed back in other parts of the city to create fresh value

Thus, VCF can serve as an infrastructure financing tool, directly or indirectly.

VCF includes a range of financing instruments used across the world: land value tax, fee for changing land use, betterment levy, development charges, transfer of development rights, premium on relaxation of floor space index and floor area ratio, vacant land tax, tax increment financing, zoning relaxation for land acquisition and land pooling system. Some of these tools, such as betterment levy and development charge, have been used extensively across states.

These tools contribute to the urban local bodies’ (ULBs’) own sources of revenue. However, their potential is yet to be fully realised as these have not been systematically deployed. Limitations in existing legislations and political constraints in fixing rates have restricted their use, along with absence of provisions for ring-fencing revenues for capital investments.

As per the 13th Finance Commission report, ULBs’ own sources of revenue met only half of their total expenditure and a whopping 82 per cent of their revenue expenditure in fiscal 2008. This indicates revenues from fees and taxes collected by ULBs did not even meet the committed costs of wages and operations, leave alone generate surpluses for capital investment.

In a bid to provide guidance to state governments and union territories to leverage their assets optimally and make use of under-utilised resources such as land, the Centre announced a policy framework and issued a guidance note on VCF in June 2017. The policy suggests a framework to examine the possibilities of using VCF to generate resources by making it a part of a project’s feasibility study.

Around the world, various cities have tried to capture value from land and harness it to develop major infrastructure. For instance, the city of Chicago has used tax increment financing to improve infrastructure and amenities at street level in its central business district (CBD), investing in bus shelters, subway entrances, landscaping (including trees, flower beds and planters) and street lighting. This has attracted people and commercial activity back into the CBD.

Cities in India, too, have resorted to such measures. Recently, the Karnataka government decided to create a dedicated fund for investment in mass transit systems using VCF methods, such as fixing premium FSI and levying fees for change of land use in the vicinity of a project. Specifically, provisions have been made for levying a betterment tax, equal to one-third of the increase in value of the land.

Similarly, the Maharashtra government is levying a 1 per cent surcharge on stamp duty to fund vital urban transport projects related to mass rapid transit system such as metro rail, mono rail, freeway, and sea-link. In 2010, Maharashtra changed the rate of its development charge, from area-based (rate per sq m) to percentage of ready reckoner land rate.

In Andhra Pradesh, the Greater Hyderabad Municipal Corporation has imposed a 0.5 per cent tax on registration value of land, if it is not used exclusively for agriculture purpose or is vacant.

But, these are early days. It is anticipated that Indian cities will be able to reduce the gap between demand and supply of infrastructure by using VCF tools more aggressively.

The writer is director, CRISIL Infrastructure Advisory

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