Pooled Finance Development Fund Scheme

Background

The growth rates in India that are reflected each financial year are largely driven by the growth in the urban areas and cities. The rural sector in India has limited potential, being majorly dependent on agriculture. Also, the continuous decline observed in the national poverty levels are being determined largely on the basis of urban cities. The Urban Local Bodies are responsible for undertaking majority of the urban infrastructure development projects. They are largely dependent on the funds provided by either the state governments or the local agencies. The poor administration in these local bodies pose a hurdle in financing such projects. They are unable to raise resources from the market/financial institutions for investment in infrastructural projects. In spite of the existing programmes of both the central and the state governments was a continuous gap between the availability and extent of requirements of funds for such projects, more commonly found in small and medium-sized cities. The Government thus, realized the need to provide direct access to capital markets for such cities. In order to make the local bodies self-sufficient and to ensure availability of resources at all times, the Government introduced the Pooled Finance Development Fund Scheme.

Objectives of PFDF

1. Decentralization of economic growth and power.
2. Improving infrastructural facilities and creating durable public assets in cities.
3. Promoting resource generated schemes for Urban Local Bodies to improve overall financial scenario.

The State Level Pooled Finance Mechanism

For implementing the Pooled Finance Development Scheme (PFDF), a state pooled finance entity (SPFE) needs to e established in every state. The SPFE could be a Trust, Special purpose entity, provided that the entity is just a pass through vehicle. The SPFE are expected to exhibit higher degrees of efficiency as compared to Urban local bodies since they will be able to generate goodwill in the bond markets and help the ULB to take advantage of scaled-up operations. With mutual co-operation, the SPFE will also hedge risks against the larger spectrum of activities of the Urban Local Bodies. The Central Government would be responsible for the funding of these State pooled finance entities through the PFDF. The Central Government makes funds available for the PFDF each year. 5 percent of this fund is utilized for project development assistance while, the remaining 95 percent would be utilized for the contribution to the Credit Rating Enhancement Fund (CREF) to improve the credit rating of the municipal bonds to investment grade. The cost of each project of the Municipality/ULBs will be estimated. 75 percent of these costs will be reimbursed by the Central Government and 25 percent by the state governments. The contribution by the Central Government will be one time in nature. It will comprise 10 percent of the proposed amount of bond issue or 50 percent of the CREF requirement as determined by a credit rating agency, whichever is less. In the event of default of the CREF, the Central Government will not be held responsible and the denouncement will be on the credit rating agency guaranteeing the ULB. At the maturity of the bonds issued, the share of the Center and state in the CREF will rest with the state entities for further leveraging of funds for infrastructure investment in Municipalities. The SPFE will be responsible for the management of accounts of the CREF and it shall not merge it with the accounts of other activities it undertakes. The funds in the CREF will be invested in bonds/notes of Government of India or bonds/accounts of other financial institutions rated by credit agencies as AAA(highest category). The bonds issued under the pooled finance scheme will have tax-free status under the Ministry's Guidelines for tax-free municipal bonds. However, the interest and dividend income earned from the CREF corpus will not be exempt from the levy of Income Tax. In order to provide exemption for the interest on bonds issued by the SPFE the Central Government by notification in the official gazette section 10(15)(vii) of the Income Tax Act has been suitably amended under Finance Act, 2007 enacted on 11 May 2007. Also, the State Pooled Financial Entity (SPFE) has been defined therein to mean such entity which is set up in the accordance with the guidelines of the Pooled Finance Development Scheme notified by the Central Government in the Ministry of Urban Development.

Guidelines for SPFEs

1. Facilitate Urban Local Bodies to access capital and financial market for investment in essential municipal infrastructure.
2. Reduce the cost of borrowing to local bodies with appropriate credit enhancement measures and through restructuring of existing costly debts.
3. Facilitate development of Municipal Bond market.
4. Facilitate the development of bankable urban infrastructural projects.
5. Responsibilities of SPFEs
6. Work in close collaboration and co-operation with the Municipalities/Urban Local bodies in urban infrastructural development projects.
7. Select projects based on viability and priority.
8. Get appraisal for the projects by recognized credit rating agencies i order to attract larger investment.
9. Mobilise resources by means of issuing bonds and redirecting funds for investment in projects.
10. Purchase bonds of ULBs or provide sub-loans to them.
11. Set up and manage Credit Rating Enhancement Fund (CREF).
12. Sign appropriate agreements with the Central Government and ULBs/Municipality.
13. Prepare projects that are technically and financially stable and in tune with environmental norms.