URBAN GOVERNANCE ASSESSMENT

Tamil Nadu Urban Flagship Investment Program (RRP IND 49107-003) URBAN GOVERNANCE ASSESSMENT I. INTRODUCTION 1. The Government of Tamil Nadu (GOTN) requested support for a Governance Improvement Component (GIC) under the ADB supported Tamil Nadu Urban Flagship Investment Program (program). The GIC aims to incentivize urban local bodies (ULBs) to improve key areas of urban governance through -based grants. The objectives of this report are (i) to assess the status of urban governance reforms in Tamil Nadu, (ii) identify key bottlenecks and issues in urban governance, (iii) summarize the state s priorities in relation to past achievements, and (iv) elaborate the design features of the GIC to incentivize governance improvements of ULBs in Tamil Nadu. 2. In past reform programs led by the Government of India s Ministry of Urban Development, Tamil Nadu performed well compared to other states in India. Under the national Jawaharlal Nehru National Urban Renewal Mission (JNNURM) and Atal Mission for Rejuvenation and Urban Transformation Mission (AMRUT), the state scored high (nearly 100% of compliance with reforms). Areas of good include accounting; systematic devolution of functions to urban local bodies; mobilizing commercial finance for urban infrastructure; and building a professional municipal cadre. 3. However, there are urban reforms still to be completed or are underperforming in Tamil Nadu, and smaller ULBs have gotten left behind in past reform programs. Key areas requiring improvement include: (i) strengthening of water supply and sewage at the ULB levels where many ULBs rely on parastatal agencies for delivering municipal services, (ii) financial management, (iii) revenue mobilization, and (iv) filling municipal vacancies. To achieve a more balanced development of ULBs across the state, the GOTN proposed a governance improvement incentive system through the program, applicable to all 135 urban local bodies in Tamil Nadu. The proposed Governance Improvement Component (GIC) of the program will support the GOTN in providing -based grants to achieve priority governance reforms of the State. II. OVERVIEW OF URBAN GOVERNANCE PROGRAMS IN INDIA 4. The of Tamil Nadu in urban governance is assessed using three frameworks: (i) the 74 th Constitutional Amendment, (ii) the reforms required under JNNURM, and (iii) the reform agenda under AMRUT. These frameworks are selected as they are nationwide frameworks and enable a simple comparison of Tamil Nadu s vis-à-vis other states. 5. 74th Constitutional Amendment. The 74th Constitutional Amendment of 1992 provided constitutional recognition of local bodies as the third tier of government. Even though ULBs had been in existence for several years under state legislations, there was lack of uniformity in their form and functions across states. In many States, elections were not held for long periods and therefore authority given to the state government. The 74th Amendment mandated certain measures be taken by the states forming the first guiding framework for urban governance reforms in India. The 74th Amendment required states to: (i) constitute ULBs for urban areas; (ii) hold regular elections; (iii) provide reservation for women and marginalized sections in the elected body; (iv) devolve, at the state Government s discretion, urban functions to the ULBs; (v) constitute district and metropolitan planning committees; (vi) decide taxes and fees that would be collected by ULBs; and (vii) constitute State Finance Commissions (SFCs) to decide the sharing of the revenue of state Governments with the local Governments, both urban and rural. After the 74th Amendment was approved, State Governments were required to take legal and administrative measures to ensure compliance.

2 6. JNNURM. The JNNURM was launched as a national grant program for the urban sector in 2005. It provided grants to ULBs and operated through separate windows for large cities and for the rest. Grants were provided for building urban infrastructure and for delivering services to the urban poor, but were contingent on the state Governments and cities implementing a list of reforms. These were divided into reforms to be implemented at the state level and those to be implemented at the city level. At the state level JNNURM focused on a) implementation of the 74th constitutional amendment and transfer of urban planning function to ULBs, b) repeal of laws on rent control and urban land holdings, c) reduction in stamp duty on property transfers and e) introducing new laws on public disclosure and community participation. At the city level, JNNURM focused on (i) e-governance, (ii) accounting reforms, (iii) property tax reforms, (iv) levy of user charges to recover operations and maintenance costs, (v) earmarking of a share of the budget for urban poor, and (vi) provision of basic services for the urban poor. In addition to these, JNNURM also required states and cities to implement ten measures to simplify processes, introduce transparent by laws and administrative reforms. These were termed optional reforms, though they were also required to be implemented within the mission duration. 7. As per the design of JNNURM, funding was provided for infrastructure investments, but was conditional on implementation of reforms as per an agreed timetable. As part of the JNNURM process, independent agencies evaluated and scored the implementation of reforms by states and cities on a common framework. 8. AMRUT. The AMRUT was launched in 2015 as national grant fund for financing urban infrastructure in 500 cities. Unlike JNNURM, AMRUT provided grants for infrastructure without any linkage to reforms. A separate window of 10% of the program funds were set aside as a reform incentive. 9. The AMRUT built further on the reform agenda of JNNURM. It retained some of the critical reforms measures of JNNURM such as devolution of funds and functions as per 74th amendment, e-governance, accounting, tax and user charge reforms, etc. It also introduced new measures such as professionalization of municipal cadre, energy and water audit, financial intermediary at state level, credit rating and implementation of Swachh Bharat Mission. The AMRUT specified a total of 54 reform milestones under 11 reform areas with yearly targets. States and cities implementing more than 70% of the reform milestones scheduled during each year of AMRUT will be eligible to receive reform incentive fund. 10. The summary of constitutional requirements and major state and ULB level reforms are presented in Table 1 and Table 2. The reforms requirements are categorized as follows: (i) constitutional framework for ULBs, (ii) state actions to strengthen ULBs, (iii) legal and institutional actions at state level, (iv) e-governance at ULB level, (v) financial management at ULB level and (vi) process simplification, by-laws and other continuous improvements at ULB level. Table 1: Summary of Urban Governance Reforms in India s National Programs Constitutional Framework for ULBs 1 Constitution of urban local bodies 2 Conduct of elections 3 Reservation of seats in the elected bodies for women and marginalized communities 4 Devolution of urban functions to ULBs 74th CAA JNNURM AMRUT

3 5 Devolving taxes and fees to ULBs 6 Constituting State Finance Commissions for sharing of revenues 7 Constitution of district planning committees 8 Constitution of metropolitan planning committees State level reforms Strengthening ULBs 9 Transfer of urban planning to ULBs 10 Transfer of water supply and sanitation function to ULBs 11 Constitution and professionalization of municipal cadre 12 Implementation of SFC recommendations within timeline. Legal and institutional actions at State level 13 Rationalization of stamp duty 14 Reforms in rent control Act 15 Repeal of Urban Land Ceiling Act 16 Enactment of law on public disclosure 17 Enactment of law on community participation 18 Establish Urban Development Authorities 19 Set up financial intermediary at State level 74th CAA JNNURM AMRUT ULB level reforms 20 E-Governance With additional milestones 21 Provision of basic services to urban poor Financial management 22 Shift to double entry accrual accounting 23 Property tax reforms (coverage and collection efficiency) 24 100% O&M cost recovery in water supply and solid waste management 25 Internal earmarking of funds for services to urban poor 26 Credit Rating With additional milestones AMRUT = Atal Mission for Rejuvenation and Urban Transformation Mission, CAA = Constitutional Amendment Act, JNNURM = Jawaharlal Nehru National Urban Renewal Mission, O&M = operation and maintenance, SFC = State Finance Commission, ULB = urban local body. 11. Other urban governance improvements are presented in Table 2. Table 2: Summary of Other Related Urban Governance Improvements Process improvements, by-laws and other continuous improvements 1 Introduction of property title certification in ULBs 2 Simplification of conversion of agricultural land to urban land 74th CAA JNNURM AMRUT

4 3 Computerized registration of land and property 74th CAA JNNURM AMRUT 4 Revision of building by-laws to streamline approvals 5 Revision of building by-laws to mandate rain water harvesting 6 Earmarking of developed land in housing projects for urban poor 7 By-laws on reuse of recycled water 8 Revision of by-laws to mandate solar rooftop 9 Regular revision of by-laws 10 Administrative reforms 11 Structural reforms 12 Encouraging public private participation 13 Preparation of Master Plan using GIS 14 Preparation of SLIP, and SAAP 15 Make action plan to progressively increase Green cover in cities to 15% in 5 years 16 Develop at least one Children Park every year in AMRUT cities. 17 Establish a system for maintaining of parks on PPPP model. 18 State level policy to implement National Mission for Sustainable Habitat. 19 Energy and water audit 20 Implementation of Swachh Bharat Mission AMRUT = Atal Mission for Rejuvenation and Urban Transformation Mission, CAA = Constitutional Amendment Act, GIS = geographic information system, JNNURM = Jawaharlal Nehru National Urban Renewal Mission, PPPP = people public private partnership, SAAP = state annual action plans, SLIP = service level improvement plans, ULB = urban local body. Other Governance Initiatives 12. Urban Reform Incentive Fund. In 2003-2004, the Government of India launched the Urban Reform Incentive Fund (URIF) to incentivize urban reforms which were later incorporated into JNNURM (items 11, 12, 13, 17, 18, and 19 in Table 1, and item 3 in Table 2). Even though state governments agreed to implement the reforms and signed a Memorandum of Agreement with the Government of India to draw down the first installment of grants, reform implementation was slow which led to a lapse of the program. 1 13. 13th Finance Commission. The 13th finance commission (period 2010-2011 to 2014-2015) constituted by the Government of India recommended -based grants provided if State governments fulfilled the following: (i) supplementary state budget for local bodies and accounting systems in local bodies, (ii) audit of local bodies, (iii) ombudsmen for local bodies, (iv) electronic transfer of finance commission grants to local bodies, (v) specifying qualifications of members of SFCs, (vi) levy of property tax and property tax valuation board at state level, (vii) publish existing and proposed service levels for urban services, and (viii) a mechanism for fire hazard response in ULBs. 1 Government of India. Planning Commission. 2005. Mid Term Appraisal of the Tenth Five Year Plan. New Delhi

5 III. PERFORMANCE OF URBAN GOVERNANCE IN TAMIL NADU 14. Performance under the 74th Constitutional Amendment. 2 Tamil Nadu, like most States, had a system for constitution of local bodies even prior to the 74th amendment. Chennai Corporation is the first local body to be constituted in India in 1688. Under state legislation, Tamil Nadu had constituted various tiers of ULBs prior to the 74th CAA. After adopting the 74th CAA in 1994, Tamil Nadu reclassified transitional village areas as ULBs and brought them under the jurisdiction of the municipal administration department; and streamlined income and population based criteria for classifying ULBs. Even though ULBs were in existence, elections had not been conducted for the local bodies since the year 1968, except once in 1986. After the 74th CAA, elections to local bodies were held under an independent State Election Commission in the year 1996. 15. Prior to 74th CAA, the state established autonomous parastatal organizations for urban functions such as Chennai Metropolitan Water Supply and Sewage Board, Tamil Nadu Water and Drainage Board, Chennai Metropolitan Development Authority (CMDA), Tamil Nadu Housing Board and Tamil Nadu Slum Clearance Board. Further, the Directorate of Town Planning was responsible for town planning functions. Thus, key functions of water supply, sewage, housing and urban planning were outside the domain of ULBs prior to 74th CAA and were performed by such autonomous organizations under the administrative control of the state Government. The functions of these agencies were not transferred to ULBs even after the 74th CAA and the functional domain of local bodies was not substantially changed. District or Metropolitan Planning Committees were not constituted. The Tamil Nadu Urban Development Project II supported reforms in streamlining responsibilities between ULBs and parastatal agencies but on completion of the Project found that the State could not sustain these reforms. 3 16. The first SFC was constituted in 1994 and its recommendations were accepted in 1997. The state agreed to devolve 90% of entertainment tax and 8% of the consolidated tax revenue of the state government to local bodies. This started systematic devolution of funds to urban local bodies and increased the financial strength of ULBs. This in turn enabled channeling of external funds into the urban sector through a state level urban financial intermediary, the Tamil Nadu Urban Development Fund. 17. While Tamil Nadu implemented the 74th CAA provisions regarding constitution of ULBs and regular elections, the functional domain of the ULBs was not expanded but substantial financial devolution was initiated. 18. Performance under JNNURM. Three urban agglomerations in Tamil Nadu, Chennai, Coimbatore and Madurai were included under the Urban Infrastructure and Governance (UIG) and Basic Services for the Urban Poor (BSUP) components of JNNRUM. 4 The three ULBs signed a Memorandum of Agreement with the Government of India agreeing to a timeline for implementation of reforms. The Memorandum of Agreement was elaborate and covered intermediate milestones for each reform commitment. As per the reform agenda of JNNURM, both the state and ULBs were expected to implement the urban reforms. During the implementation period, the Government of India provided toolkits for each reform, clarifying the implementation requirements. Independent agencies were also engaged to evaluate the quality of implementation of reforms. A standard framework for evaluation of progress was developed by 2 Madras Institute of Development Studies. 2011. State Level Background Paper on Tamil Nadu. Chennai. 3 World Bank. 2005. Implementation Completion Report Tamil Nadu Urban Development Project II. Washington. 4 Smaller ULBs were covered under two other windows of JNNURM.

6 Government of India and all States and ULBs were scored under the framework. On completion of the program, Tamil Nadu achieved a score of 99.64% 5 in reform completion (average of under State level reforms and ULB level reforms by each of the three ULBs), and ranked second in the country. The national average of reform was 84%. The State Government implemented all reforms except setting up of district planning committees. Coimbatore and Madurai implemented all ULB level reforms but received less than 100% score due to shortfall in State Government level reforms. Chennai was unable to recover 100% of O&M charges. The cities were ranked 4 th and 6 th among 65 cities ranked nationally. 19. Performance under AMRUT. AMRUT, launched in 2015, also listed governance reforms states and ULBs were expected to implement. During the year 2016-2017, States completed a self-assessment of the reform implementation in the year 2015-2016 based on a scoring framework provided by the Government of India. Tamil Nadu stood 4th nationally with a score of 94.05%. 6 The shortfall was in the area of achieving at least 90% collection efficiency in municipal taxes and fees (only 5 out of the 27 ULBs achieved this target). The state and the ULBs achieved all other reform milestones scheduled for the year in the areas of (i) e-governance; (ii) professionalization of municipal cadre; (iii) augmenting double entry accounting; (iv) urban planning and city level plans; (v) devolution of funds and functions; (vi) review of building by-laws; (vii) municipal taxes, fees and user charges improvement; and (viii) energy and water audit. 20. The number of ULBs covered under JNNURM and AMRUT and the number meeting all reform milestones are listed in Table 3 below. Table 3: Reform Achievement of Urban Local Bodies in Tamil Nadu JNNURM (UIG Component) AMRUT Number of ULBs participating 3 27 Number of ULBs meeting all 0 5 reform milestones Percentage of achievement of 99.35% to 99.78%, 4th and 6th 92.85% ULBs not meeting all reform milestones ranked among 65 Indian cities Average score of all ULBs 99.64% (ranked second) 94.05% (ranked fourth) JNNURM =, Jawaharlal Nehru National Urban Renewal Mission, UIG = Urban Infrastructure Governance, ULBs = urban local bodies 21. While Tamil Nadu scored high in reform implementation under both JNNURM and AMRUT, there are reforms not completed including (i) urban planning not in the domain of ULBs, (ii) parastatals still manage water supply and sewage in many ULBs, and (iii) low revenue generation including property tax collection. 22. The Government of India found reform implementation under JNNURM was incomplete. 7 The Arun Maira Committee 8 for evaluation of JNNURM found crucial reforms were yet to be implemented. The Committee found differing perceptions amongst stakeholders regarding the actual completion of reforms and their impact; and where laws were enacted, rules were pending thereby undermining the substance of reforms. The Isher Ahluwalia Committee 9 found most 5 Government of India. Ministry of Urban Development. 2016. Handbook of Urban Statistics. New Delhi. 6 Government of Tamil Nadu. 2016-17. State Annual Action Plan for Atal Mission for Rejuvenation and Urban Transformation. Chennai. 7 This is not specific to Tamil Nadu or any specific State, but on the overall reform implementation under JNNURM. 8 Government of India. Planning Commission. 2012. Report of the Committee on JNNURM II. New Delhi. 9 Government of India, Ministry of Urban Development. 2011. The High Powered Expert Committee (HPEC) for Estimating the Investment Requirements for Urban Infrastructure Services. Delhi.

7 states did not take serious initiatives to implement and sustain reforms and that the exercise became one of satisfying the technicalities of reforms and drawing funds from Government of India. Therefore, the near 100% reform implementation of Tamil Nadu cannot be taken as completion of the reform agenda, but only as a relative indicator of Tamil Nadu in comparison to other states. 23. Best practices of Tamil Nadu. Apart from the under national grant programs, Tamil Nadu is considered as a pioneer in four reform areas: (i) statewide accounting reforms, (ii) mobilization of external and commercial finance for infrastructure development through financial intermediary, (iii) devolution of funds based on SFC recommendations, and (iv) professionalization of municipal cadre. 24. Accounting reforms. 10 Tamil Nadu was the first state to implement accounting reforms statewide. It decided to change to a double entry accrual accounting system in late 1997 to be able to present acceptable information to funding agencies. This coincided with the parallel reform of the state government to set up a state level financial intermediary for the urban sector. The state government appointed a committee chaired by a retired joint director of the Local Fund Audit in January 1998. The committee submitted its first draft of an accounting system manual for all ULBs in the state in June 1998. In January 1999, the State Department of Municipal Administration and Water Supply decided to test the new system in 12 selected cities. The pilot began at the start of the new fiscal year on 1 April 1999. Based on the successful experience in these pilot cities, in January 2000 the State Department of Municipal Administration and Water Supply instructed the new accounting system be started in the remaining municipalities on 1 April 2000. Tamil Nadu thus became the first state to introduce comprehensive accounting reforms statewide. Tamil Nadu received technical assistance from the USAID supported Financial Institutions Reform and Expansion project and financial assistance from World Bank supported Tamil Nadu Urban Development (II) Project 11 for implementing the accounting reforms. ULBs in Tamil Nadu regularly prepare their accounts on accrual basis, their accounts are audited by the Local Fund Audit, and the audit observations are recorded and their resolution is tracked regularly. Tamil Nadu met accounting reform related milestones in both JNNURM and AMRUT. However, even though ULBs prepare financial statements and audit them, the time taken for finalization of accounts is prolonged. Completion of audits takes more than 12 months for most ULBs; as on February 2017, audit for the year 2015-2016 was completed for only 11 out of 135 ULBs. Even though the financial statements are audited, the objections raised after audit remain unresolved. As on June 2017, more than 148,672 audit observations were pending resolution. 25. Mobilizing external and market finance for infrastructure investments. The Tamil Nadu Urban Development Fund (TNUDF) is recognized as a pioneering urban financial intermediary. Prior to TNUDF, Tamil Nadu introduced the concept of a Municipal Urban Development Fund (MUDF) under World Bank supported Tamil Nadu Urban Development Project (TNUDP) in 1988. MUDF operated as an incorporated fund managed by the project management group of TNUDP. By 1996, MUDF provided support to 94 of the state's 109 municipalities and municipal corporations for over 500 subprojects; generated profits; and achieved high rate of loan 10 USAID. Indo-US Financial Institutions Reform and Expansion (Debt) Project. 2004. Project Note: 22 Introducing an Improved Financial Accounting System in Urban Local Bodies in India. Washington DC. 11 (i) The World Bank project originally intended to support ULBs to develop and implement City Corporate Plans. During implementation, the emphasis changed to supporting accounting reforms since the USAID Program had succeeded in introducing accounting reforms across all the ULBs in the State. Other reform measures in the Project included training; plans for strengthening staffing and personnel policies; and studies on sharing of responsibility between ULBs and parastatal agencies; (ii) World Bank. 2005. Implementation Completion Report Tamil Nadu Urban Development Project II. Washington DC.

8 repayment. 12 However, it needed to overcome constraints including: (i) dependence on public financing, (ii) administrative control by GOTN with a potential for political risks, and (iii) rigid staff compensation and transfers. Therefore, GOTN restructured MUDF into TNUDF, an autonomous financial intermediary with private sector participation in 1996. The GOTN contributed to 70% of the fund, and private sector financial institutions (ICICI, HDFC and IL&FS) contributed 30% of the fund. The GOTN setup Tamil Nadu Urban Infrastructure Financial Services Limited (TNUIFSL) as a fund manager to TNUDF with majority private ownership from the same private sector institutions. The TNUDF achieved 100% loan recovery for the last thirteen since 2003-04 and had no non-performing assets as of 31 March 2016. 13 TNUDF provided loan funds to almost all ULBs in Tamil Nadu (except town panchayats). 26. One function of TNUIFSL is to support ULBs in commercial borrowing and structuring of projects with private sector participation. Key TNUIFSL achievements in this area are: (i) (ii) (iii) (iv) (v) (vi) Supporting Karur ULB in structuring a bridge on Build-Operate-Transfer basis; Supporting Alandur ULB in structuring an underground sewerage project with commercial borrowing, user contribution and public-private partnership (PPP); Supporting Madurai ULB in issuing a municipal bond; Supporting Chennai Corporation and Chennai Metropolitan Water Supply and Sewage Board in issuing bonds; TNUDF own bond issue to raise resources; and Pooled bond issue to raise resources from the market for the Water and Sanitation Pooled Fund to refinance borrowings of 13 ULBs. 27. In addition to TNUDF, Tamil Nadu also has another financial intermediary for the urban sector called Tamil Nadu Urban Finance and Infrastructure Development Corporation (TUFIDCO), which is 96.4% GOTN owned company 14 incorporated under the Companies Act in 1990. TUFIDCO manages funds from the grant programs of Government of India and own funds borrowed from commercial banks. 28. The success of TNUDF in mobilizing external finance, introducing a credit culture within ULBs and in commercial borrowing encouraged other State Governments in India to set up a financial intermediary modelled on TNUDF. 29. Devolution of funds based on State Finance Commission Recommendations. Tamil Nadu was one of the first States to set up a State Finance Commission (SFC) as mandated by the 74th CAA. The first SFC was set up in 1994 and submitted its recommendations in 1996 which were accepted in March 1997 by the state government. Based on the SFC recommendations, the GOTN decided to share 8% of its own tax revenues with the ULBs. Tamil Nadu was amongst the first states to follow the approach of sharing a part its total revenues. This encouraged other SFCs to recommend this approach and has been adopted by other states. Tamil Nadu since set up four more SFCs periodically and the share of own tax revenues to ULBs has increased to 10%. In addition, the SFCs made important recommendations accepted by the state government on: (i) reclassification of ULBs, (ii) incentive and equalization funds, (iii) limiting salary expenditure of ULBs to less than 49% of revenues, (iv) debt relief for ULBs, (v) property tax reforms, and (vi) award and incentive for best practices. 12 World Bank. 1998. Implementation Completion Report Tamil Nadu Urban Development Project. Washington DC. 13 Tamil Nadu Urban Development Fund. 2016. Annual Report 2015-16. Chennai. 14 Remaining shareholding is owned by local bodies; and Housing and Urban Development Corporation Limited, a Government of India owned institution.

9 30. Professionalization of municipal cadre. 15 In 1970, the Tamil Nadu adopted a series of rules for various municipal services, which provincialized many cadres of municipal staff, bringing them within a statutory framework for recruitments, grades and salaries, and regulating transfers and promotions. These rules included the Tamil Nadu Municipal Town Planning Rules, 1970; the Tamil Nadu Municipal Medical Service Rules, the Tamil Nadu Municipal Engineering Service Rules, 1970; the Tamil Nadu Municipal General Service Rules, 1970; and the Tamil Nadu Municipal Educational Service Rules, 1970. At present, Tamil Nadu has a cadre of municipal officers for key roles such as chief officers of ULBs, engineering, finance, town planning and public health. Senior positions are recruited by the state governments which increases the attractiveness of these job positions to potential applicants. The positions are transferable across the state which ensures good practices are replicated across ULBs. Transfer of staff from small to large towns also provides opportunities for career progression. However, the average vacancy is 18.8% in key positions. 31. Other ongoing reforms. Tamil Nadu is in the process of implementing a common e- Governance system across the ULBs. This is being undertaken to eliminate inconsistencies in software systems within a ULB and across ULBs. The first phase of this exercise comprises of e- Governance modules related to accounting, revenue and financial management and implementation has commenced. This will introduce uniformity in processes across ULBs and State level supervision due to direct access to centralized accounting and revenue database. A credit rating exercise for all ULBs covered under AMRUT is underway. 32. Model Cities Program. 16 The GOTN introduced results-based grants for urban governance under the ongoing Tamil Nadu Sustainable Urban Development Program (TNSUDP) supported by the World Bank. Three small and medium sized cities (Vellore, Erode and Hosur with population of 0.5 million, 0.5 million and 0.25 million respectively in the year 2011) with a total population of 1.25 million are eligible to receive grants of up to $60 million for implementing urban governance initiatives. The governance areas targeted are: (i) ULB empowerment and organizational capacity, (ii) spatial/ development planning, (iii) sustainable finances and (iv) e- Governance and public disclosure. 33. During the period 2014-2015 to 2020-2021, the three model cities were expected to achieve 21 milestones in the four governance areas identified. The ULBs are to receive a predetermined grant of $ 0.5 million to $1.5 million on achievement of each milestone totaling to a potential grant of $60 million. 34. The results-based grants is in its third year of operation. The milestones so far have been preparatory activities such as revenue improvement plans, area development plans etc. Outputs are scheduled in the latter years of the Program and therefore no assessment of outputs is possible at this time. The GOTN feedback about the design of the program is positive and the only concerns expressed have been that the per capita incentive is high ( 501 per capita per year) and that some measures are outside the control of the ULB such as delegation of powers by the state government. 35. A summary of of Tamil Nadu on the framework for reforms is provided in Table 4. Only major reforms at state and ULB level have been considered. 15 Madras Institute of Development Studies. 2011. State Level Background Paper on Tamil Nadu. Chennai 16 International Bank for Reconstruction and Development. 2015. Project Appraisal Document Tamil Nadu Sustainable Urban Development Program. Washington DC.

10 Table 4: Performance in Constitutional and Major State and Urban Local Body Level Reforms Area Status in Tamil Nadu Constitutional Framework for ULBs 1 Constitution of urban local bodies In practice prior to 74th CAA 2 Conduct of elections Regular elections held after 74th CAA 3 Reservation of seats in the elected bodies for women and marginalized communities In compliance with requirements 4 Devolution of urban functions to ULBs Except urban planning, housing and slum clearance; Water supply in Chennai and select smaller ULBs 5 Devolving taxes and fees to ULBs In practice prior to 74th CAA 6 Constituting State Finance Commissions for sharing of revenues 7 Constitution of district planning committees 8 Constitution of metropolitan planning committees State level reforms Strengthening ULBs Leading State in India Not implemented CMDA is responsible for planning in Chennai 9 Transfer of urban planning to ULBs Not implemented fully 10 Transfer of water supply and sanitation Substantially with some exceptions function to ULBs 11 Constitution and professionalization of municipal cadre In practice prior to 74th CAA; among leading States in India 12 Implementation of SFC recommendations Leading State in India within timeline. Legal and institutional actions at State level 13 Rationalization of stamp duty Substantially 14 Reforms in rent control Act Implemented 15 Repeal of Urban Land Ceiling Act Implemented 16 Enactment of law on public disclosure Implemented 17 Enactment of law on community Implemented participation 18 Establish Urban Development Authorities Not implemented 19 Set up financial intermediary at State level Leading State in India ULB level reforms 20 E-Governance Under implementation 21 Provision of basic services to urban poor Implemented Financial management 22 Shift to double entry accrual accounting Leading State in India 23 Property tax reforms (coverage and collection efficiency) 24 100% O&M cost recovery in water supply and solid waste management 25 Internal earmarking of funds for services to urban poor Meets JNNURM requirements Meets JNNURM requirements Meets JNNURM requirements

11 Area Status in Tamil Nadu 26 Credit Rating Substantially complete for AMRUT cities AMRUT = Atal Mission for Rejuvenation and Urban Transformation, CAA =Constitutional Amendment Act, CMDA = Chennai Metropolitan Development Authority, O&M = operation and maintenance, JNNURM = Jawaharlal Nehru national Urban Renewal Mission, SFC = State Finance Commission, ULBs = urban local body. IV. URBAN GOVERNANCE PRIORITIES IN TAMIL NADU 36. The state identified priority areas for improving urban governance. The identified measures described below deepen the progress made by the state under previous initiatives. They also align with ongoing AMRUT reforms by setting additional or stricter targets. 37. The urban governance priorities identified by the State government are as follows: (i) (ii) (iii) (iv) (v) Financial management (a) Preparation of accounts; (b) Settling local fund audit (LFA) audit objections; and (c) No dues on statutory and institutional payments debt, electricity, bulk water supply and contributory pension scheme. Revenue improvement (a) Collection efficiency of user charges for underground drainage; and (b) Increase in the number of professional tax assessments. Administration a. Filling vacancies in sanctioned posts. Project management (a) Achieving targeted number of new household connections for water and underground drainage projects; and (b) Timely completion of projects. New initiatives (a) Sale of treated wastewater/ use of treated wastewater (applicable to all ULBs with functioning wastewater systems); and (b) Fecal sludge management in areas not covered by underground drainage. 38. Financial management. In accounting and audit, even though the ULBs prepare financial statements and audit them, the time taken for finalization of accounts is long. Completion of audit takes more than 12 months for most ULBs; as on February 2017, audit for the year 2015-2016 was completed for only 11 out of 135 ULBs. Even though the financial statements are audited, the objections raised after audit remain unresolved. As on June 2017, more than 148,672 audit observations were pending resolution. 39. Revenue improvement. The Fifth SFC identified that Tamil Nadu ranks last among six comparable states in realization of property tax measured as a percentage of state domestic product, even though property tax collection efficiency (of current year demand as on 31 March 2017) is 82% for municipal corporations and 80% for municipalities. The SFC has identified shortfalls in coverage, assessments, exemptions and enforcement. The SFC has recommended that 5% of the devolution to ULBs should be in the form of an incentive fund promoting improved property tax collections. The commission also identified weaknesses in collection of professional tax, the second largest own revenue source for ULBs in Tamil Nadu. The collection efficiency of professional tax is 90% (current year demand as on 31 March 2017). The SFC has found that profession tax is collected at source from Government employees, but it has not been paid regularly in the case of private enterprises, self-employed, entrepreneurs and traders.

12 40. Administrative strengthening. The system of professional municipal cadre has benefited ULBs in the state. The state government recruits senior officers and provides them to the ULBs. The senior officers are transferable across ULBs, thus ensuring opportunities for career progression as well as cross learning from the experience of well performing ULBs. However, many of the sanctioned posts remain unfilled. The average vacancy is 18.8% in key positions. This is partly due to lack of initiative by the ULBs and partly due to restrictions imposed by the state government on the share of revenue that can be spent on salaries by the ULBs. 41. User charges for sewerage. Tamil Nadu implemented underground drainage systems in several ULBs. In parallel, the state has also introduced underground drainage charges to be collected from the benefitting households. As on July 2017, only 71.1% of households were connected to underground drainage and water networks as compared to the project targets. Collection efficiency of user charges for underground drainage is only 49% (current year collection as on 31 March 2017); underground drainage projects are delayed by more than 24 months. 42. Fecal sludge management and wastewater recycling. Even though underground drainage projects have been taken up in ULBs, they are not designed to cover the entire city. There is a need to provide fecal sludge management solution in areas not covered by underground drainage. Further, several wastewater treatment plants have been set up and are operational, but the treated wastewater is being disposed of without being put to productive use. The State intends to promote reuse of wastewater, either for industrial or for agricultural use. 43. Bottlenecks in reform implementation. In the identified priority reform areas, the ULB has primary responsibility and dependence on state government is low. The state designed and implemented a common web-based statewide accounting software. The ULBs carryout financial transactions in this module and will be able to finalize accounts on the last day of the financial year itself. This eliminates delays in manual finalization of accounts. The state government stipulated the finance commission devolutions needs to be used for paying statutory debts. Thus, as and when the funds are released by the state government, ULBs can use these to clear statutory debts. The ULB has full responsibility and authority to increase collection efficiency in sewerage charges and to increase assessments in professional tax. Filling up of vacancies requires both ULB and state government actions. Project implementation and new initiatives are also within the control of ULBs, but involve support from other agencies and households. 44. The GIC enables the state government to clarify its priorities through a formal multi-year framework that has Tamil Nadu-specific targets and is applicable across ULBs. This is unlike other ongoing incentive programs (discussed further in Section V) which have same focus areas and targets across the country (or) are applicable only to few ULBs in the State. Apart from the financial incentive, the GIC provides a clear signal to the ULBs that these reforms are priorities of the State; it provides clarity to ULBs on the targets to achieve; and provides a uniform statewide framework to evaluate implementation. 45. Where required, the state government has already taken actions to enable reforms or is committed to support ULBs. For example, the state government needs to approve the resolution of audit objections. The GOTN has already formed committees to provide approvals to resolve audit objections. If positions have been vacant for more than 6 months, state government approval is required for filling up the vacancy. The state government is responsible for recruitments to senior positions. The Commissioner of Municipal Administration (CMA) has committed to take these actions.

13 V. KEY CONSIDERATIONS FOR DESIGNING THE GOVERNANCE IMPROVEMENT COMPONENT FOR THE TAMIL NADU URBAN FLAGSHIP INVESTMENT PROGRAM 46. In designing the GIC, lessons learned were collected from the past reforms programs. Since ULBs in Tamil Nadu have access to multiple sources of grants, the proposed GIC should not duplicate but complement ongoing initiatives mentioned above. 17 It should also be sized so that there is sufficient incentive for the ULBs, commensurate with the effort required to perform. Three types of incentive linked programs (applicable to Tamil Nadu) were earlier introduced in the urban sector in India in the last 15 years; these are: (i) reform linked funding under the JNNURM and the AMRUT program; (ii) linked grants by the Central Finance Commission (CFC) and the State Finance Commission (SFC) of Tamil Nadu, and (iii) ongoing TNSUDP. A. Key features of the three programs applicable in Tamil Nadu are as follows: 47. Size. The programs had an outlay of 5% to 20% towards linked incentives. On per capita basis, the average per capita outlay for incentives per annum was 45 for AMRUT. However, the reform outlay was revised to 135 capita ( 9000 crores for three years) from 2018-19 onwards. The per capita per year outlay is 98 for 14th CFC, 74 for TN SFC and 501 for TNSUDP. Excluding TNSUDP which is an outlier, the average is 102 per capita per annum for the other three programs. The JNNURM provided investment funds based on and therefore its outlay is higher and not comparable to the incentive component in other programs. 48. Coverage. The AMRUT covers about 500 ULBs across India which account for approximately 62% of India s urban population. It covers 33 ULBs in Tamil Nadu. 18 The 14th CFC covers the entire urban population (except union territories). All the ULBs in Tamil Nadu are covered. The Tamil Nadu SFC covers the entire State urban population. TNUSDP covers three model cities with a population of 1.24 million (approximately 4% of state s urban population). The JNNURM covered the entire urban population though the emphasis was on 65 select cities under the Urban Infrastructure and Governance component, which amounted to approximately one third of the urban population. 49. Nature of incentivized. Both JNNURM and AMRUT advocated a wide set of reforms. ULBs were expected to implement 13 reforms under JNNURM, while AMRUT specifies 54 reform milestones in 11 areas (some of which are the responsibility of the state government). However, AMRUT will narrow its focus to five reform areas 19 from 2018-2019 onwards. The 14th CFC specifies three simple criteria for incentives. The Tamil Nadu SFC (5th) focused on improvement in property tax as the sole criteria for incentives. The TNSUDP project specifies four indicators (with year wise milestones). A comparison of the reform areas in these Programs is provided in Annexure 1. 17 These include grants for investments (such as AMRUT, Smart Cities), devolutions (14th Finance commission grants from Government of India, State Finance Commission grants) and -based grants (reform component of AMRUT, conditional grants under 14th Finance Commission, Model Cities component under an ongoing World Bank project for select ULBs). 18 AMRUT initially covered 32 ULBs in Tamil Nadu out of which 5 were merged into larger ULBs by the state government subsequently resulting in 27 AMRUT towns. Another ULB was added to the AMRUT program in subsequent years. 19 (i) Trust-and-verify approach, (ii) credit rating and municipal bonds, (iii) land titling laws, (iv) value capture financing and (v) professionalization of ULBs.

14 B. Lessons Learned from Past Urban Reform Programs 50. Focused set of reforms is preferred over a wide agenda. The JNNURM, with a wide scope of reforms, has not been successful in reform implementation. The Committee on JNNURM II 20 noted while significant progress has been achieved in completion of many non- complex reforms, the crucial ones are yet to be completed. The committee also recommended that a robust mechanism for objective evaluation of the progress of reforms is needed. The design of JNNURM stated that release of grants for capital investments will be linked to progress in reforms. However, progress in reforms was slower than expected and these created bottlenecks in funds release. Based on this experience, in the subsequent AMRUT program, the reform component was separated from the capital investment component. However, the reform agenda continued to be wide. The Ministry of Housing and Urban Affairs (MOHUA) has now proposed to narrow down the reform agenda of AMRUT to five areas 19 to ensure that the reform agenda is not incremental but transformative. 21 51. Targets relevant to the situation in Tamil Nadu. Tamil Nadu has ranked high in reform under JNNURM (Rank 2) and AMRUT (Rank 4). Further, Tamil Nadu also scores well in areas specified by 14 th CFC. Therefore, ULBs in Tamil Nadu rank high in reform. The 14 th CFC requires ULBs to demonstrate positive growth in own revenue. Own revenues of ULBs in Tamil Nadu grew by a CAGR of 13.46% between 2010-11 and 2014-15. Therefore, any incentive program should identify measures and targets that take into consideration the already high achievement of ULBs in Tamil Nadu. Where possible, they should focus on priorities in Tamil Nadu. For example, Tamil Nadu is one of the few States which have taken up a number of underground drainage projects. The relevant measure the for Tamil Nadu would be the number of households connected to underground drainage. 52. Competition of various reform programs. The proposed based governance reforms component under the program would operate in parallel with at least three other incentives under 14 th CFC, under 5 th SFC and AMRUT. In addition, the Model City Programme will also be in operation in parallel in three cities. The CFC requirements are simple (audit of accounts, improvement in own revenue and disclosure of service levels) while the SFC is focused (property tax improvement). 53. In addition, the ULBs also receive large unconditional revenue grants from both the SFC ( 1396 per capita in 2018-19) and CFC (average of 396 per capita per annum). These are in addition to capital grants for specific investments under various programs of the Government of India and the Government of Tamil Nadu. Further, the local autonomy for expenditure and absorption capacities are low, which reduces the attractiveness of incentive funds for ULBs; their effort is upfront but their ability to utilize funds is slow. 54. As a result, the willingness of the ULBs to participate in this component will be influenced by the size and the scope of reforms that they are required to implement. Their capacity to take up reforms are also limited since they are pursuing parallel reforms and capital investments under a variety of Government of India and GOTN programs. Therefore, the reform areas should be linked to their routine functions as far as possible. 20 Government of India, Planning Commission. 2012. Report of the Committee on JNNURM-II: Clean Bastis, safe communities and people s cities. Delhi. 21 Press Information Bureau, Government of India, Ministry of Housing & Urban Affairs. http://pib.nic.in/newsite/printrelease.aspx?relid=158703.

15 55. Preference for incentivizing outputs and for actions within the control of urban local bodies. The stakeholders have shared a preference for measuring actions based on output and not based on simple measures. For example, preparation of actions plan for revenue improvement or physical plans are not preferred as a milestone. Instead outputs such as actual improvements in revenue collection or physical connection to households should be measured. Further, ULBs depend on the state government for implementation of some measures and these should not be specified as a reform agenda. For example, increased autonomy to ULBs can be provided only by the state government and this should not be a measure for ULBs. 56. Clarity on implementation. Only the Model City Programme finalized implementation modalities, data requirements and validation methods at the time of launch of the incentive scheme. In JNNURM, AMRUT and in the 13th CFC, the implementation modalities were developed after the launch of the scheme. Under AMRUT, measures are self certified and the thresholds are low. This, at the minimum, led to delays and in the case of JNNURM (footnote 20), to differing perceptions on actual implementation. Therefore, simple, transparent measures which can be quantified upfront are preferred. 57. Size of the component. The initial project proposal envisaged a reform component of 1% of the investments. This would be approximately 32.3 crores ($5 million) for the entire project period, or 3.8 per capita per year. This is very low compared to the other ongoing reform program where the average is 102 per capita per annum; and 501 per capita per annum in model cities. Even if the participating cities are limited, this outlay will still be low which would in turn affect the quality of reforms that can be targeted. Other programs have an outlay of 5% to 10% for the reform component. An outlay of 5% ($ 25 million) of the ADB loan size ($500 million) was approved by GOTN. This is approximately 100 per capita for the entire duration of the program as compared to an average of 102 per capita per annum in other ongoing programs. Out of this outlay, 2% would be available in Tranche 1 and 3% would be available in Tranche 2. 58. Coverage. The ULBs in Tamil Nadu are classified into three categories, municipal corporations, municipalities and town panchayats. GIC will cover all 135 ULBs in Tamil Nadu except Corporation of Chennai and town panchayats. The reason for excluding Chennai is the relatively large size of Chennai which would require that substantial share of the incentive fund be allocated to it. The reason for excluding town panchayats is due to the large number of small size town panchayats; they are also not under the administrative control of Commissioner of Municipal Administration who is the implementing agency for this component. Based on the Census 2011 population adjusted for amalgamations, the total number of ULBs covered is 135 and the total population covered is 16,700,000. 59. Nature of reforms targeted. The per capita incentive for GIC is less than other ongoing reforms programs. This is only a marginal addition to the based or conditional grants that the ULBs currently receive under 14th FC (average conditional grants will 97.52 per capita per annum) which has relatively simple measures. GIC will maximize impact by: (i) supporting limited ULBs to implement difficult reforms; e.g., ADB project towns incentivized for timely project completion; and (ii) supporting all ULBs in priority reforms like accounting, but with targets that will deepen and sustain these reforms, such as resolution of audit objections. Thus, even though national incentive programs provide a higher incentive, by supporting priority reforms of the Government; Tamil Nadu specific targets; and supporting select ULBs, GIC can deliver higher impact. 60. Duration. The wider the coverage of GIC, the lesser is the impact of the incentive. Therefore. as a balance, a part of the outlay would be accessible to all ULBs (except Chennai