Minister s Round Table Public and Private Financing Mechanisms for Sustainable Urbanisation, Slum Upgrading and Prevention Introduction The world has reached a turning point in 2008, for the first time in history, more than half its human population, 3.3 billion people, live in urban areas. The world s urban population grew from 220 million to 2.8 billion in the 20th century. The next few decades will see an unprecedented scale of urban growth. By 2030, this is expected to expand to about 5 billion. Such rapid urban expansion will be particularly notable in Africa and Asia where the urban population will double between 2000 and 2030. By 2030, the towns and cities of the developing world will make up 81 per cent of urban humanity. This rapid urbanization in the developing world puts great pressure on municipal governments to provide a wide range of services from housing to basic urban infrastructure. Many cities are unable to provide adequate housing and urban basic services. The main reason is the inability of municipal governments to secure adequate finance. To meet the rising demands of urbanisation, municipalities need adequate revenue instruments to pay for services. The lack of revenues is one of the biggest problems facing most cities all over the world, particularly for cities in ACP countries, which makes them one of the most vulnerable layers of governments, with increasing responsibilities and small share in the allocation of public resources (see Figure 1). As a result, deteriorating infrastructure and services with scattered landscape of slums are often the persistent scenes in many developing cities. Investment in urban services and affordable housing is not keeping pace with growing needs. Funding is a key constraint. Most cities are economically powerful, but many municipal governments remain poor. The rate of urbanisation is much higher than the financing capacity of municipal governments to provide adequate services and affordable housing in many developing countries. Municipal governments are lack of power to raise revenue and to control their own financial resources. As a result, they are often heavily dependent on intergovernmental transfers and grants which are neither stable nor timely. In many cases the borrowing power of municipal governments to finance urban infrastructure and social housing is legally constrained by regulations and complex legislative decisions.
Afghanistan Armenia Australia Austria Belarus Belgium Bulgaria Canada Cape Verde Chile Croatia Cyprus Czech El Salvador Estonia Finland France Germany Greece Honduras Hungary Iceland Iran Ireland Israel Italy Jordan Kazakhstan Latvia Lesotho Lithuania Luxembourg Macedonia Malta Mauritius Moldova Mongolia Morocco Netherlands Norway Paraguay Peru Poland Portugal Romania Russia Serbia Slovenia South Africa Spain Sweden Ukraine United Kingdom Percentage Participation of private sector investors as the source of capital, technical assistance and management capabilities is limited by perceived high risks that demand sovereign guarantees and risk sharing mechanisms. Participation of other main actors, such as NGOs, civic institutions, individual citizens, academia and interest groups in financing urban services, affordable housing and capital intensive projects is still limited and constrained by inflexible governance structure and the weak power of local municipal governments in raising and using funds. The challenge for municipal governments is to keep cities economically viable by delivering a high level of services and, at the same time, keeping taxes sufficiently low so as not to discourage individuals and businesses from locating in their cities. Over the past two decades, municipal governments have faced a number of issues and challenges that have put stress on their ability for municipal finance. This requires us to look beyond public finance and search for mechanisms from both public and private channels for sustainable urbanisation, affordable housing and slum upgrading. In this paper, we will look at the major public and private financing mechanisms available for funding urbanisation, affordable housing, slum upgrading and prevention in ACP countries. Figure 1 Local Governments Share of Total Government Revenue in 2008 Local Governments Share of Revenue in 2008 50. 45. 40. 35. 30. 25. 20. 15. 10. 5. 0. Countries Source: UN-HABITAT
Major Public and Private Financing Mechanisms 1. Central Government Funding The central government funding is the key financing mechanism for urban services and housing in most countries, particularly for ACP countries. In some African countries, the central government funding accounts for more than 90 percent of public finance. However, in many countries, housing and urban basic services are often not on the priority list of governments. It results in the severe shortage of funding in affordable social housing and urban basic services. 2. Municipal Government Budgetary Funding Although housing development is now mainly funded by the private sector except for the low income housing projects, urban basic services and slum upgrading are regarded as the responsibility of municipal governments and communities. Despite the fact that low income beneficiaries are increasingly contributing to slum upgrading initiatives, municipal government budgetary funding plays a crucial role in affordable low income social housing for slum prevention. 3. Co-financing by Users and Stakeholders/User Charge Social housing and urban basic services bring a lot of benefits to the city, residents and enterprises. In some cities, all activities of upgrading infrastructure facilities are financed by users and stakeholders on a cost recovery basis. 4. Financing by Developers In South Asia, financing by developers for slum upgrading and affordable low income housing is well-established practice. In Indonesia and Malaysia, there is a proportion set by the governments. A developer develops high or middle income housing, he/she needs to develop a certain proportion of affordable low income housing as a condition for development. India and Sri Lanka have similar practice for slum upgrading. In USA, it has a linkage approach to request developers to develop a proportion of low income housing through zoning. These experiences can be easily used in ACP countries. Considering the large scale of urban basic services and upgrading projects, the municipal government alone is often impossible financially to accomplish the tasks and upscale its operations. Therefore, the government can provide incentives to attract developers and the business sector to invest in municipal projects. The main incentives provided by the government are free provision of land on the sites and exemption of development charges or certain taxes. 5. Land Sharing Government or private sector owners negotiate with residents of informal settlements to prepare a joint strategy to develop public or private land occupied by informal settlers. The community obtains rights to a portion of the land to be used for re-housing the informal settlers, while the
government or developer uses a portion for commercial purposes. The developer avoids evicting informal settlers and can profit from the development, while the community s land rights are made secure; in some cases, relocation or some members and/or infrastructure investments can also be funded. The key to land sharing, however, is a context of rising land values. Bangkok has developed several good examples in slum upgrading through land sharing. The Bangkok land sharing cases succeeded in resolving seven long-simmering land disputes between land occupants and landowners in central areas of Bangkok by re-housing almost 10,000 low income families on the same sites they were occupying. While the seven settlements introduced here and their land sharing arrangements were diverse, they shared a number of key characteristics. First, all but one of the original settlements was located on public land. Second, the land sharing arrangements were concluded with the intermediation of local and international housing professionals, a wide range of civil society actors, as well as public authorities, including (in five cases) the National Housing Authority and (in two cases) high-ranking military officials. Third, in all cases, slum dwellers had financed a portion of the cost of their new land and housing themselves, through loan schemes. 6. Capital and Revenue Finance for Social Housing It is useful to make a distinction between the capital finance that is used to construct, improve or acquire social housing and the revenue finance that is used to cover the on-going periodic costs of providing social housing. The capital finance may involve cash grants from the public sector and it often involves loans that can be obtained from public sources or by borrowing on the private market. Revenue finance is required to meet the on-going costs of providing social housing; this includes the costs of servicing loans as well as the costs of managing and maintaining the housing stock. Depending on the exact responsibilities on the social housing organisation, the costs may also include a range of support services for tenants and improving local environments. The sources of funds for these costs include the stream of income generated by rents, and any on-going revenue grants from the public sector. 7. Loans The loans that support social housing and urban basic services provision can also involve various forms of direct and indirect subsidies. For example, the loan may involve a direct subsidy if it is provided at a sub-market rate of interest by the public sector or an indirect subsidy if the public sector guarantees a loan provided by the private market. The consequence of the guarantee is likely to be that the loan is less risky and so the interest rate is lower, thus reducing the cost of financing the loan and ultimately the cost of providing additional social housing and urban services. The loan finance might be raised directly by the housing and urban services provider or by a special agency established by government for the purpose of supporting social housing and urban services.
8. Subsidies to Social Housing Providers and Low Income Households Governments can reduce the cost of housing finance by providing subsidies. Subsidies reduce the cost of finance below what they would be without the subsidy. If a non-repayable cash grant is provided by government or a government agency, this may be reasonably regarded as a direct subsidy. Grants to social housing developers or landlords have been important in establishing social housing stocks in many countries. In England, grants to local authorities and housing associations have over many years allowed these providers to invest in new housing and the existing stock. Grants to housing associations are technically loans that are subordinated to the borrowing from private financial institutions, repayable only on sale of the property (which requires special permission). This technicality reduces the costs of private borrowing. Finance that involves subsidies can be raised and provided generally for the social housing sector with individual providers given a large degree of discretion as to which projects are instigated. Alternatively, and more usually, public funding is provided to support a specific programme of investment. In some circumstances funding is dedicated to particular buildings or estates and is linked to the particular finances of that project. A more general mechanism for supporting the finance of both the capital and revenue expenditures of social housing providers is the provision of tax concessions which effectively reduce either the costs of investment or management. Where capital finance involves subsidies, these almost inevitably come with conditions attached. We can refer to this support as conditional object subsidies. The conditions typically relate to the incomes and other circumstances of the households that occupy the subsidised dwellings and the rents that they are charged. An alternative form of support is the provision of direct support in the form of financial assistance to individual households. This involves conditional subject subsidies. These typically take the form of housing allowances that depend on household size, incomes and the rent paid. Such conditional subject subsidies have grown in significance in most European countries and can be used as means of supporting households in both the social and the private rented sectors. In some countries they also support low income owner-occupiers. In the U.S. housing subsidies also mainly take this form of subsidies. The provision of social housing almost always involves some form of subsidy. Even if subsidies are not paid now, it is likely that they were paid at some point in the past. Where there is a claim subsidies are not paid this is sometimes contestable because of differences of opinion about what constitutes a subsidy. Here it will be assumed that a subsidy to housing suppliers reduces costs below what they would otherwise have been and a subsidy to consumers reduces their housing payments below what they would otherwise have been. Such assistance can take a number of forms, including transfers from government, tax concessions, low interest loans and crosssubsidies from the development process. In most cases, countries use a variety of means to subsidise social housing and no one measure is used in isolation.
9. Community-based Approaches/ Funds One of the most significant approaches is community-based initiatives. For example, the case of the Community Development Funds is to support communities through the help of Urban Community Development Office (UCDO) and Community Organisations Development Institute (CODI) in the implementation of key development processes, while facilitating the relevant activities to strengthen the managerial capacity of stronger community organizations, which would in turn be able to lead various community processes. For the urban poor, organizing themselves into saving and credit groups is a simple, direct and uncomplicated way of taking care of their immediate day-to-day needs. Saving activities became a tool which could link poor people in a community and help them find ways to handle simple credit needs as well as managing more complex development activities. So the UCDO/CODI worked to encourage, facilitate and enable, in all possible ways, community organizations and networks to act as key operating mechanisms in development processes (see Figure 2). The ideas behind the approach were: First, community savings and loan activities draw people together and offer opportunities for members to develop their strengths through making collective decisions about concrete activities that affect the community. Second, the financial mechanisms are grounded in daily activities. Savings and lending are quick, simple and related to daily needs of the poor themselves. Third, savings and loan activities provide the urban poor an opportuniy to use their own resource base to address their basic needs. Fourth, it creates ongoing learning within the community that every member can relate to and be involved in. It is a gradual process that provides the communities with the capacity and confidence for their development process. Figure 2 Development of UCDO/CODI Community Approaches Source: UN-HABITAT
Figure 2 shows the development of the Urban Community Development Office from providing loans to single saving groups, it attempted to link those saving groups in the same city to work together as a network 10. Project Finance Project finance for urban infrastructure and housing, involves creating a legally independent project company, typically a Special Purpose Vehicle (SPV) which is often used as a business entity for debt financing of urban infrastructure. The project assets are mortgaged to the SPV and the cash flows are escrowed into a separate bank account, with the first charge on its belonging to the lenders or investors. 11. Land-based Revenue Generation Land is a potent resource, and unlocking its monetary value is an excellent source of capital for urban infrastructure projects. Land-based revenue generation is mainly through land sale and property tax. In South African cities, property tax accounts for about 10% to 30% of municipal revenues (see Figure 3). In Somalia, it accounted for 28 percent of the total municipal revenue in Hargisa Municipality. Figure 3 Property Tax Income as Percentage of Total Municipal Revenue in South African Cities Source: PDG and Isandla Institute, 2009, Municipal Rates Policies and the Urban Poor, Johannesburg: South African CitiesNetwork
12. Pooled Finance Pooled finance is an approach under which appropriate mixes of urban projects are bundled together for the debt market financing. The projects should be chosen in a way which can diversify away and mitigate the individual project risks. This is often achieved by choosing projects with robust enough cash flows, which imparts an element of credit protection against revenue shortfall in the other projects. This financing instrument is typically used to leverage investments into smaller municipalities, by mixing them with projects from more credit worthy and larger municipalities. Some countries set up a Pooled Finance Development Fund (PFDF) to enable urban local bodies to access alternative sources of funding for their bankable projects and schemes. It facilitates local governments to access the capital and financial markets for investment in essential municipal projects. It facilitates the development of bankable urban projects and reduces the cost of borrowing with appropriate credit enhancement measures and through restricting of existing costlier debt. 13. Credit Enhancement Mechanisms In order to facilitate the development of the debt market financing, it is often necessary to increase the credit worthiness of urban infrastructure investments by providing additional layers of credit protection. Such additional protection would lower the cost of capital. Such credit enhancement can be provided directly through a guarantee fund, or by purchasing guarantees from financing institutions willing to underwrite the risk of a cash-flow shortfall. All this additional layers of credit protection, over and above the Project cash flows, is meant to mitigate the risks, lower the cost of capital and thereby encourage the growth of a debt market in urban infrastructure projects. UN-HABITAT Slum Upgrading Facility (SUF) and its Experimental Reimbursable Seed Operations (ERSO) are used by municipal governments as a means to develop pro-poor "bankable" projects and make use of credit enhancement to leverage domestic bank lending to finance housing and urban infrastructure through end users participation and micro-finance institutions. Generally speaking, the mechanisms for credit enhancement can be classified into three categories: (1) originator-provided, (2) structural, and (3) third-party provided. In the originatorprovided credit enhancement mechanism, a part of the credit risk of the asset pool is assumed by the originator/seller. In the structural credit enhancement mechanism, the redistribution of credit risks among the bond classes comprising the structure, so that one bond class provides credit enhancement to the other bond classes. In the third-party credit enhancement mechanism, the credit risk is assumed by parties other than the originator and the other bond classes in the structure.
14. Decentralisation of Financial Responsibilities to Local Governments Decentralisation is a key instrument to improve the financial capacities of local governments in some developing countries. Some ACP countries have decentralised a lot of government functions to local governments. However, the decentralisation of government functions is often not matched by the decentralisation of financial responsibilities to local governments. The key for future reform is to increase the financial responsibilities of local governments. 15. Financing Urban Infrastructure and Housing through Privatisation Financing urban infrastructure can also be achieved through privatisation. In this case, local governments should ensure that the infrastructure can be accessed by the urban poor and marginalised groups. The privatisation of water services in Jakarta, Indonesia, is an example of successfully achieving this balance and delivering services. In the UK, the Thatcher government promoted the privatisation of social housing and public services. In Tanzania, the some electricity generation plants are sold to the private sector. 16. Private-Public Partnership The private sector gained a lot of experience in investing and managing infrastructure and low cost housing over the time. In general a good regulatory system needs to be in place in order to secure the smooth cooperation between the public and the private sector. The possibilities of the private-sector-participation involvement are numerous. It starts with the possibility of contracting private companies for certain services and leads further to building and operating infrastructure facilities or to provide a concession to a private company to run the facility over a certain time. In many countries, for example in Kenya, the government encourages the development of low cost housing and urban services through private-public partnership and introduced a Public-Private Act. 17. National Resources for Financing Urban Infrastructure There are several sources of national funding for urban infrastructure. Firstly, the central government funding through inter-governmental transfers and grants; Secondly, credits from national banking institutions. Thirdly, create a savings culture and encourage citizens to deposit legal funds in their own country. Fourthly, in many developing countries there are large scale pension schemes. In order to administrate the pension funds well, the pension fund management is looking for risk-averse investment opportunities. Investments in infrastructure normally seem very appropriate and safe investment, because national and/or local governments are committed and normally provide the revenues of the user fees as collaterals. With a well-qualified management the infrastructure facilities normally could perform very well. 18. The Development of Land and Housing Finance Market The urban land and housing finance markets in many developing countries are rather immature and underdeveloped, which has far-reaching impacts on overall urban development. For example, most African households cannot access formal urban land and housing finance. It is
therefore perhaps not surprising that 71.9 percent of urban population in sub-sahara Africa were slum dwellers in 2001. Among the 28 percent of the African urban population that do not live in slums, many live in non-permanent structures or without proper titles. This is a direct outcome of lack of access to formal land transactions and housing finance instruments, such as mortgage finance. Due to lack of regular or predictable incomes for the urban majorities - and as a result of the absence of financial instruments catering to the urban majority of low-income populations - only some 15 percent of Africa s urban population may be eligible for formal finance. Therefore, formal land and housing finance can only benefit the richest 15 percent of the urban population and by implication exclude 85 percent of the African urban population. In reality, the proportion of population who can access formal mortgage finance is much less in Africa. In Kenya, the total mortgage loans portfolio is about 16,000. In Uganda, it has only a few thousand mortgage loans. Formal housing finance instruments include deposits, bonds, pension funds, compulsory savings, housing savings schemes, social housing funds and securitization. Most of these formal housing finance products are provided by commercial banks and building societies. In South Africa, mortgage securitization started as early as the 1980s and the United Building Society securitized Rand 250 million mortgage loans in 1988. The four major South African banks together hold over 85 percent of all mortgage loans, accounting for Rand 167.1 billion (USD21.7 million). In Zimbabwe, building societies provide 65 percent of all mortgage loans, while the formal housing finance sector is very small. In 2007, the total amount disbursed in the formal housing sector in Zimbabwe is USD 1.15 million. Conclusion There are huge gaps between urban services needs and the current level of investment in many developing countries. Urban infrastructure development, social housing and slum upgrading cannot catch up with the rapid urbanisation process and growing urban populations. This is reflected in the poor physical conditions and operational inefficiency in developing countries, particularly in ACP developing countries, which are characteristised by lack of basic urban infrastructure and services, and affordable housing. Some of these areas are turned into slums. Local municipal governments are lack of financial resources to meet the increased infrastructure needs and pressure for slum upgrading. In order to bring urban services and basic living conditions to an acceptable level, local governments must be empowered to raise and manage their own financial resources. They should increase their share of public resources. They should be able to access the capital market. It should also encourage the involvement of the private sector, NGOs and other social and political forces. To attract the private sector to become actively involved in financing urban services, affordable housing, and slum upgrading, the improvement in urban governance is essential. Democratic decision making, community participation, inclusiveness, equity, empowerment, and peoplecentred development of urban governance ensure that city affairs are run by competent people and to ensure that public resources are shared by the entire community and that resources are also allocated to those most in need. The interest of the private sector is taken care of. The risks should be shared by the public sector. The private sector is good in managing risks of urban investment. The private sector participation and utilisation of the capital market should be the main mechanisms for urban services and affordable housing provision.
Communities and people should be put in the centre for finding solutions, many communitybased initiatives in slum upgrading are introduced around the world including community development funds, pro-poor development funds, social investment funds, community sweat equity, and community contracting, and etc. Appropriate government facilitation, support and incentives are essential to realise the value of community-based initiatives in the process of slum upgrading. There is a great need for decentralisation of financial resources to the municipal government levels. The potential of resources which can be available to local governments are far from being utilised by local governments. Significant results can be achieved through opening up local tax revenue bases for local governments and access to the capital market to raise funds to finance urban infrastructure projects. The key determinants for future progress in financing urban services, affordable housing and slum upgrading are governance reforms through decentralisation and empowerment of local governments, advocating legislative reforms to open access to innovative urban services financing schemes. All these immediate agendas will positively affect the capacity of municipal governments to attract financing for important initiatives and activities and act as developmental agents to contribute to better local, national, and regional economic, social and environmental development.