City2City

Challenges and opportunities for Municipal Financing

The role of municipal finance in financing sustainable development is high. Many of the investments needed to achieve the 2030 Agenda are made at the subnational level, especially by cities. Local authorities have a responsibility to ensure that every citizen has access to essential services and that their provision is safe, affordable and sustainable. Increasingly, they need to prepare for climate change. Governments at the subnational level need to be able to access and mobilise diverse sources of finance to make long-term investments in sustainable urban development. Yet many cities are also constrained in their ability to raise and retain local revenue sources, take on debt and engage in public-private partnerships (PPPs). Project implementation and public financial management capacities may also be limited.

On the opportunities side, many local governments are exploring a range of advanced market-based finance tools, such as equity finance, pooled finance arrangements, municipal bonds and public-private partnerships. These mechanisms can help raise the long-term finance needed for capital investments in cities’ enormous infrastructure needs. Municipal bond markets are currently small but many analysts see high potential. Green bonds in particular are seen as an opportunity for city authorities to raise finance from domestic and/or international capital markets for urban improvement projects in energy, water, housing and transportation. In 2016, Mexico City issued the first municipal green bond in Latin America to pay for transit improvements, energy-efficient street lighting and other climate-friendly upgrades.

The capacity to support urban debt means that subnational authorities must consistently maintain a reliable surplus of revenues over expenditures. In this respect, many subnational governments are exploring how they can more effectively mobilise urban revenues. This includes through the use of traditional means such as property tax, as well as new alternative financial instruments.

Crowdfunding initiatives can be especially effective for small projects that are popular with citizens, such as public parks, bike lanes or a museum/cultural institution. Governments at the subnational level can use such platforms in a variety of ways to e.g. secure “last mile” financing (raise those last few dollars to make a project reality), create momentum to secure larger donations/contributions from other sources, or to raise matching funds to fulfill grant requirements. While crowdfunding is still more prevalent in advanced economies, many believe it has enormous potential in developing countries.

Other innovative financing models that can be useful for cities include social impact bonds, a newer approach that can be used to fund social programmes with a particular focus on excluded or marginalized populations, such as prison rehabilitation, youth unemployment and homelessness. UNDP for example has developed Serbia’s first youth employment bond to tackle high youth unemployment rates.

There are however also risks and challenges associated with many of these strategies. Municipal bonds and public-private partnerships are complex financial instruments. Badly-designed public-private partnerships for example can carry significant risks for the public in terms of reduced or more costly service coverage, poor quality of service or contingent fiscal liabilities. Central governments may resist the development of municipal debt markets because it is assumed that subnational entities will be bailed out by their central authorities in case of financial difficulties. Some subnational governments may not be particularly transparent or well-managed. Good governance and integrity are non-negotiable for the success of new finance approaches. Sometimes project implementation capacity is also weak.

UNDP's support in Municipal Financing

The role of municipal finance in financing sustainable development is high. Many of the investments needed to achieve the 2030 Agenda are made at the subnational level, especially by cities. Local authorities have a responsibility to ensure that every citizen has access to essential services and that their provision is safe, affordable and sustainable. Increasingly, they need to prepare for climate change. Governments at the subnational level need to be able to access and mobilise diverse sources of finance to make long-term investments in sustainable urban development. Yet many cities are also constrained in their ability to raise and retain local revenue sources, take on debt and engage in public-private partnerships (PPPs). Project implementation and public financial management capacities may also be limited.

On the opportunities side, many local governments are exploring a range of advanced market-based finance tools, such as equity finance, pooled finance arrangements, municipal bonds and public-private partnerships. These mechanisms can help raise the long-term finance needed for capital investments in cities’ enormous infrastructure needs. Municipal bond markets are currently small but many analysts see high potential. Green bonds in particular are seen as an opportunity for city authorities to raise finance from domestic and/or international capital markets for urban improvement projects in energy, water, housing and transportation. In 2016, Mexico City issued the first municipal green bond in Latin America to pay for transit improvements, energy-efficient street lighting and other climate-friendly upgrades.

The capacity to support urban debt means that subnational authorities must consistently maintain a reliable surplus of revenues over expenditures. In this respect, many subnational governments are exploring how they can more effectively mobilise urban revenues. This includes through the use of traditional means such as property tax, as well as new alternative financial instruments.

Crowdfunding initiatives can be especially effective for small projects that are popular with citizens, such as public parks, bike lanes or a museum/cultural institution. Governments at the subnational level can use such platforms in a variety of ways to e.g. secure “last mile” financing (raise those last few dollars to make a project reality), create momentum to secure larger donations/contributions from other sources, or to raise matching funds to fulfill grant requirements. While crowdfunding is still more prevalent in advanced economies, many believe it has enormous potential in developing countries.

Other innovative financing models that can be useful for cities include social impact bonds, a newer approach that can be used to fund social programmes with a particular focus on excluded or marginalized populations, such as prison rehabilitation, youth unemployment and homelessness. UNDP for example has developed Serbia’s first youth employment bond to tackle high youth unemployment rates.

There are however also risks and challenges associated with many of these strategies. Municipal bonds and public-private partnerships are complex financial instruments. Badly-designed public-private partnerships for example can carry significant risks for the public in terms of reduced or more costly service coverage, poor quality of service or contingent fiscal liabilities. Central governments may resist the development of municipal debt markets because it is assumed that subnational entities will be bailed out by their central authorities in case of financial difficulties. Some subnational governments may not be particularly transparent or well-managed. Good governance and integrity are non-negotiable for the success of new finance approaches. Sometimes project implementation capacity is also weak.

UNDP's support in Municipal Financing

UNDP is supporting subnational governments to adapt the Sustainable Development Goals (SDGs) to local contexts, take stock of available finance mechanisms, involve citizens directly in budget processes and pilot new and innovative financing models. For example, UNDP has supported SDG localization in China, Indonesia and Pakistan. In Pakistan and Angola, UNDP is working to strengthen the capacities of municipal administrations so that they – and the communities they serve – have greater control over decision-making processes and resource allocation. Other UN agencies are also supporting urban finance, notably the UN Capital Development Programme through its Municipal Investment Finance programme, which builds the capacity of local governments to access to sustainable sources of capital financing.

Subnational entities are arguably best placed to act holistically on the SDGs in their territories in a way that is inclusively accountable to citizens. Strengthening public finance and capacities at the sub-national level will be essential if they are to meet this challenge.

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