Pfma report ipe f inal

PUBLIC FINANCIAL MANAGEMENT AND ACCOUNTABILITY IN
URBAN LOCAL BODIES IN INDIA

SYNTHESIS REPORT

October 2006

Submitted to:
FINANCIAL MANAGEMENT UNIT
THE WORLD BANK, NEW DELHI

Submitted by:
INFRASTRUCTURE PROFESSIONALS ENTERPRISE (P) LTD., NEW DELHI

CURRENCY EQUIVALENTS
(Exchange Rate Effective)
Currency unit = Rupees (Rs.)
Rs. 1 = US$ 0.0226
US$ 1 = Rs. 44.20
FISCAL YEAR
April 1 – March 31
ABBREVIATIONS AND ACRONYMS
ADB : Asian Development Bank
APUIDF : Andhra Pradesh Urban Infrastructure Development Fund
APUSP Andhra Pradesh Urban Services for the Poor
ATR : Action taken report
BATF : Bangalore Agenda Task Force
BIDS : Budget Information Data Sheets
BMC : Bangalore Municipal Corporation
BMP : Bangalore Mahanagar Palike
BWSSB : Bangalore Water Supply and Sanitation Board
CAA : Constitutional Amendment Act
C&AG : Comptroller and Auditor General of India
CARE : Credit Analysis & Research Ltd
CBO : Community Based Organization
CCF : City Challenge Fund
CDP : City Development Plan
CFC : Central Finance Commission, Citizen Facilitation Centre
CFO : Chief Financial Officer
CRC : Citizens’ Report Card
CRISIL : Credit Rating and Information Services of India Limited
CRRID : Centre for Research in Rural and Industrial Development
DEAS : Double Entry Accounting System
DCB : Demand Collection and Balance
DFID : Department for International Development
DMA : Department of Municipal Administration
DPR : Detailed Project Reports
FBAS : Fund based accounting system
FI : Financial Institution
FIRE(D) : Financial Institutions and Reforms Expansion (Debt Servicing)
FLC : Field Level Consultants
FOP : Financial Operating Plan
FRS : Financial reporting system
GDP : Gross Domestic Product
HOD : Head of Department
ICAI : Institute of Chartered Accountants of India
ICRA : Investment Information and Credit Rating Agency of India Limited
JBIC : Japan Bank for International Cooperation
JMC : Jaipur Municipal Corporation
JNNURM : Jawaharlal Nehru National Urban Renewal Mission
KEIP : Kolkata Environment Improvement Project
KM : Kapra Municipality
KMC : Kolkata Municipal Corporation
KUIDFC : Karnataka Urban Infrastructure Development Finance Corporation
KUWSDB : Karnataka Urban Water Supply and Drainage Board

LCB : Lowest competitive bid
LFA : Local Fund Audit
MAC : Municipal Accounts Committee
MFAD : Municipal Finance and Accounts Department
MIS : Management Information Systems
MMA : Madurai Municipal Corporation
MoA : Memorandum of Agreement
MoF : Ministry of Finance
MoUD : Ministry of Urban Development
MoUEPA : Ministry of Urban Employment and Poverty Alleviation
MPC Metropolitan Planning Committee
NCU : National Commission on Urbanization
NDMC : New Delhi Municipal Corporation
NEGAP : National E-Governance Action Plan
NGO : Non governmental organization
NIPFP : National Institute of Public Finance and Policy
NIUA : National Institute of Urban Affairs
NMAM : National Municipal Accounting Manual
O&M : Operation and maintenance
PAC : Public Accounts Committee
PEFA : Public Expenditure Financial Accountability
PFDF : Pooled Finance Development Facility
PFMA : Public Financial Management and Accountability
PPP : Public private participation
PROOF : Public Record of Operations and Finances
QCBS : Quality and cost based system
RBI : Reserve Bank of India
RTI : Right to Information
RWA : Residents’ Welfare Association
RUIFDC : Rajasthan Urban Infrastructure Finance Development Corporation
SFC : State Finance Commission
SWM : Solid Waste Management
TFC : Twelfth Finance Commission
TGS : Technical Guidance and Supervision
TNUDF : Tamil Nadu Urban Development Fund
TNUDP : Tamil Nadu Urban Development Project
TNUIFSL : Tamil Nadu Urban Infrastructure Financial Services Limited
UDF : Urban development funds
ULB : Urban Local Bodies
UNDP : United Nations Development Program
URIF : Urban Reform Incentive Fund
USAID : United States Agency for International Development
ZBB : Zero Based Budgeting

Acknowledgements and Report Team

The PFMA consultants wish to acknowledge the extensive and grateful cooperation and assistance
received from various sources for carrying out this PFMA study, including officials and staff of the
union and state governments, officials of ULBs met, staff of donor funding agencies, and nodal
financial and research institutions. A list of people met has been appended in Annex A.
A grateful vote of thanks also goes to the Bank’s task team, led by Ms. Priya Goel. We would also
like to acknowledge the other team members who have provided guidance and advice on the study
including Mr. P Subramanian, Mr. Ivor Beazely, Mr. Manoj Jain, Mr. Raghu Kesavan, Mr. Joel A.
Turkewitz, Mr. Vinod Sahgal, Mr. Mohan Nagarajan, Mr. Chris Heymans, and Mr. Anup Wadhawan.
We are particularly thankful to Mr. M Rajamani (MoUD, Government of India ), Mr. Aniruddha
Kumar (MoUD, Government of India), Mr. Arun Mehta (MoUD, Government of India), Mr. R. N.
Gosh (C&AG), Ms. Geeta Menon (C&AG), Prof. Om Mathur, Mr. Alok Shiromany and Mr. K
Dharamrajan for their time and insight on the study.
This report has been prepared by Infrastructure Professionals Enterprise (IPE) Limited. The team
comprised of Ashwajit Singh, Abdul Rahim, Abhijit Ray, Himanshu Sikka, Dr. Gangadhar Jha,
Ashish Rao, Suresh Gupta and Anita Kapoor.

PUBLIC FINANCIAL MANAGEMENT AND ACCOUNTABILITY IN INDIAN
URBAN LOCAL BODIES: SYNTHESIS REPORT

Table of Contents
Executive Summary I
1 Rationale and Overview 1
1.1 Background 1
1.2 Objectives of the Study 1
1.3 Approach and Scope 2
1.4 Organization of the Report 2
2 Urban Reforms in India (PFMA Context) 3
2.1 Urban Context 3
2.2 Mapping Urban Reforms 3
3 PFMA Framework: Strategic Areas, Objectives and Outcomes 8
4 PFMA Components: Benchmarks, Policy and Progress 10
4.1 Legislative Framework 10
4.2 Planning and Budgeting 12
4.2.1 Budget Planning 12
4.3 Implementation 15
4.3.1 Budget Execution 15
4.3.2 Accounting and MIS 17
4.3.3 Cash and Fund Flow Management 22
4.3.4 Procurement 23
4.3.5 Internal Control and Audit 26
4.3.6 Assets and Liabilities Management 27
4.4 Reporting 28
4.5 External Audit and Oversight 30
4.5.1 External Audit 30
4.5.2 External Oversight 34
5 Key Issues and Way Ahead 37
5.1 Review and Strengthening of ULB Audit 37
5.2 Strengthening ULB Budgeting 37
5.3 Staffing and Capacity Building 38
5.4 Ensuring Compliance 39
5.5 Others 39
Annexes 40
Annex A: People Met 40
Annex B: Case Study Documentation 41
Annex C: List of Functions to be devolved to ULBs under 12th Schedule 58
Annex D: List of Functions mentioned under 12th Schedule devolved in States 59
Annex E: Accounting Initiatives in Different States 60
Annex F: PFMA Reforms under JNNURM and Current Status 65
Annex G: Cost and Performance Indicators 67
Bibliography and References 70

List of Boxes
Box 4.1: Autonomy to Urban Local Bodies in Kerala 10
Box 4.2: Budget as a Tool for Long Term Strategic Planning – Kapra Municipality 13
Box 4.3: Output Based Budgeting 13
Box 4.4: Budget Reforms in ULBs of Karnataka 14
Box 4.5: Budgeting Process in ULBs 14
Box 4.6: PROOF Initiative, Bangalore 16
Box 4.7: Fiscal Responsibility Act 17
Box 4.8: Merits of Accrual Based Accounting System 19
Box 4.9: Sources of Municipal Accounting Policies 19
Box 4.10: HR structure in ULBs to support strong financial management 21
Box 4.11: E-Procurement in Andhra Pradesh 25
Box 4.12: 11th Finance Commission Guidelines for Involvement of C&AG in ULB Audits 33
Box E.1: Tamil Nadu Accounting Manual 60
Box E.2: Tamil Nadu Accounting – Key to Success 60

List of Tables
Table 2.1: Urban Reforms in India (in PFMA context) 3
Table 3.1: Components, Strategic Areas and Outcomes for PFMA 8
Table 4.1: Enabling Legislative Framework 10
Table 4.2: Budget Planning 12
Table 4.3: Budget Execution 15
Table 4.4 Accounting and MIS 18
Table 4.5: Situation of Conversion to DEAS based on NMAM 20
Table 4.6: Cash and Fund Flow Management 22
Table 4.7: Procurement 24
Table 4.8: Internal Control and Audit 26
Table 4.9: Asset and Liabilities Management 27
Table 4.10: Reporting 29
Table 4.11: External Audit 30
Table 4.12: External Oversight 34
Table B.1: List of Probable Case Studies Identified for Documentation 41
Table B.2: Two-Dimensional Stratification of Probable Sample Cities 42
Table E.1: Comparison of DEAS across States 62
Table F.1: Cities/States that have signed MoA for implementation of reforms under JNNURM 66
Table F.2: Status of City Development Plans (CDPs) under JNNURM 66

List of Figures
Figure 3.1: PFMA Analysis Framework 9

Public Financial Management and Accountability in Indian ULBs I
Executive Summary
INTRODUCTION
An improved Public Financial Management and Accountability (PFMA) environment has become
crucial to better urban governance and performance. The Ministry of Finance (MoF), Government of
India requested the World Bank to undertake a study on status of PFMA in ULBs in India. The main
objectives of this study are to assess the current state of PFMA systems in ULBs in India; identify,
analyze and document best practices of PFMA in select ULBs focusing on their existing context,
success factors and replicability.
URBAN REFORMS IN INDIA (PFMA CONTEXT)
Streamlining of the legislative and fiscal arrangements in India across the three tiers of government is
a continuous process in India. There exists a sound policy framework (74th Constitutional
Amendment Act, 1992, Right To Information Act, 2005 etc.), reform led nationally sponsored
initiatives (Jawaharlal Nehru National Urban Renewal Mission, National Municipal Accounting
Manual etc.), instances of best practices at state/local level, and increasing demand from civil society
for transparency and reforms. However, there is a need for greater institutionalization and more
visible results in the areas of PFMA in ULBs.
PFMA FRAMEWORK: STRATEGIC AREAS, OBJECTIVES AND OUTCOMES
A strong PFMA system is the key to achieving Public Demand

development objectives and an efficient service Planning and Budgeting
delivery mechanism in ULBs. The PFMA Legislative Framework -Budget Planning and linkages
with PFMA components

External Audit and
framework is shown alongside bringing out the
Implementation
linkages between legislative, budgeting,

Reporting

Oversight
- Budget Execution
implementation, reporting and oversight process in -Cash Management

the ULBs. Improved functioning in these areas -Procurement
-Accounting and MIS
would lead to increased accountability and enhanced -Internal Control and Audit
levels of service delivery. The recent impetus for -Asset and Liabilities
Management
reforms brings out the acceptance, need and
requirement to put PFMA at the center-stage of Increased Accountability and
improved governance and service delivery. Improved Service Delivery

PFMA COMPONENTS: BENCHMARKS, POLICY AND PROGRESS
Legislative Framework: a strong and comprehensive legislative framework is existing leading to
improved PFMA.
ULBs are governed by respective state municipal acts. While comprehensive in areas such as
financial control, budgeting and audit, there are gaps in procurement, monitoring and enforcement.
Since these laws were primarily directed to make ULBs accountable to the state government, they are
weak on participative planning, public accountability and modern accounting, audit and management
practices. Although the legislative reform environment is positive (including a Model Municipal Law
issued by the Government of India in 2003), ULBs lack in implementation capacity.
Planning and Budgeting: policy direction and budget planning and preparation is realistic,
comprehensive, orderly and participatory within overall government policy
Budgets are generally seen as a statutory requirement and hence limited to providing sanction for
expenses and revenues. Current budgeting practices are not directly linked to a larger management or
strategic planning process. The rigor of planning is replaced by incremental budgeting and the need
for debates and participation is limited to the elected representatives. Alongwith JNNURM initiatives,
some state efforts are on to improve budget processes, formats and systems. This should move
budgeting from a stand alone process to an integrated, strategically linked planning aid.
Budget Execution: the budget is used as a tool for planning, procurement, and expenditure control

Public Financial Management and Accountability in Indian ULBs II
There is weak monitoring and follow up of budgets with hardly any review mechanism for variations.
This, alongwith unpredictability of state funding causes uncertainty in the budget execution process.
Re-scheduling of budget heads during the year is a common practice. Further, any shortfall in
revenues generally leads to cut in capital expenditure and O&M. The citizen interface also remains
weak barring few successes like Public Record of Operations and Finances (PROOF) in Bangalore.
Accounting and MIS: accounting system and management information system are complete,
accurate, timely and meaningful
ULBs in India have traditionally been following the single entry cash basis of accounting. This limits
their ability to prepare meaningful performance reports and statements of financial position.
Predominantly manual, the multiplicity of registers and limited capacity of staff generally results in
accounts remaining in arrears for several years. Now, mandated by a Supreme Court decision to adopt
double entry ‘full cost’ accounting and the release of National Municipal Accounting Manual
(NMAM), many states are now moving to double entry accrual accounting system. The challenge is
to build capacity for using this financial information for improved decision making in ULBs.
Cash and Fund Flow Management: cash receipts, payments and fund flows are managed
efficiently
There are weak cash and treasury systems in most ULBs, primarily due to the weak accounting
system currently in practice. Bank reconciliations are generally in arrears and cash management is
limited to prioritization of checks issue. Some ULBs were even unable to optimally utilize funds
raised through bonds. Along with their capacity, ULBs also need to improve their inter-departmental
co-ordination for treasury management function to be successful.
Procurement: efficient system and management of procurement in place to ensure increased
competition, value-for-money and transparency
Almost 30 to 50 percent of the ULB budget requires external procurement, usually made by the
consuming department itself. Legislation governing procurement, though rudimentary, defines
procedures and limits for procurement. However, there is lack of focus on quality, performance and
linkages with planning. Procurement practices lack modern concepts such as ‘just in time’ inventory,
scientific determination of procurement quantities etc. although some states in India have also moved
to e-procurement and works based grievance redressal systems.
Internal Control and Audit: clearly defined and effective policies, systems and procedures for
internal control and audit are in use
Most ULB Acts do not specify requirements for internal audit. Internal controls are generally
incorporated in financial rules and focus on delegation of financial limits. Some ULBs have Standing
Committee for audit and accounts with the objective of scrutinizing ULB accounts at each level and
ensuring compliance with audit notings. With shift to modern Double Entry Accrual Accounting
System, the need for effective internal audit has become even more necessary.
Assets and Liabilities Management: policies, procedures and database of all assets is available
and used for effective decision making in capital investment and management
ULBs generally hold a significant amount of fixed assets in land, buildings and infrastructure. Few
local bodies have exploited the commercial potential of these properties to generate non-tax revenues.
For infrastructure assets, maintenance is poor and O&M expenditure is either not allocated in the
budget or is not available due to deficits. Most ULBs do not have a proper inventory of assets nor do
they update them regularly. Similarly, ULBs again do not have complete listings of creditors. As a
result they are neither able to utilize their assets effectively nor deal with liabilities in a planned
manner. Modern accrual accounting practices are expected to address this shortcoming.
Reporting: timely, meaningful and user-friendly reporting structures in place allowing effective
engagement with various stakeholders
The reporting requirements for ULBs remain weak. The overriding focus of state Acts is to provide

Public Financial Management and Accountability in Indian ULBs III
accountability to the state and hence reporting is limited to compliance certificates, budgets and
periodic administrative statements. There are no guidelines on disseminating financial results to the
public. Some efforts have been made through the Public Disclosure Law, National E-governance
Action Plan (NEGAP), Citizen facilitation Centers (CFC), etc. Karnataka has incorporated a public
reporting requirement in its recent accounting rules as well. These efforts are intended to improve the
accountability of ULBs to the citizens.
External Audit: clearly defined systems for timely, independent and effective external audit
Current audit mechanism continues to be the weakest link in the PFMA cycle. Audit is generally
carried out by the Local Fund Auditor limited to transaction reviews and focusing on prudence and
compliance. Audit objections or ‘paras’ are made where again the follow-up process is weak. There is
a large backlog of audits due to limited capacity of LFA and increasing transactions of ULBs. The
Comptroller & Auditor General of India has recently also been involved in ULB audits. With the
adoption of double entry accounting system, audit capacity needs to be enhanced and professional
independent audit commenting on the ‘truth and fairness’ of financial statements required in addition
to the routine compliance audits.
External Oversight: functional independent systems for increased accountability and oversight are
in place leading to improved decision making
Public involvement in ULB’s governance is prima-facie missing in the current legislative
environment. Limited availability of reports in the public domain, weak community structures and
lack of involvement of citizens lead to poor external oversight. In absence of properly functioning
ward committees, the only oversight is taken up by NGOs and CBOs. PROOF and Citizen Report
Cards in Bangalore are good examples of this. Steps for increased participation are on and these are
expected to evolve into an improved accountability mechanism in due course.
KEY ISSUES AND WAY AHEAD
Review and Strengthening of ULB Audit. The area of ULB audit remains weak. MoUD may
consider constituting a task force and review the existing capacity and suggest strengthening
measures for audit in ULBs. It could also advise on moving towards performance and management
audits, clear old audit backlogs and training of LFA auditors with reference to the changed financial
reporting scenario, double entry accrual accounting and modern audit techniques.
Strengthening ULB Budgeting. Although current schemes promote bottom-up budgeting, there
exists a gap in ‘operationalizing’ them. There is a need to consider a Budgeting Manual (perhaps on
the lines of NMAM) for evolving budgeting into an efficient planning, review and management tool
through Output budgeting; multi-year rolling plans, scientific forecasting and zero-based budgeting.
Staffing and Capacity Building. There are no benchmarks and capacity building plan in most ULBs.
Most states and ULBs are using external consultants and donor support to implement PFMA reforms,
although this may not be sustainable in long run. MoUD may consider a review and advisory
guidance for creation of skilled positions and restructuring / abolishing obsolete and outdated
positions. This could include: staffing structure of critical areas (especially PFMA related); review of
current availability of staff, training requirements etc.
Ensuring Compliance. Ensuring compliance with laws is another weak link in the PFMA cycle.
Various mechanisms could be explored such as linking devolution of funds to compliance with rules
and regulations; tabling the status of budget and financial statements of ULBs in state assembly and
fixing timelines for action taken report on audit queries.
In addition, some other areas that could be taken up include:
• Promoting adoption of key PFMA requirements from Model Municipal Law;
• Handholding and assistance to states for developing accounting policies and implementation of
NMAM;
• Development of Procurement guidelines for independent, effective and cost efficient procurement

Public Financial Management and Accountability in Indian ULBs 1
1 Rationale and Overview
1.1 Background

1. India is undergoing a distinct shift in its demography. Since independence in 1947, its
population has tripled while its urban population has grown more than five times. With liberalization
of the economy in the 1990s and development of the tertiary sector, urban centers have become
important generators of national wealth. Urban India, housing 27 percent of the population, today
accounts for more than 50 percent of GDP and 90 percent of taxes in the country. However, this rapid
urban growth has taken its toll on the civic infrastructure, widening the gap between demand and
supply and leading to deteriorating environment and quality of life in many cities of India.
2. Urban Local Bodies (ULBs), as the providers of urban services face the challenge of meeting
these demands through better management of resources and identifying new and innovative sources
of funding. It also requires ULBs to shift their dependence for funds from the traditional central / state
government grants to the citizens (for taxes), external financiers (for borrowings) and development
agencies (for soft loans).
3. With this gradual increase in external stakeholders, ULBs cannot continue to function as closed
dominions with their set systems. ULBs now need to demonstrate an efficient system of public
financial management, an ability to provide cost effective services and an environment of
accountability and transparency to their stakeholders. It is in this context that improved Public
Financial Management and Accountability (PFMA) has become crucial not only for better
governance but also for improved service delivery.
4. The Ministry of Finance (MoF), Government of India requested the World Bank (the Bank) to
undertake a study on status of PFMA in ULBs of India. This was followed by a series of meetings
between the Bank and the Ministry of Urban Development (MoUD), identifying weaknesses in
current systems and showcasing some good examples of PFMA in ULBs. This report synthesizes the
study and discussions, highlighting major issues which need to be addressed for developing a
progressive environment for PFMA in the country’s ULBs.

1.2 Objectives of the Study

5. The main objectives of this study are:
i. To assess the current state of PFMA systems in ULBs in India against best practices,
benchmarks and indicators.
ii. To identify, analyze and document best practices of PFMA in select Indian ULBs focusing on
their existing context, success factors and replicability; and
iii. To identify the challenges and suggest priorities to improve PFMA in Indian ULBs.
6. The timing of this study coincides with the launch of Jawaharlal Nehru Urban Renewal Mission
(JNNURM), an incentive led reform program initiated by Government of India with the objective of
developing economically productive, efficient, equitable and responsive local governance1. Some of
the key reform measures initiated under the Mission are introduction of modern and transparent
budgeting system, double entry accrual system of accounting, e-governance, improved asset
management and computerization of management information systems.2
7. This study is likely to provide an insight to key issues for improving the PFMA environment in
Indian ULBs. The documented cases of PFMA would also provide replicable models of success
which can be encouraged by the MoUD. Since institutional and systemic reforms in PFMA are not an

1
The JNNURM has been launched for 63 largest and important cities of India. A similar program for remaining ULBs has
also been simultaneously launched under the name of Urban Infrastructure Development of Small and Medium Towns
(UIDSMT).
2
Government of India (2005), JNNURM Toolkit, MoUEP and MoUD, Government of India

end in itself but part of the broader governance agenda, the study aims to approach the subject from
both an analytical and contextual perspective.

1.3 Approach and Scope

8. This report is largely based on desk review and research, supported by consultations with some
well-known experts on the subject, institutional donors, central and select state governments and
representatives of the Bank. The scope of this study is largely based on available literature, select
ULB case studies and discussions with a few key stakeholders.3
9. This report also documents experiences of PFMA in select Indian ULBs focusing on their
existing context, success factors and replicability. Following an initial shortlisting on April 19, 2006,
a detailed review of various cases was carried out based on the following principles:
• The activity should be directly related to enhancing PFMA in the ULB and should have
demonstrated results;
• The selection of cases should be a representative cross-section, covering ULBs of different
sizes ;
• A regional balance should be maintained (limited to one case per state); and
• The cases should represent the various facets of PFMA and be capable of being replicated
across other ULBs
10. Accordingly, a list of good cases was prepared (Annex B). Although some related agencies
such parastatals, development bodies etc. were also initially included, it was decided to limit this
study to good PFMA practices in 6 ULBs of the country.

1.4 Organization of the Report

11. The report is divided into five sections:
i. Section 1 – Overview and Rationale - provides the overall context, objective and scope of the
current study;
ii. Section 2 – Urban Reforms in India (PFMA Context) - this section briefly provides the
settings of urban reforms having an impact on PFMA in India;
iii. Section 3 – PFMA: Strategic Areas, Objectives and Outcomes - this section provides the
analytical framework under which this study has been conducted;
iv. Section 4 – PFMA Components: Benchmarks, Policy and Progress - this section analyses the
different components of PFMA outlined in the previous section, devises a set of selective
indicators and benchmarks for each PFMA areas. It then discusses the policy, progress and
gaps in each against the benchmarks.
v. Section 5 – Key Issues and Way Ahead - based on major findings from the above sections,
this section outlines some of the key priorities and way forward for improving PFMA in
Indian ULBs.

3
National institutions include discussions with C&AG Office, ICAI, NIPFP. Donor agencies include Department for
International Development (DFID), Asian Development Bank (ADB) United States Agency for International Development
(USAID) apart from the Bank itself. States covered in detail include Karnataka, Tamil Nadu, Rajasthan, Andhra Pradesh,
Delhi and Kolkata.

2 Urban Reforms in India (PFMA Context)
2.1 Urban Context

12. India has a parliamentary system of government which is federal in structure4. There are three
tiers of government; the union or national government, various state governments and the local
government bodies. Urban development, as per the Constitution, is a state subject but key functions
related to urban services are delegated to ULBs (vide the 74th Constitution Amendment, 1992).
13. Local Governments in the urban context comprise of Municipal Corporations for larger urban
settlements, Municipal Councils for small and medium urban settlements and Nagar Panchayats5 for
transition settlements. The classification of any settlement into these three categories is based on
criteria which are decided at the state level6.
14. The municipalities are created and governed by a state Act. Many states have separate Acts for
each category of ULB but some (such as Tamil Nadu) have also unified their Acts into one for all
categories. In some exceptional cases (as in West Bengal), separate Acts exist for each Corporation
with a common Act for all other municipalities. Every state also has a ‘Department of Municipal
Administration’ which is responsible for overseeing and regulating ULBs as per the State Acts.
15. Although not directly governing the ULBs, the Government of India also influences and shapes
their policies and programs. The Ministry of Urban Development (MoUD) and the Ministry of Urban
Employment & Poverty Alleviation (MoUEPA) are parts of union government which formulate
national policies, sponsor and support programs, coordinate the activities of various State
Governments and monitor programs concerning urban development in the country7. The Planning
Commission and the Central Finance Commission (CFC) are other national bodies which play a key
role through their policies and recommendations for the growth, development and financing of ULBs.

2.2 Mapping Urban Reforms

16. The streamlining of the legislative and fiscal arrangements in India across the three tiers of
government has been a continuous process and is still on. Tracing back, the National Commission on
Urbanization (NCU) Report of 1988 was perhaps the first explicit recognition of urbanization and
economic growth linkage in India. Since then, there have been a series of evolving reforms for the
overall development and improvement of urban governance environment in the country. Some key
milestones (in PFMA context) are given below:

Table 2.1: Urban Reforms in India (in PFMA context)
Year Policy Intervention Impact on PFMA in Urban Sector
1985 7th Five Year Plan Policy recommendations for revitalization of civic bodies; reform of
municipal administration; constitution of state finance commissions;
and constitutional status for local government.
1988 NCU Link between urbanization and economic growth explicitly
acknowledged. Reiteration of the need for decentralized urban
growth and emphasis on the role of local governments
1991-92 New Economic Policy Autonomy of local governments seen necessary for deregulation and
privatization of provision and maintenance of urban infrastructure
and basic services.
1992 74th Constitutional Devolution of powers (political, administrative and fiscal) to ULBs

4
Governed by the Constitution of India which came to force on 26 January 1950.
5
These may be referred to by different names in different states; for example, in Uttar Pradesh Municipal Corporations
would be referred to as Nagar Nigam, and Municipal Councils as Nagar Palika.
6
The gradation of an area into transitional, small or large is to be determined by the Governor of a state on the basis of
such factors as population, area, density, revenue generated for local administration, employment in non agricultural
activities, and other factors that point to the economic importance of the area [243 (Q) (2)]
7
http://urbanindia.nic.in/moud/theministry/ministryofurbandevelopment/main.htm

Year Policy Intervention Impact on PFMA in Urban Sector
Amendment Act for functioning as ‘independent institutions of self government’
1992-97 Formation of SFCs To correct fiscal disabilities imbalances of local bodies and improve
their financial situation and review financial position of ULBs and
make recommendations regarding distribution of taxes, revenue-
sharing arrangements, grant-in-aid system etc.
1998 First Municipal Bond Landmark initiative followed by issue of guidelines for issuing tax -
(Ahmedabad Municipal free municipal bonds in Feb 2001 and increase in the limit from Rs.
Corporation) 2000 million in 2001-02 to Rs. 5000 million in 2002-03.
2000 11th Central Finance Recommend measures for augmentation of resources of states so that
Commission they can supplement resources of local bodies.
2002 Urban Reforms Policy initiative aimed to encourage reforms in ULBs (covered some
Incentive Fund PFMA areas like accounting, budgets etc.)
Supreme Court Highlight the issue of accountability of executives in ULBs for
Judgment on SWM service delivery. Instituted reforms in accounts for greater
transparency and better management of service costs.
C&AG Task Force Took the initiative to formulate policy guidelines on municipal
accounting reforms through Double Entry Accrual Based
accounting.
Pooled Finance Precedence set by Tamil Nadu for smaller ULBs to raise funds from
capital markets.
2003 Model Municipal Law Template for states to revise their municipal legal framework. Key
focus on improving state oversight of municipal finances through
SFC recommendations
2005 Right To Information Government of India initiative towards transparency and
Act accountability. Adopted by most of the states.
National Municipal Guidelines to the states/ULBs for accounting reforms on Double
Accounting Manual Entry Accrual System
Launch of JNNURM Reforms-driven, fast track mission for planned development of
identified cities with focus on efficiency in urban infrastructure and
services delivery, community participation, and accountability of
local governments towards citizens.
2006 ULG Disclosure Bill Provide for transparency and accountability in the functioning of
ULBs

17. The key features and landmark policy initiatives related to PFMA may be summarized as
under:
Policy Framework
• 74th Constitutional Amendment Act. The 74th Constitutional Amendment Act (CAA) was
passed in 1992 to accord formal recognition to ULBs in the Constitution and make them more
autonomous and participatory. It provided powers to ULBs to function as ‘independent institutions of
self-government’ and directed states to devolve specific (18) functions to ULBs under Schedule XII
(Annex C). ULBs were also empowered to collect taxes and states were required to set up State
Finance Commission (SFCs) to review and make recommendations regarding distribution of taxes,
revenue-sharing, grant-in-aid system, issues of local autonomy between the state and ULBs. This
amendment also provided for having an elected council for each ULB (with reservation for women);
constitution of ward committees; creation of a district/ metropolitan planning committee and
establishment of funds at the ULB level to handle receipts and disbursements.
Although most states have amended their municipal laws in accordance with the CAA; the extent of
devolution / decentralization to ULBs has been uneven across the states. A comparative status of devolution /
decentralization in some of the major states is appended in Annex D8.

8
Even in states where most of the functions have been devolved to ULBs, they still depend on rules and regulations
specified by the State Government. Functional decentralization is also not backed by financial devolution. For example,
in Karnataka ULBs are required to take State approval for hiking property tax. Interestingly, though ULBs in Tamil Nadu
and Uttar Pradesh are allowed to revise property tax without State consent, ULBs generally end up asking for permission.

• Expanded scope of Central and State Finance Commissions. With enactment of the 74th
CAA, the scope of Central Finance Commissions (CFC) was expanded to recommend measures for
augmentation of resources for local bodies. The 11th CFC looked for the first time into local
government finances including issues of
i. Separate tax domain for ULBs;
ii. Establishment of a separate framework for allocations of central grants to ULBs and
iii. Requirement for Action Taken Report by state government on SFC recommendations within
six months.
The role of SFCs was also elaborated and their mandate explicitly included a review of ULB
finances and recommendations on revenue sharing, financial autonomy and improving financial
management practices in the ULBs of the state.
The CFC and SFC recommendations for ULB finances have only been partly put into practice. Although many
states have established the SFCs, Action Taken Reports show that compliance and acceptance of the
recommendations is generally weak. The earlier problems of transparency and predictability of funds for
ULBs has only marginally improved.

• Model Municipal Law (2003). In order to help facilitate the implementation of 74th CAA, the
Government of India developed a ‘Model Municipal Law’ in 2003 (facilitated by the Indo-USAID
FIRE –D project) to serve as a template for states to revise their municipal legal framework. Key
relevant provision of the Model Municipal Law include
i. Improving state oversight of municipal finances through SFC recommendations;
ii. A form of administrative receivership for cities that default in the performance of their duties;
iii. Mandatory framing of ULB debt limitation policy;
iv. Development of a state-wide municipal accounting manual;
v. Creation of a Municipal Accounts Committee at ULB level and preparation of annual
Balance Sheets;
vi. Mandatory requirement for ULBs to prepare inventory of all municipal assets;
vii. Encouragement for ULBs to implement their own development plans; and
viii. Framework for private sector participation in the construction, financing and delivery of
services.
All these, if and when implemented would have a major impact on improved PFMA.
The Model Municipal Law is yet to be adopted in any state till date. It has been argued that since the model
remains recommendatory and not linked to any incentive, its compliance is not adequately stressed.

• The Right to Information Act, 2005. This recent Act has far reaching implication for
governance and transparency in public financial management. It requires government bodies to
provide any information sought on its operations within a specified time frame. It also promotes pro-
active disclosure of certain information by government bodies. The Act provides for elaborate
disclosure requirements, appointment of responsible officers as Central and State Information
Commissioners, an independent appeal mechanism and stringent penalties for default. However, its
effective implementation at the local government level remains a challenge due to poor
recordkeeping and computerization practices, weak political will as well as the traditional mindset of
information scarcity and reluctance to part with ‘official information’ by the government.
• Draft Urban Local Government Disclosure Bill, 2006. This proposed initiative is aimed at
providing transparency and accountability in the functioning of the municipalities. As per the draft
bill, every municipality shall maintain all its records in a manner and the form which facilitates the
municipal authority to disclose the required information at regular intervals to the public. The manner
of disclosure has been defined as through newspapers, internet, notice boards, ward offices, etc. This
envisages voluntary sharing of information by the ULBs and is a step forward from the RTI Act.

Resource Mobilization and Financial Management
• Municipal Bonds and Pooled Finance. An important development in urban financing has
been the access to debt market by ULBs. The pioneer in this case was Ahmedabad Municipal
Corporation which floated its bonds in 1998. Thereafter, several other cities (generally large
Corporations) have issued similar bonds. The Government of India supported these initiatives by
exempting the interest earned on such bonds from income tax (Finance Act, 2000) and prescribing
guidelines for tax -free municipal bonds (February 2001).
Smaller municipalities which could not access the capital market on their own developed
pooled financing models, issuing bonds for a pool of cities (Ex. Tamil Nadu, 2002 and Karnataka,
2004). In 2006, the Government of India proposed development of a Pooled Finance Development
Fund to institutionalize and support smaller ULBs in this process.
The most important outcome of issuing municipal bonds was not the amount raised by the ULB, but
familiarizing them with the financial discipline and accountability requirement of the markets. These included
updated accounts, credit rating and sound reporting practices; all essential components of a good PFMA
environment in ULBs today. It is interesting to note that in spite of ULBs having weak finances in India, none
of the 15 odd municipal bond issues have defaulted in repayment till date.

• Accrual Accounting in Municipalities. One of the landmark judgments in urban governance
was by the Supreme Court in Almitra Patel vs. Union of India (2002). The case related to weak
financial management and practices in solid waste management by ULBs. The Supreme Court,
concerned with the weak financial reporting system in ULBs, ordered the Government to develop
guidelines for moving to a full cost based accrual accounting system for ULBs. Accordingly, a Task
Force was appointed in 2001 under chairmanship of the Deputy Comptroller and Auditor General of
India (C&AG) to prescribe the accounting system and processes to be followed by ULBs for better
financial recording and reporting.
Based on the recommendations of this Task Force, the Government of India initiated
development of a National Municipal Accounting Manual (NMAM) based on double entry accrual
basis of accounting, standard chart of accounts and guidance on preparation of opening balance sheet
etc. The NMAM was issued in 2005 and subsequently few states such as Karnataka, Andhra Pradesh,
Gujarat and West Bengal have adopted these recommendations in their manuals. In certain other
states such as Orissa, Madhya Pradesh and Uttar Pradesh, the adoption of NMAM is under progress.
Incentive led reforms
• Urban Reform Incentive Fund (URIF). In order to accelerate and incentivize the process of
urban reforms the Government of India decided to provide reform-linked assistance to states. The
2002-03 budget called for setting up an Urban Reform Incentive Fund (URIF) with an initial outlay
of Rs. 500 crores per annum during the 10th Plan. URIF was designed to provide incentives to state
governments for reforms in state and local government including repeal of Urban Land Ceiling Act;
rationalization of stamp duty; reform of rent control laws; introduction of computerized registration;
reform of property tax; levy of user charges; and adoption of Double Entry Accounting System
(DEAS).
URIF in practice became more allocation driven then reform driven. The progress towards the envisaged
reforms was extremely slow and one of the prime reasons behind this was stated to be the low levels of
incentive to carry out reforms. Other donor efforts such as City Challenge Fund (CCF) also did not
materialize because of similar problems of low levels of incentives. Out of the 24 states that signed
Memorandum of Agreement (MoA), only 12 states remained eligible to receive the second installment.

• Jawaharlal Nehru National Urban Renewal Mission (JNNURM). The latest in the realm of
urban reforms vehicles in India is the JNNURM. JNNURM is designed to be a reforms-driven, fast
track mission for integrated and planned development of 63 identified cities with focus on asset
creation and management, efficiency in urban infrastructure and services delivery, community
participation and accountability. JNNURM has a central outlay of Rs. 50,000 crore ($11billion) for a
seven year period. The key to achieving its ambitious objectives includes initiatives for better PFMA
in the targeted cities. In fact, the JNNURM requires a tri-partite MoA between the ULB, the State

government and the Centre that clearly identifies reforms in areas of PFMA, among others, and a
timeline for achieving the same at all levels. Some of the key reforms include: modern and
transparent budgeting system; shift to DEAS; improved asset management; e-governance; updated
financial management systems; enhanced property tax collection efficiency; enactment of Public
Disclosure Law and Community Participation Law; levy of reasonable user charges; process re-
engineering using IT; quarterly monitoring by central and state level agencies; Financial Operating
Plan under CDP; credit rating etc.
However, it will be important to ensure that the fate of this mission is not similar to previous
efforts with incentive led reforms. Eight states have signed MoA and 19 out of the 63 cities have
already come up with their City Development Plans and some have initiated the preparation of
Detailed Project Reports as well.
To summarize, there exists a sound policy framework (74th CAA, RTI), reform led nationally sponsored
initiatives (JNNURM, NMAM), instances of best practices at state/local level, and increasing demand from
civil society for transparency and reforms. More progress has been made in the last five years than in the last
two decades. However, a lot still needs to be done. There is a need for greater institutionalization, internal
reforms and more visible results especially in the areas of public financial management and accountability. It
is this which the current report hopes to address.

3 PFMA Framework: Strategic Areas, Objectives and Outcomes
18. Effective institutions and systems of PFMA have a critical role to play in supporting
implementation of policies for national development and poverty reduction.9 Essentially, a strong
PFMA system is the key in ensuring achievements of development objectives, supporting aggregate
fiscal discipline, strategic allocation of resources and efficient service delivery. Based on the
understanding of the ULB system in India, critical dimensions of performance for an efficient PFMA
system are identified (Refer Table 3.1).
19. The framework has been developed based on interaction at different levels (national, state and
ULB) on the various components of PFMA10. Subsequently, for each of the PFMA area, outcomes
and indicators were developed. The framework was shared with the World Bank11 and MoUD12 and
comments and suggestions incorporated.

Table 3.1: Components, Strategic Areas and Outcomes for PFMA
Framework Strategic Area Outcome
Component
Legislative • Enabling legislative • A strong and comprehensive legislative framework
Framework framework exists which encourages sound PFMA practices
• Policy direction, budget planning and preparation is
Planning and
• Budget planning realistic, comprehensive, orderly and participatory
Budgeting
within overall government policy
• The budget is used as a tool for planning, procurement
• Budget execution
and control, ensuring transparency
• Accounting system and management information
• Accounting and MIS
system are complete, accurate, timely and meaningful
• Cash and fund flow • Cash receipts, payments and fund flows are managed
management efficiently
Implementation • Efficient system and management of procurement in
• Procurement place to ensure increased competition, value-for-money
and transparency
• Internal control and • Clearly defined and effective policies, systems and
audit procedures for internal control and audit are in use
• Policies, procedures and database of all assets and
• Asset and liabilities
liabilities is available and used for effective decision
management
making in capital investment and management
• Timely, meaningful and user-friendly reporting
Reporting • Reporting structures in place allowing effective engagement with
various stakeholders
• Clearly defined systems for timely, independent and
• External audit
External Audit effective external audit are in use
and Oversight • Functional independent systems for oversight are in
• Oversight
place leading to improved decision making

20. The study analyses various linkages that exist between the legislative, budgeting,
implementation, reporting and oversight process in ULBs in India. Benchmarks and indicators have
been developed for each strategic area and analysis of policy, practice and progress in each of these

9
PEFA Secretariat, 2005, Public Financial Management Performance Measurement Framework, World Bank, pp.III.
10
A consultative workshop with key experts in areas of PFMA (Prof. O P Mathur, Mr. K Dharmarajan, Mr. Alok
Shiromany; Mr. Vinod Sahgal) was organized on the August 9, 2006 to identify the strategic PFMA areas.
11
Presentation organized at World Bank premises on August 21, 2006 and was attended by key officials involved in the
study from the Bank. Those present included Mr. P K Subramanian, Mr. Manoj Jain, Ms. Priya Goel, Mr. Chris Heymans,
Mr. Raghu Kesavan, Mr. Alok Shiromany, Mr.Vinod Sahgal, Mr. Joel A. Turkewitz, Mr. Gangadhar Jha, Mr. Ashwajit
Singh and others.
12
A presentation and discussion on the framework was subsequently held at the MoUD on September 7, 2006. Those
present included Mr. Aniruddha Kumar, Mr. R N Ghosh, Ms. Geeta Menon, Ms. Priya Goel, Mr. Raghu Kesavan, Mr. Alok
Shiromani, Mr. Ashwajit Singh and Mr. Himanshu Sikka.

areas has been conducted. The framework has been developed around broad areas defined in the
handbook for Performance Measurement Framework issued by the PEFA secretariat13.

Figure 3.1: PFMA Analysis Framework
Public Demand

Planning and Budgeting
-Budget Planning and linkages

Legislative Framework
with PFMA components

External Audit and
Implementation

Reporting

Oversight
- Budget Execution
-Cash Management
-Procurement
-Accounting and MIS
-Internal Control and Audit
-Asset and Liabilities
Management

Increased Accountability and
Improved Service Delivery

21. A sound legislative framework is the facilitative aspects for most PFMA initiatives. The study
reviews the current status of legislation and how they have reflected the various aspects of functional
devolution, decentralization and greater accountability in urban governance. Under planning and
budgeting process, the study looks at current planning practices and reviews the various aspects of
better planning, budgeting and reporting for participatory, inclusive and transparent planning by
ULBs.
22. In implementation, the study looks at the areas of budget execution, cash and fund flow
management, procurement, accounting and MIS, internal control and audit, and assets management.
The emphasis is on analyzing the systems for their efficiency and effectiveness. In reporting, the
emphasis is on assessing that the reporting mechanism, both internal and external, is timely,
meaningful and user-friendly. The framework also analyses whether the reporting structures in place
allow effective engagement with various stakeholders or not.
23. Finally, the analysis framework focuses on the issue of external oversight and audit. It is
important to appreciate that an improved PFMA environment has to be demand led with citizens and
stakeholders building pressure and requiring accountability from ULBs. This would not only require
their involvement in planning but in oversight of the entire PFMA cycle. Similarly, the role of
independent external audit is also a useful tool for improving the PFMA initiatives.
24. It is expected that improved functioning in PFMA areas would lead to increased accountability
and improved levels of service delivery in the ULBs. The recent impetus for reforms (including
JNNURM) establish the acceptance, need and requirement to put PFMA at the center stage of urban
reforms and improved governance in ULBs.

13
Public financial Management, Performance measurement framework, PEFA secretariat, June 2005, USA, www.pefa.org.
The PEFA PFM Performance Measurement Framework incorporates a PFM performance report, and a set of high-level
indicators which draw on the HIPC expenditure tracking benchmarks, the IMF Fiscal Transparency Code and other
international standards. It forms part of the Strengthened Approach to supporting PFM reform, which emphasizes country-
led reform, donor harmonization and alignment around the country strategy, and a focus on monitoring and results. This
approach seeks to mainstream the better practices that are already being applied in some countries.

4 PFMA Components: Benchmarks, Policy and Progress
4.1 Legislative Framework

25. Benchmark. A strong and comprehensive legislative framework is a prerequisite for effective
PFMA in ULBs. The legislative framework, in effect, provides the ‘enabling environment and hence
should cover all aspects of public financial management viz. budget, accounts, procurement, audit
etc. However, having good laws is not an end in itself – the acid test is in its implementation. Table
4.1 presents a list of indicators for assessing the suitability of legislative framework in the context of
PFMA:

Table 4.1: Enabling Legislative Framework
Outcome 1: a strong and comprehensive legislative framework is existing leading to improved
PFMA
Indicator Source
1. Legislation for PFMA areas are clearly defined with timelines (accounts, Municipal Act and Rules
budget, audit, procurement, etc.)
• Detailed Govt. orders and rules in place for defining timelines,
responsibilities and action for non compliance
2. Legislation provides for participation of all key stakeholders in budget Municipal Act, Rules
preparation
3. Legislation in place ensuring effective cash management Municipal Act, Rules
4. Legislation in place allowing for clear-cut and transparent procurement Municipal Act,
processes Procurement Rules,
Tender Transparency Act
5. Accounting rules are in place to ensure complete, accurate and timely Accounting Rules
information through DEAS
6. Legislation in place providing for effective internal audit and control Municipal Act, Rules
mechanisms
7. Provision for setting up of Audit Committees is available Municipal Act
8. Legislation provides for monitoring and enforcement of non- Municipal Act, Rules,
compliance/delays Regulations, GOs
9. Legislation provides for adequate public participation and oversight in Municipal Act, Rules
PFMA areas
26. Policy and Practice. As mentioned earlier, every state has legislated one or more Municipal
Act for governing the operations of ULBs in the state. These Acts are required to draw on the
national policy framework (including the 74th CAA, Policy guidelines from MoUD etc.) and lay
down the various aspects of urban governance, management and service delivery for ULBs in the
state.
27. Although most of the states have amended their existing Acts to incorporate the 74th CAA some
such as West Bengal and Tamil Nadu have enacted fresh legislations replacing the earlier Act.
However, the desired effect of decentralization and effective PFMA has been, on the whole, limited,
slow and uneven across states. There are however, a few exceptional states such as Kerala, which
have taken efforts to ensure greater autonomy to ULBs (Box 4.1).
Box 4.1: Autonomy to Urban Local Bodies in Kerala
The Kerala Municipalities Act, 1994 transfers 165 functions (29 groups of items) to ULBs. This is among the
most elaborate list of functions assigned to Municipalities in any state. The functions have been classified as
mandatory, sector wise and general functions. A major function entrusted to the Municipalities in Kerala is
planning and implementation of various developmental projects in the productive, infrastructure and social
service sectors.

28. The State Acts usually provide for the broad aspects of PFMA such as manner of passing the
budget, maintenance of accounts, maintenance and use of municipal fund, power to raise money,
receive loans etc. with the state empowered to issue detailed Rules in this behalf. As a result, most
states have issued a set of subordinate legislations including ‘Accounting Rules’ detailing the budget
format, accounting forms, treatment of special transactions and elaborate financial procedures for
transactions such as procurement, bill payments, maintenance of Demand Collection Balance (DCB)
Registers etc. An important distinction in this context is that the power to make Rules is generally
vested with the state for municipalities and larger Corporations are usually empowered to make their
own Rules or Bye-laws.
29. A review of this legislative framework in the context of PFMA brings out the following four
features:
i. The legislations are primarily directed to make ULBs accountable to the state governments
rather than to citizens. Almost all the Acts mention presentation of the budget to the elected
functionaries.14 However, there is generally no requirements for citizens’ involvement and /
or bottom-up budgeting in the Acts;
ii. The existing legislations, since based on older laws, generally include archaic practices
such as single entry accounting, use of colored pencil, carbon etc. which have long been
outdated. Many modern concepts such as double entry accounting, computerization, zero
based / output budgeting are conspicuous by their absence;
iii. The basic requirements for budgeting, control and audit are well laid out but there is
generally no provision for participation in budgeting, long term sustainability planning,
periodic disclosures etc. The focus seems to be on compliance rather than encouraging
autonomy and self sustainability of the ULBs;
iv. There is weak enforcement mechanism for the various provisions. For example, although
time schedules are prescribed for preparation of budget, finalization of accounts and
submission of administrative reports, there is no penalty or deterrence in case of delays. It
is perhaps for this reason that accounts of several ULBs (including until recently of Kolkata
Municipal Corporation, the second largest ULB in the country) were outstanding for upto
10 years.
30. In some states, alongwith these Acts and Rules, specific legislations / Rules have been issued
for key areas of PFMA. The Transparency in Public Procurement Act of Karnataka and Tamil Nadu
and the Karnataka Local Fund Authorities Fiscal Responsibility Act, 2003 are examples of some such
legislation. These Acts apply to all levels of government including local bodies and provide the
necessary focus for PFMA issues to be addressed in the ULBs.
31. However, legislations are just that – statements of intention by the legislature. In effect, it is the
implementation which decides the efficacy of the various amendments and improvements, especially
in the areas of PFMA. It is here that the spirit and not merely the letter of law needs to be followed.
32. Progress. The progress towards legislative reforms has been positive in the recent past. Many
states did, of their own, amend the Acts to incorporate features of the 74th CAA. Similarly,
Accounting Rules have been amended / replaced in several states to provide for accrual based double
entry accounting. Similarly, the requirements of information disclosure have also been included in the
legislative requirements of ULBs.
33. The Model Municipal Law (as discussed above) did try to integrate good practices into a
replicable template for adoption by states. However, till date, these serve more as guides for
amendment to existing laws rather than de novo legislation. An associated aspect related to these
amended laws is the volume and multiplicity of amendments. Perhaps a model such as Tamil Nadu
where several different Acts were integrated into a single ‘Tamil Nadu Urban Local Bodies Act,
1998’, reducing redundancies and consequently halving the size of the legislations.
34. Key Findings and Way Ahead. The two areas where state legislations comprehensively lack
14
Kerala Act also refers to preparation of budget estimate by the Standing Committee

focus include monitoring and enforcement for non-compliance, and provision for public oversight
and participation in PFMA areas. While the second issue is expected to be tackled by the enactment
of the Disclosure Bill, the issue of non-compliance has still not been adequately addressed and needs
to get policy priority. This should cover issues of budgeting, accounting, audit and enforcement
mechanisms should be put in place for their compliance.
35. Other areas where legislative framework needs strengthening includes requirement for internal
and performance audit of ULBs leading to a more efficient mechanisms for cost management.
Sections in the Model Municipal Law pertaining to preparation of budgets, areas of reporting of the
budget and accounts in the public domain and their respective timelines may also be disseminated
and included in the respective state statutes.

4.2 Planning and Budgeting

36. Sound planning and effective use of resources is perhaps the central tool for improved PFMA
in ULBs. Currently planning is limited to the annual budget which is essentially a financial balancing
exercise and a sanction tool to authorize spend by the council. Poor planning poses three types of
risks to a sound PFMA environment:
i. Formulation Risk in that it does not assess and provide for correct and efficient
allocations;
ii. Policy Risk in that the ULB fails to execute the budget passed, and
iii. Fiduciary Risk in that funds are not spent for the purposes mentioned in the budget.
This section deals with the use of budget as a planning tool by the ULBs.
4.2.1 Budget Planning
37. Benchmark. It is desirable that the process for budget planning is realistic, comprehensive,
orderly and participatory and reflects then ULB’s priorities and policies. This would imply the budget
to be need based, prioritized and have a multi-year time horizon. Further, the budget process should
ensure that the projections made are realistic, achievable and developed in a participatory manner.
Further, the focus of budgets should be on results achieved and not merely money spent by the ULB
(Table 4.2).

Table 4.2: Budget Planning
Outcome 2: policy direction and budget planning and preparation is realistic, comprehensive,
orderly and participatory within overall government policy
Indicator Source
1. Policy direction, Budget preparation is need-based, prioritized with Budget, Department Notes,
multi-year time horizon is used for budget forecasts Discussions with concerned
• X no. of public discussions to discuss needs held before budget stakeholders
finalization
• Based on priorities of various user departments
• Includes X% last years incomplete works/ works in progress
• Budget linked to service delivery gaps based on a longer term
document like CDP, vision plan etc
• Budget has component for O&M and capacity building
• X no. of hours of debate on the budget in the council
• X % of budget revised after the debate
• X% budgetary transfers are untied in nature
• Flexible and performance based budgeting
2. Budget is predictable, i.e., extent of devolution to ULB is known before SFC Recommendations and
budget preparation exercise is started Action Taken Report
• Variation in projected funds to actually received is not more than
X%
• Funds are regularly received on budgeted/ expected dates

Indicator Source
• Not more than X% variation from the SFC ATR
• Activity based budgeting is done
3. Budgets are realistic and achievable, Accepted standards/ norms,
• Analysis of budget vs. actual reflect not more than X% variation Budget document, balance
• % of proposed programs completed sheet/account information
• Mechanism of timely monitoring and review of budget in place
• Level of spending outside the budget is less than X%
4. The State maintains a database of budget information from all ULBs DMA’s office or State Urban
• Budgets are received by DMA latest within 15 days of clearance by Department
council as prescribed under the act
• Budget made public/advertised with specific programs and benefits
• Budget is used as a tool for monitoring by all stakeholders
38. Policy and Practice. Budgets in Indian ULBs are generally a statutory requirement and are not
seen as a management tool at all. Policy based budgeting is still not heard of in ULBs and budgets are
only referred to for making financial sanctions. Consequently, budgets do not display requirement of
revenue and capital expenditures nor are they part of a larger strategic plan. Nonetheless, some good
practices are emerging in this area with budgets being used for long term planning (Box 4.2).
Box 4.2: Budget as a Tool for Long Term Strategic Planning – Kapra Municipality15
Post 2003-04, Kapra Municipality, Hyderabad, AP, adopted a multi year perspective for the preparation of
the budget. In 2004-05, a multi year Financial Operating Plan (FOP) was prepared, with assistance from
APUIDFC. DFID funded APUSP program under the Comprehensive Municipal Action Plan for Poverty
Reduction, stresses the need for comprehensive and long term planning (financial), to enable planning of
revenue inflow and expenditure over a longer term. The FOP model has been designed to assess the impact of
proposed investment over the planning horizon (20 years). This model takes into account the regular income
and expenditure account of the local body as well as additional O&M expenditure due to increased service
levels and proposed creation of infrastructure. FOP hence also acts as an important factor in the preparation
of the annual budget
39. Information for Preparation of Budgets. Budgets are prepared by the accounts department
based on estimates of revenue and expenditures of the previous financial year. Due to lack of relevant
information, most revenue estimates are based on ad hoc or percentage increases over the previous
year’s budget, without taking into account the actual potential or requirement. This results in large
variations between budget and actuals, even in places like Bangalore where budgeting systems are
comparatively better developed.
40. Expenditure estimates are also not backed by detailed workings or breakdown such as the exact
projects that are planned, estimated costs etc. This leads to a focus on the ‘input’ i.e. the amount of
money to be spent rather than ‘output’ i.e. the result of the spend (Box 4.3).
Box 4.3: Output Based Budgeting
Budgeting exercises have traditionally been revenue based, with almost exclusive focus on input (i.e.
expenditure) and performance being judged in terms of spending. This, usually, results in poor expenditure
controls, inadequate reporting and an incentive to spend the budget allocation as soon as possible; without
focus on what is being actually delivered.
Recently, the concept of ‘output’ based budgeting has been adopted by several countries to establish a stronger
relationship between objectives and inputs. Here the objectives are considered to be ‘outputs’ i.e. the final
result expected from the expenditure (input) and planning and accountability mechanism directed towards
outputs now. Further, the outputs are linked to ‘outcomes’ and the success of policy judged by them.
The principal objective of Output based budgeting is to provide:
a focus on outputs and performance;
define links between outcomes and outputs; and

15
The municipality at the time was not under the APUSP program but as the municipal commissioner had worked
previously with the APUSP and realized the importance of preparing an FOP, he initiated the process in Kapra, this is a
good example of benefit of building capacity of the municipal officials

monitor input efficiency by the output and outcome achieved
Output based budgeting requires policy makers to define ‘outputs’. These outputs are tangible products (such
as ‘x’ nos. of tubewells, ‘y’ kms of road etc.) and based on a system of elimination and prioritisation, resource
allocation is made for the accepted output. These ‘outputs’ are further linked to ‘outcomes’ i.e. larger social
benefit flowing from the provision of outputs.
Monitoring is not done on the basis of spending but rather on the basis of ‘outputs’ achieved. This system
presumes a zero-based budgeting approach where each year’s resource allocation has to be justified on the
basis of needs and priorities.
41. Basis of Budgeting. Current budgets as tools for financial discipline are prepared on cash basis.
This means that only those expenses and revenues which are actually expected to be paid are
included in the budget. As a result, it does not consider ‘full cost’ method of planning, excluding
several items of non cash revenues and expenses (including depreciation).
42. Budget Formats. Budget formats are generally prescribed in the Municipal Act or Rules. In the
absence of separate accounting formats (as in case of ULBs which are following single entry
accounting), these also serve as the format for reporting actual spend. Many states have prescribed
standard reporting formats for budgets. Karnataka is also working in this area (Box 4.4)
Box 4.4: Budget Reforms in ULBs of Karnataka
Karnataka has taken up budgeting reforms alongwith its DEAS implementation. Infact, the Karnataka
Municipal (Accounting) Rules, 1965 have been replaced by a ‘Karnataka Municipal (Accounting &
Budgeting) Rules, 2006’. According to the new Rules, the existing budgeting forms are proposed to be
replaced with a summary sheet and a set of 8 schedules16 viz. Estimate of revenue receipts, revenue payments,
capital receipts, capital payments, loans repayment, loans & advances, deposits & recoveries and investments
made. This breakup of budget forms is expected to facilitate better planning and a more accurate estimation
by the ULBs. The budgeting is now by function and within that, for each budget code. The process of
budgeting has been streamlined providing for a number of Budget Information Data Sheets (BIDS) to be used
by ULBs for working out detailed calculations for budgeting purpose. A system of budgetary control has been
prescribed and a monthly budget variance report has been mandated.
43. Public Participation in Budget Preparation. One of the most important tenets of effective
PFMA is ensuring effective participation of concerned stakeholders in the planning process.
Generally in Indian ULBs, there are no public debates on the budgeting process. Ward Committees,
although prescribed, have either not been formed or are not active in most states (West Bengal and
Kerala being notable exceptions). However, since budgets continue to be ‘input’ based, these
documents are only of limited use and understandability for the common person.
Box 4.5: Budgeting Process in ULBs
A fundamental question that needs to be addressed in the budgeting process in ULBs is – who are the users of
ULB budgets? What is the purpose? Why is the budget prepared? Are additional resources allocated based on
ULB priorities? What is the incentive for ULBs to prepare and analyze sound budgets? Are the budgets
integrated and linked to citywide/statewide investments? Are they used as a planning and procurement tool?
The main purpose of ULB budgets is to use it as a tool for expenditure allocation and control. Additional
funds are not allocated by the state based on budgets. The individual ULB budgets are neither consolidated
nor analyzed against benchmarks at the state. The citizens and other stakeholders are normally not involved in
the process. As a result the budget process and its importance as an effective PFMA tool has diminished over
time. There is a strong case to use JNNURM and other support schemes to provide incentives and enable
ULBs to make effective use of budget as PFMA tool.
44. Progress. Current efforts at standardizing and developing better participative budgets are
standalone efforts. JNNURM and other related reform measures have emphasized on long term
strategic planning to lead the annual planning and budgeting exercise. Accordingly, JNNURM
encourages the preparation of City Development Plans (CDP) and Detailed Project Reports (DPR) for
accessing funds under the mission. These require ULBs to develop a perspective planning

16
Suggested by Infrastructure Professionals Enterprise (P) Ltd as the Nodal Firm for implementation of FBAS in 43
municipalities of Karnataka

framework, long term policies, programs and strategies to meet the emerging fund requirements. It
thus leads to a participatory, output based budgeting keeping in mind the concerns and interests of a
wide range of stakeholders.
45. Key Findings and Way Ahead. Based on the experience of JNNURM, output based budgeting
could be made a norm for ULBs. The existing budgets in ULBs are primarily used as tools to allocate
and control financial expenditure. However, not enough stress is laid on the output of the expenditure
in the entire budget planning and execution process. ULBs could greatly benefit by the ‘Output
Budgeting’ process where the sector wise/zone wise details of assets to be created and maintained
could be listed. This would also lead to increased accountability and external oversight since the
ULBs would be made accountable to the actual ‘output’/ service rather than the expenditure. Further,
since most of the capital projects extend beyond a single year, there is a need to consider multi-year
rolling plans for ULBs. Concepts of zero based budgeting specially in areas of recurring expenses
(staff, transportation etc) could also be introduced to increase value for money services in ULBs.
Budgets need to consider a long term perspective and the concept of a 3-5 year rolling plan could be
explored. The budget should also consider the other city wide expenditure on related services planned
by other parastatal agencies and District plans. DPC and MPC should have an involvement in the
budget process of larger ULBs especially in the areas of trans-municipal services. There is a need for
budgets to be approved in the council after ‘due deliberation and discussion’ and not as a mere
statutory formality required for resource allocation.

4.3 Implementation

46. Successful implementation of the budget prepared by the ULB involves a number of processes.
It needs to be used as a tool for planning, procurement and expenditure control. Linkages with the
accounting, MIS and treasury operations are also critical. It also requires strong internal control and
audit, assets and liabilities management and related systems in place for effective and efficient
implementation.
4.3.1 Budget Execution
47. Benchmark. To enable the budget document to be used as an effective tool for planning,
procurement and expenditure control. It is essential for the budget to be linked to accounting systems
and MIS. Periodic budget analysis reports need to be prepared and disseminated. Dissemination is
necessary to ensure transparency in the budget execution process leading to public pressure and
accountability (Table 4.3).

Table 4.3: Budget Execution
Outcome 3: the budget is used as a tool for planning, procurement, and expenditure control
Indicator Source
1. Budget is used by the ULB as a tool for planning, income targets and Budget, Discussions with
expenditure control Department heads
• Effectively used as the central tool for planning, control and
management linked to various activities across the ULBs
• Not more than X% variation in budget and actual expenditure and
receipts.
• Principles of zero based budgeting for expenses are followed
• Average budget deficit in last three years is less than X%
2. Budget is linked to the accounting system and MIS Accounting Rules, Accounts
• Not more than X% variation in revised budget
• Periodic (quarterly) reviews of budget with the actual are done
• Revised budgets are prepared on sound analysis of reasons for
deviation
3. Budget analysis reports are prepared and submitted to State Budget analysis report
• Budget analysis reports are sent to state on a quarterly basis –
within one month of the end of the quarter
• State analysis budgets across various ULBs and para-statal
entities based on key benchmarks

Indicator Source
4. Budget analysis reports are published and available to public for Budget analysis report,
debate Discussion with stakeholders
• Budget analysis report published in newspaper
• No. of public debates organized on the budget
• Follow-up on feedback/public debate
48. Policy and Practice. Inadequate analysis of the budget variance vs. actual continues to be a
major area of concern in ULB budgets. Further various extraneous reasons also affect the
predictability and timing of funds (such as from state government) which affect the performance and
achievement of budget targets.
49. Expenditure and Resource Realization. In the present system, expenditure is not conditional
on resource realization. The operating departments use their allocations irrespective of revenue
realized or availability of money. This further leads to the need for re-scheduling of the budget heads.
Since salary expenses are already fixed, any shortfall in revenues invariably leads to cut in capital
expenditure and Operation & Maintenance.
50. Budget Monitoring. Budget monitoring practices differ across States. In general, the
Department of Municipal Administration is required to monitor the budgets externally while
internally the responsibility of ensuring that the budgets are adhered to lies on the standing
committee/council. However, internal monitoring is generally not mandated in the Rules.
51. Progress. Good practices like Public Record of Operations and Finances (PROOF) initiative in
Bangalore (Box 4.6) provide a platform for review of the budget and performance by the citizens.
However, sustainability and replicability of such initiatives needs to be tested. For instance, in
Bangalore itself, lack of participation of Corporators17 who pass the budget in the PROOF platform
has a negative impact on the accountability criteria to some extent.
Box 4.6: PROOF Initiative, Bangalore
The PROOF campaign was a collaborative effort of four non-profit independent NGOs for carrying out
budget analysis/fiscal performance audit of Bangalore Mahanagara Palike (BMP). This initiative was started
in 2002 with a focus on ‘disclosure, debate, dialogue, and discussion’ on the use of public funds. Efforts were
made to involve citizens in performance audit.
The PROOF campaign draws from the practices in corporate governance on disclosure of financial
performance.18 Despite distinct methods in performance and administrative structures, the common principle
between corporate governance and local governance is the efficacy in utilization of public funds. The model
adopted by PROOF was that of the Governmental Accounting Standards Board (GASB).19 The PROOF
campaign focused on three aspects: (i) obtaining quarterly financial statements from the Government (now
half-yearly), (ii) developing performance indicators for assessing work done by BMP largely incorporating
the report card concept, and (iii) involving the public in functioning of BMC.
PROOF has also been involved in questioning budget allocations and rationale behind budget allocations; this
has had positive implications for budget allocations and improved accountability of BMP, but the efforts have
been very limited (school and public toilets). An analysis of expenditure incurred by BMP on schools
supported by it revealed that per student expenditure was more in these schools than even in the best of
private schools. PROOF used its BMP-citizens interface to bring this issue forward and since then suitable
changes/actions have been taken to ensure better budget utilization.
52. Further, Indian ULB legislations fail to specify fiscal management responsibilities for ULB
officials; thus, most ULB officials are unsure of their roles and responsibilities in budget execution.
As a result there is no internal performance measurement within the ULBs as to the actual budget

17
While most Corporators prefer to remain absent at the PROOF meetings, some of the politically conscious and seasoned
Corporators have started using PROOF as an opportunity for forwarding their political ambitions. Since number of such
Corporators are very limited, there have still not been any conflict of interests. However, PROOF is wary of this trend
catching on (Discussions with Swati Ramanathan, June 2006).
18
For a detailed note on the history of Corporate Disclosure & Financial Statements, see Ramesh Ramanathan, 2002,
‘Public Record of Operations and Finance: PROOF: Campaign Note, Janaagraha , Bangalore.
19
GASB was organized in 1984 by the Financial Accounting Foundation (FAF) to establish standards of financial
accounting and reporting for state and local governments in United States of America.

and its execution. The recent recommendation of the 12th CFC for state enactment of fiscal
responsibility legislation (Box 4.7) is likely to improve budget preparation, execution and monitoring
situation in ULBs.
Box 4.7: Fiscal Responsibility Act
In 2003, the Conference of State Finance Secretaries decided that the Reserve Bank of India (RBI) would
provide technical assistance to help states prepare fiscal responsibility legislation. The RBI circulated a model
fiscal responsibility bill to the states. Recently, states of Karnataka, Punjab, Kerala, Tamil Nadu, Uttar
Pradesh, Maharashtra, Orissa, Rajasthan, Assam, Gujarat, Himachal Pradesh, Haryana, Chhattisgarh, Madhya
Pradesh Tripura and Andhra Pradesh have all enacted the Fiscal Responsibility and Budget Management Act.
However, improvements in ULB budgetary systems are yet to accrue from this Act. (Source: Fitch Ratings,
India Special Report, 20 March 2006)
53. There has been limited progress in area of budget execution by ULBs. Only few Acts such as in
Kerala provide for verifying budgeted expenditure with resource realization. The recent Karnataka
(Accounting and Budgeting) have prescribed a monthly reporting format for budget variance. The
citizen interface also remains weak barring few partial successes like the PROOF initiative. With
limited own revenues, the dependence on state funds is still high and their unpredictability remains a
serious concern for effective budget execution.
54. Key Findings and Way Ahead. The effective use of budget in implementation can be ensured
only when the budget planning is itself seen in the proper perspective. Only when the budget is seen
as a development and not merely a statutory exercise, can it move into the realm of a management
aid.
55. In this context, the CDP and annual Financial Operating Plan (FOPs) advocated by JNNURM
could be useful. It also prescribes quarterly monitoring of these plans by central and state level
agencies. However, the ULBs will need considerable support in addressing the policy and fiduciary
risks of budgeting so that they are able to utilize the budgets and plans for effective monitoring and
management of their operations.
56. The ULBs would benefit from a ‘Budgeting Manual’ (perhaps on the lines of NMAM) which
could address the following issues:
i. Participative Budgeting – how to achieve it?
ii. Reflecting policies in budgets
iii. Detailed output based planning for inputs
iv. Monitoring and implementing budgets – MIS and accounts integration
v. Mid year corrections in budget and realignment to policy.
57. The Budgeting Manual budgeting manual would also provide the strategy to make operational
increased community participation and role of area sabhas in the planning process as suggested under
JNNURM.JNUNURM. Most of the MoAs signed under JNNURM have shown this as an optional
reform to be taken up after 3-4 years. However, unlike, NMAM or model municipal act, there are no
guidelines or manuals on how to make this a reality. This may lead to delays in implementation in the
absence of a manual or guidelines.
4.3.2 Accounting and MIS
58. Benchmark. ULB accounting has three broad purposes:
i. To safeguard public money and prevent corruption;
ii. To facilitate budgeting and planning of revenues, expenditures and debt management;
and
iii. To help government discharge its public accountability.
59. These are progressive stages in the accounting spectrum, moving from routine ‘recording’ of
transactions to ‘management decision making’ and finally as an ‘accountability’ mechanism.
60. To ensure the above three purposes, it is required that accounting and MIS are complete,

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