Urban Challenge Fund’s promise rests on implementation capacity [Commentary]

- The Urban Challenge Fund marks a shift from earlier urban schemes by promoting market-based financing, broader participation and integrated urban development. - Despite its ambitious design, the scheme faces major implementation challenges, including the weak financial health of ULBs and other agencies. - Without structural reforms, stronger institutional capacity and climate resilience measures, the scheme’s transformative goals may be difficult to achieve. - The views in the commentary are that of the author. The much-awaited and delayed operational guidelines for Urban Challenge Fund (UCF) were finally released by the government of India on April 15. The scheme was needed as the Smart Cities Mission ended in 2024, and as the UCF scheme announced in the 2025 budget did not get off to a start. As a result, investment in urban areas suffered, as evidenced by reductions in budgetary allocations and, more importantly, in actual releases to Urban Local Bodies (ULBs). Learning from the past shortcomings, UCF has tried to chart different ways, like expanding the range of agencies involved in implementing the scheme, encouraging market-based financing and various reforms to improve the financial sustainability of ULBs/other agencies, emphasising transformative projects, flexibility to reallocate funds to performing cities/states from the cities and states that may not be able to use UCF funds, etc. While welcoming UCF, which is studded with new features, it is necessary to examine the challenges it may encounter during implementation to ensure its success. Decoding the scheme’s design The scheme has a total outlay of ₹1 trillion for catalytic Central Assistance (CA) during the 2025–2030 period, extendable for another three years. Of this, ₹900 billion has been earmarked for project funding, ₹50 billion for project preparation and capacity building, and another ₹50 billion for the Credit Repayment Guarantee Scheme, which will be available to all tier-2 and tier-3 cities. The list of eligible projects spans three broad themes: Cities as Growth Hubs, Creative Redevelopment of Cities, and Water and Sanitation. It covers an exhaustive list of urban infrastructure projects, except metro rail and public housing. Projects under the UCF may be implemented by ULBs, Special Purpose Vehicles (SPVs) constituted by ULBs or state/union territory (UT) governments, development authorities or parastatal agencies, or other agencies notified or endorsed by the state or UT governments. Central assistance will be limited to 25% of the approved project cost, subject to the condition that 50% of the project cost is mobilised through bonds, bank loans and/or public-private partnerships, while the remaining 25% must be contributed by the implementing city or agency from its own funds. The distribution of funds between states and UTs will mainly depend on their population. An additional 10% of projects may also be considered beyond the allocated limit for states and UTs. After two years, the National Apex Committee (NAC) will review the progress of the UCF across states and UTs and may reallocate funds based on performance in project uptake, as well as physical and financial progress. A new template Compared to earlier central assistance schemes launched over the past two decades, the UCF incorporates several significant and long-needed features. One of the key aspects is its focus on catalysing market-based financing. The scheme acknowledges that while urban programmes such as the Smart Cities Mission, AMRUT and SBM funded urban infrastructure in the past decade, the use of market-based finance, including loans, municipal bonds and private investment, remained limited. The UCF seeks to address this gap by actively promoting such financing mechanisms. The scheme also broadens the implementation framework. Urban infrastructure and services in India are delivered by multiple agencies, whereas earlier schemes were largely ULB-centric. Under the UCF, all kinds of agencies involved in developing and delivering urban services are eligible to access funding. Another important feature is the emphasis on comprehensive and integrated interventions for transformative impact. The guidelines insist that projects seeking central assistance be transformational rather than incremental, with a focus on systemic improvement rather than mere augmentation. Financial sustainability has also been made a key condition. Projects must demonstrate long-term financial sustainability, including a viable revenue model and lifecycle cost considerations. The scheme further includes a Project Preparation and Capacity Building Fund (PPCBF). Under this component, ₹30 billion will be distributed among states and UTs for project preparation, monitoring support, consulting services, and institutional and technical capacity building. The fund may also be used for workshops, stakeholder consultations, field visits and IEC activities. Recognising that cities in the northeast, hilly states, and smaller towns with populations below one lakh are likely to have weaker financial profiles and limited credit histories, the scheme has also introduced a ₹50 billion Credit Repayment Guarantee Scheme. The capacity question There is an urgent need to develop climate-resilient urban infrastructure to address climate change challenges and improve urban service delivery across Indian cities. In this context, schemes such as the UCF are necessary. More importantly, however, their successful and timely implementation is critical. The UCF is likely to face several implementation challenges, which, if not adequately addressed, could undermine the scheme’s effectiveness and success. One of the foremost challenges is the weak financial health of ULBs and other implementing agencies. Various studies have indicated that the own-source revenue of ULBs constitutes only 20% to 50% of their total revenue, while their dependence on grants from higher-level governments is increasing over the years as ULBs have not undertaken enough efforts to optimise their own resources. Revenue surpluses generally remain in the range of 10% to 15%, which means nearly 85% of capital expenditure depends on grants. Even under earlier schemes, in which ULBs were expected to contribute only 25% to 30% of project costs, many were unable to do so, receiving grants covering 75% to 100% of project costs. Yet projects still suffered from time and cost overruns. Under the UCF, ULBs are expected to contribute 25% from their own resources while also mobilising 50% through market-based financing. Given their limited operating surpluses and weak creditworthiness, this requirement appears daunting. Parastatal agencies involved in urban service delivery face similar constraints. Unlike ULBs, such agencies do not have access to general taxation and depend primarily on user charges linked to specific projects or services. Since these services are public in nature, charges often cannot be levied on a full-cost or cost-plus basis. As a result, these agencies are financially weaker than even relatively efficient ULBs. Another challenge relates to political willingness to address funding problems. Municipal bonds, commercial bank loans or public-private partnership (PPP) models are financing instruments rather than funding sources. They carry financial cost and need to be repaid with interest, for which a ULB or any other agency needs to have sound funding. For ULBs, the principal funding sources remain taxes and user charges, while parastatal agencies largely depend on user charges alone. However, many ULBs have failed to optimise these revenue streams because of operational inefficiencies and political economy considerations, resulting in growing dependence on grants. Enhancing tax collections and user charges to offset higher financing and maintenance costs will require significant political will. The absence of such willingness could become a major obstacle. Low project management and capital absorption capacity also remain critical concerns. The difference between budgetary allocations and actual funds released clearly indicates that ULBs were not able to draw funds made available. A major reason has been their inability to submit utilisation certificates due to low project implementation capacity. The project-related conditionalities introduced under the UCF, though well-intentioned, may themselves create implementation bottlenecks. These conditions are intended to achieve broader systemic reforms, but they could also create a Catch-22 situation. If implemented in their true spirit, ULBs and agencies will require extensive preparatory work, institutional reforms, and consensus-building, all of which may significantly delay project implementation. On the other hand, if conditions are diluted to expedite execution, projects may proceed without achieving the intended systemic or transformative outcomes. One such condition is the requirement for projects to demonstrate long-term financial sustainability through viable revenue models and lifecycle cost considerations. While this condition is necessary and feasible, its fulfilment depends on political willingness to charge beneficiaries adequately and executive willingness to improve operational efficiency. To ensure meaningful compliance, revenue reforms and related measures would ideally need to be front-loaded and treated as qualifying conditions before project approval. If projects are approved merely on the basis of proposals without prior reforms, financial sustainability may remain unachieved. Another condition requires projects to form part of a broader city or regional growth strategy or saturation plan, covering a sizeable geographic area and population to ensure integrated and scalable urban development outcomes. Unfortunately, cities do not have a strategy or saturation plan or any of the other aspects to provide context or a base for projects proposed. Again, a growth strategy/saturation plan can be formulated, but it will require capacity, time and consensus. Similarly, the condition that projects should aim for service saturation and be transformative in scale and approach will require substantial capacity building among urban decision-makers. City decision-makers will require capacity-building to conceive transformative projects. Another notable gap is the absence of explicit climate-resilience conditionality. While Indian cities undoubtedly need expanded urban infrastructure, there is an equally urgent need for climate-resilient infrastructure and service delivery to meet India’s Net Zero commitments. Urban infrastructure like waste water treatment and reuse of water, scientific disposal of solid waste, urban flooding prevention, sea shore protection in case of cities having sea shore, air pollution control, heat spot reduction etc. are very important for mitigating climate change. Hence, it is very important that climate resilience consideration should ideally be incorporated as a cross-cutting requirement across all projects approved under the UCF, supported by clear technical and engineering norms. The guidelines remain silent on this aspect. Addressing these concerns will be important to ensure that the reforms and improvements envisioned under the UCF are not diluted or lost in execution. Banner image: A construction crew works on a public ropeway project. (AP Photo/Ashwini Bhatia) The author is a freelance consultant and visiting professor in urban finance and governance. Read more: Urban finance reforms gather pace, but key gaps persist [Commentary]