Andhra Pradesh had initiated the Urban Slum Health Care Project to provide basic primary healthcare and family welfare services to urban poor living in slums in 2002. As of now, the project has established 192 Urban Health Centres (UHCs) in 74 municipalities of the state through contracting-out process to the NGOs. These UHCs cover population of about 3 million. State government has played pivotal role in creating capacities to monitor and supervise the functioning of these UHCs. This project was started with the World Bank support and the state has effectively managed the transition from a donor-funded project to government programme and at the same achieving demonstrable impact on health status among its target population. The scheme ensures people's participation in management of the UHCs and placing the power for identifying the health priority in the hand of the community. The case study identifies emerging challenges in the scheme implementation relating to (a) involvement of NGOs as partners in service delivery, (b) financing and financial management system, and (c) need to reposition the UHCs in view of changing epidemiological scenario. Some of the areas needing attention to address the challenge include: need to refine the service mix to better respond to the health needs of the population served; evolving a financial management practices to increase efficiency in disbursement; motivating NGOs to actively participate in the scheme; developing management capacity and competencies of both partners; and repositioning relationship between the state and non-state actors away from a contractual basis to an effective partnership.