Best Practices for Water Financing and Pricing

• 1. 7th Annual High Level Session Ministerial Forum: Water Management Financing in the CaribbeanHosted by:Global Water Partnership (Caribbean) October 06 07, 2011 Guadeloupe 1

2. Best Practices for Water Financingand Pricingby Glenn A. Khan*Note: * - Deputy Executive Director of the Regulated Industries Commission (RIC). Views expressed are not necessarily those of the RIC.2 3. How important is Water?- Water is indispensable for leading a life inhuman dignity.- Therefore, the suggestion water for allrecognizes the importance of water as abasic human right. In this sense, it appears to raise questions about whether water is a private or public good. 3 4. Public vs Private GoodThe International Conference on Water andthe Environment, in Dublin, 1992, issuedfour guiding principles, one of which wasthat:Water has an economic value in all itscompeting uses and should be recognised asan economic good.4 5. If we accept that water is aneconomic good, should there be aproblem with respect to financingwater?Why are private entrepreneurs notqueuing up to provide suchservices? 5 6. Why is there a Problem to finance Water? It is part of Public Infrastructure which poses the greatest financing challenge for developing countries Ambiguity about whether it is Economic or Social Infrastructure Economic infrastructure attracts high user charges(Telecommunications, Power, etc.)6 7. ContdSocial infrastructure - heavy reliance on Public finance.Usually, there is ambivalence among politicians and waterconsumers about whether water services should beprovided free or with a subsidy, or commercially.This generally results in compromise where water ispriced below economic levels, leaving the sectorchronically under financed.Exacerbates the downward spiral of poor financialperformance, service levels and service quality.7 8. Some Financing IssuesThere is no Blueprint for an ideal system ofwater financing. 8 9. Uniformity Where there is a command economy- central government might fund services, with or without the consumer making payments In Market economies- users pay the full economic price for water In some countries (France) - the principle , Water pays for water, is used (consumers should provide the bulk of financing) 9 10. What should Public Finance be usedfor:Financing activities with strong externalbenefits?Providing for social benefits such aspublic health, and the avoidance ofdiseases? Is this a case for subsidizingwater?10 11. Need for Financial Self- sufficiency- Assurance of revenue sources to ensuresustainability- Freedom from political interference inbusiness decisions- Cost recovery tariffs- Transparent, predictable and reliablesubsidies 11 12. Financing Local Water (T&T)- Currently the public budget is the main source ofinvestment in the water sector.- The local capital market has been used also theissue of long-term bonds.- Only about 40% of operating expenditure isfunded through tariffs (or income generated fromoperations).12 13. ContdWhen we speak about the challenges offinancing water, the discussions tend to focus oninvestment in pipes, treatment plants, reservoirsetc..But it is equally important to provide resourcesfor recurrent expenditure. - People normally assume that all recurrent costs are covered by revenues. 13 14. Contd - Over the life of WASA there has probably been no period during which it was able to cover such costs from internally generated revenues. - Thus resulting in inadequate maintenance and repairs and in the end, the need for greater Investment. 14 15. Financing Needs?We have identified two types of financingneeds:- Finance for Investment (mains,plants etc.)- Finance for Recurrent Expenditure15 16. Sources on FinanceThe capital-intensive nature of water and waste water utilitiesplaces capital financing at the heart of the development of asustainable sector. But utilities also require financing for recurrentcosts. There are several sources from which financing for water isderived:- Tariffs paid by consumers- Taxes / Government budgets- Loans from Development Agencies- Funds from donor agencies- Loans from commercial banks.- Bonds 16 17. What are the Best Practices Capital Costs - large items of investments, including major repairs and replacement, modernisation and rehabilitation, generally require specific funding programmes. Instruments available: Current revenues for small and regularly recurring expenses( in private companies and mostly in developed countries, some of these needs are met from user charges) Long-term Debt for major system improvements (treatment plants, mains). Loans from government agencies, Government- guaranteed loans, Bonds, External developments assistance 17 18. Recurrent Costs these include wages and salaries, fuelcosts, electricity, chemicals, spare parts. Some of these costs are fixed(rent) while others are variable (chemicals and electricity used)depending on the volume of service.The most sustainable source of finance for variable costs items is usercharges. (long-term solution)Full cost recovery should be the goal of every utility.In the short to medium term, cross-subsidies and governmentsubsidies should be used, but not sustainable solution.Short term financing, in the form of loans to cover working capitalrequirements and to cushion irregularities in cash flow, available fromcommercial banks. 18 19. Local Financing of WaterSome issues:- In most developing countries, water isfinanced through budgetary allocations.- Given that there are competing needson the treasury, in difficult times the allocation ofwater or ability of SOE to meet servicerequirements is affected due to lack of funding,subventions and subsidies.19 20. - Public funding for water is thus a hostage of the governments fiscal situation.Sometimes, because of governmentbureaucracy the flow of funds is impeded thusleading to under utilisation and unavailabilityof allocated funds from government budget.20 21. International Financing for WaterDevelopment Assistance Given the critical importance of water for life,development agencies have always beensupportive of the initiatives of Developingcountries, especially in respect of infrastructure(either grants or concessionary loans).- That type of funding, though useful, isnot a sustainable way of financing water.21 22. Trends in International Aid to sector declining.- Between 1996 1998, $3.5 billion but fell to$3.1 billion 1999 2001.- WB lending for water and sanitation averaged$1.25 billion (1990 98) but dropped to $1.1billion between 1999 2001.- IDB lending, between 1991 1995($640 million per year), between 1996 2001 ($400 million per year).22 23. The largest funding sources are local -governments, local banks and user charges.There are challenges associated with eachform of financing. 23 24. Financing Challenges Funding the water sector from its own cash flow has proven to be unachievable. A World Bank study by Guillermo Yepes, 2002 financial sustainability of the service providers and resource mobilisation for sector development Remain elusive goals.24 25. Financing Challenges contdTariffs have three main purposes:1. Cost recovery - revenue for efficient operations and maintenance2. Reflecting cost of service and giving signals to users about the scarcity of water( volumetric tariffs provide an incentive to use water carefully)3. Environmental protection - encouraging conservation, and penalising wastage.Thus, where these objectives are not met, utilities areunable to be self-sustaining.25 26. Financing Challenges contdShort-term Loans- Commercial bank lending to water utilities hasnever been large;- Financing limited because of the perceivedlow credit worthiness of water utilities.- Usually provided only when guaranteed bygovernments.- The assets of water companies cannot be easilysold if utilities default and therefore are not agood form of collateral security.26 27. Some Possible Reasons for ProblemsWorld Panel on financing water infrastructure:- serious defects in the governance of theglobal water sector hamper its ability togenerate and attract finance.- even if these problems were overcomeinherent features in the sector will poserisks to potential lenders and investors. 27 28. ContdSome of the issues identified by the Panel include:- the low priority that central governmentsgive to water sector issues.- political interference in Utility (operation andmanagement).- resistance to cost recoveringtariffs.- confusion of social, environmentaland commercial aims. 28 29. Other Related Challenges- Social and public health benefits incompatiblewith full cost recovery and financial sufficiency?- Prices that utility will have to charge would seemhigh to most governments.- Governments would be inclined to suppressprice increases for fear of losing popularityand office. 29 30. Contd- Transition from engineeringcompany to business-oriented one. - Strong customer service focus / orientation. - Bankable, financially viable projects in the water sector.30 31. Contd - Capital intensive nature of infrastructure investments (in the US ratio of Capital investment to revenue is twice as high in water as in natural gas, and 70% higher than in electricity and telecommunications).- The assets are unusable for other purposes, andcannot be removed, thus private sector notattracted because investor is at mercy of hostcountry (international investors).31 32. CAN CHALLENGES BE OVERCOME?- Make distinction between the various policy aimsthat water satisfies and as far as possible arrangefunding for each based on its possible returns.- This is being practised in Trinidad and Tobago withindustrial water the desal plant is a commercial venture. It is probably doing well financially.- Likelihood of foreign investment low in the absenceof strong government guarantee. 32 33. Contd - In the electricity sector there are PPAs with generators but private international investment in the infrastructure has been very selective, oriented towards energy (BP, Atlantic LNG) and telecoms (Cable & Wireless, Digicel) rather than water.- More use must be made of local capital marketthrough bonds (since revenues are in localcurrency, foreign investors wont be attractedbecause of exchange rate risks, however, it shields theutility from these risks.33 34. Role of RegulatorThe Regulators role is to ensure sustainable costrecovery (SCR):- Sufficient revenues to recover recurrent costs,SCR includes operating and financing costs aswell as the costs of renewing infrastructure.- Revenue from charges should be covered by usersas a group using appropriate tariff structures(based on consultations).- Ensuring utility meets service requirements tocustomers. 34 35. - Budget allocation should be secured to ensurethat it is not subject to change.- Subsidies should be targeted and transparent.35 36. Conclusion Effective financial management is key for sustainable infrastructural development and management. Important considerations include; the conduct of fundamental business processes, and the institutional and regulatory framework within which tariffs are considered and enforced. Improving revenue collection efficiency is also important. 36 37. I know that we are discussing financingwater, and while that is very important andcritical to our sustainability efforts, we shouldalso consider another important factor- thegovernance model used by utilities in the region.Is it a factor that is impeding utility success?37 38. An important question for Ministers toanswer is how to cover the costs ofservice delivery, in the absence of full costrecovery? Of course, that is a politicalquestion.38 39. The End39