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A knowledge and practice review in water sector financing
Main Author : Mwiinga Godfrey with co-authors: Kevin Wall (CSIR) and Mike Marler (DBSA)
There is global acknowledgement that the financing of water projects is not easy. Preparation of water sector projects is understood to take long and still when they are finally financed, cost-recovery is comparatively difficult. The challenges in preparing water sector projects relate to the fact that water cuts across all spheres of society, and therefore many stakeholders are involved. Bringing them to one table for a single goal (supply water services) has often become a daunting task. Often, because of their complicated nature and their high social flavour, the associated risks in financing water sector projects are usually not well analysed to ensure development of attendant risk mitigation measures. This has particularly been the case where community involvement and participation issues are inadequately addressed. As a result water sector projects, especially in developing countries where the poverty trap adds to service deliver challenges, have been financed without much long-term consideration of sustainability aspects. The political use of water as a vote-winning vehicle has exacerbated the challenge of delivering water services sustainably. Political promises of delivering water are common, but often forgotten after the elections. These sector issues have meant that many water sector projects remain unattractive to private sector financing and participation.
Although historically water has largely been taken as a free social good, it has in recent years been receiving its due attention as an economic good as well that could be provided commercially. Hence, many developing countries are now acknowledging the relevance of providing water commercially in order to ensure financially sustainable services. This development is seen to be slowly easing the challenges of cost-recovery in many water projects. It is becoming clear that additional funding is not the panacea to sustainability of water services.
This paper presents a review of recent knowledge and practices in water sector financing, with particular focus on Africa. The paper aims to give an overview of the challenges and opportunities in financing water sector projects and describe the way forward for Africa’s efforts towards delivering sustainable water services.
The water sector is divided into water resources and water services. The water resources subsector deals with management, development and protection of water sources, while the water services deals with the supply of water to various users and consumers for social and economic development. The focus in this paper is on water services.
Some of the more alarming global statistics pertaining to water services are: 1 billion people lack access to clean water; 2.4 billion people do not have access to safe sanitation; 4 in every 10 people do not have access to safe sanitation (DBSA, 2006). Experience to date has shown that the packaging and financing of water sector projects is more risky than other public infrastructure sectors. One of the main issues include the lack of information and long project preparation periods characteristic of water projects as a result of their social and environment impacts, which require consultations with many stakeholders. This is particularly more challenging where governance systems are weak or not in place.
Although historically water has largely been taken as a free social good, it has in recent years been receiving its due attention as an economic good that could be provided commercially. Hence, many developing countries are now acknowledging the relevance of providing water commercially in order to ensure quality and sustainable services to its consumers. This development is seen to be slowly easing the challenges of cost-recovery in many water projects. It is becoming clear that additional funding is not the panacea to sustainability of water services.
The objective of this paper is to present a review of knowledge and practices relating to the financing of water services, with particular focus on Africa.
The paper was written from a desktop review of selected literature. Commentaries and analysis on the reviewed literature has been provided based on the authors’ knowledge and experiences.
The paper largely limits its coverage to water services, although some of the issues raised apply to water resources as well. It begins by presenting the water services challenges that Africa faces. Thereafter, financing practices, opportunities and way forward for Africa are presented in separate chapters, before concluding comments are made.
The challenges of water services Africa
Although water resources in Africa are relatively abundant, it has the lowest water supply coverage of any region in the world (DBSA, 2006). This is because of the continent’s insufficient capacity to exploit water resources. Some key statistics regarding the supply water services in Africa include (Mwanza, 2005):
The specific challenges of the delivery of water services in Africa include: meeting the increasing water demand due to population and economic growth; ensuring food security using water; dealing with the low investment/financing in the sector; and managing the performance of water services providers. Above these challenges, serious defects in the governance of the global water sector have been reported to fetter its ability to generate finance (Winpenny, 2003).
Since this paper focuses on finance, the financing/investment issues are discussed in a separate section. Given the significant role Water Governance plays in financing, it is also discussed separately. Before discussing the financing and governance challenges, it is necessary to discuss the characteristics and associated risks of the water sector projects.
Characteristics of water projects
The challenges of the water services delivery are exacerbated by the inherent features of the water sector compared to other sectors. These features cause financial and operational risks even if the governance issues were overcome. The specific characteristics and attendant risks which apply to the commercial funding of water services projects are:
To address the challenges brought in by the characteristics and risks of water projects, the role of effective governance becomes critical. In recent developments, the role of water governance has come to the fore of the water sector. Pegram et al. (2006) and Winpenny (2003:9) specifically reported on water governance as being a key root of problems pertaining to the delivery of sustainable water services. Given its importance, the topic is dealt with in the following section.
Water Governance refers to a range of political, social, economic and administrative systems that are in place to develop and manage water resources, and the delivery of water services, at different levels of society (Rogers & Hall 2002). It is further perceived in its broadest context as entailing those social, political and economic organisations and institutions and their relationships, which are regarded important for the management of water and sanitation (UNDP, GWP & ICLEI 2002).
The indicators for effective Water Governance include participation, transparency, equity, accountability, coherency, integrative, and ethical consideration (UNESCO 2006). An additional criterion is that there must be predictability in the political and administrative systems such that all players know the rules and accept that these will be applied consistently (Pegram et al. 2006). The issues of lack of coordination in governance systems and lack of accurate information to inform decisions need to be dealt with (Mwiinga 2008).
The Report of the World Panel on Financing Water Infrastructure indentified that serious defects in the governance of the global water sector fetter its ability to generate finance (Winpenny 2003:9). The report enlists the following governance issues as important:
The relationships among the above issues were not presented in the report. Therefore, an attempt to prioritise the above issues and analyse their relationships was made and the results are illustrated in Figure 1.
From the relationships of the governance issues shown in Figure 1, three indications can be drawn:
It should also be noted that without addressing the apparently low priority that central governments give to water sector issues, it would be difficult to address the current low financing and investment woes faced by the water sector. The issues of low financing and investment are discussed in more detail in the following section.
Low financing and investment
The characteristics of the water projects and the attendant risks (see Section 2.2) have resulted in low investment participation from the private sector. On the other hand, the public sector responsible for water services, has not fully appreciated the complexity of the risks of water projects. As a result, the water sector is in many circles reported to be poorly prioritised, which leads to under-funding and low investment.
Due to short-comings in governance systems, associated risks in financing water sector projects are usually not well analysed to ensure development of attendant risk mitigation measures. As a result water services projects have been financed without considering long-term sustainability aspects. This practice is common in Africa where poverty and high politicisation of water add to water services delivery challenges. Therefore, many water sector projects remain unattractive to private sector financing and participation.
It is not surprising that the continent’s investment in water is comparatively low given its historical economical and governance profile. Although history tells us that African governments have given the sector low priority in funding, the recent recognition of the sector being a linchpin in achieving the MDGs have led to African states making several declarations that are envisaged to propel investments in the sector (Manu 2008). Manu (2008) estimates that Africa needs about US$6 Billion per year to meet water and sanitation challenges of the MDGs. This funding is likely to come from public sources as the private sector is slowly shunning away from participation in the water sector. The generally poor enabling operating environment that exists in many African countries is reported to be the reason for poor PSP. The sector is potentially political in African where the majority of the population is poor and located in rural and peri-urban areas where the challenges of providing water services are further hampered by lack of adequate infrastructure. Therefore, commercially viable tariffs are a challenge to implement in such areas and political interference would be potentially rampant if PSP was sought.
Financing practices for water services in Africa
Challenges in financing water sector projects
Prasad (2006:670) reports that “It is estimated that over 90% of the world’s population is currently served by the public sector1”. This means that financing for public services largely depends on public funds and the attendant challenges are dictated by the capacity of National and Local Governments to raise funds. AMCOW (2008) reports the following challenges in financing the water sector in Africa:
The above challenges have largely been attributed to the fact that a large part of the public sector in Africa is inefficient and incapacitated but are still responsible for the provision of water services.
Sources of revenue and financing practices
Sources of revenue for the water sector can be categorised into basic and repayable (Winpenny, 2008:9). The former include tariffs, taxation and transfers, while repayable funding sources include loans, bonds and equity. The fundamental difference between these sources of revenue is that the basic revenues provide an assured cash flow which can be used to attract repayable finance.
In Africa, the public sector is largely responsible for providing water services and water utilities usually survive on a financial hand-to-mouth basis reliant on infrequent and inadequate government tax-funded subsidies. Because water is in many countries considered a free social good, hence governments and consumers are unsure as to how far water can be commercialised. Thus tariffs are in many cases below economic levels resulting in basic revenues not covering recurrent costs. The poor cost-recovery is making it difficult to attract repayable funding sources.
In order to improve the financing and delivery of water services, various options for Private Sector participation (PSP) and commercialisation have been sought. However, the lack of operating environments that are conducive for PSP has been a main hindrance. In Africa, the commercialisation of water services through establishment of public water utilities that emulate private sector performance was being promoted against the backdrop of economic decline, reduced incomes, increasing poverty and high national indebtedness (IPCIG, 2008:1).
Currently, the water sector in Africa is experiencing targeted financing initiatives aimed at improving the operating environment for investment. The recognised inherent complexities of water projects have led to the development of project preparation facilities aimed at assisting with the preparation of bankable projects. Examples include the African Water Facility (AWF), The European Investment Bank’s Facility for Water Projects and the Technical Assistance Grant Facilities in many Development Finance Institutions. The AWF was established as an instrument designed to assist the successful implementation of the African Water Vision 2025 (AMCOW, 2008).
Experiences with private sector
To presumably bring in efficiency, the water sector in Africa has experienced various options for PSP. Earlier attempts were more inclined towards full-privatisation and the subsequent failures led to the emergency of Public-Private Partnerships (PPPs) models (see Table 1).
Table 1: Main types of PPPs models and allocation of responsibilities (World Bank, 1997)
Despite distinctions of PPPs shown in Table 1, the World Bank says that many governments often use hybrid models. For instance, it is possible to have Management Contracts in which the private sector takes on some commercial risks, or Lease Contracts in which the private sector is responsible for some capital investments. The world’s largest water privatisation has to date taken place in Manila through a concession contract (Dumol, 2000). Concession contracts have been reported to be favourable where the area of service is large enough to take advantage of economies of scale (Farlam, 2005:24). However, where the operating environment is too complicated or the area of service too small to take advantages of economies of scale, public water utilities have tended to opt for ‘partial management contracts’ rather than full-privatisation.
While there have been some successes in privatisation, the high expectations of privatisation of basic utilities have not matched the results in the sub-Saharan region (Ivo 2008:2). Ogunbiyi (as cited in Farlam, 2005:20) reported that “PPPs have not had much success in Africa’s water sector”. The implementation of PPPs models has yielded mixed results and in several instances the private sector has seemed no more efficient in delivering services than the public sector (Prasad, 2006: 669).
Prasad (2006:688) concluded that experiences with PSP worldwide suggest that there is a significant conflict between social development, public health and environmental concerns and poverty reduction, on the one hand, and the private sector’s motive of profit maximising, on the other. The profit concerns from the private sector should not be a surprise as any PSP business comes at a cost and must ensure financial sustainability in the long term. However, what seem to have received little attention are efforts to balance the objectives of financial sustainability and financial profitability in order to achieve social development, environment sustainability and poverty reduction. It is possible to achieve financial sustainability without financial profitability being the key driving force (Prasad, 2006:688). But such a possibility can only be held true where there is minimal PSP, otherwise the need for financial profitability still remains.
One of the key contractual lessons learnt in financing water projects based on PPPs models is the need to ensure that contracts are concluded based on sufficient information and predictability of the future operating environment. Otherwise, contracts remain susceptible to renegotiations, which can be frustrating to both the private and public partners. Farlam (2005:21) reports of a case in South Africa in which a 30-year water services concession contract was subjected to renegotiations due to extreme changes in the operating environment within 5 years of its implementation.
Despite the challenges and reported failures of the implementation of PPP models, there have been successful ones. The Senegal Water Sector Reform that led to successful implementation of PPPs is a good case study for Africa (DBSA, 2006:111). Amongst several other African Countries, South Africa has also recorded some failures and successes in PPPs (Farlam, 2005:21-25).
Water is life and there will always be a growing demand for it. Investment opportunities in water can only be realised by appreciating the true value of water and its role as a key input to social and economic development and environmental sustainability. Consideration should be given to managing the development of water resources and water supply in the same manner as sectors such as energy. Water has a central role to play in society and most importantly managing it as a business can also address poverty and health challenges.
The poor condition of water infrastructures in a many African countries as a result of years of ineffective operation and neglected maintenance provides a huge investment opportunity. Manu (2008:21) reports that targeted investments of US$12 billion per annum in drinking water and sanitation over the next ten years should be sufficient to attain the Millennium Development Goals (MDGs). However, the financing opportunities lie in understanding the implications of the sector challenges on public welfare. There is growing evidence that African Governments and development partners have taken major steps to respond to financing requirements of Africa’s aspirations in the water services sector, although a finance gap of the order of US$4 billion p.a remains (Manu, 2008:4).
Water services have to reach all communities and successful delivery entails engagement of local communities for sustainability purposes. Hence, job creation opportunities in the delivery of water services are inevitable. Ultimately, access to clean water and sewerage systems improves public health and protects the environment. Hence, investments in the water sector have a direct impact on the social-economic development and environmental sustainability. Many industrial processes need clean water and at the same time produce effluents that pollute the environment. Therefore, there are opportunities to optimise the use of water by industrial/commercial consumers.
The hydrology of Africa is that of extreme rainfall variability and distribution. There are regions that have scarce water resources and focussing on managing current water resources is becoming more important than the building of new physical infrastructures. Hence there are opportunities to invest in water conservation initiatives, which can minimise water losses and at the same time make more water available for other uses. However, the need to increase storage to ensure sustainable water services is very much necessary.
Although the provision of water is largely a responsibility of the public sector, the reality in Africa is that PSP and PPPs still have the potential to improve procurement of public services and enable more efficient use of resources. Given this scenario, there are numerous opportunities to invest in strengthening the implementation of PPPs options that can result in the sector attracting repayable finances.
The way forward for Africa
Africa is now in an era of abundant knowledge, experiences and commitments. The only way forward is to use these developments to deliver/implement commitments. It is thus inevitable for Africa to begin collating existing knowledge and experiences, a task that is seemingly on-going and has resulted in various declarations and commitments.
Findings in recent research indicate that ‘Effective Water Governance’ is now becoming a very important tool to measure the ability to attract finance. National Governments must take the lead in the water sector reforms and the attendant initiatives to promote investor/private interest in financing water projects. The trend of decentralising the provision of water services must go hand in hand with appropriate support from national governments and not leaving local authorities to their own demise. International Financing Institutions are now focussing on dealing with sub-sovereign (local) risks and requesting that local authorities be financially accountable on their own (Winpenny, 2008). Hence, national governments must invest more in supporting local authorities with respect to regulation and capacity building initiatives that create conducive environments for implementation. Expert knowledge is still largely in the private sector; hence PPPs models are still cardinal to bringing efficiency in the public water utilities.
Given the social value of water services, political risks in the sector have been high on the African Water Governance challenges. The relevance of political structures to facilitate delivery of public services cannot be overemphasised. However, these structures need strong water sector advisory services so that politicians avoid making unrealistic promises relating to delivering of water services. This would further assist politicians to establish operating environments that are predictable and conducive to PSP and financing.
Given the challenges regarding the poor status of existing water infrastructures in Africa, it is important to begin with managing what is available. The push for investigating in new infrastructure development must be preceded or move along with effective management of the existing infrastructure. The trend by Development Finance Institutions has been to fund new infrastructure developments and hope that resulting revenue would finance recurrent costs. The latter has not been forth-coming and it is increasingly becoming evident that targeted financing for rehabilitation, operation and maintenance is inevitable.
It is important that financing for physical water infrastructures be preceded by long term capacity building and institutional development support. This should include establishment of mechanisms to ring-fence water sector revenues so that attendant recurrent costs are met from the revenues. In Africa most local authorities are still managing pools of public services (water, electricity, buildings, transport) whose revenues all go in one basket. Water revenues are one of the reliable sources of municipal local funds, but re-investment in the water infrastructure is normally inadequate and need to be enhanced.
In addition, Government departments in many African countries usually have the largest water bills, at the same time the most payment arrears. Hence, African governments must lead by example in paying their water bills in order to improve the willingness-to-pay from consumers that would ensure the financial sustainability.
Currently, knowledge and experiences regarding the practices in water sector financing are abundant, but have not been optimally utilised. Hence some reported challenges in attempts to increase funding the sector from private capital markets are common. What is evident is that the large part of the management of water services in Africa still remains in public hands. Hence, the capacitating of state owned or supported water utilities / authorities must be given priority, even to a minimum level that would ensure professional engagement with the private sector. Although there have been mixed results pertaining to PSP in the water sector, the chronic lack of capacity and low funding in the sector still retains the potential for the use PPPs.
Given the abundance of the sector financing knowledge and experiences, it is important that Africa starts focussing on prioritising water sector projects and ensuring targeted implementation. The commitments that have been made so far must be followed through if the ever rising challenge of financing is to be stalled. Improving governance issues relating to water must be accelerated as matter of urgency to ensure conducive operating environments that will be able to attract sustainable financing.
In considering various financing options, it is important that Africa acknowledges and understands the inherent characteristics of the water sector projects and attendant risks, both in the short and long terms. In mitigating such risks consideration of the existing operating environment and status of water infrastructures must be given primary attention. Furthermore, in attempting to involve the private sector, a balance between financial profitability and sustainability need to be negotiated considering social and environment impacts. Experience shows that state subsidies are necessary in Africa to facilitate the attainment of such a balance given that a large part of its population is indigent.
Finally, financing opportunities in the water sector are evident given the strategic role water plays, both socially and economically. Given the numerous lessons learn, the potential for Africa to optimise the use of water as a social and economic development vehicle is immense. The trans-boundary characteristics of Africa’s water resources also provide opportunities for cross-border collaboration using water as the common denominator.
Submitted by KMAadmin on 2 August 2009 - 10:36am. categories [ ]