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Best Practices for Water Financing and Pricing

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Presentation made at the 7th High Level Session (HLS) Ministerial Forum of the Global Water Partnership-Caribbean (GWP-C).

Presentation by Mr. Glenn A. Khan, Deputy Executive Director of the Regulated Industries Commission (RIC).

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Best Practices for Water Financing and Pricing

  1. 1. 7th Annual High Level Session – Ministerial Forum: Water Management Financing in the Caribbean Hosted by:Global Water Partnership (Caribbean) October 06 – 07, 2011 Guadeloupe 1
  2. 2. Best Practices for Water Financing and Pricing by Glenn A. Khan*Note: * - Deputy Executive Director of the Regulated Industries Commission (RIC). Views expressed are not necessarily those of the RIC. 2
  3. 3. How important is Water?- Water is indispensable for leading a life in human dignity.- Therefore, the suggestion “water for all” recognizes the importance of water as a basic human right. In this sense, it appears to raise questions about whether water is a private or public good. 3
  4. 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. 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. 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. 7. Cont’d Social infrastructure - heavy reliance on Public finance. Usually, there is ambivalence among politicians and water consumers about whether water services should be provided free or with a subsidy, or commercially. This generally results in compromise where water is priced below economic levels, leaving the sector chronically under financed. Exacerbates the downward spiral of poor financial performance, service levels and service quality. 7
  8. 8. Some Financing IssuesThere is no Blueprint for an ideal system of water financing. 8
  9. 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. 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. 11. Need for Financial Self- sufficiency- Assurance of revenue sources to ensure sustainability- Freedom from political interference in business decisions- Cost recovery tariffs- Transparent, predictable and reliable subsidies 11
  12. 12. Financing Local Water (T&T)- Currently the public budget is the main source of investment in the water sector.- The local capital market has been used also – the issue of long-term bonds.- Only about 40% of operating expenditure is funded through tariffs (or income generated from operations). 12
  13. 13. Cont’dWhen 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. 14. Cont’d - 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. 15. •Financing Needs?We have identified two types of financingneeds:- Finance for Investment (mains, plants etc.)- Finance for Recurrent Expenditure 15
  16. 16. Sources on Finance The capital-intensive nature of water and waste water utilities places capital financing at the heart of the development of a sustainable sector. But utilities also require financing for recurrent costs. There are several sources from which financing for water is derived: - Tariffs paid by consumers - Taxes / Government budgets - Loans from Development Agencies - Funds from donor agencies - Loans from commercial banks. - Bonds 16
  17. 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. 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. 19. Local Financing of WaterSome issues:- In most developing countries, water is financed through budgetary allocations.- Given that there are competing needs on the treasury, in difficult times the allocation of water or ability of SOE to meet service requirements is affected due to lack of funding, subventions and subsidies. 19
  20. 20. - Public funding for water is thus a hostage of the government’s 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. 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, is not a sustainable way of financing water. 21
  22. 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 $1.1 billion between 1999 – 2001.- IDB lending, between 1991 – 1995 ($640 million per year), between 1996 – 2001 ($400 million per year). 22
  23. 23. The largest funding sources are local -governments, local banks and user charges.There are challenges associated with eachform of financing. 23
  24. 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. 25. Financing Challenges cont’dTariffs 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. 26. Financing Challenges cont’dShort-term Loans- Commercial bank lending to water utilities has never been large;- Financing limited because of the perceived low credit worthiness of water utilities.- Usually provided only when guaranteed by governments.- The assets of water companies cannot be easily sold if utilities default and therefore are not a good form of collateral security. 26
  27. 27. Some Possible Reasons for ProblemsWorld Panel on financing water infrastructure:- serious defects in the governance of the global water sector hamper its ability to generate and attract finance.- even if these problems were overcome inherent features in the sector will pose risks to potential lenders and investors. 27
  28. 28. Cont’dSome of the issues identified by the Panel include:- the low priority that central governments give to water sector issues.- political interference in Utility (operation and management).- resistance to cost – recovering tariffs.- confusion of social, environmental and commercial aims. 28
  29. 29. Other Related Challenges- Social and public health benefits – incompatible with full cost recovery and financial sufficiency?- Prices that utility will have to charge would seem high to most governments.- Governments would be inclined to suppress price increases for fear of losing popularity and office. 29
  30. 30. Cont’d- Transition from engineering company to business-oriented one. - Strong customer service focus / orientation. - Bankable, financially viable projects in the water sector. 30
  31. 31. Cont’d - 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, and cannot be removed, thus private sector not attracted because investor is at mercy of host country (international investors). 31
  32. 32. CAN CHALLENGES BE OVERCOME?- Make distinction between the various policy aims that water satisfies and as far as possible arrange funding for each based on its possible returns.- This is being practised in Trinidad and Tobago with “industrial water” – the desal plant is a commercial venture. It is probably doing well financially.- Likelihood of foreign investment low in the absence of strong government guarantee. 32
  33. 33. Cont’d - 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 market through bonds (since revenues are in local currency, foreign investors won’t be attracted because of exchange rate risks, however, it shields theutility from these risks. 33
  34. 34. Role of RegulatorThe Regulator’s role is to ensure sustainable costrecovery (SCR):- Sufficient revenues to recover recurrent costs, SCR includes operating and financing costs as well as the costs of renewing infrastructure.- Revenue from charges should be covered by users as a group – using appropriate tariff structures (based on consultations).- Ensuring utility meets service requirements to customers. 34
  35. 35. - Budget allocation should be secured to ensure that it is not subject to change.- Subsidies should be targeted and transparent. 35
  36. 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. 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. 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. 39. The End 39

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