“Innovative approaches to financing water and electricity in developing countries”

Presentation prepared for Multi-stakeholder Consultation on

“Financing for Development in Asia and the Pacific”Organized by ADFIAP in cooperation with FfDO (Bangkok, Thailand,

17 December 2007)

Daniel PlatzEconomic Affairs Officer

Financing for Development Office Department of Economic and Social Affairs

United Nations

Overview (I)

More than one billion people in the world today live without access to clean drinking water, about 2.6 billion people do not have access to basic sanitation and nearly 1.6 billion lack access to electricity (UNICEF 2005, IEA 2006).

The total cumulative investment required for electricity to achieve the MDGs in Sub-Saharan Africa alone is estimated at US$46 billion between 2003 and 2015 (IEA, 2004).

Access to electricity by region

Access to improved drinking water sources by region and segment of population

Access to improved sanitation facilities by region and segment of population

Overview (II) For water and sanitation, the domestic public sector provided

nearly 65%, while the domestic private sector provided 19% of the total, multi-lateral and bilateral donor funds provided 12% and the international private sector just 5% of funding (Fonseca & Cardone, 2004).

As a starting point, it is therefore important to realize that the overwhelming majority of utilities in the water and electricity sectors of developing countries remain in public hands and continue to rely on domestic funds. The discussion should therefore put emphasis on the immediate financing challenges public utility providers are confronted with in funding and improving their services.

Overview (III)

This does not imply that market mechanisms are not important. In order to finance capital expenditures that cannot be funded through current revenues or fiscal transfers, the utility provider must take into account all appropriate options, whether market-based or not.

Once finance is raised, the utility has to generate its own “internal” revenue to pay off its debt and finance recurrent expenditure. At the same time, if full cost recovery cannot be achieved, the utility will depend on “external” sources of funds such as tax revenue and transfers from the government.

Any sustainable strategy to improve access to basic utilities for all must therefore follow a multi-pronged approach and focus on improving financing (borrowing) mechanisms as well as “internal” (cost recovery) and “external” (tax revenue) revenue generating mechanisms.

Mobilizing investment: Innovative financing mechanisms

Ensuring sustainability: Revenue-generating mechanisms

Mobilizing Investment: innovative financing mechanisms

A cautionary note. “Innovative” financing mechanisms are not a panacea. Their potential for success depends on the depth of the local capital market, the local economic and social environment and the viability of the utility itself.

Important to remember that loans have to be repaid, usually with substantial interest. Foreign exchange risk occurs in cases where the loan is denominated in foreign currency and revenues are collected in local currency.

Nevertheless, it can be instructive to take a closer look at some innovative financing approaches at the municipal and community level. Depending on the local context, some of these experiences may be at least partially applicable in other settings.

a. Innovative municipal financing mechanisms in South Africa and India (I)

In 2002, Johannesburg experienced a capital expenditure backlog of R8 Billion (1,077,215,884.24 USD) with significant adverse impacts on investments in electricity infrastructure and water provision.

In order to generate new funds the city decided to prepare the issuance of two institutional bonds to be financed out of operational surpluses from water and electricity revenues.

The following steps were important in establishing the bonds: establishing the City Treasury; embarking on a study tour to Mexico to learn about best international practice in municipal bonds; eliciting political support for the move and developing a 10 year financial plan.

In India, municipalities have come together in pooled financing schemes that can helped diversify risk and enabled less creditworthy municipalities to tap the capital market.

The Water and Sanitation Pooled Fund (WSPF) is a common financing arrangement of fourteen municipalities and towns in the Indian state of Tamil Nadu.

With a 15-year tenure, it is the first successful bond issue of its kind outside of the U.S., using a pooled financing structure for financing water and sanitation projects of small and medium municipalities.

a. Innovative municipal financing mechanisms in South Africa and India (II)

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0 20 40 60 80 100 120 140 160 180

Turkey

South Africa

Slovak Republic

Russian Federation

Romania

Poland

Mexico

Malaysia

Latvia

Hungary

Estonia

Czech Republic

Croatia

Argentina

UPPER-MIDDLE-INCOME ECONOMIES

Ukraine

Thailand

Kazakhstan

Jordan

Ecuador

Colombia

Bulgaria

Brazil

Bolivia

LOWER-MIDDLE-INCOME ECONOMIES

India

LOW INCOME ECONOMIES

Number of cities, states and municipally owned corporations in low and middle-income countries that are rated by at least one of

the three major credit rating agencies

d. Improving actual and perceived creditworthiness

Perceived creditworthiness is critical for the cities and states abilities to raise finance, whether it is through bond or bank lending.

With the exception of Mexico, the overwhelming

majority of cities and states in developing countries have not been rated by Standard & Poor’s, Moody’s Investors Service and Fitch Ratings.

One strategy to overcome this gap could be to promote linkages between local and international credit rating agencies.

b. Innovative community financing in Ghana

Issuing bonds is, however, not a practical option for municipalities in most low-income countries with shallow capital markets.

Local mechamism: Upper East Region of Ghana women have developed a so-called "susu" group (an informal savings scheme) to pool resources.

Regular collection of fixed amounts of money from people participating in the arrangement. The collected amount is paid out as a loan for productive ventures for one person at a time until each member is served.

The collected interest of these loans together with water levies and other income sources is ploughed back into the susu fund, which is used for maintaining and operating the water handpumps in the region. Variants of scheme exist in other developing countries.

c. Output-based aid (OBA) in Cambodia

OBAs are performance-based subsidies designed to better target the poor by identifying who will benefit, the types of activities that qualify for the subsidy, and how much subsidy will be provided

In Cambodia, 8 firms were invited to participate in an international competitive bidding process for the first batch of a $3.1 million OBA grant to supply water to 4 towns. Under the OBA arrangement, service providers were obligated to connect any household within their service areas that requests a connection.

The results of the OBA approach in Cambodia still have to be assessed. However, common sense would suggest that a good regulatory environment and corporate transparency appear to be critical for a successful OBA arrangement.

Mobilizing investment: Innovative financing mechanisms

Ensuring sustainability: Revenue-generating mechanisms

Ensuring sustainability: revenue-based mechanisms

An effective collection system of taxes and user fees provides the basis for sustainable revenue generation.

It is vital to strengthen capacities of utilities to help ensure efficiency, effectiveness, transparency, accountability and sustainability.

Whereas full cost recovery seems unrealistic for most utility providers in developing countries, many utilities have gone a long way in improving efficiency of their operations.

a. Increasing efficiency in cost recovery in Uganda

As of 1998, the operational efficiency of the old Ugandan National Water and Sewerage Corporation (NWSC) was low.

A reduction in administration and overhead costs, a stricter appraisal of capital projects and a simplification, rationalisation and indexation of tariffs led to major operating efficiency gains and resulted in significantly increased coverage.

Cross-subsidies were applied across customer groups and across areas by application of a uniform tariff. At the same time, disconnecting users from their services upon non-payment could be avoided.

b. Capacity building and technical assistance through partnerships

There is a need to strengthen technical, financial, managerial and institutional capacities of water utilities, including utility operators and regulators.

The emerging consensus seems to be that capacity building

programs should focus on educational training, monitoring of research and forecasting, legislation and regulation as well as finding sustainable financing mechanisms for infrastructure investments.

Developing partnerships mechanisms between utility operators, such as the Global Water Operators Partnership mechanism (WOP) recently initiated by the UN System can help improve the performance and effectiveness of utilities on a on a regular but not-for profit basis .

c. Increasing budgetary allocations to water and electricity

In order to immediately increase access to basic utilities to the poor, allocations for utilities from national, state and municipal budgets must increase.

Increasing budgetary allocations to these sectors is a joint responsibility of the developing and the developed world, particularly in low-income countries.

Governments should reevaluate fiscal constraints at the sovereign and sub-sovereign level as to whether they unnecessarily limit much needed investment in infrastructure.

At the donor level, ODA falls far short of what is needed. Overall, ODA rose to $106.5 billion in 2005 or 0.33% of GNI of developed countries. However, in 2006, ODA decreased to 0.30 per cent of GNI.

THANK YOU!

For more information:www.un.org.esa/ffd