The price of saving water
In the current financial crisis, risk-weary investors worry more about keeping their own boats afloat than in pumping money into a sector noted for high upfront costs, long pay back periods and low rates of return.
Add to that an inefficient use of resources, weak regulation and lack of up-to-date information, and the water sector faces what may prove to be a dry season for investment.
The United States and China have included water management in their stimulus packages. In the US, the Alliance for Water Efficiency estimates that every million dollars invested would generate between 15 and 22 jobs, add $2.5 to 2.8 million to economic output and raise GDP by $1.3 to 1.5 million. If investors are looking to clean up their soiled reputations, they could hardly make a better choice. If they hesitate, it is because the risks remain high. As the saying goes about “leading a horse to water”, governments will need to do a lot to reassure investors.
Their reluctance is understandable. Revenue from water and sanitation projects comes mostly from user fees and government subsidies. These revenues, being in local currency, put investors at a high foreign exchange risk if funding is in foreign currency. Water and sanitation are also managed at the local level, where poor co-ordination and local politicians, anxious over the support of their constituencies, may scupper plans to raise artificially low tariffs to sustainable levels.
This said, one message governments must do more to get across is that while there are financial risks for investors who may not enjoy a good rate of return, there are nevertheless major economic and social benefits from investing in water and sanitation. This makes it a good long-term deal. The WHO estimated that the economic rate of return was between 4-12 for every dollar invested for health benefits alone. The return would likely be higher if other benefits are taken into account, such as children (particularly girls) being able to go to school rather than fetching water, and higher productivity in industrial and other water-reliant sectors.
But there is another problem which this crisis has brought to the fore, and that is the philosophical and practical debate as to whether the private sector should be involved in water investment at all. Do investors have the wherewithal over the long term, and can they be relied on to provide the service in the public interest? Such questions reflect scarred reputations in finance, but also more than a few disappointments in the water sector too, with investors withdrawing or simply not showing enough interest in water investment.
Investment returns were not the main problem either. Difficulties experienced in the past by the private sector have not typically been related to specific projects but to poor risk management, lack of capacity in host countries, and an unhealthy environment for all kinds of investment, not just water. This is something governments should act upon. Whether the source of investment is public or private, it is ultimately the responsibility of governments to establish the institutional frameworks, allocate roles, demand accountability from providers, and guarantee the provision of a public good.
Clearly, the water stakes are so high that the policy focus of the debate must shift away from public versus private issues, to identifying the conditions under which water services can be provided safely, efficiently, affordably and sustainably. What matters is what works. The vast majority of water service providers are publicly owned and operated, but there is a significant number of private providers, and lessons can be learned from these and applied to all kinds of local situations. Moreover, whereas in the past, large international companies were the major players, there is a “new generation” of private providers, including a growing number of local and regional actors, and hybrid arrangements that are neither entirely public or private. Some are joint ventures and there are also cases of companies that are public in one country operating as private companies abroad.
But while the choice of operator– public or private–should be determined locally, how can that choice be made? The OECD has developed a check-list to help governments particularly in developing countries to address this question (see box). If the private option is being considered, the check-list can help ensure that the arrangement meets both long-term investment and public policy objectives.
Beyond the checklist, there is a simple condition: more investors would be drawn to water if prices were right. Many users, however, bristle at the idea of paying for water. In Mexico there is even a law exempting large swathes of the public sector from paying. In many countries, the view is, because water is essential and is a right, it should be free. Alas, the hard reality is that, whatever about the commodity itself, cleaning and distributing safe water is not cost-free. Persuading users that water and sanitation services would improve if private investment could be harnessed is no easy task, especially in the heat of a financial meltdown. Low prices are a comforting illusion but in reality, unless there is a major public sector investment to back them, they can be a trade-off for poor service, increased health hazards and higher sales of bottled water. The argument does not always wash with providers, whose creditworthiness would benefit as a result of adequate pricing. In Latin America, for example, banks do not accept revenue from water operators as collateral for loans and frequently require guarantees from the state should the operator default.
Ensuring that tariff levels are adequate and fairly apportioned among the richest and poorest is crucial to their acceptance. People doubt governments’ ability to right a capsized economy and fear that, in the end, it is they who will have to pay. According to some, poorer households, especially those benefitting from artificially low tariffs, would resist any increase. However, this is not always true: poorer people are often paying much more than, say, the middle class for their water simply because they are not connected to water networks and have to pay more to vendors for what is often lower quality water. That said, no price increase will be politically popular unless it can be transmitted quickly in to improved services. At present in too many cases, the middle class benefit from keeping water prices artificially low, but the services are not expanded. Charging for water is fair, because it can enable providers to extend water services and access to poorer communities. In short, providers need to balance tariff levels against the allocation of costs to different consumers.
There are examples to follow. Take Portuguese families, for instance, who were alarmed over a proposed tariff reform which threatened to increase household bills by 10.5% over the national affordability threshold. In fact, the majority of households experiencing the full increase were located in only 60 out of 309 municipalities. In the Portuguese case, the proposed tariff reform identified flexible solutions in different municipalities to address localised affordability problems, including support to local service providers This flexibility soothed customers, as well as regional authorities, who are better placed to determine what local populations can afford. Such approaches have lessons even for much poorer countries.
Unfortunately, what is defined as “affordable”, at both the national and international levels (usually 3%-5% of household income), may be a fraction of what consumers actually pay; vendors selling to households not connected to the network may charge exorbitant fees. International criteria also ignore the willingness and ability of local populations to pay for improved services. For example, many communities in developing countries are willing to pay for upgraded sanitation facilities. In Mumbai, one of India’s better-off cities, one out of twenty people defecate in the open for lack of toilets. People were willing to contribute to the capital costs of constructing 330 community toilet blocks and pay for their maintenance through a membership scheme and user fees. Some 400,000 people benefited from the Mumbai Slum Sanitation Project, which has become a model for similar initiatives under India’s National Urban Sanitation Policy. When the poorest cannot pay, there are better ways of ensuring they have access to water and sanitation than keeping prices low for all. Tariffs can be designed so that higher-income consumers cross-subsidise the most vulnerable. Poorer households can be provided with income support to cover part of their water bill. In Chile, the poor are provided with water vouchers to help pay their water bills. A better option in many developing countries is to subsidise access, not consumption. This approach has proved effective in countries where pipelines are few or outlets lie at a great distance from households. Connecting to the network is free or cheap; and consumers pay only for the water they use.
But even with the adjustment of tariffs, investors may still be jittery. Rightly so, as most of their money is going into a dark hole.
The bulk of pipe networks are underground. Deteriorating infrastructure and leakage are major drains on revenue. Even in well-run water utilities in OECD countries, leakage accounts for 10%-30% of unaccounted water loss; in developing countries it often exceeds 40%, even reaching 70% on some occasions.
In OECD countries, where most people have ample access to water and sanitation facilities, upkeep and conformity with health regulations means that countries such as the UK and France will have to increase the share of GDP in water spending by 20% just to maintain services; for Japan and Korea, the figure is 40%. In developing countries, the situation, though not dismal, falls well short of the targets set in the Millenium Development Goals. The World Health Organization (WHO) recently announced that to extend existing water facilities in developing countries will cost up to $18 billion per year, roughly double the current amount, and this figure excludes the maintenance, rehabilitation or modernisation of existing systems.
The victims of poor infrastructure are not only households; businesses are harmed as well. The World Bank Enterprise Surveys measure the number of days that businesses lack sufficient water for production. For OECD countries, the average is less than half a day, whereas in Kenya, Tanzania and Mauritania, firms grind along with insufficient water for about three months of the year, anywhere between 85 and 105 days.
Ensuring access to safe and affordable water and sanitation for all will not be easy, particularly in developing countries. The gates will only be raised to investment when governments establish sound regulatory frameworks, including provisions for sustainable cost recovery for the services provided. Investors, however, can reassure themselves at least in one respect. While not the heady ambrosia of previous years, water offers investors the refreshing alternative of stable returns–all in the name of the public good. Rory J. Clarke
OECD (2009) “Managing water for all: the OECD perspective on pricing and financing”, Paris. OECD (2009) Managing water for all:Key messages for policy-makers”, available at www.oecd.org/water
OECD (2009), Private Sector Participation in Water Infrastructure: OECD Checklist for Public Action, OECD, Paris, www.oecd.org/daf/investment/water
OECD (2009), “Strategic Financial Planning for Water Supply and Sanitation”, OECD internal document, www.oecd.org/water
OECD (2009), “Pricing Water Resources and Water and Sanitation Services”, OECD internal document, www.oecd.org/water
OECD (2009), “Alternative Ways of Providing Water and Sanitation: Emerging Options and their Policy Implications”, OECD internal document, www.oecd.org/water
OECD/WWC (2008), Creditor Reporting System: Aid Activities in Support of Water Supply and Sanitation - 2001-2006, OECD, Paris.
©OECD Observer No. 270/271, December 2008-January 2009
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