Difference between revisions of "Financial approaches"

Revision as of 11:52, 16 December 2008

The availability of finance instruments for the implementation of WASH service delivery approaches (SDA) differs for each approach. None of the financial approaches ¹ suits all SDAs. The availability of their instruments, however, is considered an enabling factor for the implementation of the SDA itself.

In the 2006 “Landscaping of Approaches to Support Service Provision of Water, Sanitation and Hygiene” prepared for Cranfield University, AguaConsult and the IRC International Water and Sanitation Centre for the Bill & Melinda Gates Foundation, finance instruments (within a finance approach) were considered enabling factors for the SDA. Other enabling factors identified were "demand stimulation" and "support to systems". ²

This Financial Approaches Portal illustrates a selection of approaches to water and sanitation service provision as well as some articles on project management. It is primary built upon the finance mechanisms identified in the above-mentioned landscaping prepared for BMGF, although several parts are edited according to the experience of the current editor(s).

Build Own Operate and Transfer (BOOT)

Build-Operate-Transfer (BOT) is a form of project financing, wherein a private entity receives a concession from the private or public sector to finance, design, construct, and operate a facility for a specified period, often as long as 20 or 30 years. After the concession period ends, ownership is transferred back to the granting entity.

During the concession the project proponent is allowed to charge the users of the facility appropriate tolls, fees, rentals, and charges stated in the concession contract. This enables the project proponent to recover its investment, operating and maintenance expenses in the project.

Due to the long-term nature of the arrangement, the fees are usually raised during the concession period. The rate of increase is often tied to a combination of internal and external variables, allowing the proponent to reach a satisfactory internal rate of return for its investment.

Examples of countries using BOT are India, Croatia, Japan, Taiwan (Republic of China), Malaysia, Philippines and Hong Kong. However, in some countries, such as Canada, Australia and New Zealand, the term used is Build-Own-Operate-Transfer (BOOT). Recently, in the United States, BOT strategies are being considered for construction of portions of Interstate 69, with groundbreaking on the Southern Indiana Toll Road segment expected to begin in 2008.

Traditionally, such projects provide for the infrastructure to be transferred to the government at the end of the concession period. (in Australia, primarily for reasons related to the borrowing powers of states, the transfer obligation is omitted).

BOT is a type of project financing. The hallmarks of project financing are:

(i) The lenders to the project look primarily at the earnings of the project as the source from which loan repayments will be made. Their credit assessment is based on the project, not on the credit worthiness of the borrowing entity.

(ii) The security taken by the lenders is largely confined to the project assets. As such, project financing is often referred to as "limited recourse" financing because lenders are given only a limited recourse against the borrower.

Most project finance structures are complex. The risks in the project are spread between the various parties; each risk is usually assumed by the party which can most efficiently and cost-effectively control or handle it.

Once the project's risks are identified, the likelihood of their occurrence assessed and their impact on the project determined, the sponsor must allocate those risks. Briefly, its options are to absorb the risk, lay off the risk with third parties, such as insurers, or allocate the risk among contractors and lenders. The sponsor will be acting, more often than not, on behalf of a sponsor at a time when the equity participants are unknown. Nevertheless, each of the participants in the project must be satisfied with the risk allocation, the creditworthiness of the risk taker and the reward that flows to the party taking the risk. In this respect, each party takes a quasi equity risk in the project.

Cost recovery for operation and maintenance

According to the BMGF lanscaping, this approach has been identified mainly in water related service delivery approach. The idea is that the actual user pays the cost for operation and maintenance as a contribution to the system.

The principle that users should pay for recurrent costs has gained widespread acceptance in the last years, specifically for the rural sector in many countries. Urban users pay through regularised billing in many cases. However, tariffs are often set too low (sometimes for political reasons) and generally do not cover the true costs of system replacement over the long-term.

Tariff structures and costing need better incentives, strategies and support to enhance efficiency (benchmarking, water metering etc.). Poor need differential (social) tariffs. In rural Gujarat 25 water user committees have successfully started to set-up operation and maintenance funds. ³ However, most urban and rural schemes in India survive on large operating subsidies. ⁴.

This could be the most suitable financial model for service delivery, which could even have a higher impact if also repairs and replacement were accounted and financed.

Cost sharing for capital investment

The idea is that end users contribute, mostly in kind or labour, to the cost associated to the capital investment. This is seem also as a way to enhance ownership and thus ensuring that service responds to demand.

Accordingly with the BMGF landscaping, this idea is increasingly accepted as best practice and mainstreamed into many national policies, especially in rural sector. Users contribute in cash (paying a connection fee) or kind (labour), mainly for the connection facilies of water systems. It is increasingly also needed for replacement and large repairs. It is recognized that poor would need support through differentiation in contributions.

Examples are mainly found in the water supply. A 1999 report of the Swajal project in UP⁵, India claims that for the first time in India users are paying 10% of the investment cost of water supply.

The NGO Dustha Shasthya Kendra in Dhaka has negotiated with the water authority to locate at least 90 community water points in slum areas, providing improved water to more than 8,000 poor households. Before a site is built, the community signs an agreement with DSK that covers its obligations to run the site and the charges made to recover the costs of the water, maintenance and capital costs. [1].

This approach has high potential to reach also the poorer sections of the community, if properly targeted.

Related links

Cross subsidies / Differential tariff systems

The idea is to differentiate tariffs based on a specific factor common to a group of users, as the volume of water consumed or users' living area. This can also also be used for connection fees.

This approach is considered to be a good way to reach the poorest. However, the Asian Development Bank (ADB) concluded that whereas it helps to sustain existing systems, current approaches do not reach the poorest [2]. Tariffs based on volume are interesting, but metering is normally a problem, since it is costly. Customer involvement in the process is also very important. China’s Rural Water Supply program, for instance, has over 90% payment compliance in households with metered systems whereby the salaries of the operations staff are tied to monthly bill collection and raising tariffs if they do not cover operating costs [3]. Cross subsidies have high potential however, particularly for poor slum dwellers, but innovative ways of dealing with the problem of metering are needed.

Regarding sanitation, the BMGF landscaping recognized differential tariffs in sewered systems charging below cost to poor users and above cost to others. These is a tipical example of cross subsidies (non-poor users subsidizing poor ones).

It is considered a good approach that address the differences in users' income, aiming at recovering total system cost, which at present is often not the case. It is however difficult to ensure that subsidies reach the poorest groups in sanitation approaches [4] ; [5].

This approach has high potential for connecting more people, but it is costly and may reduce interest for dry alternatives.

Fighting Corruption

Although this is not a finance approach on its own, increased transparency can have a great impact in allowing more efficient use of more available funding.

Corruption is a widespread phenomenon and drains part of the funding that could be used for productive activities, better salaries, etc. Rising transparency requires better procedures and access to information [6]. A study comparing productivity among 21 water utilities in Africa found that nearly two-thirds of their operating costs were due to corruption [7].

Fighting coruption has high potential because the part of the sector's funds that are currently lost due to its presence can be used for service improvements or expansion of water and sanitation systems.

Franchising

Creating economy of scale, quality control and back-up support

Franchising is not used in the sector, but amply in other sectors. It could provide the economy of scale and back-up support that is now often lacking (http://wbln0018.worldbank.org/water/bnwp.nsf/files/WSS_Franchise_published.pdf/$FILE/WSS_Franchise_published.pdf ). High potential as a model to provide necessary information, support and control

Franchised water treatment and sales

Entrepreneurs treating and selling water under an umbrella organization for quality control and back-up

Experience exists with SWPs, but impact is likely to be much larger if they are grouped under an umbrella organization to guarantee quality of water and service delivery. More than 650 local entrepreneurs sell water through water kiosks to half a million poor people in Kibera (Kenya). They are now forming an association with support from WSP-World Bank, which is self-regulating and can negotiate with utility on lower block tariffs. (http://www.wsp.org/publications/Rogues%20No%20More-Water%20Kiosk%20Operators%20Achieve%20Credibility%20in%20Kibera.pdf ). Application of franchising holds a promising potential of a high impact

Full capital investments by donor funds or government

People receive facilities as a gift; historically linked to large externally-funded projects

Significant in the past and applied by various funding agencies including national governments, foreign donors and even NGOs. Now discouraged, with a paradigm shift towards cost sharing because of overall costs involved and to enhance ownership. Leveraging public resources is seen as a key component towards increased financial sustainability (http://planningcommission.nic.in/plans/mta/mta-9702/mta-ch20.pdf).

People receive facilities as a gift

In the past, governments often provided 50% to 100% subsidies for household latrines, which tended to ignore or even ‘crowd out’ household resources. It was a typically supply- driven approach which often resulted in many unused facilities. This approach is now discouraged, shifting to cost-sharing or no subsidy because of cost involved and to enhance ownership (http://www.wsp.org/publications/af_finsan_mdg.pdf ).

Improving financial efficiency

Reducing unaccounted for water by leakage control and improved billing

A considerable source of funding is in fact available within existing systems by reducing leakage, optimizing consumption (through water metering, making it possible to extend systems to more users) and by reducing back-logs in payment by users. This approach is successfully followed in large systems, but much less in smaller ones. It includes both savings in the systems by repairs and adjustments and in households by repairing leakages, and introducing water saving devices and meters. Good facilitation and promotion is needed (http://www.irc.nl/content/download/11496/168599/file/Uso_Efficiente_2004.pdf ). High potential as it can lead to expanded coverage and better use of water resources at low cost

Innovative financing mechanisms

Issuing bonds, equity mechanisms, pooling resources, etc.

Experiments with innovative financing are ongoing in different locations. These often involve considerable transaction costs that may not be attractive for donors. Further testing is needed and interesting (http://www.euwi.net/download_monitoring.php?id=209).

Loans/credits/guarantees

Different models are available for people, water providers and private sector to obtain funding from banks or others, including guarantees from enterprises with too little collateral.

Funding of water sector loans is not very attractive because of relatively high risk, unfair competition from grant money. Procedures are often very complex, particularly for smaller settlements. Requires support to simplify procedures, guarantees and better local credits. In Cambodia, GRET, an international NGO has a Rural Infrastructure Fund, with a public development bank. This provides medium-term loans to local commercial banks, to finance investors of piped water systems, providing a 30% guarantee in case of default. The private sector has installed 10 water systems, representing coverage of up to 85%. (http://www.lboro.ac.uk/well/resources/Publications/Briefing%20Notes/BN16%20Local%20financing.htm) High potential because people and WPs may have to take expensive loans from local money lenders

Loans made available to households

Good potential as people cannot afford paying high investment. Results of loan schemes specifically for sanitation are mixed if the demand for sanitation is low (sometimes poor repayment) but work better for broader schemes (house improvements). Instalment payments make capital investments easier for the poor. The vulnerable poor, (the poorest people) need additional support because they may not be reached (http://www.williams.edu/Economics/neudc/papers/What%20to%20Expect%20from%20Development%20NGOs%20July%209.pdf). Micro credit schemes exist in different contexts, often through local NGOs or with NGOs acting as a guarantor. Cases on sanitation loans show positive repayments in Honduras, but considerable back-logs in Ghana ( http://www.lboro.ac.uk/well//resources/fact-sheets/fact-sheets-htm/mcfs.htm ). High potential because it may be expected that attention for sanitation will create larger market

Loans made available to municipalities

Many municipalities are indebted by loans for water and sanitation facilities for which they pay from regular budget and too a much lesser extent from users contributions. Potential relates to changing this practice to a sound repayment on basis of users fees

Micro credit for private sector

Helping small enterprises without sufficient collateral to obtain credit

Improving local access to micro-credit is essential to enhance private sector involvement. Requires good regulatory framework because there is a large difference in the performance of micro-credit organizations. (http://www.microcreditsummit.org/papers/fundspaperfinal.htm#4.7). High potential as opportunities for private sector involvement in sector are growing

Limited access to venture capital often restricts small private sector to expand

Risk capital needed for further experiments; quality insurance. Often paid through local NGOs. Since the 1980s over 7,500 different types of small family businesses have received credit from the Orangi project in Karachi, with good repayment (http://www.oppinstitutions.org). In Bangladesh, Burkina Faso, Ghana, Peru and Senegal the private sector supply of latrine parts, construction and sale of soap has been supported, not by micro-credit but by social mobilization programs that increase the demand for the products. These programs are funded by governments and external agencies (http://www.wsscc.org/pdf/publication/Sanitationisabusiness.pdf). Potential exists in removing a barrier for private sector to grow

Output based aid (OBA)

Using explicit performance-based subsidies to support basic services where conditions justify public funding to complement or replace user-fees.

Experience with OBA is new, but growing and interesting. The difference with other subsidies is that OBAs are targeted for example to the poorest families (Cambodia) or to the poorest neighbourhoods (Paraguay) clarifying why subsidy is given and they are performance-based. The provider largely self-finances the service, receiving reimbursement mostly after the verification of successful delivery. The latter may reduce possibilities for small providers with limited capital. A bonus-malus approach might be more feasible, perhaps linked to longer-term system performance. (http://www.gpoba.org/documents/OBApproaches_What_is_OBA.pdf).

OBA uses explicit performance-based subsidies to support the delivery of basic services where it is justified using public funding to complement or replace user-fees.

The core of the OBA approach is the contracting out of service delivery to a third party, usually a private firm, where payment of public funds is tied to the actual delivery of these services. The Global Partnership for OBA is supporting programmes in different regions and sectors, including working with SSPs for on-site sanitation in Dakar and utilities in Punjab ( http://www.gpoba.org ).

Partial Subsidies in latrine programmes

Users contribute in cash or kind or pay connection fee.

Good approach to enhance ownership. Also needed for replacement. Some examples of no-subsidy for hardware, but poorest sections may require subsidy. The governments of India and Bangladesh suspended subsidies because they did not reach the poor but then re-introduced them at lower levels (the equivalent of about USD 10) in order to reach the poorest of the poor. Management of subsidies remains a challenge. In Ouagadougou (Burkina Faso): a surtax on water supply is applied by ONEA, an autonomous public water and sanitation company, to subsidize on-site sanitation facilities (25% contribution and supervision of trained masons). 20,000 facilities have been constructed in schools and households. Management of funds presents difficulties, but approach was extended to other towns (http://www.wupafrica.org/toolkit/resources/pdf-files/good_practices/good_practice_Africa.pdf) Good potential to reach the poorer sections of society

Pay and use toilets/public bath houses

People pay when they use the facilities that are built and managed by NGOs, entrepreneurs or local government

Good approach if systems are kept clean. Can quickly enhance coverage. A wide range of approaches are existing including public-private arrangement with users paying per visit but also some with monthly contributions (http://www.wupafrica.org/toolkit/resources/pdffiles/good_practices/good_practice_Africa.pdf ; http://www.lboro.ac.uk/well/resources/Publications/Country%20Notes/ CN4.1%20India.htm ). A good option to guarantee quality and back-up support, is to use a franchise concept. Sulab International has developed 4000 "pay and use" community toilets serving more than 11 million people daily (http://web.mit.edu/urbanupgrading/ waterandsanitation/resources/caseExamples/sanitation-services.html ). Pay-and-use public toilets for crowded areas and slums, without space or funds for latrine construction. Also for transient populations such as bus stops. Managed by local government, NGOs or entrepreneurs. This includes women groups jointly developing sanitation facilities (http://www.irc.nl/page/7706). High potential particularly in densely populated slums

Revenue financed expansion

Expansion of piped system based on revenues

Common practice in utility water supply, but much less in developing countries, where often no or negative profit margins exist. It is applied in some places benefiting from increased efficiency, but insufficient to quickly speed up coverage.

Revolving funds

Funds established often by NGOs and managed by a community group; Repayments become loans for others

Interesting approach in the absence of financial institutions, sometimes even in kind (chickens etc.). Current funds often do not include interest, so capital diminishes. Revolving funds have been widely used in Kenya for example, usually by church based NGOs providing financial resources to women's groups. As a result thousands of rainwater tanks have been built. (http://www.dams.org/docs/kbase/contrib/opt163.pdf). Provision of small-scale loans for investment in water supply systems has also been successfully implemented in peri-urban areas of Cochabamba in Bolivia, where the micro-credit agency CIDRE has joined forces with a private sector company, the municipal government, the utility and community organizations to expand infrastructure (http://www.aguatuya.com/html/our_partners.html ). High potential for rural areas without banking facilities and areas with good social cohesion

Used at community level

Interest in this concept is increasing and good results are reported for example from Anhui province in China, particularly where community leaders were involved (http://www.unicef.org/evaldatabase/index_14260.html). In Nepal the government does not provide subsidies for sanitation but has established revolving funds which the community can keep if they have obtained 100% coverage (http://www.livelihoods.org/hot_topics/docs/CLTS_update06.pdf). Requires transparent management. High potential particularly in homogenous communities aiming at 100 percent sanitation

Self-financing

people investing individually or jointly in water supply

Widely used, but often substandard performance. Could benefit enormously from proper support (advice, materials, innovation). Legalisation of property rights is key. Poorest need support. In Baroda (India) a 1999 study showed that households invested, on average, at least 70 USD in their own facilities such as rainwater tanks, underground tanks, lift pumps etc. (http://www.wsp.org/publications/sa_indiapoor.pdf). The World Bank estimated that half of the investments (totalling 1.8 billion USD) made in rural China between 1990 and 1995, were made by the users themselves. (http://www.chinadevelopmentbrief.com/node/248). High potential because of growing access also of poorer groups to credits and remittances of overseas workers

People investing individually or jointly in sanitation

Widely used but often poor quality because of weak management and supply chain and particularly because many toilet technologies are unaffordable for the very poor. Needs better access to micro-finance, information, advice and products. Better access to support / stronger private sector involvement would be very beneficial. Actual examples demonstrating success in leveraging household and community resources for sanitation can be found in countries as diverse as India, Lesotho, Vietnam, Bangladesh, Pakistan and Burkina Faso. (http://www.wsp.org/publications/af_finsan_mdg.pdf). Self-financing is increasingly becoming an issue as more and more externally supported programme pay for the software costs for demand creation but no longer for facilities. High potential because of growing access to funding

Social development funds

Donor funding to mitigate effect of structural adjustment; Often linked to income generation and employment targets

These funds have improved over the years, but the problem remains that they are typically project based with arrangement that are in parallel with existing structures and having their own rules. In Tanzania, regional development funds are now financing community identified projects (http://www.iadb.org/sds/doc/sgc-GN1930-2-E.pdf and http://www.wsp.org/publications/af_socialfunds.pdf). A recent report carried out by the World Bank's evaluations department found that social funds do not always reach the poorest sections of society and can be subject to political influence. Impact in the WS&H sector has varied and sustainability issues have not been well addressed (http://www1.worldbank.org/publications/pdfs/15141overview.pdf).

Often grant or food/pay for work-based interventions

Mixed track record in sanitation with earlier interventions even frustrating work of others. Risk remains that it operates as a parallel program. Approach is for example promoted in Latin America and Caribbean by the Inter-American Development Bank (http://www.iadb.org and www.iadb.org/sds/doc/957eng.pdf ).

Tariff

Users pay the cost for operation and maintenance

Accepted as a rule, but not always covering all costs in sewered systems. Poor often cannot afford the fees. Also used for communal facilities that are managed by group of families, paying monthly rates, for example in Nairobi (http://wupafrica.org/toolkit/resources/caseExamples/narrative-form.html). In South Africa differential tariffs are used to support the poor, and no tariff is charged to families using less than 6000 litters of water per month (http://www.joburg.org.za/services/water3.stm). Potential relates to the need to sustain services

References

1. ↑ strategy that consider how best to utilize different financial instruments for an specific financial requirement
2. ↑ Fisscher & Da Silva Wells, 2006, Landscaping and Review of Approaches to support service provision for Water, Sanitation and Hygiene, [IRC International Water and Sanitation Centre]. http://www.irc.nl/page/35949
3. ↑ http://www.wsp.org/publications/sa_indiapoor.pdf
4. ↑ http://siteresources.worldbank.org/INTINDIA/Resources/Bridging_the_Gap_Exec_Sum.pdf
5. ↑ http://www.wsp.org/publications/sa_indiapoor.pdf