Financing Strategies for Water and Environmental Infrastructure Lessons learned from case-studies

1. Financing Strategies for Water and Environmental Infrastructure • Lessons learned from case-studies • in FSU • OECD Global Forum on Sustainable Development • Financing Water and Environmental Infrastructure for All • 18-19 December 2003, OECD Headquarters, Paris Alexander Martusevich OECD

2. Financing Strategies applying FEASIBLE approach – case-studies in FSU

3. MAIN OBSERVATIONS FROM CASE-STUDIES IN FSU • Water and wastewater infrastructure in former Soviet Union is rather extensive, more than in other countries with similar level of income, but inefficient and deteriorating • Connection rates in FSU are high (70%-100% in urban areas), but service level is rather low due to lack of proper maintenance and investments • Low incentives for rational water use by consumers

4. MAIN OBSERVATIONS FROM CASE-STUDIES IN FSU • Efficiency is low (water losses amounts to 30-75%, excessive energy consumption per 1m3 by water utilities) • In case of Yerevan: Huge excessive energy consumption at 14,000 MWth per annumto pump water from Ararat valley can be avoided as gravity flow from mountains is almost sufficient to meet the demand

5. MAIN OBSERVATIONS FROM CASE-STUDIES IN FSU • Little incentives to optimise infrastructure and public capital expenditure and increase efficiency of public investments (e.g. FEASIBLE simulations proved that in oil rich Khanty-Mansijskprovince WSWW infrastructure development targets could be achieved with lower public expenditure than it was initiallyprojected / or actually spent ) • Very little proportion of public capital expenditure targeted to rural area • In FSU there is not enough finance to cover even baseline (O&M) expenditure needs – with few exceptions (e.g. KhMAO)

6. BASELINE SCENARIO: O&M EXPENDITURE NEEDS COMPARED WITH TOTAL FINANCING AVAILABLE 51 42 34 EUR per connected inhabitant per year 25 17 8 0 Pskov Ukraine Georgia Novgorod Kazakhstan Moldova Rostov Kaliningrad Eastern Kazakhstan O&M expenditure needs Supply of finance

7. FOCUS ON TWO ISSUES: • (1) BALANCING O&M EXPENDITURE NEEDS WITH AFFORDABLE USER CHARGES • (2) PRESENT AND FUTURE ROLE OF MAIN SOURCES OF FINANCING: • User charges • Public funds • Debt financing and private strategic and equity investments

8. BALANCING O&M EXPENDITURE NEEDS WITH AFFORDABLE USER CHARGES • Reduce excessive or illegal water consumption - demand side incentives for rational water use • Increase operational efficiency (reduce water losses, excessive staff, energy savings) – supply side incentives • Create incentives for infrastructure and capital expenditure optimisation, utilise economy of scale • Improve collection (often poor in FSU) and/or increase user charges (not much room in most poor countries)

9. LESSONS LEARNED FROM CASE-STUDIES IN FSU • (1) Demand and Supply side incentives are equally important: • Billing based on Metering does create strong incentives for rational water use but needs to be supported by appropriate Tariff policy not to make Water utility a bankrupt • Huge water and energy saving potential could be utilised in the short term (and may counter balance upward trend in electricity prices) • (2) User charge revenues • - at present are not sufficient to cover O&M expenditure

10. PRESENT USER CHARGES AS % OF EXPENDITURE NEEDED TO IMPLEMENT BASELINE SCENARIO 100% 80% 60% 40% 20% 0% Moldova Kazakhstan Novgorod Rostov Ukraine Georgia Kaliningrad Pskov Eastern oblast Kazakhstan User charges as % of O&M expenditure requirements User charges as % of O&M and re-investment expenditure requirements

11. MAIN FINDINGS FROM CASE-STUDIES IN FSU • … are present User charges affordable ? • In most of cases present user charges are affordable for majority of households (HHs) – applying 3-4% threshold • Even in poor countries there is some room for user charges increase to affordability limit • However, there is little sense to further increase user charges until collection is substantially improved (Armenia) • … are HHs able and willing to pay more ?

12. MAIN FINDINGS FROM CASE-STUDIES IN FSU • Some proportion of HHs is able to pay for water more (and even willing to pay more for improved services)  4.5% 4.0% 3.5% Potential affordability limit 3.0% 2.5% 2.0% water bill as % of average household income 1.5% 1.0% 0.5% Eastern Kazakhstan Kaliningrad province Novgorod province Georgia Rostov province Ukraine Pskov Province Moldova Kazakhstan

13. MAIN FINDINGS FROM CASE-STUDIES IN FSU : Affordability constraints • Affordability limit (as well as WTP) is site specific while substantial fall of the collection rate after tariff increase may indicate that the limit is achieved • FEASIBLE model was used to assess at which level of average per capita income user charges could fully cover O&M cost (assuming that the user charge for HHs is set at the affordability limit of XX% of average per capita income)

14. Potential O&M expenditure coverage in WSWW sector by User charges and average per capita income

15. LESSONS LEARNED FROM CASE-STUDIES IN FSU: Affordability constraints and role of Public funds • These estimates and income distribution analysis show that in most poor countries and provinces (e.g. Armenia, Pskov) user charges which would allow to cover full O&M cost would not be affordable for substantial proportion of population (40-60%) • Public funds will therefore have to play essential role in the short and medium term providing income support to the poor and/or operating subsidies to water utilities bridging the cash flow gap

16. LESSONS LEARNED FROM CASE-STUDIES IN FSU:role of Municipalities and local public budgets • In FSU Municipalities are often owners of the infrastructure therefore formally responsible for major repairs and capital investments • BUT most of local public budgets are not sufficient to cover just operational expenses and have very limited investment and borrowing capacity •  additional burden for national and regional budgets

17. LESSONS LEARNED FROM «FEASIBLE» COUNTRY STUDIES:obstacles for Private sector participation • Private sector (operators, strategic investors) could and will play more important role in operating and financing water supply and environmental infrastructure in FSU • But there are some obstacles: • Limited management capacity of Municipalities • Improper regulation, institutional set up and tariff policy create too big risk and uncertainty • Affordability constraints • - elimination of these obstacles will take years

18. Policy measures to accelerate progress in WSWW sector in FSU • Regulation, Institutional set up and Contractual relations, as well as tariff policy in Housing and Communal Services sector should be improved to create proper incentives and reduce risk and uncertainty for operators and investors • Overall reform of public finance is needed to balance responsibilities and revenues of local (municipal) budgets and improve their borrowing capacity • Sound economic and fiscal policy aimed at fast growth - measured not only in terms of GDP, but also in terms of HHs incomes and public revenues