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For more information, please visit www.wsp.org. © 2014 International Bank for Reconstruction and Development/The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives Abbreviations and Acronyms $1 = Rs 55 One Lakh Rupees: Rs 100,000 (One Hundred Thousand Rupees) One Crore Rupees: Rs 100,00, 000 (One Hundred Lakh Rupees) BOT build-operate-transfer DPR Detailed Project Report GoI Government of India IFC International Finance Corporation IRR internal rate of return JNNURM Jawaharlal Nehru National Urban Renewal Mission kl kiloliter km kilometers KMC Khandwa Municipal Corporation KUWASIP Karnataka Urban Water Supply Improvement Project KUWSDB Karnataka Urban Water Supply and Drainage Board LMC Latur Municipal Corporation LoI letter of intent lpcd liters per capita per day MCC Mysore City Corporation MJP Maharashtra Jeevan Pradhikaran mld million liters per day MUDA Mysore Urban Development Authority NRW nonrevenue water O&M operations and maintenance PPP public-private partnership RFP request for proposal RFQ request for qualification Rs Indian rupees SPML Subhash Projects and Marketing Limited UIDSSMT Urban Infrastructure Development Scheme for Small and Medium Towns ULB Urban Local Body ii Creating Sustainable Services Through Domestic Private Sector Participation Contents Abbreviations and Acronyms................................................................... ii. Acknowledgments....................................................................................v I. Overview .........................................................................................1 II. Introduction......................................................................................6 III. Case Studies ..................................................................................13 Khandwa, Madhya Pradesh............................................................13 Nagpur, Maharashtra.......................................................................19 Latur, Maharashtra..........................................................................24 Aurangabad, Maharashtra...............................................................30 Mysore, Karnataka..........................................................................36 IV. Observations and Lessons Learned..............................................42 V. Conclusion......................................................................................51 Appendix: City Project Sheets................................................................53 Endnotes .......................................................................................58 Bibliography .......................................................................................60 Boxes 2.1 International Experience with Water PPPs........................................7 2.2 Three Karnataka Cities Achieve First 24/7 Continuous Water Supply in India......................................................................10 2.3 Jawaharlal Nehru National Urban Renewal Mission (JNNURM).....11 4.1 Findings from International Experience of Urban Water PPPs .......43 Figures 2.1 Service Delivery Parameters in Indian Cities.....................................6 2.2 Service Efficiency Parameters in Indian Cities..................................6 3.1 Khandwa PPP Time Line.................................................................14 3.2 Khandwa PPP Project Flow of Funds.............................................16 3.3 Nagpur PPP Time Line....................................................................20 3.4 Nagpur PPP Project Flow of Funds.................................................21 3.5 Latur PPP Time Line........................................................................25 3.6 Latur PPP Project Flow of Funds....................................................28 3.7 Aurangabad PPP Time Line............................................................31 3.8 Aurangabad PPP Project Flow of Funds.........................................33 3.9 Mysore PPP Time Line....................................................................38 3.10 Mysore PPP Project Flow of Funds.................................................39 Tables 1.1 Five Representative Public-Private Water Supply Partnerships in India..........................................................................2 2.1 PPP Projects Contracted from 2005 through 2011...........................8 3.1 Service and Efficiency Parameters, Water Supply, Khandwa City..................................................................................13 www.wsp.org iii 3.2 Service and Efficiency Parameters, Water Supply, Nagpur City.....................................................................................19 3.3 Service and Efficiency Parameters, Water Supply, Latur City.........24 3.4 Service and Efficiency Parameters, Water Supply, Aurangabad City..............................................................................30 3.5 Breakdown of Funding Sources, Water Supply, Aurangabad City..............................................................................32 3.6 Service and Efficiency Parameters, Water Supply, Mysore City.....................................................................................36 4.1 Financial Summary of the Five Case Studies..................................47 4.2 Funding Mechanisms for the Five Water PPPs...............................49 iv Creating Sustainable Services Through Domestic Private Sector Participation Acknowledgments This report was prepared by a team from the South Asia Public-Private Partnerships Advisory Services) and Clive Transport, Water and ICT unit (TWISA) of the World Harris (World Bank Institute, Public-Private Partnership Bank. It is was written by Suneetha Dasappa Kacker, SR Practice). Their inputs were instrumental in refining the Ramanujam and Tracey Miller, based on case studies under- analytical content. taken by a team including SR Ramanujam, Anand Jalakam and Dr. Dahasahastra. Suneetha Dasappa Kacker served as Thanks are also due to Jaehyang So (Global Manager, Task Team Leader. TWIWP), Juan Costain (TWISA) and Jemima Sy (TWIWP) for their support at various stages of preparation; Vandana A part of the information contained in the report was Mehra (TWISA), for support in the design, production and collected to support a wider study of PPP models, initi- dissemination of the study; and Ammini Menon (TWISA), ated by Bill Kingdom (World Bank, South Asia Urban and for coordinating logistics during the study period. The Water), who also provided valuable feedback and comments team would also like to thank the many representatives of to the case studies. The study and findings were discussed city and state governments in Khandwa, Madhya Pradesh; at several workshops on Public-Private Partnerships (PPPs) Nagpur, Latur and Aurangabad, Maharashtra; and Mysore, in India, and acknowledgements are due to the partici- Karnataka; and private sector, who provided data and pants, including Sheoli Pargal (World Bank, South Asia information for the study. Acknowledgement is due to the Energy) and Sri Kumar Tadimalla (World Bank, South Asia Ministry of Urban Development, Government of India, Transport), whose feedback led to an enrichment of the for facilitating the process. The team thanks Jill Armstrong contents of this report. (World Bank, India Country Program Coordinator) for guidance in facilitating publication. Special thanks to The final draft was peer reviewed by Isabel Chatterton Onno Ruhl, (World Bank, Country Director, India), for (International Finance Corporation, South Asia support and guidance through the process. www.wsp.org v vi Creating Sustainable Services Through Domestic Private Sector Participation I. Overview India is home to more than 370 million people in urban public-private partnerships (PPPs) in water supply opera- areas. Historically, almost all water supply provision has tions in the early 1990s, following economic liberaliza- been managed by the public sector through municipal or tion. Many of these early projects focused on bulk water state-level departments or parastatals. augmentation, with expectations of significant private investment. Most failed because of poor enabling frame- Benchmarking initiatives show that coverage through piped works for private investment, poor project preparation, water supply ranges between 55 percent and 89 percent in weak financial strength of project proponents, and opposi- urban areas. Per capita availability is fairly high, at 90 to tion to private sector participation. 120 liters per day, but no city yet offers continuous water supply. Daily supply averages four hours, with many cities In the first half of the 2000s, a shift in focus toward distri- alternating supply every other day. bution services took place, although projects were still handicapped by opposition to private sector involvement Service efficiency is weak, which means utilities have low in water supply services. The management contract model cost recovery, further exacerbated by low tariffs that have was explored, and governments started providing funding little relation to operating costs. Only about 20 percent of to meet a significant part of the investment needs while the connections are metered, and nonrevenue water—water for private sector focused on creating efficiencies. which no revenues are collected—averages over 40 percent in most cities. By 2005, cities were creating a mix of PPP arrangements, including concession agreements, management contracts, These challenges occur in a context of weak management and build-own-transfer (BOT) projects. A review of the systems and little data on existing assets, which makes it achievements of Indian water PPPs, drawing upon a study difficult to assess investment needs and time lines to improve in 2011,1 reveals the following: the shift in focus to service service levels and operational efficiencies. While investment delivery; the increasing willingness of cities to explore and requirements are likely to be significant, it is recognized design solutions that suit their needs; the recognition that that investments alone will not be effective unless the coun- PPPs may be pursued for efficiency gains, in addition to try simultaneously addresses related issues such as complex private financing; the recognition and handling of sensi- and fragmented institutions with little accountability; lack tivities around tariff issues; the success in attracting interest of capacity to run utilities efficiently and meet performance from a cross section of domestic and international opera- standards; weak commercial orientation; interference in tors; the embedding of competitive selection processes; utility operations by external entities; and the absence of and an increased ownership demonstrated by cities toward a regulatory framework focused on customer service and PPPs. The number of projects achieving financial closure financial sustainability. has also increased significantly: of the 15 projects awarded between 2005 and 2011, 10 involved private finance and Against this sector backdrop, some cities began to attempt eight achieved financial closure. www.wsp.org 1 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Overview Table 1.1 Five Case Studies in Water Supply PPPs in India Nagpur Aurangabad Mysore Latur Khandwa Population (millions) 2.5 1.2 1.0 0.38 0.2 Mandate Rehabilitation + Bulk + Reconstruction + Operations + Bulk + operations reconstruction + operations select reconstruction + operations rectification operations Duration (years) 25 20 6 10 25 Bid parameter Lowest bid price Least annual subsidy Least rehabilitation Highest payment Least end user cost and fee to state entity tariff Operator Veolia & Essel-SPML JUSCO SPML Vishwa Vishwaraj Private investment 30% 50% Nil Nil 10% Government grant UIG (70%) UIDSSMT + State UIG (90%) Nil UIDSSMT (90%) Revenue model Fee/kl Tariff + annual Management fee Tariff Tariff subsidy Contract signed Late 2011 2011 Mid-2009 2008 Late 2009 Contract management City City Parastatal Parastatal City Current status WS system Preparatory phase: Rehab, O&M in Under Construction in handed over WS system yet to be progress suspension progress handed over Note: UIG: Urban Infrastructure and Governance. UIDSSMT: Urban Infrastructure Development Scheme for Small and Medium Towns. While the shift in focus toward distribution, and hence in the movement to build stronger, more sustainable, and service delivery, is a positive one, it is meaningful only to customer-responsive water supply services through PPPs. A the extent that objectives are achieved through the arrange- snapshot of the case studies is presented in Table 1.1. ments, an outcome closely linked to the manner in which projects are structured and contracts are designed. A more Both UIG and UIDSSMT are components of Government detailed assessment of five PPP projects was consequent- of India’s JNNURM Program. UIG is applicable to 65 ly undertaken to evaluate the underlying rationale of the mission cities, and UIDSSMT is applicable to cities other initiatives; the preparatory and bid process; key contract than mission cities. provisions; risk allocation and related issues that may have a bearing on the operational trajectory; and impact the Observations and Implications for Future achievement of objectives. PPP Initiatives 1. Distribution projects have been taken up where bulk water The five projects, in Maharashtra, Karnataka, and Madhya availability has been assured. These five projects reflect Pradesh, provide a detailed analysis of the process, politics, the shift from bulk water to service delivery or end user and preparation of PPP projects in India. They represent experience with the assurance of bulk water at the start all PPP initiatives in urban water supply undertaken in the of each project. country between 2005 and 2011 that have a citywide distri- bution focus.2 All of the projects are currently under way 2. Data and information on the existing infrastructure was and still face significant challenges, but they are milestones poor. Distribution projects are inherently brownfield 2 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Overview and closely tied to the nature of existing assets. In the current funding environment, PPP structures However, all contracts have been executed with poor must be consistent with the depth of public financing. data. In three of the projects—Mysore, Khandwa, PPP design should seek to balance public objectives and Latur—this resulted in additional distribution such as optimization of capital investments and focus rehabilitation estimates once the operator was able to on application of technical skills, expertise, and inno- more closely assess the system, rendering committed vation along with underwriting risk for the private funds inadequate. operator in order to maximize the impact of available funds. Lack of accurate data is a real risk for water PPPs. Public agencies should explore contractual approaches 4. PPP design and monitoring are not always consistent with that incentivize the operator to cope with this risk. This the rationale for reform. In all projects except Latur, could include more detailed project preparation, in city officials clearly articulated the need to focus on which operators assume a role, providing incentives to customer service and therefore on distribution. This the operator to maximize achievement of service stan- formed the basis of the rationale for PPP in all cities: in dards within the initial budget. Contracts could also Khandwa and Aurangabad, the promise of daily water explore clauses that permit changes in scope or service supply and 100 percent coverage; in Nagpur, the scal- standards to cope with increased costs or to include a ing up of the pilot project and equitable supply; and contingency fund. in Mysore, continuous water supply, which was thrust on the city although the initial project design did not It is reasonable to expect that brown-field water PPP envisage continuous supply. contracts may require adjustment or even renegotia- tion, given that they are awarded in the context of poor However, in all the projects the consequences of not data relating to the existing system and inadequate meeting the targets, or standards outlined in the preparation. A credible and transparent mechanism contracts, are either too weak or too unrealistic. There would help address this issue during implementation; is not adequate incentive to perform, and there is limit- in the absence of this currently, public sector officials ed recourse for poor service performance. The service are reluctant to exercise judgment to resolve issues level objectives should not only influence the PPP objectively and stakeholders perceive any adjustment choice and contract design but should be embedded in negatively. specific and meaningful contractual commitments. In the absence of such enforcement, the primary objective 3. None of the projects have targeted capital investment effi- of PPPs, which is to leverage private sector efficiency, ciency. All the projects reviewed rely substantially on stands compromised. This is further compounded by public funds. However, the availability of public funds lack of strong institutional mechanisms to monitor has had an unintended consequence on project devel- performance. opment and implementation, in that the imperative for efficiency of capital deployment has been diluted Additionally, there is no balanced assessment and treat- or compromised. The focus has shifted from rehabili- ment of risk sharing in any of the projects. Standard tation to replacement; and the scope of replacement clauses such as treatment of escalation in power tariff, has further expanded in three of the cities after initial change in law, compensation in the event of termina- design. In all cases, the PPP design did not build in tion, arbitration, and so forth vary significantly between adequate incentives for the operator to optimize capi- contracts. High bidder interest is one of the indicators tal expenditure or draw out rigorous technical exper- of a successful PPP process. Following well-established tise, creativity, or innovation to address the challenges principles for standard commercial risks is shown to of service delivery in the context of existing Indian enhance the possibility of increased bidder participa- cities. tion. www.wsp.org 3 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Overview 5. The PPP contracts focused on delivering technical improve- be paid by the government, it can create signifi- ments while the financial sustainability of operations has cant employee resistance, as in the case of Mysore. not been addressed in the PPP design. This has been the case in all the projects except in Khandwa. Other cities Conflicts occur when staff are transferred physically to will continue to be responsible for providing subsidies a private operator but remain tied administratively to from the general budget. Cities have (justifiably) insu- the city. Staff may transition better if they are able to lated the operator from cost-recovery risks; however, see a clear gain for both themselves and the project if they do not seem to have put in place any parallel it succeeds. Contracts that provide clear incentives to mechanisms to ensure financial sustainability of the employees help build staff ownership to work toward a water supply function at the city level in the medium successful project. to long term. 8. All projects rely on either external grants or public Public funding aims to reduce the cost of initial service agencies to implement linked investments. None of delivery improvements so that cities may dilute the the contracts have a practical or bankable mecha- impact of capital expenditure on corresponding tariffs. nism for resolving either delays in receipt of grants However, it is important to ensure that the PPP design or the need for additional grants due to expansion is part of an overall framework to ensure long-term in scope of works, an issue that two of the proj- financial sustainability and viability of water supply ect cities—Mysore and Khandwa—are confronting. functions for the city, as well as the viability of the PPP project. Appraisal of PPP projects also has to take into account the capacity of the city to manage changes in scope and 6. In all cases, institutional arrangements have had an impact delays in funding. External grants are helping cities on project design, implementation, and management. In take up projects far beyond their financial capacity, but two of five cities—Latur and Mysore—responsibilities they also make them vulnerable to unforeseen events. in the water supply chain are divided between the para- Project preparation, the financing plan, and the tariff/ statal and the city. This fragmentation has led to weak fee design would benefit if a contingency was built in PPP design and implementation, as interests of differ- to handle these issues. ent agencies do not seem to be aligned. A meaningful focus on service delivery improvements and realistic 9. All projects had weak communication and stake- contract management is possible only when the entity holder engagement. None of the projects included accountable for service delivery is the key counterpart to any type of opinion research or communications the contract and when clear institutional mechanisms assessment. These could have helped the propo- are provided to monitor private sector performance nents understand stakeholder opinions and atti- objectively and buffer the contract against external and tudes toward reform, which could have fed into a extraneous interests. While PPP designs may require broader more responsive communication strategy. the city to develop sophisticated contract management skills and decision-making capability, which they may If upfront communication about the rationale for lack, contract arrangements should seek to supplement a PPP is weak, it puts the project at risk. This will city capabilities without undermining their position as have a cascading effect when citizen support is poor the key counterpart to the contract. and political consensus across party lines is lack- ing, such as in Latur. Projects are also vulnerable to 7. Transitioning of city employees to the private opera- vested interests. Communication programs should tors is challenging, as loyalties and incentives are be implemented well before the bidding of the proj- not always aligned. When public sector employ- ect. An effective communication strategy helps miti- ees are delegated to the operator but continue to gate political, social, economic, technical, and even 4 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Overview commercial risk. Where there is limited buy in, an in encouraging operator behavior that is consistent initial focus on gaining and communicating quick with sector objectives. Projects have to be designed so results also helps to build support from stakehold- that both local knowledge and international expertise ers. In such interactions, platforms provided by an are available to cities, and operators are encouraged to independent regulator—absent, so far, in the water look beyond short-term gains from construction and sector in India—or an ombudsman offer a valu- focus on longer term objectives of sustainable service able institutional space for transparent discussions. delivery. The Government of India, in a recent decision, now 11. All five projects include a target of universal coverage requires PPP projects to disclose information volun- and common service standards, including continu- tarily. Communication programs should be designed ity of supply, for all consumers—conditions that are to reflect this principle, and platforms for interaction acknowledged to deliver maximum benefits to lower should implement it proactively. income populations. 10. Market appetite for PPPs is fairly strong, but seems to In response to social issues, all contracts have proac- be dampened by inadequate project preparation, poor tively provided for service delivery options to consum- treatment of risks, and weak prequalification standards. ers as well as tariff concessions (bulk supply to poor A standard approach to prequalification has increased neighborhoods, fortnightly payment options, special competition in other infrastructure sectors in India, tariff for group connections, and so forth). It would such as highways and ports. A similar approach also be useful to explicitly state the subsidy that the may be needed to provide predictability to potential city will bear for connecting poor consumers to the domestic and international bidders. Improving proj- network. Explicit arrangements in the contract would ect preparation and PPP structuring is also important allay apprehensions of urban poor as well as encourage to convert the overall bidder interest in the sector to the operator to connect the poor. actual bids for specific projects. A key challenge lies www.wsp.org 5 II. Introduction Key points • Service levels as well as service efficiency of water supply continue to be poor across all Indian cities • Water PPPs in India have recorded significant achievements—notably a stated focus on leveraging private sector efficiencies for improved service delivery, rather than private sector finance alone • PPPs are one among options to improve water supply services, and are being preferred due to the perceived limitations of public sector reform India is home to more than 370 million people in urban below established norms, with coverage through piped areas. No city in the country meets the government’s targets water supply ranging between 55 percent and 89 percent, for continuous pressurized safe water with full coverage and while per capita availability is fairly high, at 90–120 and full cost recovery. Groundwater sources are also being liters per day, no city offers continuous water supply.3 Daily depleted putting severe constraints on economic develop- supply averages four hours, with many cities alternating ment. To make up for unreliable services, households have supply every other day. invested significantly in alternate arrangements over the past three decades. Large gaps exist in terms of service efficiency (Figure 2.2). There is little tradition of managing water networks as Reliable estimates of asset condition and performance in commercial ventures, and metering is abysmally low (20 Indian cities are difficult to establish, given the poor culture percent of connections) or nonfunctional. Coupled with of documentation, data collection, and reporting. Data high levels of illegal connections, poor customer records, drawn from several benchmarking initiatives indicate the and weak billing and collection systems, this has resulted in following (Figure 2.1): service delivery parameters are well low levels of cost recovery, which are further exacerbated by Figure 2.1 Service Delivery Parameters in Indian Figure 2.2 Service Efficiency Parameters in Indian Cities Cities GoI Benchmark SLB 2011 GoI Benchmark SLB 2011 Coverage Metering (%) (%) Community day Cost (%) Recovery (%) % of Quantity (lpcd) NRW (%) 20 40 60 80 100 20 40 60 80 100 Percentage of Norm Percentage Source: Service Level Benchmarks, Government of India gazette notifications, 2011. Source: Service Level Benchmarks, Government of India gazette notifications, 2011. Note: lpcd – litres per capita per day. Note: NRW – Non Revenue Water. 6 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Introduction low tariffs that have little relation to operating costs. Cost recovery ranges from 30 to 60 percent for operation and Box 2.1 International Experience with maintenance (O&M) costs only. Operating costs are also Water PPPs inflated due to inordinately high staffing levels, high power Recent studies of water PPPs in developing countries consumption, and high levels of nonrevenue water, averag- across Africa, Latin America, East and Central Asia, ing 40 percent in most cities. show the increasing use of hybrid PPP models, includ- ing those in which investment is largely funded by public These challenges occur in a context of limited data or data money, with the private operator focusing on improv- management capability and largely unknown conditions ing service and operational efficiency. A number of of existing assets, which present difficulties in assessing the approaches have been attempted, in what has practi- costs and timelines involved in improving service levels and cally been a market test of a wide variety of contractual operational efficiencies. Moreover, the investments required designs, in order to respond to the requirements of the are likely to be significant, particularly since most cities have very challenging environments in the respective coun- seen little systematic investment in asset management and tries. Setting a reliable baseline to study the effective- ness of the arrangements has been an issue, making expansion over the years. Simultaneously, it is recognized levels of investment difficult to determine and contrac- that investments alone will not be effective in the context tual targets complex to establish. Moreover, poor levels of complex and fragmented institutions with little account- of operational efficiency at inception, with tariffs well ability; lack of capacity to run utilities efficiently and meet below cost recovery, and weak regulatory frameworks performance standards; weak commercial orientation; introduce further complexities in ensuring sustainability. interference in utility operations by external entities; and the absence of a regulatory framework focused on customer Thus, of 65 developing countries that attempted PPPs service and financial sustainability. in urban water supply after 1990, only two-thirds, or 41, still had private water operators by end 2007. Moreover, a high proportion of water PPPs ended up An Institutional Challenge being renegotiated shortly after the start of the contract- Almost all service provision in India to date has been on average, 1.6 years after award. PPPs are seen to be managed by the public sector. Except in a few large cities, incomplete contracts, naturally requiring adjustment services are the responsibility of municipal- or state-level over time to changing conditions in the volatile environ- departments/parastatals, which do not link organizational ment of developing countries. Despite this, 84 percent or individual staff incentives to performance. Many of the of all contracts awarded were still active, and 50 million agencies who manage services lack technical skills and the (of 70 million served by projects for a duration sufficient freeze on public sector recruitment for the past several to demonstrate results) were assessed to be served years has depleted the quality and quantity of in-house by PPP projects that could be classified as broadly manpower. Older and more seasoned senior staff are leav- successful—suggesting that the overall performance of ing and taking their knowledge with them. Institutional water PPP projects In developing countries has been drawbacks in the system are forcing utilities to pursue generally satisfactory. The major determinants of final alternate arrangements to acquire the technical exper- outcome have been the choice of contractual design tise that is required to achieve improved service delivery and the willingness of public and private partners to standards. Box 2.1 presents lessons learned in other devel- make it work during implementation. These and other oping countries facing similar daunting challenges offer lessons learned are elaborated further in chapter 4, in the light of analysis of the Indian case studies. hope with regard to the potential of PPPs in addressing these obstacles. Source: Marin, Philippe, Public-Private Partnerships for Urban Water Utilities: A Review of Experiences in Developing Countries, A World Bank Publication, Washington DC, World Bank 2009; Gassner, Katharina, Popov, Alexander Trends in PPPs in India4 Pushak, Nataliya, Does Private Sector Participation Improve Performance in The first PPP initiatives in infrastructure in India followed Electricity and Water Distribution? A World Bank Publication, Washington DC, World Bank, 2008. economic liberalization that took place in 1991. Private www.wsp.org 7 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Introduction sector investment was considered as a significant require- private investment in generation, ignoring opportunities to ment to upgrade infrastructure in the country, and it improve distribution. began in the telecom and power sectors. A few cities experimented with private sector investment in water Late 1990s sector to meet the increasing demands for water supply In the late 1990s, European companies tried to establish a infrastructure resulting from rapid urbanization. Prior to presence in Goa, Bangalore, and smaller cities in Karnataka this, the involvement of the private sector in the water State with a focus on distribution services. The efforts were sector had been limited to conventional areas such as handicapped by stakeholder opposition to privatization and supply of materials and equipment and construction— to some extent by a perception that PPP models were being either on item rate basis or within turn-key engineering forced by international operators and multilateral agencies. contracting frameworks. This perception was reinforced by unsolicited proposals with no competition and limited transparency. Mid-1990s Early attempts at PPPs in the mid-1990s were focused A New Focus on Distribution on investment for bulk water projects and industrial cum More PPP projects were proposed in early 2000 with a bulk water supply. Failure rates were high because of poor focus on management contracts involving operations and enabling frameworks for private investment, poor project management improvements that were more consistent with preparation, and opposition to private sector participation. sector priorities. Because public utilities were not recover- To some extent this approach was similar to the experi- ing operations and maintenance costs fully through tariffs, ence in the power sector, where early policies focused on governments started providing public funding to meet a Table 2.1 PPP Projects Contracted from 2005 through 2011 Project Distribution focus6 KUWASIP: 24/7 water supply pilot for Belgaum, Hubli-Dharwad, and Gulbarga (Karnataka) 3 Dewas industrial water supply (Madhya Pradesh) Chennai desalination plant (Tamil Nadu) Contract for water supply system, Sector V, Salt Lake, Kolkata (West Bengal) O&M contract for pilot zone, Nagpur (Maharashtra) 3 Management contract for O&M, Latur (Maharashtra) 3 Industrial water supply contract, Haldia (West Bengal) Bulk water supply project, Bhiwandi-Nizampur city (Maharashtra) O&M contract for water supply system, Mysore (Karnataka) 3 O&M contract for water supply system, Madurai (Tamil Nadu) 3 Concession agreement: distribution system, Khandwa (Madhya Pradesh) 3 Concession agreement: distribution system, Shivpuri (Madhya Pradesh) 3 BOT agreement: bulk water supply, Naya Raipur (Chhattisgarh)* 3 Nagpur full city concession (Maharashtra) 3 Aurangabad concession agreement (Maharashtra) 3 * Note: The project was initially designed to include distribution, but during bidding, the scope was limited to bulk water supply to specific storage reservoirs. 8 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Introduction significant part of the investment requirements to bring in in turn encouraged many cities to opt for a PPP arrange- the private sector to leverage their abilities to create efficien- ment to improve services either in a pilot zone (Nagpur) or cies. an entire city area. This project was critical because it also created a precedent through which public funding could be Starting in 2005, a significant number of small and large provided to a PPP project. PPP projects reached the contract award stage, and a mix of new PPP arrangements for both industry and consum- Since 2005, a total of 10 projects have been awarded involv- ers started showing improvements, including concession ing distribution of water to domestic consumers. Several agreements, management contracts, and build-operate- more projects are at different stages of procurement. In transfer (BOT) projects. Unlike the earlier PPP projects, addition, at least five projects involving bulk water supply which saw an active engagement of mostly international to utilities or industrial water supply projects have been private operators, more and more domestic national and awarded using the PPP model. provincial operators started bidding on projects. Of the 15 projects contracted between 2005 and the end of 2011, 12 Achievements in Water PPPs So Far are at various stages of construction or operation; three are A study was carried out by WSP, Trends in Private Sector nonoperational. Ten addressed distribution improvements Participation in the Indian Water Sector A Critical Review (Table 2.1). Together, the 15 projects addressed services to (WSP 2011), of 12 PPP projects in India. Drawing upon about 8.5 million people.5 this review, as well as the case studies that follow, the achievements of Indian urban water PPPs are summarized Two projects in particular have had a positive impact on the below. perception and trajectory of PPPs in India: the Karnataka Urban Water Supply Improvement Project (KUWASIP), a Focus on 24/7 supply and service delivery: All water demonstration project for 24/7 water supply through a PPP, supply projects with the exception of Latur clearly targeted and the Latur project, which helped increase domestic oper- 24/7 supply and/or other service delivery parameters. This ator interest. The KUWASIP four-year performance-based focus and the early results in the Karnataka and Nagpur management contract was awarded in 2005 and targeted pilot projects significantly contributed to mainstreaming 24/7 continuous water supply for some 22,000 connections service delivery objectives—and hence end user satisfac- (about one-tenth of total connections) in five demonstratio tion—in the water sector in India, and specifically among n zones across three cities. The operator was provided a fixed PPPs. This is a significant shift from the overriding focus on capital investment threshold. The operator was responsible asset creation prevailing in the 1990s. for preparing a capital investment plan within this thresh- old after studying the existing  water  distribution  system. Cities’ willingness to explore and design solutions that suit The operator was also responsible for implementing the their needs: During the 1990s, the majority of projects were plan with public funding to achieve a set of performance primarily based on BOT models with 100 percent private targets and operating and maintaining the services for two financing. This changed to a scenario in early 2000, when years. The KUWASIP project had an appropriate mix of the majority of O&M improvements were sought through ingredients: a focus on distribution, use of public funding management contract-based interventions. Currently, the to keep costs low, and restricted risk exposure for the opera- operational contracts are a mix of management contracts, tor while maximizing gains from private sector expertise. concessions, and annuity-type contracts. Often, two cities This allowed a focus on achieving stated objectives to be in the same state have made varying choices regarding the maintained and efficiencies to be maximized. PPP model. Moreover, hybrid models have been attempt- ed—drawing upon public as well as private sources and user The KUWASIP experience demonstrated that it was possi- tariffs to finance initiatives—in a move beyond conventional ble, through a transparent PPP process, to achieve continu- arrangements. Thus, cities are open to designing PPP struc- ous pressurized water supply in Indian cities (Box 2.2). This tures that suit their context, signaling an acknowledgement www.wsp.org 9 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Introduction of sector realities in India and willingness to work in a realis- strong public funding compared to earlier years. The tic manner through PPPs in addressing these. Jawaharlal Nehru National Urban Renewal Mission (JNNURM) explicitly encourages PPPs and makes public Recognition that PPPs can be pursued for efficiency funds available for PPP projects (Box 2.3), whereas in gains: Water PPPs in recent years have been backed by the past, public funds were available only if projects were Box 2.2 Three Karnataka Cities Achieve First 24/7 Continuous Water Supply in India In 2003, the Government of Karnataka (GoK) set out to The amount of water being supplied was reduced by 10 achieve 24/7 continuous water supply in five demonstra- percent because of the dramatic improvement in water tion projects (zones) in three cities. The focus for this losses in the old system. Nonrevenue water, which was demonstration project—Karnataka Urban Water Sector above 40 percent in the demonstration zones, was reduced Improvement Project (KUWASIP)—were the three cities to between 6 and 18 percent. The demonstration zones of Hubli-Dharwad, Belgaum, and Gulbarga in northern recover 80 percent of the operating costs, well above the Karnataka with a total population of about 2 million people. cost recovery levels in the city. The capital cost of deliver- ing an entirely renewed distribution network and the initial A two-year performance-based management contract was 22,450 new connections was Rs 11,635 (US$212) per awarded to Veoila in April 2005 to manage implementation connection, or about Rs 1,430 per person served (US$25). of the improvements and to operate the upgraded system. Good customer service was made an obligatory, and the The total funding for the project was US$52.7 million. The operator was required to redress customer complaints World Bank provided a US$40.4 million dollar loan for within the contractually stipulated time. the project and the GoK provided the additional US$12.2 million. The majority of the funds went into physical invest- Customers also received an indirect economic gain through ments ($48.3), followed by development and technical an increase in their property values, ranging from 40 to 60 assistance (US$2.6) and project implementation support percent for the properties located in the demonstration (US$1.8). zones when compared to the value in the adjacent localities. A vital element of success was the creation of the Social Special focus was given to service delivery for the poor. All Intermediation and Communication Strategy, which carried households were provided direct service connections. Poor out baseline surveys to understand the environment for households, defined as those living in houses of less than reform and concerns around the project. Another compo- 600 square feet of built space, were not required to pay nent was the creation of water user committees, which any deposit for availing a water connection. The volumetric helped coordinate local citizen meetings and raise aware- tariff for lifeline consumption of 8 kiloliters per month was ness because of the initial resistance and skepticism to the also kept well below average costs. project. The demonstration project proved that with a significant All five zones met the objective of continuity of supply, and change in the management approach to consumers, to connections increased by 50 percent. Overall, there was billing, and to revenue collection, 24/7 continuous and a five-fold increase in revenue billed and approximately a metered water supply is achievable even in the poorest seven-fold increase in revenue collected. Households are areas. These shifts can be seen as a utility becomes more now consuming an average of 91 liters per day per person, consumer and commercially oriented. a significant increase over previous levels of consumption, which is expected to improve household hygiene. Source: WSP-South Asia Region 2010. 10 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Introduction case have tariffs been left open for determination during the Box 2.3 Jawaharlal Nehru National Urban term of the PPP project. In some cases, the PPP is delinked Renewal Mission (JNNURM) from tariff and the operator is compensated through a fee; All the projects reviewed in this paper received fund- in others, the tariff has been revised upfront and predeter- ing from the Jawaharlal Nehru National Urban Renewal mined escalations have been approved. Any resulting viabil- Mission (JNNURM), a city modernization program ity gap is provided as an operational subsidy to the project. launched in 2005 by the Government of India under the In a few cases, the tariff has been used as a bidding param- Ministry of Urban Development. eter upfront. The design of projects involving fee-based compensation, operating subsidies, upfront public funds, The $20 billion reform-linked investment program, and so on, shows that cities are willing to develop contex- named after the first prime minister of India, aims to tual solutions to side step these sensitivities. improve the quality of life and infrastructure in select cities. A key objective is the operational and financial Attracting both domestic and international operators: sustainability of assets created. Funds are channeled Indian water PPPs have attracted participation from the to cities through state-level nodal agencies to cover domestic private sector, international operators, and joint a significant percentage (70–90 percent) of project ventures. Though the level of interest and participation has costs, as established through Detailed Project Reports varied across projects, the sector as a whole has attracted prepared by the cities and scrutinized and approved by interest from a diverse cross section of operators. This may a Central Sanctioning and Monitoring Committee in the be a reflection of the potential for PPPs that the operators ministry. see in the Indian water sector. It also underscores that the sector is not averse to adopting international experience Disbursal is made in tranches over the project imple- or experimenting with willing but inexperienced domes- mentation period but is conditional upon the achieve- tic investors. It also reflects the perception that, amid the ment of specific governance reforms at state and city challenges, some projects are adequately well structured to levels, which may not always be in alignment with attract competition. requirement of funds during the implementation cycle. The program also seeks to leverage PPPs for financing Competitive bidding for projects: Without exception, all and implementation. the water PPP projects have been competitively bid. There are residual concerns about the reasonableness of prequali- fication process, but competitive procurement has been implemented through the public procurement route. established as a rule and there are no tendencies for directly Thus there is a clear recognition that private finance need negotiated water PPPs—signaling intent to focus on the not be the primary or only reason for pursuing PPPs; most technically appropriate and financially attractive solu- efficiency, arising both from efficient use of public funds tions. and efficient private sector management, are recognized as reasons for supporting PPPs. Thus, in a context where Local demand for PPPs: Cities have chosen to pursue PPPs public sector reform has proved difficult, PPPs are seen as due to a bottom up recognition of the need for PPPs. There a catalytic mechanism. is no explicit mandate either from the JNNURM (or) from donors to exclusively pursue PPPs. Even though public A recognition of the sensitivities regarding tariffs: Indian funding has helped PPPs, the cities still had the freedom water PPPs have recognized that tariffs or cost recovery is to pursue traditional methods; several states and cities have a sensitive issue that often derails PPP initiatives, particu- chosen the PPP method instead. The ownership that cities larly in a situation of poor service levels prior to improve- have toward PPPs augurs well for the potential of PPPs in ments being implemented. They have addressed the tariff the sector. issue in several ways while designing PPP projects. In no www.wsp.org 11 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Introduction As a result of these positive trends, the success rate of proj- Madhya Pradesh; Mysore, Karnataka; Latur, Nagpur; and ects reaching the award stage has significantly increased, Aurangabad, Maharashatra. The objective is to assess the from 40 percent for projects attempted prior to 2005 to underlying rationale of the initiatives, the preparatory and around 80 percent for projects since 2005. The number of bid process, key contract provisions, and related issues that projects achieving financial closure has also gone up consid- may have a bearing on the operational trajectory and influ- erably: of the 15 projects awarded in the period 2005–11, ence the achievement of objectives. 10 involved private finance and 8 achieved financial closure. One failed to achieve closure, and one project is still in the These projects represent all PPP initiatives in urban water preparatory stage. The remaining five projects were funded supply undertaken in the country between 2005 and the fully through government. end of 2011 with a full city distribution focus (see Table 2.1).7 As noted, of the 15 projects awarded between 2005 A Deeper Look and 2011, 10 involved a distribution focus; of which eight While the above provides an overview of the progression were full city initiatives. Of those eight, Madurai and and achievements to date in Indian urban water PPPs over Bhiwandi did not progress after the contract was signed; the past two decades, more projects are in motion. Projects and Shivpuri was identical to Khandwa, and so studies of have demonstrated a distinct shift in focus to service deliv- these were not undertaken. The remaining five projects are ery. However, this is meaningful only to the extent that presented in the section that follows. The appendix captures objectives are achieved through the arrangement, which is information relevant to each in a project sheet format. The closely linked to the manner in which projects are struc- key observations and lessons learned are highlighted in the tured, and contracts designed. This report thus takes a executive summary. more in-depth look at five PPP contracts: in Khandwa, 12 Creating Sustainable Services Through Domestic Private Sector Participation III. Case Studies Key points • These five cases represent urban water PPP projects undertaken in India between 2005 and end of 2011, with a full city distribution focus • Aspects assessed include the underlying rationale of the PPP project; the preparatory and bid process; and key contract terms that may impact the operational trajectory and achievement of objectives Khandwa 25-Year Concession Contract In early 2008, the Khandwa Municipal Corporation India, with a population of 200,000 spread over 35.8 (KMC) bid out a PPP project that resulted in a 25-year square kilometers (km). Approximately 20 percent of the concession agreement with the Vishwa Infrastructure Ltd. population lives below the poverty level. There has been no The private operator is responsible for investing in bulk significant capital expenditure in water supply for about 40 and distribution assets and operating and maintaining years and assets are in poor condition. Approximately half the system from source to customer, including providing the city has piped water supply, which is provided two to adequate water, collecting tariff revenues, ensuring cost three times per week for approximately half an hour. The recovery, and improving customer service. The contractor city relies on limited surface and groundwater resources. is also responsible for doubling the number of households Nonrevenue water (NRW) is estimated to be approximate- connected, to reach 100 percent coverage; doubling the per ly 42 percent. Water shortages are an issue, and city offi- capita water supply to 135 liters per capita per day (lpcd), cials have reported that economic growth was constrained and achieving continuous water supply. as a result.8 Table 3.1 provides additional information on service levels and efficiency. Ninety percent of the upfront capital costs are financed through a grant from the federal and state governments. The Table 3.1 Service and Efficiency Parameters, Water operator is responsible for arranging the residual financing Supply, Khandwa City needs and has secured a loan from the International Finance Indicator Status for Khandwa Corporation (IFC) as well as arranged equity contribution. Coverage 51% The total agreed capital cost of the project was Rs 115.32 crore (US$21 million) and the annual operations and main- Per capita supply 60–70 lpcd* tenance cost was estimated at Rs 7.62 crore (US$1.4 million). Continuity of supply Two to three times a week, for 30 minutes at a time A major challenge of the project is a large financing gap in Operating cost recovery 13.3% the estimates for rehabilitation. The operator says the city Collection efficiency 50% underestimated the existing distribution system by near- *lpcd = liters per capita per day. ly 50 percent and that it will not be able to meet service standards and revenue targets without the expanded reha- bilitation. Construction has begun, but the financing of In accordance with the 74th Constitutional Amendment additional rehabilitation is unresolved. Act (1994), the responsibility for operation and main- tenance and tariff setting was handed solely over to the Overview Khandwa Municipal Corporation. Earlier this responsibil- Khandwa is a small-sized city in Madhya Pradesh in Central ity was with the Public Health Engineering Department. www.wsp.org 13 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies When the Urban Local Body (ULB) took over, the infra- Medium Towns (UIDSSMT), which offered the town an structure was in poor condition, the utility lacked qualified 80 percent grant from GoI and another 10 percent grant technical staff, and because services were not dependent on from the state government. The city was unable to secure revenue from consumers, customer orientation was weak. the residual financing from its own sources which prompted it to explore options for a PPP to bridge the financing gap. Compared to other southern and western Indian states, the The state government was also convinced that any capital State of Madhya Pradesh was not seen as pro private sector. expenditure under the existing institutional set-up would However, the state introduced a successful highway program not be productive, as tariffs would not be revised in time and has an active PPP cell, which promotes and supports and service improvements would not be made. private sector initiatives and provides training programs to help officials better understand and engage in PPPs. The PPP Process The city considered two PPP options: a bulk supply option Stakeholder Environment where the operator would develop upstream assets and There was already significant public support for the initia- deliver bulk water to the ULB and an integrated PPP where tive, particularly since it had the backing of the (then) the operator would be responsible from source to customer mayor, who enjoyed widespread respect. The state govern- service and would recover the investment through tariff reve- ment organized consultations with the mayor and oppo- nues. The city was convinced that investments would not be sition leaders from the city to explain the PPP options. sustainable without tariff revisions and that an upfront polit- Citizens, customers and other stakeholders have been open ical commitment for tariff reforms would be possible only to PPPs because of such poor services so there had been no with private sector participation. Therefore, the city chose significant opposition to the PPP project in the initial stag- a model in which private sector revenues are based on user es. Citizen opposition has been reported lately (mid-2012), charges. The bulk supply option would have insulated the due to apprehensions that traditional water sources of citi- operator from tariffs and therefore would not have secured zens, such as wells within households will also be disallowed. the necessary political commitment for tariff reforms. Rationale for a Public-Private Partnership Support by the then chief engineer in the state’s Municipal Economic growth in Khandwa was slow due to water Administration Department and the mayor, who was well constraints, and dissatisfaction with water supply was acute, respected, helped secure backing for the PPP from the city but the city did not have the financial capacity to invest in the council and senior administration and citizens. Overall system. In 2006, the Government of India (GoI) launched poor services and the availability of grant funds helped an Urban Infrastructure Development Scheme for Small and build support for the project. Citizens were reported to be Figure 3.1 Khandwa PPP Time line Khandwa Municipal KMC requested GoMP Price Offer II for Corporation (KMC) in for implementing under consumer tariff principle approves water PPP model submitted by Letter of supply improvement bidders commencement project Bid notice amended of work issued as PPP project First pre bid meeting 2007 2008 Price Offer 1 2009 2010 KMC approves for bulk water lowest price bid Consultant supply rejected Vishwa Infra KMC approves appointed for signs the State Nodal estimate cost of transaction concession Agency approved Rs 93.37cr advise Bid submission agreement lowest price bid 14 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies willing to pay the projected monthly bills, which would revenue model relying on tariff revenues from customers has be approximately three to four times the existing tariff, for inherent risks, so the bidders sought revenue guarantees from an improved level of service: they were about three times KMC and the state government (which was not agreed to). less than what customers were paying to private vendors to Bidders also opined that unless they were provided flexibil- supplement existing services. ity in the choice of pipe material, they would not be able to control costs within the limits of financial viability. KMC Technical Preparation: A Difference of Opinion acceded to their request for flexibility in the pipe material. A substantial part of the preparatory work for the PPP The city also agreed to partially cover the financial risk and was done by the state’s chief engineer and the PPP cell. An pay the operator 50 percent of domestic customer dues that Indore based consultant (Mehta Associates) was engaged are overdue for more than a year. This provision is valid to prepare the Detailed Project Report (DPR) and the throughout the duration of the contract. transaction documents. The DPR includes provisions for augmenting the water supply from a reliable surface water The government carried out a single stage, two cover bidding source and new bulk water supply infrastructure capable of process. Qualification norms for eligibility for the financial providing 56 million liters per day (mld) to meet long-term bid were listed. The bidders were required to provide their demand. It also included water treatment and pumping financial bids under two options: (i) bulk water supply to machinery sized to deliver 45 million liters per day (mld) the town and (ii) integrated operations including revenue intermediate demand. collection from consumers as part of one contract. The full service PPP option was selected. The existing bulk infrastructure depends upon an unreliable irrigation reservoir that is more than 40 years old. The sizing KMC received four eligible financial bids. The qualifica- of new infrastructure components was fixed in the DPR tion criteria permitted construction contractors to partici- and the concessionaire was required to undertake detailed pate, which helped increase bidder interest. However, well hydraulic and structural design of each of the components known domestic and international operators chose to stay and obtain approval before construction. out of the process, possibly anticipating revenue collection risks. Vishwa Infrastructure was chosen as the preferred The DPR initially estimated the existing length of the bidder based on the lowest proposed tariff. distribution network as 195 km. It proposed to utilize some of the existing service reservoirs and to re-engineer Contract Terms the networks with additional service storage as well as 120 km of new networks (rehabilitation as well as for network A. Scope of Contract expansion). But before the bid submission, due to cost revi- The PPP contract is for a duration of 25 years, including the sions resulting from final sizing of bulk infrastructure, the construction period. The operator is fully responsible for distribution improvements were limited to only 60 km. The the water supply system from source to customer service, operator subsequently surveyed the existing infrastructure including financing of residual capital costs, construction and found that the city required 290 km of network and of bulk water off-take, the treatment plant, transmission that 230 km of refurbishing/ new construction is required, system, and distribution network; operation and mainte- or nearly double the estimates. nance of the entire system; and service provision, billing and collection, and customer service, including new customer Bid Process: Overcoming the Disadvantages of Small connections and customer complaint redressal. Any exten- City sion of the project, including new distribution lines, is the The city officials were aware of the disadvantages that a small responsibility of Khandwa Municipal Corporation. city would face while pursuing a PPP option and undertook an extensive program to convince bidders to participate. The Flow of Funds: The operator is responsible for establishing private sector had not invested in cities of this size, and a an escrow account into which all receipts (capital as well as www.wsp.org 15 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies revenue) are credited. The escrow agent permits the operator B. Regulation and Contract Management to use the funds in the escrow account as per a contractually Contract Management: Any dispute resolution is primar- established priority. Khandwa Municipal Corporation is ily based on arbitration as per the Indian Arbitration Act. responsible for securing all clearances in time for construc- However, the sole arbitrator is the commissioner of the tion but has not been able to secure disbursal of public state’s Urban Development Department, which potentially grants in time. (see Figure 3.2). has significant implications in case disputes require the state government to financially support the municipal corpora- Financing: The project includes construction of new tion. A state-level steering committee comprising munici- assets as well as rehabilitation of the existing distribu- pal officials and the design consultant has been established tion network. Upfront capital costs are financed through to provide overall support on contract interpretation and the grant money (90 percent) from the Government of in securing approvals. Events of force majeure, change in India and the state government.9 The operator arranged law, and termination are consistent with industry practice. the residual financing needs through a loan from the IFC The only remedy for force majeure and change in scope is and from promoter equity contribution. The total agreed an extension of the concession period, which may not fully capital cost of the project was Rs 115.32 crore (US$20.96 address the impact. million) and the estimated annual O&M cost was Rs 7.62 crore (US$1.4 million) with tariff at Rs 11.95 per This mechanism has not been able to resolve the issue of kiloliter (US$0.22/kl). Out of the total capital cost the expansion of scope (the need to replace additional pipe- KMC provides Rs 93.25 crore (US$17 million) and the lines). This led to a stalemate, and decision making has been operator provides the balance of investments. The oper- slow, partly due to the fact that the city cannot finance the ator also raised debt funding of US$5.5 million10 from additional scope. The operator would not have been able to the IFC to cover its investment for the project as well resolve this through arbitration since the sole arbitrator is a as for a wastewater PPP project in Maharashtra State. government functionary. Similar decisions will be required Figure 3.2 Khandwa PPP Project Flow of Funds Govt. of India 80% grant in two installments Equity State Government Shareholders 80% GoI grant— Operator state share of 10% KMC Lenders Debt Escrow Account Usage as per established Tariff payments, priority connection costs Consumers 16 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies in the future as the city expands and the contract manage- revenue risk. The operator is exposed to significant reve- ment structure could be put to test. nue collection risk, especially since the city would be implementing metering and volumetric tariff for the first Revenue Model and Incentives: The revenue model relies time. In addition, the Operator also is exposed to the on tariff collection from consumers. The key incentive and risk of the city not notifying agreed tariff revisions and penalty for poor service (at least for quantity of supply) being unable to compensate the operator for such default. is loss of revenue. For other performance parameters, any shortfall in service levels leads only to a reduction of the Contingency Management: There are no explicit provisions concession period, and hence operator revenues, with an for true up of tariff, except for predefined tariff adjustments implied liability loss of three to three-and-a-half years. for cost escalations; however, the project scope allows for negotiations when the scope increases. The KMC is partial- Staffing: The operator is not required to absorb any of the ly financing the construction costs and must compensate city’s utility staff. the operator for persistent customers defaults (50 percent under recoveries that remain pending for a year). They also Performance Standards and Linkages to Revenue: assume responsibility for change in scope, including expan- Specified service standards include continuity of supply sion of facilities. (24/7), pressure (12 metres), and volume of water supplied. There are no measurement systems specified for actual deliv- C. Financial Sustainability ery. The operator is also required to reduce NRW by 10 The PPP project is designed to be viable on a standalone percent each year. Performance standards include a target basis through user charges alone with no recourse to the of 100 percent of households connected and 100 percent of city. Thus, the project is anticipated to be operationally customer complaints responded to within 24 hours. sustainable and not expected to strain the city financially. The risks to achieve financial sustainability are (i) the Tariff Mechanisms and Revenue Collection: The opera- acceptability of consumer tariff, which will be tested only tor remuneration is solely through tariff collection as when the project commences operations, (ii) the ability of determined through the bid process. Tariffs for higher the city to implement tariff revisions as per the price escala- consumption slabs and commercial consumers are specified tion formulae agreed in the contract, and (iii) the ability as a predetermined multiple of the base tariff. The mini- of the city to finance changes in scope and future capital mum base tariff is Rs 11.95 Rs per kiloliter. Based on this expenditure needs. This last risk is significant because the tariff the average monthly household bill is in the range of city was unable to fund the increased scope of the distribu- Rs 150–20011 (US$2.7–3.6). The escalations in raw water tion network rehabilitation that led to a stalemate, which is and electricity costs are automatically passed along to the not fully resolved. The financial strength of the city is also consumer. In addition, tariffs are adjusted periodically by a weak and careful planning will be required to meet future Price Review Committee for other cost escalations based on needs. a previously agreed upon mechanism. D. Project Status Universal Coverage and Tariff Considerations: The proj- The contract is still in the construction stage and therefore ect targets universal service delivery for all consumers and no final assessment of the results is available. The key issues common service standards. The tariff determined through from the construction phase are related to the change in bidding is discounted significantly for urban poor customers. scope of rehabilitation and a delay in receipt of grants from The operator is also permitted to provide group connections the Government of India. Both parties have dialogued to to urban poor consumers, reducing their connection costs. resolve these issues, for which there is no practical solution under the contract structure. The KMC has advised the Revenue Risk: Any shortfall in performance leads to short- operator to start operations after implementing the rehabil- ening of concession period and this implies a back-ended itation as covered under the contract and the operator does www.wsp.org 17 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies not appear to have escalated this issue further. At this stage, out of ten zones. Over a period of two months, in July the city and state government officers see early gains in the and August 2013, the operator supplied water to a few operator’s concern regarding the quality of assets and their zones in the city on a daily, but intermittent basis, to operability, which was so far unseen in traditional construc- demonstrate system improvements. Meanwhile, contesta- tion contracts. tion of the tariff and resolution of this issue has held up commissioning of the new system. Water supply opera- Currently,12 construction of the bulk water off-take, treat- tions continue under the KMC in all but two zones, with ment plant and transmission line have been completed; the operator hopeful of extending services on a city wide and new distribution pipelines have been extended to two basis by March 2014. 18 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies A 25-Year Performance Improvement Project in Nagpur After a pilot management contract to achieve continuous operating losses are met through the general budget of the water supply for 175,000 residents (about 10 percent of NMC. The percentage of NRW due to commercial losses connections) in 2009 was deemed successful, the city of alone is at approximately 23 percent. Nagpur decided to scale up the initiative. They secured a grant, from JNNURM, for the rehabilitation of water treat- Table 3.2 Service and Efficiency Parameters, Water ment and distribution assets, which will cover 70 percent of Supply, Nagpur City the project costs. Indicator Status for Nagpur To secure the remaining 30 percent, the Nagpur Municipal Coverage 80% Corporation (NMC) awarded a 25-year performance Per capita supply 135 lpcd* contract to a consortium of Vishwaraj and Veolia, which Continuity of supply 2–12 hours per day also ran the previous management contract. Shortfalls Operating cost recovery 59.7% between tariff and operator remuneration are anticipated Collection efficiency 73% and must be covered by the NMC’s general budget. *lpcd = liters per capita per day. The project includes operations and management of the existing distribution system (treatment plants and distribu- tion networks) and rehabilitation of a significant part of the The state government has formally supported the PPP network including replacement of customer connections project and provided all the clearances necessary to help and meters. The performance obligations of the operator facilitate the process. The pilot project also helped build begin five years after takeover of the assets in November support among a segment of customers and NGOs who did 2011, and the linkages between performance standards and not initially support the project. A very visible successful operator revenue is weak. concession of the city buses helped build support as well. Overview Concurrent with the PPP, the city also incorporated a fully Nagpur is located in central India in the western State owned company called Nagpur Environmental Services of Maharashtra. The city is home to 2.5 million13 people Limited (NESL). The water supply functions have been with approximately 850,000 (35 percent) living in slums. transferred to NESL. Key elected officials and executives of The Government of Maharashtra decentralized responsi- NMC constitute the board of NESL. The PPP contract is bilities for water supply services in early 2000s. The city signed and supervised by NESL. took ownership of the entire water supply value chain and since 2002 has initiated a series of outsourcing contracts for Stakeholder Environment supply of labor, small maintenance activities, and so forth. Since the scope of the project was complex, several meetings The city also built two water treatment plants on a partial were held with citizens, editors, NGOs, and elected officials financing cum operations basis. The water supply function to discuss the PPP contract in detail and explain the core enjoys a relatively higher level of autonomy as compared benefits to citizens. Draft PPP contracts were made avail- to other cities with similar institutional structures, and the able on the city website, and in-depth discussions helped city’s technical capacity is strong. clarify the proposed outcomes and the technical, financial, and social aspects of the project. In spite of this, pockets of The city has daily but intermittent supply of 2 to 12 hours resistance to the project persist. (Table 3.2). About 80 percent of citizens have access to piped water supply and about 77 percent of connections Rationale for a PPP: Improved Performance are metered. The city recovers about two-thirds of its opera- For some years, NMC had been pursuing outsourcing of tion and maintenance expenses through water tariffs. The operations in the water supply function and was aware of www.wsp.org 19 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies Figure 3.3 Nagpur PPP Time line Approval to DPR Second stage Resolution passed from JNNRUM/ bid submission & by NMC General CSME opening Body for 24x7 project Invitation to NMC’s GB Contract purchase RFP & approval to 24x7 effective draft contract PPP contract document 2008 2009 Short listing of 2010 2011 2012 eligible applicants Technical bid submission and opening Resolution passed Approval for the for formation Letter of Intent formation of the (LoI) of NMC owned SPV (NESL) GR company from Govt. of Maharashtra the difficulties in managing multiple fragmented contracts, The Bidding Process in particular where maintenance responsibilities were The city carried out a two-stage bidding process that was outsourced in addition to routine operations. The key open to international companies. The first phase prequali- reasons for pursuing a PPP were to ensure a single point of fied three bidders based on experience and financial strength. accountability and to improve performance and the qual- The second phase included an assessment of the qualifica- ity of infrastructure in a context of staff reluctance to be tions of the technical proposals followed by a series of meet- deployed in water supply operations, which were perceived ings to seek clarifications or amendments. The bidder with as difficult. Sufficient water resources were also available, the lowest evaluated bid price (a term not defined in the which reduced the risk to the Operator. The decision was request for proposals)15 that was consistent with technical backed by a strong political will at the local level. Both and financial requirements was awarded the contract. The the political stakeholders and NMC officials were unani- operator was selected based on a bid price, which is the per mous in pursuing the PPP, which was subsequently ratified unit (cubic meter) remuneration to the operator for water formally by the city council. that is billed and collected. Technical Preparation Eleven bidders participated in the first stage of prequali- The detailed project report (DPR) was prepared by DRA fication, and only three were qualified, including the Consultants. The estimates in the report call for replace- Veolia-Vishwaraj consortium, IVRCL-Aqualia, and Cascal- ment of 429 km of pipeline and replacement of all Nagarjuna Construction. In 2010, the city concluded 320,000 service connections. Under the PPP contract, the the procurement and awarded the project to the Veolia– city would reimburse additional costs if the scope of reha- Vishwaraj consortium. The winning financial bid was bilitation increases in order to achieve the performance marginally lower than the estimated base price (0.625 standards. percent). One of the possible reasons could be limited competition at the stage of submitting financial bids. The total investment for the project was estimated at Rs 387.86 crore (US$70.5 million). Considering the total To build political and civil society support during the bid investments estimated as per the DPR, the service improve- process, NMC asked the Administrative Staff College of ment cost works out to about Rs 21,300 per connection India (ASCI) to organize a stakeholder workshop with (US$387) at 2009 prices.14 key policy makers. A key outcome16 of the workshop was 20 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies a request for NMC to assess the impact of the pilot 24/7 contract. Though stylistically referred to as a concession, project. ASCI, at the request of NMC, undertook an the contract is a hybrid of several contractual arrange- impact study, and assessed that the key performance indica- ments, including an annuity. The operator’s performance tors “moved favorably” with about 50 percent of targeted obligations start only five years after contract signing, consumers provided with 24/7 water supply.17 which was November 2011. Contract Terms Flow of Funds: The revenues from user charges collected by the operator will be transferred to an escrow account, A. Scope of Contract which is used to make payments for the cost of electric- The contract is a 25-year performance improvement ity, raw water, and so forth) and for payments back to the contract with a clause for extension based on mutual operator (figure 3.4). Any shortfall in collections, which is consent for up to another 25 years. The operator is respon- anticipated since costs exceed current revenues, are covered sible for billing and collection of revenue. The project by NMC from the general budget. includes the O&M of the existing distribution system (treatment plants and distribution network) and rehabilita- Financing: Seventy percent of the initial capital invest- tion of a significant part of the network, including replace- ments are financed through JNNURM, and the operator ment of customer connections and meters. The operator is expected to invest the residual 30 percent. Future capital is required to implement an initial performance improve- expenditure remains the responsibility of the city. ment project in five years, under a bill-of-quantities-based Figure 3.4 Nagpur PPP Project Flow of Funds Govt. of India 50% grant State Government 50% GoI grant + state share of 20% NMC 70% grant NESL costs Construction contract NESL NMC tops up collection Equity Operator’s revenue account to provide for Shareholders NESL expenses and operator’s revenue Operator Escrow Account Lenders All revenues deposited by operator into escrow account Debt Consumers www.wsp.org 21 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies Investment commitments from the operator are not signifi- costs due to overrun or delay in commencement of opera- cant compared to the committed revenue flows to the oper- tions. ator. The operator receives revenue from the city four times greater than its investment obligations in the first five-year The rate is subject to a periodic rebasing every five years, period, and so the operator’s financial risk is effectively which takes into account all costs and expenditure and minimized. The performance requirements begin only at revision of performance standards as determined by the the end of the performance improvement project period operator. Thus, while operating expenses are nominally the (first five years) and are further phased during the first responsibility of the operator, due to the rebasing clause, twelve years. The operator is required to finance 30 percent every five years the operator has the right to determine a of the initial capital investments. rebased rate. B. Regulation and Contract Management The operator is compensated for rehabilitation works based The operator has the obligation to treat and distribute on an-item rate contract, which provides for escalations in water, bill, and collect revenues. As part of separate works costs linked to price indices. Moreover, capital expenditure contract, the operator is also responsible to execute rehabili- estimated during the time of bidding is subject to revision tation and performance improvement works estimated in by the operator, so as to meet the performance standards. the DPR. NMC has three obligations under the contract: completion of a parallel investment program, arranging 70 Staffing: Under the PPP contract, staff have an option to percent of the financing for rehabilitation programs, and be transferred to the operator, become familiar with the the supply of raw water. operator, and then decide if they would like to become an employee of the operator. The operator also has the choice NESL, the subsidiary of NSC, is responsible for contract to select the staff to which it wishes to offer employment. supervision. However, the contract places limitations on Staff who choose to stay with NMC or those not selected the liability to the operator (at 5 percent of revenue) and by the operator will be redeployed by NMC in other func- also requires periodic rate revisions, substantially as per the tions. determination of the operator. Therefore, the ability of the NESL to ascertain expenditure and calibrate the rates with Performance Standards and Linkage to Revenue: The service standards is contractually limited and is not linked operator is given 60 months to achieve continuous water to its capacity. The project is in the early stages of imple- supply, and there are no intermediate targets within this mentation, and no serious issue appears to have arisen so period. The operator is not required to meet either raw water far. consumption norms or electricity consumption norms in the first 48 months. The operator is required to achieve NRW of Revenue Model and Incentives: The operator is compen- 40 percent after 60 months of commencement, reaching to sated through a fee per unit of water billed and collected NRW levels of 25 percent progressively within 120 months. while tariff setting remains under municipal control. The Similarly, the operator is required to reach a collection effi- operator rate is revised automatically every year for changes ciency of 75 percent after 60 months of commencement, in price indices termed as standard adjustment. rising to 98 percent progressively within 120 months. The operator is assured of a minimum guaranteed revenue In the first five years of operations, the operator has been in the first five years if the billing is less than the stipulated assured a return, as he is compensated on the basis of a mini- threshold of 250 million litres per day (mld). The rate is mum volume of 250 mld or actual volume, whichever is also subject to extraordinary rate adjustment. The events higher. There are no service standards during the transition triggering such adjustment include change in the operator’s period of five years and therefore no incentives or penalties. obligations, change in law, force majeure, variation in busi- Specific performance targets include a 20 percent increase ness planning assumptions, and increase in the operator’s of households connected, to reach 100 percent coverage, 22 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies 24-hour continuous supply of water; a 50 percent increase would receive payments based on a normative billing and in the number of complaints addressed (to reach 100 collection of 250 mld. After the five-year period, the opera- percent); and a water quality target of 96 percent, which is tor assumes the risk of demand, collection efficiency, ener- an 18 percent increase in the number water samples meet- gy consumption, and raw water consumption. Liquidated ing quality targets. damages for not meeting performance standards (continu- ity, pressure, etc.) is limited to 5 percent of annual revenue. From the fifth year of commencement, the operator’s Operator revenue is revised every five years through a rebas- remuneration is automatically reduced for excess raw water ing and is also subject to regular escalation and open to an consumption and electricity consumption. From the sixth extraordinary rate adjustment. Thus the revenue risk to is year onward, the operator assumes the collection efficiency low. risk as the operator’s rate is payable only for water billed and collected. There are no quantified incentives or penal- Contingency Management: An amicable settlement is the ties for shortfall in performance in other areas, including first step to resolve disputes. This is followed by arbitration in continuity of supply. There is a provision for liquidated in Nagpur under the Indian Arbitration Act. The choice damages for shortfall in performance persisting for 60 days, of the arbitrators would be by the Bombay High Court, which is capped at 5 percent of annual revenues. Thus, even which is required to choose retired Supreme Court judg- though performance standards are applicable from the sixth es. Both NMC and NESL have agreed to waive the legal year onward, the consequences for failure are not high for immunity on sovereign rights. Termination is provided for the operator. The maximum revenue that can be withheld in the event of force majeure or default of NMC, NESL, through liquidated damages for failure to perform is only 5 and the operator. Termination due to defaults attributed percent of annual revenues. to the operator is restricted to abandonment of the facil- ity and a determination that liquidated damages are not The operator has the right for a rate revision if it finds exces- adequate remedies for operational default that persists sive costs are required to achieve or maintain performance beyond 180 days. parameters. C. Financial Sustainability Tariff Mechanisms and Revenue Collection: Tariff fixation The city implemented a tariff revision along with the proj- will remain the responsibility of the city and is independent ect, which improved cost recovery levels. The operator’s of the PPP contract. The operator is paid a per-cubic-meter revenue model is a per unit fee, which is distinct from the fee for water that is billed and collected. Prior to the conclu- user charges. The city bears the cost of raw water supply, sion of bidding, the city undertook a tariff revision exercise electricity, and water supply staff retained with the city. to narrow the cost recovery gap. User charges will not recover costs, and the city will need to provide a subsidy through the general budget, though in Universal Coverage and Tariff Considerations: The this case the subsidy is not capped. The project design does project aims to provide universal coverage. Service stan- not address financing needs for change in scope or future dards are the same for all classes of consumers. The water expansions. tariff is fixed by NMC and includes a subsidized rate for consumption below 8000 litres per month per connection. D. Project Status The operator has an additional mode of service provision to NMC and NESL handed over operations to the Operator poor customers; group connections to poor customers are in November 2011. In August 2012, rehabilitation work permitted in the contract, thus reducing the initial connec- for conversion of the first zone into 24/7 had commenced. tion costs for the poor. Currently18, rehabilitation work is on-going in six of ten wards and over 30,000 house service connections have been Revenue Risk: The operator carries minimal revenue risk replaced. Additionally, a 24/7 call center, with a toll free for the first five years of the contract, since the operator number has been in place since a year. www.wsp.org 23 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies Consensus Eludes the Latur PPP Project In 2008, the Latur Municipal Corporation (LMC) and Table 3.3 Service and Efficiency Parameters, Water Maharashtra Jeevan Pradhikaran19 (MJP), signed a tripartite Supply, Latur City 10-year lease contract with SPML consortium to operate, Indicator Status for Latur meter, and collect revenues for the city. The lease officially Coverage 47% commenced 2.5 years later, in January 2010, because condi- tions could not be met in the period initially set. Less than six Per capita supply 100 lpcd* months later, the operator “communicated intent” to with- Continuity of supply Twice a week, 3–4 hrs each time draw, and by December 2011 it had reduced its staff to one. Operating cost recovery 34% Collection efficiency NA The project failed because of political opposition that arose out of metering and customer billing in the context of *lpcd = liters per capita per day. system deficiencies. Delays in the project put the forecasted revenues in jeopardy, so the operator requested a change to a 2005 were Rs 133 crore (US$24.1 million), more than 100 management contract contractor on a fee basis to eliminate years of water supply income. its commercial risk. This proposal was accepted by LMC but not by MJP. In January 2012, MJP stepped into the Capital investments in the city’s water supply systems have contract in place of the operator and is operating the assets. traditionally been made by the MJP, which had a statewide monopoly over this function until 2001. Subsequently, The contract is technically alive while MJP contem- Latur, like other financially constrained small and medium plates termination and the SPML consortium contin- cities, continued to rely on MJP to raise finances for capital ues to pursue the alternative contract structure. The expenditure. original objective of achieving commercial improvements has not been realized and several years of political oppo- In 2005, MJP carried out a bulk water augmentation that sition have resulted in losses to all stakeholders, includ- improved bulk water availability to 80 mld but increased ing the LMC, the MJP, the operator, and the customers. operating costs. The liability for servicing the loan rested with LMC. With the completion of the project, the city was able Overview to supply 100 lpcd of water twice a week, for three to four Latur is a medium-sized city in the State of Maharashtra hours each time. The LMC took over the new project assets with a population of 0.38 million.20 Prior to the PPP from MJP but was unable to operate them due to technical contract, water supply operations were managed by the deficiencies.22 Moreover, the operating costs of the upgraded Latur Municipal Council (now a municipal corporation), bulk water supply system were expected to go up significantly. while capital investments were planned and implemented by MJP. With access to only 35 mld of bulk water, Latur Rationale for the PPP faced drinking water shortages and acute scarcity in the With the debt from the bulk water project and increasing summer months. Less than half of households had water energy costs, LMC submitted a proposal to increase tariffs, connections and received water only two times per week for but this was rejected by the elected members of LMC, which three to four hours each time (see Table 3.3). The number then requested MJP to take over the water supply opera- of legal connections was only 26,000 though there are an tions because it was not in a position to absorb the costs and estimated 55,000 connections. Only 199 connections were did not have the capacity to operate the system. A resolu- metered, but even these meters were largely nonfunctional. tion to transfer operations was finalized in September 2005 The average cost recovery was only 34 percent.21 LMC was and the board of MJP approved the takeover in January also in default to MJP, to the power utility, and to lend- 2006. The agreement also specified that MJP would engage ers. The total outstanding liabilities of LMC by September a private operator. 24 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies In other cities that MJP oversees, it typically adopts meter- for Proposal (RFP) was issued to the short-listed bidders ing and a volumetric tariff. It estimated that with the state- in December 2006. The first prebid meeting was held in wide tariff structure, Latur city water supply services could January 2007, in which all the short-listed bidders partici- have an operating surplus by the year 2007–8, if metering pated, followed by another prebid meeting in which only and volumetric tariff are introduced; the number of legal three short-listed bidders attended. connections is increased up to 44,150; and the collec- tion efficiency is increased to 80 percent. These forecasts During the prebid discussions, several amendments were included fixed payments to MJP to cover staff costs and the made to the draft contract. The contract duration was servicing of the loan that was required to remedy technical extended from 5 to 10 years since the operators provided deficiencies in the project. feedback that 5 years is inadequate to stabilize the system and to improve cost recovery. The draft contract had a Thus, the PPP decision was taken by LMC and MJP to “Conditions Precedent” period during which MJP agreed address constraints largely related to technical capacity and to assist the operator to achieve a target of 25,000 metered cost recovery. MJP commenced procurement soon after the connections, which will reduce the commercial risks in the decision to adopt the PPP was ratified by LMC. There was contract. Both parties agreed to reduce this target from little technical preparation of the project, and, significantly, 25,000 to 10,000 connections. Three financial bids were no diagnosis was made on whether the private operator received, and SPML Consortium emerged as the highest could deliver at least daily water supply (a service standard ranked bidder. In August 2007, LMC passed a resolu- under the contract) with the existing assets. tion agreeing to transfer the function to a private operator through MJP for a period of 10 years. Thereafter, the finan- PPP Process cial bid of SPML Consortium was accepted by MJP on the The MJP issued a Request for Qualification (RFQ) for the basis of the highest payment committed, and a Letter of project in March 2006 for a five-year “lease” contract. Six Intent (LoI) was issued in September 2007. The contract consortia were shortlisted in the RFQ stage, and a Request with SPML was signed in June 2008. Figure 3.5 Latur PPP Time line Operator Protests begin declares intent in the city to scale down against PPP involvement Latur City Council (LMC) and metering The PPP till protests are decides to hand over contract resolved MJP starts water supply operations commences revenue to Maharashtra Jeevan Letter of District Collection intent issued collection from Pradhikaran (MJP) through appoints a Study to SPML customers, fully a resolution Committee to review Consortium in charge of the PPP which rules in operations favour of the project 2005 2006 2007 2008 2009 2010 2011 2012 2013 Protests Tripartite intensify and An informal agreement LMC passes agreement Operator is reached to defer a resolution signed between is unable MJP and LMC sign the commencement to convert MJP, LMC and to install an agreement for of PPP contract the contract operator meters. Some transfer of operations till National and into an O&M protestors are and agree for PPP State elections are contract arrested approach completed MJP is operating the system under step-in right in the contract, intends to terminate www.wsp.org 25 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies Soon after the financial bids were submitted, LMC expressed government constituted a Study Committee headed by the interest in being a part of the contract. The city wanted to district collector to review the PPP project, understand share in the estimated revenue “committed” (projected) by stakeholder concerns, and provide its recommendations. the operator. After prolonged negotiations, MJP agreed to The Opposition Committee made written submissions share 50 percent of the surpluses from the contract with to the Study Committee. MJP and LMC were requested LMC at the end of the contract period. MJP and the opera- to respond to the submissions. The Study Committee tor signed a management contract, which was followed by a conducted several meetings and submitted a report in tripartite agreement between MJP, LMC, and the operator. September 2008 giving the project the go ahead on the basis By this route, LMC avoided taking responsibility for PPP that concerns had been satisfactorily addressed by MJP and decisions but ensured that it had a stake and share in the LMC and that the contract safeguards the interests of LMC PPP arrangement. and is beneficial to the citizens of Latur. The report was accepted by the state government. Stakeholder Environment The profile and visibility of this project were elevated Elections Slow Down the Process because of the city’s complex institutional and political In early 2009 the chief minister and the city mayor asked context. Latur is a politically significant city. The former the operator to slow field activities in view of the impending chief minister of Maharashtra was, at the time, a legisla- national elections in early 2009, followed by state elections tor from Latur, and decisions such as the PPP were thus in late 2009. At the same time, the technical partner to endorsed at the highest political level in the state. the consortium, Hydro-Comp, withdrew from the project. This was followed by the resignation of the project manag- However, the state government itself was a coalition, and er.23 While the operator interpreted the slow-down advice coalition partners were often targeting the same political as a delay in formal takeover of the project, MJP interpreted base. At the time, MJP was among the ministerial portfolio this as a mere extension of the Conditions Precedent period. of a coalition partner. Thus, Latur would face the spillover of From the operator’s perspective, commencing the contract high-level coalition dynamics, which overlaid the technical without the ability to do field work (surveys, metering, complexities of the project, resulting in a volatile situation. repairs) would not be productive, but the MJP maintained The events that impacted the contract are described below. that contractual responsibilities had already commenced. Local political opposition started as soon as the contract was Subsequent to the national elections, asset transfer from signed in 2008. One of the reasons cited is that locally avail- LMC to MJP and transfer of LMC workers to the operator able meters did not meet the specifications, and so the oper- were completed; and the take-over of assets by the operator ator had to import meters. Consumers felt that they were was effected from April 1, 2010. The period for satisfying being forced to incur high costs for imported meters (even the Conditions Precedent is deemed to have commenced at though the costs were predetermined during bidding) and this time. However, the operator still maintained that MJP were unable to verify actual costs. The opposition to meters had not completed preparatory activities as agreed, includ- was further fuelled by the fact that existing system deficien- ing major repair works in the system and rehabilitation of cies did not permit for even one hour of daily supply to all the bulk water supply system, as proposed by the operator; households. This was seized upon by opponents to argue transfer of MJP employees; and updating of the customer that the arrangement was prioritizing commercial aspects database. MJP maintained a stand that no technical inputs over service delivery. were received from the operator for rectification and effi- cient operation of the network. As the opposition hardened, the Latur Water Supply Opposition Committee was formed. Impending elections The Project Continues to Face Opposition put it high on the political agendas. The operator’s office in Meanwhile opposition escalated, resulting in violence and Latur was ransacked in August 2008. At this stage, the state vandalism of the operator’s office. Consumers opposed the 26 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies distribution of bills in August 2010. This also led to a delay Conditions Precedent period. If this goal is not met, both in metering. The operator appears to have ordered meters the operator and the MJP have an option to terminate the only in July 2010 and had installed only 450 meters by contract. This safety clause ensures that the basic assump- December 2010. By this time, nine months of the Conditions tion underlying the contract structure (metering) is tested Precedent period had lapsed, but no significant progress had before the operator starts taking financial liabilities under been achieved on the ground. However, both the operator the contract. and the MJP passed on an opportunity to terminate the contract at the end of the Conditions Precedent period.24 Flow of Funds: No financing was expected from the opera- tor under the contract, and all asset additions are the respon- Metering could not progress significantly in the face of ongo- sibility of the MJP. The contractor collects all revenues from ing violent protests. By February 2011, it had become clear the customers, meets all operating expenditure, and makes that the financial projections of the water supply opera- lease-like payments to MJP. Arrears due to LMC/MJP from tions were unlikely to be achieved. Up until January 2011, the precontract period and security deposits from custom- the operator had not been entitled to any revenue from ers are collected by the operator, but deposited to MJP. (See the system. Having taken over the assets in February 2010, figure 3.6). the MJP was incurring operational liabilities, which, in the absence of proper billing and collection, far exceeded collec- Financing: The PPP arrangement does not include signifi- tions. The financial situation could not be resolved without cant investments. The obligation for major repairs and political consensus on metering, which was still elusive. system expansion is that of MJP. The operator is required to carry out minor repairs (which are defined in the contract) By May 2011, the operator appears to have concluded that at his own cost. This was based on the assumption that the the PPP arrangement is not enforceable on the ground and existing network can deliver daily water supply with minor proposed to convert the PPP arrangement into a fee-based and immediate improvements. This assumption may have management contract where the operator would be respon- been misplaced, since the operator was unable to provide sible for operations, billing, and collection. Though the daily supply without significant corrections to the system, project continued to receive support from the chief minis- which he found difficult to undertake. ter, local opposition does not seem to have waned. The operator eventually wrote to the MJP in November 2011 B. Regulation and Contract Management indicating its intent to scale down operations by December Contract Management and Structure: The tripartite agree- 31, 2011, and withdraw all but one staff member. ment provides for dispute resolution by the chairman of the steering committee (district collector), which would be Contract Terms binding. No arbitration is provided in the tripartite agree- ment. The steering committee was not equipped to handle A. Scope of Contract the intense political opposition to the project. When it The following functions were set out over the period of a was clear that service improvements would be required 10-year contract for the private operator: recommending before implementation of metering, the steering committee measures to remedy technical deficiencies in the system; mechanism was unable to resolve this issue among the three operating and maintaining existing assets; distributing parties. Lack of independent arbitration may have been an water; introducing metered connections and volumetric additional constraint in resolving this issue. tariff; and billing and collection. MJP is responsible for assisting the operator in all commercial functions: new Since the contract does not envisage any asset construc- assets, major repairs, and transfers to the operator. tion by operator, the treatment of extraordinary events is elementary. Upon termination, the operator is compensated Both MJP and the operator are responsible for identify- for book value of assets built, if any, and the cost of meters ing and metering at least 10,000 connections as part of a not recovered from consumers. Obligations are suspended www.wsp.org 27 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies Figure 3.6 Latur PPP Project Flow of Funds Asset transfer agreement LMC MJP Existing Committed assets, new payments, minor Tripartite investments repairs Agreement Operator Water Water supply charges Arrears, deposits Consumers during force majeure and the contract is extended by the not have a share in any upside accruing to the operator. duration of force majeure. Staffing: LMC and MJP transferred their existing employees Revenue Model and Incentives: The revenue model is (55 and 15, respectively) to the operator. The operator pays based on the collection of user charges on the basis of meter- the monthly salary termed as a service charge (prespecified ing and MJP’s statewide tariff. The operator is responsible in the contract). LMC and MJP will bear other compensa- for meeting all operating costs and is expected to absorb tion related liabilities like pension benefits. The operator augmentation in energy unit rates up to predetermined has the flexibility to repatriate a maximum of 10 percent of rates for each year during the contract. Escalations in unit the transferred employees during the entire duration of the rates beyond the prespecified limits would be borne by contract for insubordination, nonperformance etc. MJP. The operator was expected to make monthly predeter- mined payments (based on the financial bid) to MJP. These Performance Standards and Linkage to Revenue: Key payments were expected to cover the administrative costs of service standards for the operator set under the contract are MJP and the cost of servicing loans required for additional as follows: expenditure in the project area. • Provision of daily water supply, of potable quality standards, for at least one hour. Surpluses from tariff income, over and above the operating • Supply of 100 lpcd on average and a minimum of expenditure and the payment to MJP, constitute the profits 80 lpcd. to the operator. Incentives to the operator are built into the • Maintenance of enough pressure to fill a 10 liter revenue model, since the upside of any commercial or oper- bucket within 30 seconds at customer premises for ational improvement accrues to the operator. MJP receives all customers. only a fixed payment during the contract period and does • Provision of new connections within 15 days of 28 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies approval by LMC. per month (US$2.7) instead of Rs 300 per month. Metered • Provision of a customer service and complaint center; slum connection would receive a discount of Rs 2 per kl if redressal of customer complaints relating to pressure the monthly consumption is below 12 kl. If the monthly and quality within 24 hours and other complaints consumption is above 12 kl, normal rates would be appli- within seven days. cable. • Reduction of nonrevenue water by 15 percent each year. Universal Coverage and Tariff Considerations: The tariff structure provides concessions for slum dwellers if The operator is also required to maintain water losses with- their monthly consumption is below a threshold. There in specified levels in each stage of the water supply network. are no special provisions related to service delivery, but Time limits for repair of surface leaks are also specified in the contract design encourages the operator to connect all the contract. customers. Damages for each default incident with respect to service Revenue Risk: The operator bears both the upside and standards and operating requirements (loss levels, leak downside revenue risk, which may arise due to less than the repairs) range between Rs 500 to Rs 2000 (US$9–36) per anticipated number of connections, lower consumption, incident. The contract is liable for termination by MJP if increase in costs, and so forth. The revenue of the operator the damages in any month accrue to Rs 20,000 (US$364), is also reduced per incident of default in performance as implying that 10 to 20 incidents in a month (across all described earlier. Since there is no capital expenditure, the operational parameters) may result in termination. operator does not bear any investment risk. The operator is required to maintain a performance security C. Financial Sustainability of Rs 42 lakh (US$76,360) with MJP and a Letter of Credit The main objective of the PPP project is to achieve oper- amounting to two months of fixed payment due to MJP. ating surpluses by introducing metering and a volumet- These are liable to be cashed in the event of termination or ric tariff. The project design did not address the need for nonpayment to MJP. immediate capital investments or expansions. The Water Board was responsible for investments but was unable to Tariff Mechanisms and Revenue Collection: The operator make them in the absence of an operating surplus accruing is responsible for metering all existing connections, detect- from the project. The operator was unable to implement ing and regularizing illegal connections (with the help of commercial improvements when service delivery continued MJP), and providing new connections to customers. to be poor. Therefore, while the project envisaged financial sustainability for operations, lack of a clear plan for overall A volumetric tariff was prespecified in the bid docu- financeability and viability affected project implementa- ment for the entire duration of the contract. For domes- tion. tic connections, a flat monthly rate of Rs 78 per month (US$1.4) would be applicable for the first three months of D. Project Status the Conditions Precedent period. Connections that remain MJP has taken over the water supply system under the step- unmetered after this period will pay a higher flat monthly in clause as per the contract since January 1, 2012. Though rate: Rs 120 per month (US$2.2) for the next three months alternate day supply had been achieved by the operator, and Rs 300 per month (US$5.45) thereafter escalated at 18 service levels appear to have slipped gradually after the percent per annum. operator withdrew.25 The operator is awaiting a response to its offer to convert the PPP contract into a fee-based Slum dwellers receive concessions in the tariff structure. For management contract. While LMC has agreed to this, MJP the first nine billing cycles after commencement, unme- appears to be contemplating termination. This situation tered slum connections would be charged only at Rs 150 remains unresolved to date. www.wsp.org 29 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies Aurangabad 20-Year Concession Contract In 2011, the City of Aurangabad awarded a 20-year conces- lead to further losses of 44 mld of treated water. As a result, sion to a consortium led by SPML Ltd26 to operate and the city supplies only 88 mld to consumers, which results in maintain its water system, including bulk water systems, a per capita supply far below the recommended supply level and reconstruct the distribution infrastructure with an of 135 liters per day. aim of 24/7 continuous water supply. The private opera- tor is expected to finance approximately 50 percent of the Table 3.4 Service and Efficiency Parameters, Water cost, making it the largest private sector investment project Supply, Aurangabad City for water distribution in India. The national government Indicator Status for Aurangabad is financing approximately 36 percent of the project cost, Coverage NA and the state government is financing 14 percent through grants. Total investments for the project are Rs 7.92 billion Per capita supply 110 lpcd* (US$144 million), which is 36 times more than the current Continuity of supply 45 minutes every second day annual water supply revenues of the city. Cost recovery is Operating cost recovery 48.5% through predetermined end-user tariffs. Collection efficiency NA The city will subsidize water operations from the general *lpcd = liters per capita per day. municipal account through an annual operating subsidy. The objectives of the proposed investments are to increase bulk water capacity and reduce distribution losses, thus Consumers receive water for a duration of 45 minutes every improving the overall availability of water to the citizens. second day (Table 3.4). An estimated 85 percent of the households have a direct service connection. The city levies This PPP project is considered high risk and high gain for a flat monthly tariff, and cost recovery is approximately both the private operator and the government. The private 48.5 percent. operator is exposed to significant investment and cost risks, such as escalation in electricity costs and raw water costs. The Because of the shortfall in service levels, AMC prepared city has the benefit of achieving significant service improve- plans to build a parallel bulk water supply line and invited ments without bearing operational or financial risk. In turn, private participation in the year 2006 under a build-oper- it faces the political challenges of convincing citizens to ate-transfer (BOT) arrangement. The city received several accept the revised volumetric tariff as well as managing its responses, but the financial bids were deemed unafford- finances prudently to be able to contribute significantly high able. Moreover, without rehabilitation of the distribution levels of subsidy (through the annual grant). network, the benefit of increased bulk water would not be realized because of high distribution losses. Therefore, Overview AMC decided to pursue both bulk supply augmentation The city of Aurangabad, in Maharashtra state, is a medi- and partial rehabilitation of distribution network and um-size city in India with a population of 1.2 million. sought government grants for the project under JNNURM. Aurangabad Municipal Corporation (AMC) manages the water supply as well as other urban services for the city. Commitment to the project from the stakeholders is high, Aurangabad receives water from a dam which is 45 kilome- since having the city continue with current levels of service ters away from the city and 159 metres below the city eleva- was not an alternative. tion, requiring pumping over a long distance. The bulk water off-take and transmission facility has a capacity of The Rationale for PPP: A Financing Gap 156 mld. Leakages in raw water transmission pipes lead to Between the submission (2006) and the approval of the proj- a loss of 15 mld of raw water. Distribution system leakages ect (2009) under JNNURM, the project cost appreciated 30 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies significantly, from Rs 3.6 billion to Rs 5.1 billion (US$66.6 Technical Preparation – 92.7 million). Under the terms of the JNNURM fund- AMC received project development assistance from the India ing, Rs 3.24 billion, (US$58.9 million), or 90 percent of Infrastructure Project Development Fund (IIPDF) admin- the original project cost, would be provided as grants from istered by the Department of Economic Affairs (DEA), national and state governments. AMC will have to finance GoI. DEA approved the project under their Pilot Projects 10 percent of the original project cost and 100 percent of Initiative,27 which fully funded the cost of transaction advi- cost escalations. sors. AMC appointed CRISIL Risk and Infrastructure Solutions as the transaction advisors for the project. AMC was unable to meet its share of financing, which amounted to Rs 1.86 billion (US$33.8 million) (51 percent Based on the preparatory work, AMC decided to pursue of the original project cost) and decided to seek private a concession model in which the operator would have investment to meet the financing gap—initially including end-to-end responsibility to source and distribute water. only the bulk water supply component. AMC later decid- The end-user tariff would be fixed by the AMC upfront ed it lacked the capacity to rehabilitate the distribution and escalated during the term of the contract at a prede- network and decided to make the private operator respon- termined rate. The operator would be provided an annual sible for rehabilitation of the entire distribution network grant to bridge the gap between cost recovery tariff and that (instead of the partial rehabilitation envisaged earlier). Full fixed by AMC. This would also be the bidding parameter replacement increased the project cost to Rs 7.92 billion and the operator requiring the lowest annual grant would (US$144 million). be selected. The General Body of AMC formally resolved to pursue a PPP arrangement in August 2009. The state government agreed to finance 50 percent of the cost escalation in the original project proposal, which The Bidding Process amounted to Rs 0.75 billion (US$13.6 million). Thus, A Request for Qualification (RFQ) was launched in end the private investment required in the project was Rs 3.92 of August 2009. Eleven consortia submitted RFQs and billion (US$71.2 million) nine were shortlisted for the proposal stage. Three pre-bid Figure 3.7 Aurangabad PPP Time line AMC accepted the best offer Two financial GoI sanctions AMC’s bids were request for a grant under received Operations the UIDSSMT program for taken over the water project Requests for by private qualification partner notice issued 2005 2006 2007 2008 2009 2010 2011 2012 2013 Bidders were AMC decided to Contract shortlisted implement the signed project under PPP mode Financial bids were opened and evaluated www.wsp.org 31 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies conferences were held with the bidders to discuss the RFP Flow of Funds: The operator will establish a collection documents, provide clarifications and agree on amend- account into which all the user charges collected from ments. Bidder interest was high since this was a large PPP the customers are deposited. This account is used to make project (in terms of investment), but the bidders had many predetermined payments such as electricity payments, raw concerns with the initial contract package, which they water payments, and salaries to employees deputed from said put all the risks on the operator, contained unreal- AMC to the operator. The surplus after these payments is istic performance expectations, imposed high penalty/loss transferred on a monthly basis to a water payment account clauses, and had nonstandard/un-bankable concessions for use by the concessionaire. terms. AMC will provide an annual grant to the operator from the AMC agreed to some of the requests, but many issues first year of the contract. This is increased at the rate of 6 remained outstanding including unrealistic service stan- percent per annum during the term of the contract. AMC dards, especially with nonrevenue water, termination will deposit this grant into the water payment account. In payments that were inconsistent with national practices, addition, AMC will also maintain a water payment reserve and severe performance security and penalties. Only two account in which 1.5 times the annual grant will be main- companies submitted bids. The financial bid of one of the tained throughout the duration of the contract as a payment consortiums was not accepted since it was conditional;28 security to the operator. so the remaining bidder, a consortium led by SPML Ltd., was accepted in March 2011. A Letter of Intent was issued Financing: The national government finances 80 percent of to the preferred bidder in April 2011 and the concession the original project cost (figure 3.8 and Table 3.5). The state agreement was signed in September 2011. Preparatory peri- government is financing 10 percent of the original project od activities are under way at this stage. cost and 50 percent of the cost escalation. The private oper- ator is required to finance the residual costs. Contract Terms AMC has secured approval of grants from the JNNURM A. Scope of Contract and from the state government. The grants will be provid- The 20-year concession contract requires the operator to ed in prespecified installments by the national and state manage the entire water supply chain, including construct- governments. If the grants are delayed or withheld for ing new assets, rehabilitating the existing distribution any reason, the operator has the responsibility to mobi- system, and making significant service improvements. The lize additional financing, which would be compensated contract can be extended by a maximum of ten years to by AMC. The annual grant by AMC is also a source accommodate increase in the share of private financing of financing since it is available upon the first year of and/or changes in scope of the project. contract. A part of this grant could be used to finance Table 3.5 Breakdown of Funding Sources, Water Supply, Aurangabad City Value National Govt. Share State Govt. Share Operator Share (Rs billion) (Rs billion) (Rs billion) (Rs billion) Original project cost 3.60 2.88 0.36 0.36 Escalation in original scope 1.50 - 0.75 0.75 Increased scope 2.81 - - 2.81 Total cost 7.92 2.88 1.11 3.92 % of total cost 36.32 14.11 49.57 32 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies Figure 3.8 Aurangabad PPP Project Flow of Funds Govt. of India 80% grant in two installments State Government 80% GoI grant + state share of 10% Equity 1.5 times annual grant Shareholders AMC Operator Capital Annual Water Payment Lenders grant grant Reserve Account Debt Escrow Account Usage as per To be used to established top up deficits in Tariff payments priority escrow account and connection costs Consumers operating expenditure, since the existing water operations AMC’s obligations are to secure the release of grants from are in deficit. The residual amounts are available for the the national and regional governments; secure raw water incremental expenses the operator may incur in O&M of allocations from the dam; provide an annual grant to the the existing system or to partially finance capital expendi- operator; and implement the tariff structure and its revi- ture for new assets.29 sion. In the year 2012, the operator inducted another member The concession agreement provides for an independent audi- into the consortium by diluting the equity stake of the lead tor and engineer for providing advice and determining costs consortium member (SPML Ltd). This conforms with the on technical and financial issues, respectively, in events such as terms of the concession agreement. The new consortium expansion of scope. They are appointed jointly and the costs member has taken the lead in arranging financing for the are shared equally. It also provides for amicable resolution of project. disputes through dialogue within a period of ninety days. If an amicable resolution is not reached, arbitration as per the B. Regulation and Contract Management Indian Arbitration and Reconciliation Act is triggered. The The obligations of the operator include construction of terms of arbitration are based on industry standards. bulk water off-take and transmission systems; rehabilitation of the distribution network; part financing of investment The project is in the preparatory stage and no issues have requirements; service delivery to customers; and billing and arisen so far. The city needs to ascertain actual performance revenue collection. and make performance grant payments accordingly. The www.wsp.org 33 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies capacity of the city to do this may be limited at present and standards, including a schedule for completion of construc- will need strengthening. tion and rehabilitation and achievement of continuous water supply in the city; service delivery standards during Revenue Model and Incentives: The revenue model is based the period of construction and rehabilitation; and service on user charges and the AMC annual grant. The operator delivery standards after rehabilitation. levies and collects user charges based on the prespecified tariff that differentiates between domestic and nondomes- The service standards are weighted and include 100 percent tic consumers. During the construction and rehabilitation coverage, 24 hour continuity of supply, water loss (15 phase, the tariff structure is on a flat monthly basis. On percent in the entire chain), complaint redressal (at least 80 completion of this phase, the tariff structure turns volumet- percent within 24 hours), water quality (potability), and at ric. Consumers in the higher categories of consumption are least 95 percent functional meters. levied a higher per unit rate for the entire consumption. The tariff is indexed every three years at an average rate of approx- Twenty-five percent of the annual grant is linked to the imately 7 percent per annum during the term of the contract. achievement of service standards. If the operator is unable to maintain a service standard above the requirements, the The annual grant is escalated at the rate of 6 percent per annual grant is reduced by a proportion equal to the weight- annum. In effect, the revenue base of the operator will age of the service standard. Some of the parameters such as grow in the range of 6–7 percent, excluding the effects of continuity of supply are unlikely to be met all the time.30 increased customer base and consumption. Tariff Mechanisms and Revenue Collection: The operator The concession agreement limits the operator’s revenue in is compensated through user charges that are levied by the two ways because the annual grant and the tariff structure operator as per the tariff predetermined by AMC and an are predetermined. The operator has commercial freedom annual grant from AMC. in all other respects and retains the upside of (i) optimiza- tion of capital expenditure, (ii) operating efficiencies, and Universal Coverage and Tariff Considerations: The (iii) commercial efficiencies such as maximizing connec- contract does not envisage any special provisions on tariffs tions, consumption, and collections. There are no other or service delivery mechanisms for the poor. However, it specific incentives provided in the contract targets common service standards for all consumers and universal coverage. Staffing: AMC will depute its existing employees to the operator throughout the term of the contract after obtain- Revenue Risk: In addition to service standards, the opera- ing their consent. The existing terms of employment will tor is also exposed to significant cost risks. The operator be preserved while they are on deputation. All employee is required to bear escalation in electricity costs and raw liabilities after the contract comes into effect will be borne water costs up to 10 percent and 15 percent per annum, by the operator, including salary increments and promo- respectively. The operator also bears the risk of raw water tions, and the operator will have to bear the cost impacts of unavailability up to 50 percent of the allocated quantity as such decisions. Although the employees will be under the well as revision in salaries of the employees deputed to the day-to-day control of the operator, their terms of employ- operator by AMC. ment and increments will continue follow government law. This decreases the degree of control the operator has over the The operator is required to maintain a performance security employees. It also increases the cost risk of the operator since of approximately Rs 792 million (US$14.4 million) during the employee overhead becomes an uncontrollable cost. the construction and rehabilitation period and an amount equal to the annual grant during the rest of the contract Performance Standards and Linkages to Revenue: The period. The performance security is cashable at the rate concession agreement contains three sets of performance of 1 percent per week in event of material breach during 34 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies construction and rehabilitation period; failure to complete beyond 50 percent of allocations is treated as a force majeure construction and rehabilitation within three years, subject event. For the other contingencies mentioned above, the to a maximum deduction of 10 percent; and failure to contract provides for remedy through measures (adjust- remedy material breach during the operations period. The ment of tariff, reimbursement of additional financing, and performance security is also cashable in the event of termi- extension of contract period) designed to protect the equity nation due to operator’s default, in order to realize any internal rate of return of the operator. payments due from the operator. C. Financial Stability Termination payments outlined in the contract do not The city implemented volumetric tariff concurrent with conform to national practices. If the contract is terminat- the project. Even with the revised tariff, operations will ed due to the default of the operator, AMC is entitled to not fully eliminate the need for subsidy from the general receive debt due to lenders from the operator. If termination budget. Therefore, the city subsidizes the project with an is due to AMC’s default or due to political force majeure, annual operations grant, capped through bidding. This the operator receives debt due to lenders and adjusted equi- provides predictability to the city budget. The success of the ty. If termination is due to other events of force majeure, project design depends on the ability of the city to gener- the operator receives only the debt due. These provisions, ate additional revenue from other sources to finance this especially those related to operator event of default, are not subsidy. The project design envisages financing of future consistent with standard industry practices. costs through tariff revision or an extension of the conces- sion period, but no clear plan is included. Contingency Management: The contract provides for six types of contingencies: (i) change in scope of the project, D. Project Status (ii) expansion in project boundaries, (iii) non-release of The concession agreement was signed at the end of 2011, grants by national and regional governments, (iv) change in subsequent to which the operator started carrying out prepa- law, (v) unavailability of raw water, and (vi) cost escalations ratory activities. The contract was to have been effective six in electricity and raw water beyond a specified threshold. months after signing, but this period has been extended. Adjustments to the contract are provided for each of these The operator has inducted another partner, Essel Ltd., who events. has taken charge of financing activities. In October 2013, the project had achieved financial closure, and permission Cost escalations in electricity and raw water beyond the from state government was awaited for hand over of assets threshold are borne by AMC. Unavailability of raw water to the operator. www.wsp.org 35 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies Six-Year Operations Contract in Mysore The City of Mysore signed a six-year distribution contract provided by MCC, while the Karnataka Urban Water in 2009 with the private operator JUSCO to rehabilitate the Supply and Drainage Board (KUWSDB)32 designed and distribution assets and improve operational performance to implemented capital expenditure. But in the 1980s the achieve continuous 24/7 water supply. The contract is a O&M function also was transferred to the KUWSDB, combination of fixed construction payments for rehabilita- which absorbed all the employees of MCC. In 1996, a tion and a management fee for operations. The project was constitutional amendment handed back O&M func- financed through a national grant program (JNNURM), tions to the Urban Local Bodies (ULBs). While the func- which covers 90 percent of the project fees. The Mysore tion was transferred to MCC, the employees remained on City Corporation (MCC) is responsible for financing the KUWSDB payrolls, keeping loyalties to the KUWSDB residual costs through its own sources. even though the day-to-day operations are overseen by MCC. The government estimated 1,281 km of existing network and proposed rehabilitation and expansion of approxi- The city has one of the lowest tariffs in the state with suffi- mately 922 km for 1.13 lakh customer connections. The cient water resources to ensure a daily water supply unlike contract made the operator free to study the system and many other cities in the state, which have limited services. come up with rehabilitation and expansion of up to 110 Seventy-nine percent of households are connected to the percent of the sum agreed through the contract. The oper- distribution network and receive water for about 4.5 hours ator discovered a total of 1,780 km of existing networks per day (Table 3.6). Customers receive about 135 liters per that needed to be rehabilitated—nearly double the govern- person per day, and about 81 percent of water samples meet ment’s original estimate—and almost two times the origi- targets for water quality. MCC recovers about 52 percent of nal cost. its O&M expenses through water tariffs and the operating deficit is met through the city’s general budget. The operator is responsible for preparing the service improvement plan within one year and taking over opera- Table 3.6 Service and Efficiency Parameters, Water tions and maintenance ninety days from commencement. Supply, Mysore City Within four years, it must rehabilitate the distribution Indicator Status for Mysore network, implement metering, and achieve 24/7 supply; it Coverage 79% must operate the system for two years before handing it back to the public sector. The contract gives the operator Per capita supply 248 lpcd* limited flexibility because the performance standards were Continuity of supply 4.5 hours per day fixed up front and the capital expenditure was also capped. Operating cost recovery 51.7% The short-term nature of the contract encourages aggres- Collection efficiency Unclear sive (and unrealistic) performance setting since significant results have to be demonstrated. *lpcd = liters per capita per day. Overview Like many other cities in India, there was a general The City of Mysore has a population of 983,000 and is the distrust of private participation in water in Karnataka. second largest city in the southern Indian state of Karnataka.31 However, a dedicated state-level infrastructure develop- Eighteen percent of the population is considered poor. The ment and financing agency, a PPP cell (supported by the city is a major Indian tourist attraction and hosts a large Asian Development Bank), and a Transparency in Public scale training centre of Infosys, a global IT company. Procurement Act have helped foster a climate for PPPs. The state is known for having implemented the first 24/7 pilot Water supply services in Mysore have historically been initiative (KUWASIP) in the country. 36 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies Rationale for a PPP: Continuous Water Supply There were prolonged discussions on whether the opera- MCC sought grant funding under the federal JNNURM tor should have execution responsibility for rehabilitation Program to rehabilitate its distribution assets. At this time, (therefore taking a price risk) or only a project management the city did not envisage continuous water supply. The responsibility (receiving a fee for supervising execution JNNURM approved the grant in 2006, but it was condi- through third party contractors). A combination of fixed tional on the city achieving continuous water supply. This construction payments for rehabilitation and a manage- triggered the PPP project since the stakeholders (KUIDFC ment fee for operations was finally decided upon because of and KUWSDB) perceived that conventional style of proj- a desire to cap the rehabilitation costs within the available ect execution, through construction contractors, could not JNNURM funding and to provide procurement flexibility achieve continuous water supply. The success of KUWASIP to the operator. also strengthened the case for partnering with the private sector. Technical Preparation MCC appointed the KUWSDB to prepare the Detailed Stakeholder Environment Project Report (DPR), which KUWSDB in turn contract- The decision to move forward with the PPP lacked politi- ed out to STUP Consultants. cal acceptance as there was no elected body in the city at the time. The city administrator was informed of the The overall cost of distribution improvements was esti- decision by the state agencies. Having seen the experi- mated at Rs 194.54 crore (US$35.4 million). The Board ence of an earlier PPP project, the city administration decided to implement improvements to feeder networks concurred. Consultations with city representatives and and service storage (costing Rs 71.18 crore, or US$12.9 citizens were deferred to after the election of local govern- million) through a conventional construction contract. ment. Consequently, the operator was made responsible for The works pertaining to rehabilitation of the distribution communication with stakeholders. network and management system, costing Rs 123.26 crore, were left for procurement through the PPP model, which Public opinion improved after initial opposition, as a result would include operations. of direct communication by the operator and MCC with citizen groups. The operator also implemented a commu- The DPR estimated 1,281 km of existing distribution nication program to keep customers informed about network and proposed rehabilitation and expansion total- project benefits, to collect feedback from customers and ing to about 922 km of network. It also estimated about address customer complaints, and to maintain customer 1.13 lakh customer connections. The contractor later satisfaction. The city also maintained detailed fact sheets discovered that the existing network length is 1,780 km to respond to concerns and educate customers on contract and assessed that the entire network needed replacement terms and objectives. to achieve performance standards. The number of customer connections increased to 1.7 lakh. The Process for PPP: Short-term versus Long-Term Approach The original DPR limited the scope of improvements to The key stakeholders, including the state agencies, the the area within the boundary of MCC and excluded about city, and the city administration, considered two broad 15 percent of the city’s developed area, which is in the approaches: a long-term contract for the entire water supply administrative jurisdiction of Mysore Urban Development system, including future investment responsibilities, and a Authority (MUDA). This had led to differential service short-term approach focusing on rehabilitation and perfor- levels within the city and also loss of revenue opportunities. mance improvement. As the state did not foresee tariff and institutional reforms—which were considered essential The Bidding Process for a long-term approach—the short-term approach was The KUWSDB split the city into two geographical zones pursued. and invited separate bids from operators. The Board adopted www.wsp.org 37 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies Figure 3.9 Mysore PPP Time line JUSCO signs Financial bids contract received Distribution improvement project secures national JUSCO grant approval under commences JNNURM JUSCO selected rehabilitation of as preferred assets bidder 2006 2007 2008 2009 2010 Procurement JUSCO process submits service launched improvement plan Stakeholders finalize PPP structure a single stage competitive tendering process. During the increased costs and in any case was reluctant to admit that prebid consultations, the bidders expressed willingness to its initial estimates were wrong. This resulted in a stalemate make partial investment in the facility. There were strong in rehabilitation and also impacted the performance targets suggestions from the bidders to avoid a Bill of Quantities for the operator. KUWSDB’s performance obligations are based approach to bidding and to avoid the responsibility limited to the supply of treated water. for collection of revenue arrears. Flow of Funds: The construction costs are paid to the oper- Three bids were received and JUSCO was the lowest bidder ator on a milestone basis (figure 3.10). Unlike other cities for both the zones. The financial evaluation criterion was where JNNURM grants are transferred to the city, in this the sum of rehabilitation costs (construction costs), operat- case the grants are transferred directly by KUIDFC to the ing fee, and performance fee, quoted by the bidder. The KUWSDB. Payments are made after a verification of the cost quoted for rehabilitation was slightly lower than origi- quantities on a periodic basis. Fixed fees for O&M are paid nal DPR estimates and significantly lower (about two to at the end of every quarter. The performance linked fee for four times) than that of other bidders. JUSCO was awarded O&M is to be released every six months based on perfor- the project even though the financial bid was considered mance targets met. too aggressive and impractical by other bidders. Financing: The JNNURM provides 80 percent of the Contract Terms approved project cost as a grant. The State Government provides an additional 10% and MCC is responsible for A. Scope of Contract financing the residual costs through its own sources. The operator is responsible for rehabilitating the distribu- tion assets and improving operational performance within B. Regulation and Contract Management a six-year period. The scope of rehabilitation is defined The contract management is carried out by the KUWSDB in the contract but turned out to be inadequate, and the on behalf of MCC. The contract is a rehabilitation cum operator proposed a doubling of rehabilitation investments. operating performance improvement contract and is divid- The KUWSDB did not have a source of financing for the ed into three phases: a preparatory phase to prepare an 38 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies Figure 3.10 Mysore PPP Project Flow of Funds Govt. of India 80% grant in four installments State Government 80%GoI grant + state share of 10% MCC’s share Board Board Performance linked Construction payments, operations and fixed operations and management fee management fee Operator Tariff receipts, other receipts deposited by operator into MCC account Consumers investment plan (twelve months), implementation phase Dispute resolution is limited to amicable settlement (thirty-six months), and a last phase focusing on operations and adjudication. The sole adjudicator is a retired engi- and maintenance. neer from the KUWSDB or an engineer to be appoint- ed by the Karnataka chapter of the Institution of Eight service standards are set in the contract with phased Engineers. The contract does not provide for arbitration. performance targets. Some of the “phasing” is seen as The project was not able to resolve a serious expansion in aggressive and difficult to meet, such as the 24/7 and NRW scope. The Board as a contract monitoring agency did not targets. There is no mechanism to control or adjust the have stakes in resolving this issue and the city may not have targets during the execution of the contract, irrespective of been prepared to finance the expansion. Lack of independ- the findings of the preparatory phase surveys. ent arbitration could also be a factor in this. The operator is responsible for all repairs and mainte- Revenue Model and Incentives: The operator is paid a fixed nance of the entire distribution network. The contract construction fee for rehabilitation. The rehabilitation costs differentiates between rehabilitation works in the nature are adjusted for price escalation as per inflation indices. Up of asset replacement (which are funded through an item to 85 percent of the inflation in indices is passed on to the rate contract) and routine repair activities. For other operator through a predetermined formula. For operations, O&M activities, the operator is paid a fee based on the bid the operator is paid a fee (consisting of a management fee price. and operating costs). www.wsp.org 39 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies A large part of the recurring fee for the operator is perfor- six-month period, the installment lapses and cannot be paid mance linked, thereby requiring the operator to focus on proportionately for partial performance or when the target performance targets. However, the contract has an implicit is achieved at a later date. This style of the performance- price cap and stiff targets and there is no material upside to linked fee is inconsistent with the operating cost pattern the operator. Moreover, mechanisms for handling unfore- and the poor quality of initial estimates of rehabilitation in seen events and dispute resolution are not forward looking. the DPR. As a result, if the contract encounters difficulties, the incen- tives to continue performance are low. The management of the contract has further aggravated the inconsistent and irrational targets. JUSCO has reportedly Staffing: The public sector employees are delegated to the not received any performance payment and even the fixed operator for the duration of the contract, but their sala- payment for costs and management fee were not fully paid ries will continue to be paid by MCC and KUWSDB. This as of mid-2012. creates a disconnect between payment and performance, and as a result the operator has had difficulty in secur- Tariff Mechanisms and Revenue Collection: Tariffs ing cooperation of all the employees. The operator is also will remain unchanged during the PPP arrangement. responsible for training all public sector employees. The operator is responsible for billing and collec- tion. One of the performance parameters for the Performance Standards and Linkages to Revenue: The operator is a gradual increase in revenue collection, operator is remunerated in four ways: (i) rehabilitation starting with an increase of 5 percent. costs; (ii) management fee, which includes all management costs including staff costs; (iii) operating cost, which covers Universal Coverage and Tariff Considerations: The PPP the cost of consumables, equipment, and material; and (iv) project does not have special provisions for services to the provisional items. poor but targets universal coverage and common service standards. Group connections are permitted for the urban The operator is expected to meet eight performance stan- poor. Since the operator fee is distinct from user charges, dards, among which are the following: no specific pro-poor tariff mechanism is proposed in the • 100 percent of households to be provided with 24/7 PPP contract. water supply (up from 79 percent coverage with intermittent supply). Revenue Risk: Revenue risk is significant for the operator: • A nearly 20 percent improvement in percentage of 50 percent of the management fee and 70 percent of the samples meeting water quality targets. operating fee are performance linked. While the service • A revenue improvement marker of 40 percent and improvement targets are very stringent and are difficult to NRW decreased to 15 percent. achieve, the revenue collection and customer service targets • Ninety-eight percent efficiency in complaints are manageable considering the service levels already being redressed. maintained by the city. Ten percent of each payment is retained by the Board as retention money (up to 7.5 percent Performance parameters are weighted. Fifty percent of of contract value) to be returned on completion of defect management fees and 70 percent of operating costs are liability period (approximately fifteen months after expira- performance linked. Six monthly performance targets tion of the contract). are specified, and the performance component is subdi- vided against these targets (for each performance element The operator is liable to pay liquidated damages of 0.005 and each six month period of contract). In all, there are percent per day of default, which will be capped at 7.5 82 performance installments for the management fee and percent of the contract value. The KUWSDB and MCC are another 82 installments for the operating fee. If the opera- entitled to terminate the contract once the cap is reached. tor is unable to achieve a performance target specified for a In addition, the operator is exposed to the performance 40 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Case Studies security (6 percent of the contract price) being invoked. cost recovery is low (51.7 percent) and no tariff revision was Thus, in addition to the performance-linked fee for opera- planned. The project design does not address both current tions, 21 percent of the contract price is linked to perfor- and future cost needs of the city and is purely a grant fund- mance. ed service improvement project. Contingency Management: The contract has poor mecha- D. Project Status nisms for addressing changes in scope. The rehabilitation The objective of the PPP was to achieve city-wide rehabili- costs proposed in the investment plan cannot exceed 110 tation and performance improvement. The contract has percent of the price quoted by the bidder’s original estimates, only one year to completion. However, both objectives irrespective of the increase in quantities that may be warrant- remain seriously challenged, largely due to poor techni- ed due to poor initial estimates. Other variations during the cal preparations leading to expansion in scope; poor PPP contract cannot exceed 5 percent. However, variations are design, especially performance standards, revenue risk and permitted in the event of more than 10 percent variation contingency management; a hybrid contract that requires in data provided by the client in the tender documents. both construction and operation responsibilities; conflict- If the KUWSDB terminates the contract unilaterally or ing stakeholder interests; and aggressive bidding by the due to force majeure, it must pay the operator for all works operator. Among these, the inability to resolve the increase completed and services satisfactorily rendered (although in rehabilitation scope and costs appears to have cascaded this is not clearly defined). The operator is not entitled to issues. MCC and the operator expected the state govern- recover reasonable costs as compensation in all other events ment to resolve this issue. However, the latter is not envis- of default. This also includes default in payment by the aging any further capital investment in the project under KUWSDB/MCC. The only recourse available to the opera- the current contract. Likewise, the operator is not propos- tor is legal recourse through a court process. ing to seek an extension of the contract period, as is permis- sible under the contract. The project has shown results / C. Financial Sustainability benefits in terms of achieving a significant increase in the By design, City of Mysore does not aim to achieve finan- city’s water supply revenues; as well as in the number of cial sustainability through the project. The investments, as customer connections, a large number of which consisted well as the management fee, are funded by the city. Current of conversion of illegal connections. www.wsp.org 41 IV. Observations and Key points • The direction that the PPP projects are taking is appro- Lessons Learned priate for the Indian water sector: projects are leverag- ing private sector efficiency with public funding, and are targeting distribution improvements, universal coverage and continuous supply • PPP Projects are ignoring vital ingredients that will ensure success and sustainability: project preparation, PPP design and monitoring are weak; projects costs are not optimised, financial and institutional sustainability are not being addressed; employee and citizen communica- tion is weak The projects reviewed in the previous sections represent all Observation 2: Data and Information on the the PPP initiatives in urban water supply undertaken in Existing Infrastructure Was Poor the country between early 2005 and late 2012 with a focus Initiatives to address distribution aspects in existing cities on citywide distribution. Three of these are, as yet, in early are inherently brownfield projects—and thus closely tied stages of implementation, and operational experience is to the nature of existing assets. However, all the contract limited. However, across projects, the underlying rationale studies have been executed with poor data. As a result, for PPP; aspects of the preparatory and bid process; and initial assessments for rehabilitation were underestimated key contract provisions will have a bearing on the opera- and committed public funds proved inadequate. Two cities, tional trajectory and impact achievement of objectives. An Khandwa and Mysore, are now unprepared to mobilize analysis of these, across all five initiatives, is captured in this additional financing, putting the projects at risk. In Latur, section. Relevant observations culled from international the operator discovered that daily water supply was not experiences of water PPPs in developing countries are also possible using the existing infrastructure. presented to allow a comparative perspective (Box 4.1). It is reasonable to expect that most brown-field water Observation 1: Distribution Projects Have PPP contracts may require adjustment or even renegotia- Been Taken up Where Bulk Water Availability tion, given that they are awarded in the context of poor Has Been Assured data relating to the existing system and inadequate prepa- A decade ago, cities were largely concerned with bulk ration. A credible and transparent mechanism would help supply augmentation. The focus has shifted from bulk address this issue during implementation; in the absence of water to service delivery or end-user experience. In all cases, this currently, public sector officials are reluctant to exer- bulk water availability has been assured at the start of the cise judgment to resolve issues objectively and stakeholders projects. Khandwa is an integrated project with a large look upon any adjustment negatively. Therefore, decision proportion of investments in transmission and off-take. In making is escalated to the state government level, as in Mysore, the city is also investing in bulk water treatment Khandwa and Mysore, leading to delays. In Latur, this also and transmission. In Nagpur, the parallel investments in exposed the project to significant political risks. transmission and treatment far exceed the proposed invest- ment under the PPP project. In Latur, the PPP followed a Lessons Learned bulk water augmentation project that improved the avail- Lack of accurate data is a real risk for water PPPs. Public ability of water but pushed up operating costs—and as a agencies should explore contractual approaches that result, the public sector agencies decided to pursue PPP to incentivize the operator to cope with this risk. This could implement metering and volumetric tariff to improve cost include more detailed project preparation, in which opera- recovery. Aurangabad is also building a bulk water supply tors assume a role of providing incentives to the operator line as part of its concession contract. to maximize achievement of service standards within the 42 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Observations and Lessons Learned Box 4.1 Findings from International Experience of Urban Water PPPs Meaningful analysis of the impact of PPPs in improv- private concessionaires on average did not perform ing service delivery and sector outcomes in develop- demonstrably better than public utilities. In Guayaquil ing countries has been handicapped by the difficulty in (Ecuador), Jakarta, and Manila concessionaires obtaining good performance data in the sector, includ- performed better, but the performance may be attrib- ing baselines from public entities. Analysis from recent utable to the size and financing advantages available reviews of cases that were successful indicate that the to these cities. In Sub-Saharan Africa, private opera- biggest and most consistent contribution that private tors have clearly performed better than public utilities operators have made is in improving operational effi- accounting for a 20 percent increase in the household ciency (water losses, cost recovery, and collection effi- connections although PPPs have only a 9 percent ciency) and service quality (coverage, quantum and market share. However, this difference also gets diluted continuity of supply). when considering more detailed measures of perfor- mance. NRW reduction: In Colombia, three of ten water PPPs showed strong gains in absolute reduction in NRW While projects have not necessarily included targets percentage. In Brazil, seven of eight large PPPs signifi- for financial sustainability in the short term, improved cantly reduced water loss levels; Limeira achieved NRW services are expected to result in lower costs and levels of 13 percent. PPP projects in Gabon, Niger, and increased revenues from customers. This is further Senegal achieved NRW levels below 20 percent. expected to help generate adequate cash flow from operations to invest in expansion, increase the custom- Collection efficiency and global efficiency: In Brazil, er base and revenues, and create a virtuous cycle of several PPP projects (Campo Grande, Campos, Limeira, sustainable operations in the long term. Other findings Niteroi, Manaus, and Tocantins) achieved significant include the following: collection increases within a few years. Most manage- ment contracts have performed well in improving bill • Improving water supply services and operations in collection. In Yerevan, the collection rate went up from the context of developing countries takes time. For less than 20 percent to 80 percent within five years. In example, as compared to concessions and other ten out of twelve management contracts, significant long-term arrangements, management contracts gains were achieved in the global efficiency ratio (the have shown a mixed result in reducing water loss- ratio of water billed and collected to water input to the es. Out of twelve management contracts studied, system), while the remaining two also showed improve- fewer than half achieved a sizeable reduction, and ments. no significant change occurred in five other cases. This is possibly due to the short-term duration and Continuity of supply: In Colombia, all ten PPPs awarded inherent limitations of the management contract. In demonstrated significant progress in improving number Senegal results took ten years to achieve, and in of hours of supply and six projects awarded in 1997- Niger positive results are emerging only after five 98 achieved continuity within five to six years of private years of implementation. operations. Ten of twelve management contracts stud- • Water PPPs have been successful mainly when ied showed water rationing was significantly reduced by implemented within a wider framework of sector the end of the contract. Progress was particularly signif- reforms. For example, in Chile, Colombia, Côte icant in Mozambique, Monagas, La Rioja, and Yerevan. d’Ivoire, Morocco ,and Senegal, the introduction of Only in a few cases was no significant improvement PPP was a part of a wider reform by the central achieved. government to establish a sector framework that Coverage: The evidence for increased coverage is supported financial viability and accountability for mixed. In Argentina, Brazil, Colombia, and Morocco, performance. All these countries had clear policy www.wsp.org 43 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Observations and Lessons Learned to move to cost recovery tariffs in a sustainable the water sector occurred in 74 percent of cases and socially acceptable manner. In countries where and, on average, just 1.6 years after award. Where public sector and private sector co-exist, such undertaken, contract renegotiation has been as in Morocco and Colombia, benchmarking was controversial, fuelling criticism that operators may promoted at the national level to foster a sense of have taken advantage of adjustments to make competition among providers. financial gains. Transparency in contract regulation • The extent of improvement that can be achieved has helped to mitigate distrust among stakehold- through a PPP project depends on the allocation of ers. responsibilities and risks. This includes the incen- • Poor households have benefitted significantly from tive structure and the nature of the arrangement increased access (universal coverage) and conti- between the private partner and the government nuity of supply that was achieved by a significant for implementing civil works when the government number of PPP projects. Instances in which public remains responsible for funding investment. funding has complemented tariff revenues have • Contractual targets must reflect realistic goals been most successful in ensuring benefits for the in order for PPP projects to be viable. Given the poor. For example, Senegal demonstrated much difficulty of setting baselines, a few PPP projects better results in achieving increased coverage as have adopted a flexible approach, which gives the compared to Côte d’Ivoire. The difference is attrib- private operator the opportunity to establish the utable to the fact that Senegal saw an injection of baseline in the first year of operation, under the donor funding while Côte d’Ivoire relied on financ- supervision of an independent technical auditor. ing expansion through customer revenues. For example, in Johannesburg and in Niger, the • Many of the PPPs classified as broadly success- private operator was tasked with putting in place ful were implemented by local private operators or the necessary framework, and the baseline perfor- investors that had little or no previous experience mance was agreed to in the first year of operations in operating water utilities. Local private operators under the control of an independent technical audi- serve more than 40 percent of the market as of 2007 tor. and several have performed well. In Brazil, Colombia, • Given the prevailing context of water supply, PPP and Malaysia, investors with previous experience contracts have been prone to adjustment over in construction, engineering, or consulting proved time; for the period 1985 to 2000, renegotiation in able to operate water utilities satisfactorily. Sources: Marin 2009; Gassner and others 2008. initial budget. Contracts could also include clauses that substantial replacement of distribution networks. In permit changes in scope or service standards to cope with Khandwa, the private investment is 10 percent and in increased costs or have a contingency fund. Mysore, under a management contract, the private opera- tor is not putting up any financing. In Nagpur, the operator Observation 3: None of the Projects Have is required to invest 30 percent of the initial improvement Targeted Any Capital Investment Optimization plan, but the city has committed substantial cash flows to All the projects reviewed have been executed after the the operator against this. Only in Aurangabad is the opera- inception of JNNURM and rely substantially on public tor required to invest substantially. funds made available under the program: from 50 percent in Aurangabad to 90 percent in Khandwa and Mysore. However, the availability of public funds has had an unin- Khandwa, Nagpur, Aurangabad, and Mysore include tended consequence on project development and imple- 100 percent replacement of customer connections and mentation, in that the imperative for efficiency of capital 44 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Observations and Lessons Learned deployment has been diluted or compromised. The focus All four contracts thus had a goal for service delivery has shifted from rehabilitation to replacement, and the scope improvements and included targets for service delivery of replacement works has further expanded in Khandwa, parameters. However, the targets are not linked to operator Mysore, and Aurangabad after the initial design. revenue in a realistic manner. In Nagpur, only 5 percent of the annual operator revenue is linked to service deliv- As a result, cities are bearing additional costs and the objec- ery standards. In Khandwa, the revenue is protected but tive of public funding, which was to keep the impact on the concession period is shortened, which is a back-ended citizens and cities low, has been negated. In all cases, the impact. In Aurangabad, 25 percent of the operating subsi- PPP design did not build in any incentives for the operator dy provided by the city is linked to performance. In Latur, to optimize capital expenditure or succeed in drawing out service delivery targets are not the primary objective of the more rigorous technical expertise, creativity, and inno- the contract. On the other hand, an aggressive contract vation implied in addressing service delivery in the chal- in Mysore links approximately 60 percent of the opera- lenging context of existing Indian cities. The approach has tor’s revenue to performance and subjects 21 percent of the been on construction of new assets rather than the selec- contract price to performance guarantees. tive rehabilitation of existing assets. This recalls the earlier pattern of significant, construction-focused investments in While it may be argued that credible targets are difficult bulk water assets, whereas addressing distribution aspects to establish, given the initial conditions, once operators may benefit, rather, from a focus on operational and techni- have signed up to the targets, clear incentives for meeting cal experience / knowledge. them are necessary and meaningful. Moreover, all projects are building fresh assets, and for such areas or components, Thus, not only has financial leverage from the private sector realistic targets can be set. The linkage between service deliv- been limited, technical expertise has also not been opti- ery targets and operator revenue, in the contracts reviewed, mized. is either too liberal or too unrealistic. Lessons Learned Lessons Learned In the current funding context, PPP structures must be In the contracts reviewed, the consequences of not meeting consistent with the depth of public financing. PPP design the targets or standards are too weak or too unrealistic. The should seek to incentivize optimization of capital invest- service level objectives should not only influence the PPP ments, through a focus on application of technical skills, choice and contract design but should be further embedded expertise, and innovation—rather than underwriting risk in specific and meaningful contractual commitments. This for the private operator—to maximize the impact of avail- weakness is especially significant since the private sector able funds. is not risking its capital in these projects. Therefore, the incentive for achieving service levels relies significantly on Observation 4: PPP Design and Monitoring enforceable commitments in the contract. In the absence Are Not Always Consistent with the Rationale of such enforcement, the primary objective of PPPs, which for Choosing PPPs is to leverage private sector efficiency, stands compromised. A. It is important to enforce service delivery contractu- This is further compounded by lack of strong institutional ally. In all the contracts (except Latur), the city officials mechanisms to monitor performance. clearly articulate the need to focus on customer service and therefore on distribution improvements. This formed the B. There is an inconsistency in the treatment of standard basis of the rationale for PPP in the cities: in Khandwa and issues (such as key escalation clauses or changes in law) Aurangabad, the promise of daily water supply and 100 between contracts, which may have resulted in limited percent coverage; in Nagpur, the scaling up of the pilot competition. There is no balanced assessment and treat- project and equitable supply; and in Mysore, continuous ment of risk sharing in any of the projects. Standard clauses water supply. such as treatment of escalation in power tariff, change in www.wsp.org 45 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Observations and Lessons Learned law, and compensation in the event of termination, arbitra- revenue from users and there is no support from the city. tion, and so forth vary significantly among contracts. There A new tariff was agreed upon to cover operating expenses is no common approach to prequalification of bidders, and recovery of capital. While this is four times the flat which affects bidder interest and competition. tariff currently in place, it has been agreed to by the resi- dents and is to be implemented on completion of the proj- In Aurangabad, the contract transfers all performance and ect. In Nagpur and Mysore, the operator’s revenue is not financial risk to the operator. In Nagpur, although the PPP linked to water supply revenues, and the gap between the contract is designed to improve operating performance, water supply revenue and the operator payments is met the city has retained significant risks, and the consequence from the general budget of the city. Mysore has a short- to the operator for any shortfall in performance is mini- term performance improvement contract with a fixed mal. The city prequalified only three bidders and received price and the financing has been provided by through a only two financial bids. Mysore had a risky contract, but state grant and the city budget. Due to the short-term open competition, and received only three financial bids. nature of the contact there are no significant vulnerabili- However, the open competition may have resulted in an ties for the budgeted expenditures. But there is no clear aggressive (possibly speculative) bid by one of the compa- framework for financial sustainability for the future. The nies. PPP arrangement expects to improve commercial prac- tices, but after the PPP project, the water supply function This situation is not necessarily due to lack of awareness; will continue to rely on city finances for meeting deficits there is adequate experience of PPPs in India to inform the in recurring costs as well as to finance future expansions. water sector. Aggressive risk-sharing clauses benefit conser- vative public sector officials who are hesitant to take poten- In Nagpur, the operator receives a fixed rate per unit of water tially controversial decisions on risk sharing; and these billed and collected. This rate is delinked from the water clauses may also benefit interests that may not be unhappy tariff and does not allow for full cost recovery, and therefore to see a project fail. This position also benefits some aggres- the water supply function will continue to be dependent sive private sector bidders, as cautious competitors opt out on city finances for sustainability. In Aurangabad, the city of the process. has agreed to provide an annual operating subsidy through the life of the contract, drawn from the general budget of Lessons Learned the city. One of the key indicators for the success of a PPP process is attracting sufficient participation followed by using well Thus, cities have (justifiably) insulated the operator from established principles for prequalification (aligned with the cost recovery risks; however, they do not seem to have responsibilities of the operator). Standard commercial risks put in place any parallel mechanisms to ensure financial such as power tariffs or change in law enhance this possibil- sustainability of the water supply function at the city level ity. in the medium to long term. (See Table 4.1 for financial and operational details.) Observation 5: The PPP Contracts Focused on Delivering Technical Improvements While Lessons Learned the Financial Sustainability of Operations Has Public funding aims to reduce the cost of initial service deliv- Not Been Addressed in the PPP Design ery improvements in order that cities may dilute the impact This has been the case in all the projects except in Khandwa. of capital expenditure on corresponding tariff. However, Other cities will continue to be responsible for providing it is important to ensure that the PPP design is within an subsidies from the general budget. overall framework for long-term financial sustainability and viability of water supply functions for the city, in addition Khandwa is the most financially sustainable project because to ensuring viability of the PPP project. the operator’s revenue is tied directly to the collection of 46 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Observations and Lessons Learned Table 4.1 Financial Summary of the Five Case Studies Khandwa Aurangabad Nagpur Latur Mysore Project is concurrent with tariff revision to Yes Yes Yes Yes No improve cost recovery User charges are an integral part of the Yes Part user Distinct from Yes Distinct from revenue model of the operator charges, part user charges user charges subsidy Project eliminates need for operating cost Yes No, but No; will require Yes No subsidy from the city subsidy is operating capped subsidy Project finances part of initial capital costs 10% 50% 30% of No No distribution network Project design includes a solution for No No No NA No financing of change in scope in initial capex Project design includes a solution for No No No No No financing of future expansions Observation 6: Institutional Arrangements interfaces are with the Water Board, which is not directly Have an Impact on Project Design and answerable for service delivery. On the contrary, the Board Contract Management may benefit from negative perceptions regarding PPPs since In Nagpur, the institutional commitment to PPP did not this would strengthen its position as an executing agency translate into effective contractual terms that secure service and operator. This has resulted in a contract that is unreal- delivery. However, the city has the strongest institutional istic on performance expectations and has poor risk sharing mechanism for contract management, because the PPP and substantial penalties for the operator. contract is housed within a city-owned utility and is super- vised by the utility. In Latur, the parastatal entity, MJP, is the primary coun- terpart in the tri-partite arrangement. MJP prioritized As part of the reform program in Khandwa, the state commercial improvements in the PPP design—which are government transferred the entire water supply function to of primary interest to itself—rather than service delivery the Urban Local Body, including tariff setting. The contract improvements. Not having taken their views adequately on reduces dependence on the city because of the city’s limited board, MJP was also unable to secure city and citizen coop- capacity to manage the project. Arrangements to address eration during implementation. contract-related issues have been proposed, such as a committee to revise tariffs based on the formula specified in In three out of the five cases, serious scope expansion the contract. A contract monitoring committee, consisting (Khandwa, Mysore) and/or disputes (Latur) have arisen of municipal officials and a design consultant, has also been during the implementation stage and led to a stalemate. In set up at city level, and the state government will continue all three cases, though the city is responsible for resolution to provide technical assistance to the city. of these issues, the institutional mechanisms put in place were not able to do so. All three projects lack indepen- In Mysore, the Water Board, a parastatal entity, has limited dent arbitration, and possibly this may have also limited experience executing or monitoring a performance contract. the options available to the operator to resolve the issue. The contract arrangement is unique: although the formal All five contracts require active participation of the city to counterpart for the contract is the city, all operational audit service standards, verify capital expenditure plans, www.wsp.org 47 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Observations and Lessons Learned and adjust operator fees and/or tariffs. The experience so far political opposition was able to use citizen apprehensions indicates that it will be a serious challenge to all five cities. regarding metering to criticize the project and slow down implementation. This was compounded by the operator’s Lessons Learned inability to rectify technical deficiencies in the system A meaningful focus on service delivery improvements and rapidly enough to quell initial opposition. realistic contract management is possible only when the entity accountable for service delivery is the key counter- Stakeholders also lack a credible platform to express their part to the contract and clear institutional mechanisms are views and grievances; the city government is seen as implic- provided to buffer the contract against external and extra- itly favoring the private sector. Political representatives pres- neous interests. Institutional fragmentation weakens PPP ent the only accessible platform. However, once stakeholder design and implementation. The PPP designs require the opposition is politicized, meaningful resolution of issues city to develop sophisticated contract management skills become difficult. In such a situation, an independent regu- and decision-making capability, which they appear to lack. lator or an ombudsman can provide an alternative institu- tional space to stakeholders where their grievances can be Observation 7: Communication and addressed. Stakeholder Engagement Was Weak in All Projects The Government of India, in a recent decision, now None of the projects included any type of opinion research requires PPP projects to disclose information voluntarily. or communications assessment to help understand the key Communication programs should be designed to reflect opinions and attitudes around reform, which could have this principle, and platforms for interaction should imple- fed into a broader, more responsive communication strat- ment it proactively. Together, these approaches can help egy. the city generate an informed political and citizen opinion around the project. In Khandwa, the climate-for-reform rationale for PPP was well explained and accepted by the public, against the back- Lessons Learned drop of almost nonexistent supply. This is reflected in the If upfront communication about the rationale for a PPP is willingness to pay for improved supply. Also, at the time, weak it puts the project at risk. This will have a cascading the city had strong political leadership at the city level and effect when citizen support is poor and political consensus administrative leadership at the state government level. The across party lines is lacking. Projects are also vulnerable to Nagpur project is strongly supported by local political lead- vested interests and political opposition. Communication ership across party lines, but public sentiment and support programs should be implemented widely and well before varies. There is persistent public skepticism of the rationale, the bidding of the project. An effective communication expressed in ongoing opposition to the project, in spite of strategy helps mitigate political, social, economic, techni- a number of stakeholder meetings held by the corporation. cal, and even commercial risk. Where there is limited buy in, an initial focus on gaining and communicating quick Mysore did not have either political or administrative lead- results helps to mitigate the damage that can be done by ership in support of the PPP initiative. On the other hand, lack of stakeholder buy in. the city had the PPP decision thrust upon it, and conse- quently, communication of the rationale was weak early Observation 8: Staffing and Transitioning of on. As a result, the initial opposition in Mysore was the Staff Can Create Opposition from Within strongest. However, this has subsequently abated, as a result Transitioning of city employees to the private operators of JUSCO’s concerted information and public outreach is challenging, as loyalties and incentives are not always program, and the quick gains demonstrated by the PPP. aligned. When public sector employees are delegated to the Latur had negligible communication with citizens during operator but continue to be paid by the government, it can project design and limited political consensus. As a result, create significant employee resistance. This is particularly 48 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Observations and Lessons Learned true when contracts are short term, such as in Mysore, where has progressed (Khandwa, Latur, and Mysore), this reli- the public sector employees work for the private operator ance has led to problems in implementation. Khandwa and but their salaries are paid by MCC and KUWSDB. This Mysore faced expansion in scope and the public agency was creates a disconnect between payment and performance unable to resolve this. Khandwa also faced delays in receipt and, as a result, the operator has had difficulty in securing of public grants. In Latur, the public agency was unable to support from the employees. implement committed capital expenditure due to unavail- ability of funds. In Aurangabad, the operator bears (in addition to salaries) the revision in salaries of the employees deputed to the None of the contracts have a practical or bankable mecha- operator by the city but has no control on the extent of nism for resolving either delays in receipt of grants or the revision. On the other hand, Nagpur has a strong arrange- need for additional grants due to scope expansion. ment, where both the operator and the staff have the free- dom to choose who will work in the private organization. Lessons Learned Both sides are also provided sufficient time to familiarize Appraisal of PPP projects also has to take into account the themselves with each other before they make a final choice. capacity of the city to manage changes in scope and delays in funding. External grants are helping cities take up proj- Lessons Learned ects far beyond their financial capacity, but they also make Conflicts occur when staff are transferred physically to a them vulnerable to unforeseen events. Project prepara- private operator but remain tied administratively to the city. tion, financing plan, and tariff/fee design should build in a Staff may transition better if they are able to see a clear gain contingency to handle these issues. for both themselves and the project if it succeeds. Contracts that provide clear incentives to employees help build staff Observation 10: Market Interest Is Fairly ownership to work toward a successful project. Strong but Dampened by the Poor Treatment of Risks Observation 9: Projects Relied on External The market appetite for PPPs appears to be strong. The Grants or Public Agencies for Investments earliest PPP attempt in Latur witnessed six prequalified All projects relied either on external grants or, in the case bidders, all but two being domestic bidders. Aurangabad of Latur, on a public agency to implement linked invest- received eleven applications for prequalification, represent- ments (Table 4.2). In the three cases where implementation ing consortia with domestic as well as international firms. Table 4.2 Funding Mechanisms for the Five Water PPPs Khandwa Aurangabad Nagpur Latur Mysore Is the city responsible for providing grants for initial capital investment or for linked Yes Yes Yes Yes Yes investments? Are public funds available unconditionally No No No No No and are they secured? Did the projects face delays in availability Yes Not tested yet Not tested yet Yes No of committed funds? Was the city able to resolve expansion in No Not tested yet Not tested yet No No scope quickly? Did the projects suffer due to reliance on Yes Not tested yet Not tested yet Yes Yes public funds/public execution? www.wsp.org 49 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Observations and Lessons Learned3 In Nagpur, three consortia were prequalified. While this Lessons Learned indicates the receptivity to PPP project opportunities, the A standard approach to prequalification has increased number of financial bids received has been low in all proj- competition in other infrastructure sectors in India, such ects: four in Khandwa, three in Mysore and Latur, and two as highways and ports. A similar approach may be needed in Nagpur and Aurangabad. Though interest appears high, to provide predictability to potential domestic and inter- participation appears limited either because of prequalifi- national bidders. Improving project preparation and PPP cation criteria or because of poor project preparation/PPP structuring is also important to convert the bidder interest structuring. in the sector to bidding for specific projects. The prequalification criteria used vary significantly from Observation 11: All Projects Have a Goal of project to project. In this regard, international operators Universal Coverage and Common Service have tended to seek balanced risk sharing, while domes- Standards for All Consumers tic operators have inherently shown a willingness to take All five projects include a target of universal coverage and higher risks, possibly to establish their credentials in water common service standards, including continuity of supply, PPPs or due to greater comfort with the operating environ- for all consumers. Standposts are being replaced with house ment. Poorly designed prequalification criteria can result in service connections. Operators are encouraged to provide a group of bidders that is either too risk averse or excessively group connections to poor customers. Tariff concessions are risk taking. Bidder response is also a function of project also common. design, which must seek to ensure that both local knowl- edge and international expertise, as relevant, are available Lessons Learned to cities. In response to social issues, all contracts have proactively provided for service delivery options to consumers as A related issue is that of eliciting operator behavior that is well as tariff concessions: bulk supply to poor neighbor- in alignment with sector objectives, that is, focused on a hoods, fortnightly payment options, special tariff for group long-term service delivery perspective rather than on quick connections, and so forth. It would also have been useful profits from construction activities. Most water operators to explicitly state the subsidy that the city would provide are integrated players with interests in construction and for connecting poor consumers to the network. Explicit equipment supply. Poorly designed PPP structures may arrangements in the contract would allay the apprehen- encourage operators to focus on short-term gains through sions of the urban poor as well as encourage the operator to related party contracts for construction and equipment connect the poor. supply rather than on hard-earned gains through improv- ing system efficiencies in the long term. 50 Creating Sustainable Services Through Domestic Private Sector Participation V. Conclusion Key points • Cities need to substantiate their willingness to engage with private sector with better project preparation and meaningful contracts • Cities need to focus on strengthening public sector insti- tutions to build on the private sector’s contribution • Building public sector capacity to manage PPPs and sustain the project gains is an important task • The federal Government has high stakes as well as lever- age to ensure that cities and states adopt the desired principles Indian cities are the engine for the country’s economy, deliver in an urban water supply distribution mandate accounting for over 60 percent of GDP and over 50 in India is complex. Meeting the objectives of improved percent of new jobs created (2001–11). Infrastructure, service delivery rests on the details of project design and in especially water and sanitation, is central to support the embedding objectives meaningfully in contract documents growth momentum through urbanization. Partnerships through realistic targets and effective incentives. This calls are important to this agenda, including the aspect of meet- for adequate information to support the contract mandate ing investment targets, and several of GoI’s programs seek and also for a readiness to accommodate information vola- to coordinate public and private financing toward this. tility, and hence cost uncertainties. Future initiatives will Although there has been limited financial leverage from have to demonstrate more robust diagnostics underpinning private sector for urban water supply projects so far, the project preparation alongside mechanisms that allow for experience of PPPs in the sector has recorded significant flexibility and transparency in resetting targets or renego- achievements over the past two decades. The most impor- tiating funding allocations, as and if necessary. This may tant of these has been the shift in focus to service delivery be facilitated by strong monitoring and oversight—backed and the increased ownership demonstrated by cities toward by a comprehensive information-sharing and reporting PPPs, leading to increased willingness to explore and design regime—as may be exercised by a third party, independent solutions that suit their specific context and needs. In addi- technical supervisor. tion, projects have succeeded in eliciting interest from both domestic and international operators, through well- The Institutional Aspect established competitive selection processes. There is good That public funding is making PPP projects possible, and ground for forthcoming initiatives to build upon. increasing their acceptability, owes much to the growing perception of PPPs as arrangements that may facilitate a The projects reviewed in this paper are making headway transition to a more sustainable institutional and gover- in the right direction: all projects focus on distribution nance context in the sector. It is recognized that reform of and service delivery, on the basis of competitive procure- these aspects may otherwise prove difficult or lengthy. Thus, ment, and have drawn upon public funds and subsidies while “cities could, in principle, improve their manage- to minimize tariff impacts on consumers. They show that ment skills and deliver better quality of services, given the PPPs backed by public funding are offering a viable option complex web of relationships, often infusion of a new orga- to local governments that do not have the technical and nization or private participation tends to catalyze success.”33 managerial capacity to improve service delivery. This direc- Improvements in sector governance are recognized as valid tion is likely to persist in the short to medium term: private justification for undertaking PPPs. sector efficiency, rather than privately mobilized capital, will be the predominant focus of forthcoming PPPs until In order to be credible, such improvements must involve such time as the water sector enables commercially viable and be embedded in an institutional counterpart that is projects. While this overall direction is relevant and prom- able to continue and build upon them beyond the term ising, the context within which operators are required to of the PPP project. Capacity building of the local service www.wsp.org 51 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Conclusion provider—extending, if necessary, to establishing an partners may be bridged. While this may best be addressed entity responsible for city water supply—to sustain the at the level of the states and local bodies, the federal govern- changes introduced would be an important factor in this. ment is perceived to have a proactive role in incentivizing Forthcoming projects will benefit in according greater and facilitating the process through central level support attention to this aspect through the contract arrangement. systems and tools to streamline contract design and docu- This would necessarily include considerations of financial mentation. The leverage the federal government has while sustainability of water supply operations, through a city appraising projects and disbursing grants is relevant in this utility, in the long term. respect: an appraisal process and disbursal mechanism that encourage sound project preparation and associated reforms The Issue of Public Sector Capacity can significantly incentivize the adoption of desirable prin- Designing PPP projects that rest upon an informed under- ciples into a project. standing of technical aspects and a balanced perspective of objectives, responsibilities, risks, and rewards is a complex No project in India yet has adequate operational experience undertaking. A key challenge in this has been weak compe- to allow a fair evaluation of the impact of private sector tencies in the public sector, both in state government and in involvement on cost-effective improvements in service the implementing entities at local level,34 as, over the years, delivery at a city wide scale. Yet decades of negligence under local bodies have nurtured competencies in tune with tradi- public sector management have created a fertile ground for tional models of delivery of services. Projects at the formula- alternate options to be explored. The opportunity for the tion stage will benefit from initiatives to build public sector private sector is enormous, but it must deliver, and convinc- institutional capacity, in order that asymmetries in informa- ingly. This rests upon both partners and the partnership. tion and understanding between public and private sector 52 Creating Sustainable Services Through Domestic Private Sector Participation Appendix: City Project Sheets Project Sheet: Khandwa Key Project Data Name of the City Khandwa Service Coverage 51% Size 0.2 Million Continuity of Supply Two to three times a week for 30 minutes at a time Location Madhya Pradesh, Central Water availability 60-70 litres per capita per day Western India Institutional Structure - O & M Water department of Municipal NRW Unreliable estimates of 41.9% Corporation (no metering) Institutional Structure -Planning Water department of Municipal Operating Cost Recovery 13.30% and investments Corporation Scope of PPP Construction of new bulk water off take, treatment and transmission facilities Rehabilitation of distribution network, metering of all consumers Operation of distribution network and supply to customers on 24 x 7 basis Billing and collection Responsibility for financing approximately 10% of capital costs and all cost escalations Term of Contract 25 Years Status of Project Awarded in 2009, the project is in the construction phase and is expected to commence operations in early 2013 Investments in Phase 1 USD 18.8 Mn Public funds provided as grants 90% Private finance 10% Project Preparation The city received assistance from the State Government during project preparation and procurement. Political consensus for the PPP option was secured. Technical estimates of rehabilitation were poor. Bid Process Single stage, three step international bidding; qualification assessment, followed by technical evaluation and financial evaluation Number of prequalified bidders Not applicable Number of financial bids received 4 Selection Criteria Least end user tariff Contract Structure and Risk Sharing Revenue model for the operator User charges from consumers Consumer tariff Determined through bidding process and escalated based on pre agreed formulae. Source of operating subsidy if any None anticipated as per contract. Key performance requirement Implementation of new Linkage of key performance Operator revenue depends on the bulk water supply project, requirement to operator revenue quantum of water made available for achievement of continuous consumption to consumers. Linkage water supply to other performance standards such as continuity, quality and customer service are weak. Key investment phase Providing financing for 90% of Key operating phase responsibilities Tariff revisions as per agreed responsibilities of the city the investments budgeted (as of the city formulae per bid) Risk Allocation Remarks Change in project scope City Financial capacity of the city to bear consequences is poor. Capital Cost over run Operator Delays in receipt of grants Operator to manage delays, Financial capacity of the city to bear consequences is poor. impact to be borne by city Operating cost escalations Substantially by Operator Tariff is adjusted based on price indices. Investment risk Operator Time over runs in rehabilitation/ Operator Delays affect Operator's ability to collect user charges investment Demand Risk Operator Significant since current consumption is not known Revenue Collection risk Operator Mitigated by disconnection policy, city commitment to bear 50% of dues that remain uncollected for a year. Condition of pre-existing assets Operator Bulk water assets were to be newly built. Only a part of the distribution network was to be new and the condition of the network that was to be retained was not known well. Baseline information risk Operator Information to forecast consumption and revenues is inadequate. Expansion City Ability of the city to bear this responsibility is weak www.wsp.org 53 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Appendix Project Sheet: Nagpur Key Project Data Name of the City Nagpur Service Coverage 80% Size 2. 5 Million Continuity of Supply 12 Hours per day Location Maharashtra, Central India Water availability 135 litres per capita per day Institutional Structure - O & M Water department of Municipal NRW Estimated at 54% Corporation Institutional Structure - Planning Water department of Municipal Operating Cost Recovery 59.70% and investments Corporation Scope of PPP Conversion of intermittent supply to continuous supply Rehabilitation of distribution network, replacement of house service connections and metering, rehabilitation of select treatment plants Operation of treatment plants and distribution network, supply to consumers Billing and collection Financing of 30% of initial capital expenditure Term of Contract 25 Years Status of Project Awarded in 2011, Operator has taken over assets and has commenced rehabilitation Investments in Phase I 70.52 USD Mn Public funds provided as grants 70% Private Finance 30% Project Preparation The project was based on an overall water sector roadmap. A pilot project preceded the decision to implement continuous water supply for the entire city. Political consensus was secured. Bid Process International two stage competitive bidding Number of prequalified bidders 3 Number of financial bids received 2 Selection Criteria Least operator fee per unit of water billed and collected from consumers Contract Structure and Key Risks Revenue model for the operator Fee per unit of water billed and collected from consumers. Consumer tariff Delinked from PPP. The city will fix tariff independently Source of operating subsidy if Required since tariff realisation will not cover city's cost and operator fee. Subsidy from the general budget of the city. any Key performance requirement Achievement of continuous Linkage of key performance No direct linkage. A maximum of water supply requirement to operator revenue 5% of operator fees deductible as liquidated damages for all performance shortfalls in aggregate. Repayment of investments financed by Operator is through an annuity like structure. Key investment phase Providing 70% of investment Key operating phase responsibilities Supply of raw water, electricity responsibilities of the city requirement of the city Risk Allocation Remarks Change in project scope City City is responsible for financing any change in scope. Capital Cost over run City Escalation risks are addressed through adjustment. The city bears the risk of any increase in the initial capital investments required to meet performance standards Delays in receipt of grants City Operating cost escalations City Operator fee is reset to adjust for actual expenditure Investment risk City There is no material impact on operator compensation. Time overruns in rehabilitation/ Substantially by the city There is no material impact on operator compensation due to delays. investment phase Demand Risk City Operator is compensated based on a normative billing in the first five years. The fee is reset after five years if the business planning assumptions change Revenue Collection risk Operator The operator bears the risk after the first five years. Condition of pre-existing assets City Any change in investments is borne by the city Baseline information risk City Increase in investments is borne by the city. Any change in business planning assumptions leads to fee reset. Expansion City 54 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Appendix Project Sheet: Latur Key Project Data Name of the City Latur Service Coverage 47% Size 0.38 Million Continuity of Supply Twice a week, 3 to 4 hours each time Location Maharashtra, Western India Water availability 100 litres per capita perday Institutional Structure - O & M Water department of municipal NRW No reliable estimates corporation which delegated the function to the Water Board Institutional Structure - State level water supply board (Water Operating Cost Recovery 34.00% Planning and investments Board, MJP) Scope of PPP Operation of the water supply system Technical inputs for system improvement/ up gradation Metering of all consumers Billing and collection Operational efficiency improvements Term of Contract 10 years Status of Project Awarded in June 2008, the contract is currently under suspension Investments in Phase 1 Not applicable Public funds provided as grants NA Private Finance NA Project Preparation Quality of existing assets not documented adequately. The asset condition did not permit achieving performance parameters expected from the Operator. Stakeholder engagement proved to be inadequate. Bid Process Two stage international bidding Number of prequalified bidders 6 Number of financial bids received 3 Selection Criteria Highest net present value of payments to Water Board. Contract Structure and Risk Sharing Revenue model for the operator User charges from consumers less fixed payments to Water Board Consumer tariff Consumer tariff pre-determined for the life of the contract (including periodic escalations) Source of operating subsidy if Not applicable. The Operator was required to share the operating surplus with the Water Board. any Key performance requirement Daily water supply. Commercial Linkage of key performance Operator revenue was entirely from improvements (legalising illegal requirement to operator user charges which is directly linked connections, metering and volumetric revenue (Performance risk) to performance. billing) Key investment phase Implementing the pre agreed investment Key operating phase Supporting the Operator in all responsibilities of the city plan. Supporting the Operator in responsibilities of the city commercial functions. Any major achieving regularisation of illegal capital expenditure. connections and mete ring of at least 10000 connections Key Risk Allocation Remarks Change in project scope Water Board Water Board is responsible for meeting all major capital expenditure Capital Cost over run Water Board Operating cost escalations Substantially by Operator Electricity tariff revision beyond a threshold is borne by Water Board Investment risk Water Board in achieving regularisation of illegal connections and metering of at least 10000 connections Time overruns in rehabilitation/ Operator Delays affect Operator's ability to collect user charges based on investment volumetric tariff Demand Risk Operator Significant since current consumption is not known Revenue Collection risk Operator Mitigated by disconnection policy Condition of pre-existing assets Operator Service standards have to be met without any significant fresh investments Baseline information risk Operator Expansion Water Board www.wsp.org 55 Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Appendix Project Sheet: Aurangabad Key Project Data Name of the City Aurangabad Service Coverage NA Size 1.2 Million Continuity of Supply Alternate day supply Location Maharashtra, Western India Water availability 110 liters per capita per day Institutional Structure - O & M Water department of Municipal Corporation NRW Estimated as at least 33% Institutional Structure -Planning Water department of Municipal Corporation Operating Cost Recovery 48.50% and investments Scope of PPP Construction of new off take, transmission and treatment facilities Reconstruction of the entire distribution network to achieve mete red continuous water supply Operation of the entire water supply system and supply to consumers Billing and collection Financing of 50% of initial capital expenditure Term of Contract 20 Years Status of Project Awarded in 2011, Operator is in the preparatory stage Investments in Phase 1 USD 144 Mn Public funds provided as grants 50% Private Finance 50% Project Preparation Detailed project report prepared with a focus on bulk investments. A water audit report with sample assessments of distribution network and NRW estimates was available. Concerns of pre-qualified bidders about the reasonableness of risk sharing was not fully addressed in the bidding stage. Bid Process International two stage competitive bidding Number of prequalified bidders 9 Number of financial bids received 2 Selection Criteria Least operating subsidy to be provided by the city. The starting subsidy is escalated at 6% per annum. Contract Structure and Risk Sharing Revenue model for the operator User charges collection from consumers, Operating subsidy provided by the city from the general budget during the entire term of the contract. Consumer tariff An escalating tariff curve has been pre-fixed for the contract duration by the city. Source of operating subsidy The gap between cost recovery tariff and the pre-fixed tariff is met by the city through an annual operating subsidy. if any Key performance requirement Construction of bulk water assets. Linkage of key performance 25% of operating grants are linked Rehabilitation of distribution network. requirement to operator to performance parameters. Achievement of continuous water revenue Key investment phase Providing 50% of investment requirement as Key operating phase Securing raw water allocations; responsibilities of the city grant. Any shortfall or delay has to be met responsibilities of the city providing annual operating grant; by Operator. Shortfall in public funding will implementing the pre-determined be compensated by extending concession tariff structure; maintaining payment period, which is not a fully bankable solution. security accounts Risk Allocation Remarks Change in project scope City Mode of compensation to the Operator is not clear and may not be bankable Capital Cost over run Operator Delays in receipt of grants Operator to manage delays, impact to be Operator to arrange alternative financing. The adjustment borne by city mechanisms provided are not bankable. Operating cost escalations Substantially by Operator Electricity tariff revision and raw water tariff revision beyond a threshold are borne by the city. Investment risk Operator 25% of subsidies are linked to performance standards. Time over runs in rehabilitation/ Operator Delays affect Operator's ability to collect user charges based on investment volumetric tariff Demand Risk Operator Significant since current consumption is not known Revenue Collection risk Operator Mitigated by disconnection policy Condition of pre-existing assets Operator The project relies substantially on assets to be newly built. Baseline information risk Operator Information to forecast consumption and revenues was inadequate. Expansion Operator at the cost of city Adjustments provided in the contract may not be realistic. 56 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Appendix Project Sheet: Mysore Key Project Data Name of the City Mysore Service Coverage 79% Size 0.98 Million Continuity of Supply 4.5 Hours per day Location Karnataka, Southern India Water availability 248 litres per capita per day Institutional Structure - O & M Water department of Municipal NRW Estimated 52. 36% Corporation Institutional Structure -Planning State level water supply and Operating Cost Recovery 51.70% and investments sewage board (Water Board) Scope of PPP Conversion of intermittent supply to continuous supply Rehabilitation of distribution network and metering of all consumers Operation of distribution network and supply to customers for a period of two years Billing and collection No financing responsibility Term of Contract 6 Years Status of Project Awarded in 2009, the project is in the rehabilitation phase. Investments in Phase I USD 21. 77 Mn Public funds provided as grants 100% Private Finance 0% Project Preparation Quality of the technical report which formed the basis for the project was poor. Stakeholder communications and acceptance was inadequate. Bid Process Single stage, three step international bidding; qualification assessment, followed by technical evaluation and financial evaluation Number of prequalified bidders Not applicable Number of financial bids received 3 Selection Criteria Least bid for rehabilitation cost and O & M fee Revenue model for the operator Rehabilitation fee based on quantities used and unit rates (as per Operator bid) and O & M fee (as per Operator bid) Consumer tariff Delinked from PPP. The city will fix tariff independently Source of operating subsidy if Operator fee for 0 & M borne by the city out of the general budget. any Contract Structure and Key Risks Key performance requirement Achievement of continuous Linkage of key performance Approximately 60% of the Operator water supply requirement to operator revenue fee for O & M is linked to 8 performance parameters. 10% of the savings from initially budgeted capital costs is provided as an incentive. Key investment phase Providing financing for 100% of Key operating phase responsibilities Supply of treated water responsibilities of the city the investments budgeted (as of the city per bid) Risk Allocation Remarks Change in project scope City Not clear. The city bears the risk but the Operator is not allowed to propose deviations beyond a narrow band. Capital Cost over run Operator Delays in receipt of grants City Operating cost escalations Operator Investment risk City Operator bears the risk to the extent of performance component of the O & M fee. Time overruns in rehabilitation/ Operator Delays affect Operator's remuneration (performance component) investment phase Demand Risk City Significant since current consumption is not known Revenue Collection risk City One of the performance parameters of the Operator is overall increase in revenue collection, though the revenue risk is borne by the city. Condition of pre-existing assets Operator The project was designed based on partial rehabilitation of distribution network. Quality of assets to be retained was not known. Baseline information risk Operator Information on quality of assets was inadequate. Expansion City www.wsp.org 57 Endnotes 1. For more information on the achievement of Indian 9. The federal share is through the JNNURM Program. water PPPs, see Trends in Private Sector Participation in the Indian Water Sector: A Critical Review (WSP 2011). 10. See Khandwa PPP water supply project information in the IFC Project Database, online: http://ifcext.ifc.org/ 2. This excludes pilot initiatives (KUWASIP, Nagpur) and ifcext/spiwebsite1.nsf/ProjectDisplay/ESRS30859. bulk and industrial/commercial water supply projects (Dewas, Chennai, Kolkata, Haldia, and Naya Raipur). 11. As against this, the KMC levies a flat monthly tariff of Initiatives in Madurai and Bhiwandi were nonstarters, Rs 50 per household. and the initiative in Shivpuri, identical to the Khandwa project, was not undertaken. 12. October 2013. 3. GoI 2011a; ADB 2007; WSP-SA 2007. 13. Figure taken from the 2011 Census of India (GoI 2011b); censusindia.gov.in. 4. This sections draws upon the WSP study, Trends in Private Sector Participation in the Indian Water Sector: A 14. As against Rs 10,500 per connection (at 2008 prices) Critical Review (WSP 2011). for total infrastructure replacement in KUWASIP. 5. By comparison, projects whose performance was 15. It was not clearly stated that the lowest financial bid reviewed in Public-Private Partnerships for Urban Water would win. Instead, the term “evaluated” was intro- Utilities (Marin 2009), include 15 projects serving duced. Post facto, it can be said that this was misused. 22.15 million in Africa; 7 projects, serving 22.3 million in East Asia and the Pacific; 4 projects covering 2.9 16. Chary, Srinivas. “24x7 Water Supply Project for million in Europe and Central Asia; and 41 projects Nagpur City.” Presentation by ASCI (Administrative serving 49.7 million in Latin America. All projects were Staff College of India). PDF accessed at Ministry of undertaken after 1993, with the exception of the lease Urban Development, Government of India website: affermage in Côte-d’Ivoire, initiated in 1961 and serv- http://urbanindia.nic.in/programme/lsg/lsg_presentation/ ing 8.7 million. ASCI/Nagpur%20PPP-dist %20copy.pdf. 6. Distribution focus is considered important, since tradi- 17. The study was not very quantitative. tionally the focus was only on enhancing bulk water supply capacity, with little consideration of improve- 18. October 2013. ment in service to the end-user: without improvements in distribution, service delivery to the customer will not 19. The MJP is the state level entity mandated with engi- improve. neering and construction of water supply infrastructure in the state of Maharashtra. It had a monopoly on capi- 7. This excludes pilot initiatives (KUWASIP, Nagpur) and tal investments until the year 2001. bulk and industrial/commercial water supply projects (Dewas, Chennai, Kolkata, Haldia and Naya Raipur). 20. 2011 Census of India (GoI 2011b); censusindia.gov.in. 8. Certain facilities of the Indian Railways, which service 21. On cash basis, without considering unpaid liabilities. Khandwa, were also relocated as a result of water shortage. 58 Creating Sustainable Services Through Domestic Private Sector Participation Running Water in India’s Cities: A Review of Five Recent Public-Private Partnership Initiatives | Endnotes 22. The MJP admits to its inability to rectify these without (Rs 630 million) in the year 2012–13. The grant is external technical inputs. escalated at 6 percent per annum. AMC carried out an internal assessment of its ability to pay the annual 23. Originally an employee of Hydrocomp. grant quoted by the bidder prior to accepting the bid. AMC concluded that strict financial discipline, better 24. It is not clear whether it was continued interest to tax collection efforts and new sources of revenue will pursue the arrangement or the political overlay that be needed, among other measures to meet its financial kept the contract alive. commitments. 25. Current service levels, however, are not well document- 30. It is unclear if minimum requirement is calculated as ed. a yearly average. If the requirement is not measured as a yearly average, and if even a one-time failure attracts 26. Comprising SPML Ltd., National Water and Sewerage deduction, the revenue risk to the operator increases. Corporation, and VA Tech Wabag Ltd. 31. 2011 Census of India (GoI 2011b); censusindia.gov.in. 27. A joint initiative of the Department of Economic Affairs and the Asian Development Bank. 32. A state level entity mandated with water supply. 28. The financial bid was 79 percent higher in any case. 33. HPEC 2011. 29. 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