57786 October 2010 Note Number 36 Output-Based Aid in Water and Sanitation The Experience So Far | Geeta Kumar and Josses Mugabi O utput-Based Aid (OBA) has been used since the early 2000s to deliver basic infrastructure and social services to the poor, typically through public-private partnerships. Given the limited experience with OBA in the water and sanitation sector, GPOBA has made a concerted effort to test OBA approaches in the sector. A growing number of regional and local private providers have emerged, and some projects involve public providers. This note is based on the World Bank study "Output-Based Aid: Lessons Learned and Best Prac- tices" (Mumssen, Johannes and Kumar 2010) and aims to share experiences so far with the use of OBA in water and sanitation. Photo by Jonathan Davidar Output-Based Aid(OBA) is a results-based financing the Senegal On-Site Sanitation projects which are funded mechanism that ties the disbursement of public funding by IDA and GPOBA. (mostly in the form of subsidies) to the achievement of Co-financing comes mostly from beneficiary contribu- clearly specified services or outputs. In water and sanita- tions and on average is about 15% of the total costs. In tion, there are currently 22 OBA projects with World some cases it is provided by the government or the private Bank Group participation: 15 water supply schemes, sector and in a few cases by the public sector utility, as in three sanitation schemes, and four providing both water the case of the National Water and Sewerage Corporation and sanitation.1 Most of these projects involve one-time in Uganda. Another example of co-financing arrange- subsidies for access to service. And most involve piped- ments is a scheme in Honduras that set up an OBA facil- water schemes, with access usually defined as the delivery ity targeted to small and medium-size projects, including of working connections. About half the projects are in new (greenfield) and extension (brownfield) projects Sub-Saharan Africa (figure 1), in part because of con- in peri-urban and rural areas. Funding sources include certed efforts by the Global Partnership on Output-Based a central government contribution of US$1 million to Aid (GPOBA) to pilot projects in this region. provide access to finance--"bridge financing"--for proj- ects being implemented by public operators with limited Funding access to commercial credit; and a GPOBA grant of US$4 million (Mandri-Perrott, Schiffler, and Aguilera 2009). Of the 22 projects identified, seven include OBA subsi- dies funded by the World Bank, for a total of US$82 mil- Targeting lion. This includes both concessional funding from the International Development Association (IDA) and non- Almost all the water projects identified use geographic concessional funding from the International Bank for targeting as the primary screening mechanism. These Reconstruction and Development (IBRD). The other 15 projects are usually small scale and located in areas projects include GPOBA subsidy funding, for a total of US$54.9 million. Typically, subsidy levels make up about Geeta Kumar is a Consultant with the Global Partnership on 65% of total costs. Some of the GPOBA-funded schemes Output-Based Aid. Josses Mugabi is a Young Professional in the are part of a larger IDA or IBRD initiative, for example World Bank's South Asia Urban and Water Department. Supporting the delivery of basic services in developing countries Figure 1. Regional distribution of World Bank part of the output-based payment is withheld until Group OBA projects in Water and Sanitation after several months of service delivery, to enhance the sustainability of the scheme. a) By value · In the Vietnam Rural Water Project 80 percent LCR, 21% of the GPOBA subsidy is disbursed to the inter- AFR, 61% national nongovernmental organization (NGO) implementing the project, the East Meets West EAP, 8% Foundation, once the connection is verified and SAR, 2% the other 20 percent after six months of satisfac- tory service delivery. MENA, 9% · In the Kenya Microfinance for Community Water Schemes Project, the community water associa- b) By number of projects tions involved are paid only after verification of working connections, several months of service LCR, 18% delivery, and, in some cases, demonstration of increased sales (Virjee 2010). AFR, 41% EAP, 18% In the water sector, where service providers tend to be small local operators, NGOs, and community orga- nizations, poor access to finance can limit their ability MENA, 9% SAR, 14% to pre-finance outputs. That limits the performance risk that can be shifted to providers, as shown by an AFR = Sub-Saharan Africa Region; EAP = East Asia and Pacific Region; example from Uganda (box 1). LCR = Latin America and Caribbean Region; MENA = Middle East and North Africa Region; SAR = South Asia Region Beyond shifting performance risk, a robust con- tractual framework for OBA water schemes can help where the poorest are concentrated and the risk of ensure quality service provision and provide appropri- including non-poor beneficiaries is low. Some service ate checks and balances should problems arise. providers have developed additional mechanisms: · The Manila Water Supply Project, Philippines, Monitoring and verification "Outputs" in the water sector mainly include func- combines geographic and means-tested targeting. tioning household, yard tap or kiosk connections to It targets communities officially certified as "indi- the network. In theory, the monitoring of outputs gent"--those where per capita income is less than in the water sector is not dissimilar to other sec- $1 a day (Menzies and Suardi 2009). tors. But in practice, because the majority of water · In Andhra Pradesh, India, a project to improve ru- OBA schemes identified are funded by GPOBA, and ral water supply combines geographic, means-tested GPOBA tends to fund the hiring of independent veri- and self-selection targeting. To target beneficiaries fication agents, most water projects identified involve in the 25 villages covered, the project used the gov- independent verification engineers. ernment's "white ration card" system, which entitles If monitoring is to generate lessons for scaling up low-income individuals to obtain basic commodi- water schemes, government entities should also be ties at a reduced price (Mandri-Perrott 2008). involved. In the Uganda small towns project, the in- dependent verification agent reports to the Director- Performance risk ate for Water Development of the Ministry of Water and Environment. In some cases, because of capacity Under an OBA scheme the service provider bears the issues, development partners may play a larger role in performance risk--this means that service providers the monitoring and verification process for projects pre-finance the outputs before being reimbursed by involving small local providers. the OBA subsidy upon independent verification that pre-agreed outputs have been delivered. In the water Emerging lessons sector these outputs are generally working connec- tions, often demonstrated through billing or collec- Although the OBA approach is still at the pilot stage in tions records. In most projects funded by GPOBA, the water sector, important lessons are already emerging. October 2010 Note Number 36 Box 1. Phasing in payments in Uganda's strengthen potential private providers, especially small water sector and local ones. Greater capacity building (including in billing, marketing, and access to finance) and greater The GPOBA-funded Water Supply in Uganda's Small partnership with local organizations can both help. Towns Project, involving small local private opera- tors, uses two different methods of disbursing output- Access to finance remains a major hurdle. Constraints based payments. In small towns, requiring mainly ex- on access to finance can be eased with formal financial tensions from the existing system, it uses a relatively "pure" form of OBA: private operators are paid after instruments such as guarantees. But there has been connections and water service delivery are verified. limited experience with this in the water sector, though But in rural growth centers, requiring new systems, a few guarantees and lines of credit to the banking output-based payments are phased, with 60 percent sector are being tested in different settings. Where disbursed during construction and 40 percent after such financing instruments are less readily available, connections and service delivery are verified. OBA schemes may need to phase in payments against This phased method was chosen because lim- reasonable milestones--as long as performance risk ited access to affordable finance to cover costs until remains mostly with the service provider. outputs are delivered, and the newness of the OBA In addition, more work needs to be done to ad- approach, were expected to result either in very dress the constraints of small local providers, those high bids that the poor could not afford (a share of the costs is included in the tariff) or in no bids at most likely to operate in rural and peri-urban areas. all. Later, depending on the results of the pilot, the Some examples show the possibilities not only for pre- disbursement method in the rural growth centers financing but for project financing in general. may move closer to a more `pure' form of OBA. · In the Kenya water project, K-Rep Bank has purchased a USAID Development Credit Author- Subsidies should be aligned with incentives. OBA ity partial credit guarantee to reduce the collateral schemes piloted in the water sector provide a clear, dis- required from the borrowers, namely community crete, one-time subsidy for access. But the sustainability water associations (Virjee 2010). of such schemes depends largely on the relationship · In Honduras, for private providers (includ- between the subsidy provided and the tariff charged to ing NGOs), limited commercial debt is possible customers for ongoing service provision. Tariffs should (though with very short repayment periods), be affordable for the poor and cover all reasonable and ultimately secured against municipal assets but efficient operating costs. with commercial lenders drawing comfort from Where tariffs are lower than operating costs, con- an OBA grant mechanism payable by GPOBA. For necting new customers will result in losses for service public implementers, bridge loans are possible-- providers. As a result, they will have insufficient funds government loans (issued at effectively zero inter- to maintain the system--and no incentive to serve est) secured against future sector transfers from customers at those tariffs. Thus efforts to scale up and the central government to municipalities. mainstream OBA in the water sector need to go hand · In the Uganda project several measures have been in hand with tariff reform. OBA schemes such as the tried, including phasing in outputs to reduce the Kenya and Uganda water projects have brought these amount of pre-finance capital needed as well as issues to the forefront (Azuba, Mugabi, and Mumssen some capacity building for private operators and 2010; Virjee 2010). local banks. Still, private operators have relied more on their own cash and on working capital Private capital leveraging depends on tariff reform. OBA than on bank loans. But now that the operators does leverage private funding, but the amount lever- are starting to deliver results, some local banks are aged will be limited by the extent to which tariffs can showing renewed interest in participating (Azuba, incorporate investment costs while remaining afford- Mugabi, and Mumssen 2010). able. Ultimately, the service provider must be able to recoup its investment through the tariff. If the aim is Demand creation is critical. Demand risk can be to have a smaller amount of subsidy with more of the substantial in OBA schemes in the water sector. Poor investment recouped through private financing, the people, often unfamiliar with the services or connection tariff needs to be able to absorb these costs. and payment procedures, may be slow to sign up. That Where private sector experience is bringing efficien- can prolong project rollout and thus the wait before cy gains and market discipline to the water sector (as providers can be reimbursed. Community mobilization in Uganda), more needs to be done to encourage and and outreach are critical. Both the rural community wa- ter project in India and the Senegal On-Site projects use mainstreaming, a supportive enabling environment is nongovernmental organizations (NGOs) to promote critical. OBA schemes bring private sector expertise to community participation and to improve uptake. poor areas that the service provider otherwise might not have served but can succeed only where legal or Capacity-building needs can be great. Shifting from in- regulatory practices support private sector risk-taking. put- to output-based approaches means new challenges As development partners scale up and widen the for both public authorities and service providers. Capac- use of OBA, they should be encouraged to broaden ity to implement and monitor OBA schemes is limited, its application to include funding for upstream policy especially in the countries where OBA is needed most. and institutional reforms as well as other initiatives to Providing targeted training, hiring independent verifica- improve utility or sector performance in ways that are tion agents, and involving NGOs in community outreach measurable and therefore amenable to results-based and private administrators in managing OBA funds are approaches. all solutions being used to ease capacity constraints. References The following aspects appear to be particularly impor- tant to the success of OBA in the water sector: Azuba, C., J. Mugabi, and Y. Mumssen. 2010. "Output- Based Aid for Water Supply in Uganda: Increasing · Market structure and experience with competitive Access in Small Towns." OBApproaches 35. processes to encourage efficiency Mandri-Perrott, C. 2008. "Output-Based Aid in India: · Regulatory or legal and contractual framework, Community Water Project in Andhra Pradesh." including policies for setting and adjusting tariffs OBApproaches 21. · Capacity of implementing agencies--for example, Mandri-Perrott, C., M. Schiffler, and A. S. Aguilera. to handle transaction processes, monitoring and 2009. "Output-Based Aid in Honduras: An OBA verification, and the flow of funds as well as an Facility for the Water and Sanitation Sector." understanding of and willingness to work with OBApproaches 29. performance-based arrangements Menzies, I., and M. Suardi. 2009. "Output-Based · Extent of experience with the private sector in Aid in the Philippines: Improved Access to Water service provision, where relevant Services for Poor Households in Metro Manila." OBApproaches 28. Conclusion Mumssen, Y., L. Johannes, and G. Kumar. 2010. Output- Based Aid: Lessons Learned and Best Practices. Wash- OBA schemes involving both public and private pro- ington, DC: World Bank. viders are starting to show results, including efficiency Virjee, K. 2010. "Leveraging Private Sector Finance gains through competitive bidding processes. Most for Rural Piped Water Infrastructure in Kenya: The importantly, these projects are increasing access to Use of Output-Based Aid." OBApproaches 30. water and sanitation services for poor households. However, OBA is only as sustainable as its envi- ronment and cannot be isolated from broader sector 1 One additional OBA scheme identified in the water sector is outside the World Bank Group. issues. Experience shows that for greater impact and About OBApproaches OBApproaches is a forum for discussing and disseminating The case studies have been chosen and presented by the au- recent experiences and innovations in supporting the delivery thors in agreement with the GPOBA management team and are of basic services to the poor. The series focuses on the provi- not to be attributed to GPOBA's donors, the World Bank, or any sion of water, energy, telecommunications, transport, health, other affiliated organizations. Nor do any of the conclusions rep- and education in developing countries, in particular through resent official policy of GPOBA, the World Bank, or the countries output- or performance-based approaches. they represent. To find out more, visit www.gpoba.org e Global Partnership on Output-Based Aid e Global Partnership on Output-Based Aid Supporting the delivery of basic services in developing countries