WATER GLOBAL PRACTICE SUMMARY NOTE AUGUST 2019 Amanda Goksu, Alex Reform and Finance for the Bakalian, Bill Kingdom, Gustavo Saltiel, Yogita Urban Water Supply and Mumssen, Gerard Soppe, Joel Kolker, and Vicky Delmon Sanitation Sector About the Water Global Practice Launched in 2014, the World Bank Group’s Water Global Practice brings together financing, knowledge, and implementation in one platform. By combining the Bank’s global knowledge with country investments, this model generates more firepower for transformational solutions to help countries grow sustainably. Please visit us at www.worldbank.org/water or follow us on Twitter at @WorldBankWater. About GWSP This publication received the support of the Global Water Security & Sanitation Partnership (GWSP). 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Reform and Finance for the Urban Water Supply and Sanitation Sector Amanda Goksu, Alex Bakalian, Bill Kingdom, Gustavo Saltiel, Yogita Mumssen, Gerard Soppe, Joel Kolker, and Vicky Delmon © 2019 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington, DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. 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Contents Preface v Acknowledgments vii Abbreviations ix Chapter 1  Background 1 Water and Sanitation in Cities 1 Notes 2 Chapter 2  The Challenge at Hand 3 The Status Quo: Low Access, Poor Quality Services 3 The Utility of the Future: Credible, Accountable, Autonomous 3 How the Sector is Financed 4 Note 6 Chapter 3  What Will It Take? 7 The Foundations of Urban Reform 7 Components of the Integrated Approach: Three Global Initiatives 9 Note 15 Chapter 4  Maturity of the Urban Water Sector 17 The New Status Quo 17 Sequencing and Resources 18 Five Stages of Reform 20 Chapter 5  Bringing It All Together 31 Chapter 6  Conclusion 35 References 37 Appendix A  Reference Tools and Documents 39 Appendix B  Maturity Matrix for Urban Water Reform 41 Reform and Finance for the Urban Water Supply and Sanitation Sector iii Boxes 1.1 The Cost of Water for the Poor 2 3.1 PIR (Policy, Institutions, and Regulation) Defined 10 4.1 Medium-Term Planning Boosts Sector Reforms in Shimla, India 19 4.2 World Bank Lending Instruments to Support the Water Supply and Sanitation Reform Agenda 20 4.3 Discovering Perverse Incentives 21 4.4 Addressing Capacity Constraints First 22 4.5 When Incentives Elicit the Wrong Response 23 4.6 CESAN’s Turnaround: Credibility Paves the Way for a New Corporate Culture 24 4.7 General Sequencing of Successful Turnarounds 27 4.8 Successful Sector Reform Balances Efficiency and Affordability 28 4.9 The Cost of Commercial Finance 30 Figures 2.1 Vicious Cycle of Utility Performance 4 2.2 Virtuous Cycle of Utility Performance 5 2.3 Traditional Revenue Sources for the WSS Sector 6 3.1 The Cycle of Improved WSS Sector Performance 8 3.2 Three Global Frameworks 9 3.3 Schematic of PIR Interventions and Incentives within the Enabling Environment 11 3.4 Correlation between Enabling Environment and PIR Interventions 12 3.5 Four Phases of the Utility Turnaround Framework 13 3.6 The MFD’s Three Components and Key Recommendations 14 3.7 Potential Pathways to Fill the WSS Financing Gap 15 B4.1.1 Major Milestones of the Shimla Water Supply and Sewerage Service Delivery Reform Program, 2018–21 19 4.1 Initial Utility Performance Improvements and Their Impact on Financial Viability 23 4.2 Incentives of Key Actors in the Water Supply and Sanitation Sector 26 4.3 Improved Financial Performance Changes the Mix of Financing Sources 30 5.1 Maturity Ladder for the Urban Water Sector 32 Table 3.1 The Evolution of Water Utility Reform Sequencing 12 iv Reform and Finance for the Urban Water Supply and Sanitation Sector Preface The World Bank and Urban Water: A Brief More recently, and with the aim of improving out- History comes in the urban water sector, the World Bank has taken more comprehensive approaches to understand- For decades the World Bank has supported national ing reform. These include identifying the key charac- governments to expand access to basic water supply teristics of well-performing utilities and designing and and sanitation (WSS) services through technical maintaining a global database on performance indica- assistance and lending operations. Most World Bank tors from thousands of utilities worldwide.1 These funding to the WSS sector has gone to urban infra- efforts have provided more objective insight into the structure operated and maintained by public service factors of good sector performance. And while the rec- providers (hereinafter “utilities”). Infrastructure ommendations stemming from these and other analyt- investments were sometimes complemented by ical pieces have been embedded into the design of the technical assistance to strengthen water institutions, current generation of urban water reform programs, as well as in support of broader sector reforms related the outcomes of this shift are yet to be fully realized. to water pricing, governance, regulation, and access for the poor. The Stimulus for this Work Several low- and middle-income countries (LMICs), In 2015, the World Bank looked to its own operational from Cambodia to Uganda, have completed urban experiences to develop a new, comprehensive global water sector reforms that brought forth vast improve- framework for improving WSS sector performance. ments in health and development outcomes. And The concurrent formation of a new Water Global while the World Bank has provided complementary Practice (GP) provided a timely opportunity to consult support to those national programs, there are many WSS experts across the Bank to formulate a strategy. other examples where long-term Bank investments have failed to foment lasting change. This is because, The group concluded that there was both a “science” until recently, approaches have tended to focus on a to delivering WSS services, or factors within the con- sub-set of issues rather than the sector as a whole. trol of the utility itself, and an “art” generated by exter- nal factors, such as the broader enabling environment Early approaches emphasized selection of the “right” and political economy context of a given country. delivery model, such as a move toward corporatization Countries needed to take a more holistic view; one that or the use of private sector participation. A mandate focuses on the underlying incentive structures that for full cost recovery tariffs, sometimes written into enable or prohibit successful sector reform. project covenants, was another attempted remedy. Even sweeping reforms—such as those to replace entire These discussions led to an expansion of the purview regulatory frameworks—were often unsuccessful. The of the sector reform agenda, moving from the tradi- lesson learned from these experiences is that even tional focus on infrastructure economics to also when interventions are based on sound principles, no encompass a deeper understanding of the behavior of single delivery model or policy can shift the trajectory and between sector institutions and of the people of an entire water sector. Sustainable reform requires within those institutions. Staff proposed splitting the multiple interventions that are harmonized and work in two: what works at the sector level, and what well-coordinated. works at the utility level. Reform and Finance for the Urban Water Supply and Sanitation Sector v When the Water Supply and Sanitation Global Solutions one-size-fits-all solution and puts forth a set of guide- Group (GSG) was launched in 2016, the GP dedicated lines and tools for developing a reform program tai- resources to develop a global strategy for urban water lored to a specific local context. The reference materials reform. A deep dive analysis was required to meet the are meant to be applied by countries at various stages objectives. Three unique global initiatives were thus of sector maturity. created: The three frameworks—and as a compendium—set 1. Policy, Institutional, and Regulatory (PIR) Incentives, forth the key principles of a holistic approach to which looks at the broader sector enabling environ- reform. This summary paper collates the main themes ment, or the “art” of reform; and conclusions of the three global frameworks. Its primary aim is to integrate the three lines of work— 2. Water Utility Turnaround Framework (UTF), which utility reform, sector reform, and sector finance—in looks at utility level reforms, also called the “sci- order that readers understand the critical links ence” of delivery; and between the three frameworks, and how improve- 3. Maximizing Finance for Development (MFD) for the ments in one area directly affect progress in another. water sector, which looks at shifting the financing The new contribution of this paper is the Maturity paradigm to reach the SDGs. Ladder for the Urban Water Sector (figure 5.1), which summarizes the key stages of reform and delineates a A Holistic Approach few of the key ways to make gradual improvements in line with a comprehensive strategy. Between 2017 and 2019 the GP published more than a dozen new analytical pieces under these three initia- A secondary aim is to help readers refer to the suite of tives (appendix A), including a global framework, or documents for guidance on the specific challenges and flagship document, for each initiative which summa- topics that are most relevant for their context, and to rizes various analyses and case studies developed more easily cross-reference and navigate the rich set of under that initiative. materials. They can then apply the relevant tools to begin the improvement process. The frameworks discuss reform cases from around the world to show how different countries have approached—some successfully and others less Note successfully—their sector challenges. Each of the ­ 1. The International Benchmarking Network for Water and Sanitation three global frameworks concludes that there is no Utilities (IBNET). vi Reform and Finance for the Urban Water Supply and Sanitation Sector Acknowledgments T his paper was produced by the World Bank’s Bill Kingdom, Gustavo Saltiel, Yogita Mumssen, Water Supply and Sanitation Global Solutions Gerard Soppe, Joel Kolker, and Vicky Delmon. Group (GSG) and the Financial Innovation The authors would like to thank the following Team (FIT) with the support of the Global Water World Bank staff for their input: Richard Damania, Security and Sanitation Partnership (GWSP). It Patricia Lopez, Smita Misra, Charles Delfieux, was written by Amanda Goksu, Alex Bakalian, Takuya Kamata, and Aileen Castro. Reform and Finance for the Urban Water Supply and Sanitation Sector vii Abbreviations CESAN Companhia Espírito Santense de Saneamento DPL development policy loan FIT financial innovation team GDP gross domestic product GP global practice GSG global solutions group GWSP Global Water Security and Sanitation Partnership IDT institutional diagnostic tool IPF investment project financing LMIC low- and middle-income country MDB multilateral development bank MFD Maximizing Finance for Development OCCR operating cost coverage ratio ODA official development assistance O&M operation and maintenance ONEA L’Office national de l’eau et de l’assainissement NRW nonrevenue water PBC performance-based contracts PER public expenditure review PforR program for results PIR Policy, Institutional, and Regulatory PPP public-private partnerships PSP private sector participation SDG Sustainable Development Goals SJPNL Shimla Jal Prabandhan Nigam Limited SMC Shimla Municipal Corporation UTF Utility Turnaround Framework WASH water supply, sanitation, and hygiene WHO World Health Organization WSS water supply and sanitation Reform and Finance for the Urban Water Supply and Sanitation Sector ix Chapter 1 Background T oday, more than half of the world’s population urban areas have fared much better than rural areas in ­ rea. By 2050, the propor- lives in  an urban a all. the race to bring basic access to ­ tion is expected to rise to 68 percent, equiva- However, urbanization across the developing world is lent to 6.6 billion people, and just 12 years from now, so rapid that it is now eclipsing ­progress. Between 1998 the world will have 43  megacities with more than and 2008, the same time frame in which 1 billion million inhabitants each (UN 2018­ 10 ­ ). These epicen- urbanites gained access to an improved water source, ters are on a continual path of expansion and change, the urban population grew by 1.1 billion, essentially gaining millions of new r ­ onth. ­ esidents every m decreasing the proportion of the total population pro- transformed. An esti- The developing world is being ­ vided with access.1 mated 90 percent of urbanization will happen in To bring basic WASH access to everyone in the world, Africa and Asia alone, with 35 percent in just three including operation and maintenance (O&M) costs, ). These countries: India, China, and Nigeria (UN 2018­ would require LMICs to spend between 0.8 and trends are a result of both population growth and rural 0.9 percent of gross domestic product (GDP) annually ­ eason. Cities offer to urban migration—and for good r (Rozenberg and Fay 2019), an investment that will economic opportunities, more mobility, better access ­ eturns. And yet countries are striving yield significant r to health care and education, as well as services like to achieve much more than this, in line with the global ­ electricity, water, and s anitation. Although urban Sustainable Development Goals (SDGs) set in 2015. economies benefit from the influx of workers, local Many are looking to provide safely managed WSS governments are simultaneously under pressure to services, which, over and above basic access, denotes ­ absorb new residents and to meet their basic ­ needs. WSS services that meet quality standards, are more convenient, and are properly managed to reduce Water and Sanitation in Cities ­ ollution. ­contamination and p Despite significant progress toward combating poverty investment. These larger goals will require more ­ and boosting shared prosperity, many governments of From a global perspective, reaching the WSS SDGs low- and middle-income countries (LMICs) continue to (6.1 and 6.2) will cost LMICs an estimated US$406 grapple with providing safe and affordable water sup- ­ billion to US$509 billion annually (equivalent to ply and sanitation (WSS) services to ­citizens. Add to this between 1.1 and 1.4 percent of GDP) (Rozenberg and the more recent stressors of urbanization and water Fay 2019­). variability, and even countries with relatively high rates Even if what is currently invested in the sector is spent of access to WSS are finding it difficult to keep up with efficiently (that is, well-targeted and transparent), it the needs of an ever-growing customer ­ base. still covers only about one-third of the way to the Significant investments have been made to expand SDGs. More public investment at both the national and ­ world. Global rates of access to basic WSS around the ­ subnational level is clearly needed, in addition to tariff access to basic water supply and sanitation are at recovery. setting policies that allow for more cost ­ respectively. To date, 89  percent and 68 percent, ­ Public spending alone will be ­ insufficient. Reform and Finance for the Urban Water Supply and Sanitation Sector 1 According to a 2016 study of 140 countries, another BOX 1.1. The Cost of Water for the Poor 3.2 billion urban residents still need access to safely managed sanitation (only 26 percent have it); and Fifty liters of water per person per day another 2 billion urban residents still need access to (the minimum World Health Organization [WHO] safely managed water (only 68 percent have i ­t). 2 requirement) from a private vendor costs the Most of those still without WSS services live in following, based on a typical daily salary of a informal and overcrowded parts of large cities or on low-income person living in each city: the outskirts of cities—areas that are difficult to • Port Moresby, Papua New Guinea: 54 percent of reach with a traditional piped ­network. These urban daily salary residents are willing to pay for formal WSS services, • Accra, Ghana: 25 percent of daily salary which often come at a more affordable rate than ). But few urban utilities informal provision (box 1.1­ • Maputo, Mozambique: 14 percent of daily salary are reaching these underserved ­areas. If the demand Source: WaterAid 2016. for more and better water services exits in cities around the world, why are there still so many with- out access? In line with global best practices, the WSS sector must also tap into private markets, whether through public-­ Notes private partnerships (PPPs), bonds, microfinance, or 1. As cited at https://www.un.org/waterforlifedecade/water_cities.shtml.” finance. Most of the invest- other forms of commercial ­ 2. The 140 countries included in this study represent 6.12 billion ment need for meeting the SDGs is in urban ­ areas. This (84  percent) of the world’s projected 7.3 billion population in brings us back to cities, where the investment needs 2015  and 7.15 billion (85 percent) of the projected 8.4 billion ­population in 2030. The majority of the world’s LMICs are included, as are highest, as are the opportunities to leverage private well as a few selected high-income countries with low coverage  of ­markets. ). basic WASH services (Hutton and Varughese 2016­ 2 Reform and Finance for the Urban Water Supply and Sanitation Sector Chapter 2 The Challenge at Hand The Status Quo: Low Access, designing incentives that work, some countries c ­ ontinue Poor Quality Services to use bandages to manage a systemic problem, essen- tially surrendering to the vicious cycle. Public utilities deliver water, and often sanitation, ser- vices in most large cities. Like other public entities, utilities in low- and middle-income countries (LMICs) The Utility of the Future: are often poor performers, stemming from low levels Credible, Accountable, Autonomous of efficiency. Although they have the mandate to This paper argues that, despite these major shortcom- deliver services in support of national water supply ings, utilities are often still the best mechanism available and sanitation (WSS) targets, many often lack the to reach large areas of unserved populations. This is expertise, resources, and incentives they need to reach because many utilities are already well-established enti- their targets. ties with legal mandates, expertise, and the potential to The result is that residents are not guaranteed attract commercial finance. Moreover, as will be detailed high-quality services and are forced to find alternative further in this paper, it could be more efficient to work solutions to address the deficiency, often at a much within the prevailing institutional arrangement and try higher price. In turn, when customers are unwilling to to change the way existing utilities operate rather than pay for poor services, utilities do not have the strong create new utilities or other types of service providers. customer base they need to sustain revenues at levels Utilities can realize their full potential as professional- that allow for proper asset maintenance. Ironically, ized organizations that meet the demands of their cus- this vicious cycle results in deferred maintenance with tomers. Many utilities across high-income countries, huge rehabilitation costs (figure 2.1). as well as in LMICs like Brazil (SABESP, a state-owned In response, many governments choose to fill the gap company), Cambodia (Phnom Penh Water Supply with an operational subsidy. These funds are often Authority, a municipal-owned company), and the provided without conditions, such as requirements for Philippines (Manila Water, a private company), have the utility to first achieve access targets or cut costs. become world-class service providers, in part Rather, operational subsidies act as an implicit, per- because they are able to leverage commercial finance. verse incentive for the utility to maintain the status It is important to note that leveraging commercial quo of low-service quality and to remain dependent on finance is not the same as privatizing water services. public resources. The former refers to the source of finance, while the latter denotes who owns or manages the sector’s This cycle of poor performance—a detriment to achiev- assets. Well-run public utilities often tap into commer- ing the Sustainable Development Goals (SDGs)—has cial markets to finance their infrastructure needs. been the status quo for decades. Thus, despite billions of public dollars invested in WSS, many countries are not A series of well-designed changes to improve the per- expanding services quickly enough to keep pace with formance of a utility can add up quickly to transform urbanization rates. Rather than addressing the founda- its culture. Once a utility is focused on measuring and tional issues around more efficient public spending and incentivizing performance improvements, it will start Reform and Finance for the Urban Water Supply and Sanitation Sector 3 FIGURE 2.1. Vicious Cycle of Utility Performance Low tari s, Low collection Consumers use water ine ciently High usage and system losers drive up costs Investment, maintanance are postponed Service deteriorates Customers are ever less willing to pay Service provider lives o state subsides Managers lose autonomy and incentives E ciency keep dropping Subsides often fail to materialize Service provider can’t pay wages, recrument costs or extend system Motivation and service deteriorates further Sysem assets go “down the drain” Crisis, huge rehabilitation costs Source: Goksu et al. 2017. on an upward spiral that leads to better customer ­ and a greater capacity to finance improvements on orientation and financial sustainability (figure 2.2). ­ its own. From there, a focus on building the utility’s creditwor- thiness will enable it to leverage commercial finance. How the Sector is Financed But utilities do not function in a vacuum. They require The WSS sector receives revenue from three main the right incentives to emanate from the surrounding funding sources: tariffs (customer fees and invest- environment. With those incentives in place, a utility can ments by households), transfers (grants from donors ­ ustainable transition out of the status quo toward a more s and charitable foundations), and taxes (­ provided as business model that enables ­ independence, autonomy, utilities) (figure 2.3). government subsidies or grants to ­ 4 Reform and Finance for the Urban Water Supply and Sanitation Sector FIGURE 2.2. Virtuous Cycle of Utility Performance Sustainable water sector Private nance mobilized to increase investment capacity Investments in new access expand revenue basis Subsides for new access provided in transparent and targeted manner System assets adequately maintained Service providers fully cover operating costs Consumers use water more e ciently Tari s increased to cover greater portion of e cient costs More satis ed customers are more willing to pay Service quality improves Reduced losers: reduced costs Technical e ciency improves Sta motivation improves Sta and managers rewarded for improved performance Source: Goksu et al. 2017. Government funding to utilities is, generally, either most affordable form of repayable finance for most transferred for building new infrastructure (capital countries. ODA has peaked at only US$8 billion glob- subsidies) or for covering the gap between operating ally (Winpenny et al. 2016), far behind ODA for health revenues and costs (operational subsidies). or education; but in 24 of the lowest-income countries, it still accounts for a large share of water sector finance Many emerging market countries also rely on some (WaterAid 2016). form of repayable financing in the form of official development assistance (ODA). Low-income countries A second type of repayable finance is offered at market often use “soft loans” from multilateral development rates. This includes microfinance, bonds, equity, and banks (MDBs) like the World Bank, offered at commercial bank loans. More market-oriented finance below-market interest rates. These soft loans are the 1 from the private sector will be harder to attract but is Reform and Finance for the Urban Water Supply and Sanitation Sector 5 FIGURE 2.3. Traditional Revenue Sources for the WSS Sector Funding sources (”3Ts”) Repayable financing Tariffs Concessional finance Prefinance User fees for services provided and Provided by development agencies with a grant households’ investment for self-supply element (for example, “soft loans”) Transfers Private finance Transfers from external sources, such as Repay Provided by private sector financiers at market international donors (ODA grants), rate (vendor finance, microfinance, loans, foundations, NGOs, remittances bonds, equity) Taxes Key Domestic taxes levied by local and central Private funds governments and provided as grants or Mixed public and private funds subsidies Public funds Source: Goksu et al. 2017. Note: NGOs = nongovernmental organizations; ODA = official development assistance. required to meet the SDGs. Moreover, commercial frameworks. If subsidies are needed, they are best finance—in and of itself—offers important incentives directed to areas where costs cannot be recovered for utilities to directly sustain high levels of perfor- through tariffs, such as to serve the poor; to promote mance, a prerequisite for ensuring sustainable service merit goods, including sanitation; or to generate delivery for all. ­external benefits. Because public funds are scarce, they are best directed where other funds are unavailable, such as to provide Note access to the poor in periurban and rural areas and to 1. Also codified as concessional loans, “soft loans” contain a minimum strengthen the sector’s institutional and regulatory grant element of 25 percent, calculated at a discount rate of 10 percent. 6 Reform and Finance for the Urban Water Supply and Sanitation Sector Chapter 3 What Will It Take? T he current status quo, shaped by the size and Change is difficult. As with any new policy or strategy, flow of government funding, is insufficient government support and successful piloting will be to reach the Sustainable Development Goals critical to changing mind-sets. Governments and (SDGs). The water sector needs substantive reform development institutions will need to lead the para- measures that can tackle the sector’s pervasive ineffi- digm shift by viewing utilities as future borrowers of ciencies, low service quality, and poor performance of commercial finance. Development banks have an urban and rural providers. especially important role to play in bridging the inter- ests of utilities with those of potential lenders by The Maximizing Finance for Development (MFD) designing innovative transactions that make commer- approach posits that commercial finance will be cial borrowing less expensive for utilities and less risky required to meet the SDGs. MFD calls for public invest- for lenders. ment in the sector to be used as leverage to crowd in additional sources of finance. The agenda starts with urban utilities, which have the highest potential for “This stark reality calls for a major shift in the way tapping into commercial finance. resources are allocated in the sector. Each country is different and will require a customized solution There are thousands of utilities across low- and mid- that, where possible, leverages public funding … dle-income countries (LMICs) currently operating to mobilize commercial finance—either under quasi-business models with the potential to international or domestic.” begin strengthening their balance sheets through effi- – Easing the Transition to Commercial Finance for ciency improvements. What they need are stronger Sustainable Water and Sanitation incentives from the surrounding enabling environ- ment to encourage them to become more efficient and to move away from the status quo toward a new financ- The MFD agenda for urban water is not just about ing model. expanding the investment envelope. It requires using A second challenge, beyond improving the perfor- existing and new money in smarter ways that will mance of utilities, is attracting the interest of lenders. attract, rather than crowd out, commercial finance. Commercial financiers have steered clear of investing It is a new way of thinking about reaching the SDGs, in water supply and sanitation (WSS) in LMICs because and it promises to make safely managed services, not of the perceived risks of the sector, namely its politici- just basic access, more sustainable for all. zation stemming from the social importance of WSS. When given a choice, investors seek more stable returns from the transportation and energy sectors The Foundations of Urban Reform rather than the water sector. This paper proposes that Reaching the point where utilities can access commer- the changes needed to improve utility performance cial finance on their own starts by addressing two foun- will require the broader sector reforms needed to dational issues (figure 3.1). The first is the sectorwide reduce borrower risk. Thus, progress on one challenge governance and institutional arrangements in a given will invoke progress on the other. country that inhibit or enable positive sector outcomes. Reform and Finance for the Urban Water Supply and Sanitation Sector 7 FIGURE 3.1. The Cycle of Improved WSS Sector Performance Access to Commercial Finance Maximizing Finance for Easing the Transition Creditworthiness Development (MFD) to Commercial Finance Operational E ciency Technical and Governance and Financial E ciency Institutional Arrangements Utility Turnaround PIR/Aligning Framework (UTF) Institutions and Incentives Note: PIR = Policy, Institutional, and Regulatory; WSS = water supply and sanitation. The second foundational issue is that of utility perfor- utility (technical and financial efficiency) levels will mance at a local level, an issue that is itself greatly influ- enable the utility to gradually improve its creditwor- enced by the wider governance and institutional thiness and, eventually, reach the goal of accessing arrangements. For most LMICs, commercial finance commercial finance. The financial improvements then will not be attainable without first making foundational allow for further improvements to the foundational adjustments to the overarching governance framework issues, which subsequently strengthen the financial and aligning newly created incentive frameworks in capacity of the sector, and so on. support of improved utility performance. On a practical level, however, the process of successful Much like the virtuous cycle of utility performance, sector reform is much less structured than the theory found in figure 2.2, the MFD agenda itself is a cyclical suggests. Reforms taken in one of the three areas often process, but it applies to the entire water sector of a overlap—in terms of sequencing and scope—with given country, not just to its utilities. Starting from the another. For this reason, a deep-dive analysis has been bottom of figure 3.1, the initial changes at the sector conducted for all three components of the approach to (governance and institutional arrangements) and tease out important considerations for each. 8 Reform and Finance for the Urban Water Supply and Sanitation Sector FIGURE 3.2. Three Global Frameworks Aligning Institutions and Incentives for Sustainable Water Supply and Sanitation Services, the agship document of the PIR initiative, looks at how integrated policy, institutional, and regulatory interventions can help align incentives for more sustainable WSS services. This report also recognizes the critical importance of the informal conventions that will be key factors in the success of any incentive regime. The Water Utility Turnaround Framework: A Guide for Improving Performance draws on empirical evidence from turnaround case studies that were both successful and unsuccessful, identifying key factors for starting and maintaining utility performance improvements. It also provides a four-phase, step-by-step approach to designing and implementing a turnaround program. Easing the Transition to Commercial Finance for Sustainable Water and Sanitation, the agship work of the MFD agenda for water, encourages more e cient use of public funds to mobilize new sources of nance. By explaining the costs and bene ts of commercial nance, the report seeks to guide sector leaders to tap into new nancing as both a means to and an incentive for improving sector performance. Note: MFD = Maximizing Finance for Development; PIR = Policy, Institutional, and Regulatory; WSS = water supply and sanitation. Components of the Integrated Approach: Policy, Institutional, and Regulatory Incentives Three Global Initiatives The Policy, Institutional, and Regulatory (PIR) incentives The three components of the cycle (figure 3.1) initiative, jointly undertaken by the Water and Governance ­ correlate with three global initiatives, the conclu- Global Practices (GPs), was conducted around four major sions of which were published in various research topics: political economy perspectives, regulation of WSS papers by the World Bank between 2017 and 2019 services, trends in public sector reform and intervention, (appendix A). Each initiative has a corresponding and policy and institutional reforms in WSS. The initia- global framework, or flagship document, that sum- tive, to date, is composed of a suite of global research on marizes the research conclusions of that initiative regulation and institutional frameworks, as well as case (figure 3.2). Each global framework provides concrete studies and a regional PIR application for South America examples of how governments have successfully (appendix A). PIR offers a comprehensive and holistic reformed and put forth a set of principles and pro- view of the key institutional and governance components cesses to follow for designing a successful reform of a country’s water sector (box 3.1). agenda. The unique scope of each of the three global frameworks can be found in figure 3.2 and the subse- The flagship publication of this initiative, titled quent text. Aligning Institutions and Incentives for Sustainable Water Reform and Finance for the Urban Water Supply and Sanitation Sector 9 BOX 3.1. PIR (Policy, Institutions, and Regulation) Defined Public policy is a framework through which government decisions are made. The implementation of policy is often done through the enactment of laws, regulatory measures, and financing arrangements. Policies set goals and expectations, which can provide guidance and enhance accountability between government and citizenry. Institutions are defined as “social, political, and economic relations governed by formal and informal rules and norms. They provide a structured, predictable manner by which people interact and shape incentives for people and organizations, which in turn can also contribute to institutional development” (North 1990, as presented in Mumssen et al. 2018). One key factor for the successful implementation of incentives is to have both vertical (across levels of government) and horizontal (across ministries) alignment of institutions. Regulation is the “control exercised usually by a public agency over activities that are valued by a community” (Ogus 1994). In water supply, economic regulation is used to control tariff setting and service standards, and some countries may use regulatory mechanisms to help ensure social goals like access and equity of water services. Forms of regulation vary from country to country and include regulation by agency or by contract. Supply and Sanitation Services (also referred to here as The final factor to consider is the feedback loops the PIR framework), is the synthesis report. The frame- that exist among the actors. The actors involved in work is centered around the broader sector enabling and affected by the PIR process include: policy environment, characterized by the sector’s institutional makers, regulators, utility staff and management, ­ and governance arrangements and the incentives that consumers, unions, consulting firms, and contrac- emanate from them. One can view the enabling envi- tors. Consumers’ feedback to their government on ronment as either conducive to reform actions or pre- the quality of service can, in turn, influence the senting binding constraints to reform actions. enabling environment for the next round of reforms. Well-designed PIR interventions provide the incen- The document is a guide for reform-minded govern- tives to deliver specific actions that lead to positive ments to assess their sector situations, understand sector outcomes. There are two levels of incentives: (1) drivers for reform, anticipate the potential constraints endogenous and exogenous drivers for reform, which they will face, and plan interventions under a broad set stem from the enabling environment; and (2) PIR of principles. The principles have been shown to work incentives that stem from specific PIR interventions. It well across a variety of country contexts, pulled from a is important to note that P, I, and R are not wholly sep- series of 11 case studies. arate spheres; they often overlap (figure 3.3). Figure 3.4 demonstrates the diversity of country expe- None of the incentive setting happens in a vacuum. riences (the size of the bubble indicates the relative Both levels of incentives are influenced by one another. level of access to WSS services, and the numbers reflect There are also intrinsic, or personal, incentives at play. country rakings in terms of gross domestic product For example, utility staff will have intrinsic incentives [GDP] per capita, with 1 as the highest GDP per capita). that will determine whether and how reforms are Higher-income countries tend to have endogenous implemented. This can determine the difference drivers for reform and better access to WSS services, between de jure (implemented as planned) and de as  is the case in Australia, Portugal, Brazil, and facto (implemented not as planned) reforms. Colombia. Secondary factors, like whether reforms are 10 Reform and Finance for the Urban Water Supply and Sanitation Sector FIGURE 3.3. Schematic of PIR Interventions and Incentives within the Enabling Environment Enabling environment: Current state of the sector/ political economy/governance structures Sector outcomes may lead to some citizens demanding Provides the drivers for speci ic actions reform, removal of binding constraints, determining the P, I and R chosen De jure vs. de facto: Enabling environment will in uence the implementation of PIR and attainment of outcomes PIR interventions are crafted to WSS outcomes? meet sector Policy Sustainable water objectives supply and sanitation Provides the services incentives for (if binding constrainsts speci ic actions to are removed and deliver WSS service enabling environment Institutions Regulation allows for implementation of appropride P, I and R) Source: Mumssen, Saltiel, and Kingdom 2018. Note: PIR = Policy, Institutional, and Regulatory; WSS = water supply and sanitation. WSS-specific, show more mixed results. In all cases, Water Utility Turnaround Framework the success of reform programs is strongly influenced The Water Utility Turnaround Framework (UTF) initia- by the political economy of the country. Details on tive seeks to understand what makes a successful util- each case study, as well as comparisons between case ity turnaround—or the upward movement on the studies, can be found in the document. virtuous utility cycle of performance toward providing more reliable, convenient, and safe water services. The “Improving the performance of water utilities is Water Utility Turnaround Framework was designed difficult because the issues affecting their through careful study of five turnaround case studies performance are complex and multidimensional.” in Benin, Brazil, Burkina Faso, Peru, and Vietnam and The Water Utility Turnaround Framework references 15 other case studies from around the world.1 Reform and Finance for the Urban Water Supply and Sanitation Sector 11 FIGURE 3.4. Correlation between Enabling Environment and PIR Interventions Portugal Zambia 8 High focus on WSS High IPR interlinkages 2 Burkina Faso 10 Brazil Australia 3 1 Colombia Albania 5 Mozambique 11 4 Endogenous Exogenous drivers drivers for reform for reform Indonesia 6 Philippines Low PIR interlinkages 7 Low focus on WSS Bangladesh 9 Source: Mumssen, Saltiel, and Kingdom 2018. Note: PIR = Policy, Institutional, and Regulatory; WSS = water supply and sanitation. By studying these 20 cases, the UTF was able to verify TABLE 3.1. The Evolution of Water Utility Reform eight key lessons from previous World Bank analyti- Sequencing cal work conducted on urban water reform and Former approach New approach nuance those previous findings. The new evidence is Create institutions first: ­ inancial Improve service and f beginning to shift the World Bank and its clients’ water law and policy; performance first; build formal ­ approach to reform on three critical issues: creating create regulatory; ­institutions progressively institutions, reforming tariffs, and borrowing money ­corporatize utility (table 3.1). These conclusions have informed the Raise tariffs to cost Utilities should use the resources sequencing and resources discussion in Chapter 4 of recovery quickly at their disposal to build credibility ­ djusting tariffs before a this paper. Borrow money to Use available resources first; build The key conclusion of the UTF is that though there is no finance major infrastruc- ­nformation base capacity and i one-size-fits-all solution for a turnaround program, key ture quickly before making sizable capital ­investments success factors include strong management and a clear 12 Reform and Finance for the Urban Water Supply and Sanitation Sector FIGURE 3.5. Four Phases of the Utility Turnaround Framework Phase 0: Phase 3: Phase 1: Assess the utility Phase 2: Strategic Create sapce and and its external Action planning planning and virtuous cycles environment institutionalization 3 months 2–3 years 6–12 months 5 years + sustaining customer-oriented vision. A second key conclusion is tools includes three types: decision tools, navigation that a successful turnaround program will be a gradual tools (including checklists for moving from one stage series of improvements using the existing resources of of maturity to another), and analysis tools to assess the utility. Finally, there are a few key ­ conditions to performance and maturity and to prioritize actions. starting a turnaround: a competent and  incentivized manager with a minimal level of managerial autonomy Maximizing Finance for Development and a government champion who is committed to mak- The MFD initiative is a World Bank–wide strategy for ing the changes to promote the right incentives. supporting LMICs in meeting their SDG-related targets by leveraging commercial finance. The World Bank has In addition to providing key principles and good prac- developed several advocacy pieces to catalyze support tices, the UTF sets out a four-stage process for planning for the MFD agenda in water, as well as practical guid- and executing a turnaround. Figure 3.5 provides the ance tools and training sessions on preparing water phases along with an illustrative timeline. A utility is first institutions to leverage commercial finance (appendix assessed by its maturity in five areas: organization and A). Within the World Bank, teams continue to identify strategy, human resource management, financial man- synergies between IBRD/IDA, IFC, and MIGA to sup- agement, technical operations, and commercial opera- port MFD at the country level. tions. Then priority actions are identified and carried out through an action plan. Once initial reforms have been For the urban water sector, Easing the Transition to successfully completed, and the requisite political sup- Commercial Finance for Sustainable Water Supply and port and enabling environment are in place, the utility Sanitation is the flagship MFD document. The docu- then moves on to strategic planning and institutionaliza- ment lays out a three-step approach for governments tion of the performance improvement system. to support utilities to move toward greater financial sustainability through efficiency gains and better use The World Bank has applied the UTF in two client of public resources (figure 3.6). countries, Vietnam and Botswana. In both cases, the UTF has been tailored to the specific conditions of the The document then lays out different measures that will utilities and has thus far proven to be a comprehensive help make commercial finance work for borrowers way to assess performance and to provide the tools for (affordability) and for lenders (reduce their risk), and planning a turnaround program. The series of UTF how governments canprovide incentives for these two Reform and Finance for the Urban Water Supply and Sanitation Sector 13 FIGURE 3.6. The MFD’s Three Components and Key Recommendations 1. Plan, budget, and 2. Improve utility 3. Leverage public allocate public performance and funds to attract resources more governance commercial nance e ciently Match the supply Integrate Set in motion a and demand for incentives: link culture and cycle commercial strategy to policy of improved nance, and and policy to sector understand costs nance performance and bene ts Aim for Leverage Use tari s and long-term concessional subsidies in a nancial funds by smarter way sustainability blending Build demand for commercial Invest in sector nance, and use frameworks and tools to make it institutional more a ordable capacity and to de-risk the sector Note: MFD = Maximizing Finance for Development. spheres to begin to work together. Challenges to be Finally, the paper attempts to dispel the myth that donor addressed at this final stage include building the credit- funding is always less expensive than private finance. worthiness of utilities, mitigating the risk perception of A  comparative analysis of a typical concessional loan potential lenders, and designing innovative transactions and a typical commercial loan demonstrates how, despite that help ease the transition to commercial finance. the lower interest rates and longer grace periods offered by concessional loans, currency risk and the opportunity Eventually, the current financing gap in urban water cost of preparing and approving concessional loans can should be filled by a mix of lower costs, larger tariff rev- add significant costs to the long-term repayment of a enues, and less (but more targeted) taxes. The  paper concessional loan. Private finance, on the other hand, is advocates for replacing larger shares of public funding often more readily available and, if provided in the (taxes) and concessional finance with private finance domestic market, eliminates currency risk. over time (figure 3.7). 14 Reform and Finance for the Urban Water Supply and Sanitation Sector FIGURE 3.7. Potential Pathways to Fill the WSS Financing Gap Costs Funding Financial Finan- Cost savings costs cing gap Capex Financial Finan- Financial Finan- Finan- Private Financial Private For ongoing costs cing costs cing cial finance costs nance capex gap gap costs needs Capex Capex Capex Capex Conces- sional Taxes Targeted Taxes taxes only Conces- sional Tari s Conces- Conces- sional sional Tari s Opex Taxes and Opex Opex Opex Opex mainte- Taxes and and and and nance Taxes mainte- mainte- Tari s mainte- mainte- nance nance nance nance Tari s recover a Tari s Tari s large part of the costs 1. Starting point 2. Cost saving from 3. Mobilize domestic 4. Mobilize financing 5. Services financed De ne water SDG efficiency revenue sources from multiple sustainably going forward. strategy. Strategic Lower opex and Raise tari s and user sources Water SDG achieved nancial planning. maintenance costs charges. Mobilize Leverage commercial and capex efficiencies. domestic taxes and finance with blending. catalytic loans and grants. Source: Winpenny et al. 2016. Note: capex = capital expenditures; opex = operating expenditures; SDG = Sustainable Development Goal; WSS = water supply and sanitation. Note 1. The utilities in the five case studies are as follows: Companhia Espírito Santense de Saneamento (CESAN) (Vitoria, Brazil); SEDAPAR (Arequipa, Peru); ONEA (Ouagadougou, Burkina Faso) and SONEB (Cotonou, Benin); and DAWACO (Da Nang, Vietnam). Reform and Finance for the Urban Water Supply and Sanitation Sector 15 Chapter 4 Maturity of the Urban Water Sector T   aken together, these three global initiatives pro- For more specifics on utility performance, see vide complementary sets of tools and processes the UTF’s five-stage maturity matrix (from that governments can draw from to design their elementary to world-class) for each of its five urban water sector reform strategy. In addition, this areas: organization and strategy, human resource summary paper puts forth two final reference tools—the management, financial management, technical maturity matrix for urban water reform and the matu- operations, and commercial operations. rity ladder for the urban water sector—which show how the three frameworks can be compiled to visualize improvements over time. Regardless of where they begin, a government should aim to move to the next stage by considering each of The matrix (appendix B) provides a cohesive view of the factors associated with each topic. In general, a the scope of the three frameworks by detailing stages move from one stage to the next will require either of sector development across five topics: Policy, removing a constraint or barrier to sector improve- Institutional, and Regulatory (PIR); finance ment (such as a perverse subsidy) or by creating a new (Maximizing Finance for Development [MFD]); and incentive to improve sector outcomes (such as man- utilities (Utility Turnaround Framework [UTF]). The dating the expansion of access for the poor). matrix starts with Stage 1, which characterizes a poor-performing and inefficient sector, and ends with The most common actions taken to mature a water Stage 5, which characterizes a credible and profes­ sector are summarized in the maturity ladder sionalized sector that supports utilities to leverage figure 5.1). The actions listed are general markers and (­ performance improvements and, eventually, access ­ are not meant to be prescriptive for any single country commercial finance. or utility context. Rather, this paper encourages gov- ernments and utilities to utilize the UTF, PIR, and MFD The matrix is intended as a reference tool to help resources to design their own unique maturity ladder ­ governments and utilities assess their own maturity. as part of a strategic reform process. Finally, while the It provides a general idea of the most common charac- maturity matrix and the maturity ladder point to simi- teristics seen in the literature and is not a complete lar content (see colored text in both), they maintain view of any country’s water sector. separate objectives; thus, the actions and characteris- Reform is not a linear process. Rather, as concluded in tics are relatively—but not perfectly—aligned across the PIR, reform is an iterative process with unparal- the stages. leled progress and reversals across the five different topics. This idea is reiterated by the matrix, where gov- ernments may find themselves starting at different The New Status Quo stages on each of the five topics and may need to build In the past, governments and donor institutions resources or capacity in one area as a prerequisite to alike have sometimes tackled sector reform as a maturing in another. series of high-profile changes to sector policies and Reform and Finance for the Urban Water Supply and Sanitation Sector 17 infrastructure, often through individual, uncoordi- Ideally, Stages 1 through 3 will use the utility’s existing nated projects. Many projects designed to jump- resources to build its credibility. The focus should be start major sector change, such as raising tariffs on improving quality of service such that customers (prematurely) or building large-scale infrastructure, will be willing to pay a higher rate that is closer to cost were done without first making the requisite recovery. Utilities should invest in areas that will save ­ adjustments to the foundational issues of utility costs, enhance efficiency, or improve staff capacity. ­ performance and sector governance. Using this These “soft” investments should be viewed as the pre- approach, billions invested in the urban water sector liminary stages of a long-term sector improvement have failed to reap the expected outcomes. For program. Governments can look for support primarily example, expanding water supply without first from bilateral donor technical assistance funds and, in reducing leaks in the network only puts greater risk some cases, may find assistance from multilateral on the long-term sustainability of a utility’s opera- development banks (MBDs), such as the World Bank’s tions by increasing both costs and inefficiencies. development policy loan (DPL) instrument, which supports policy and institutional change. However, learning from these experiences—and pro- cessing that learning through the development of the three global frameworks—has helped define a new sta- Another well-documented case of tus quo. Governments and donors should work comprehensive sectorwide reform by together to take a long-term (20-year) view to improv- milestones—at the national level—can be found in ing urban water sector performance. A comprehensive the Australia Urban Water Reform Story (Salisbury, blueprint that encompasses long-term financial plan- Head, and Groom 2017). ning should be the new norm for any sector reform program. Utility reform should be part of a much broader effort to make the necessary, commensurate The Shimla DPL is one such World Bank–financed adjustments to sector governance frameworks and operation that approaches reforms from a holistic per- should include the objective of bringing the utility spective. The project is an example of how sector and closer to accessing commercial finance. utility level reforms are planned through medium-term milestone targets, which act as the basis for project Sequencing and Resources disbursements (box 4.1). The UTF concludes that while there is no official recipe Only after the foundational issues have been improved for a turnaround, “successful turnaround strategies should a government or utility attempt to make sizable sequence similar actions in roughly the same order.” capital investments while moving up to Stages 4 and 5 Many of the most typical actions are shown in the of the ladder. These investments can be financed with maturity ladder (figure 5.1). The first three stages set concessional loans from MDBs but should also attempt the foundation for an affordable, quality service for to crowd in public investment through blending instru- customers, whereas the final two stages promote inno- ments, where feasible. In some cases, commercial vative approaches to maximize financial and technical finance may be preferable to concessional loans, espe- performance while ensuring equitable service cover- cially given high currency risk or high opportunity age. It is important to note that broader sector level costs associated with the time it takes to finalize con- reforms are ongoing while utility level reforms are cessional loan agreements. Governments should underway, and progress at one level is often a prereq- assess all options before selecting the lender and lend- uisite for progress at another level. ing instrument. 18 Reform and Finance for the Urban Water Supply and Sanitation Sector BOX 4.1. Medium-Term Planning Boosts Sector Reforms in Shimla, India In 2018, the World Bank approved the US$40 million Shimla Water Supply and Sewerage Service Delivery Reform program, the first of three planned development policy loans (DPLs) to support the government of Himachal Pradesh’s water supply and sanitation (WSS) reform strategy. The medium-term plan builds on the 2018 incorporation of a new autonomous utility—Shimla Jal Prabandhan Nigam Limited (SJPNL)—to begin transforming the sector toward a service-delivery orientation. The Shimla Municipal Corporation (SMC) delegated WSS service delivery to SJPNL in 2018. The program relies on significant capacity-building support to both SMC and SJPNL, including through a partnership with a global publicly owned WSS utility to advise the managing director cum CEO of SJPNL. The holistic agenda touches on all three aspects of sector reform: • Sector governance and policy: New regulatory mechanism to govern tariff and subsidy policies toward cost recovery; performance-based contracts (PBCs) for service improvements; grievance redress mechanisms • Utility performance: Energy efficiency; competitive hiring processes; staff performance incentive system to affect one-third of staff salaries • Sector and utility finance: Initial public capital grants to finance service expansion under modernized procure- ment framework; commitment to transparent and predictable subsidies; SJPNL eventually to tap into commer- cial finance to expand services to satellite towns The program is implemented through a series of targets enforced through the DPL. The initial major milestones for 2018–21 are shown in figure B4.1.1. FIGURE B4.1.1. Major Milestones of the Shimla Water Supply and Sewerage Service Delivery Reform Program, 2018–21 SJPNL incorporated PBC with global 24 x 7 supply goal as ring-fenced utility public utility signed achieved New tari guidelines PBC for bulk water 100% of distribution in place; government supply signed O&M costs recovered commitment to subsidies Note: O&M = operation and maintenance; PBC = performance-based contract; SJPNL = Shimla Jal Prabandhan Nigam Limited. Source: World Bank 2019. World Bank projects that use instruments like invest- This new status quo will necessitate much better donor ment project financing (IPF) and program for results coordination than exists in most countries today. (PforR) can be leveraged for both the financing they Bilateral donors, which most often provide technical provide to governments and the long-term capacity assistance, and MDBs, which most often provide loans building and technical assistance they provide to or credits for capital investments, need to work together implementing agencies (box 4.2). to support different aspects of the reform agenda over Reform and Finance for the Urban Water Supply and Sanitation Sector 19 BOX 4.2. World Bank Lending Instruments to Support the Water Supply and Sanitation Reform Agenda • Investment project financing (IPF): Supports capital-intensive investments and service delivery improvements with a 5- to 10-year horizon. IPF also provides continued technical assistance, including support to project preparation and implementation throughout. • Development policy loan (DPL): Includes budget support to clients whereby funds are made available after the successful completion of a reform program or policy or institutional action programs. • Program for results (PforR): Links disbursement of funds to achievement of results. PforRs support a piece of a government’s own program, using and building country systems in parallel with implementation. time to ensure that the planning is done right before siz- Moreover, some countries are facing declining service able capital investments are made, as shown in the case coverage or utility performance in this stage. Even those of Burkina Faso (box 4.4). International protocols that can function in the short term will not be prepared to should be developed to guide where and how donors respond to new risks like drought or conflict. It is also coordinate to both ensure the correct sequencing of common that long-term goals are being ceded to short- interventions and confirm their shared commitment to term political gains. In dysfunctional political econo- maximizing finance for development. mies, where incentives are not aligned with overall sector goals, employees of sector institutions sometimes priori- tize personal or political goals instead (box 4.3). Five Stages of Reform The remainder of this chapter outlines five general stages Approaches to Moving to Stage 2 of reform (appendix B), along with the typical challenges Understand why the sector operates as it does. By taking one would find at each stage and a few approaches that a “problem-driven approach based on binding con- sector institutions, including utilities, could apply to straints,” the sector can begin to know how to address move to the next stage (figure 5.1). It also points the the major political economy challenges, which itself reader to the relevant tools within each framework that creates an incentive for change (Mumssen, Saltiel, and may support implementation of the various approaches. Kingdom 2018). Understanding the underlying power asymmetries in a country sheds light on why a sound Stage 1: Battling Inefficiencies policy is not being implemented or why institutions Typical Challenges are unable or unwilling to fulfill their mandates. This stage is typically characterized by low rates of The institutional diagnostic tool (IDT) is a first access to water supply and sanitation (WSS) services. step governments can take to map institutions, There may be no clear policy direction at the national isolate problems, and determine “entry points” to level or a policy signal that has yet to be translated into design appropriate interventions. local goals. Under this scenario, the sector may be frag- mented across institutions without clear delineation of roles and responsibilities, making it difficult to know Create the space needed for change. Reform is s ­ ometimes which institutions are authorized to access which imposed by external circumstances, such as a chronic funding source(s) to meet national targets. water shortage in Burkina Faso (L’Office national de 20 Reform and Finance for the Urban Water Supply and Sanitation Sector BOX 4.3. Discovering Perverse Incentives Water sector institutions sometimes operate for purposes that are contrary to their mandates. For example, as concluded in the Policy, Institutional, and Regulatory (PIR) framework, an agency or person in that agency may have stronger incentives to prioritize short-term personal gains over long-term social well-being. A regulatory agency may keep tariffs below the cost of service or allow certain institutions to not pay their water bills to support political goals to the detriment of the financial sustainability of utilities. Similar types of perverse incentives are documented in the Utility Turnaround Framework (UTF), such as using utility jobs to secure votes or building overdesigned and more expensive infrastructure that eases opportunities for rent seeking. Eliminating such incentives requires first understanding their source and then designing positive incentives to reverse course. l’eau et de l’assainissement [ONEA]) or a threat of pri- manager—SEDAPAL (Peru)—reforms were unsustain- vatization in Brazil (Companhia Espírito Santense de able. Moreover, managers need to have autonomy Saneamento [CESAN]). It is important for water sector because only they can “maneuver within their space for institutions to leverage these events and disruptions as change” (Soppe, Janson, and Piantini 2018). opportunities for positive change. Define and support local implementation. When reforms Stage 2: Building Capacity are imposed from the top, as part of a national decen- Typical Challenges tralization effort (Albania) or an effort to boost eco- nomic productivity (Australia), sector institutions Many capacity-building resources exist for benefit already from high-level political leadership. practitioners to learn on different topics, such In those cases, it will be important to effectively trans- as the Danube Learning Partnership (D-LeaP), late the new national policies to the local WSS sector which has programs on nonrevenue water (NRW), level and outline how the reforms will take shape. energy efficiency, commercial efficiency, asset There are many cases of national decentralization pol- management, and water safety planning. icies that failed because local utilities still lacked the administrative authority, responsibility, or funding to deliver services. Sometimes this change in authority is Sector institutions in Stage 2 are often operating at low even resisted by high-level government officials who capacity for various reasons. There is often a differ- risk losing power. Understanding the power asymme- ence between how institutions act (de facto) and how tries and other binding constraints is thus a precursor they are intended to act (de jure), which depends on to creating the space needed for reform. whether they are composed of staff with the requisite capacity and skill level needed to complete their tasks. Design governance arrangements that support compe- Stuck in a cycle of poor performance (figure 2.1), public tent, autonomous leadership. Each UTF case study had a utilities operate without autonomy to make their own government champion: someone who worked with business decisions and are therefore not accountable autonomy to maintain reform programs without politi- to their customers. cal interference from other parts of the government. Equally important was the competence of the general Utilities may lack the funding to properly attract or manager of the utility. In one case without such a utility retain the right talent or even the autonomy to make Reform and Finance for the Urban Water Supply and Sanitation Sector 21 hiring decisions. The UTF case studies show how turn- more efficient uses to generate the right incentives for arounds can be achieved without dramatically chang- reaching sector goals. However, budget allocation in ing the staff composition of a utility. However, where and of itself is a complicated process with inherent retrenchment was possible, it played a crucial role in political tradeoffs. Subsidies to the water sector still the success of the turnaround. Where retrenchment is often disproportionately benefit the wealthy in contra- not possible, due to the prevailing political economy diction to stated policy goals. conditions (and staffing is therefore static), utilities are best served by first investing in the capacity and skills A public expenditure review (PER) can help of their existing employees. governments assess the flow of funds to the sector (transfers, subsidies, grants), including level, The UTF concludes that any type of public investment trend, and composition, as well as budget will be more efficient and effective if resources are prioritization, allocation, and spending. A PER can focused first on strengthening the internal capacity of also assess the efficiency and equity of expenditures. the recipient utility. Capacity building was an early step in several successful turnaround programs, including ONEA (Burkina Faso) (box 4.4). The same Use public funds as an incentive to improve performance. can be said for the institutions that channel and man- Many countries have had success by linking public fund- age sector funding. The MFD concludes that sector ing to utility planning and capacity building. For exam- institutions without the “absorptive capacity” to take ple, Indonesia and Portugal required business plans as a on more funding are not able to help the sector effi- prerequisite for utilities to access government funding. ciently spend additional public resources when they But governments must also ensure that utilities respond become available. correctly to the incentive, which may require the Approaches for Moving to Stage 3 removal of additional barriers. In the case of Brazil, capacity constraints need to be removed (box 4.5). Understand sector financial flows and how they create implicit and explicit incentives for sector institutions. As Colombia coupled capacity building with funding to recommended by the MFD framework, governments create sustainable improvements in access. Following should first budget and allocate public resources more decentralization in the 1980s, the government created efficiently. Governments can then redirect the funds to a new institution—FINDETER—to provide technical BOX 4.4. Addressing Capacity Constraints First L’Office national de l’eau et de l’assainissement (ONEA), the national water company serving urban areas throughout Burkina Faso, attempted its first turnaround in the early 1990s. Before it was able to access World Bank financing to build the US$200 million Ziga Dam and treatment plant to expand water supply, it had to strengthen its internal capacity to manage a large project. Funding from German Technical Cooperation Agency and the Danish International Development Agency provided ONEA with managerial and technical assistance focused on establishing a baseline, increasing managerial autonomy and efficiency, and developing a staffing plan. These critical foundational changes paved the way for building the new dam and meeting the service expansion goals. Source: Soppe, Janson, and Piantini 2018. 22 Reform and Finance for the Urban Water Supply and Sanitation Sector BOX 4.5. When Incentives Elicit the Wrong Response Brazil’s current sector funding program, the National Sanitation Plan (PLANSAB), requires that municipalities complete a basic sanitation master plan before they can access funding for needed investments. The plan is also used to define goals, which regulators then use to monitor progress. The prerequisite, while a good incentive to ensure funding is tied to sector goals, is not in line with local capacity constraints across the country. Given the economic and social diversity of the country’s more than 5,000 municipalities, a portion of them do not have the funds or skills needed to complete the planning, essentially barring them from participation. FIGURE 4.1. Initial Utility Performance Improvements and Their Impact on Financial Viability A 10% increase in revenue would 90 then increase this to 77% of utilities. 77 80 Percentage of utilities deemed viable 70 With operational e ciency gains, 65 65% of utilities can cover 60 Only 15% of operational costs and some debt utilities in service. 50 developing countries cover 41 40 O&M costs and generate cash 29 30 surplus. 20 15 10 0 Currently viable Step 1: Step 2: Step 3: Step 4: Collection rate Nonlabor cost With reduction of Increase revenue by increased to, 100% reduced by, 15% current level of 10% nonrevenue water to 25% Source: Modified from Kolker et al. 2016. Note: O&M = operation and maintenance. assistance to local government utilities to design ser- low 17 percent of utilities in low- and middle-income vice projects. At the same time, FINDETER transferred countries (LMICs) cover their operation and mainte- central government funds through commercial bank nance (O&M) costs and generate a cash surplus. By loans to the utilities, working to bridge the knowledge improving bill collection rates, reducing labor costs, gap between borrowers and lenders. This institutional and reducing nonrevenue water (NRW) to 25 percent, arrangement was critical to reducing public lending in 65 percent of these utilities could generate a cash water while expanding WSS access. surplus (figure 4.1). And while these steps are relatively ­ simple to undertake, they require the right enabling Reduce inefficiencies, cut costs, and increase revenue at environment conditions to be in place. For example, the utility level. The MFD framework estimates that a improving collection rates may require utilities to Reform and Finance for the Urban Water Supply and Sanitation Sector 23 disconnect customers in arrears or enforce payment Stage 3: Aligning Institutions and Incentives from public institutions that have not traditionally paid Typical Challenges their bills. These issues often go back to the PIR incen- In Stage 3, governments are often funding the sector tive structures and require broader government support. in a progressive way that generates positive incen- The UTF case studies confirm that taking steps to tives. Most will need to turn their attention toward a reduce inefficiencies can make a big impact over a better alignment of these incentives across finance, short time period. Such measures demonstrate the policy, institutions, and regulation and at the util- commitment of the sector to improving performance ity level. For example, regulatory and institutional while building the capacity, credibility, and autonomy frameworks need to complement one another, of the utility. Upon this foundation, utilities, such as and they need to be supported by the right poli- CESAN (Brazil) (box 4.6), have been very successful in cies and laws that enable their implementation or implementing a robust action plan to make further enforcement. improvements that transform their culture to one When incentives are not aligned, there is the risk that based on sustainability and customer orientation. reforms will not be sustainable or that perverse incen- Support utilities in aiming for financial viability. Viability tives will ensue (box 4.2). In the case of Indonesia, means that a utility has an operating cost coverage ratio competing policies confused sector institutions. (OCCR) of 1.2 or better, giving them 20 percent additional A 2004 water law permitted the use of private sector cash (beyond operating expenses) to provide a cushion participation (PSP) and declared that water had eco- for future expenses and to service debt. For each of the nomic properties. Ten years later, the law was found to UTF’s successful cases, the OCCR was above 1.2 and col- be unconstitutional in that it conflicted with the 1945 lection rates were above 90 percent by the end of the Constitution’s definition of water as a social good turnaround. If utilities are unable to charge cost recovery (Mumssen, Saltiel, and Kingdom 2018). Aligning incen- tariffs, it is still important to aim for financial sustainabil- tives thus requires taking a holistic view to the way in ity by ensuring that government subsidies are provided which institutions (vertically and horizontally) inter- in a transparent and predictable manner such that the act with one another to ensure they point to the same utility can conduct long-term planning. overarching sector objectives. BOX 4.6. CESAN’s Turnaround: Credibility Paves the Way for a New Corporate Culture Brazil’s Companhia Espírito Santense de Saneamento (CESAN), which serves about 4 million people in the state of Espírito Santo, experienced a successful turnaround between 2003 and 2011. At the start of the turnaround, CESAN’s newly appointed manager committed to stabilizing CESAN’s finances. By focusing both on cutting costs and increasing revenues, CESAN started generating profits only nine months after the manager had been appointed. With this credibility, the manager persuaded the governor to invest in CESAN and negotiate a repurchasing agreement to buy back CESAN’s shares. The governor also supported the manager’s decision to implement new management practices and thereby change CESAN’s corporate culture and revitalize the company. Source: Soppe, Janson, and Piantini 2018. 24 Reform and Finance for the Urban Water Supply and Sanitation Sector Countries with a federal structure have an additional agents responsible for implementation of reforms is layer of institutions and incentives to be harmonized. often the reason why many externally influenced Brazil’s experience has shown both the advantages and reforms are poorly implemented and ultimately fail to disadvantages as it has attempted to balance the federal change behavior.” This can be the case with exogenous government’s role in setting PIR incentives. National drivers of reform, especially cases where donors are sector strategies have unified heterogenous states heavily involved in the design of the reform program. toward common goals, but federal funding programs This was the case in Zambia where “textbook” reform have enhanced disparities among states in terms of WSS was not carried out as planned for lack of local institu- services. In contrast, the role of the federal government tional ownership, resulting in what the PIR calls in Australia was to instigate WSS reforms as part of “­isomorphic mimicry.” improving economic growth. The strategy created Align institutions. For example, regulatory frame- healthy competition among states through perfor- works should be designed considering the WSS ser- mance-based fiscal transfers to improve WSS services. vice delivery model and existing regulatory structures Approaches to Moving to Stage 4 outside of water. Regulation can have one or more objectives (improving service quality, controlling pol- Quantify the costs and benefits of different institutional lution, ensuring affordability) and, as such, can take arrangements, such as whether to decentralize service several forms (by contract or by agency, national or provision to the local level or to aggregate utilities into decentralized, multisector or single sector). The form larger providers. Regardless of the model, what is most and function of regulation determine both its costs important is the alignment of financial, governance, and benefits. The PIR framework promotes the con- and regulatory arrangements that will support the cept of “good enough” governance, showing that long-term rollout of the model and ensure stakeholder broad regulatory frameworks that exist in some commitment to the reform process. high-income countries tend to be too expensive and onerous. In the case of Brazil, where a regulatory vac- A road map for governments considering uum persisted from 1998 to 2007 in terms of formal aggregation of utilities into larger providers is institutions, national performance reporting and part of the Toolkit on the Aggregation of Water benchmarking tools were used to enhance transpar- and Sanitation Utilities. ency in an informal manner. Embed incentives. Incentives can be embedded in dif- Engage early and often. A wide spectrum of sector ferent mechanisms. For example, the UTF finds that stakeholders should be engaged in this important deci- initial utility improvements can be made without an sion-making process, as well as the specific planning overhaul of the legal framework. Once improvements and implementation of interventions. The PIR recom- were made to enhance the autonomy and credibility of mends starting with a “goal consensus” approach to the utility, they were followed by complementary help understand what is possible within the prevailing changes to the legal and regulatory frameworks (set- incentive structures. Reforms that require smaller, ting out possible service delivery model[s], institu- incremental changes that are less disruptive to the pre- tional roles and functions, and laws on PSP or vailing conditions are more likely to be sustained than commercial finance). In some cases, a strong policy sweeping reforms. aided successful reform; and in others, where a com- Understand the intrinsic incentives of individual actors. prehensive policy framework was absent, a strong set The PIR framework states that “(t)he exclusion of the of laws was sufficient. In Brazil, the alignment of laws Reform and Finance for the Urban Water Supply and Sanitation Sector 25 with funding programs toward common sector objec- Stage 4: Incentivizing Performance tives was enough to expand affordable access. The key Typical Challenges is that incentives are aligned and mechanisms do not Countries in this stage may be ready to reflect on which contradict one another. incentives have spurred progress toward sector out- Make the route to public accountability shorter. This is comes and which have not. The PIR framework con- an important principle for both the PIR framework cludes that reform is an iterative process that requires figure 4.2) and the UTF. Continuing with the regula- (­ significant learning and will inevitably lead to progress tion example, a fit-for-purpose regulatory frame- and reversals over time. Governments are best served work will also respond to the demands of local if they remain flexible and open to new ideas for con- citizens, which will help reinforce the accountability tinuous improvement and consider that what may of utilities toward their customer base. Ghana goes have worked in the past may not be right for today’s beyond just publishing utility performance data evolving conditions. online to using regulation to protect consumers, Governments may also need to reassess the status of resolve consumer disputes, and include stakehold- the sector vis-à-vis long-term goals or shifting policy ers in tariff reviews and decisions (Mumssen, Saltiel, objectives. Utilities that are already financially sustain- and Kingdom 2018). Citizens are an important part of able may need additional incentives to reach new mar- the PIR framework’s continuous feedback loop, kets, especially the poor. which demonstrates how the incentives generated by reforms both shape and are shaped by the broader Moreover, it may be necessary to take steps to ensure that enabling environment. progress already made is sustained by institutionalizing FIGURE 4.2. Incentives of Key Actors in the Water Supply and Sanitation Sector The state Political incentive to provide Providers dominate where they Policy services that are targetable, Politicians makers are monopolies, with a strong visible, and attributable to professional cadre, with high of account Co discretion and not easily political intervention route mp Long abil ity ac measured t ice Vo Citizens/clients Short route Providers Coalitions/inclusion Client power Management Nonpoor Poor Frontline Organizations Services Users’ control is greater where there is choice and the service is delivered within a local territory and is used frequently and predictably Source: Wild et al. 2012 as referenced in Mumssen, Saltiel, and Kingdom 2018. 26 Reform and Finance for the Urban Water Supply and Sanitation Sector the positive incentive structures and the processes and Build a professionalized sector based on performance procedures required to c ­ ontinue producing the desired improvement and accountability. As the MFD framework outcomes. For example, to ensure that utilities continue states, “incentives for improving efficiency come from to make the best business decisions, governments may policy makers and trickle down through local govern- consider reformulating rules and norms around technol- ments and service providers, including management ogy choice, service levels, or procurement. and technical staff,” which reinforces the PIR frame- work’s focus on intrinsic incentives. Approaches to Moving to Stage 5 The UTF recommends different types of incentives Monitor and benchmark utility performance. Investing in for  staff, including profit-sharing systems, prize data collection and management will support regulators systems, bonus policies, and large differentiation ­ to engage with utilities in a transparent and objective between salary grades as mechanisms for ensuring manner. Benchmarking can show differences in perfor- long-term staff development and delivery of targets. mance among similar utilities, helping point to the gaps ONEA uses performance objective contracts, signed and constraints that need to be addressed. between staff and their managers, as the basis for staff Performance monitoring also sets the foundation for evaluations, rankings, and promotions. long-term strategic planning or business planning, which was a key action for each of the successful UTF As the sector matures, consider advanced delivery case studies (box 4.7). For example, CESAN produces a ­ models, such as greater use of PSP. For example, corpo- ratization or commercialization of large utilities allows strategic plan in agreement with the regulator—ARSP— them to use a more business-oriented operational which is a basis for monitoring performance and is tied model, resulting in positive incentives to deliver better to tariff adjustments. services to customers. These incentives can be further enhanced by using PSP. The PIR framework concludes BOX 4.7.  eneral Sequencing of Successful G that PSP seems to have the added value of insulating Turnarounds utilities from political interference in their finances and management. 1. Establish a baseline as key input for business Forms of PSP are varied and include large-scale planning ­public-private partnerships (PPPs) for building, operat- 2. Set clear objectives and multiyear targets ing, and maintaining new infrastructure (leveraging 3. Develop sustainable business plans private finance), such as in the Philippines, and deliv- 4. Improve human resource and management infor- ery models that delegate management to the private mation systems sector (leveraging private expertise), as in the case of Mozambique. 5. Increase revenues and/or reduce costs PSP can also be used to help the utility meet a specific 6. Sign performance contract with government, objective like reducing NRW, which is a typical step defining improvements to be made and govern- taken to improve financial viability (figure 4.1). ment support to be provided Performance-based contracts (PBCs) for NRW reduc- 7. Make sizable capital investments tion are a low-risk tool for improving service quality Source: Soppe, Janson, and Piantini 2018. and financial sustainability of a utility and have been used worldwide. Reform and Finance for the Urban Water Supply and Sanitation Sector 27 growth for ONEA and thousands more people with The Use of Performance-Based Contracts clean and safe WSS services. (PBCs) for Nonrevenue Water Reduction (Kingdom, Sy, and Soppe 2018) is an operational manual for developing PBCs. Contractors are Stage 5: Going to Market paid for outputs such as the amount of water Typical Challenges saved, the number of customers receiving The aim of improving sector performance across Stages 1 continuous water supply, or the number of illegal through 4 is not only to spend public funds and tariff connections detected. revenues more efficiently but also to improve the financial viability of the utility to enable the sector to Encourage a higher rate of cost recovery through tariffs attract nonpublic sources of finance. Countries in Stage while balancing policy goals related to affordability 5 will see a greater portion of public funding and con- and  equity. Chile has had one of the most successful cessional finance being replaced by market finance. cases of sector reform, where the dual goals of finan- Public resources will then be freed up from the urban cial sustainability and equity were balanced through water sector to be invested in other priority areas such well-designed tariffs and subsidies (box 4.8). as WSS services in rural areas or supporting sanitation services in selective communities. In some countries, regulatory institutions may consider new tariff regimes that also build in capital costs for Stage 5 is not the end of the road for a country’s urban additional outlays to reach the unserved. In other coun- water sector. As new challenges arise, such as changing tries, there may be fewer or different types of barriers to demographics, climate, or customer demand, govern- extend access to the poor. For example, ONEA (Burkina maintain  or ments can continue making reforms to ­ Faso) looked to informal settlements as a potential new expand services in an affordable and efficient manner. market to increase revenues, rather than as a risk, given Even in cities with universal access to safe WSS services, the poor were already paying more than ONEA’s tariff to emerging threats, population growth, and the continual informal providers. ONEA built thousands of kilometers need for adequate maintenance will always require vigi- of pipeline to the perimeter of informal settlements and lance on the part of sector institutions. Furthermore, delegated construction inside the settlements to private capacity and political will are always required to make operators. This approach resulted in rapid revenue additional reforms. BOX 4.8. Successful Sector Reform Balances Efficiency and Affordability Chile’s 1980 Constitution codified the government’s desire to eliminate state subsidies for public services. This provided the impetus for a gradual shift from a public to a private model of water supply and sanitation (WSS) service provision, with utilities decentralized over a period of 20 years through a three-stage reform process. Reforms were sequenced to first ensure service efficiency and tariff setting to support financially healthy public operators. A 1988 law established a new tariff system based on the principles of equity, efficiency, and transparency. It mandated universal access while stating that tariff increases would be approved only in line with the marginal cost of service as applied to a model company. This forced operators to make efficiency improvements, which were translated into lower costs for consumers. At the same time, a consumer subsidy program was established to ensure the poor (comprising 15 percent of customers) could afford a basic amount of water. Source: Flores Ariasuijtewaal, Goksu, and Saltiel 2018. 28 Reform and Finance for the Urban Water Supply and Sanitation Sector Thus, the integration of new reforms within the pre- other benchmarking systems to help utilities assess vailing enabling environment will always be required and plan for improvements. to sustain progress. By embedding positive incentives Quantify the true costs and benefits of alternative financing and ensuring they are supported by new policies and schemes. Commercial finance is costlier than nonrepay- regulation, water sector institutions will continue to able government grants or subsidies and likely—but not meet more ambitious sector goals. Finally, the contin- always—costlier than concessional finance (box 4.9). On ued alignment of changes across policy, institutions, the other hand, the long-term benefits of commercial regulation, finance, and utility performance will help finance (for example, a more sustainable service pro- ensure that one aspect of the sector does not regress or vider, larger investment capacity, quicker access to com- become subject to political capture because of the next mercial finance, and a reduced need for public subsidies) economic, financial, or political crisis. most likely outweigh the difference in costs. Beyond Stage 5: Approaches to Sustaining Reforms Start by blending commercial and concessional finance. Move from financially viable to fully creditworthy. Under the MFD agenda, donors and governments will Creditworthiness, which implies that a utility can ser- have incentives to work together to identify and lever- vice its debt obligations, requires a reliable cash flow age the full spectrum of commercial financing mecha- from operations and cash reserves. As a general rule, nisms, such as blending commercial and concessional creditworthiness—as determined by potential lenders finance. Blending instruments can include grants; con- or independent parties—is more likely to occur for util- cessional loans and equity; and credit enhancement, ities that recover 150 percent or more of their operating such as guarantees. Blending can support different costs (Goksu et al. 2017). The process of moving up the types of commercial finance, including loans, microfi- ladder of financial sustainability (figure 4.3) will slowly nance, and vendor finance (a detailed list of the types open greater opportunities to leverage greater volumes of commercial finance is provided in Appendix A of commercial finance. Governments and donor agen- of Easing the Transition to Commercial Finance for cies can start by providing shadow credit ratings or Sustainable Water and Sanitation [Goksu et al. 2017]). Water Creditworthiness Initiative—Self—Assessment and Planning Toolkit Utility completes 1 creditworthiness questionnaire Toolkit suggests key 2 creditworthiness challenges based on self-assessment results Utility selects and ranks Utility re nes and implements 3 challenges based on 6 its action plan to strengthen their priorities its nancial performance and creditworthiness Toolkit guides utility Utility receives customized 4 5 creditworthiness self-assessment through options to address creditworthiness challenges and preliminary action plan report Source: http://www.watercred.org. Reform and Finance for the Urban Water Supply and Sanitation Sector 29 FIGURE 4.3. Improved Financial Performance Changes the Mix of Financing Sources Service providers Financing sources Fully creditworthy Higher borrowing cost More commercial viable More Commercial Dononpublic credit nance Becoming creditworthy enhancements Financially sustainable Co nc es na sion nc al e Lower borrowing cost Operating cost recovery Less commercial Less viable pay-as-you-go recovery of cash outlays Grants Unviable/loss making BOX 4.9. The Cost of Commercial Finance The Maximizing Finance for Development (MFD) framework concludes that though concessional finance is generally offered at lower interest rates than commercial finance, it does not necessarily cost a country less in the long run, especially when commercial finance can be provided in local, rather than foreign, currency. Governments should carefully consider all relevant factors, including tenor and grace periods and currency risk, when determining loan affordability. Blending will require a paradigm shift in the way devel- short-term efficiency improvement projects, before opment institutions function. As the PIR framework capital investment funds are tapped to expand infra- acknowledges, the intrinsic incentive of donor agency structure. Bilateral and multilateral donors must ­better staff is to maximize the volume of concessional lending. align efforts within a country to ensure their programs The MFD approach turns this incentive structure on its are working with the same timeline and toward the head, asking agencies to step back from lending to same MFD goals. financially sound utilities and rather use their resources Broker partnerships between borrowers and lenders. more strategically to crowd in commercial finance. Instruments such as tenor extensions, project prepara- Coordinate across donor agencies. MFD inherently pro- tion facilities, and output-based aid can be used to motes the proper planning for reform in a logical make commercial finance more affordable for utilities. sequence under one long-term sector blueprint. For Donors can also help de-risk the sector for potential example, technical assistance grants should be focused financiers by designing transactions that use insur- upstream, such as for the application of the UTF and ance, hedging instruments, or guarantees. 30 Reform and Finance for the Urban Water Supply and Sanitation Sector Chapter 5 Bringing It All Together T he urban water maturity ladder (figure 5.1) set informal institutions should not be discounted because out here combines three distinct global frame- they often substitute where formal institutions are works—Maximizing Finance for Development weak. Understanding context goes beyond the written ­ (MFD), Utility Turnaround Framework (UTF), and rules and formal institutions and should include a (PIR). The ladder, Policy, Institutional, and Regulatory ­ study of the de facto functioning of the sector, includ- in synthesizing the key elements of each framework, ing political economy influences and informal rules of puts forth a series of actions to move up to higher game. This also extends to sector funding, which the ­ maturity. As a simplified version of stages of sector ­ will have implicit and explicit incentives that impact the maturity matrix (appendix B), the ladder empha- ­ unction. the way institutions f sizes the most critical aspects of reform: leadership reform. All Capacity is almost always the first barrier to ­ and political commitment, capacity, efficiency, perfor- three frameworks recommend investing in people and mance incentives, alignment, and ­ harmonization. institutions before pouring more public money into Although each framework approaches urban water ­ ector. The difference between de jure the urban water s sector reform from a unique vantage point, there are and de facto functioning of sector institutions, a theme several common principles and approaches that can be seen across several unsuccessful reform efforts, comes summarized as follows: down to whether interventions are designed through an inclusive process and are commensurate with the The first step in any reform process is to identify the capacity. institution’s human resource and financial ­ existing problems and to understand how the prevailing political economy context constrains positive sector Reforms should be inclusive, designed through a com- ­outcomes. Countries should, according to the PIR prehensive stakeholder buy-in ­ process. The PIR frame- framework, take a “problem-driven approach based on work emphasizes the need for “broad engagement” constraints.” The UTF recognizes the need to binding ­ across the wide spectrum of sector ­ actors. Regulatory first assess institutional strength and then plan mechanisms are important for improving transpar- improvement programs based on performance ency with the aim of protecting consumer i ­nterests. ­ measurement. Similarly, the MFD posits that a full The UTF mirrors this concept by recognizing how cus- assessment of how public resources are being spent is tomer engagement should guide performance critical to engaging decision makers in discussions on ­ improvements. A critical part of reform at the sector ­ reform. As such, the identification stage in and of itself and utility level is the feedback loop, whereby the can provide the critical first steps to build stakeholder dynamics between institutions are shaped by underly- ­consensus. ing governance structures and political economy ­factors. context. Each framework con- Work within the current ­ cludes that there is no “best practice” formula for suc- ­ ossible. Quick wins help garner addi- Start with what’s p cessful ­ reform. Rather, countries should look for the tional support for even deeper ­reforms. The UTF recom- “best fit” for the prevailing ­ conditions. In the unpack- mends that short-term actions, which yield high-impact ing of the complex enabling environment, the role of results, be used to initiate a turnaround  ­ effort. Reform and Finance for the Urban Water Supply and Sanitation Sector 31 FIGURE 5.1. Maturity Ladder for the Urban Water Sector Stage 5: Go to the market Illustrative actions for moving up the ladder: (less public, more private money) • Introduce blended nance options • Consider more sophisticated delivery models (corporatization, PPP) • Develop shadow credit rating system • Achieve sector nancial sustainability Policy, Institutional, and Regulatory (PIR) interventions • Monitor and benchmark performance • Conduct strategic action planning Utility technical and operational performance Stage 4: Incentivize performance • Engage the private sector as a potential technical or nancial partner (for public and private sector) • Redirect subsidies to reach the poor • Use performance-based contracts • Adjust tari s • Leverage results-based nancing • Embed policies in the legal framework • Abandon perverse subsidies Stage 3: Align institutions and • Engage customers early and often incentives (harmonize and embed) • Ring-fence utilities • Back sector goals with consistent and transparent subsidies • Clarify policy direction and targets • Achieve nancial viability (OCCR > 1.2) • Reduce NRW Stage 2: Build capacity • Create an information base (invest in people rst) • Build regulatory enforcement capacity • Fully resource sector institutions • Hire based on merit and skill • Identify strong sector leaders and champions • Improve metering • Cut energy and labor costs Stage 1: Battle ine ciencies • Increase billing and collections (understand barriers to reform) • Conduct a political economy analysis partnership. Note: NRW = nonrevenue water; OCCR = operating cost coverage ratio; PPP = public-private ­ This means that actions that cost less and require lower process. Similarly, the MFD framework requires a the ­ political capital should precede those with higher polit- gradual progression away from perverse subsidies ­ ical and financial ­ costs. Cutting utility operating costs is creditworthiness. and  toward financial viability and ­ a typical first intervention, but in some cases, even PIR, on the other hand, is more of an “art” in that it these changes will require some adjustments in the requires iteration and dynamism with more room for ­ tructures. Incremental change is broader PIR incentive s ­ equence. variability in s best because staff—whether they sit in a development Align institutions and incentives to ensure a comprehen- agency, a utility, or a regulatory institution—are more sive reform ­ program. Isolated interventions can under- likely to implement policies that do not require large- mine one another if they are not h ­ armonized. PIR scale ­restructuring. interventions should not just point in the same policy program. Although There is no one-size-fits-all reform ­ direction but should work in tandem to achieve spe- context is incredibly important, successful utility cific sector g ­ oals. When interventions are not aligned, ­ turnarounds had a relatively structured sequence with ­ncentives. they often lead to perverse or distorted i key actions taken in roughly the same order, pointing Moreover, well-designed incentives do not always to the idea that there is somewhat of a “science” to ­ esponse. Decision makers should yield the expected r 32 Reform and Finance for the Urban Water Supply and Sanitation Sector carefully follow and measure the result of incentive incentives should be well understood and, in the case ­ eeded. setting and course correct as n of MFD, will need to be changed to align with new ­strategies. Under the right governance and regulatory frameworks, the private sector can be a productive partner in achiev- Comprehensive reform requires flexibility, learning, and ing sector ­ goals. Chile is an excellent case in ­ point. ­endurance. The PIR framework concludes that “reform Private sector participation (PSP) enabled very rapid is not an event or a linear process … but relies on incor- improvements in wastewater treatment l ­ evels. porating a high degree of ­ learning.” Those countries However, before PSP was aggressively promoted that adapted to change, and that continually searched through legal reforms in 1990, coverage rates in urban for the most practical next steps, were the ones with areas were already brought very high through effi- ­ rograms. Realizing the the most sustainable reform p ciency improvements by public utilities (97 percent for full effects of sector reform in New South Wales, water, 84 percent for ­sanitation). It is important to note ­ ears. Australia took more than 30 y that a strong regulatory framework and institution outcomes. Finally, institutionalization yields sustainable ­ were in place, and these were continually strength- Reforms are not single actions taken once to improve ened alongside greater use of P ­ SP. eternity. They are changes to the sector outcomes for ­ reform. The conclusions of both the UTF People drive ­ foundational structures of the sector, institutionalized and PIR framework prioritize the role of individuals ­ ystems. Embedding positive through processes and s institutions. Utilities that understand what within ­ incentives into the practices of institutions protects motivates their staff—and link institutional perfor- them from future attempts at predation or the co-­ mance to those motivations—are likely to see quicker gain. opting of those institutions for political ­ change. And individual leaders—including political ­ Institutionalization also safeguards against backtrack- champions and competent utility managers—are a pre- ing on the reform program in the face of future politi- requisite for positive reform o ­ utcomes. Intrinsic cal, economic, or financial ­ crises. Reform and Finance for the Urban Water Supply and Sanitation Sector 33 Chapter 6 Conclusion M any countries have committed to achiev- The cases studied in the three global frameworks— ing ambitious water supply and sanitation related to utility turnaround, sector reform, and sector (WSS) goals by 2030, including expanding finance—indicate that there are multiple pathways to services. These access to and improving quality of ­ ­reform. And while reform programs must be ­tailor-made goals must be achieved under the duress of rapid for each local context, the research shows a few com- change. Meeting them will urbanization and climate ­ mon prerequisites for success, such as understanding of cost upward of three times the current level of sector broad political economy structures, competent leader- ­investment. ship, alignment and embedding of incentive structures, a focus on performance, and a long-term commitment With governments strapped for cash, they will be ­ uo. to moving away from the status q unable to satisfy the growing demand through tradi- tional a ­ pproaches. A paradigm shift is needed to attract Progress can be made if individual interventions are more money to the sector, and it starts with changing harmonized, such that incentives across institutions the way public money is ­ spent. ­ ligned. Key to harmonizing interventions is to put are a money behind the policies and programs that aim to Changing the way governments approach meeting shape sector outcomes and to embed sector changes their water-related Sustainable Development Goals frameworks. across the legal, regulatory, and policy ­ ­ ays. First, by taking a holistic (SDGs) can help in two w A  long-term (20-year) planning horizon works, and view of sector reform, they can tackle the major foun- all  donors should be brought in early to help design dational issues—utility performance and governance coordinated interventions in s ­ ­ equence. and institutions—that have stifled the sector for decades. Second, by taking a Maximizing Finance for ­ Governments can take steps today to begin to assess, Development (MFD) approach, they can use their interventions. A good plan, and implement sector ­ funds as a positive incentive, turning what used to be starting place is with the maturity ladder for the urban a perverse subsidy into a tool to leverage commercial water sector, which points readers to the most typical ­finance. challenges and approaches that are found in more detail across the Policy, Institutional, and Regulatory Successful and sustainable reform is not only possi- (PIR); Utility Turnaround Framework (UTF); and MFD ble; it is within ­ reach. From Australia to Benin, coun- resources. tries have transformed an inefficient urban water sector to a commercially viable sector with the Improving water sector performance will be neither autonomy and independence to attract its own easy. But by first assessing the maturity level quick nor ­ financing. And individual utilities across sources of ­ of their urban water sector, countries will be able to Burkina Faso, Brazil, and Vietnam have implemented identify barriers to success and create the new incen- turnaround programs by working within the broader tives needed to take one more step up the ­ ladder. enabling environment, allowing the government to Ultimately, building a transparent urban water sector redirect scarce public resources to other priorities for with creditworthy utilities will put countries on the poverty ­reduction. ­ DGs. right path to attaining the S Reform and Finance for the Urban Water Supply and Sanitation Sector 35 References Flores Ariasuijtewaal, Berenice Brigitte, Amanda Joan Goksu, and Gustavo Ogus, A. 1994. Regulation: Legal Form and Economic Theory. Oxford, UK: Saltiel. 2018. “Incentives for Improving Water Supply and Sanitation Hart Publishing. Service Delivery: A South American Perspective.” Water Global Practice Pories, Lesley, Catarina Fonesca, and Victoria Delmon. 2019. “Mobilizing Knowledge Brief. World Bank, Washington, DC. Finance for WASH: Getting the Foundation Right.” Water.org; IRC, The Goksu, Amanda, Sophie Trémolet, Joel Kolker, and Bill Kingdom. 2017. Hage, The Netherlands; and World Bank, Washington, DC. “Easing the Transition to Commercial Finance for Sustainable Water and Rozenberg, J., and Marianne Fay, eds. 2019. Beyond the Gap: How Sanitation.” World Bank, Washington, DC. Countries Can Afford the Infrastructure They Need While Protecting the Planet. Washington, DC: World Bank. Hutton, Guy, and Mili Varughese. 2016. “The Costs of Meeting the 2030 Sustainable Development Goal Targets on Drinking Water, Sanitation, Salisbury, Chris, Brian W. Head, and Eric Groom. 2017. “Australian Urban and Hygiene: Summary Report.” World Bank, Washington, DC. Water Reform Story: with Detailed Case Study on New South Wales.” World Bank, Washington, DC. Kingdom, Bill, David Lloyd-Owen, Sophie Trémolet, Sam Kayaga, and John Ikeda. 2018. “Better Use of Capital to Deliver Sustainable Water Soppe, Gerhard, Nils Janson, and Scarlett Piantini. 2018. “Water Utility Supply and Sanitation Services: Practical Examples and Suggested Next Turnaround Framework: A Guide for Improving Performance.” Steps.” World Bank, Washington, DC. World Bank, Washington, DC. Kingdom, Bill, Jemima Sy, and Gerhardus Soppe. 2018. “The Use of United Nations. 2018. World Urbanization Prospects: The 2018 Revision. Performance-Based Contracts for Nonrevenue Water Reduction: Output Key Facts. New York: United Nations. of the Global Program on Developing Good PBC Practices for Managing WaterAid. 2016. “Water: At What Cost? The State of the World’s Water NRW.” World Bank, Washington, DC. 2016.” Briefing. WaterAid, London. Kolker, Joel Evan; Bill Kingdom, Sophie Trémolet, James Winpenny, and Winpenny, James, Sophie Trémolet, Rachel Cardone, Joel Kolker, Bill Rachel Cardone. 2016. “Financing Options for the 2030 Water Agenda.” Kingdom, and Lyndsay Mountsford. 2016. “Aid Flows to the Water Sector: World Bank, Washington, DC. Overview and Recommendations.” World Bank, Washington, DC. Leigland, James, Sophie Trémolet, and John Ikeda. 2016. “Achieving World Bank. 2019. “Shimla Water Supply and Sewerage Service Universal Access to Water and Sanitation by 2030: The Role of Blended Delivery Reform Program Project Appraisal Document.” World Bank, Finance.” World Bank, Washington, DC. Washington, DC. Mumssen, Yogita, Gustavo Saltiel, and Bill Kingdom. 2018. “Aligning World Bank and UNICEF (United Nations Children’s Fund). 2017. Institutions and Incentives for Sustainable Water Supply and Sanitation “Sanitation and Water for All: How Can the Financing Gap Be Filled?” Services.” World Bank, Washington, DC. World Bank, Washington, DC; UNICEF, New York. Reform and Finance for the Urban Water Supply and Sanitation Sector 37 Appendix A Reference Tools and Documents Initiative Name of tool/document PIR framework Aligning Institutions and Incentives for Sustainable Water Supply and Sanitation Services (Mumssen, Saltiel, and Kingdom 2018) Other PIR-related Incentives for Improving Water Supply and Sanitation Service Delivery: A South American Perspective (Flores reference tools Ariasuijtewaal, Goksu, and Saltiel 2018) Institutional diagnostic tool Body of Knowledge on Infrastructure Regulation Australian Urban Water Reform Story: with Detailed Case Study on New South Wales (Salisbury, Head, and Groom 2017) PIR case studies for: Argentina, Brazil, Chile, Colombia, and Peru (unpublished) MFD framework Easing the Transition to Commercial Finance for Sustainable Water and Sanitation (Goksu et al. 2017) Other MFD-related Public-Private Partnership Legal Resource Center reference tools Achieving Universal Access to Water and Sanitation by 2030: The Role of Blended Finance (Leigland, Trémolet, and Ikeda 2016) Financing Options for the 2030 Water Agenda (Kolker et al. 2016) Aid Flows to the Water Sector: Overview and Recommendations (Winpenny et al. 2016) Training courses on creditworthiness and financing access Sanitation and Water for All: How Can the Financing Gap Be Filled? (World Bank and UNICEF 2017) Mobilizing Finance for WASH: Getting the Foundation Right (Pories, Fonesca, and Delmon 2019) Better Use of Capital to Deliver Sustainable Water Supply and Sanitation Services: Practical Examples and Suggested Next Steps (Kingdom et al. 2018) Training course on financial analysis for water utilities Water Creditworthiness Initiative—Self-Assessment and Planning Toolkit UTF Water Utility Turnaround Framework: A Guide for Improving Performance (Soppe, Janson, and Piantini 2018) Other UTF-related Water Utility Turnaround Framework: Volume II (unpublished) reference tools The Use of Performance-Based Contracts for Nonrevenue Water Reduction (Kingdom, Lloyd-Owen, et al. 2018) Note: MFD = Maximizing Finance for Development; PIR = Policy, Institutional, and Regulatory; UTF = Utility Turnaround Framework; WASH = water supply, sanitation, and hygiene. Reform and Finance for the Urban Water Supply and Sanitation Sector 39 Appendix B Maturity Matrix for Urban Water Reform Reform and Finance for the Urban Water Supply and Sanitation Sector 41 Maturity Matrix for Urban Water Reform Color coding refers to actions listed on various stages of the maturity ladder for the urban water sector (figure 5.1) Topic: Stage 1: Battling Stage 2: Building capacity Stage 3: Aligning institutions Stage 4: Incentivizing perfor- Stage 5: Going to the market 42 ­inefficiencies mance Policy Policy direction; Policy framework with sector goals Institutional setup; policies Efficient procurement with Stable policy environment with national strategy; good and targets backed by consistent harmonized and embedded in other flexible technology selection; policies periodically refreshed to understanding of the financing policy (transfers/budget); frameworks (institutional/legal/ performance-based financing capture changing social contracts at underlying political decentralization/aggregation/PPPs regulatory); capital subsidies aligned policy with incentives for utility national level; pro-poor subsidies economy constraints and with sector goals; economic and efficiency improvements/ to reach new service areas; barriers to reform social tariff policy; vertical (national/ sustainable universal coverage; implementation of PPPs subnational) alignment perverse subsidies abandoned Finance Grants to increase service Grants to achieve minimum service Performance-based grants for Strategic financial planning; Blended finance; financial coverage and improve standard; fiscal transfers/subsidies utilities; work toward financial matching grants to encourage sustainability; loans; more market performance allocated in a transparent manner; viability; results- based financing to nonpublic finance; guarantees; finance replacing public finance; public utilities ring-fenced increase coverage shadow credit ratings resources freed up for other uses Regulation Regulatory impact analysis Institutional capacity strengthened for Utility performance improved Broadened regulatory scope to Norms and methods to monitor to clarify regulatory regulatory enforcement; information through regulatory functions include additional responsibilities creditworthiness established to raise objectives, forms, functions, base created including performance monitoring, such as accounting for the capital through available markets; new costs and benefits of benchmarking, and appropriate regulatory asset base, gradually regulations address emerging threats regulation, and opportunities performance incentives; public installing protocols to cover or cover alternative service providers/ for incentivizing utility engagement through hearings or other capital and operating expenditures differentiated services performance mechanisms; tariffs; adjusted as needed through tariffs and business plans Institutions Institutional framework Strong leadership identified; institutions Service providers ring-fenced; High level of institutional Institutions have strong credibility; Reform and Finance for the Urban Water Supply and Sanitation Sector enables separation of have sufficient resources to carry out technical capacity embedded coordination between levels of professional capacity well-established functions; roles and their core duties; active program of in institutions; institutions fully government; de facto institutions and respected; can proactively responsibilities delineated; training and capacity building to fulfill resourced; legitimacy established; operate as they were intended adapt to changing environment; supported by legal mandates; hiring based on merit and legal framework enables (de jure) corporatization of large service framework that enables skill; decentralization/aggregation implementation of any new policies; providers; leverage private sector institutions to carry out backed by funding and legal and private sector considered as skills, investment, and financing their core duties institutional reforms productive partner Utilities Focus is on improving access Vision and mission clarified; billing and Customer orientation/engagement; Clear customer processes; Customer needs serviced; and arresting declining collections improved; more systematic intermittent service improved; NRW business decisions reflect creditworthy; culture of improved coverage; some customer metering; limited routine maintenance; reduced; use of performance-based economic efficiency; performance; full-cost recovery; metering; rely on minimal water losses managed; energy and contracts for PSP; strategic metering; transparency; IT/MIS/ comprehensive network management; and erratic cash ­ surplus labor costs falling; moving away from plan for improving cost coverage ratio; GPS improved; financial new technologies pursued and intermittent supply multiyear business plan viability; performance-based deployed compensation; budgeted O&M; NRW management Note: GPS = global positioning system; IT = information technology; MIS = management information system; NRW = nonrevenue water; O&M = operation and maintenance; PPP = public-private partnership; PSP = private sector participation. SKU W19041