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Water Financing - Bridging the Credibility Gap
Address by Lakshmi Venkatachalam, Vice-President (Private Sector and Cofinancing Operations), Asian Development Bank, at Session 5: Financing to Address the Global Water and Sanitation Crisis1, Budapest Water Summit, 11 October 2013.
Colleagues, good morning.
A weak water outlook
It is an honor for me to talk to you today about bridging the credibility gap in financing the water sector. Before getting into the specifics, I would like set out the context of water security, which broadly encompasses managing water competently as a resource, and efficiently delivering water as a service.
Earlier this year, ADB and the Asia-Pacific Water Forum published the Asian Water Development Outlook 2013 or AWDO. The report provides the first quantitative and comprehensive analysis of water security in Asia on a country-by-country basis. Let me clarify that by "water", I mean "water supply, wastewater management and sanitation' services. AWDO examines all dimensions of water security from the household-level to water-related disasters, and uses indicators (and a scaling system) to rank the progress of each of the 49 countries assessed.
The findings of the AWDO are striking. More than 75% of the countries studied suffer a serious lack of water security. Many face an imminent water crisis unless immediate steps are taken to improve water resource management in a more holistic way.
None of the countries have reached a “model” stage of water security; this should be at the back of minds during our deliberations today. More importantly, the region needs $59 billion in investments for water supply and $71 billion for improved sanitation.
Defining the gap
There is therefore an urgency to our discussion on financing water and sanitation. Around 1.8 billion Asian people lack access to improved sanitation and access to clean water. And this “service gap” poses extreme challenges to public health and the environment.
Asian and Pacific countries need to hugely increase investments in water infrastructure. But most governments, unfortunately, only spend 3-4% (sometimes even lower) instead of the recommended 6-7% of their annual GDP on infrastructure sector as a whole. This creates a huge gap in investment, which will have to be filled by private funding or other means. However, the private sector currently accounts for only about 20% of infrastructure spending, while 70% comes from public funding, and the remaining 10% from Official Development Assistance. This practice is not sustainable – particularly for the water sector, which is bedeviled by low user-fees. The finance gap is thus quite significant and needs to be redressed urgently.
In all of this, we should remember that our water services providers or utilities are the gateway to successful service delivery. But they are also the principle “bottleneck”. Money needs to be invested in our utilities in order to bridge the finance gap. However, many utilities are neither robust enough to attract financing in the first place, nor able to use funds in an efficient and prudent manner. Until this is addressed the sector will lack credibility as a recipient of public sector support, and a destination for private sector engagement and investment.
In no other part of the "business" of water do utilities need to work harder than in improving their “bankability”. Some confuse this as developing “bankable projects” – but this misses the point. While bankable projects are a prerequisite, our utilities need to evolve into "bankable" businesses, be they public- or private-sector entities. Without this transformation the sector will remain an investment “dead-end”.
A growing body of evidence shows that success follows when agencies have transformed themselves into corporate entities, or have adopted a corporate approach to their operations. Cambodia's Phnom Penh Water Supply Authority, for example, has made a remarkable evolution from a failing state-owned entity to a peak-performing, world-class, government-owned utility.
Such approaches work – not only in our larger cities, but also in secondary towns and cities. In Lao People’s Democratic Republic, ADB has been helping provincial utilities (or Nam Papas) to become corporate entities under the "Enterprise Law". The Small Towns Water Supply and Sanitation Sector Project helps set tariffs at levels that will enable Nam Papas to recover the costs of operations and maintenance, debt servicing, and gradually increasing levels of depreciation. It also includes minimum service level targets, regulatory reporting and funding arrangements, and possibly an automatic tariff adjustment mechanism.
In contrast to the limited investment in water, we have seen very extensive investment in power. The key difference is that power is generally a central government sector with a central government off-taker, and associated guarantees. Water is typically a municipal affair, which means that the credit profile is normally very poor, and the utilities and their projects are almost always "unbankable". Over and above this, cost-recovery in power is generally better than water. It follows that vigorous policy reform and redesigning of the management framework of utilities to enable flow of investments is an imperative for efficient and sustainable development of the water service industry.
Utilities with sustainable cash-flows will find it much easier to draw investment from all sources for expanding services. The fundamental success factor is setting – and then getting – the right price to deliver a service, with full cost-recovery as the goal. Appropriate pricing policy stabilizes approaches to long-term investment and drives conservation in water consumption. The key step is to determine the actual cost of water services, and mobilize the necessary support for implementing cost recovery over a staged and considered timeframe.
The financial sustainability of water companies has been hampered by low tariffs. Local political considerations often prevent the timely application of tariff adjustments. At ADB, we strive to convince our developing member countries that change is possible and feasible. For example, under an ADB-financed project in Viet Nam2, there has been a 70% tariff increase in Ho Chi Minh City over the last five years and a one-off increase of 85% in Da Nang.
Under this project and many others, study after study of “affordability” and “willingness-to-pay” have indicated that consumers are prepared to pay for improved services, especially poor people living in peri-urban areas. And they are better able to pay when upfront costs are levied on more flexible terms, such as installments. Ultimately, water services can be financially viable when they are customer-oriented and worth paying for. The bigger issue is not “willingness to pay”, it is “willingness to charge".
This is not an easy process, however we must start somewhere.
Getting the basics right
We should not forget that engineering-led interventions can also improve operational performance and hence “bankability”. Non-revenue water or NRW is a proxy benchmark for assessing a utility’s performance. The estimated annual volume of NRW in urban water utilities in Asia is on the order of 29 billion cubic meters. Assuming a value of US$0.30 per cubic meter, Asia’s water utilities are losing nearly US$9 billion per year. This cannot be ignored. Most utilities in the region have a great deal of room for improvement here. In Sri Lanka, ADB’s Water and Wastewater Management Improvement Investment Program for Greater Colombo is seeking to reduce NRW as one of the outputs. It is anticipated that citywide NRW 49% will be reduced to 20%.
Tapping the private sector
As for attracting private sector investment, the key is greater political will – the will to put in place the enabling conditions, and set appropriate tariffs. Ultimately, this begins with clear policies, fair and transparent performance standards and regulations, and the empowerment of providers to perform their mandated function. The clever thing to do would be to translate these efforts into financial returns for investors and operators, and to allow the markets to grow and fill the gap (in finance and management expertise).
There are many ways to stimulate interest from the private sector. It is important to “package” engagement in ways which meet both public- and private-sector expectations. A good example of this is the use of performance-based contracts, against which the private sector can deliver. ADB is promoting this approach to improving water supply services under its North Karnataka Urban Sector Investment Program in India.
Many governments do need some help to stimulate engagement with the private sector. ADB’s projects in Ho Chi Minh City and Da Nang include operation management contracts under the loan to specifically involve the private sector. The Government of Viet Nam is developing public-private partnership or PPP legislation to increase private sector financing and improve the level of service. The first projects to be financed under this new legislation will be in the water and sanitation sector.
In countries where a PPP framework is well developed, ADB has been able to successfully advance loans without recourse to sovereign guarantees to the private sector sponsors to enable them to pursue their expansion and modernization plans. In the People’s Republic of China, for example, such loans are extended to holding companies that have onshore and offshore facilities. These companies then lend onward to subprojects in municipal areas where the sponsor has been able to secure the concession for water distribution.
If allowed to do so, this is where the private sector can excel. It can drive the adoption of new business models and uptake of technology to improve service levels and expand service coverage. In China, which is experiencing severe water scarcity, a potential solution lies in the treatment and reuse of waste water. As an example, ADB will assist Beijing Enterprises Water Group to treat 600 million tons of wastewater annually to Grade 1A (National Standard), which can then be reused for industrial and urban environment purposes. This is ADB’s first private sector intervention to water reuse, and it promotes an integrated approach to wastewater management. Needless to add, this project is supported by a robust policy framework. Under its 12th Five-Year Plan for National Urban Wastewater Treatment and Reuse Infrastructure Construction, the Government aims to (i) build centralized wastewater facilities in all cities and counties; (ii) increase the wastewater treatment rate to 85% in cities and 70% in counties; and (iii) increase the wastewater reuse rate to at least 15% -- all by 2015.
Addressing sanitation is a more challenging task: Starting in 2007, ADB stepped up its efforts to address hygiene, household and environmental sanitation. Since then, the issue has been tackled on three fronts, namely greater advocacy, increasing knowledge of solutions and through projects. This year, the Bill & Melinda Gates Foundation agreed to establish the Sanitation Financing Partnership Trust Fund. The fund will support ADB’s pilot implementation of innovative sanitation solutions to increase support for non-networked sanitation and septage management in our developing member countries.
You will appreciate that maintaining the status quo in water sector on a gradualist approach is no longer a realistic or preferable option. Water is and will continue to be an important investment theme for public, multilateral and private financial institutions in the coming years. Overcoming barriers to investment requires a transformational vision and active orientation on the part of all stakeholders.
Bridging the gap3
ADB plans to invest $14 billion in water related infrastructure, governance and capacity development through our Water Financing Program by 2020. We aim to use these investments to leverage external sources of finance, including bilateral official sources and private sector finance. We will complement the financing by sharing knowledge on water security issues and their solutions. Together, these represent a “Finance++” model: finance plus leverage plus knowledge.
Building “bankable” utilities will address the credibility gap and help deliver the necessary infrastructure to expand service coverage to those communities which need it most, typically the poor and underserved. It will drive enhanced service and financial sustainability, and build initiatives to transfer utilities into well-managed entities.
Ladies and gentlemen, I have in this overview touched upon several aspects of water sector financing and ADB’s recent efforts to address all relevant areas for improving the investment environment for modernization and expansion of facilities for water distribution, waste water treatment and reuse in the public and private sector. I would like to close by quoting President Nakao of ADB at the recently concluded 2nd Asia-Pacific Water Summit. He said: “innovative, inclusive, and integrated solutions for our water security challenges are available in the region. However, because so many agencies are involved and the issues complex, these solutions require leadership at the highest level of government……. Strong, diverse partnerships and good governance will deliver the best results. Empowering civil society and women leaders will add to the success.” Bridging the credibility gap in water finance will be an important step in solving the overall water security challenges in our region.
1 Full session title - "Investment in and financing to address the global water and sanitation crisis and related SDG"
2 The Water Sector Investment Program 2011 - 2020
3 In each year to 2020, ADB plans to invest US$2 billion in water-related infrastructure, governance and capacity development through our Water Financing Program. ADB will provide access to financing to utilities to help them improve their operations and expand service coverage.