Global Policy Forum

By David Hall
Public Services International Research Unit, University of Greenwich

Preface

PSI is the global confederation that represents the world's water workers, through our 510 affiliated unions in 154 countries. Those workers are intimately involved in, and deeply concerned by, the decisions taken by politicians and water managers.

Decision-makers are now under increasing pressure to contract the operation of water systems to the private sector, usually through a concession or management contract. The water division of the World Bank, the multinational water companies themselves, and bodies such as the Global Water Partnership have all argued that the solution to water problems is always in the private sector – whether it is called privatisation, public-private partnership (PPP) or private sector participation (PSP) .

This orthodoxy is now virtually compulsory for developing countries. Both the World Bank and the IMF impose privatisation in some form as a pre-condition for funding water and sanitation. The institutions are saying, in the words of Mrs Thatcher: ‘there is no alternative'.

PSI is publishing this guide as a counter to these theoretical and commercial publications which advocate a central role for the private sector . This guide is the result of research conducted by the Public Services International Research Unit (PSIRU) at the University of Greenwich in the United Kingdom. It is based on extensive empirical observation of what has happened, not on a pre-determined ideological position. It shows simply the problems experienced with private sector involvement, and also the real achievements of public sector water and sanitation systems. Finally, it shows the potential for development and capacity-building through using the experience and know-how of the public sector, through public-public partnerships (PUPs).

PSI believes that it shows why the private sector should not dominate decision-making. Water and sanitation systems are essential in sustaining life, in social progress, and for economic development. Access to water should not be left to market forces, which affect too heavily the basic questions of who gets water (only those who can afford to pay), the impact of water decisions on the environment, and a range of other questions. Water should remain a public good, owned and operated by the public sector.

Hans ENGELBERTS
General Secretary
Public Services International

Acknowledgements
The booklet has benefited greatly from the comments on an earlier draft by a number of people, including Guus Actienribbe, Karen Bakker, David Boys, Steve Bloomfield, Jan-Willem Goudriaan, Roland Werchota and others. The author owes a special debt to the work of Emanuele Lobina, who has collaborated in much of PSIRU's research on water. Any faults that remain are the responsibility of the author.

Executive Summary

Many organisations encourage developing countries to privatise water through some form of public-private partnership (PPP) or private sector participation (PSP). The alternative of a public sector water undertaking (PWU) is ignored, although public sector water undertakings are the providers of water and sanitation services for the great majority of the population in developed countries.

Ignoring this option means that the main competitor to any of the private companies is being excluded. Yet there is evidence of problems with PPPs, and evidence that the public sector can successfully operate PWUs in developing countries, which the booklet sets out. Decision-makers are advised to follow three rules:

- Always construct and consider a public sector option.
- Always evaluate any PPP proposal against a public sector option, in a public process.
- Avoid secret agreements and secret contracts.

There have been problems with privatised management of water systems through all forms of PPPs, whether concessions, leases, management contracts, or build-operate-transfer (BOTs). These include:

- a lack of competition, with two globally dominant multinational companies
- higher prices, often caused by privatisations used to make debt reductions
- difficulty in terminating unsatisfactory concessions
- poor results from private management
- private sector reluctance to extend water and sanitation access to the poor
- multinationals use of water profits to subsidise other global investments
- difficulty in regulation, lack of transparency, secrecy and cases of corruption

Public authorities have been able to operate successful PWUs in transition and developing countries, as well as in developed countries.

- PWUs score well on efficiency indicators, and have better public support
- a PWU can take various forms, ranging from a department to a corporatised body
- transparency, accountability and defined managerial autonomy can be built in
- business plans and pricing policies can include a range of cross-subsidies
- PWUs can turn around their finances and improve collection of bills.

Examples of good practice by PWUs are drawn from cities in a diverse range of countries, including Sao Paulo, Brazil; Debrecen, Hungary; Lilongwe, Malawi; Tegucigalpa, Honduras.

Raising finance for investment is a key issue for any water undertaking. A range of sources is available to both private and public sector operators, including internally generated surpluses, government grants or loans, bank loans and bond financing, and aid agencies. Special municipal development funds may also be used. The development banks, including the World Bank, can and do make loans for investment by PWUs, but conditionalities may create a political obstacle. Lenders use defined criteria for making loans. PWUs may be able to get loans on terms as good as the private sector.

Where there is a need for managerial capacity-building it can be done through ‘public-public partnerships' (PUPs), without the need to hand control to the private sector. These are twinning arrangements which linked established public sector providers with PWUs in need of restructuring. There are successful examples of PUPs in transition and developing countries, especially in the Baltic states where financial packages were often arranged as part of the PUP.

Abbreviations:

Contents

Preface 2

Acknowledgements 3

Executive Summary 3

Table of abbreviations 5

1. Introduction 8

¨ Challenges, objectives and decisions 8

¨ Public sector is normal 8

¨ Table: Water supply in EU countries by public or private (including mixed) management, 1996 8

2. Problems with water privatisations and concessions 10

2. A. Lack of competition 10

¨ Reserved construction or supply contracts 10

2. B. Higher prices 10

¨ Water users may pay for government debt reduction 10

¨ Comparative prices 11

¨ Table: Water prices in France under municipal provision, delegated management and public-private joint ventures, 1994-1999 11

2. C. A concession is forever 11

2. D. Problems with private management 11

¨ Puerto Rico: worse finances and services 11

¨ Trinidad: Severn Trent go home 12

¨ Budapest: losses and bonuses 12

2. E. Problems with extending access 12

2. F. Private cross-subsidies for the multinationals 13

2. G. Public financial support for private sector 13

¨ Nelspruit: public financial support for private venture 13

2. H. Weak accountability: regulation, secret contracts, and charters 13

2. I. Corruption 14

¨ Bribery by the water multinationals in France 15

¨ Lesotho: multinational bribes for water scheme 15

2. J. Privatisation of efficient public sector water undertakings 15

3. Public sector water - efficiency and reform 16

3. A. Efficiency and effectiveness 16

¨ Table: Comparison of key performance indicators, water supply industry, five industrialized countries 16

¨ Public ownership and public response 16

3. B. Structure and organisation 16

¨ Organisational forms and legal status 16

¨ Level of government 17

¨ Range of forms of public sector water undertakings - examples from Europe and central America 17

3. C. Labour relations and staffing levels 17

3. D. Public service and accountability 18

¨ Political accountability – formal structures and wider representation 18

¨ Transparency and public right to information 18

¨ Defined managerial autonomy and accountability 18

¨ Electoral accountability 19

3. E. Examples of reforms of public sector water undertakings 19

¨ Sao Paulo, Brazil 19

¨ Lilongwe, Malawi 19

¨ Sri Lanka 19

¨ Hyderabad, India 20

¨ Debrecen, Hungary 20

¨ Tegucigalpa, Honduras 20

3. F. Business plan 20

¨ Pricing policies and objectives 21

3. G. Full cost recovery and use of subsidies 21

¨ Stepped tariffs, solidarity charges, free water 22

¨ Free water is feasible for poor communities in South Africa 22

¨ Tax-based charging 22

¨ Property charges 22

3. H. Billing and collection 23

¨ ONEA, Burkina Faso: collection rates 95% 23

4. Financing Investment 24

4. A. Financing investment 24

4. B. Internal resources – using surpluses 24

4. C. Central government financing 24

4. D. Municipal finance 25

¨ Financial intermediaries – development and environmental funds 25

4. E. Borrowing by corporatised public sector utilities 25

4. F. International financial institutions (IFIs) 26

¨ World Bank (WB) (www.worldbank.org ) 26

¨ European Investment Bank (EIB ) (www.eib.org) 26

¨ Inter-American Development Bank (IDB) (www.iadb.org ) 26

¨ The Asian Development Bank (ADB) (www.adb.org) 26

¨ The African Development Bank (AFDB) (www.afdb.org) 26

¨ European Bank for Reconstruction and Development (EBRD) www.ebrd.org 26

¨ Development Bank of Southern Africa (DBSA) (www.dbsa.org) 27

¨ Islamic Development Bank (ISDB) www.isdb.org 27

4. G. Conditionality, privatisation and exclusion of public sector 27

4. H. Bilateral funding - aid agencies 27

4. I. Creditworthiness 27

¨ Standard and Poor's Credit ratings 27

¨ INCA criteria 28

5. Capacity-building and public-public partnerships (PUPs) 29

5. A. Capacity building through public partners 29

¨ South Africa: regional public partners 29

¨ Honduras: national public partner 29

¨ Baltic states: international wastewater ‘twinning' 29

¨ Malawi: World Bank successful twinning 29

5. B. Co-financing with twinning: Baltics and Mediterranean 30

6. Further information 30

7. Notes 32

1. Introduction

¨Challenges, objectives and decisions

In most countries, water undertakings face a similar set of challenges and objectives. They include:

· Infrastructure – reducing leakage, replacing and extending networks, improving technology

· Social and political – improving coverage, affordability, higher standards, transparency, accountability

· Environment and health – public health needs, environmental management, conservation of water

· Financial – sustainable and equitable tariffs, effective revenue collection, financing investment

· Managerial – improving efficiency and productivity, capacity building, efficient procurement

In the last 10 years many organisations have promoted privatisation, invariably through a concession or lease arrangement on the French model (sometimes described as a public-private-partnership – (PPP)), as the way forward for urban water supply and sanitation. This is the position taken, understandably, by the multinational water companies, and is the dominant view in the World Bank.

The purpose of this booklet is to show that the challenges facing developing and transition countries can be met by restructuring and development of water undertakings within the public sector – providing a public service directly owned and controlled by a democratically elected authority. It is based on actual cases.

It is intended to complement the existing literature on water and sanitation, much of which concentrates on the question of how to privatise management through PPPs - but does not spend much time discussing whether it is in fact the best of the possible options.

Decision-makers need information on alternatives which can be considered, in order for rational choices to be made. But this cannot be fulfilled if the only option presented and considered by most public authorities is some form of privatised management. The alternative of a public sector water undertaking (PWU), historically the most favoured model, is ignored. Ignoring this evidence means that the main competitor to any of the private companies is being excluded.

This booklet offers three simple messages for sounder decision-making:

- always construct and consider a public sector option

- always evaluate any PPP proposal against a public sector option, in a public process

- avoid secret agreements and secret contracts

The public sector water undertaking is a necessary option.

¨Public sector is normal

In developed countries, the public sector is the normal mode of management of water supply and sanitation services. The table shows the picture for the EU – everywhere except for the UK and France, water supply is predominantly public sector managed. In the USA, Canada, Japan, Australia and New Zealand the picture is the same – privatisation or public-private partnerships (PPPs) are the exception.

¨Table: Water supply in EU countries by public or private (including mixed) management, 1996

(percentage of population supplied by each type)

Source: Eureau: Management Systems of Drinking Water production and Distribution Services in the EU Member states, 1996.

2. Problems with water privatisations and concessions

The privatisation of water takes many forms. Sale to the private sector of the complete system has only been done in the UK. Most common is the French model, which involves concessions or leases under which the private contractor collects all the revenues for a water service, carries the cost of operating and maintaining it, and keeps the surplus as a profit. A more restricted form is the ‘management contract' whereby the company is paid a fee for managing the undertaking but does not take over the revenues. Problems have been experienced with all these forms.

2. A. Lack of competition

One key argument advanced for any form of privatisation is the theoretical benefits of competition. However, as the World Bank has acknowledged, there is very little competition in water. Not only are water systems natural monopolies, but the private part of the industry is dominated worldwide by just two multinationals – Vivendi and Suez-Lyonnaise. A third French multinational, SAUR, holds a dominant position in Africa. A few contracts have been obtained by some UK companies, Thames Water (now owned by the German conglomerate RWE), Anglian Water, and International Water (jointly owned by two construction multinationals, Bechtel of the USA and Edison of Italy). Attempts by the USA company Azurix – owned by Enron – to break into the market have been a failure.

Some of the privatisations have happened without any competitive tendering at all, even between the private sector companies. For example, all the private concessions in Czech republic, Hungary and Poland up to 1997 were awarded without any competitive tendering process , as was the SODECI concession in Cote d'Ivoire, yet they will persist as long-term monopolies.

¨Reserved construction or supply contracts

The lack of competition is worsened in cases where contracts for building and construction of new works may be reserved for the construction companies of the same group. For example, both Suez-Lyonnaise and Vivendi have large water engineering subsidiaries, and own major suppliers of chemicals and materials, which are likely to receive preferential treatment in procurement by the groups' concessions.

An institutionalised example of this occurred when Vivendi (Générale des Eaux) was awarded the operating concession in Szeged (Hungary) in 1993, through its subsidiary Szegedi Vizmu. At the same time a works company, 70% owned by Générale des Eaux, was also established – which has an annual contract for all the maintenance work, and exclusive rights to all works contracts issued by Szegedi Vizmu.

2. B. Higher prices

Privatisation introduces a new set of financial demands on the water system which tend to increase the price of water and sanitation. These include the demands of the company owners for profits and dividends, which may then be globally redistributed for investment in other company activities, and the desire of the public authority for a boost to the authorities' finances.

¨Water users may pay for government debt reduction

Governments and municipalities usually expect privatisations to benefit their own finances, by using the proceeds of a sale to reduce the debts or deficits of the government itself. But this can conflict with the financial needs of the water service itself, because the price that a company is willing to pay to obtain a concession will depend on the profit stream that the private company can expect, which in turn will be affected by the price it charges to users, and how generous the conditions such as regulation are. So what is good for the government's finances may not be best for water users.

This has been recognised as a serious problem in France, where a national audit report said that "privatising concessions has been converted into a way of improving the balance sheets of municipalities at the expense of the user/taxpayer". Since 1996 it has been illegal in France for any council to sell a concession to a private company which can then charge users for the cost of that ‘entry fee'. But the same problem occurs in other countries where it is still legal to do this. In Budapest (Hungary) in 1997, the water supply concession was awarded not to the consortium which offered the cheapest price for water, but to the consortium – led by Suez-Lyonnaise and RWE – which promised the council an extra 3 billion forints in payment - although the price of water to consumers was higher by 3 forints per cubic meter than another bid.

¨Comparative prices

Private operation is sometimes expected to reduce prices, but this is not the experience in many countries. In France itself, where some water is managed by municipalities, and some by private companies (or joint ventures PPPs), figures show a consistent picture of the private or PPP concessions charging higher prices – 13% higher in 1999.

¨Table: Water prices in France under municipal provision, delegated management and public-private joint ventures, 1994-1999

(average prices for yearly consumption of 120 m3 in FF, water supply and sanitation)

Management type 1994 1995 1996 1997 1998 1999 Public Municipal/Régies 1,489 1,621 1,716 1,803 1,848 1,841 Private Delegated/Private 1,784 1,908 1,993 2,050 2,100 2,100 PPP Public-Private Joint Venture 1,734 1,812 1,963 2,014 2,076 2,101 Average Average all modes 1,689 1,799 1,910 1,974 2,015 2,049 Source: DGCCRF

2. C. A concession is forever

Most privatised water operations are long-term concession contracts, usually of 20-30 years. Build-operate-transfer projects (BOTs), for example to construct and operate a specific water or sewerage treatment plant, usually involve concessions lasting a similar period. Because of legal constraints and the administrative processes involved, these contracts can be very difficult to cancel, even if the performance is unsatisfactory. Such problems have been found in Tucuman (Argentina), Szeged (Hungary) and Cochabamba (Bolivia) - the multinational companies concerned have pursued legal claims for compensation which could make ending these contracts impossibly expensive.

Even in developed countries terminating a water concession can be very difficult. In Valencia, Spain, the local council tried to retender the water concession which was expiring after 99 years with the same company (a SAUR subsidiary). The company threatened to sue for damages if any competitor was allowed to take over the system. In Grenoble, France, even when a Suez-Lyonnaise executive had been convicted of paying a bribe to get the water concession, it still took 5 years intensive campaigning before the council finally replaced the company with a municipal service.

2. D. Problems with private management

Where private companies have been contracted to manage water utilities their performance has not always been impressive. The box shows some problems experienced with private sector management, on three of the larger examples of this form of privatisation.

¨Puerto Rico: worse finances and services

In 1995 Puerto Rico contracted the management of their water authority, PRASA, to the largest water multinational in the world, Vivendi, through a subsidiary now called Compania de Aguas. In August 1999, an official report condemned the contract for failing on all grounds: "The Puerto Rico Office of the Comptroller (Contralor) issued an extremely critical report on the PRASA-Compania de Aguas contract. The document lists numerous faults, including deficiencies in the maintenance, repair, administration and operation of aqueducts and sewers, and required financial reports that were either late or not submitted at all. Citizens asking for help get no answers, and some customers say that they do not receive water, but always receive their bills on time, charging them for water they never get. A local weekly newspaper published reports of PRASA work crews who did not know where to look for the aqueducts and valves that they were supposed to work on." The finances got worse, and the state has had to provide subsidies. By 1999: "According to the Comptroller's report, under private administration PRASA's operational deficit has kept increasing and has now reached a whopping $241.1 million. This has required the Government Development Bank (Banco Gubernamental de Fomento) on several occasions to step in and provide the agency with emergency funding."

¨Trinidad: Severn Trent go home

There was a similar picture in Trinidad, where in 1994, the government contracted out the management of the islands' water authority, WASA, to Severn Trent. One of the central features of the original Business Plan submitted by Severn Trent was that they would make WASA financially viable by the end of the three year contract period but the deficit for 1998 actually increased over 1997 to $378.5 million. In April 1999 Severn-Trent's contract expired without renewal and WASA was taken back as a public sector responsibility. WASA has since taken on new local managers, and is reportedly planning significant investments.

¨Budapest: losses and bonuses

In 1997 the water supply of Budapest was privatised, partly under a management contract, to Suez-Lyonnaise. In July 1999, Budapest Municipal Council rejected a business plan which projected HUF 2.7bn in net losses, a 5% decrease in sales income for 1999, but premiums paid to the managers of almost HUF 250m. .

2. E. Problems with extending access

For private water companies new connections to households who cannot afford to pay the full economic cost always creates a potential risk to the companies' profitability. The point was succinctly made in December 1999 by UK water company Biwater, who pulled out of a major water supply project in Zimbabwe, because the project could not deliver the rate of return now demanded by private investors. The company manager said: "Investors need to be convinced that they will get reasonable returns. The issues we consider include who the end users are and whether they are able to afford the water tariffs. From a social point of view, these kinds of projects are viable but unfortunately from a private sector point of view they are not".

In La Paz, Bolivia, a concession was awarded to a Suez-Lyonnaise subsidiary in 1997. The contract included explicit targets for extending connections to poor households. The contract has not however provided adequate financial incentives for the company to make extensions in some areas, and it is being suggested that the service offered to the poor should be determined by ability to pay rather than by public policy.

The Buenos Aires concession is used as an example of how a private operator has extended access by imposing cross-subsidies on wealthier users, but the process caused a crisis for the multinational, required a complete rewriting of the concession contract, and was resisted by consumers who brought court cases claiming the imposed subsidy was illegal.

The problem is posed most acutely by the companies and others being more insistent on the need for ‘full cost recovery' from customers as a basis for pricing. To the extent that this is applied, privatised/PPP water supply undertakings may be unable to extend full service to anybody who cannot afford the full economic price of water. Extending water access then ceases to be a subject of public policy, and is simply left to market forces.

2. F. Private cross-subsidies for the multinationals

Under privatised systems it is not possible to stop water profits being used to finance other activities of the parent multinationals, and both the UK and the French water companies have taken advantage of this.

In the UK, a study of the private water companies' accounts after 5 years of privatisation concluded that: "The cash surplus has been drained by the parent companies which have given generous dividends to the shareholders; made spectacularly unsuccessful acquisitions which have resulted in huge losses; and finally recycled the remaining surplus cash as interest bearing loans back to the core water business:"

The French multinational Vivendi provides a clear example of a multinational group "milking the cow" of water to finance its other activities. In January 2000, Vivendi loaded the entire debt of the group, equal to Euro 16.5 billion, onto its water, energy, waste and transport operations – the ‘environment' division' - while the communications division, which has received most of Vivendi's investment in recent years, became virtually debt free. Based on the 1999 sales in the Environment division of Euros 22.2bn, this is equivalent to a surcharge of about 4% on the bills of every user of Vivendi's water, waste and transport in the world, in order to subsidise the communications division.

2. G. Public financial support for private sector

The private sector often enjoys significant financial support from the public authorities, which needs to be properly acknowledged in any decision-making process. According to a World Bank report, this support may include: "Cash contributions during the construction period; subsidies during the operating period, e.g. in the form of non-refundable grants; and a favourable tax regime - including tax holidays, refunding of tax on construction and operating costs".

Public authorities are also expected to provide financial guarantees, which minimise the risk transferred to the private sector. These include guarantees of loans – development banks especially may require a government guarantee before any money can be lent to a privatised operation; and guarantees of profitability – many water concession contracts include clauses under which public authorities guarantee the profitability of the operator for the duration of the contract – e.g. Pecs, Szeged (Hungary), Plzen (Czech republic) , Cochabamba (Bolivia).

¨Nelspruit: public financial support for private venture

Multiple, global forms of public sector support have been used in Nelspruit, capital of Mpumalanga province in South Africa, where water supply was contracted in 1999 to a private concession operated by Biwater, of the UK. The main argument used at the time for the concession was the need to attract private finance. But since then:

· Biwater has brought in as a partner Nuon, a Dutch municipally-owned company, to provide some of the necessary finance

· The private venture has benefited from a new water treatment plant at Matsulu, a suburb of Nelspruit, which the government of Portugal financed, and the South African government constructed , but is being handed over free to the new private operator

· In July 2000, nearly two-thirds of the total finance for the project was finally obtained by Biwater, in the form of a Rand 125m loan from the state-owned Development Bank of South Africa.

2. H. Weak accountability: regulation, secret contracts, and charters

Regulation is supposed to be the way in which the public interest is represented in privatised concessions. But in practice it is rare for regulators to be an effective independent control, and so privatisation may simply increase the scope and incentives for corruption associated with contracting-out: "In many countries, regulatory structures are still embryonic, in others they lack transparency, while in others they appear to be excessively complex in their organisational structure, laying them vulnerable to political interference. In particular, the study has identified questions concerning the limited accountability of the essentially 'political' nature of the regulatory process associated with the French-style concession contracts".

A recent study of public-private-partnerships in South Africa concluded that "lack of public sector capacity is, as the BOTT experience demonstrates, an important reason not to privatise, rather than a justification for public-private sector partnerships" The same is true in the countries of the former Soviet Union: "The capacity of most NIS governments to effectively regulate private sector participation, particularly the more extensive forms, is an important constraining factor [on developing public-private partnerships]."

Commercial operations invariably prefer confidentiality and secrecy, as it protects their ability to manage financial affairs to maximize the benefit to their owners. For example, Aguas del Tunari, the privatised water concession in Cochabamba, Bolivia, refused to disclose the financial model behind its price rises on the grounds that the model itself was a commercial secret.

Even more surprisingly, private operators frequently insist that the contract itself should be a secret document – even from the elected councillors of the authority which has given the contract. In Fort Beaufort, South Africa, the contract prevents any member of the public from seeing the contract without the explicit approval of the company WSSA (owned by multinational, Suez-Lyonnaise): "2.2.2: Confidentiality: the documentation contained herein has been developed exclusively by the operator (WSSA) and shall not be disclosed to third parties without the written approval of the operator."

Documents relating to the privatised Budapest Sewerage Company, where Vivendi is the multinational, are kept secret, even from council officials, and Budapest City Council debates related issues only in closed sessions. In Morocco, a Suez-led consortium was awarded a multiple concession for water and energy in Casablanca by King Hassan, which the city council was not even informed about until later.

A review of community participation in water projects found that although the private sector may act with governments, donor agencies and NGOs to set up a variety of privatisation options - such as BOTs, concessions, leases, etc. - they do not in practice include any role for the community itself: "It is uncommon to find a project with a large private and community involvement component."

Another form of providing accountability to consumers, the charter, is also weak. In the former Soviet Union, there existed for water a "vodokanal charter", a document which has been criticised as "usually ambiguous with regard to financial and technical performance targets, and does not address terms and conditions on which the utility's performance can be evaluated, such as price, quantity, and quality." A similar tool, the ‘Citizens Charter', was introduced in the UK under the Thatcher government, setting out expectations for a number of public services, but has in practice been of little value as an instrument of accountability.

2. I. Corruption

Corruption is a systematic feature of privatisation processes, in water as in other areas. The reasons for this have been summarised in a World Bank paper: "…the privatisation process itself can create corrupt incentives. A firm may pay to be included in the list of qualified bidders or to restrict their number. It may pay to obtain a low assessment of the public property to be leased or sold off, or to be favoured in the selection process …firms that make payoffs may expect not only to win the contract or the privatisation auction, but also to obtain inefficient subsidies, monopoly benefits, and regulatory laxness in the future".

This is borne out by experience in Europe. In the UK, the police have said that: ‘the overwhelming majority of corruption cases in Britain are connected to the award of contracts. Compulsory contracting-out in local government, and the new Private Finance Initiative have produced an explosion in the number of such deals'

UK multinationals adopt the same approach to overseas contracts, as emerged in 1999 when former government minister Aitken was jailed for lying to cover up a meeting to broker such bribes: - UK multinational GEC had agreed to pay a commission worth 10 per cent of the value of possible sales into an account controlled by Aitken's solicitor.

¨Bribery by the water multinationals in France

Two of the French water multinationals have been convicted of paying bribes to obtain water contracts in France.

· In Grenoble in 1996, a former mayor and government minister and a senior executive of Lyonnaise des Eaux (now Suez-Lyonnaise des Eaux) both received prison sentences for receiving and giving bribes to award the water contract to a subsidiary of Lyonnaise des Eaux.

· In Angoulí¨me, the former mayor was jailed in 1997 for two years, with another two years suspended, for taking bribes from companies bidding for contracts, including Générale des Eaux

· Executives of Générale des Eaux were also convicted of bribing the mayor of St-Denis (Ile de la Réunion) to obtain the water concession.

The same groups - Suez-Lyonnaise and Vivendi, together with Bouygues – have been investigated in France for corruption practiced by their construction divisions, in a scandal described as ‘an agreed system for misappropriation of public funds'. The companies ran a corrupt cartel over building work for schools in the Ile-de-France region (around Paris) between 1989 and 1996. Contracts worth FF2.8 billion (about US$500m) were shared out by the three groups.

¨Lesotho: multinational bribes for water scheme

In Lesotho, subsidiaries of a dozen multinationals - from the UK, France, Italy, Germany, Canada, Sweden and Switzerland - are being prosecuted for paying bribes to obtain contracts in the Lesotho Highlands project – a huge water supply scheme. The companies included subsidiaries of Suez-Lyonnaise, Bouygues, and RWE (the German parent of Thames Water).

2. J. Privatisation of efficient public sector water undertakings

There is an assumption in most of the literature that wherever privatisation occurs it must be because of the unsustainable inefficiency of the previous public sector provider. This is not however always true. In the last 2 years most of the water undertakings in Chile have been partly privatised (by selling shares to a number of multinationals), yet these same companies – and especially EMOS – were previously held up as model examples of efficiency, even by the World Bank. Where one of the motives is raising money to finance the public authority's budget, then there is in fact a perverse motive to privatise the most financially efficient water undertakings, because they will obtain a higher price.

3. Public sector water - efficiency and reform

3. A. Efficiency and effectiveness

Public sector ownership is not in itself a cause of inefficiency or an inferior basis for providing water and sanitation. The great majority of the population in developed countries, including the USA, Europe, and Japan, have water supplied by public sector undertakings. As the table below shows, on a number of simple indicators they compare well with their private sector counterparts. Historically, water and sanitation was brought into the public sector over the last century because of the perceived inefficiencies of the private sector, for example in Finland, where the use of private companies was explicitly rejected in 1912 .

¨Table: Comparison of key performance indicators, water supply industry, five industrialized countries Country Dominant mode of water supply Water charge, major cities, in ECU (1) Utility staff per 1,000 connections Unaccounted for water (2) France Delegated private 237 4.5 (3) 15 (4) UK Direct private 195 1.0 (5) 28 Netherlands Public PLC 172 1.3 5 Japan Public 181 1.7 11 USA Public 67 2.7 12 (1) Average water charge for a family living in a house consuming 200 m 3 per annum (2) Water produced minus water legitimately consumed, as % of water produced (3) Paris only (4) Bordeaux only (5) Best estimate - 1.86 for water and sewerage.

There are also examples of efficient public sector water undertakings in transition and developing countries in all regions. A report in 1997 found that in many developing countries public sector water undertakings achieved major efficiency gains, without privatisation or PPPs, by using benchmarking information. The box in Sec. 3.E. below, shows a number of cases where water undertakings have been successfully reformed within the public sector.

¨Public ownership and public response

Public ownership itself can be an important positive factor for effective conservation of water resources . During a drought in the UK in 1976, when water was under public ownership, there was an appeal for the public to cut consumption of water – the response was a reduction of about 25% in usage. In 1995, when the privatised Yorkshire water faced a drought and made a similar appeal, the public made very little reduction in their usage in response - the company was seen as a greedy exploiter of the water monopoly and so not entitled to public support.

3. B. Structure and organisation

There are a range of possible structures and forms for public sector water operations. Different structures can be useful for different objectives. For large scale works and procurement, a national or regional structure may be most efficient; for borrowing money,a corporatised plc may be most effective; for accountability, a municipal base may be best; environmental and water resource management is best dealt with at river-basin level.

¨Organisational forms and legal status

Various forms of organisation are available for a water undertaking under public ownership:

· administrative department, where water is carried out as part of a public authority's departmental structures.

· "Regie" - an internal entity, defined by a set of accounts, within a municipality, e.g. the Regies in France, Germany: examples include Amsterdam Water (Netherlands); Grenoble (France).

· "Corporatised undertaking" – the external corporatisation as a utility owned by the public authority. The possible legal status of such an external corporatised entity MWC will depend on the specific laws of each country. These may have varying degrees of corporatisation and closeness to private company law:

· A special status municipal or state company, e.g. Azienda Speciale (Italy) Stadtwerke (Germany) Lilongwe Water (Malawi), SANAA (Honduras)

· A ‘not for profit' company

· A company incorporated as a p.l.c. under company law, but with shares owned 100% by the public authority (e.g. Netherlands water companies, SABESP (Brazil)), Debreceni Vizmu (Hungary)

The regie and the corporatised undertaking have the advantages of separate accounts which should improve financial discipline. If combined with publication, they can also improve transparency and accountability.

¨Level of government

Different countries have their own histories of political, administrative and economic development, which have resulted in different structures for water and sanitation. Responsibility for water and sanitation lies at various different levels of government – commonly with municipalities, in most countries in Europe and North America, but the state may retain responsibility in some countries, for example, Sri Lanka, while in others responsibility for water has been at regional level – e.g. in Brazil, or, for bulk water supply, in South Africa.

Many reform programmes aim to decentralize responsibility for water to municipal level, but a report on central America warned against a simple assumption that municipal is best: "…It is striking that, in many countries of the region, the most effective arrangements for development of rural and peri-urban systems are in the hands of the national state water corporations. This raises an important issue in the context of sector reform, since often these corporations are slated for abolition or major restructuring, creating a risk that the best programs aimed at the poorest communities might become a casualty of the reform process."

¨Range of forms of public sector water undertakings - examples from Europe and central America Type of undertaking Europe Central America Administrative departments or semi-autonomous ‘regies' Amsterdam, Netherlands; ‘regies' in France DIMA, San Pedro Sula, Honduras. Public corporations ‘Stadtwerke' in Austria, Germany; ‘aziende' in Italy Guatemala, El Salvador (municipally owned) , Nicaragua and Honduras (state-owned) Limited companies (100% owned by public authorities) Netherlands, Sweden Puerto Cortés, Honduras. Source: various

3. C. Labour relations and staffing levels

Public sector water undertakings are more likely to respect their employees and their trade unions, and to develop policies on the basis of partnership rather than conflict. This does not mean inefficiency – indeed in a number of cases – Sao Paulo, Debrecen, Tegucigalpa, Burkina, for example – the trade unions have played a crucial role in restructuring a utility into an efficient organisation.

The problems to be addressed by public sector water undertakings may sometimes include corrupt practices, and inefficiencies of various kinds, including over-staffing. Restructuring into a more effective public service may involve some reduction in employee numbers, as happened in Tegucigalpa, or may not – in Debrecen, for example, employment did not fall.

Lower staffing levels do not automatically imply greater efficiency, they may simply reflect inadequate resources: in central America "The higher production of water per person in municipal systems is actually associated with higher physical losses and not with better service—due partly to the lack of qualified staff."

3. D. Public service and accountability

¨Political accountability – formal structures and wider representation

Clear and regular accountability is necessary to ensure that the social and public service objectives are being achieved. In a public sector water undertaking, the fundamental form of accountability is to the public authority, which may include:

· regular reports to and meetings with committees of elected representatives.

· formal annual meetings at which the public authority lays down the objectives, and social and economic guidelines for the coming year.

It is important also to promote broader accountability and to ensure links with the local reality/needs, by including provision for representation of the user communities, employees, and other members of civil society, e.g. environmental associations:

· The Philippine Water Districts have an organisational structure which allows for government shareholdings, and provides for representation of users as well. Cost recovery is well above the Asian average.

· The Netherlands municipally owned water companies have a high degree of transparency and accountability. This includes workers on the supervisory board, and representation of users' interests through locally elected bodies.

¨Transparency and public right to information

Transparency is not always a strength in either public or private water undertakings.

Public sector operations have the advantage over privatised operations, in that they have no commercial interest in secrecy. All information about the finances of and charges for water should be as transparent as possible: this should be the main advantage of a distinct set of accounts for a PWU. Transparency of information should help improve efficiency - in the Netherlands the public sector water undertakings carry out a comprehensive mutual benchmarking every year on finance and costs, and on service and environmental quality every three years - and provide a safeguard against corruption. It is desirable for environmental reasons as well, so any water venture should make "available for consumers, users and taxpayers the information on who uses, who pollutes, what does it cost and who pays for these costs".

The strongest way of doing this within the public sector is to simply provide the right of public access to all documents produced by a public utility. There is a cost associated with such measures, but there are already functioning examples of this right of access in both developed and developing countries. In the USA there is a general public right of access to documents of public authorities, so that even management records of utilities can be inspected. And Kerala, in India, has introduced a highly democratic form of decentralisation of public services, including a similar comprehensive right of public access to all documentation of public authorities.

¨Defined managerial autonomy and accountability

The relationship between the managers of the company and the political authority should be clearly spelt out. Most current advice emphasises the problems that arise from political ‘interference' in decisions, for example on pricing, that are more appropriate for management to take. As a result, there is a strong emphasis on the advantages of defining those areas where management has autonomy.

It is equally important, however, to define clearly which decisions are to be taken by the authority, and for what and how the management are held accountable. These should include:

· the requirements set by the owning authorit(ies) are extremely important: e.g. charging for investment not for profit maximization, limitation of dividends/reinvestment of proceeds, maximization of social impact in terms of coverage extension, service reliability, affordability, employment, environmental impact etc.

· in external corporatised undertakings, management may also have specific responsibilities under company law (e.g. personal financial responsibility for gross misconduct/losses)

¨Electoral accountability

The ultimate accountability in democracy is through voting in elections, and there is evidence that privatising water is often unpopular with electorates. A Hungarian minister has commented that "Municipalities mistrusted foreign companies, while the population at large did not generally understand the role of a foreign partner in the ownership of a utility". This is especially visible at election times:

· In Panama, for example, one reason for the defeat of the incumbent president in 1999 was his proposal to privatise water.

· In Lodz, Poland, in 1994 the ruling party, which had proposed privatisation of water, lost the municipal elections.

· In Chile in 1999 the presidential candidates from all four major parties took the unusual step of issuing a joint press statement disassociating themselves from the current privatisation of the water in the major cities.

3. E. Examples of reforms of public sector water undertakings

¨Sao Paulo, Brazil

SABESP, the state-owned water company covering the majority of the 22 million inhabitants of Sao Paulo state, is the world's largest water utility. Since 1995 it has undergone extensive restructuring aimed at organisational modernisation and operating efficiency, through simultaneous efforts to expand revenue generation on the one hand and cut excessive costs and inefficiencies on the other. In the course of 1995 alone, the population in the service area supplied with treated water increased from 84% to 91%, the population receiving sewerage services increased from 64% to 73%, and non-functioning accounts plunged to 8%. Operating costs were reduced by 45%, partly by outsourcing. SABESP can now finance its investment programmes through loans and its own funds (its finances were affected, however, by the currency devaluation of 1999, which increased the cost of foreign debt). SABESP is also effectively carrying out its environmental responsibilities, including a major clean-up of the Tiett river, considered to be the largest environmental scheme in Latin America, completed in 1998.

¨Lilongwe, Malawi

A project to improve the water and sanitation services of Lilongwe, Malawi, was a success, from the point of view of institution building, and provided the model for a national approach to managing water in cities and larger towns. Funded by the World Bank, the project produced a master plan and expanded the distribution system and strengthened the capacity of the water board.

Access to water improved significantly; the project helped develop an effective management support and training programme; the efficiency of operations increased considerably; the level of unaccounted-for water fell to 16 percent; labour costs were reduced; response time to new service applications and customer complaints has improved.

¨Sri Lanka

In Sri Lanka, water and sanitation is operated by the National Water Supply and Drainage Board (NWSDB), which remains under the ownership and control of central government. In the 1990s the NWSDB carried out a series of reforms which successfully transformed the financial structure. A report states that "Organisational restructuring and improved tariff management, underpinned by government insistence on financial viability, have led to significantly improved performance" and concluded "change of ownership is not the key issue".

¨Hyderabad, India

The Hyderabad Metropolitan Water Supply and Sewerage Board has gradually changed its organisational approach. The changes made include: adopting a business and human resources development plan; decentralising management of billing, revenue collection, and customer service; creating local ‘Customer Service offices'; a training programme at a local university; restructuring staffing responsibilities.

¨Debrecen, Hungary

In 1995 the city council of Debrecen, a 220,000 population city in Hungary, decided to reject privatisation proposals from two major multinationals in favour of its own municipal water undertaking, Debreceni Vizmu (Debrecen Waterworks). The company was created in 1995 as a corporatised separate entity from the municipality, with a business plan drawn up by the management with the support of the trade unions.

The business plan ensured that all costs were covered, including depreciation, without generating unnecessary profits.

The cost of financing the necessary investments has proved to be much lower under public provision - 23 kilometres of pipework had been finished by April 1997, at a cost of Forint 320m, equal to 40% of the amount Eurawasser (a Suez-Lyonnaise-led consortium) would have spent on the same work, partly due to the use of local suppliers of equipment, such as meters and pipes. Employment considerations were internalised in Debreceni Vizmu's business plan so that 300 more people are employed compared with the workforce planned by Eurawasser. The financial performance of the company compares favourably with that of privatised water companies in other cities in Hungary.

¨Tegucigalpa, Honduras

In four years from 1994 there was a successful restructuring of SANAA, the state-owned water company responsible for the capital Tegucigalpa, which dramatically improved efficiency, management and effectiveness. It was based on joint working with the trade unions, through a process aimed at positively involving the workforce. The restructuring involved decentralisation of management, computerisation of billing, a significant increase in tariffs to boost revenue, reduction in staffing levels, including some contracting out of work. SANAA established six regions, which were allowed to retain their tariff income and given substantial control over day-to-day operations. Leaks were reduced - in Tegucigalpa savings amounted to 100 litres per second - and the continuity and reliability of supply also improved allowing the majority of the population to receive piped water 24 hours a day.

3. F. Business plan

Any water undertaking needs a business plan to make clear what the financial requirements are for operating, maintaining and investing in the system. The plan should include:

· an analysis of the requirements of the water service;

· the capital investment required, for extension or modernisation of the system, for example;

· the annual operating and maintenance costs (O&M);

· the annual costs of financing capital investment.

This will result in a table showing a forecast each year of the costs of the undertaking and the income requirements. This can then be used to decide on the user charges and other payments required to finance the plan.

Item Year 1 2 3 4 5 O&M costs: existing system 1800 1870 1940 2020 2120 O&M costs: extensions to system 450 550 950 Total O&M costs 1800 1870 2390 2570 3070 Capital costs 3060 3450 3515 3430 4475 Total Income required 4860 5320 5905 6000 7545 Source: Raftelis , Table 2.2

For example, St Petersburg's Vodokanal has now reorganised its divisions, decentralised responsibilities, reduced operating costs, and developed a capital investment programme, and produced a comprehensive business plan. Vodokanal has been assisted it doing this by a ‘twinning' agreement with Helsinki Water (Finland, municipally owned) and others.

¨Pricing policies and objectives

Water pricing policy is in practice an attempt to cater for different objectives - environmental, economic, financial or social. Different groups may have different priorities - for the banks, pricing is primarily seen as a financing tool that secures the repayment of a loan; for the local population pricing is a matter of social equity, an instrument of economic development, environmental policy, and demand management.

One advantage of public sector undertakings is that they are not confined to the simple financial objectives of private companies. A pricing policy can be developed based on an assessment of the social, economic, political, and environmental conditions, and on a public consensus about objectives and a sustainable way of reaching them. A report to the South African water authority, for example, states that: "The primary goal of the pricing policies advocated here is to improve access to water services. The policies seek to ensure that households not only have access to adequate water services, but also can afford to consume a target of 50 lcd (litres per capita, per day). Thus the pricing policies and methodologies recommended here have the twin goals of encouraging domestic water use where this is less than 50 lcd and discouraging water use where this is in excess of 200 lcd.."

3. G. Full cost recovery and use of subsidies

The total income from subsidies and charges to users must cover the total costs of operating, maintaining and investing in the water service, and there should be public and transparent accounting. But this does not preclude cross-subsidy, or support from central government to municipal operations, which is rather a matter of economic and political assessment.

The idea of "full cost recovery" however goes beyond this, and argues that water users should pay, through charges, the full costs of operation, maintenance and even capital investment in the system. When this was proposed at the 2nd World Water Forum at The Hague in March 2000, it was rejected in its simple form: the international ministerial declaration agreed only to "move towards" pricing water to reflect costs, emphasising the need to "take account of the need for equity and the basic needs of the poor and the vulnerable". This reflects the widespread use of subsidy and cross-subsidy in water systems, and the view that water supply is a public good and a human right, not simply an economic good.

Government finance may be necessary in many transition and developing countries where users cannot afford the full costs of the necessary water and sanitation programmes. For example, a recent report on water services in newly independent states (Georgia, Kazakstan, Moldova, Ukraine, Russia) concluded that "National and local budgets will have an essential role in the short and medium term in financing rehabilitation and capital investments, providing social protection and in facilitating access to credit….In some cases, donor grants and IFI projects may need to be designed with operational costs initially being covered from public budgets rather than user charges."

This practice is not peculiar to water, or even to public sector operations - the same system is widely used in public transport systems, including the privatised rail transport system in the UK which relies on heavy subsidies from the government to the private operators, such as Vivendi.

¨Stepped tariffs, solidarity charges, free water

Cross-subsidy of the poor, by charging richer users more, is commonly regarded as a desirable redistributive objective of water systems. This may involve cross-subsidies between different social, economic or regional groups of users. A report on water in Sri Lanka, for example, concluded that: "Designing and managing a tariff system that discriminates between rich urban areas (who can afford commercial rates) and poor rural and small township communities (who cannot) is a key challenge for government and managers."

The most common method of doing this is through some form of stepped ‘block' tariff, which is usually intended to reduce the cost of water for poorer households. This can include a ‘lifeline' element of free water, the cost of which is covered by higher charges elsewhere: South Africa recently announced such a system in response to a cholera outbreak (see box). Another simple form of cross-subsidy within a given service is a ‘solidarity charge', whereby affluent users, or those with their own connection, pay a supplement designed to cover the cost of supplying water to poorer users.

¨Free water is feasible for poor communities in South Africa

"A government committee has found that it would be feasible to provide water free of charge to poor communities, Water and Forestry Minister Ronnie Kasrils said on Friday [October 2000]. Kasrils said in a statement that the inter-ministerial group, comprising himself and the ministers of finance and provincial and local government was formed to investigate the provision of free basic water to the poor. A study by the committee found it would be "feasible and viable" to provide free water once schemes were established. Funding for free water would come from local government and by recovering costs from those who could pay. In many areas, particularly rural districts, the poor do not pay at present for water. "The problem is that when we try to implement cost recovery, many of the poor cannot pay." Kasrils said health problems, such as the current cholera outbreak in KwaZulu-Natal, arose when the poor were excluded from water supplies. He said his visits to rural areas had highlighted the fact that many people were so desperately poor that they could not afford what might seem to ordinary people a very small price for water. He said rural women complained that should they have to pay a R10 per month for water, their families would have less to eat. They therefore chose to buy food instead and took their chances in searching for river or ground water, he said. "It is our moral duty to make a basic amount of safe water available to all South Africans, or at least to those who cannot afford to pay for it". Kasrils said the cholera outbreak in KwaZulu-Natal would not have happened if all South Africans had access to safe drinking water".

¨Tax-based charging

Charging according to property values, rather than consumption, is a tax-like charge, whereby users pay according to the value of their home, not according to what they consume. It thus provides for cross-subsidy from those with more valuable properties to those with less. This method of charging for water is used for example in Canada, New Zealand and is still predominantly used in the UK, even after 10 years of privatisation.

¨Property charges

The cost of connection of new properties to the system may be financed by ‘development charges', or ‘valorisation', whereby the residents who benefit from the new connection bear all the cost of making that connection in the first place, which has been used in Colombia, for example,to finance "street improvements, sewer extensions, and other services."

For new private property developments, or commercial connections, especially in richer countries, this may make sense. But in developing countries where water and sanitation services are being provided to the poor for the first time, this is a regressive payment system, with the rich who already have connections being exempted from even sharing the costs of a social programme.

3. H. Billing and collection

The collection of payments due from users is important to balancing income and expenditure and achieving the financial plan. Failure to collect all charges due from users is a common reason for financial deficits - increasing collection rates is a simple method for restoring profitability. This is usually the most significant change introduced by private companies – in Aguas Argentinas, for example – yet it is a technically and managerially simple process to create a comprehensive and up-to-date database of users, and issue invoices for the amounts owed.

¨ONEA, Burkina Faso: collection rates 95%

The public sector water company of Burkina Faso went through some major reorganisations in the early 1990s. Part of this was computerisation of its systems, which included creating and maintaining up-to-date customer databases. Monthly billing of customers was carried out by staff who read meters at the same time, which assisted both ONEA and its customers in managing their cashflow. These policies have resulted in high collection rates for all types of customer.

Type of Client % of Total Business Rates and Time for Debt Collection Fountain Makers 13% +98% upon presentation of the bill Households and Small Businesses 50% +95% within a period of 4 months Administration (State) and Para-Public Institutions 20% 100%, but still irregular Industries and Large Households 17% +80% with a delay of 4 months Source: ONEA

The question of community support, and ultimately sanctions, such as cutoffs, need to be addressed. Cutting off the water supply of non-payers is an ‘ultimate' sanction which is illegal in many countries. This is partly because it is usually seen as a basic human right, partly because there is a general public health interest in water and sanitation being universally available.

4. Financing Investment

4. A. Financing investment

The question of how to finance investment was simply summarised by a contributor to a recent electronic discussion: "So who pays for investment? Ultimately, we do, of course. The choice is: when (now or the future); how (user charges or taxes); and who (extent of cross subsidisation). In the short term, the up-front monetary investment costs are paid for by savers - intermediated as government debt, bank loans or private equity."

Users or taxpayers can pay the cost of investment immediately, out of income from charges or taxes. To spread the cost over a number of years, money can be borrowed. Public sector water undertakings can raise funds to finance investment from the same range of sources as used by private companies. The table below shows a simple categorisation of these sources, which are discussed in more detail in the following sections.

Source of funds Domestic (inside country) International Internal resources Surplus of undertaking - State Government, national funds Aid agencies Bank loans Domestic banks International banks Bonds Domestic bonds International bonds Intermediate funds Municipal development funds - International finance institutions - Development banks e.g.World Bank

The one form of finance not used in public sector undertakings is equity finance from private shareholders. However, the high cost of equity finance makes it unattractive as a way of financing water services. In the UK, the private water companies' own advisors are now arguing that water prices in the UK could fall by 5 per cent if the industry financed itself purely by debt, instead of the mixture of debt and equity used since privatisation.

4. B. Internal resources – using surpluses

The simplest way of raising finance is by the water undertaking itself generating enough of a surplus to reinvest in the operation. For example Stockholm Vatten, the municipally-owned water company of Stockholm, Sweden, financed 53% of its investments from internally generated surpluses in 1998 ; Debreceni Vizmu, the municipally-owned water company of Debrecen, Hungary, did better: internal surpluses accounted for 66.4% of infrastructure investment in 1998 .

Unlike private companies, public authorities are not obliged to maximise profits or distribute them, so they can decide as a matter of policy that their water undertakings should pay no dividends, so that surpluses can only be reinvested into the water system itself, and not used for example to reduce taxes for other services. This is done by a number of Dutch municipalities, and by the New Zealand public authorities which own the water supply undertaking Watercare: this undertaking nevertheless has an excellent international credit rating of A+ (better than Vivendi, for example, which had a long-term credit rating of BBB at the same time).

4. C. Central government financing

In many countries the national government provides some or all the finance for investment in water infrastructure. Central government finance may be provided in the form of grants or loans to local authorities, or through special funds. This is true in developed countries as well – in Canada and Ireland, for example, capital investment in water is paid for by central government.

This may be done through special government funds. In Poland, the existence of such a fund proved crucial to the city of Lodz in 1994, which found that this method of financing investment compared favourably with the cost of a private finance plan submitted by the multinational Générale des Eaux (Vivendi). The Lodz municipal water undertaking obtained funds from the Polish National Environmental Fund, which finances projects meeting the fund's criteria for community benefits. Local trade unions estimated that up to 1998 some US$ 8m was saved by choosing this option rather than the PPP.

4. D. Municipal finance

Muncipalities are usually responsible for water and sanitation, and so the ways that municipalities raise finance for infrastructure investment is of the greatest importance. The World Bank has a special section on municipal finance (separate from the Bank's water section), which publishes helpful advice on http://www.worldbank.org/html/fpd/urban//mun_fin/mf_body.htm .

Borrowing from local banks is a traditional source of finance for local governments, but may be limited. Bonds may be issued by municipalities as well as by governments and companies. The ability of local authorities to issue bonds, domestically or internationally, depends on the creditworthiness of the municipality, the guarantees available, either from government or from a bank, and the collateral offered. The World Bank has said that in Indonesia, for example, water utilities were especially suited to bond financing, based on revenues.

Municipalities can also issue international bonds if they get an appropriate credit rating (see below). However, international bonds and loans which have to be repaid in international currency carry a risk - if the value of the national currency collapses the repayments may become unbearably expensive. This happened with the water utilities of Sao Paulo (Brazil) and Lilongwe (Malawi) – in both cases an otherwise efficient and financially sound utility faced a financial crisis simply because of a currency devaluation.

¨Financial intermediaries – development and environmental funds

Where water is the responsibility of municipalities, the undertaking and investments involved are relatively small, and so of less interest to large banks because of the comparatively high transaction costs and potential risk.

One solution is to use financial intermediaries, which can raise funds in the national and/or international capital markets and then re-lend them to municipalities in their respective countries. The most common form of this is a Municipal Development Fund (MDF), and there are a number of examples in developing countries:

· In the Philippines most long term financing for infrastructure projects comes through a revolving MDF government-administered funds.

· In Honduras, revolving funds are used to finance peri-urban water in small districts around the capital.

· In Tamil Nadu (India), the Urban Development Fund (TNUDF) acts as an intermediary approving muncipalities' applications to draw on a World Bank US$80 million line of credit.

· In South Africa, a private intermediary fund, INCA, borrows money from capital markets and lends to infrastructure providers: its attractions to investors include its AA credit rating, risk pooling, and the fact that it operates its own system for credit-rating municipalities (see annex).

4. E. Borrowing by corporatised public sector utilities

Water undertakings which are wholly owned by the public sector, but corporatised as distinct entities, can borrow on their own account, in the same way as private companies. Many public sector water undertakings in the EU do this – for example, Dutch and Swedish water undertakings – and in transition and developing countries too.

This kind of finance was used in Hungary in 1995 by Debreceni Vizmu (Debrecen Waterworks Incorporated Company), which was created as a separate entity from the municipality, with its own accounts, but remaining wholly owned by the municipality. The undertaking obtained grants from the EU, from the Hungarian state, and a long-term bank loan from a large commercial bank.

Corporatisation may be an advantage where municipal borrowing is controlled by government monetary policies, aimed at limiting public sector borrowing. In the EU, for example, the monetary convergence criteria requiring limits on general government borrowing do not apply to trading bodies owned by the public sector. Corporatisation may thus provide a way of moving the borrowings for water investment off the balance sheets of public authorities without privatisation.

4. F. International financial institutions (IFIs)

The international development banks are a major source of funding for infrastructure of all kinds, including water. They can and do lend to public sector water undertakings (subject to the points in the next section). They include:

¨World Bank (WB) (www.worldbank.org )

The World Bank's main divison is the International Bank for Reconstruction and Development (IBRD), which provides loans to public authorities. In June 2000 there were 78 water and sanitation projects worldwide, providing loans totalling $5.6 billion. (There is another division of the World Bank, however, the International Finance Corporation (IFC), which invests in the private sector – see below).

¨European Investment Bank (EIB ) (www.eib.org)

The EIB is the European Union's long-term lending institution, established in 1958 to finance capital investment projects which further European Union (EU) policy objectives. EIB loans may be granted to public or private borrowers in support of projects in all sectors of the economy. Recent examples of EIB loans in water and sanitation include EUR 20 million to the city of Torun (Poland) and EUR 50 million to the Development Bank of Southern Africa (DBSA) for financing small and medium-scale infrastructure projects.

¨Inter-American Development Bank (IDB) (www.iadb.org )

The IADB can lend to any public sector organisation - governments, states, provinces, municipalities, development corporations, public utility companies, etc. This has included, for example, a $250 million loan in 1997 to Brazil to support the government's programme for subsidizing investments for basic sanitation services in small and low income urban municipalities under 50,000 inhabitants to improve their health and environmental conditions.

¨The Asian Development Bank (ADB) (www.adb.org)

The ADB makes or guarantees loans to governments, government agencies, and public or private enterprises in its developing member countries, as well as to economic development agencies with an interest in the region. In 1999, ADB lent US$1.24 billion, or a quarter of its total lending, for water-related operations in the region.

¨The African Development Bank (AFDB) (www.afdb.org)

Established in 1964, the AFDB provides loans, equity investments, and technical assistance, including finance for water projects.

¨European Bank for Reconstruction and Development (EBRD) www.ebrd.org

The EBRD was established in 1991 to help fund the transition economies of central and eastern Europe and the former Soviet Union. The EBRD lends to public and private sectors, and has a specific programme for municipal and environmental infrastructure investment, including encouragement of local municipal borrowing arrangements (but it restricts some of its loans to selected multinational companies – see next section).

¨Development Bank of Southern Africa (DBSA) (www.dbsa.org)

The DBSA's key purpose is to address socio-economic imbalances and help improve the quality of life of the people of South and southern Africa. DBSA funds many public sector water programmes, for example, a loan of Rand 300m towards a programme of upgrading urban infrastructure in Cape Town; a multiyear credit line to Namibia's national water authority to fund bulk water infrastructure.

¨Islamic Development Bank (ISDB) www.isdb.org

The IDSB is an international financial institution established in pursuance of the Declaration of Intent issued by the Conference of Finance Ministers of Muslim Countries held in Jeddah in Dhul Q'adah 1393H, corresponding to December 1973. The purpose of the Bank is to foster the economic development and social progress of member countries and Muslim communities individually as well as jointly in accordance with the principles of Shari'ah, i.e., Islamic Law. Loans are normally extended to governments or public institutions.

4. G. Conditionality, privatisation and exclusion of public sector

The major IFIs, the World Bank and the IMF, often have an important negative impact on finance for PWUs, by making their loans conditional on privatisation. By doing so, they effectively cut PWUs off from a major source of finance and, at the same time, deter other potential lenders.

Conditionality operates at a number of levels: the International Monetary Fund (IMF) frequently makes water privatisation in one form or another a requirement of its structural adjustment loans, and these requirements then become conditions for any other loans. A recent study found that IMF loan agreements in 12 out of 40 countries included conditions imposing water privatisation or full cost recovery. The World Bank may also make privatisation a condition of finance for water projects, as in Ghana, for example.

Some IFIs' lending policies effectively exclude PWUs from finance. The International Finance Corporation (IFC) is part of the World Bank but invests exclusively in the private sector. By definitions its loans cannot go to a public authority. The EBRD has allocated some funds to multinationals through dedicated ‘multi-project facilities': one of these is attached to Suez-Lyonnaise, another to Vivendi. Again, these cannot be accessed by public sector operators.

4. H. Bilateral funding - aid agencies

Aid agencies of developed countries also finance infrastructure projects. This aid may sometimes be part of a wider package of support: for example, the successful ‘twinning' projects in the Baltic states used aid as ‘seed' money as part of a package which included long-term development bank loans and capacity-building support.

4. I. Creditworthiness

Banks and financial institutions have their own criteria for deciding whether to lend money to an institution. The criteria published by two different institutions provide some guide as to what the financial community regard as credit-worthy.

¨Standard and Poor's Credit ratings

Standard and Poor's (S&P) is the leading international credit rating agency. Their criteria for water and sanitation utilities and projects cover: "different ownership structures, regulatory regimes, levels of government involvement, and macroeconomic operating environments." However S&P imply that public sector ownership is a positive advantage: "Many water utilities, especially government-owned utilities, benefit from both implicit and explicit support from what is often a higher-rated and supportive parent. Conversely, the credit rating of a fundamentally strong water utility might be restricted by a cash-strapped owner, who might use the water utility to support other business activities. The impact of the utility's ownership arrangements is factored in after the stand-alone quality is assessed."

Operations are valued by constructing two profiles. Firstly, a business profile, which covers: Regulation, Markets, Operations, Competitiveness, and Management. Secondly, a financial profile, covering: Profitability, Capital structure, Cash flow analysis, and Financial flexibility.

Because water is essential, and there is never any real competition, "Standard & Poor's considers water utilities to be the lowest-risk utility sector. As a consequence, financial ratios and flexibility can be lower."

¨INCA criteria

The methodology used by the South African intermediate fund INCA to evaluate municipalities which can receive loans, assesses municipalities against five key criteria:

· Financial position, including solvency, liquidity, profitability and cashflow;

· Economic environment, including the sensitivity to growth, natural resource levels and the condition of existing infrastructure;

· Institutional capacity, in effect a review of management capability, and other indicators of competence and efficiency;

· Environmental management; and

· Socio-political issues, such as unemployment, housing, payment backlogs.

5. Capacity-building and public-public partnerships (PUPs)

5. A. Capacity building through public partners

Practical development of PWUs may require support in capacity-building. The key element is training, to ensure that the water and sanitation service has a workforce with appropriate skills at all levels, including managerial expertise. This kind of training and development can be carried out without the drastic step of privatising the management or the operation of the water service, by using established public sector companies with no vested interest in recommending privatisation.

This support can be provided through 'public-public partnerships' (PUPs). The partnership is then based on a common understanding of public service objectives. The partners may come from within the same country – ‘local PUPs' - or from other countries - ‘international PUPs'. This kind of partnership has been successfully used in a number of cases.

¨South Africa: regional public partners

Odi, in the North West Province of South Africa, is a semi-rural region with a poor population, - only 27% of households have inside taps. The municipalities formed a project with the parastatal bulk water authority, Rand Water, to develop water services capacity over a period of three years, after which the municipalities would take over the running of it. Democratic structures, including local councillors, trade union representatives and elected village committees have played an important role, for example, in increasing payments – the income from charges quadrupled in 18 months. The project has involved capital investment and transitional consumer subsidies from central government.

¨Honduras: national public partner

Most rural water systems are administered through community-based bodies such as juntas de agua, patronatos, or NGOs. Capacity-building through training and technical assistance (TA) is given at the development stage by technicians employed by the national water corporation SANAA (using aid funding). These include both técnicos en agua y saneamiento to promote system development and técnicos en operación y mantenimiento to support the juntas de agua in system operation.

¨Baltic states: international wastewater ‘twinning'

There is a major international cooperative project since the 1980s to reduce the pollution of the Baltic sea.

This has involved identifying problem ‘hot spots' needing wastewater treatment in all the river basins draining into the Baltic, and channelling technical and financial resources to dealing with these as common issues. In Lithuania, there have been major projects to develop wastewater plants at Kaunas, funded by the EBRD, and advised and assisted by public sector bodies from Finland (the Finnish Environment Institute) and twinning arrangements with Stockholm Water. Similar twinning arrangements were made between other Swedish municipal companies and water authorities in Estonia, Latvia and Lithuania. A review process in 1998 reconfirmed the soundness of the basic approach and concluded that it should therefore largely be maintained in its original form as the framework for this regional environmental programme and only limited adjustments to the structure and content should be made…"

¨Malawi: World Bank successful twinning

The World Bank funded a pair of long-running and apparently successful capacity-building projects in Malawi, using a (public sector) partner from the UK (the project was carried out in the 1980s, before UK water was privatised). The key role of the partnership was in providing training to the point where local officials took over all the running of the authority themselves: "The projects helped develop an effective management support and training program through a twinning arrangement with a British water authority. After the program was completed in 1994, the water board successfully took over the functions of expatriate advisers. All senior level management positions are now filled by local officers, and staff productivity has increased above target levels."

5. B. Co-financing with twinning: Baltics and Mediterranean

Financial packages were a crucial element of the twinning programmes in the Baltics. An evaluation report for the Helsinki Commission stated that: "In the countries in transition, where affordability is a critical constraint to investments, the use of cofinancing that blends loans from IFIs and grants from the European Union and bilateral donors has proven to be a critical tool…. The process of project design used by the IFIs in the Baltic Sea region has provided a sound framework for evaluation of potential projects and allowed for careful assessment of the ability of national governments, municipalities and private sector parties to borrow on a medium and long-term basis. When combined with grants, the size of the projects can be larger, allowing greater impacts and reducing the effective cost to the cooperating government or investors. This approach also reduces the impact of adjustments to tariffs for services to project beneficiaries, thus decreasing potential adverse impacts on populations with low or fixed incomes. The linking of grants to loans has provided an important incentive for governments to undertake environmental investments on an accelerated basis for both national and regional benefits. Cofinancing has also reduced project preparation and supervision costs; allowed for more effective sharing of experience; and supported efficient use of limited management, technical and financial resources by all parties."

6. Further information

· Barraqué, B. Les politiques de l'eau en Europe. Paris: í‰ditions la Découverte. (1995)

A clear account of the range of water management systems in Europe, including an historical chapter on their development.

· Blokland M., Braadbaart O. & Schwartz K. (Ed.) Private Business, Public Owners – Government Shareholdings in Water Enterprises. (2000) Published for the Ministry of Housing, Spatial Planning and the Environment of the Netherlands (fax +31 70 339 1568; order no 20059/199).

This has detailed studies of how some publicly owned water underatkings operate in a number of developed and developing countries.

· Cour des Comptes La gestion des services publics locaux d'eau et d'assainissement. Les éditions du Journal, Paris. (1997).

A critical report on the French water system, by the state audit body of France. Available at www.ccomptes.fr/Cour-des-comptes/publications/rapports/eau/cdc72.htm .

· DfID: Guidance Manual on water supply and sanitation programmes (1998)

A manual on technical aspects of water and sanitation projects, including sections on economic and institutional aspects. Available from www.lboro.ac.uk/well/gm/contents.htm

· Lobina and Hall, « Public Sector Alternatives to Water Supply and Sewerage Privatisation: Case Studies," International Journal of Water Resources Development, March 2000.

For more details of the case studies referred to in this booklet. Available at www.psiru.org/reports/9908--W-U-Pubalt.doc

Some websites which carry useful information include:

www.wsscc.org The website of the Water Supply and Sanitation Collaborative Council, which carries much information of relevance to water and sanitation in developing countries.

www.worldbank.org/html/fpd/urban//mun_fin/mf_body.htm Municipal finance section of the World Bank website.

www.psiru.org PSIRU's own website publishes reports and news items concerning privatisation and the companies involved.

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