A3.2 Financing options I: Grants and internal sources
This tool deals with grants and sources which are “internal” to the water sector (A3.3 deals with loans and equity sources). Allowing for the diversity of the water sector in different countries, and variations in financial sources available, a rational financing strategy is as follows:
- Minimise financial costs by the choice of appropriate standards (e.g. deferring the introduction of central sewerage in every case) and technology (avoiding “gold-plated” options);
- Encouraging water users to take on some of the costs of local schemes (“sweat equity” in urban upgrading or rural communal schemes) supported by small loan schemes for materials and installations;
- Getting commercial enterprises to undertake their own investment in water conservation and pre-treatment of effluent by a mixture of legal penalties and tariff incentives. In irrigated agriculture there is already a high degree of self-financing, especially on smaller schemes;
- Use revenues from the sale of water and related services (C7.1) to cover recurrent operating and maintenance costs plus a contribution to the cost of investment in expanding and modernising the system. It is important to cover O&M (operation and maintenance) costs from normal revenue, otherwise operations will proceed on a hand to mouth basis and maintenance will be neglected. In the long term, capital investment in water services should also be funded from internal revenues plus borrowing (which is repaid from revenues) but this ideal state may need to be approached gradually, especially in irrigation;
- Tap all potential sources of grants, but take steps to reduce long-term dependence on them (because they are unlikely to be permanent)
- Subsidies from central and local governments, particularly for investment (most governments are reducing recurrent subsidies for water). Funding “public goods” (e.g. watershed conservation, hydrological research) is also an appropriate function of governments;
- Grants from international aid agencies (bilateral donors, UN agencies, EU ISPA, etc). Appropriate for technical assistance, capacity building, setting up regulatory systems, etc.;
- Grants from local and international NGOs raised from voluntary donations, sometimes matched by official aid agencies, which can encourage lending from local banks;
- Grants (including soft loans) from the proceeds of pollution and other environmental taxes, which are recycled within the sector for such purposes as water conservation, pre-treatment of effluent, etc.
- An active tariff policy, generating an adequate and inflation-proof cash flow, is the best foundation for the sector’s long-term financial health, and will be needed as the basis for attracting loans and equity.
- Cost recovery through taxation is difficult in poor countries with weak governments and a weak fiscal position.
- In recent years international aid for water has been declining, partly in response to bad experiences, a thin flow of good projects and the poor governance of this sector (see B1.1). In the current climate, with growing international interest and commitments, the prospect for aid is brighter, but much will depend on reforms and capacity building efforts.