A3 FINANCING AND INCENTIVE STRUCTURES – Financial resources to meet water needs
Allocating financial resources to meet water needs is a major challenge. At the 2nd World Water Forum (The Hague 2000) it was suggested that, in order for developing countries to meet the needs for ecosystem protection, water supply, sanitation and wastewater treatment, and agricultural production, annual investment in the water sector would have to double from about $US90bn per year to about $180bn in the years up to 2020.
Funds to meet this challenge may be sought from government, communities and individuals, commercial banks, the private water sector and the donor community. None of these sources can fill the gap alone, and a combination of these is surely needed. Financial resources are needed for:
The availability of funds for water depends on overall development priorities and policies (see A1) and legal and institutional frameworks (A2 and B1). The introduction of IWRM does not change these realities, but tries to adapt policies in these areas to the realities of water resources, and to adapt water policies to the development strategy. Part of the financing of the nation’s development strategy thus involves direct funding of the water sector.
All the costs of investing in and operating water services have to be recovered eventually. The only ultimate sources of revenue are charges and fees levied on users themselves, plus the various kinds of subsidies available from national taxation, international grants, and voluntary contributions made through NGOs. All loans have to be repaid, and all equity rewarded, from one or other of these sources. Having said this, the choice of financial facilities is important. “Financial engineering” can make the difference to a project’s sustainability and affordability.
All governments need a water funding strategy that estimates overall investment requirements, and identifies funding sources (A3.1). Financing needs in the water sector are often huge, since projects tend to be indivisible and capital-intensive; furthermore, many countries have major backlogs in the provision of services. The important contributions of international and bilateral donors are declining, and are highly limited in relation to need. Private finance through loans is available, but the risks involved in lending to certain groups, such as municipalities or farmers’ associations may be too high to attract private finance, or make it too costly. Better co-ordination between public and private finance can be effective in mobilising better financial resources.
Sustainable financing is linked to improved cost recovery, often entailing tariff increases. These can be made more acceptable if better service results and their impact on poorer users is cushioned (A3.4). Note the distinction between the value of water as an economic good and the financial issues covered by charging and paying for water. The value of water in alternative uses is important for the rational allocation of water as a scarce resource and should inform policy.
Finance can be raised either from internal sources (A3.2) or loans and equity (A3.3).
The typical characteristics of water investments influence the choice of finance. It usually involves a heavy initial outlay (particularly for new centralised systems and advanced treatment), its physical assets have a long life, and once the investment is made it produces a steady, though usually modest, cash flow for the indefinite future. Almost all revenues are in local currency and there is a high local cost content of investment (civil works), maintenance and operation. Financial rates of return on new projects and concessions are usually modest, and closely regulated. Investment is beset principally by foreign exchange, regulatory and revenue risks.
The “water sector” is very diverse, and a different spectrum of financial sources is appropriate for each of its different parts. Not all options cost money directly; the water sector can benefit from improvements to water management resulting from investments in other sectors (e.g. power, industrial pollution abatement) and some projects (“win-win”) have other benefits to offset their costs.