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Public and Private Sector Roles in Water Supply and Sanitation Services

For borrowing countries, effective delivery of water supply and sanitation services is essential for poverty reduction. Bringing these services to the billions who are still unserved and meeting the Millennium Development Goals remains a daunting challenge. Private financing flows for water supply and sanitation in developing countries have declined in recent years, alongside declines in private flows for other infrastructure sectors. Much of this reflects difficulties in sustaining the reforms required to place the water supply and sanitation sector on a commercial footing in many countries as well as a wider reduction in investment flows to emerging markets.

At the global level, the majority of consumers connected to networks are served by publicly owned and operated utilities, and public finance remains the predominant means of funding the
expansion of water and sanitation services. This has led to a search for practical approaches to public-private partnerships for the provision and financing of water supply and sanitation services
that lie between the purely public and purely private solutions.

This article provides guidance on assessing the suitability of available options for public-private roles in the provision and financing of water supply and sanitation, and the main considerations in choosing among these options. It cautions against one-size-fits-all prescriptions, recognizing the variations in circumstances among developing countries.

Content Table

Context and Background

Infrastructure services are critical to poverty reduction, growth, and the achievement of the Millennium Development Goals (MDGs). Extending access to safe water and improved sanitation will help to reduce child mortality from diseases related to unsafe water and inadequate sanitation, and reduce the time and income spent on obtaining water. There are enormous
unmet needs for water supply and sanitation services in developing countries: it is estimated that investment must double from the current US$15 billion to $30 billion annually to achieve
the MDGs for this sector.

Closing the gap of access to service is not simply a matter of providing more money. Consumers have for the most part been served by inefficient, unresponsive utilities that recovered less in revenues than the cost of provision. In reaction, some governments have sought to increase the role of the private sector in the management and financing of these utilities. However, private financing in water supply and sanitation has accounted for less than 10 percent of investment in water utilities over the last decade. Private financing flows for water supply and sanitation in developing countries have declined in recent years, alongside declines in private flows for other infrastructure sectors. Much of this reflects difficulties in sustaining the reforms required to place the water supply and sanitation sector on a commercial footing in many countries as well as a wider reduction in investment flows to emerging markets. At the global level, the majority of consumers connected to networks are served by publicly owned and operated utilities, and public finance remains the predominant means of funding the expansion of water and sanitation services.

This article provides guidance on a broad menu of options for public and private infrastructure service provision and financing. The article remains focused on the efficient delivery of infrastructure services rather than simply building new physical capacity. Given the variety and complexity of country circumstances, the article does not provide detailed recommendations for each and every situation. It focuses on the provision of water supply and sanitation services in urban areas, including smaller urban centers and towns. For water supply this means both utility-based models and smaller-scale provision, while for sanitation it includes both on-site and network systems. Rural water supply and sanitation is not specifically addressed. However, many of the issues discussed here are also relevant to rural areas.

Formulating and Implementing Sector Reform Strategies

Water supply and sanitation sector strategies should create the conditions for the sustained expansion of access to services of adequate quality, thereby contributing to poverty alleviation, improved health outcomes, and sustainable economic growth. The major elements of these strategies, such as private participation, tariff policy, or the reform of public sector utilities, are not ends in themselves.
Rather, by improving the economic efficiency and financial viability of service providers and the environmental sustainability of service provision, they seek to contribute to these goals.

These strategies have to be adapted to conditions that differ from country to country as well as to the specific situations that service providers face within each country. Important factors include income levels, the population density and size of the area served, and the existing structure for service provision (for example, water supply and sanitation separately; water supply and sanitation combined; and the last two combined with other infrastructure services such as electricity). “One-size-fits all” solutions for water supply and sanitation sector reform are therefore to be avoided. But while conditions differ across countries, solutions must address a common set of concerns. In particular, water supply and sanitation services have to be ultimately paid for by either consumers or taxpayers. Shortfalls in revenue prevent system expansion and lead to deterioration in service.

In addition to addressing financial sustainability, sector reform strategies will also have to strengthen sector policy and regulatory frameworks, improve the commercial and operational efficiency of the service provider, address the specific needs of the poor, and reflect externalities and environmental impacts. They may also include strengthening the management and financial capacity of local government units of which water service providers are a part. Basic steps such as separating service provision from policymaking and regulatory functions not only reduce politicalinterference in day-to-day operations, but also provide greater clarity and accountability in policy formulation, oversight, and service delivery (see figure 1).

Establishing clear and realistic targets for service levels that are monitored and reported on will help in evaluating the performance of service providers in meeting policy goals. Measuring progress toward these national objectives, as well as benchmarking progress against other countries, will be important in evaluating the impact of reform strategies. Economic and sector efforts that
provide cross-national indicators, such as the Recent Economic Developments in Infrastructure (REDIs), can contribute to this, as does the International Benchmarking Network (IBNET).

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As water supply and sanitation services are often decentralized, assignment of respective roles of different levels of government in defining and implementing reform policies requires careful assessment. Central governments retain an important role even where service provision responsibility resides at the subnational level. This may include, for example, the development of common approaches and core contractual/regulatory principles for private participation and national-level monitoring and disclosure of the performance of local utilities. Such performance benchmarking should help guide the allocation of central government

cofinancing, whether through budgetary transfers or development banks. Policies need also to address the broad institutional framework for service delivery, and ensure effective coordination between the institutions responsible for providing water and sanitation services. Responsibilities for sanitation provision in particular are often shared across several
ministries. Entities responsible for asset management and service provision may not be the same as those responsible for financing and executing investments. In some cases one entity may be responsible for water supply and another for sewerage, and the former may be responsible for collecting revenues for both services, which will require mechanisms to ensure an adequate flow of revenues to both service providers.

Staff should assess the credibility and realism of proposed government strategies. A realistic medium-term performance improvement plan should address reductions in ‘non-revenue’ water, collections, staffing levels, tariff levels and structure, subsidy levels and mechanisms, service to the poor, and recovery of operations and maintenance costs and depreciation and financing costs. The credibility of the program should be assessed through comparison with past performance and some benchmarks within the industry, which will indicate what is typically feasible within a given timeframe.

Financial Sustainability

The long-term financial viability of service providers is central to reform strategies and is essential for sustainable improvements in access to safe water supply and adequate sanitation services.
Operators must generate revenue streams sufficient to cover operations and maintenance costs, including depreciation, as well as provide a return on invested capital in order to expand systems and improve service quality. The revenue requirements for the utilities concerned, on this basis, should be compared to the sum of revenues from user charges and from transfers and subsidies to be provided by the government. Expected revenues may not always support the desired investment levels and service standards (see figure 2).5 In these cases, less ambitious targets should be established, their timeframe for achievement delayed, or revenues must be increased. This requires a careful evaluation of priorities for the sector—for example, expanding water supply services versus rolling out sewerage networks.

Key measures for a reform program to bring about a more sustainable financial situation might include an agreed program of tariff increases that keeps the ability to pay of different segments of the population in perspective; predictable, performance-based allocation of tax revenues for targeted and well-justified subsidies; and appropriate incentives for service providers to improve billing and collection performance and more generally to reduce costs.

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In some cases, steps such as simply sending out and collecting bills can substantially improve the financial position of the utility. There is often considerable scope for reducing costs by improving efficiency, but such improvements will take time. Therefore changes in the level and structure of user fees will often be required. Total revenues collected from users for these services are often well below costs—even though many consumers are willing to pay for services if service providers can be held accountable for meeting quality and performance benchmarks.6 However, in many countries tariff adjustments to reflect the true cost of service will have to be implemented gradually, during which time government transfers will be required to bridge the gap between overall revenue and costs.

Where changes in the level and structure of prices for services are required, Bank staff should work with governments to identify the nature and impact of these changes. Given concerns about impacts on the poor who are connected to these networks, it will be important to evaluate the extent to which existing tariff structures are pro-poor, and the impact of changing these. Cross-subsidies are commonly employed to meet social goals. However, these crosssubsidies are often not well targeted and consequently enjoyed by too many consumers, meaning that revenues are insufficient to maintain and expand services. In many cases, tariff rebalancing will be required where subsidies to certain segments of the population are to be financed by other users.

Where government support is provided, it will be important to evaluate the rationale and efficacy of government transfers, existing and proposed, to service providers operating in the sector. Analytical work such as Public Expenditure Reviews (PERs), and Poverty Assessments can help to evaluate the extent to which planned government support to the sector will effectively meet social and environmental objectives, the administrative costs of these programs, and whether these programs represent priority areas of expenditure compared to other sectors. This analysis should also determine whether there is sufficient fiscal space for these subsidies to be sustained. Understanding whether subsidies are directed at the expansion of access to the network as opposed to the consumption of water by connected consumers, particularly where a sizeable proportion of poor households do not have access to network services, will be important. Although services have to be paid for either by users or taxpayers, the extent to which each is relied on has important implications for the sector and the economy. Government transfers are ultimately funded by taxation, which implies some economic costs. Relying heavily on these transfers is likely to make a utility more beholden to those in charge of authorizing transfers than to consumers, and is also likely to prove a less reliable source of revenues over time. Where provided, therefore, subsidies should be predictable and based on clear and transparent criteria that hold the service provider accountable for delivering the services for which the subsidies are intended.

Achieving financial sustainability is particularly challenging for sanitation where substantial externalities are present. Sanitation offers important positive environmental and public health benefits for society. In many situations, for example where coverage is low, or population density is only moderate, it may be better to promote on-site sanitation rather than the expansion of sewerage networks. Where on-site sanitation is concerned, realizing the benefits of improved sanitation and hygiene depends largely on investment decisions at the household level. Public funds should be allocated principally to the promotion and stimulation of demand for sanitation rather than to subsidizing individual households’ installation of the hardware. In some situations governments can consider subsidizing investments in on-site sanitation.

Improving the Performance of Public Sector Providers

Many governments will seek to improve the performance of publicly owned and operated service providers so that they can better meet the water supply and sanitation demands of their present and potential consumers. The critical issue for utilities that do not currently operate efficiently is how to establish a reform program to improve governance and introduce incentives to improve efficiency and customer responsiveness.

The separation of policy and regulation from functions such as asset ownership, corporate oversight, and service provision can help to provide greater autonomy and accountability for service providers. Many countries still use the traditional direct public management model, where asset ownership and service provision are concentrated in a single entity, such as a department or ministry. This entity often also exercises de facto policymaking and a nominal regulatory functions. Direct public management models have in general proven to perform poorly.

Changes in institutional structures can improve performance. Going from lesser to greater autonomy, these are: creating a ring-fenced department; creating an autonomous statutory body; and establishing the utility as a government-owned enterprise, the public limited company (PLC). (See section below for details.) However, these also need to be complemented by competent and
independent oversight of management, and mechanisms must be established to incentivize managers and staff of service providers to meet targets, and to hold them accountable for poor performance. Given the history of many performance-related contracts with public sector enterprises, caution has to be adopted in expecting major changes in incentives and, more important, commitments by governments to reduce interference in day-to-day management of the utilities. More generally, the quality of public sector governance should be taken into account, as should the overall financing and management of municipalities.

Internal incentives should be reinforced by external pressures, including the comparison of utility performance against sensible benchmarks, and the public disclosure of these results. The responsibility for water supply and sanitation service provision is decentralized to subnational government bodies in many of the Bank’s client countries. This can help introduce local knowledge into service delivery and sharpen lines of accountability but raises questions as to whether the required technical capacities will be present in smaller, decentralized entities. A particular concern is smaller population centers in decentralized environments that have small revenue bases. Given the limited capacity at the municipal level, staff should consider the extent to which well-performing water utilities might be able to play a role of institutional anchor. Financial resources provided by central government and its agencies to decentralized entities can be linked to performance and meeting clear targets for operations and expansion, thereby providing an additional impetus for reform and accountability. Sanitation often requires different approaches that are not centered on networks. The vast majority of urban residents in developing countries do not enjoy the benefits of sewerage, and their best hope for service in the near term frequently lies in on-site sanitation. Therefore the development and support of institutions to promote on-site sanitation is a high priority to achieve meaningful progress in this area. Expanding sewerage networks will require supportive land-use management and housing policies and programs.

Structural Options for Service Provision

Creating a ring-fenced department. This would be established by separating (“ring fencing”) the service provision into a separate body. Although part of a (local) government, a ring-fenced department has separate accounts and a certain level of autonomy for day-to-day management. The management oversight function remains with the owner of the utility. Ring-fenced departments in general function more efficiently than do direct public management models. However, this utility model has not been proven to work in a sustainable way over the long term, as it is prone to political interference.

Creating an autonomous statutory body. This step is essentially a change of legal status: a government department becomes an undertaking with an independent corporate oversight board. These autonomous bodies separate the functions of asset ownership (often the local government), the management oversight (a board), and the service provision function (a utility with the legal identity of a statutory body). Creating an autonomous statutory body offers opportunities for improvements in efficiency by information allowing bureaucratic administration to be replaced by commercial management, (ii)
facilitating the introduction of clear financial and operational performance targets and cost accounting systems, (iii) creating greater management autonomy, and (iv) allowing centralized supply-driven decisions to be replaced by demand-driven ones. The model is fairly common around the world, and has had mixed performance.

Establishing the utility as a government-owned enterprise, the public water PLC.This would operate under company law, while the shares of the company are owned by national, regional, or local
government authorities. The legal framework under which government-owned companies operate can create a buffer between the day-to-day commercial business operations of the utility and the political environment in which it operates.

Broadening Private Provision

Private participation has been sought in the expectation that it would introduce efficiencies in operations and investments, and that the contractual and commercial discipline involved would also prompt the government to put in place better rules for the sector, such as more cost-reflective prices and more clear-cut policy and regulatory objectives.

There are a wide range of private participation options. Going from lesser to greater transfer of risks and responsibilities to the private partner these include service and management contracts, leases, concessions, and in a few cases, divestitures. There are a number of variations of these main forms, such as public-private companies (for example, empresas mixtas). The likely benefits flowing from these options will vary (see table 1).14 In assessing the suitability of these options, the present situation in the sector and the objectives to be achieved through private participation are the key factors to be taken into account.

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There may be scope for transferring some investment responsibility to the private operator, as well run utilities finance a significant part of their development from cash generated from operations. Although this would not necessarily cover major investments, it could include the supply of meters and the rehabilitation and extension of the secondary distribution network. Where service areas extend beyond large urban areas,  people need to identify the options suitable for those circumstances. These options may include aggregation of services areas and strengthening local capacities to manage smaller systems.

Most public-private partnerships in the water supply and sanitation sector will continue to require public funding, either because of difficulties in raising tariffs to cost-covering levels in the near term, or because there are social or other objectives that cannot be met through cross-subsidies. Public funding may be utilized to augment private sources in all types of contractual arrangements, including deeper forms of private participation, such as concessions. It should be focused on specific service goals, such as access expansion or covering a temporary shortfall in revenues over costs. There are a number of approaches to subsidy delivery, including output-based aid (OBA), that should be examined with client governments.16 Public financing is likely to be particularly important in funding the expansion of sewerage networks, although the private sector may invest in treatment plants.

Even where prices fully reflect costs, explicit measures to attract private financing may be required, owing to uncertainties regarding the long-term financial viability and the sustainability of the legal and regulatory framework. In the absence of a solid track record of compliance with contractual obligations, governments may have to provide stronger commitments to agreed contractual and regulatory frameworks. Backstopping commitments on risk-sharing and regulatory regimes with partial guarantees from third parties can be used to help mitigate these risks as well.Table 2 shows some examples of public support; however, the nature and extent of public support should be carefully evaluated on a case-by-case basis.

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Responsibilities, risks, and rewards need to be carefully allocated in public-private partnerships. This could take the form of a risk and reward allocation matrix for private participation options, as well as an assessment of explicit and contingent government liabilities so that the real costs and benefits of each private participation option are clear to the government and its development partners. Where governments decide to provide some form of financial support, staff should work with clients to evaluate whether or not the proposed instruments match the policy objective to be supported. For example, direct subsidies will be the best approach to meeting social objectives or dealing with externalities. Credit enhancement to reduce the cost and/or extend the maturities of financing will help to address concerns about investments in assets that have long lives compared to the tenor of debt available commercially.

In fashioning reform strategies, governments should consider the full range of private sector options available. Qualified domestic or regional companies should have the opportunity to compete for public-private partnerships. In countries with low coverage levels, the gap between connected and unserved households is often filled by small scale providers, usually community based organizations, nongovernmental organizations (NGOs), and the small-scale local private sector. Community-based programs focused on on-site sanitation are a necessary complement to network sewerage systems, and the local private sector can play an important role in providing necessary services for on-site sanitation. Measures for strengthening or more formally incorporating small-scale service providers should be undertaken as part of a broader strategy for extending services to poor and unserved households. Recent initiatives to integrate these providers into utility contracts and invite small-scale operators to provide a range of services have yielded positive results for consumers, particularly those in poor households.

Regulatory Frameworks

Water supply and sewerage network services have natural monopoly characteristics, as well as significant health and environmental impacts. Regulation of service provision is therefore required regardless of whether the provider is a public or private entity. In situations in which regulation has been bundled with service provision, very often the first steps will be in setting up the framework that will operationalize policies, covering tariff structure and levels, service standards, and expansion targets.

Local responsibility for service provision in many countries can represent a significant challenge, with a large number of decentralized service providers, accountable to their respective local governments. While local regulation may make the best use of local knowledge, technical and management capacity is often uneven at the lowest tiers of government. National regulatory authorities may have greater capacity, but will have difficulties or may be prohibited, constitutionally or otherwise, from regulating a large number of diverse local service providers. The appropriate distribution of roles between national and local authorities needs to be clearly established. The information generated by regulators can also be used by central funding
agencies in allocating financial resources on the basis of actual performance. The regulation of public sector providers poses a unique challenge as public sector entities do not typically respond to economic incentives that drive much of private regulation. Where there is little planned reform in terms of transformation of the service provider, the need for changing the regulatory framework greatly, for example by creating independent regulatory agencies, needs to be carefully evaluated. However, better oversight and monitoring of performance of public sector service providers can lead to increased transparency and pressure for further reform. Where private finance is sought, the regulatory framework must provide financiers sufficient comfort that they will earn a return on their investments commensurate with the risks involved. Developing robust regulatory frameworks and the strong institutions to implement them takes time. In many countries it will be necessary to provide stability and predictability in the regulatory regime by limiting the amount of discretion that regulatory bodies have in setting prices and key parameters, particularly during the initial years of public-private partnerships. This can be done by setting out the main parameters, such as prices and service standards, in the key regulatory instruments, such as licenses or contracts, or by having clear principles in legislation. Robust and workable dispute resolution mechanisms that allow for credible and timely scrutiny of regulatory determinations and contribute to the accountability of regulators are an integral part of such measures. Placing contracts and other regulatory instruments in the public domain will also improve transparency.

In countries undertaking reform, people will need to assess the appropriateness of alternative regulatory oversight arrangements, taking into consideration that regulatory institutions, instruments, and skills develop over time (see table 3). Placing the key regulatory instruments in the public domain will increase transparency within the sector. Building professional regulatory capabilities requires political commitment and adequate funding on the part of the government. Where these prerequisites are in place, it is possible to mobilize a wealth of resources and networks (for example, IFUR and the regional networks such as SAFIR, AFUR, and ADERASA). In countries with little regulatory capacity, contracting out of many of the technical functions of regulation should be considered. Support from established regulatory agencies—perhaps linked through regional fora—will be important in transferring knowledge and best practice.

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Extending Services to the Poor

Reforms that place the sector on a sound financial footing will generate increased resources for investment in system expansion. But this alone will not guarantee that the poor are reached. Extending services to the poor requires specific attention and targeted interventions. The nature of the problem—involving a lack of the access by the poor to credit and unaffordable connection fees and consumption charges—should first be well analyzed, and this diagnosis should form the starting point for formulating policies to address access and equity issues in the sector. government counterpart need to ensure that the content and sequencing of reforms and investments take into account the needs of the urban poor. Deferring the implementation of pro-poor reforms in order to focus on improving services for existing consumers may worsen conditions for the poor. In several cases, reform programs have suffered setbacks because of public perception that the poor have been adversely affected. This would include upfront poverty mapping, demand and willingness-to-pay (WTP) assessments, design of contractual arrangements that encourage the operator (whether public or private) to serve new customers regardless of their expected level of consumption, and a tariff structure that favors access to and minimum consumption of piped water.

The urban poor often have unique and differentiated service demands that cannot be met through one-size-fits-all approaches. In some cases, service might be best supplied by non-network solutions. Successful reforms require inclusive, transparent, and well-informed stakeholder consultation. Improving mechanisms for communication and participation, by providing greater voice to and acceptance by poor communities, will assist in developing programs that meet the needs of the poor. Developing or strengthening partnerships between utilities or regulatory agencies and NGOs, community organizations, and civil society should be explored. Identifying and removing administrative and legal barriers that the poor face in connecting to water supply and sanitation networks is often critical, as is tackling land tenure security, housing, and land-use management through broad citywide strategies.

A number of regulatory and policy approaches can be used for expanding access and affordability.These include the use of direct or cross-subsidies, connection targets or universal service obligations in PPPs, liberalizing entry for unserved or under-served areas, and allowing differentiated levels of service in line with consumer preferences and their ability to pay. Very often existing subsidies are captured for the most part by non-poor households and suitable measures should be taken to redirect these to lower-income consumers. As noted earlier, where subsidies are proposed, even where these benefit the poor, the government’s ability to fund these should be fully assessed.

Environmental Considerations

Reform of the sector provides an opportunity for improving environmental oversight, and for assessing the relationship between the economic and environmental regulation in terms of standards,
institutional roles, and decisionmaking processes. It is particularly important to ensure that environmental standards are consistent with the economic and social policies and regulations and that compliance is within the financial capacity of the operator, customer base, and government. Failure to do so may lead to, for example, environmental standards requiring investments that cannot be financed by user fees or government transfers.

Raising Finance from Domestic Capital Markets

Utilities that improve their financial position may be able to directly access local financial markets. This might include longer-term borrowing, particularly in middle-income and transition economies. Where utilities are in a position to repay from their own revenues the costs of financing, this option can be a good possibility for mobilizing financial resources to fund system expansion. Borrowings
by state undertakings should be monitored and ultimately controlled by the government, since both explicit and implicit government guarantees may affect the government’s overall fiscal position. In the long run, local currency financing will be the most sensible approach to dealing with foreign exchange risks in a sector where revenues are denominated in local currency. However, domestic capital markets in many countries are limited, and developing them requires reform that goes well beyond the scope of water supply and sanitation, encompassing the country’s financial sector, pension systems, and insurance markets among others. Reforms here will require the use of banking, capital markets, and municipal finance skills.

Access by local governments and their utilities to domestic savings through financial markets can provide additional sources of financing for investment. There are many ways in which utilities and their parent government bodies can access local credit markets, including general municipal bonds, revenue bonds linked to water supply and sewerage programs, project/structured finance, and long-term bank debt. There is scope for international financial institutions to play a role in the development of these financial markets by providing appropriate risk mitigation and sub-sovereign lending instruments. This could include credit enhancement to lengthen the tenor and reduce the cost of finance accessed by creditworthy water companies and their municipalities.

Resources

The issues in this article are addressed in the operational guidance note for World Bank staff, Public and Private Sector Roles in Water Supply and Sanitation Services. 

The Note provides guidance to World Bank Group staff on assessing the suitability of available options for public-private roles in the provision and financing of water supply and sanitation, and the main considerations in choosing among these options. It cautions against one-size-fits-all prescriptions, recognizing the variations in circumstances among developing countries. The note links the various public-private options with appropriate World Bank Group instruments, including project-specific, sector-wide, and broader interventions.

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