56309 July 2010 Note Number 35 Output-Based Aid for Water Supply in Uganda Increasing Access in Small Towns | Chris Azuba, Josses Mugabi, and Yogita Mumssen I n Uganda small private companies have been operating water supply systems since 2001. A pilot output-based aid (OBA) project is expanding this approach. The project is leveraging private sector finance and expertise to provide access to piped water for an estimated 45,000 people in small towns and rural growth centers while increasing efficiency and accountability in the use of funds. About 8,100 people have benefited so far, and the govern- ment is exploring the use of OBA approaches as part of its national framework for water supply. Uganda has 160 small towns and about 850 rural growth centers, with a total estimated population of 2.5 million. In 2008 safe water coverage extended to about 46 percent of the population in the 160 small towns, and systems functioned 89 percent of the time on average. The government's goal is to achieve 65 percent coverage and 95 percent functionality by 2015, and full coverage by 2035. Photo courtesy of the World Bank Before 1997 the central government, through the Directorate of Water Development--an agency under the Ministry of Water and Environment--ran all formal wa- Through a process drawing on consultation and ter supply systems in small towns, with little involvement past experience with decentralization, the institutional by local authorities. This approach was considered unsus- framework evolved from central control to a system of tainable, as decisions were made far from the users and performance agreements between the ministry and local revenues were not ring-fenced. Ensuing sector reforms authorities, which delegate the management of the water supported by the World Bank and other development systems to local private operators through one- to three- partners emphasized improving the efficiency and quality year management contracts. Today, private operators of service delivery by separating asset ownership from (about 20 are active in the sector) are managing 72 water operation and commercializing service delivery through supply systems. an appropriate form of public-private partnership (PPP). Uganda's approach to private participation in small- town water supply has led to improvements in service Chris Azuba is a Principal Engineer in the Uganda Ministry of quality and customer satisfaction and is widely seen as a Water and Environment's Directorate of Water Development and model. Yet rising investment costs combined with afford- Josses Mugabi is an Infrastructure Specialist with the Global Partnership on Output-Based Aid. Yogita Mumssen is a Senior ability problems for users have limited the expansion of Infrastructure Economist in the World Bank's Finance, Economics, services to poorer segments of the population. Building and Urban Development Department and the original Bank team on its experience so far, sector experts suggest, Uganda leader of the project. needs to develop a more sophisticated PPP arrangement Supporting the delivery of basic services in developing countries that allows greater transfer of risk to the private sec- to cover at least 10 percent of expected investment tor, to unlock innovation and efficiency and increase costs in rural growth centers and up to 30 percent accountability. in some small towns (whereas past tariffs covered Against this background an output-based aid no share of the costs). (OBA) pilot project was conceived to test a new form · In small towns, where the scheme largely involves of risk transfer mechanism that leverages private sec- extending existing systems, the private opera- tor finance and expertise in system design, construc- tors are compensated for agreed investments after tion, and operation within the existing institutional targeted connections have been made and indepen- framework. dently verified. Some of the payment is withheld until after a period of water delivery demonstrated The output-based aid pilot scheme through bills paid. In rural growth centers the operators receive compensation in phases for inter- In November 2005 the Ministry of Water and En- mediate outputs, although 45 percent is withheld vironment approached the Global Partnership on until after verification of connections and a period Output-Based Aid (GPOBA) for help in designing of water delivery. and funding a pilot OBA scheme in small towns and · The Ministry of Finance, Planning and Economic rural growth centers. The rationale is to provide af- Development provided an exemption to work fordable safe water to new customers among poorer outside the budgeted "sector ceiling" and with a groups while promoting effective implementation, private fiduciary agent, as the GPOBA grant would value for money, and private participation. be provided to local private operators based on The scheme consists of 10 subprojects, 4 in rural output delivery and because the program is a pilot. growth centers and 6 in small towns.1 In each one, a · An independent verification agent checks the private company was selected on a competitive basis quality and quantity of outputs and reports to the to implement a predefined investment program for Ministry of Water and Environment and the pri- improving the water supply system and to oper- vate fiduciary agent. ate the extended system. In small towns the goal is to expand access by increasing active connections The contractual arrangements for implementation and extending the distribution networks and, where and the flow of funds include three key agreements necessary, to increase the capacity for production, (figure 1): storage, or both. In rural growth centers the scheme involves the design, construction, operation, and · A memorandum of understanding between GPOBA maintenance of new piped water supply systems and the implementing agency, the Directorate of (greenfield installations). The scheme is expected Water Development, which assigns specific roles to deliver 2,000 connections (yard taps and public to the directorate and other implementing stake- kiosks), benefiting almost 45,000 people. The cost holders. is covered through a US$3.2 million grant from · A grant agreement between GPOBA and the fidu- GPOBA, plus cofinancing of about 20 percent from ciary agent, which outlines the fiduciary agent's user contributions and in some towns, a small share roles and responsibilities and sets out the rules from conditional grants by the government to local governing financial management, disbursement of water authorities. payments, and auditing for the project as well as those governing the release of funds to the private Key features operators. · An implementation agreement between the fiduciary The OBA pilot, built largely on the existing institution- agent and the Directorate of Water Development, al framework, differs from the more common arrange- under which the fiduciary agent delegates key ments in Uganda's small towns in several main ways: implementing functions to the directorate and other implementing stakeholders. · Rather than management contracts of 1­3 years, the OBA pilot involves design, build, and operate Results so far (DBO) contracts of 5 years for small towns and 7­10 years for rural growth centers. The Ministry of Water and Environment and local · Tariffs are written into the DBO contracts along authorities signed DBO contracts in 2008 with each with simple escalation clauses. They are intended private operator winning a competitive tender in a July 2010 Note Number 35 town or rural growth center. All 10 subprojects are Emerging lessons have started to deliver outputs. Of the 2,000 targeted connections, 961 have been completed, all in the small Emerging lessons and challenges in this pilot could towns. Of these, 450 yard taps have been verified, ben- inform dialogue on scale-up in Uganda and elsewhere: efiting an estimated 8,100 people. Construction in the four rural growth centers is advanced, with intermedi- · The shift from input- to output-based approaches ate outputs completed and verified in some (Azuba means new challenges for the public contract- 2010; GPOBA 2010). ing authorities and the private operators and may Already the OBA approach has shown clear necessitate capacity development for both. benefits. The competitive bidding process (based · Private operators need affordable access to finance on lowest subsidy required) resulted in a 20 percent to "prefinance" investments before output-based average efficiency gain,2 and in three of the towns the disbursements are made. Some measures have been winning bidder proposed a zero subsidy, meaning that tried, including phasing in outputs to reduce the it would connect households solely for the expected prefinance capital required and providing capacity tariff revenue. building for private operators and local banks. So The OBA approach has also demonstrated several far, operators have relied more on their own cash advantages over traditional approaches to investment. and on working capital (such as supplier credit) The subsidy per person gaining access is US$0­36 (for than on bank loans. As they start to deliver results, extension projects) and US$83­108 (for greenfield some local banks have shown renewed interest projects) in the OBA pilot, compared with US$30­138 in participating, but access to finance remains an and US$37­250 in traditional input-based projects important part of the "capacity building" gap. (COWI 2009). The OBA pilot also has faster times · The project has faced significant delays, showing for processing payment requests from operators and, that the original estimated timeline was too ambi- generally, for getting to contract signature and from tious and did not fully take into account potential signature to completion of the operational system. delays in procurement and tendering. Figure 1. Institutional framework for pilot implementation Memorandum of Understanding MoWE Grant Agreement Implementation Agreement GPOBA DWD Implementing Agency Independent Private Monitoring and Verification Agent Fiduciary Agent Sector Verification Function Funds Administration Agreement Performance Agreement Funds Disbursement Agent Small Town or RGC Local Water Authority DBO Contract Private Operator Service Provision Contracts Control Water Users Funds Source: MoWE 2007. · The project has higher advisory and finan- Given the successes so far, as well as lessons learned cial intermediary costs (12 percent of the total regarding key challenges, the ministry has sought to subsidy amount) than traditional projects (4­8 explore OBA for its water supply development facili- percent)--not surprising for a pilot. Clustering ties (WSDF). The WSDF represent a shift from a seg- of towns might lower some transaction costs and mented project approach toward a coherent national lead to additional economies of scale. funding program and implementation framework for · The highly competitive bidding processes result- water supply in small towns and rural growth centers. ed in tight bid prices, leaving operators with little The World Bank and GPOBA are working with the room to fund unexpected or emergency opera- government and its development partners to explore tional costs. The Ministry of Water and Environ- how such an OBA scale-up would work in Uganda's ment is exploring ways to mitigate that outcome small towns and rural growth centers. in the future. · Given the ever-increasing constraints to available References water resources, the risk related to availability need to be more carefully considered and shared Azuba, C. 2010. "Output-Based Aid for Water in Af- between the providers, authorities and users. rica: Uganda Small Towns Water Project." Presen- · An OBA scale-up must carefully consider capac- tation at the African International Water Congress, ity to monitor and regulate private operators Kampala, March 15­18. Available at http://www. throughout the life of their contracts. nwsc.co.ug/publications-afwa.php COWI. 2009. "Development of Detailed Options for Conclusion OBA Scale-up in Uganda's Water Sector: Scoping Report." GPOBA and World Bank, Washington, DC. Uganda's experience further demonstrates some of the GPOBA. 2010. "OBA in Water Supply in Small Towns advantages of the OBA approach in financing infra- and RGCs in Uganda: Semi-annual Status Report." structure services. By shifting performance risk to the February. Washington, DC. service providers, the project has increased account- Ministry of Water and Environment (MoWE), Direc- ability for results and efficiency. Moreover, contrary to torate of Water Development. 2007. "OBA in Water the view that the private sector has no appetite for risk Supply in Small Towns and RGCs in Uganda: Final taking in the water sector, the pilot has shown that Operations Manual (May 2009 Revision)." Kampala. relatively small private companies are willing to take on prefinance and performance risk and have strong incentives to roll out improved service quickly. The 1 An 11th subproject in a small town is being contracted out. The Ministry of Water and Environment has now adopted town fell under the technical assistance from the International the DBO contract as one approach for private partici- Finance Corporation, which acted as transaction adviser for the pation in the sector, a longer and more advanced form Ministry of Water and Environment. 2 Efficiency gain is based on budgeted subsidies calculated from of PPP made possible by several years of experience existing unit costs and similar piped water schemes in Uganda. with private participation. About OBApproaches OBApproaches is a forum for discussing and disseminating The case studies have been chosen and presented by the au- recent experiences and innovations in supporting the delivery thors in agreement with the GPOBA management team and are of basic services to the poor. The series focuses on the provi- not to be attributed to GPOBA's donors, the World Bank, or any sion of water, energy, telecommunications, transport, health, other affiliated organizations. Nor do any of the conclusions rep- and education in developing countries, in particular through resent official policy of GPOBA, the World Bank, or the countries output-, or performance-, based approaches. they represent. To find out more, visit www.gpoba.org e Global Partnership on Output-Based Aid e Global Partnership on Output-Based Aid Supporting the delivery of basic services in developing countries