pproaches46317 S e p t e m b e r 2 0 0 8 N o t e N u m b e r 2 0 Output-Based Disbursements in Mexico: Transforming the Water Sector in Guanajuato By Gustavo Saltiel and Cledan Mandri-Perrott A project in the Mexican state of Guanajuato shows how tying disbursements to specific outputs can provide incentives for effective implementation of a water sector strategy. The disbursements, from pooled government and World Bank loan funds, are made against connections to safe and reliable water service and improvements in utilities' ef- ficiency and wastewater treatment. This scheme has shifted the focus from inputs to performance standards. And it has put the burden of good design on the state government, requiring it to develop a clear strategy for the sector and a system for measur- ing results. The scheme has proved to be effective in improving sector performance, ensuring accountability by municipal utili- ties, and supporting medium- to long-term planning for better water and environmental management. Project background The Decentralized Infrastructure Reform and Devel- © World Bank opment Project in the Mexican state of Guanajuato, approved by the World Bank (WB) in 2005, was the first multi-sector, infrastructure sector-wide approach significantly above the average for Latin American (SWAp) funded by the WB in Latin America.1 The WB and other developing countries. About 90 percent of financing, a US$108 million investment loan, is sup- the population now has access to a water connec- porting Guanajuato in achieving sustainable invest- tion (either in the house or nearby) and sanitation, ment levels and efficient implementation of sector strategies for roads, low-income housing, and water and sanitation.2 The project is piloting the use of a country's own systems for managing social and envi- 1The SWAp design means that the rules governing project ronmental risks in WB-funded projects. It also includes execution apply to all expenditures under the sector both an output-based disbursement (OBD) mecha- strategies regardless of the funding source--whether the nism (see Box 1) and a currency conversion mechanism WB loan, federal government transfers, state revenues, or allowing disbursements in local currency. This note municipal contributions. 2 describes how the OBD scheme has helped improve The WB channels the funds to the state through BANOBRAS, the Mexican Development Bank. performance in the water sector in Guanajuato. Gustavo Saltiel is Sector Leader for Mexico in the Sustainable Designing a sector strategy Development Department, Latin America and the Caribbean Region of the World Bank. CledanMandri-Perrott Access to water and sanitation in Mexico has in- is a Senior Infrastructure Specialist with the World Bank's creased steadily in recent decades, reaching levels Finance, Economics, and Urban Department. Supporting the delivery of basic services in developing countries pproaches Box 1: OBD and OBA Compounding this inefficiency is the lack of a clear national policy framework for water and wastewater Output-based disbursement (OBD)* was developed specifi- cally for high-capacity IBRD members in the middle-income tariffs, subsidies, and cost-recovery goals. Moreover, countries (MIC) group, as well as for select IDA countries the traditional focus on developing infrastructure with reliable implementation capacity. Under an OBD ap- has shifted attention away from increasing efficiency, proach, a government entity, operating on a non-commer- improving the quality of service, and extending services cial basis, undertakes or causes a third party to undertake to the poor. the achievement of a pre-defined output by providing To tackle problems like these, Guanajuato has financing and technical assistance to that third party. After verification that the pre-defined output has been achieved, developed a comprehensive water sector strategy to be the government entity requests that the WB disburses the implemented by the State Water Commission, directly loan or grant resources (to the government entity). OBD is or through municipalities or municipal utilities. The similar to output-based aid (OBA) in that both approaches strategy is built on three main pillars: always involve a pre-agreed payment for the delivery of a specified output. They differ in that an OBA approach is usually linked to the provision of basic services by a service · Policy focus: The State Water Commission is consoli- provider. The service provider undertakes the achievement dating its role as a policy maker, process facilitator, of pre-defined outputs, bearing the associated risk (e.g., implementing agency, and provider of technical pre-financing, quality of service), and upon completion assistance for municipal water utilities. In addi- the outputs are reimbursed through subsidies, provided tion to streamlining tariff structures and improving that independent verification is satisfactory. The subsidies managerial practices, the commission has recently (typically capital subsidies) can be financed through donor funding, including WB loans and/or grants, which are then updated the state water plan through a participa- on-granted to the service provider by the government bor- tory process, strengthening the focus on gender, rower/recipient.** sustainability, equity, participation, and reversal of * For more information on OBD, see Implementing Output-Based environmental degradation. The commission has Disbursement Mechanisms for Investment Operations, Operational / also strengthened the focus on performance report- Technical Guidance Note to Staff, OPCS, April 2, 2007. ing by the water operators. ** In the case of projects funded by the WB-administered Global Partner- ship on Output-Based Aid (GPOBA), the grant agreement can be signed · Integrated water resources management: The State Water directly with the service provider or fiduciary agent. Commission seeks to integrate diverse disciplines. For example, the commission has supported the creation of groundwater committees that have an important say in water management issues. The but sharp differences remain between urban and rural commission also is supporting the construction of areas. In the State of Guanajuato, overall coverage is wastewater treatment plants to improve the qual- 92 percent for water and 75 percent for sanitation, but ity of the state's scarce water resources, ranking in rural areas, where a third of the state's 4.9 million Guanajuato among the leading states in wastewa- people live, coverage is only 77 percent and 60 percent ter treatment coverage in Mexico. respectively. · Increase in service coverage: The commission has been Mexico's water and wastewater sector faces many working toward sustainable solutions to rural water challenges. The share of municipal wastewater receiv- and sanitation needs by supporting the creation ing treatment (30 percent) is more than twice the Latin of rural water boards (community organizations American average (14 percent), but far below levels in charge of the local water system) and making investments in rural communities a priority. in OECD countries (CONAGUA 2008; World Bank 2005). Many treatment plants do not comply with ba- sic standards for effluent discharge. Some 55 percent Choosing output targets of households connected to the water distribution After extensive debate among stakeholders, the project network experience interruptions to supply, a problem partners chose three key output indicators and es- most acute in smaller municipalities and for the poor (World Bank 2005). And as measured by nonrevenue water, operating and collection efficiency in Mexico is 3Nonrevenue water is the difference between water supplied well below the average for OECD countries.3 and water sold as a percentage of water supplied. Supporting the delivery of basic services in developing countries pproaches Table 1. Unit values for output-based disbursements Output indicator Disbursement unit value Target Total (US$) Access to service $250 per rural or urban inhabitant 90,640 inhabitants 22,666,000 Overall efficiency $160,000 per utility that increases 64 utilities increasing efficiency 10,240,000 efficiency by 10% by 10% Wastewater treatment level $60,000 per 150 kilograms BOD 12,750 kilograms BOD 5,100,000 removed Total 38,000,000 tablished unit values for WB loan disbursements (see Picking the output indicators and setting the unit Table 1): values proved to be complex. The value for the access- · The overall efficiency indicator, defined as revenues to-service indicator was set higher than the national relative to the volume of water produced, aims to average connection cost to promote greater coverage, reward municipal utilities for increasing revenues while the value for the wastewater treatment indica- and reducing water use and thus ultimately improve tor was set lower than actual costs to give improving their financial standing. On the basis of historical treatment facilities less priority than increasing service data on efficiency improvements and associated coverage and efficiency. While the value for the effi- costs, a unit value of $160,000 was established for ciency improvement indicator was based on historical utilities demonstrating an efficiency increase of 10 cost data, many efficiency improvements clearly require percent or more. only small investments (such as changes in managerial · The wastewater treatment indicator aims to ensure practices). So the value chosen provides a clear incen- that municipal utilities put wastewater connections tive to allocate funding toward rehabilitating water and treatment on their agenda--a priority given systems, which should improve the quality and sustain- the low levels of wastewater treatment in Guana- ability of service. juato. A value of $60,000 for every 150 kilograms The State Water Commission played a crucial role in of biological oxygen demand (BOD) removed was the project's success. Although the commission is a established based on projected costs and treatment state agency, it can act as an arbiter between the state plant efficiencies. and municipalities if disputes arise; there is no conflict · The access-to-service indicator was intended to of interest because (unlike other water commissions ensure that each municipality targeted both urban in the country) it has no mandate to develop and and rural populations. A single value of $250 was construct projects. The commission is also an essen- set for each inhabitant connected, rural or urban. tial part of the payment mechanism, providing inde- Higher than the national average cost for new pendent verification of the outputs achieved by each connections, this amount was expected to provide municipality. a clear incentive for expanding services to poor residents without access. Results of the OBD scheme Lessons learned Tying pooled funds to specific outputs required a paradigm shift for both the WB (in its assistance Establishing baseline data was critical for measuring approach) and the borrower country (in its mecha- outputs. Data on household connections were taken nisms for disbursement and implementation). Under from census data. Revenues relative to volume of water the OBD scheme, payments are not conditional on produced were derived from utilities' performance and outputs alone: total outputs must be reconciled cost accounts. Baseline data for the wastewater treat- with eligible expenditures, i.e. expenditures procured ment indicator were determined on the basis of the under WB procurement rules. But flexibility in the plants in operation before the project began. project design allows for outputs and expenditures in Supporting the delivery of basic services in developing countries pproaches different categories as long as the total amounts dis- free to focus their efforts where most effective. Thus, bursed under the two concepts match. For example, some improved their customer registers while others the State of Guanajuato can claim a disbursement aggressively pursued delinquent customers, shortened on the basis of the results achieved in the wastewa- collection times, increased tariffs, or reduced produc- ter treatment indicator and later "justify" the claim tion costs. through eligible expenditures incurred in water or Measuring outputs and results fostered account- sewerage works. The burden of proof for expenditures ability and transparency. Thus, the State Water Com- is on the state. mission used loan resources to develop an auditable In terms of the output targets, by April 2008 the statistical methodology to measure implementation project had surpassed the target for access to ser- progress. vices, providing full access to more than 90,640 The OBD scheme improved institutional arrangements, inhabitants, most of them living in poor areas. leading to more transparency, better coordination and Similarly, more than 60 municipal utilities had shown planning, and greater accountability. It also generated an increase in overall efficiency of at least 10 percent. valuable information on the sector's performance, pro- And treatment plants had made important progress viding inputs for budgetary decisions and the design of on wastewater treatment (the state is now verifying future programs. their performance). The output-based design encouraged greater ef- References ficiency. It was up to each municipality to contract the construction of physical works needed to make CONAGUA (National Water Commission). 2008. "Situ- new connections and the construction or upgrading ación del Sub-Sector de Agua Potable, Alcantaril- of wastewater treatment plants--and by using com- lado y Saneamiento 2007." (www.conagua.gob.mx) petition in the contracting process, they were able to World Bank. 2005. "Mexico: Infrastructure Public realize significant savings. Similarly, it was up to utili- Expenditure Review." Latin America and the Carib- ties to decide how to improve efficiency, leaving them bean Region, World Bank, Washington, DC. About OBApproaches OBApproaches is a forum for discussing and dis- The case studies have been chosen and presented seminating recent experiences and innovations by the authors in agreement with the GPOBA for supporting the delivery of basic services to the management team, and are not to be attributed to poor. The series will focus on the provision of water, GPOBA's donors, the World Bank or any other af- energy, telecommunications, transport, health and filiated organizations. Nor do any of the conclusions education in developing countries, in particular represent official policy of the GPOBA, World Bank, through output, or performance,-based approaches. or the countries they represent. To find out more, visit www.gpoba.org The Global Partnership on Output-Based Aid Supporting the delivery of basic services in developing countries