August 2010 Number 160 www.worldbank.org/enbreve 56688 A regular series of notes highlighting recent lessons emerging from the operational and analytical program of the World Bank`s Latin America and Caribbean Region. THE WORLD BANK Innovative Results-Based Approach to Tackling Water Scarcity in São Paulo By Carlos E. Velez and Julia Tierney Water is an essential part of supporting sustainability. Despite high urban coverage rates to sustainable economic growth within a more potable water (98 percent) and public sanitation (75 equitable and inclusive society. Possessing about percent), the State faces water scarcity and pollution problems due to the low availability of water, high 14 percent of the world's water, Brazil is rich in level of demand and lack of wastewater treatment.1 The water resources, but 70 percent is in the Amazon metropolitan region's extremely low per capita water River and only 1.6 percent in the State of São availability is comparable to the driest areas of the Paulo, where 25 percent of the population resides Brazilian Northeast. and 33 percent of the country's GDP is generated. The Bank has recently approved the innovative In this densely urbanized region an increase in water São Paulo Water Recovery Project (REAGUA) availability, both through an improvement in its quantity which adopts output-based financing to tackle and an enhancement of its quality, is of crucial importance, water scarcity. This is the first Bank-financed but more investment is not the panacea as past project in the water supply and sanitation (WSS) interventions have been insufficient in terms of amplifying sector to implement a comprehensive results- water availability. It is important to go beyond works to based scheme. Its objective is to increase clean improve the efficiency of WSS systems and promote the water availability in São Paulo but its lessons could sustainability of investments. be applied worldwide. Output-Based Financing Against this backdrop, São Paulo and the Bank have agreed Water Problems in the State of São Paulo on a programmatic engagement in the WSS sector that addresses the challenges of attaining universal coverage, The State of São Paulo is emblematic of the urban water promoting the sustainable use of water resources, challenges facing Brazilian cities. Over the past three decades, implementing an integrated WSS strategy and developing Brazil has undergone a rapid process of urbanization, institutional and technical capabilities among service catalyzing economic innovation yet bringing myriad providers to improve their efficiency and ensure their problems. Nowhere is this truer than the State of São Paulo, compliance with planning and regulation requirements. with over 41 million people, of which 95 percent live in urban As part of this evolving and dynamic partnership, the areas, including the metropolitan region which is one of the State and the Bank agreed to execute a pilot project largest cities in the world with 20 million inhabitants. using output-based financing to tackle the issue of water Among the critical issues facing the State of São Paulo are scarcity in concurrence with the Mananciais Program, water scarcity and environmental degradation, both of which which focuses on pollution control and slum upgrading are constraints on economic growth and environmental within the metropolitan region. 1 Brazilian Institute of Geography and Statistics (IBGE) National Household Survey (2003). 1 REAGUA will use output-based disbursement to encourage a critical fiduciary safeguard on accurate targeting of funds investment aimed at increasing water availability in the State and evidence that public funding has been well spent. of São Paulo's most critical watersheds.2 As opposed to the traditional input-based mechanism, whereby the Borrower The Bank is also moving in the direction of a more results finances specific investment expenditures (such as the inputs oriented approach as it has expressed interest in eliminating to build a wastewater treatment plant), the results-based the disconnect between programmatic engagement as approach finances outputs (the completed wastewater reflected in the Country Partnership Strategy and the static treatment plant) that are directly tied to outcomes (cubic stages of the basic project cycle.3 REAGUA is a step in meters of treated wastewater). Funds will be disbursed the direction of reform as it directly ties disbursements to state or municipal water service providers against with results (outputs and outcomes) and facilitates a independently verified outputs, effectively transferring programmatic engagement by disbursing against agreed performance risks to the service providers and explicitly outputs rather than specific expenditures and moving to the linking funding to the achievement of project objectives. use of government fiduciary and safeguards systems. The disbursement of funds against outputs will sharpen the targeting of results in a more transparent, accountable REAGUA Outputs and Unit Costs and efficient manner. Public expenditure performance will improve as payments will shift financial and operational REAGUA aims to increase clean water availability by risks to those best positioned to manage such risks. Outputs focusing on increasing the quantity and enhancing the will be verified by a verification agent to ensure that they quality of water. Activities and their respective outputs and are delivered according to agreed conditions and provide outcomes include: Activities to increase Outputs Outcomes water quantity ·m3ofrecoveredwater ·m3ofrecoveredwater(byreducingwater ·Reducerealwaterlosses ·Appliancesinstalledandawarenesscampaigns losses) ·Promoterationaluseofwaterinpublicschools executed ·m3ofrecoveredwater(byrationalizingwater ·Reusetreatedwastewater ·Wastewaterreusefacilitiesbuilt consumption) ·m3ofrecoveredwater(byreusingwastewater) Outcomes Activities to increase Outputs water quality ·m3ofrecoveredwater(byconnecting ·Activeconnectionstowastewaternetworkbuilt householdstowastewatertreatmentplants) ·Buildwastewaterconnections ·Transportpipesinstalledandpumpingstations ·m3ofrecoveredwater(bytransporting ·Buildwastewatertransportnetworks built collectedwastewatertotreatmentplants) ·Build/upgradewastewatertreatmentplants ·Wastewatertreatmentplantsbuilt ·m3ofrecoveredwater(byreturningtreated wastewatertowaterbasins) The implementing agency is the State Secretary of Water a rigorous economic, financial, technical, environmental and Supply and Sanitation and Energy. It published a Call for social analysis to determine their feasibility and select the Proposals outlining eligibility criteria: (i) activities had to target highest ranking proposals for financing. The Bank will conduct the five most water scarce basins in the State; (ii) priority had to a capacity assessment on all selected service providers to go to serving the poor; (iii) activities had to be in an advanced verify that fiduciary systems meet Bank standards to ensure stage of preparation; (iv) service providers had to be state or that expenditures take place in lines with the principles of municipal companies; (v) service providers had to provide economy, efficiency, transparency and competition. at least 10 percent upfront financing; and (vi) proposals could not involve resettlement or include procurement The calculation of unit costs to price the outputs was one processes above the national competitive bidding threshold of the most complex aspects of project preparation. An as this would facilitate implementation and avoid delays. extensive selection of data from the National Information All disbursements are in the form of subsidies from the System on Water Supply, Sanitation and Solid Waste (SNIS); State to the service providers. Although this was the State's the National Water Agency's program partially subsidizing first results-oriented scheme, the response from the service wastewater treatment plants by paying for results (PRODES) providers was huge, with US$275 million of proposals from and the State Water Company (SABESP) was analyzed to over 30 service providers. These proposals were subjected to determine the unit costs. 2 The State has determined that watersheds are in critical condition when the relationship between demand and availability surpasses 50 percent, but because of the limited amount of project funds, investments will only be eligible if they target the most critical watersheds with a water demand/availability greater than 80 percent. 3 Investment Lending Reform Concept Note discussed by the Executive Directors on February 12, 2009. 2 When calculating the unit costs for the water losses repetitive actions and a change in management focus to activities, where the cubic meters of recovered water is the ensure sustainability. To account for the different levels of output, the project team was reminded of the challenges effort required to achieve substantial reductions in water of weight loss. Much like a weight loss program where losses, the service providers were categorized into four shedding the first few pounds is relatively quick and easy groups based on their technical performance,4 with the but losing the remaining pounds takes longer, involves inefficient ones receiving only R$1.80 for every cubic meter more strenuous efforts and requires a change in habits, the of recovered water but with the better performing ones, reduction of water losses is relatively easy for extremely where further water loss reduction is the most difficult, inefficient service providers but more difficult for better receiving R$2.60 for every cubic meter of recovered water, managed utilities as these activities call for continuous, as shown in Table 1. Table 1. Calculation of Unit Costs for Water Losses Technical Infrastructure Liters/connection/day performance Leakage Index (when the system is pressurized at a medium pressure of mwc=meters of water column) category (ILI) 10 mwc 20 mwc 30 mwc 40 mwc 50 mwc A 1to4 <50 <100 <150 <200 <250 Unit Cost B 4to8 50-100 100-200 150-300 200-400 250-500 C 8to16 100-200 200-400 300-600 400-800 500-1000 D >16 >200 >400 >600 >800 >1000 A Furtherlossreductionuneconomicunlessthereareshortages;carefulanalysistoidentifycosteffectiveimprovement 2.60 B Potentialforimprovementswithpressuremanagement,betteractiveleakagecontrolpracticesandnetworkmaintenance 2.20 C Poorleakagerecordtolerableonlyifwaterisplentifulandcheap;analyzelevel,natureofleaksandintensifyreduction 1.80 D Veryinefficientuseofresources;leakagereductionprogramsimperativeandhighpriority 0.00 Intricate engineering modeling was also necessary to and sustainability conditions; and (iv) refund intermediate calculate the remaining unit costs. For example, to estimate payments if the final outputs are not completed in accordance the unit costs for the wastewater transport activities the with the standards specified in the Agreement. The midterm diameter, depth, extension and initial wastewater flow for review will re-examine the unit costs, technical standards, the gravity and forced transport pipes and the elevation and performance indicators and targets to ensure that unit costs initial flow of the pumping stations, as well as the obstacles are in line with actual costs. in the way of construction, affected the cost of building the network. As shown in Table 2 (on the next page), if the initial An independent verification agent will be competitively wastewater flow of the forced transport pipe is 40 liters/ selected to monitor and verify that the outputs are produced second, then according to the table of unit costs, the cost of according to standards established in the Agreement before the pipe is R$800/meter. For the pumping station with the the disbursement of project funds. Payments for completed same flow and height of 23 meters, the unit cost is R$780,000. outputs will be paid in two portions, a first payment (representing 70 percent of the value of the Agreement) Verification and Sustainability for the delivery of the final output, and a second payment (representing the remaining 30 percent) for fulfillment of The Bank and the State have agreed on several safeguards to sustainability conditions.5 This second payment will be ensure that the agreed outputs are produced and delivered withheld for a period to measure the sustainability of in an efficient, transparent and sustainable manner. All the outputs to ensure that they meet agreed technical service providers will be required to enter into Project and standards, achieve performance targets and are operated Performance Agreements that set forth their obligations to: and maintained to ensure continued service delivery. (i) deliver the outputs in accordance with timeframes, targets and sustainability conditions; (ii) follow fiduciary standards Lessons Learned and comply with the Bank's social and environmental safeguards and anti-corruption guidelines; (iii) permit the Incorporating lessons learned from the Mexico verification agent to monitor outputs, indicators, targets Decentralization Infrastructure Reform and Development 4 Technical performance categories were developed by Liemberger & Partners based on criteria from the International Water Association, as referenced in The Challenge of Reducing Non-Revenue Water in Developing Countries: How the Private Sector Can Help by Bill Kingdom, Roland Liemberger and Philippe Marin. Water Supply and Sanitation Sector Board Discussion Paper Series, Paper No. 8, December 2006. 5 In the case of water losses, the first payment will be 60 percent and the second payment will be 40 percent of the value of the Agreement to reflect the importance of ensuring the sustainability of activities to reduce water losses. 3 Table 2. Unit Costs of Wastewater Transport Network 40 Forced transport 40 40 pipe Pumping station H= 23 m Reference Unit Costs for Wastewater Pumping Stations Reference Unit Costs for Forced Wastewater Pipes Height (meters) Average Initial Flow l/s m3/h Reference Unit Cost (R$/m) 5 10 15 20 25 30 m3 liters/second 1.4 5 80 110 130 150 170 190 11 3 120 2.8 10 110 150 190 220 240 260 18 5 170 Average Initial Flow 5.6 20 150 220 260 300 340 370 8.3 30 190 260 320 370 410 450 25 7 220 11.1 40 220 300 370 420 470 520 13.9 50 240 340 410 470 530 580 36 10 290 16.7 60 260 370 450 520 580 630 54 15 390 19.4 70 280 400 490 560 620 680 72 20 480 22.2 80 300 420 520 600 660 730 25.0 90 320 450 550 630 700 770 90 25 570 27.8 100 340 470 580 660 740 810 108 30 650 33.3 120 370 520 630 730 810 890 144 40 800 38.9 140 400 560 690 780 870 960 44.4 160 420 600 730 840 930 1,020 180 50 950 Loan Project, where unit costs were not predefined and and implement a promising approach that through a longer required revision during implementation, REAGUA's unit time horizon and with appropriate financing may eventually costs have been methodically based on proven engineering solve the problem faster, safer and less expensively than models and subject to review and benchmarking by expert through the conventional type of input-based financing. The independent consultants. As one of the most important project's results-based financing mechanism was designed by-products of output based financing is the establishment in the expectation that it will sharpen the focus on efficient, of a clear results framework, REAGUA's outputs have been transparent results that transfer risks to the service provider. defined in the Project and Performance Agreements. REAGUA Instead of the traditional rink-fenced infrastructure project will disburse funds not against individual expenditures based on inputs, REAGUA is focused on broader concerns on the input side but against agreed outputs to avoid the with obtaining results, ensuring effective public expenditure problems of double accounting. REAGUA has also borrowed and strengthening institutions. The hope is that in tackling innovative features, such as the independent verification the State of São Paulo's water scarcity problems from a agent, successfully applied by the Global Partnership for results-based perspective, REAGUA provides lessons that Output-Based Aid (GPOBA). could be applied worldwide to other urban areas grappling with constraints to growth, environmental degradation, lack REAGUA does not intend to be the solution to the problem of service access by the poor and inappropriate planning of water scarcity in the State of São Paulo but to develop and management of WSS services. About the Authors Carlos E. Velez is a Lead Economist and Julia Tierney is a Junior Professional Associate with LCSUW. 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