1 S f Viewpoint The World Bank et January 1997 Note No. 102 Getting the Private Sector Involved in Water -What to Do in the Poorest of Countries? PenelopeJ. There is growing recognition that the private endowed developing countries-countries in Brook Cowen sector can do much to help meet infrastruc- which incomes are rising, there is an established, ture needs in developing countries. But the professional bureaucracy, and the government countries most in need of the private sector's has some track record of fair dealing with the assistance-technical, managerial, and finan- private sector. But they are particularly acute in cial-are those least likely to be attractive to it. the poorest countries. Some of the poorer coun- This problem is particularly acute in the water tries of Central and Eastern Europe, for example, sector. and Sub-Saharan African countries emerging from long periods of internal conflict suffer not Water has historically been hugely underpriced only from very low incomes, but also from lim- in most developing countries. Though subsi- ited administrative capacity and a limited or un- dized water tariffs generally do little to help the favorable government track record. very poor (who often lack formal water connec- tions), governments have clung to them in the While much stands in the way of private pro- belief that they are doing the socially appropri- vision of water services in such countries, there ate thing, and proposed tariff increases tend to are a number of ways to reduce the costs and meet with vociferous opposition from the increase the attractiveness of contracting. There middle class and wealthy. Water systems are is, of course, no magic formula that a country often poorly run, sustaining losses through can apply to instantly transform itself into an physical leaks and poor collection systems. attractive destination for large sunk investments. (Many developing country water utilities collect But the options below each target some aspect revenues on as little as a third of the water that of the problem and, individually or in combi- they supply.) And with many of the assets un- nation, may speed transformation. derground, the actual state of systems is often unknown. Regulatory frameworks are often Option 1: Taking a stepwise approach lacking, incomplete, or internally inconsistent, and the relevant skills thinly spread. Because of Some countries are considering a stepwise ap- the political sensitivity of the sector, govern- proach to private sector involvement-begin- ments often have little credibility as regulators ning with a management contract and building or contractual partners. There is little trust that up to a concession or divestiture.' Albania and they will maintain a favorable operating envi- Angola, for example, are weighing this ap- ronment and a tariff yielding a reasonable rate proach. Trinidad and Tobago recently imple- of return. mented a management contract for water and sewerage services and plans to move to a con- This is not a setting conducive to the substan- tract involving greater private sector risk in tial, long-term, sunk investments needed to three to five years' time.2 And in 1989, Guinea build or rehabilitate infrastructure. Nor is it a entered into a lease contract for water services setting in which the private sector will happily in seventeen cities and towns, with the hope take on commercial risk. All these problems of moving to a concession when the lease occur to some extent even in relatively well- comes up for renewal in 1999.3 LIW Private Sector Development Department . Vice Presidency for Finance and Private Sector Development Getting the Private Sector Involved in Water-What to Do in the Poorest of Countries? The virtue of the stepwise approach is that it bidding for subsequent contracts, and seeing allows gains from private sector involvement this, other potential bidders may stay away. while providing the government time to ad- But barring that company from bidding for the dress tariff, regulatory, or information problems next phase may reduce interest in bidding for in the sector. For example, the government may the management contract. introduce gradual tariff increases over the life of the management contract, use the time to In either case, competition is likely to be lim- build up regulatory capacity and implement ited or absent during the shift to a more com- regulation, or require the contractor to build a plex contract. This raises the stakes in the database on the state of the water system. In bidding of the original contract. Ideally, this each case, the effect will be to create an envi- contract should be let with all the seriousness ronment a little more conducive to private sec- of a concession or divestiture. But the infor- tor investment and risk taking. mational deficiencies justifying a stepwise pro- cess in the first place generally preclude such But while stepwise approaches are an attractive a sophisticated approach. Much work remains way to secure at least some private sector in- to be done in finding innovative solutions to volvement in risky countries, there is no guaran- this cluster of problems. tee that they will get beyond the first step. Because decisions about involving private companies in Thus, while stepwise approaches have many the water sector can be politically costly, gov- attractions-and may be the only viable option emments may be unwilling to take the next step for poorly endowed countries-their design and beyond a management contract, especially if they implementation are not straightforward. Much have not raised tariffs to cost recovery levels attention must be given to creating incentives during the term of the contract. Governments to take subsequent steps and mechanisms for may also be lulled into a false sense of security if maintaining competitive pressures on the ini- the management contract provides just enough tial contractual partner. gains to keep key voter groups happy and feel that they need do no more-even if many people Option 2: Simplifying contracts still lack adequate service. Management contracts can be good at improving services for those who In countries with limited administrative capacity already have connections, but typically do not (even more than in countries that see themselves do as much for those without connections, who as administratively competent!), simplifying con- are often less politically powerful. Transitional tracts can do much to simplify monitoring and arrangements should therefore include incentives reduce uncertainty. One of the attractions of for the next steps, such as sunset clauses on gov- management contracts is that, in principle, they ernment roles or triggers in the contract for real- need not require the kind of regulatory and locating risks between the parties once specified monitoring infrastructure required by leases, conditions have been met. concessions, or divestitures. But if a manage- ment contract is to yield real improvements in In stepwise processes that replace low-respon- performance, a good system of incentives and sibility, low-risk contracts with high-responsi- monitoring is essential. There are two key re- bility, high-risk, and potentially high-return quirements for a good system: clear and indis- contracts, the question of rebidding necessar- putable performance indicators and a monitoring ily arises. While there may be real competition agency or official with the skills and budget to in awarding the initial management contract, do the job, and the strength, integrity, and au- maintaining competitive pressures during the tonomy to do it independently. transition to a lease or concession is more dif- ficult. The company that wins the management Management contracts often contain long laun- contract will naturally have an advantage in dry lists of performance indicators, providing for bonus payments when targets are met or cantly reduce the government's administrative exceeded. But finding indicators that offer a fair burden. It can also increase the credibility of and indisputable basis for managerial incentives the regulatory process if the auditing company is difficult. Many of the conventional indicators has a strong reputation for quality and integ- of water utilities' performance-such as unac- rity. Not all aspects of the regulatory function counted-for water and staff productivity-de- can be contracted out, however. No regulatory pend on factors that may be only partially within rule or contract for private participation, no the control of a management contractor. Suc- matter how precisely written, can remove all cess in reducing physical losses may depend in discretion from regulatory decisions, and the part on the government's investing in rehabili- exercise of this discretion cannot be contracted tating pipes. Success in improving collections out. Contracting out parts of the regulatory may depend on the government's paying its own function can, at best, cast greater light on the bills and supporting a policy of disconnection exercise of that discretion. for nonpayment. Success in reducing operating costs may depend on the ability to lay off work- Option 4: Increasing predictability in ers. Moreover, the measurement of some indi- the use of discretion cators can lead to disputes. Which definition of unaccounted-for water is to be used? If meter- In poorly endowed countries, private investors ing is incomplete or faulty-as it generally is- perceive their risks as high in part because of how are water losses to be measured? concerns about how regulatory discretion will be used, including in revising and renegotiating There is no simple solution to these sorts of contracts. Even if a contract were bid on the problems. Generally, though, there is a case basis of perfect information about the current for moderation in using indicators-sticking to status of the water company's assets and about those least likely to lead to measurement prob- new investments needed, the future would hold lems and disputes-and for adding more di- uncertainties that could not be handled by con- rect incentives, such as revenue sharing. tract. And an initial contract is usually based on highly incomplete information about such fac- Option 3: Contracting out parts of the tors as the condition of underground assets and regulatory function future investment requirements. Careful provi- sion must therefore be made to deal with unex- Many developing country governments have pected events over the life of the contract. limited administrative capacity, little or no regu- latory experience, and little tradition of creat- Provisions must be carefully specified for re- ing independent regulatory agencies. As a negotiating aspects of the contract and for ad- result, several countries are considering con- justing contractual terms over time. Over the tracting out parts of the regulatory function- life of the partnership, these provisions can turn the collection and processing of data on out to be even more important to success than company performance. Angola is considering the initial terms of the contract. Such provi- this in the context of preparations for a sions need to specify at least four elements: management contract. And the Philippine gov- - The conditions under which adjustment of ernment, which is preparing twin concessions terms or renegotiation may occur (including for water and sewerage in Manila, plans to penalties to curb frivolous renegotiation). contract out a range of performance auditing * When and under what conditions a contract functions. must be renegotiated-as opposed to when price or service adjustments are made by Contracting out the task of gathering and pro- agreement or by regulatory discretion. cessing the detailed information necessary to - The process for initiating and conducting carry out the regulatory function can signifi- renegotiation. Getting the Private Sector Involved in Water-What to Do in the Poorest of Countries? The processes to be followed and the authori- return necessary to go into business in a risky ties to be appealed to in the event that the country and what governments view as an ac- parties to the contract cannot agree on how ceptable level of profit. (Advisers to develop- to resolve an issue (arbitration provisions). ing country governments considering private participation in water will all be familiar with In countries with no history of regulatory or the gasps of disbelief and indignation when judicial independence, clearly specifying pro- they first voice assumptions about expected cesses for articulating and resolving disputes returns on equity.) Governments that have is particularly critical. International arbitration happily (or at least blindly) tolerated high lev- is often advocated as a means of offering com- els of rent seeking and wasteful behavior by fort that disputes can ultimately be resolved in public water company officials can become a neutral forum. But such arbitration is costly, positively puritanical about relatively modest and for most disputes-and for many smaller profit taking by a private company. This is not contracts-it may not be feasible. In these cases, to say that private companies with a monopoly there may need to be more reliance on the to supply water services should be allowed to incentives for dispute resolution implicit in ar- take any level of profit that they choose. But bitration rules. governments should be realistic about the prof- its that they should allow, recognizing the need The need for realism of their private partners to earn a reasonable The Note series is an return and to be rewarded for the risks that open forum intended to encourage dissemina- The main objective of projects to secure private they shoulder. tion of and debate on sector participation in the water and sanitation ideas, innovations, and sector is to get better services to consumers at host practices forFodeiiinofdfeetknsoprvtsetratcpto, expanding the private lower cost. In most developing countries, the see Pierre Guislain and Michel Kerf, "Concessions-The Way to sector. The views poorest consumers face an appalling situation. PrivatizeInfrastructure SectorMonopolies" (Note 59, October t995). published are those of Many lack access to potable water and any kind See Helen Nankani, "Testing the Waters-A Phased Approach to the authors and should . a Water Concession in Trinidad and Tobago" (Note 103, January not be attributed to the of sanitation. In many cities, the wealthy receive 1997). World Bank or any of its piped water at below cost, while the poor must See Penelope J. Brook Cowen, "The Guinea Water Lease-Five affiliated organizations. rely on unsafe water at very high cost. In Luanda, Years On: Lessons in Private Sector Participation" (Note 78, May Nor do any of the con- , . ' 1996). clusions represent where recipients of piped water pay less than a official policy of the cent per cubic meter, people without connec- World Bank or of its tions may pay as much as US$16.00 per cubic PenelopeJ Brook Cowen, Private Sector Devel- Execatise Directors opment Specialist, Private Sector Develop ment or the countries they meter for untreated water delivered by tanker. Dpament p broocoenSworl pank.org) represent. To order odditional Involving a private sector partner in the deliv- copies please call the ery of water and sanitation services is often FPD Note line to leave a the only sustainable way of making a dent in message (202-458-1111) these kinds of problems. But it is easy to lose or contact Suzanne Smith, editor, Room sight of this (obvious) objective in the course G8105, The World Bank, of designing, implementing, and monitoring a 1818 H Street, NW, private participation arrangement. Governments Washington, D.C. 20433, or Internet address often start with a fear that the private partner ssmith7w@orldbank.org. will be a rapacious profit-taker. Considerable Previous issues are also efforts will (rightly) be made during project available on-line (http:// www.worldbank.org/ preparation to guard against possible abuses html/fpd/notes/ of monopoly power. notelist.html). @Printed on recycled But there is often a sharp difference between paper. what private companies see as the minimal