pproaches M a y 2 0 0 5 N o t e N u m b e r 0 7 34303 Output-Based Aid in Water Lessons in Implementation from a Pilot in Paraguay Franz Drees-Gross, Jordan Schwartz, Maria Angelica Sotomayor, and Alexander Bakalian P araguay's aguateros--small private water compa- 10,000 inhabitants, has reached about 37 percent of nies--form an important part of the water sector, that population segment (or about 18 percent of serving about 9 percent of the total population (or households nationwide). In the process it has created about 17 percent of those with piped water supply). But until more than 1,000 water users associations, which as- recently they operated only in urban areas, where water re- sume responsibility for service provision in their com- sources are abundant and they could choose customers based munity. SENASA theoretically contributes only 40 on their ability to pay the full costs of providing service. A new percent of the cost of constructing systems in larger World Bank­funded initiative seeks to attract aguateros and communities and about 82 percent in small settle- construction firms active in the water sector to unserved rural ments. But the actual subsidies it provides are far areas and small towns by providing an output-based aid sub- larger, since communities often fail to make agreed sidy, awarded through competitive bidding. The initiative is the cash contributions or to service their debt. first attempt anywhere to apply this approach to rural and SENASA, in considering the water users associa- small-town water sector investment. This Note reviews the tions as a vehicle for expanding service, recognized early lessons. that many found it difficult to charge tariffs recover- ing full costs. As a result, reliance on public financ- In the late 1990s water and sanitation officials in ing remained high. Public subsidies for rural water Paraguay, together with the World Bank, began to con- and sanitation systems have amounted to an esti- sider the most cost-effective way to expand water ser- mated US$300­400 per connection. At the current vice coverage. The government first looked to its level of public financing, Paraguay would need more national water and sewerage utility (Empresa de than 20 years to reach 85 percent coverage in rural Servicios Sanitarios del Paraguay, or ESSAP), respon- areas. sible for urban areas, and its rural water agency Alongside the two public entities, small private pro- (Dirección General de Salud Ambiental, or SENASA). viders known as aguateros supply water to about The urban national utility offers piped water to less 500,000 people in periurban areas, mainly in the than 40 percent of households in its service area, de- greater metropolitan region of Asunción. Aguateros fined as cities and towns with populations of more have constructed piped water supply systems over the than 10,000. Constrained by heavy debt service obliga- past 20 years with no public financing. Indeed, many tions, ESSAP is unlikely to be able to serve as a vehicle have not registered as businesses, operating as part of for expanding service to Paraguay's unconnected Paraguay's active informal sector. Paraguay's aguateros periurban communities anytime soon. have an average age of about 12 years, while the oldest have been operating for more than 20. Their systems SENASA, responsible for providing water and sani- average around 300 connections, but some have as tation service to rural communities with fewer than many as 3,000.1 This OBApproaches is an updated reprint of Viewpoint No. 270, Altogether, aguateros serve around 9 percent of April 2004, World Bank. Paraguay's population--or about 17 percent of all Paraguayans with piped water supply. In some depart- Franz Drees-Gross is a sector leader, Jordan Schwartz is a senior infrastructure specialist, and Maria Angelica Sotomayor is an economist in the World Bank's Latin America and the Caribbean 1Consorcio Asociación Euroestudios-Hidrocontrol, "Revisión de la Region. Alexander Bakalian is a senior water supply specialist in the Estrategia de SENASA, Informe Final" (SENASA, Asunción, World Bank's Middle East and North Africa Region. Paraguay, 2001). Supporting the delivery of basic services in developing countries pproaches ments aguateros provide water for more people than the two public entities combined. Box 1 Minimum subsidy bidding in output-based aid schemes A 2002 survey of 1,000 households served by aguateros found that 90 percent were satisfied with the Over the past decade several Latin American gov- service and 75 percent were unwilling to pay more for ernments have sought to induce private operators better service.2 The overall customer satisfaction with to make socially desirable--though not always fi- lower rates and a somewhat lower level of service led to nancially viable--investments in rural areas by offer- a conclusion that, subject to suitable groundwater ing one-time subsidies covering part of the capital conditions, aguateros represented a viable alternative for costs. The private operators recover the rest of their expanding service into periurban areas. costs through user tariffs. To minimize costs, gov- ernments use competitive bidding based on the The output-based aid pilot minimum subsidy offered. Chile pioneered this ap- proach in telecommunications in 1994­95. Several Given the constraints of the state water utility and the low-income countries (Colombia, Guatemala, Peru) traditional water users association model, Paraguayan have followed suit, extending the approach to such officials concluded that private providers would be the sectors as transport, rural electricity, and water and best means of reaching unserved communities and rap- sanitation. idly expanding rural coverage. SENASA agreed to In parallel, development agencies such as the implement a pilot output-based aid program to attract World Bank began to explore ways to move from aguateros and local construction companies to small financing inputs (typically, physical assets) to fi- towns, large villages, and periurban communities (box nancing outputs (services provided or results 1). The program was to be implemented in several achieved) to ensure the best use of public funds phases so that lessons could be incorporated along the while achieving development objectives. They de- way. vised a subsidy approach--output-based aid--using Still, several questions remained: public funds to reimburse private operators for · Quality and scope of service. What service quality and part of their investment after they demonstrate characteristics would be required? that they have delivered the service contracted for. · Incentive structure and subsidy design. How could The reimbursement method may range from cash private providers be enticed to serve the targeted paid per connection out of an offshore escrow ac- communities with a mandate for universal or near- count (as in Guatemala's rural electrification pro- universal access? If public subsidies were needed, gram) to vouchers given to consumers for use as how could they be structured so as to minimize the payment to private operators. cost to the government and the community while maximizing the likelihood of sustainable service? · Bidding process and variable. How would the bidding be contracted to build water networks that included a be structured, and what variable would it be borehole, a system for disinfection, an elevated or pres- based on? surized ground storage tank, and a distribution system · Legal, regulatory, and contractual framework. Given the with household connections. Meters could be installed water sector's legal structure, who would have at the discretion of the operator unless a customer re- regulatory responsibility for tariffs and service quested one. Standards for water quality, pressure, and quality? How would that responsibility be reflected hours of service would be set out in a contract between in contracts? the community and the operator. Perhaps most impor- tant, the operator would be required to connect any household within the defined service area that re- Quality and scope of service quested a connection and paid the fee. To meet the minimum requirements of safe, reliable service, it was decided that the private operators would Incentive structure and subsidy design In the first phase of the pilot it was determined that a 2The survey was designed with a 95 percent confidence interval and 3 per-connection subsidy would be needed to attract op- percent margin of error. erators to the four participating communities. To as- Supporting the delivery of basic services in developing countries pproaches sure SENASA that the subsidy costs would be less than cash and with vouchers to reduce their connection fee. the traditional cost to the state of rural water supply In addition, many residents opted to pay the connec- systems, the subsidy was fixed at US$150 for each con- tion fee in installments at a "social" interest rate not to nection up to the maximum number of connections set exceed 24 percent a year (with payments in guaraníes). for each community's service area. This subsidy was The success of the first round of bidding showed less than the current theoretical one of about US$200 SENASA that there would be enough competition for per connection and far less than the actual subsidies the right to build the systems. That allowed the bidding that SENASA paid in some communities. Tariffs for in the second phase to be structured so that towns metered and unmetered connections were set in agree- would not have to assume the risk, with the bidding ment with the communities and incorporated into the variable changed from the connection charge paid by bidding documents. users to the connection subsidy. Connection charges as well as tariffs were negotiated by SENASA and the wa- ter users association for the participating towns and in- Bidding process and variable corporated into the bidding process. The maximum Private operators would be invited to bid on the fee connection subsidy that bidders could request was they would charge users up front to connect to their capped to prevent excessive costs to the state. system. The bidder that was both responsive to the technical requirements and offered the lowest connec- tion fee would be declared the winner. Once selected, Legal and regulatory framework operators could charge users for the connection fee in Paraguay's water sector law of 2000 assigns the right installments at a defined interest rate. Operators to operate water supply systems to the executive would recover their costs from the connection subsidy branch of government, which may delegate it to mu- (paid by SENASA) and the connection charge and tar- nicipalities or departmental governments. Service iff (both paid by users). Each town would have the provision by the private sector and water users asso- right to reject the winning bid if it considered the con- ciations is regulated through 10-year permits in sys- nection fee too high. tems of less than 2,000 connections (around 10,000 The lowest bid emerging from the first round of people) and concessions of up to 30 years in larger competition was extremely competitive, committing systems. Permits can be awarded through simple bid- the winning consortium--two construction companies ding procedures, while concessions require national and an aguatero--to build systems in all four towns at (or international) competitive bidding. US$200­217 per connection (table 1). The commit- Regulations adopted in October 2002 match tariffs ment from the towns ranged from US$50 to US$67 per to different service levels to allow for differences in the connection. To make it easier for poor residents to pay, characteristics of service providers. At the minimum the winning consortium hired them during construc- service level the regulations require that water meet tion (mostly to dig pipe trenches), paying them with chemical and bacteriological safety standards. Failure Table 1 The bidding process Phase 1 Phase 2 Fixed components Subsidy to private operator of US$150 Per-connection charge of US$80 for households per connection and US$112 for businesses and institutions Tariffs paid by users Tariffs paid by users Bidding variable Connection charge to users Connection subsidy from the government Winning bid User connection charge of Investment subsidy of US$196 per connection US$50­67 per connection Party assuming risk of Community Government uncompetitive bid Preliminary design provided in bidding documents? Noa Yesb aBidding documents specified simple borehole, disinfection, storage, and single-settlement distribution system. bPreliminary design specified surface water intake, filtration and disinfection systems, elevated and ground storage tanks, and multisettlement distribution system. Supporting the delivery of basic services in developing countries pproaches to comply with the standards can trigger the suspen- · Operator and the water users association. This simple sion of a permit in addition to penalties. concession contract defines the service area and sets coverage targets. It also provides the operator with exclusivity in this area, defines water and Contractual arrangements service quality standards and penalties for noncom- Under the terms of the pilot and the water sector law, pliance, provides adjustment formulas for tariffs communities (through the water users associations) and fees, and establishes compensation for early contract private operators to build and operate water termination of the contract. supply systems in their area under 10-year permits. SENASA manages the construction phase and acts as To ensure that the water users associations under- an arbitrator between the community and the operator stand their obligations as signatories to the two con- during the operation phase. Supporting this structure tracts, a local institute has been providing training in is a triangle of mutual obligations set out in contracts contract administration. governing the relationships between the three parties: · SENASA and the operator. This contract, based on the standard World Bank bidding document for small Results works, governs the construction phase (defining The contract for the first phase (4 systems) was the technical standards, supervision, subsidy, awarded in August 2002. A legal dispute between the guarantees, and the like). In the first phase of the community and an aguatero holding an operating per- pilot all subsidy payments (apart from an advance) mit for part of the service area identified for one of the were withheld until the operator had demonstrated systems required one community in the first package that it had successfully provided the connections, to be replaced. All four systems are now in operation. forcing the private sector to mobilize most of the The response from the communities that have received construction financing. In the second phase shares service has been overwhelmingly positive thanks to the of the total subsidy payment will be released as the rapid progress from concept to construction, all with- operator completes components of the system. out up-front cash contributions from the communities. Given the difficulties small construction companies Under the second phase, bids for an integrated 2000- face in mobilizing investment capital, this staggered connection system supplying the towns of Nanawa, release of payments should allow greater competi- Puerto Falcon and Beteretecue outside of Asuncion, tion for contracts. were received in late February, 2004. The contract was · SENASA and the water users association. This contract awarded in August, 2004 and system construction is sets out SENASA's agreement to provide a subsidy near completion. A third OBA contract (for the town for system construction once the water users of Capitan Bado-Mariscal López in the Department of association has signed the concession contract with Amambay with 2,000 connections) was awarded in De- the operator. cember, 2004; construction is advancing satisfactorily. About OBApproaches OBApproaches is a forum for discussing and dis- The case studies have been chosen and presented seminating recent experiences and innovations for by the authors in agreement with the GPOBA man- supporting the delivery of basic services to the poor. agement team, and are not to be attributed to The series will focus on the provision of water, en- GPOBA's donors, the World Bank or any other af- ergy, 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. Global Partnership on Output Based Aid World Bank To find out more, visit Washington, DC 20433, USA www.gpoba.org Supporting the delivery of basic services in developing countries