40917 noTE no. 25 ­ MaY 2007GRIDLINES Sharing knowledge, experiences, and innovations in public-private partnerships in infrastructure Helping a new breed of private water operators access infrastructure finance Microfinance for community water schemes in Kenya Meera Mehta, Kameel Virjee, and Serah Njoroge S mall-scale providers of water services are Small-scale providers: here to stay? no longer seen as merely temporary substi- tutes for formal utilities. In many developing For decades small-scale water providers were seen countries governments and donors increasingly as temporary sources of inferior services whose view them as long-term partners in the work to high prices and lack of health and safety measures extend and improve water services, particularly called for replacement by formal utilities. But as governments accelerate efforts to meet water today governments in many developing countries targets associated with the Millennium Develop- view small providers as a practical way of serving ment Goals. But a host of problems complicate low-income households and dispersed popula- efforts to make small-scale providers produc- tions in rural and periurban areas. tive partners, including their lack of access to finance. In Kenya, a collaborative program is In most cases this new perception is simply a bringing together community-based organiza- recognition of what is already taking place. A tions and microlenders to provide better water recent survey identified 23 African countries services to poor people--and generating lessons where small-scale providers are supplying different for similar initiatives. kinds of services (Kariuki and Schwartz 2005). In at least 11 of them such providers account for a In Kenya, the government has made a determined significant share of water services. And given the effort to partner with small-scale water provid- scarcity of documented evidence, the numbers ers. It has already put into place a basic legal probably capture only a small fraction of the and regulatory framework to support this effort. population of small-scale providers. Donor organizations have joined in, developing, funding, and managing innovative pilot programs In Nairobi the picture is a little clearer. Commu- to generate and test hypotheses about the best nity management of water schemes was ways to support small water providers. introduced in both rural and urban areas in the 1980s, and today CBOs or small companies One such program, now being rolled out in 21 serve at least 60 percent of Nairobi households. communities, brings together the government, a Indeed, in Nairobi's large urban slums CBOs or Kenyan microfinance institution, local commu- informal neighborhood groups are typically the nity-based organizations (CBOs), and several only providers, because residents have no legal multidonor trust funds. Managed by the World tenure and therefore cannot be served by formal Bank, these trust funds include the Water and utilities. Sanitation Program, the Global Partnership on Output-Based Aid (GPOBA), and the Public- Private Infrastructure Advisory Facility (PPIAF). Meera Mehta is a consultant and former team leader, and The program has already generated important PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY Kameel Virjee a financial specialist, with the Water and lessons for engaging small-scale providers in deliv- Sanitation Program. Serah Njoroge is a program officer for ering water services to poor people. PPIAF in East and Southern Africa. Helping to eliminate poverty and achieve sustainable development through public-private partnerships in infrastructure PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY In rural areas, home to 70 percent of Kenya's In Kenya microlenders are licensed and have rela- population, about 30 percent of water schemes tively wide outreach. While only 10­15 percent have been handed over to or set up by CBOs. of the poorest families across Africa have access The number of such operations--especially those to microcredit, in Kenya the share is estimated that can serve both domestic and irrigation to be about 30 percent. Nevertheless, even needs--is expected to grow. In periurban areas Kenyan microfinance institutions typically do domestic demand for water services from small not lend money for infrastructure projects such as providers is already growing rapidly as urbaniza- small-scale water schemes. Microlenders do not tion accelerates. understand the water sector, prefer not to make long-term loans (required for even small infra- Yet CBOs and other small-scale service providers structure projects), and have little interest in or have well-documented weaknesses, and many of understanding of project finance loans (backed these are evident in Kenya. These providers typi- only by project revenues). cally lack both access to finance and the technical and managerial capacity to use finance effectively. Moreover, because the financing would be done as They also face resistance from formal public single loans to CBOs rather than individuals, soli- utilities, lack legal status or tenure, and provide darity lending would be less effective. So would services that are largely unregulated in terms of repayment measures now used in urban areas, both price and quality. such as automatic payroll deductions. Instead, microlending to CBOs would require project credit Kenya has already made progress on some of these analysis, something with which most microlenders fronts. To deal with the unclear legal status, resis- are unfamiliar. tance from utilities, and lack of regulation, regional water boards--which generally own water service Microlenders are also resistant to lending to assets--are working with small providers to help CBOs out of a legitimate concern that they often them gain legal status as companies or associations. lack the technical and managerial skills to design They can then operate as independent service and supervise the construction of facilities that providers under Kenyan law and enter into service can be run efficiently on a cost-recovery basis. provision agreements with the boards. These agree- Small local water systems tend to be either overde- ments regulate prices and service quality. signed and too expensive or designed in ways that Small-scale seriously underestimate demand growth. And private sector entities offering finance or advi- providers The role of microfinance sory services helpful to fledgling businesses do typically lack not understand CBOs or the water supply busi- The biggest challenge facing CBOs is their lack ness and often are uncomfortable with small-scale both access of access to finance. They often must save for project finance. to finance and years for the initial capital investments if they the capacity need to lay pipes, buy pumps, dig a borehole, or construct storage tanks. Often the only sources of Bringing the two together in Kenya to use it well credit are family loans, community savings groups, or informal moneylenders who charge exorbitant A partnership of multidonor trust funds is work- interest rates. ing with the Kenyan government, local CBOs, and a Kenyan microlender to help CBOs access In a country such as Kenya microlenders are microfinance for small water projects. The Water the logical source of finance for CBOs and other and Sanitation Program designed the initiative small providers of services. Microlenders can be based on its work since 2003 to understand the anything from community-based revolving funds potential demand for and supply of finance and to commercial banks that provide a full range of technical services associated with small-scale water normal banking services to low-income clients. provision in Africa. The modern microlending model, generally traced to Bangladesh's Grameen Bank, established in In early 2005 PPIAF financed, and the Water and 1976, centers on "solidarity loans." These put Sanitation Program managed, a study that looked less emphasis on credit assessments or pledges more closely at the capacity needs of CBOs and of collateral for individual borrowers, instead the possibility of market-based financing of small involving small groups of borrowers who vouch water operations. The study also investigated busi- for one another and ensure repayment through ness models for combining donor subsidies with peer pressure. private sector finance and technical assistance to Having a new breed of private water operators access infrastructure finance Box 1 Some community-based water projects in Kenya Kerarapon. With a population of about 2,500, this community is located just outside Nairobi. The community relies on water from a spring, piped to nearby households, but needs about US$80,000 for more pipe network, storage tanks, and a backup pump to connect new customers. The scheme is run by a community-based organization that has mapped out a way to make the project viable with community contributions, loan funds, New tools and a subsidy from the Global Partnership on output-Based Aid (GPoBA). can help Kamandurra. Located just outside Nairobi, this community consists mostly of small dairy farmers, forced microlenders to purchase water from vendors at exorbitant rates. The community raised funds to commission a technical appraise design for a groundwater-based system that could provide water for domestic and livestock needs. The proj- ect would cost about US$105,000. Now the community is raising funds to meet its share of the costs and to small-scale match a commercial loan along with a later GPoBA subsidy. The possibility of links with a dairy where most water projects farmers daily sell their milk increases the comfort level of lenders. Kanunga. This community has managed to revive a failed water system through contributions from members and fund-raising. It offers limited water to some residents through kiosks and individual connections. But because of poor technical construction there is water loss and the project fails to collect revenue for all the water produced. The community management group needs US$70,000 to rehabilitate some parts of the system so that the project can collect more revenue, reduce costs, and add new connections. The proposed invest- ments should improve access to water services for the entire community and for livestock, helping to increase income from milk sales. help CBOs expand and improve their water deliv- To help address this problem, new assessment ery operations. tools that lenders can use to appraise small water projects have been developed and tested (Mehta The study led in 2006 to a successful applica- and Virjee 2006). One is an approach for indus- tion to GPOBA for technical assistance funds to try assessments of small water projects in Kenya. develop a pilot output-based subsidy program A second is a set of 10 project assessment tools, managed by the Water and Sanitation Program. organized as part of a typical microloan process, The program will facilitate market-based infra- for assessing technical, financial, and community structure finance for 21 CBO water providers in management viability. Some of these tools can be used for simple rapid assessments in the prelimi- rural and periurban areas of Kenya. The partner- nary identification of projects; others for more ship between the three trust funds has already sophisticated appraisals of formal loan applica- generated some key lessons: tions. Yet another is a business planning tool that allows both CBOs and microlenders to assess the · Microlenders need new tools to deal with CBO long-term financial viability of a water project. water projects. · CBOs need greater capacity to operate like Building capacity businesses. Many CBO operations in Kenya are well run, · Subsidies can be used to kick-start partner- with regular financial record keeping and policies ships between CBOs and microlenders. for cash management. But most need support in developing viable investment and financial plan- ning that effectively incorporates community Providing new tools for microlenders consultation. Most will also need ongoing train- ing and guidance in business planning for efficient operations that recover costs as well as help in Microlenders that want to identify market oppor- preparing viable borrowing proposals and plans tunities and develop and appraise opportunities for managing debt service. for lending to CBO water projects face high initial transaction costs. Most have much to learn before To help ensure that small water service providers they can manage such lending prudently. can obtain the continued guidance and capacity- building support they will need, the Water and Sanitation Program is leading efforts to develop Box 2 a local market in business development services. Business development services for Each CBO applying for a capital investment loan small-scale private providers as part of the pilot program will receive a small fixed subsidy enabling it to choose a prequalified Small-scale providers typically lack the tech- business adviser whose services best fit its needs. nical and managerial capacity to develop and This approach may help stimulate development of implement projects that use bank financing. a sustainable local market in such services. Support from business development services will help them with a range of tasks: Kick-starting partnerships GPOBA has added a final, critical building block · Community mobilization (initial planning, to the program by helping to design and provide identification of the scheme, arrangements output-based subsidies to the 21 community- for community management and decision- managed water projects. Each of these projects, making, financial commitments) selected through a transparent application process, · Business entity formation (legal registration will be prefinanced through community resources (20 percent) and a loan from a local microlender of the CBo where required) (80 percent). The lender, K-Rep Bank, will follow · Prefeasibility planning (to identify the scope due diligence procedures enhanced with some of and cost of the scheme) the appraisal tools. · Financial assessment (to establish the financial basis for the scheme, including Once a community project has generated its agreed- projections of tariff levels) upon outputs, as confirmed by an independent · Business planning (to establish manage- audit, GPOBA will provide the community with a ment arrangements, staffing, establishment subsidy amounting to 40 percent of the total eligi- costs, financial management arrangements, ble project costs. The outputs can include such and the like) achievements as household water connections or · Technical project design kiosks and demonstrated water sales. The subsidy · Procurement of construction contractors can then be used to refinance the loan, meaning that the community ultimately is responsible for · Construction supervision. 60 percent of total project costs. judicious use of subsidies offers potential for Conclusion bringing together community organizations and microlenders in a much-needed partnership. CBOs and other small-scale service providers References constitute a new breed of local private operators Kariuki, Mukami, and Jordan Schwartz. 2005. "Small-Scale Private in the rural and periurban areas of many develop- Service Providers of Water Supply and Electricity: A Review of ing countries. They play an important role that Incidence, Structure, Pricing, and Operating Characteristics." World will strengthen the water sector reforms urgently Bank Policy Research Working Paper 3727. World Bank, Energy and Water Department, and PPIAF, Washington, D.C. needed in many of these countries. But small providers can contribute significantly to Kariuki, Mukami, Jordan Schwartz, and Michael Schur. 2006. GRIDLINES "Reaching Unserved Communities in Africa with Basic Services: efforts to expand and improve water Can Small-Scale Private Service Providers Save the Day?" Gridlines supply, particularly for poor people. series, no. 9. PPIAF, Washington, D.C. Gridlines share emerging knowledge Helping small providers responsi- Mehta, Meera, and Kameel Virjee. 2006. "Credit Assessment Tools on public-private partnership and give an for Community-Managed Water Projects." Report prepared for overview of a wide selection of projects from bly access market-based finance PPIAF, Washington, D.C. various regions of the world. Past notes can be for capital investments adds an ------. 2007. "Microfinance for Rural Piped Water Services in found at www.ppiaf.org/gridlines. Gridlines are a important dimension to their Kenya: Using an Output-Based Aid Approach for Leveraging publication of PPIAF (Public-Private Infrastructure role. Combining support to PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY and Increased Sustainability." Policy Note. Water and Sanitation Advisory Facility), a multidonor technical assistance microlenders with capacity Program­Africa, Nairobi. facility. Through technical assistance and knowledge dissemination PPIAF supports the efforts of policymakers, building for CBOs and the nongovernmental organizations, research institutions, and others in designing and implementing strategies to tap the full potential of private involvement in infrastructure. The c/o The World Bank, 1818 H St., N.W., Washington, DC 20433, USA views are those of the authors and do not necessarily PhoNe (+1) 202 458 5588 FAx (+1) 202 522 7466 reflect the views or the policy of PPIAF, the World Bank, PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY GeNerAL eMAIL ppiaf@ppiaf.org WeB www.ppiaf.org or any other affiliated organization.