50836 September 2009 Note Number 29 Output-Based Aid in Honduras: An OBA Facility for the Water and Sanitation Sector | Cledan Mandri-Perrott, Manuel Schiffler, and Ana Silvia Aguilera H onduras has achieved a reasonable level of access to water supply and sanitation, but gaps in cover- age remain, especially in rural and peri-urban areas, and service quality for those with access is often poor. To help the Government of Honduras achieve universal coverage and improve service quality, the Global Partner- ship on Output-Based Aid (GPOBA) is funding a project to test the viability of an innovative output-based aid mecha- nism for financing water and sanitation services. Housed within the Honduran Social Investment Fund, this "OBA Facility"--the first such facility funded by GPOBA--aims to improve access to water and sanitation services for about 15,000 low-income households, and to increase efficiency and transparency in sector investment funding. To be eli- Photo courtesy of the World Bank gible for funding from the OBA Facility, projects must meet specific criteria and payments are made against verifiable results. panies as well as a number of municipal companies and municipalities operate in other intermediary cities and small towns. Most connections are unmetered, and both Background water consumption and water losses are high. Tariffs, on the other hand, are very low, at about US$3/month in Honduras, a Central American nation with 7.5 million Tegucigalpa and typically less than US$1/month in rural inhabitants, is the fourth-poorest country in the Western areas. Such low tariffs generate barely enough revenues Hemisphere. While the country has achieved a reason- to recover operating costs at a low level of service quality. able level of access to water supply and sanitation, gaps Some US$262 million was invested in the sector between in coverage remain, especially in rural and peri-urban 1997 and 2006, to a large extent financed by external areas. Moreover, service quality for those having access donors through a multitude of projects with different to infrastructure is usually poor. Only a small fraction rules and different implementing agencies. This resulted of those connected to the water network receive water in some increase in coverage, but with little transparency continuously;1 less than half receive disinfected water;2 and without significantly improving service quality or and only 10 percent of the collected wastewater receives ensuring financial sustainability.5 any form of treatment.3&4 To achieve universal coverage and improve service Water and sewer services in Honduras are provided quality, not only is a higher level of investment required, by a variety of entities. The rural population, about half the total, is served by 5,000 water boards (juntas de agua). In urban areas, a private concessionaire serves the Cledan Mandri-Perrott is a Senior Infrastructure Specialist in country's commercial capital, San Pedro Sula; the nation- the World Bank's Finance, Economics and Urban Development Department. Manuel Schiffler (now at KfW) was a Senior Economist al water company SANAA serves the capital Tegucigalpa and Ana Silvia Aguilera is a Consultant in the World Bank's Latin and twenty intermediary cities; and three mixed com- America and Caribbean Region. Supporting the delivery of basic services in developing countries but local leadership, more accountable and sustain- make a request to FHIS for a one-off subsidy to cover able management models, and a mechanism to ensure the unit cost per connection which is payable against a more efficient and transparent use of public fund- prespecified outputs for each project. The Facility ing for investments are needed. The Government of operates on a four-month cycle. Projects are evalu- Honduras made a step in that direction by passing the ated for their social benefits and feasibility as they are 2003 Drinking Water and Sanitation Sector Frame- received, and are ranked against other project applica- work Law. The law created a supreme policy-making tions for that corresponding cycle. At the end of each council and a regulatory agency and aims at transfer- four-month cycle, projects that are deemed eligible by ring services from SANAA to municipal utilities over the specialist unit in FHIS proceed to implementation. a ten-year transition period.6 However, the frag- Figure 1 describes the project cycle and the OBA mented financing mechanism of the sector remained Facility's criteria in more detail. The project cycle untouched by the reforms. The government's strategic starts when the OBA Facility receives a project ap- plan for the modernization of the sector, published in plication. Then the project is reviewed to determine 2005, foresaw the harmonization of funding through whether the technical design and proposed solution is the creation of a Honduran Water and Sanitation feasible. Next, the OBA Facility undertakes a full tech- Fund, which so far has not been established. nical, socioeconomic, environmental, and financial feasibility review. It also determines the maximum Rationale for GPOBA Involvement subsidy requirement for each project subsidy based and Project Objectives on the project's costs and tariffs (always ensuring that tariffs cover at least operation and maintenance expenditure).7 In no case will the proposed OBA sub- In this context, the Government of Honduras ex- sidy exceed US$117 per person for water services or pressed interest in using the OBA approach, under US$130 per person for sanitation services. Regardless which subsidies are paid once agreed-upon results of whether the implementer is public or private, the (outputs) are verified. The project has two interlinked total community contribution needs to be at least 20 objectives: most immediately, improving water and percent of the project cost. sanitation service and access; and in the medium For a project to be eligible for further consider- term, demonstrating innovation in funding sector ation the Economic Net Present Value (ENPV) of the investments through an efficient and transparent project's cash flows must be positive and the Financial mechanism for financing water and sanitation infra- Net Present Value (FNPV) must be negative. This ef- structure projects. The project will improve access to fectively implies that projects will be considered only and quality of water and sanitation services for low- if they have clear social benefits and if the implement- income households with an average per capita income er has no financial incentive to execute the project of US$2/day in rural and peri-urban communities. without a subsidy. The project is currently fully funded by the Global Given the limited amount of resources available, Partnership on Output-Based Aid (GPOBA). It has the OBA Facility assesses subprojects according to an three components. Component 1 provides US$4 mil- eligibility criteria which consists of (a) the unit cost lion for direct subsidies to finance eligible water and efficiency index based on the lowest subsidy amount sanitation infrastructure projects. Each project has benefiting the greatest number of households; and specific outputs, including final working connections (b) a comparison of the total costs of a subproject (either domestic water or sewerage connections or expressed on a per capita basis as compared to a yard taps) and measurably improved water quality. World Health Organization (WHO) reference value. Component 2 provides up to US$60,000 to support Subprojects are then compared against each other and project implementers in enhancing project designs ranked by the lowest subsidy reaching the greatest and their capacity to implement the projects. Com- number of beneficiaries. ponent 3 provides US$390,000 for the running and At this stage, the OBA Facility determines whether management of the OBA Facility, including payment the projects that have been deemed to be eligible for for Independent Verification Agents (IVA). financing will need additional technical assistance resources to enhance technical designs and/or lo- How the OBA Facility Functions cal capacity by supporting specific processes during implementation. The OBA Facility is housed within the Honduran Each implementer will enter into a Performance Social Investment Fund (FHIS). Project implementers Agreement, which details the roles and responsibilities September 2009 Note Number 29 Figure 1. The Project Cycle and OBA Facility Criteria Project Cycle OBA Facility Criteria 1. Application and pre-identification Subproject is considered as part of the Initial project request by project implementer to OBA Facility preliminary list of projects for consideration for funding by the Facility Project fulfills basic FHIS eligibility criteria Preliminary assessment (technical, 2. Project assessment financial, management) of subprojects to determine: Review of quality of existing project documentation, including preliminary project design, costing, and specifications Ownership/availability of water resource Facility preliminary assessment Willingness of the population to connect to proposed services Nature and ability of the implementer to execute the project Information deemed Information Willingness and ability of current/future adequate/sufficient deemed inadequate implementer to provide service Poverty level criteria Field visit to assist Number of households > 300 implementer in supplying Information still required information deemed inadequate Project rejected Box 1. Project approval stage consists of: 3. Project appraisal according to OBA Facility eligibility criteria and ranking a. Verification of subsidy need and calculation: Subsidy = Difference between total Subsidy requirement investment and other contributions Cost values cannot exceed WHO reference values (operator + donors + community) (Unit Cost Efficiency Index) Subsidy around < 60% of investment per Ranking of project vis-à-vis other projects in assessment cycle capita Project formally included in Facility's project portfolio b. Financial feasibility Cost recovery (tariff covers O&M costs) } FNPV < 0 Refer to project ENPV + ENPV ­ ENPV + ENPV ­ c. Technical and environmental feasibility approval stage FNPV ­ FNPV ­ FNPV + FNPV + Appropriateness and sustainability of Box 1. (a and b) proposed (or identified) technical solution d. Socioeconomic feasibility YES NO NO NO User contribution to the proposed connection Eligibility criteria applied. charge (willingness to pay) Refer to Box 1. (c, d, e) ENPV > 0 e. Implementation feasibility Unit cost, collection efficiency, access to Cost Efficiency Index < 3 Cost Efficiency Index > 3 financing, management capacity Apply ranking criteria Ranking criteria: Unit Cost Efficiency Index: Based on a comparison of subproject costs per capita against maximum ceilings PASS FAIL Subsidy: US$117 for water, US$130 sanitation ranking criteria ranking criteria Investment: US$194 water, US$216 sanitation O&M: 30% of investment costs 4. Project implementation Performance agreement negotiated and signed Technical support, including enhancing OBA subsidy payment on verification by Independent preinvestment studies and project management Verification Agent as required by project implementers Note: ENPV = Economic Net Present Value; FNPV = Financial Net Present Value Figure 2. OBA Facility Eligibility Criteria payment of up to 10 percent of the total amount, with the rest gradually disbursed according to a schedule of required procurements. The performance guarantee · Daily income per capita < US$2 and the works guarantees for public implementers that outsource the construction are provided by the · Number of households > 300 contractors. · ENPV > 0 Implementation of the OBA Facility in Honduras · FNPV < 0 The OBA Facility in Honduras started operations in · Unit Cost Efficiency Index < 3 2008. Under the first cycle of subprojects assessment (Phase 1), the OBA Facility evaluated around twelve · Tariff O&M costs projects and signed two contracts with implement- ers, which are currently in execution. One contract was signed with SANAA grouping 12 water subproj- ects in 16 peri-urban areas of Tegucigalpa. These projects include the installation of meters, construc- of the parties, as well as the indicators against which tion of tanks, and laying of distribution lines, pay- payment of the subsidy will be made. The implementer able against working household connections. The will either undertake the construction itself or out- contract with SANAA, a public implementer, is for source the construction. An Independent Verification a subsidy amount of US$0.9 million. The contract Agent is contracted before construction begins to with SANAA was accompanied by a bridge loan of verify the baseline data upon which the outputs will be US$0.63 million. paid, and subsequently to verify the outputs. Subsidy The second contract was signed with Aguas de disbursements are paid in three tranches: 10 percent Puerto Cortes (APC), a private implementer, for a after the contract has been signed; 65 percent after subsidy of US$0.18 million. The output is increased construction has been finalized and the number of water quality to households. As part of Phase 2, new connections has been independently verified; and eighteen subprojects with public implementers and a final 25 percent after the project has been in opera- four subprojects with private implementers were tions for six months and a number of indicators for assessed and ranked. Taking into account this as- service quality and sustainability have been indepen- sessment and the availability of funds for additional dently verified. contracts, the OBA Facility envisages signing four As part of the obligations set out in the Perfor- more contracts with public implementers and two mance Agreement, each implementer must provide additional contracts with private implementers in the following guarantees: advanced payment guar- 2009­2010. antee for the initial cash payment of up to 10 percent of the total subsidy amount; performance guarantee Results and Lessons Learned for 15 percent of the total amount of the construction contract during the construction period; and works The establishment of an OBA Facility is not without guarantee for 5 percent of the total subsidy amount challenges. Unlike a traditional OBA project, the OBA for a period of one year after the works have been Facility funds a number of projects with many charac- commissioned. teristics. Some lessons learned from the implementa- The OBA Facility has funds to finance bridge tion include the following: loans to public implementers for preinvestment. These funds have been provided by the Government · The original structure envisaged that the regula- of Honduras as a revolving fund, with a balance of tory agency ERSAPS would act as the OBA Facil- US$1 million. The bridge loans are repaid by the ity's independent verifier of outputs. However, public implementers to the OBA Facility when the the regulator's actual capacity (both technical subprojects have achieved the agreed results. Bridge and financial) is very weak. Accordingly, it was loans are not given as a lump sum payment; instead, necessary to hire consultants to act as verification the payments have been structured as an initial cash agents. September 2009 Note Number 29 · The use of technical assistance funds is crucial Conclusions for enhancing implementers' capacity to execute projects, particularly in the case of poor munici- A number of challenges have been identified when palities or communities. using an OBA Facility. To a certain extent, the jury · The eligibility methodology, as currently de- is still out as to whether an OBA Facility is right for vised, gives an advantage to projects that are Honduras. FHIS is considering applying an OBA able to supplement funding from other donors approach to all its funding for the sector if the pilot or other sources. Furthermore, the ranking facility is successful; it could even be extended to all methodology tends to favor areas with high publicly funded water and sanitation projects in Hon- population density and flat topography. Giving duras. The benefits of using an OBA Facility approach a high weight to the greatest number of ben- for water and wastewater sector investments include eficiary households for every dollar of subsidy the following: spent means that small communities are less likely to benefit from the scheme. Water service · The process by which projects are chosen may provision is more expensive for projects that become fairer and more transparent, as projects require pumping; thus those projects may not are evaluated according to their respective merits be deemed eligible or may be assigned a lower and compared against one another. ranking score. · The fact that payments are linked to outputs · The increase in construction prices has made it sharpens the implementers' focus on results and necessary to lower physical targets and to adjust improves the quality of monitoring and evalua- benchmark costs used to determine eligibility and tion, since all results must be validated through rank projects. Cost increases between the time the independent verification agents. contract is signed and the work is executed pose a · Tariffs for each project must cover at least opera- significant risk to implementers. tion and maintenance costs, in contrast to the · Establishing a more efficient and accountable current situation in Honduras, where many ser- way to use public money for investments in vice providers barely cover their operating costs the sector will take time. In particular, donors and defer maintenance. in Honduras use input-based funding mecha- · For public implementers, prefinancing is avail- nisms (which do not require implementers to able through bridge loans. While this type assume any prefinancing risk) and provide a of financing involves complex arrangements higher subsidy for capital costs. It is hoped that between the loan recipient (the implementer) through the results of the pilot OBA Facility, and the government, it places responsibility on stakeholders--notably donors that are willing to the implementer to achieve or meet the agreed fund investments--will progressively adopt the results. This enhances accountability for the use OBA approach to channel funds in the sector, in of such funds. order to improve access and increase the service · For private implementers, prefinancing can be ar- level to underserved or unserved communities ranged by tapping their own revenues or through on a wider scale. Using the mechanism already local commercial banks. established by the OBA Facility for all projects · Some of the projects funded by the OBA Facil- in the sector would also reduce transaction costs ity complement upstream investments sup- for the government. ported by other donors. OBA Facility-supported · It is too early to tell whether using an OBA ap- projects filled in a critical gap in these efforts. proach as opposed to a traditional approach to Cases include SANAA and San Agustin, where funding sector investments reduces the time the European Union and USAID respectively needed for implementation. However, this experi- have funded water distribution trunks, but ence does suggest that setting up an OBA Facility water connections have not been installed for all takes time. beneficiaries and sanitation infrastructure is still · The actual needs on the ground are somewhat missing. different from what had been expected at project design. For example, the project assumed that The OBA Facility also builds upon and strengthens there would be a demand for yard taps, while us- good practices in the sector, such as the contribución ers actually want and are willing to pay for house por mejoras initiative, under which municipal govern- connections. ments negotiate the cost-sharing and payment ar- rangement with community residents for the installa- 1 The figure was 2 percent in 2000, according to the World Health tion of new public works; as well as community work Organization. (Evaluación 2000 agua potable y saneamiento in-kind, local government involvement, and commu- en las Américas, Honduras). This percentage has increased nity participation in decision making. somewhat since then, with the cities of Puerto Cortes and San Pedro Sula enjoying continuous supply. 2 Some 75 percent of urban water supply and 12 percent of rural water supply was being disinfected in 2006, according to Los desafíos de los sistemas de agua potable rural, Lino Murillo. 3 Personal communication, Rodolfo Ochoa Alvarez, División de Investigación y Análisis Técnico en Agua Potable y Saneamiento del SANAA, October 3, 2007. 4 To complicate matters, sector data are not reliable and sometimes conflicting. For example, according to the 2006 household survey, access to an improved source of water supply stood at 81 percent, while the Joint Monitoring Program (JMP) that tracks the achievement of the Millennium Development Goal (MDG) target for water supply and sanitation at the global level estimates access at 87 percent in 2004. The 2006 survey estimated that 86 percent of Hondurans had access to adequate sanitation, while the JMP estimates the same indicator at only 69 percent. 5 A notable exception is the city of Puerto Cortes, where since 1993 water production and access have more than doubled, water supply has become continuous, meters have been installed, service is being cut off to those who do not pay, tariffs have more than doubled, wastewater treatment has been introduced, and the first mixed-enterprise model with citizen participation in Honduras has been introduced. Sadly, the success of Puerto Cortes has not been replicated elsewhere in Honduras. 6 As of early 2009, services had been transferred to only one municipality (Siguatepeque). The original five-year transition period under the 2003 law had to be extended to ten years in 2008. 7 The proposed OBA subsidy is set by assessing the project's total investment and deducting other contributions, such as community work in-kind, land, municipal contributions, other donors' contributions, and, as appropriate, any contributions from the tariff over and above covering operation and maintenance expenses. About OBApproaches OBApproaches is a forum for discussing and disseminating The case studies have been chosen and presented by the au- recent experiences and innovations in supporting the delivery thors in agreement with the GPOBA management team and are of basic services to the poor. The series focuses on the provi- not to be attributed to GPOBA's donors, the World Bank, or any sion of water, energy, telecommunications, transport, health, other affiliated organizations. Nor do any of the conclusions rep- and education in developing countries, in particular through resent official policy of GPOBA, the World Bank, or the countries output-, or performance-, based approaches. they represent. To find out more, visit www.gpoba.org e Global Partnership on Output-Based Aid e Global Partnership on Output-Based Aid Supporting the delivery of basic services in developing countries