4. Financing water supply and sanitation
To achieve its ambitious policy objectives, Thailand would benefit from strengthening its capacity to finance water supply and sanitation (both capital expenditure and operation and maintenance costs). The chapter explores several avenues: economic regulation for water supply and sanitation services; benchmarking the performance of water utilities; and blended finance. A range of smart water technologies are presented as well, which can add value for money.
Thailand has made impressive progress to reach some indicators of the Sustainable Development Goal (SDG) 6 in the last decades. In 2020, the country had 100% of the population using an improved drinking water source and sanitation facility. However, in 2020, only 26% of the population was using safely managed sanitation services and only 24% of the wastewater flow was safely treated, being one of the lowest in the region with Lao People’s Democratic Republic and Mongolia (UN Water, 2022[1]).
The main drivers for future investment needs in water supply and sanitation include population growth and urbanisation, economic growth (and raising social expectations) and the need to adapt to a changing climate. These drivers trigger additional investment needs to adjust to shifting circumstances. It is not clear how these drivers are reflected in Thai plans to extend coverage and improve quality of service, in both urban and rural settings.
Moreover, the information shared does not seem to reflect financial needs for the operation, maintenance and renewal of existing and future water and sanitation services. These costs tend to be more challenging than funding the capital investment to build infrastructures. Failing to do so can deprive service operators from the revenues they need1, accelerate the decay of existing infrastructure and enhance the need to rebuild facilities sooner than expected. Recent upsurge in energy prices confirms that operational efficiency is critical for a sustainable water sector. Financing operational efficiency and adequate maintenance requires a robust and sustainable business model that contributes to several policy objectives, including inclusive access to service and rural livelihood, now and in the future.
In parallel to its SDG goals, Thai government continues its strategy to attract private investments, focusing in industry and tourism sectors. This is illustrated by the Asian Development Bank 2021-2025 strategy programmes and projects in Thailand, focused on “helping Thailand achieve prosperity and sustainability through private sector-led growth and knowledge solutions”. Financing for private sector operations will target environmental solutions: sustainable energy, transport and agricultural development (Asian Development Bank, 2022[2]). Although the private sector is extremely active in Thailand (World Bank, 2022[3]), the water and sanitation sector has not yet been able to attract private and commercial finance.
To increase the volume of finance available for water supply and sanitation services in Thailand, a number of requisites need to be in place. The first is operational efficiency of existing services. This is a condition to efficient allocation of (public and private) funding, willingness to pay of domestic water users, and minimising financing needs in the future (avoiding rapid decay of existing assets). Then, it becomes feasible to consider accessing a range of private and commercial sources of finance. Here, private and commercial finance does not refer to the private operation of water services2. It refers to access to bank loans or capital markets to finance investment and heavy maintenance.
This section focuses on tools that can enhance the performance of water supply and sanitation services, as a condition to make the best use of available assets and available sources of finance and a requisite to attract additional sources of finance from the private sector. Three tools are particularly adjusted to the Thai context:
Economic regulation for water supply and sanitation services. Economic regulation has a pivotal role to play to support the design of a tariff policy for water supply and sanitation services, to benchmark the performance of water service providers (with a view to enhance performance), to build trust in the sector (and attract the attention of domestic commercial finance).
Benchmarking the performance of water utilities (criteria to assess, monitor and compare performance; incentives to align with the best performers). This can lead to discussions on the appropriate size of service providers (to reap economies of scale and scope) and incentives to transition towards a sustainable and cost-effective sector3.
Smart water technologies. They can facilitate data collection and processing in view to monitor technical efficiency of networks and assets. They can also contribute to better information of users.
The last section focuses on blended finance as a way to use available development and public finance to crowd in private and commercial sources of finance. As mentioned above, blended finance is not a panacea and only delivers if the sector is properly regulated; hence the relevance of the following discussion on economic regulation, operational performance and smart water technologies.
Currently, several authorities are in charge of regulating water and sanitation service provision in Thailand. Regulatory responsibilities are divided across several bodies such as the Ministry of Interior, ONWR, National Water Resources Commission, Prime Minister Office, Ministry of Industry, Ministry of Agriculture and Cooperatives, Bureau of budget and Ministry of Natural Resources and Environment. The Ministry of Health monitors compliance with national standards, by regularly testing water samples from rural and urban areas. However, limited resources restrict its implementation such as funding constraints, inadequate numbers of skilled graduates and recruitment practices (WHO, 2015[4]).
This section considers the benefit and the options to enhance economic regulation, as a tool that can enhance the performance of water and sanitation services operators and thereby increase their creditworthiness and the financial sustainability of the sector. Economic regulation comes in addition to the definition of performance standards set by health and environmental authorities. It is a requisite for robust performance monitoring and enhancement (see next section).
As indicated in the Recommendation of the OECD Council on water, countries should “ensure that sound water management regulatory frameworks are effectively implemented and enforced in pursuit of the public interest” (OECD, 2021[5]).
Comprehensive, coherent and predictable regulatory frameworks founded on effective regulatory policies and institutions are essential for setting the rules, standards and guidelines to achieve water policy outcomes. Sound regulation serves to ensure that services function efficiently while meeting important social and environmental goals. It also builds public trust in the administration as an effective rule maker (OECD, 2021[5]).
Different types of regulatory frameworks exist to discharge regulatory functions in relation to water services. Aside from self-regulation, major regulatory models include: regulation by government; regulation by contract, which specifies the regulatory regimes in legal instruments (the French model); independent regulation (Anglo-American model); and the outsourcing of regulatory functions to third parties, which makes use of external contractors to perform activities such as tariff reviews, benchmarking and dispute resolution (OECD, 2021[5]).
The third model, the establishment of dedicated regulatory bodies for water and sanitation services is the most common response to some of the challenges of regulatory frameworks for water services. It has also accompanied the reform of the water industry that many countries have undergone over the past two decades, in particular in the trend towards corporatisation4 of water operators and the consolidation of water service provision. While independent from local and national authorities, economic regulation for water and sanitation services can be bundled together with (or discharged by) a regulator covering other sectors (such as energy supply, for instance).
Economic regulators for water and sanitation services interact with a broad range of institutions, at national or subnational level. This framework typically involves line ministries (environment or natural resources) in charge of water policies, health department in charge of water quality standards and ministries of environment in charge of effluents. Various public agencies, e.g. environmental protection agencies, also play a role in specific issues of water regulation (OECD, 2015[6]).
Thailand authorities would benefit from designating a single entity in charge of the economic regulation of the water and sanitation sector. Based on other countries experience, the key features of robust economic regulation for the sector are: (1) the regulator can independently oversee the sector and (2) has the required resources to fulfil its role and impose sanctions.
Several arguments justify providing regulatory powers to an entity for the water and sanitation sector in Thailand:
1. The water and sanitation services sector is a typical example of a monopolist sector. Water companies constitute natural monopolies since the costs of production are lesser in the case of a single producer. Consequently, the water and sanitation services market is characterised by a low level of competition and important restrictions on the entrance of new players. Regulation is justified on the ground that it ought to prevent market power issues arising from a natural monopoly and to protect customers. In the absence of regulation, water operators can be tempted to neglect the quality or the cost-efficiency of services (OECD, 2015[6]).
2. The sector also displays important asymmetry of information. The water operators own information which the responsible public authorities and the consumers do not have access to (e.g. on the state of the asset, maintenance needs, or the cost of service provision). This asymmetry of information may lead to market abuse by the monopolist operators and cause mistrust amongst consumers with regard to the quality or costs of services provided. A transparent access to water and sanitation services data can reduce the risks of information asymmetry (OECD, 2015[6]).
3. The water sector needs to balance a range of economic, social and environmental interests. Water is essential for the lives, health and social protection of citizens. Therefore, water services must fulfil a number of requirements such as universality, continuity, quality of service, equality of access, affordability and transparency. At the same time, the provision of water and sanitation services has a cost – important investments and management and operating costs are involved – that needs to be covered in the most efficient way to ensure its sustainability over time. In the absence of competition and considering information asymmetry, the management of trade-offs across various interests requires public intervention (OECD, 2015[6]).
4. The water sector generates important externalities, in particular in relation to public health, the economy and the environment. The quality of water has strong impacts on public health, which justify the involvement of the ministry of health to define and set the quality standards for drinking water and wastewater treatment. The way wastewater is treated can also impact the environment, and, if ignored or badly managed, generate pollution and negatively impact water availability, environmental services and productive activities (farming, fishing and tourism) downstream (OECD, 2015[6]). Again, as market mechanisms fail to consider these externalities, economic regulation is required to ensure cost-effective service provision.
Thai authorities could benefit from setting a single body in charge of economic regulation of water and sanitation services, tasked with the regulatory functions presented in Table 4.1.
Source: OECD (2015), The Governance of Water Regulators, OECD Studies on Water, OECD Publishing, Paris, https://doi.org/10.1787/9789264231092-en.
As mentioned above, these functions can be bundled with similar functions related to energy supply or other services. Economic regulation of water services can be discharged by a sector-specific regulator, a multi-sector regulator, a competition authority or similar agencies. Critical factors here are expertise in economic analyses to set appropriate levels of ambition in terms of operational efficiency and cost-effectiveness; to review investment plans and financing strategies; to review operational performance, to set incentives, rewards and sanctions based on actual performance; to engage with service providers and users.
According to the Department of Water Resources and Department of Local Administration, four sets of criteria are used to evaluate the performance of water providers including water quality, water quantity, pressure on pipeline and operation efficiency of facilities. However, none of the departments use the performance results as criteria for economic incentive. The Department of Local Administration hosts a contest to choose the best water service provider of the year. According to the interviews, however, no financial and other regulatory benefit are provided to the winner, other than public recognition. This section explores how benchmarking can be arranged and combined with economic incentives to enhance the performance of WSSS operators.
4.2.1. Performance indicators
Performance indicators allow the contracting authority to measure the performance of the operator in a more objective and transparent way. Indicators need to cover the multiple dimensions of service provision, in relation to health, environment, equity (including universal access and affordability) and cost-efficiency (a condition to other dimensions). Environmental and health authorities set performance targets in their domain and need to be closely involved in the definition of performance criteria.
Incentives need to be in place to rewards performance and sanction failure to achieve targets. Incentives can take many forms. Some are financial, such as easy access to (public) finance for well performing operators, or penalties for those who fail to perform. Some are non-financial, such as lax supervision of well-performing operators and more stringent control for others. Where operators are corporatized and engage in contractual arrangements with (local or national) authorities, performance-based contracts can provide the appropriate incentives: the bonus and penalty system built into performance-based contracts should be directly linked to the achievement of the performance indicators (see next section).
Based on other countries experience (OECD, 2011[7]), Thailand could benefit from setting performance indicators taking into account the following good practices:
Indicators should be few and easy to monitor and verify. They should be targeted at the needs of the individual utility and should reflect the most urgent and critical issues to be solved by the operator. A dozen indicators usually cover the main dimensions of performance. Large number of indicators can be counterproductive, in particular at the beginning of the process.
Investment indicators alone may not be effective as they do not necessarily translate into actual service improvements.
Providing a clear definition of the indicators is crucial. Indicators need to be defined in terms of levels, timeframe for their achievement and methodologies for their monitoring, calculation, measuring and revision. Having these methodologies agreed upon well in advance between parties is key in order to avoid future conflict situations.
Where initial data is limited, it is better to set indicators as increments, or improvements defined in terms of percentage above a baseline, rather than as absolute values. This makes it easier to reflect modifications to the baseline calculations, when necessary.
Technical auditors can make the system credible and help operators understand the challenges they face and options to address them. However, the powers and responsibilities of the auditor should be carefully defined and balanced with regard to the responsibilities of the operator and the contracting authority.
4.2.2. Performance-based contracting arrangements
Performance contracts have emerged as a tool to improve public sector accountability and performance in many countries. Such interest in performance-based contracts is based on governments’ increasing focus on bottom-line results and a general shift toward more decentralized management (OECD, 2011[7]).
Performance-based contracting arrangements are intended to promote savings, efficiency, and responsiveness that are expressed in terms of performance expectations linked to budgets, service, and management (OECD, 2011[7]).
These contracts spell out clearly overall targets to be achieved by the contractor but the specific manner employed to achieve such results is left to the contractor’s discretion. Thus, results-oriented contracts differ from contracts that focus principally on inputs, means and procedures. The contracts also contain a mutually agreed set of monitored performance targets with financial incentives and penalties. As the contractor’s remuneration is tied to its ability to meet set targets, such agreements provide an incentive for the contractor to improve its performance and efficiency (OECD, 2011[7]).
In the case of Thailand, performance-based contracts could be set for public service providers such as Metropolitan Waterworks Authority and Provincial Waterworks Authority and other public or private operators. Setting this type of contract requires a regulator capable to monitor utilities independently and potentially enforce sanctions. Agreements between public sector entities are generally “quasi-contractual” agreements and are not legally enforceable. To be effective and efficient, the use of performance contracting for legally enforceable contracts between public entities, there need to be separate legal entities to ensure independence.
In order to improve the vicious cycle of “low tariffs, low efficiency and high costs, inadequate resources, low service quality, and loss of community support” faced in rural areas in Thailand, Provincial Waterworks Authority could benefit from having contractual relationship. In addition, the involvement of the private sector through Private Public Partnership or the private sector in the EEC could also provide an opportunity to increase formal contracting arrangements in the water sector. The country has some experience on performance based contracts, such as those implemented by Metropolitan Water Works Authority back in 2000 with the World Bank, lessons learned could add to the development of similar contracts by the Provincial Waterworks Authority (World Bank, 2000[8]).
Table 4.2 presents some of the good practices that Thailand authorities could consider when putting in place the legal and regulatory framework for this type of arrangements. These criteria are relevant regardless of the type contract (service contract, management contract, lease, concession, build operate transfer, divestiture).
Source: Guidelines for performance-based contracts between water utilities and municipalities, OECD, 2011. https://www.oecd.org/env/outreach/48656736.pdf
Several mechanisms can be set in place within contractual arrangements to manage conflict resolution. These include given priority to court decision as first instance, and other contracts give preference to amicable non-binding solutions and arbitration. Regardless of the mechanism, the procedures for applying the mechanisms should be well established in the contracts. Arbitration through (a panel of) experts has proven its effectiveness as a working mechanism and is worth considering. However, its application also requires clear rules and procedures. It is important to note that solving conflicts through courts usually costs a lot of time and money and should be a solution of the last resort. Envisaging going to international courts when conflicts arise between parties is a common practice in complex contracts particularly where international operators are involved (OECD, 2011[7]).
Contract monitoring and reporting obligations should be a major element in all performance-based contracts for the water and sanitation services in Thailand. Regular, timely and consistent reporting by the operator on progress with contract implementation allows detecting problems early in the process (OECD, 2011[7]).
Reporting and disclosure of information should be regular but balanced. Too much or too little of it may impose additional and unnecessary burden on both the operator and the contracting authority. Reporting requirements (type of data and information to be collected and monitored, the format in which these will be provided, frequency of submission of reports, procedure for providing feedback by the contracting authority) should be specified in the contract as precisely as possible. If this is not feasible, the contract should envisage a procedure for developing such reporting requirements by some precise date after the contract starts (OECD, 2011[7]).
Given the significant risks involved in water sector contracts, international experience shows that there is a need for explicit mechanisms to ensure contract enforcement and these mechanisms will need to be aligned with the legislation in force in Thailand.
4.3.1. Smart water management - defined
Technical innovations in information and communications technology (ICT) can be beneficial to the water sector. Smart water management (SWM) is defined as the combination of ICT and water technologies to support water resources management and the delivery of water services. It is designed to tackle increased uncertainties and risks of water-related disasters by developing systematic and effective response mechanisms in a sustainable manner. It does so by making the best use of information and communication technology (ICT) to produce and use large volumes of data in real time to support (and integrate as much as possible) water resources management at different scales, from dam management and flood prevention to detection of leakages and promotion of water use efficiency in homes.
SWM can support progress toward financial sustainability of water and sanitation sector. One way to increase revenues while keeping prices low is to minimise non-revenue water (leakage) and to increase consumption (in particular for drinking purposes). SWM can help detect leakage and inform (domestic) water users about water use and water quality.
Smart water supply systems support safe drinking water with scientific water quantity and quality management and information supply, which is achieved through incorporating ICT into the entire water supply process, from water intake source to faucet. The full spectrum of technology options is sketched below along the water cycle.
The benefits for water supply and sanitation – from an operator and a user perspective – are captured below.
Thoroughly manage tap water supply process
Integrated monitoring and control system for the entire supply process of tap water
Real-time water quantity/quality management technologies for water supply process (block system, smart metering, leak detection system, pipe damage prevention system, re-chlorination, automatic draining, pipe cleaning, automatic water quality meter, etc.)
Pipe network diagnosis technology (exploration and diagnosis of pipe hot tapping)
Provision of consumer-oriented tap water service
Real-time water quality information supply technology (water quality electronic display board, smartphone app)
Total care service customers can experience in their daily lives
(Water quality check made with visit, diagnosis /cleaning of indoor pipes, safe water insurance)
Infrastructure to improve tap water drinking such as drinking water fountain.
Smart water management can rely on (and combine) a range of technologies. See a comprehensive list in Annex 1. More detailed analyses are required to consider the ones best suited to the Thai context, and the conditions for their deployment.
4.3.2. Policies to support the deployment of smart water management
Market mechanisms alone will not provide an appropriate amount of eco-innovation at the right time. This is because innovators may not reap all the benefits of their innovations, and because environmental benefits may not be appropriately valued by markets. This is particularly the case for water-related innovation, where the opportunity costs and environmental costs of using or polluting water are not reflected in prices paid by water users. Since markets fail to deliver the appropriate level of environment-related innovation, policy interventions are required. The question then is: what is the best way to support the development and diffusion of eco-innovation?
The development and deployment of smart water systems has been encouraged by a number of Adherents to the Recommendation of the OECD Council on water, such as Australia, France, Israel, Korea and the Netherlands, several states in the US (Arizona, California) or provinces in Canada (Ontario). They have been deployed in combination with water tariff reforms and implementation of measures to encourage efficiency. In Arizona, water utilities adopted smart water meters to inform customers about their water usage. New smart water companies have emerged in Ontario and Israel. In France, incentives to reduce leakage in water supply and sanitation networks have driven the diffusion of smart meters and investment in data monitoring to detect and locate anomalies in real time (OECD, 2021[5]).
In Israel, water policies illustrate the benefit of economic instruments (fines for water leakage, or tariffs that reflect scarcity) to support the deployment of smart water technologies:
Water loss fines for municipalities at a level of above 12% water loss created incentives for development of water loss detection and dynamic water pressure equipment. The 12% ratio is particularly stringent, reflecting water scarcity in a semi-arid country (OECD, 2017[9]). It could be adjusted to local contexts in Thailand, in particular to the situation in the EEC.
Several consecutive years of drought led to a significant increase in water prices. In 2009, an additional “surplus use” fee has been imposed on domestic uses, to discourage excessive water consumption. During these years, one could observe establishment of many water technology start-ups and also implementation of technologies at all scales – from home water-saving devises to accurate reading of water meters to establishment of new desalination plants (OECD, 2017[9]).
It should be noted that, as for any environment-related innovation, environmental performance is best rewarded when the policy framework reflects the environmental externality (the cost for the community of pressures on the environment, such as water scarcity and water pollution). Therefore, as the case of Israel illustrates, water charges that fully cover the costs of supply (including the opportunity costs) are required to make smart water management attractive for users.
In addition to economic regulation and instruments, smart water management benefits from involvement of water users in the definition of services that suit their needs. It also requires appropriate capacity in operators of water and sanitation services.
Investments in water and sanitation services and water resources management have historically been financed by the public sector, with concessional finance playing an important role in developing countries. The mobilisation of private finance for the water sector has been limited to date. Risk-return considerations and structural issues related to profitability of operating business models often undermine commercial investment. While finance from domestic public budgets and development finance, particularly concessional finance, will continue to have an important role to play in the sector, these flows are not sufficient to address total financing needs (OECD, 2019[10]). It is estimated that Thailand needs 6.9 billion USD investment to reach SDG6 by 2030, including a potential private sector investment opportunity of 0.7 billion USD (World Bank, 2016[11]).
Blended finance could play a critical role in mobilising the commercial finance required as well as strengthening the financing systems upon which water–related investments rely. The OECD defines blended finance as the strategic use of development finance for the mobilisation of additional finance towards sustainable development in developing countries. Blended finance can add value by shifting funds that are currently not directed to sustainable development in countries and sectors that have significant investment needs in order to deliver on the SDGs (OECD, 2019[10]). For example, blended finance instruments can be guarantees, syndicated loans, technical assistance provided in-kind or grants and direct investments in utilities.
As the next section explains, operational efficiency is a condition to attract commercial finance and for making blended finance materialise for WSS.
4.4.1. The enabling environment for blended finance for water-related investments
Blended finance cannot compensate for an unfavourable enabling environment, but rather needs to be accompanied by efforts to promote a stable and conducive policy environment. A weak enabling environment characterised by poorly-designed or absent regulation, policies (e.g. water prices and tariffs), or institutional arrangements, compounded by political interference in the management of utilities, constrains commercial investment (OECD, 2019[10]). This section summarizes some commonalities among the key conditions identified which are relevant for Thailand (OECD, 2022, FC).
Policies, legal and regulatory elements:
Laws establish governing, contractual and enforcement parameters for sustainable operating models.
Financial contracts are supported by statutory authority and contract law precedents.
Regulatory regime that defines an explicit goal for a defined environmental resource, such as the U.S. Clean Water Act’s “no net loss” of aquatic resources. Goals can be forward-looking or can account for prior environmental harm requiring remediation.
In the case of ecological restoration, contractual means to procure ecological credits to provide an incentive for investment.
Unwavering implementation of the regulated and agreed tariff adjustments (as well as the annual indexation) is mandatory sustainable, revenue-based, long-tenor debt financing.
Governance arrangements and political support:
Qualified entities that are empowered to administer programs at national and sub-national levels.
Clearly defined roles and responsibilities for water and sanitation service delivery and for water resources management across the institutional landscape.
Political support at the national and local levels, in particular in developing countries.
Market access and financial support:
Viable local capital markets with established securities laws and regulations are tested and resilient.
Secondary market trading is well established. Securities firms are subject to standards of integrity established by law and accreditation.
Federal and or state government investment quality enables market access at reasonable cost.
A dedicated funding stream can be secured for investment or security support (i.e., guarantee facilities).
Capacity and resources for quality project development and selection:
Project selection criteria is established, publicly vetted and reflected in published project prioritization list.
There is an emerging critical mass of projects in development that can support aggregating models and private investor support.
Ensuring responsiveness and capacities of local utilities to the demands of the project preparation phase.
For water and sanitation service delivery:
Revenue streams are established and supported by high collections.
Cost management and investments that reduce non-revenue water loss.
For water resources management and ecological performance:
Defining the basic principle of a credit founded on science-based criteria and a financial mechanism for long-term monitoring and maintenance.
A metric of ecological success that reflects scientific understanding of desired physical, biological and chemical outcomes, applied in a predictable, consistent manner for a given resource type.
Monitoring and information generation to allow for adequate decision making, effective implementation as well as adaptive management and institutional learning. This includes impact monitoring to demonstrate the long term impact and financial returns, drawing on rigorous data collection in collaboration with constituents and scientific partners
The principle that private investment in restoration must provide results before sales can occur and a profit obtained.
4.4.2. The challenges of blended finance for water-related investments
Blended finance6 models to mobilise additional commercial finance for water-related investments are emerging but have not reached scale. The analysis of water and sanitation utilities, off-grid sanitation, multipurpose water infrastructure and landscape-based approaches shows that this assessment varies by subsector given the heterogeneity of the operating models in each of them. In general, blended finance should aim to have a transitory nature over the long-run that works towards scaling the total financing available by crowding in commercial finance at a transaction level. By doing so, it enables a capital market building process. Within this process, there are several stages, which characterise the interaction of development/public and commercial finance. Over time, there should be a shift from purely concessional development finance, to blending concessional development finance with non-concessional development finance (e.g. the blending of a donor grant facility with a development finance from public and private actors), to crowd in commercial finance.
For water and sanitation-related investments, the public sector will likely continue to play a significant role in financing due to the public good dimensions of the sector. Shifting towards an increasing share of commercial finance in the sector can not only increase the total amount of financing available, but also strengthen the financing systems on which these investments rely and put the sector on a more sustainable footing.
The success of blended finance is dependent on the ability to mobilise domestic commercial investment tailored to the local context. In general, blended finance should aim to build local capital markets by working with and mobilising local financiers, as highlighted in the OECD DAC Blended Finance Principles. Water and sanitation services are, by definition, locally sourced and provided; water resources are best managed at the basin scale. At the same time, the sector requires strong public regulation due to the public good dimension of water and sanitation services and the common pool nature of water resources. These characteristics emphasise the need to work closely with local actors and align with local development needs.
To effectively tailor blended finance models for water-related investments, an understanding of the underlying business models and value chains is needed. Blended finance models can enter the sector at different points along the value chain, for example at the water provision or treatment level, downstream at the end-user level or at the investor level. Effective blended finance approaches take into account the underlying business models and respective revenue streams, and incorporate different stakeholder perspectives.
Pooling projects could be an effective way forward to address unfavourable project attributes. Providing commercial investors access to a variety of different transactions in the water and sanitation sector can mitigate concerns around small ticket size, risk exposure, limited sector or regional knowledge as well as high transaction costs. Pooling mechanisms - such as blended finance funds - tailor different risk and return profiles for individual investors, with development financiers often taking first loss and junior traches buffering the risk for commercial investors in the senior tranches. Guarantees, moreover, can strategically mitigate portfolio risk.
Blended finance will not fix issues in underlying business models. Beyond addressing a financing gap, it is a transitory market building tool that is designed to enable stand-alone commercial investment in the long-run. It does so by providing confidence, capacities and track record in markets where commercial investors are not yet present. Blended finance, starting with concessional elements, should phase out over time and ultimately exit in order to prevent market distortion. An analysis of the exit strategy should be integrated in any programme design.
4.4.3. Blended finance for water and sanitation utilities
Water and sanitation utilities are relatively heterogeneous depending on the specific context of service provision. Thailand presents significant differences in the characteristics of utilities, particularly between urban and rural areas (East Water vs Provincial Waterworks Authorities). Large-scale, centralised water and sanitation utilities tend to serve large urban areas such as Metropolitan Waterworks Authority, while small-scale, decentralised operators tend to be major service providers to low income households in rural communities such as local government authorities. Low-income households often make up the majority of under-served communities across both urban and rural areas.
Blended finance for water and sanitation utilities can take multiple forms (credit lines, credit enhancements, grants, etc.) depending on contexts (urban and rural; large and smaller operators). Instruments can be introduced upstream, at the level of the lender or utility (technical assistance, loans, credit lines, risk-reducing guarantees), or downstream to customers (utility-based pro-poor financing schemes, access to microfinance loans). It is often accompanied by technical assistance at all stages of the project (OECD, 2019[10]).
Guarantees are the most commonly used credit enhancing tool in the blended financing of water and sanitation utilities. Guarantees can lower both the political and commercial risk of lending to utilities. In a guaranteed arrangement, the guarantor agrees to their obligation to service the loan in the event that the borrower cannot repay. This obligation limits incurring losses for the commercial lenders, thereby increasing their willingness to finance a project. The Philippine Water Revolving Fund (PWRF) had primary and secondary guarantees in place: a credit risk guarantee provided participating banks with a partial guarantee from the Local Government Unit Guarantee Corporation (LGUGC) - a private entity - that covered a maximum of 85% of the bank’s exposure against a 1% guarantee fee. This primary guarantee was backed (up to 50% of the LGUGC’s exposure) by a co-guarantee from the USAID Development Credit Authority.
Credit enhancement can be a powerful tool to allow existing revenue streams to be used as collateral.
Another effective pooling mechanism in mobilising commercial finance is through investment funds or collective investment vehicles. Funds pool resources to invest in specific sectors (or regions) using different type of instruments, including equity, debt or guarantees. For instance, the USD 234 million Philippine Water Revolving fund blends domestic public funds of the Development Bank of the Philippines which received a concessional loan from Japan International Cooperation Aid, with commercial financing from finance institutions at a 75%-25% ratio from each source respectively. This set up aims at sharing risk-return profiles, lower borrowing costs, and to market water and sanitation projects to private finance institutions. The Philippine Water Revolving fund revolves principal repayments on the loans while interest rates payments service blended contributions from the Development Bank of the Philippines and local banks. In order to mitigate the liquidity risks of the banks involved, the Development Bank of the Philippines uses the loan from Japan International Cooperation Aid to create a credit line that the bank can rely on to disburse its share of the blended loans.
Credit lines are a conditional avenue to provide private financial institutions with capital to on-lend to water and sanitation projects. Furthermore, by providing utilities with access to dedicated commercial financing, the long-term aim is to enable them to build the capacity and creditworthiness they need to attract market based financing.
In the majority of cases, technical assistance, provided in kind or through grants, is an integral part of blended finance arrangements. Technical assistance can play a key role in boosting investor confidence at multiple levels:
In the project preparation phase, technical assistance can support government institutions with policy advice.
Assessing the profitability of a project, by providing support to commercial financiers through capacity building. The concessional nature of the technical assistance grant is critical in addressing the capacity gap of financial institutions in better assessing project proposals, and its cost will need to be shared between the borrower and lenders in the context of phasing out of the blended finance arrangement over time.
Building capacity, technical assistance is often deployed to enhance utilities’ creditworthiness capacity. Such assistance can be effective at reducing water losses, improving billing and collection rates, and improving the management of the utility.
Generating demand and increasing number of paying customers.
Beyond improvements in the operational and financial management of utilities, technical assistance and grants can support utilities in developing pro-poor pricing schemes. As part of the Facilitated Access to Finance project in Cambodia, development finance providers offered subsidies to reduce the cost of the connection for low-income households. In order to incentivise water service providers and ensure that low-income households had access to a continuous water supply with functioning metering, the water service providers received a pro-poor subsidy on an output-based basis. They had to charge the lower fee to the household, and could only claim the subsidy once the connection had been established, and the metered connection verified. The implementation of financing schemes adapted to the needs of the poor can further enlarge the utility’s customer base, in turn increasing its financial sustainability.
4.4.4. Blended finance for multipurpose water infrastructure and landscape based approaches
Multipurpose water infrastructure and landscape-based approaches refer to investments that deliver multiple water-related benefits, which can include cross-sectoral benefits such as energy production, agriculture and biodiversity conservation. They can be defined as “all man-made water infrastructure, including dams, dykes, reservoirs and associated irrigation canals and water distribution networks, which are used or may be used for multiple purposes, for economic, social and environmental activities”. While they may be designed for a single purpose, in practice, water is used in a multi-faceted way and as such, they can be multi-purpose by either design or practice (OECD, 2019[10])
Landscape-based approaches refer to projects within a given spatial area (e.g. catchment or basin), which often incorporate nature-based solutions. These are emerging approaches which complement traditional approaches to water-related investments that can deliver cross-sectoral benefits. These approaches may include investments to protect and manage watersheds - areas of land that drain rainwater or snow into one location such as a stream, lake or wetland. They include projects that prevent pollution, hydrological risks, such as floods and droughts, erosion and run-off that negatively effects the quality and quantity of water used for drinking water supply, agriculture, industry, ecosystems and habitats (OECD, 2019[10]).
Even within the subsector of multi-purpose water infrastructure and landscape-based approaches, there is great variation in terms of project types, and as a result risk and return characteristics. Given the large size of most multipurpose water infrastructure projects, these are typically financed by setting up special purpose vehicles owned by a consortium of project sponsors that can raise further debt funding if needed. Special purpose vehicles are set up for the sole purpose of financing, building and potentially running the infrastructure project. These companies are of limited recourse to their owners’ assets and hence depend on the quality and cash flows of the asset. As such, multipurpose water infrastructure projects are not different to other infrastructure projects and hence appeal to commercial investors that seek long-term opportunities at scale (OECD, 2019[10]).
Commercial investors value projects with a power element, such as hydropower production, in part because of the predictable business case of revenue streams associated with such infrastructure projects. That is, tariffs and power purchase agreements for electricity produced can provide private investors with a clear idea of the project funding. For example, the Nam Theun 2 power station in Lao is funded via a power purchase agreement between the Electricity Generating Authority of Thailand and Electricity de Lao, a state owned utility. In such cases, off-taker or counterparty risk is driven by the public sector’s ability to honour contractual obligations (OECD, 2019[10]).
Other business risks refer to market risk (also often referred to as demand risk) associated with a varying demand for the water-related services. In addition, such projects are often not without substantial macroeconomic risks. While not unique to the water sector, foreign currency risks often make the participation of private sector investors in infrastructure projects challenging. Infrastructure projects are often funded in local currencies. However, a large portion of infrastructure projects are still financed in US dollars, resulting in volatile debt servicing cash flow needs (OECD, 2019[10]).
Blended finance models in this subsector apply a whole range of instruments and mechanisms to mobilise commercial finance in this subsector.
Within multipurpose water infrastructure projects, development actors engage in providing equity and debt, underwrite guarantees to mitigate risk for commercial financiers, or provide viability gap grant funding with ambition to mobilise commercial financing typically from local and international financial institutions; sponsor equity is often sourced from private or public utility companies (OECD, 2019[10])..
Multipurpose water infrastructure projects have the potential to mobilise commercial finance from banks and institutional investors as they present a familiar business case for such type of investors. Particularly large scale projects with clear revenue streams such hydropower or largescale wastewater treatment plants can attract financing from institutional investors (OECD, 2019[10]).
Large-scale infrastructure projects should include an assessment of potential negative environmental and social impacts during the project preparation stage, design and implementation. Programmes should be implemented to mitigate these risks and progress consistently monitored. While this requires additional resources it is essential to ensure that potentially negative effects such as displaced persons, ecosystem and wild life damage and potential threats to water quality are identified and addressed (OECD, 2019[10]). Box 4.1 presents the case study for Nam Theun 2 power station in Lao.
Strategic direct investments in projects finance vehicles via loans or equity can be an effective tool to mobilise private capital.
This was the case with Nam Theun 2. Total project volume of the SPV Nam Theun 2 is more that USD 1 300 million of which 85% is commercially financed. The complexity is reflected in the total of 27 institutions including MDBs, DFIs, Export Credit Agencies (ECAs) and Thai Banks involved. The SPV Nam Theun 2 Power Company is owned by Lao Holding State Enterprise (LHSE), a state-run business, which helped to mobilise USD 327.5 million of private investments in equity. The LHSE has in turn raised a combination of debt (e.g. AFD, EIB and ADB) and grant funding (AFD, World Bank’s IDA). Debt is raised in both LCY by local banks and USD by international lenders, which overall reduces the currency volatility risk for the project company. Also, this large-scale project received grant funding and technical assistance for project development from the World Bank.
The experience of Nam Theun 2 has shown that a co-ordinated approach can help mitigate negative impacts if it is strongly integrated into project planning and financing. Most explicitly, the project is a key part of the government’s poverty reduction strategy with an agreement in place between the World Bank and the government that revenues generated from the project would be invested in poverty reduction and public services. However, the additionally of revenues as result of revenues as opposed to previously planned budget increases was not verified. This was in part due to the lack of baseline data and changes in budget classification. Therefore, it is unknown whether revenues replaced planned government expenditure increases. Efforts have been made to increase transparency with revenue statements shared with the World Bank and State Audit Office as well as audits of projects funded by revenues.
The 2017 assessment following the closure of the environmental and social programme concluded that the environmental targets around watershed management, water quality and species protection had been met. The report found that 100% of displaced persons had been resettled and 97% villages met income targets - the rural poverty line which was approximately double pre-project incomes. The remaining 3 % received additional in-kind support. In addition 100 000 people lived downstream and were potentially vulnerable to the project induced changes. A programme to compensate for lost land and provide infrastructure and livelihood training, and a fund to provide investments for livelihoods was created by the World Bank. However, the complexity, large scale, long lifetime and the variety of actors involved undermine a comprehensive and causal assessment of the full negative or positive impacts upon downstream users.
Source: OECD (2019), Making Blended Finance Work for Water and Sanitation: Unlocking Commercial Finance for SDG 6, OECD Studies on Water, OECD Publishing, Paris, https://doi.org/10.1787/5efc8950-en.
4.4.5. Requisites to further deploy blended finance for water-related investment in Thailand
Should Thailand further explore the benefits of blended finance for water-related investments, the following recommendations might be helpful.
Blended finance cannot compensate for an unfavourable enabling environment, but rather needs to be accompanied by efforts to promote a stable and conducive policy environment. Due to the public good dimension of services provided and the monopolistic characteristics of service provision, the sector requires a strong regulatory and policy framework to function well. Moreover, water resources are a common pool resource, which requires robust allocation arrangements as well as policies and regulations to manage water quantity and quality. A weak enabling environment characterised by poorly designed or absent regulation, policies settings (e.g. water prices and tariffs), or institutional arrangements, compounded by political interference in the management of (often public) utilities, constrains commercial investment (OECD, 2020[12]).
Supportive policy reforms can increase water service providers’ credit worthiness required to attract blended finance. For example, the government of the Philippines implemented policy reforms in the water and sanitation sector, including Republic Act 9275 in support of the implementation of the Clean Water Act and Executive Order 279, which shifts financing of creditworthy utilities to market and cost-based lending from banks. These regulations were instrumental in transferring utilities’ demand for financing away from public sources. This not only avoided the crowding out effect, but also encouraged commercial financiers to extend their portfolio, diversifying their risk profiles and strengthening their capacity. While the stimulated private sector lending, continuing this innovative financing scheme depends on efficient implementation of policy reforms and market conditions (OECD, 2020[12]).
Commercial investors are cautious about uncertainty regarding any of the risks related to an investment opportunity. With adequate contractual arrangement or blended instruments and mechanisms, it is possible to mitigate a variety of risks, share the remainder with the public sector or commercial co-investors, or take a certain level of risk on the financier’s own book. However, in order to make such an assessment, risks associated with an investment should be transparent and quantifiable (OECD, 2020[12]).
An excessive reliance on concessional finance can inadvertently crowd out commercial finance, creating market distortions that impede greater accountability and financial sustainability of the sector. Co-ordination and co-operation among development finance actors on their blended finance engagements is a key for the market building aspect of blended finance, particularly when a concessional element is involved. Development financiers should co-ordinate more structurally beyond single transactions. While there is general agreement about the need for improved cooperation, actions on the ground may remain fragmented (OECD, 2020[12]).
References
[2] Asian Development Bank (2022), Asian Development Bank, https://www.adb.org/news/adb-partnership-thailand-focus-private-sector-led-growth-and-knowledge-solutions.
[5] OECD (2021), Toolkit for Water Policies and Governance: Converging Towards the OECD Council Recommendation on Water, OECD Publishing, Paris, https://doi.org/10.1787/ed1a7936-en.
[12] OECD (2020), Addressing the social consequences of tariffs for water supply and sanitation., https://www.oecd.org/officialdocuments/publicdisplaydocumentpdf/?cote=ENV/WKP(2020)13&docLanguage=En (accessed on 2022).
[10] OECD (2019), Making Blended Finance Work for Water and Sanitation: Unlocking Commercial Finance for SDG 6, OECD Studies on Water, OECD Publishing, Paris, https://doi.org/10.1787/5efc8950-en.
[9] OECD (2017), Enhancing water use efficiency in Korea, Environment Policy Committee, https://one.oecd.org/document/ENV/EPOC/WPBWE(2017)9/REV1/en/pdf (accessed on 2022).
[6] OECD (2015), The Governance of Water Regulators, OECD Studies on Water, OECD Publishing, Paris, https://doi.org/10.1787/9789264231092-en.
[7] OECD (2011), Guidelines for performance based contracts between water utilities and municipalities. Lessons learnt from Eastern Europe, Caucasus and Central Asia, https://www.oecd.org/env/outreach/48656736.pdf (accessed on 2022).
[1] UN Water (2022), SDG 6 Data, https://sdg6data.org/country-or-area/Thailand (accessed on 2022).
[4] WHO (2015), Sanitation, drinking-water and hygiene status of overview_Thailand, http://www.who.int.
[3] World Bank (2022), The World Bank data, https://data.worldbank.org/indicator/FD.AST.PRVT.GD.ZS?locations=TH.
[11] World Bank (2016), The cost of meeting the 2030 Sustainable Development Goal targets on drinking water, sanitation and hygiene, https://openknowledge.worldbank.org/bitstream/handle/10986/23681/K8543.pdf?sequence=1.
[8] World Bank (2000), Increasing supply thru non revenue water, Bangkok, Thailand, https://iwa-network.org/wp-content/uploads/2018/12/NRW_ThailandCase-2.pdf.
Notes
← 1. For instance, the Background report indicates that non-revenue water (NWR) in the Metropolitan Water Supply Authority (MWA) of Bangkok is approximately 30 % and that of Provincial Water Authorities (PWA) is around 26%.
← 2. International experience confirms that private operators seldom contribute to financing. And when they do, they expect repayment through revenues from water tariffs, which are conditioned by operational efficiency and water users’ willingness to pay for the service they benefit from.
← 3. Issues related to the status of service providers are not covered in the Dialogue as they do not have a direct impact on the performance of service provision.
← 4. Here, corporatisation refers to setting up the operator of the service as a stand-alone entity with secured revenues (from water tariffs) and decision making capacity, severed from the political interference of local or national authorities. It does not entail private operation of the service.
← 5. This section builds on previous OECD work on the topic. In particular see OECD (2017), which looks into the Korean experience with smart water management in some details and synthesises policy framework in place n a range of OECD countries to promote SWM.
← 6. This section builds on recent research by the OECD on blended finance for water management and water services globally. For more information, see (OECD, 2019[10])