Enhancing the Economic Regulatory System for Moldova’s Water Supply and Sanitation

Chapter 3. Good practice and country experience

Abstract

This chapter discusses good practice and experience potentially applicable in the Republic of Moldova from selected reference countries. Chile has a highly advanced regulatory system. Kazakhstan, a former country of the Soviet Union, has embarked on comprehensive regulatory reform. The Netherlands, which regionalised water supply in the mid-1970s, is also known for its multistakeholder approaches and special social instruments. The Flanders region of Belgium is known for its advanced system of tariff-related social measures.

Good practice in economic regulatory systems does not provide for practices that may simply be copied. The examples merely illustrate the importance of transparency, dialogue and how instruments should fit with policy objectives and with regulatory capacity.

This chapter looks at what can be learned from other countries in developing economic regulatory systems in Moldova to accommodate water policy objectives.

Good practice

A first principle in good governance of water supply and sanitation (WSS) is the separation of policy, regulation and service provision (Rouse, 2007[1]). This separation is never completely finished or without controversy. Regulators shall be willing to engage in discussion and co‑ordinate what belongs to each of the three categories.

Standards in regulation are emerging. Eight principles have been identified for sound economic regulation (see Table 3.1):

Table 3.1. Eight OECD principles of economic regulation

1	Serve clearly identified policy goals, and be effective in achieving those goals.
2	Have a sound legal and empirical basis.
3	Produce benefits that justify costs, considering the distribution of effects across society and taking economic, environmental and social effects into account.
4	Minimise costs and market distortions.
5	Promote innovation through market incentives and goal-based approaches.
6	Be clear, simple and practical for users.
7	Be consistent with other regulations and policies.
8	Be compatible as far as possible with competition, trade and investment-facilitating principles at domestic and international levels.

Source: (OECD, 2015[2]), The Governance of Water Regulators.

Similarly, standards for the governance of regulators have been developed, with remarkable resemblance to the principles of regulation (see Table 3.2):

Table 3.2. Seven principles for the governance of regulators

1	Role clarity
2	Preventing undue influence and maintaining trust
3	Decision making and governing body structure for independent regulators
4	Accountability and transparency
5	Engagement
6	Funding
7	Performance evaluation

Source: (OECD, 2015[2]), The Governance of Water Regulators.

Considering economic regulator and regulatory practice described in the previous chapter and the above two lists, there is scope for enhancing both the regulation and the governance of the regulator in Moldova.

Some of the principles above hint at the need to accept iteration, learning and stakeholder consultation (feedback, dialogue) as key elements of best practice. The economic regulatory system (ERS) is therefore circular, operating on a plan-do-check-act basis.

Regulation is part of the entire sector governance (Rouse, 2007[1]). Furthermore, good governance of the regulators is vital for good regulation and thus for service delivery. Distinctions between regulation and policy are not always clear and do require periodic calibration.

Table 3.3 presents several regulatory tasks and functions. It is not immediately obvious in the Moldovan context which task belongs where. It is more important to recognise these functions should be carried out at all.

Berg et al. (2013) make observations on the relations and interactions between regulator, service provider and policy maker: to regulate, one needs a sector that can be regulated. The right interactions are critical to successful development of the ERS:

The problem boils down to getting a broader set of institutions to support regulatory and managerial actions that promote good sector performance. This means getting the governance structures right (rules of the game) and the substantive actions right (play of the game). (Berg et al., 2013[3])

Best practice in economic regulatory systems does not provide for practices that may simply be copied. It requires most of all transparency, dialogue, patience and a professional solution- oriented attitude. For more practical experiences, one can look at country cases (Trémolet and Hunt, 2006).

Table 3.3. Typical functions and tasks for economic regulation

Tasks Functions	Price regulation	Service quality regulation	Competition regulation	Consumer protection
Gather information and data
	● Get information on current and projected tariff revenues and costs ● Get information on willingness-to-pay, for alternative service levels	● Obtain information on current service levels ● Carry out technical studies	● Obtain information on illegal conduct or monopoly behaviour	● Conduct customer surveys ● Organise call centres to file complaints
Monitor implementation of rules
	● Audit financial accounts ● Ensure that adequate tariffs are charged	● Ensure service levels are met ● Ensure coverage targets are met	● Investigate abuses of monopoly power – predatory practices, etc.	● Perform an administrative audit of systems and procedures in place to educate customers, and share information
Determine rules
	● Review tariffs, linking analysis to inflation or tariff rebasing ● Modify tariff structures and payment methods	● Define or review quality standards ● Adapt quality standards to real needs	● Organise bidding process ● Rule on competition case following complaint	● Define consumer service standards and requirements
Enforce decisions
	● Define tariff adjustments on basis of performance ● Apply penalties	● Require improvements in service quality	● Mandate break-up of monopoly power or changes in access terms	● Resolve dispute between consumers and regulated firm

Source: (Trémolet and Hunt, 2006[4]), Water Supply and Sanitation.

Country experience

There is a long list of countries with experience that is potentially applicable. Reference is made also to the “Improving Domestic Financial Support Mechanism in Moldova’s Water and Sanitation Sector” report that considered experience in Armenia, Romania, France and Ukraine (OECD, 2017[5]). The country experience described below should be seen as a useful addition.

1. Chile is a middle-income country with a highly advanced regulatory system.

2. Flanders is known for its advanced system of tariff-related social measures.

3. The Netherlands had regionalised water supply in the mid-1970s. It is known for its multistakeholder approaches and has a special WSS social instrument.

4. Kazakhstan is a former country of the Soviet Union that has embarked on comprehensive regulatory reform.

As illustrated Figure 3.1, the countries are in many aspects different from Moldova. When drawing on lessons learned, these differences should always be kept in mind (UNDP, 2015[6]).

Figure 3.1. Gross National Income (GNI) and Human Development Index (HDI) scatter diagram and position of reference

Source: (UNDP, 2015[6]), “Human Development Report 2015: Work for Human Development”.

Chile

Chile is well regarded both for its water sector performance and its good social services. Water sector reform started in the 1970s, leading to regionalisation and gradual tariff increases. A highlight of this process was establishment of an independent economic regulator Superintendencia de Services Sanitarors (SSIS). In addition, four principles of tariff setting were set: non-discrimination, cost recovery, economic efficiency and encouraging conservation. The small SSIS developed a model company against which the 14 utilities could be compared. When setting the tariffs, the future efficiency improvement measures of the utilities were factored in. Under SSIS, leakage levels and cost recovery improved. Still, investment remained too small. SSIS had too little power to have leverage over some of the larger inefficient utilities. These issues were resolved by:

• granting SSIS more power and independence, including funding through a levy on water utilities

• attracting finance for infrastructure through equity sales, concession contracts and involving the private sector, raising USD 1 bln that was subsequently wholly invested in infrastructure.

Among its main activities, SSIS monitors performance of both the sector and concession contracts.

In social terms as well, Chile is a success story. From a social costs perspective, having no access to water is more costly than access at cost recovery tariff levels. Social measures have concentrated on funding extension or financing the costs of increased access, half of which went to the poor.

All consumers are billed the same full rate for the metered amount of water consumed. Means- tested poor customers, however, can bring bills to the municipality. The municipality pays part of the bill, provided the beneficiary pays the other part. In this way, municipalities cover on average 6% of turnover of water utilities.

There can be little debate about the success of Chile in water sector reform. It is not clear, however, to what extent others can achieve the same results. Chile has a long tradition of effective administration and an acceptance of a contractual approach in public sector management. As a result, it has been able to provide targeted support to the poor and raise capital, mostly for wastewater treatment investment. The case of Chile illustrates that economic regulation needs periodic recalibration with policy targets, which is a task for the government at large.

Even in a highly advanced regulatory framework, the regulator must fight its corner. The social system provides for local autonomy (autonomy of local actors) with respect to the extent of support, but not with respect to defining the poor or how to support them. At the same time, capital expenditure has ensured almost universal access to water supply. With half the new connections going to the poor between 1987 and 1995, capital expenditure for WSS can be seen as the most important part of the social protection measures package.

Flanders

The Flanders region of Belgium has perhaps the most advanced and, in the eyes of many, ideal system of securing (social) water tariffing. First, there is only a small fixed fee for costs related to customers such as metering and billing. Overall, it is less than 10% of the bill. The volumetric part of the bill is charged either as “normal” or as “social”. The normal tariff structure is a straightforward Increasing Block Tariff (IBT), but based on the household size rather than on fixed brackets (blocks). In this way, larger households pay a similar price per cubic metre as small households, provided they are in the same tariff group and have a similar per capita consumption.

The social tariff is zero for the first 15 m³ per person per year or 41 lcd. Above that, the social tariff is lower than the normal tariff. Figure 3.2 and Figure 3.3 illustrate the concept. The built-in cross subsidy between smaller and larger units of consumption ensures the marginal price of water is the most expensive for rich and poor alike. In this way, there is an incentive to reduce consumption.

Figure 3.2. Composition of annual water costs for various household sizes and consumption levels, 2017

Source: https://www.farys.be/nl/watertarieven

Figure 3.3. City of Ghent:2018 total household bill equivalent costs per m³ for different household sizes

Source: Source: https://www.farys.be/nl/watertarieven

Intuitively, the concept is appealing. It provides for the poor, provides for environmental incentives at the margin and maintains cost recovery.

Flanders illustrates an advanced social system carried out through the tariff. The regulator exercises a strong influence on social policy, stipulating the size of the volume brackets and the relative tariff differential. There are two brackets (below and above 30 m³ per household member per year). The tariff in the first bracket shall be half that of the second bracket. The regulator also stipulates the size and conditions of the social tariffs, presently at one-fifth of the normal fixed and variable tariff elements.1

The maintenance of the dual block tariff system, however, puts an administrative burden on the utilities. To charge appropriately, utilities have to maintain records on inhabitants per household and the IT systems. Expenditure for WSS is in the order of 1-2% of household income i.e. quite affordable by international standards. It is difficult to assess how well the system maintains affordability for the poor. Obviously, the per capita delineation of the tariff brackets addresses the most pressing argument against IBTs. But little is known on how well the brackets and tariffs perform in maintaining affordability in relation to, for instance, single volumetric tariffs. Brackets are not adjusted in light of updated, more recent poverty statistics. Brackets and tariff structures easily become bastions of vested interests.

This type of redistribution can only take place within the service area. Small consumers and social cases are subsidised by the remaining customers from within the service area. Three factors are necessary for this type of social measure to function optimally:

• The average tariffs should be similar among the nine service areas.

• The distribution of income within the service areas should be similar.

• Per capita income across the service areas should be similar.

Deviations on these conditions bring distortions to distribution of benefits that are difficult to quantify. Assuming the conditions have been sufficiently met in Flanders, one can still ask whether the social benefit of increased affordability of services outweighs the economic costs of the increased administrative burden for utilities. This is ultimately a political question. For Moldova, however, the difference between rich and poor is larger between (current) service areas than within individual service areas. To achieve better affordability for some, poor municipalities would have to redistribute substantially. Other, richer municipalities would barely need to redistribute to achieve basic affordability of services for the poor. IBTs, no matter how they are set, remain an inflexible and broad way to achieve better affordability. Many people benefit and many people contribute. Forecasting revenues and cost recovery tariffs becomes harder for utilities and regulators. An advanced IBT system puts another sizeable administrative burden on the billing systems of utilities.

For all these reasons, it is not clear how effective IBTs and dual tariffing are for Flanders or could be for Moldova.

Netherlands

In the mid-1970s, the Netherlands considered that its municipal water works lacked economies of scale and scope to retain efficient service provision in the future. The 1975 Water Law kicked off a regionalisation process that resulted in the ten current suppliers of drinking water. They are incorporated public entities that are 100% owned by municipalities and provinces.

Wastewater reticulation has remained a municipal responsibility. It is financed through a special municipal tax.

Responsibility for wastewater treatment and water management rests with the democratically elected water boards. Water boards are legal persons, the first one of which was established in 1255. The 23 water boards operate on a regional scale.

Historically, the rationale behind regionalisation has been the need for efficient operations. Regionalisation, however, has supported affordability for the less densely populated areas (see Table 3.4).

Table 3.4. Relationship between size of agglomeration and unit costs of WWT

PE (Population equivalent)	Unit investment costs EUR/PE	Unit operating costs EUR/PE annually
5	1 980	90
10	1 390	70
25	1 000	64.10
50	850	64
100	730	63.10
250	640	53.70
500	610	47.60
1 000	600	42.20
2 500	460	36
5 000	390	31.90
10 000	350	28.20
50 000	230	18.10
100 000	180	14.20

Source: (EAP Task Force, 2013[7]), Business Models for Rural Sanitation in Moldova.

If all agglomerations up to 1 000 population equivalent (PE) charged based on cost recovery, then tariff rates in rural areas would need to triple those in large urban conglomerations. Rural income is typically smaller. Regionalisation of operations and harmonisation of tariffs across each expanded service can help share this burden. High-income/low WSS unit cost consumers cross-subsidise the lower-income/high WSS costs rural population through the harmonised tariff.

Municipalities collect the following:

• The wastewater reticulation charge to cover municipal sewerage costs. The charge can be based on drinking water consumed, property value or the number of inhabitants.

• The wastewater treatment charges and pollution charges on behalf of the water boards. The charge is not based on metered water consumption, but on three categories: single person households, two person households and households with three or more persons.

• The water system charges on buildings and land, also on behalf of the water boards, for water resource management. It is charged on the main owner occupant of the house or apartment (or land), as a fraction of the property value (or as fee per ha).

As one can see from the above, these charges mostly provide a fixed component to the WSS- related expenditure and may be seen as regressive.

Municipalities in the Netherlands provide for a WSS-related social measure through a partial or full exemption of (exclusively) their poorer citizens. Exemption of only fixed elements of the WSS-related bills leaves intact the incentives to save drinking water.

The Dutch system of WSS provision is complex and appears fragmented. Because of the long tradition and a strong culture of co‑ordination among authorities, it does provide for a high level of service and reliability. The regionalisation of services has enabled an automatic cross-subsidy mechanism that would otherwise have been impossible to set up. In addition, a decentralised targeted WSS-related social assistance is in place through the exemption of fixed charges on poor citizens.

Both the effect of regionalisation and the design of the WSS-related social measures provide interesting lessons for Moldova. As with Chile, the effective redistribution generated by the regionalisation may be as significant as the more explicit WSS-related social measures. Whereas the former is practically irreversible and general, the municipal WSS-related measures provide for firm targeting and flexibility in the amount of redistribution.

If operators rather than the municipality carried out the Dutch concept, policy and execution would be separate. This would incur, perhaps, additional costs and the burden of co‑ordination. The flexibility in the criteria remains, as well as local autonomy to determine how much solidarity is needed in WSS.

Kazakhstan

Until recently, Kazakhstan has approached the subject of economic regulation of WSS from an “anti-monopoly” perspective. Despite being a government agency, the Committee on Regulation of Natural Monopolies and Protection of Competition under the Ministry of National Economy of the Republic of Kazakhstan (KREMZK) is a large organisation with many regional branches. Among others, it monitors and interferes in industry accordance to the Law on Competition. It seeks to control, if not prevent, industry dominance. WSS operators, being natural monopolies, are dominant players by definition. WSS operators turn to KREMZK with a tariff application.

Tariff applications are based on a methodology set by KREMZK. The process shows a number of similarities with the Moldovan situation. The tariff application process takes a long time; it involves furnishing numerous data; the methodology is in some respects ambiguous; and the methodology and the way it is applied puts a large administrative burden on WSS operators.

As part of a broad economic reform programme, the government of Kazakhstan also intends to reform the tariff-setting process and the regulatory framework for WSS operators, district heating, seaports and airports. An interesting aspect of this process is the strong collaboration with the European Bank for Reconstruction and Development (EBRD). Based on the government’s request, the EBRD has arranged, or is arranging, for an array of Technical Assistance (TA) projects to facilitate this reform. TA takes place at pan-sectoral level with respect to the overall reform of economic regulation, as well as to individual sectors, such as water, heating, electricity, seaports and airports.

With respect to WSS, this TA involves development of a new tariff policy, the elaboration of a detailed methodology and the testing of that methodology in a pilot utility.

A separate project has been launched to elaborate and pilot social measures. Social measures are mostly administered through the housing subsidy system in a way similar to the Russian Federation and Ukraine. These systems aim to cap household utility expenses to a maximum percentage of income, based on a complex reimbursement procedure. A permanent stream of documentary evidence is required to remain eligible for payments. Furthermore, one must prove payment to the utility for amounts not paid to the utility by the housing payment system. Also, in the case of Kazakhstan, the eligibility criteria and the system of subsidy rates are complex and costly to administer for both recipient and subsidy provider. With respect to social measures, the government of Kazakhstan seeks to at least streamline the mechanism, if not to overhaul it entirely (OECD, 2016[8]).

With respect to the reform of the ERS for WSS, the government of Kazakhstan will continue to regulate WSS alongside other sectors within an overall framework. The specific framework may be close to or similar to the one for district heating. These sectors will now be approached as one that naturally need regulation, following from their natural monopoly status. This perspective looks more appropriate than the pure anti-monopoly stance.

Technically, the reforms will lead to a regulatory asset base (RAB) and weighted average costs of capital (WACC) that are better and more appropriately defined. Both items determine an important component of the eligible tariff. The RAB determines the amount of depreciation that may go into the tariff calculation. The WACC determines the cost of capital of the RAB and hence the amount of free cash flow for investment that a utility can build into its tariff.

The reforms are likely to lead to a more business and performance-oriented regulator rather than one based on sometimes inappropriate norms and ambiguous standards. The future economic regulator is likely to be leaner, more oriented to the business plan and its Key Performance Indicators. It will also likely focus on incentivising performance improvement over time. Furthermore, it shall be more aware of its own regulatory impact and the administrative burden placed on its subjects. The involvement of EBRD may suggest that the new regulatory framework will accommodate strong lending to a sector that currently lacks creditworthiness.

The new regulatory framework will be responsive to the interest of lenders, rather than the short-term interest of consumers in terms of low tariffs. Currently, tariffs in Kazakhstan are on average half those in Moldova, though many provinces of Kazakhstan are not less water-stressed than Moldova. In the longer term, however, poor and rich customers alike will be much better off with rehabilitated and extended networks, wastewater treatment, improved customer service, etc. That requires that the ERS also addresses financing the WSS sector.

Yet Kazakhstan is by no means unique in designing ERS reform in collaboration with an IFI. In Romania, the EBRD has also played an active role for many years. Kazakhstan provides a relevant reference because the starting point of its ERS shows a number of similarities to the Moldovan ERS and because it is also a former Soviet Union state. The organisation of the ERS reform in Kazakhstan may inspire Moldova where it is only just beginning. It shows how a country in 2017 with similar reform challenges can go about this process.

References

[3] Berg, S. et al. (2013), “Best practices in regulating State-owned and municipal water utilities”, http://repositorio.cepal.org/bitstream/handle/11362/4079/S2013252_en.pdf?sequence=1 (accessed on 8 February 2018).

[7] EAP Task Force (2013), Business Models for Rural Sanitation in Moldova, https://www.oecd.org/environment/outreach/Business%20models%20for%20rural%20sanitation%20in%20Moldova_ENG%20web.pdf.

[5] OECD (2017), Improving Domestic Financial Support Mechanisms in Moldova’s Water and Sanitation Sector, OECD Studies on Water, OECD Publishing, Paris, http://dx.doi.org/10.1787/9789264252202-en.

[8] OECD (2016), OECD Council Recommendation on Water, https://www.oecd.org/environment/resources/Council-Recommendation-on-water.pdf.

[2] OECD (2015), The Governance of Water Regulators, OECD Publishing, http://dx.doi.org/10.1787/9789264231092-en (accessed on 7 February 2018).

[6] Programme, U. (ed.) (2015), Human Development Report 2015: Work for Human Development, Communications Development Incorporated, Washington DC, http://dx.doi.org/978-92-1-057615-4.

[1] Rouse, M. (2007), Institutional Governance and Regulation of Water Services | IWA Publishing, IWA, London, https://www.iwapublishing.com/books/9781843391340/institutional-governance-and-regulation-water-services.

[4] Trémolet, S. and C. Hunt (2006), “Water Supply and Sanitation Working Notes TAKING ACCOUNT OF THE POOR IN WATER SECTOR REGULATION”, http://regulationbodyofknowledge.org/wp-content/uploads/2013/03/Tremolet_Taking_into_Account.pdf.

Note

← 1.  See https://www.vmm.be/wetgeving/algemeen-waterverkoopreglement.pdf