Making Blended Finance Work for Water and Sanitation

Annex B. Case Studies: Water and Sanitation Utilities

The Kigali Bulk Water Supply project: When a Public Private Partnership meets Blended Finance

Development finance

The International Finance Corporation (IFC)’s Public-Private Infrastructure Advisory Facility (PPIAF), a multi-donor trust fund, provided technical assistance and capacity building to Rwanda’s Energy Water and Sanitation Authority (EWSA) leading up to the project. Following the decision to split EWSA into two specialised water and energy utilities in 2014, PPIAF developed a high-level strategy for the operation of WASAC, Rwanda’s Water and Sanitation Corporation. PPIAF also provided capacity building training to government officials to support the water sector reform process.

Three organisations affiliated to the Private Infrastructure Development Group (PIDG) helped finance the project at different stages of its development:

• DevCo, a facility managed by the IFC and funded by PIDG, provided initial financial support and technical assistance to the government of Rwanda to cover the legal, financial, technical and environmental feasibility assessments of the project.

• The Emerging Africa Infrastructure Fund1 (EAIF) provided USD 19 million in senior debt and USD 2.6 million in junior debt. The EAIF also crowded in African Development Bank funds amounting to USD 19 million in junior debt.

• PIDG’s Technical Assistance Facility provided a USD 6.25 million grant to cover upfront capital costs and avoided an increase in water tariffs as a result of the project.

Commercial finance

The private investor in charge of implementing the public-private partnership was competitively selected by the IFC via a bid order. The United Arab Emirates-based Metito consortium, comprising Metito Utilities Ltd. and Metito Overseas Ltd. (hereafter, Metito), won the 27-year concession to build, operate and maintain and transfer the facility. Metito, one of the world’s largest water utility providers, provided USD 11 million in equity finance.

Challenge

The Government of Rwanda has committed to achieving universal and reliable access to safe drinking-quality water supply to Kigali and to the country’s 12.4 million inhabitants, as set out in its Vision 2020 strategy.

There is a lack of access to piped water supply in Rwanda, with only 40% of the total population connected to a supply system as of 2015. There are also significant inequalities between urban and rural areas; 73% of the population have access to a piped water supply connection in urban areas, whereas only 27% of the population in rural areas has such access (WHO/UNICEF, 2019[6]).

Rapid urbanisation and population growth in Kigali, the capital city of Rwanda, are straining the city’s infrastructure services. The limited public water production and supply capacity, impaired by a high rate of non-revenue water, frequently leads to water rationing for increasing numbers of water supply subscribers in the city.

Solution

The Kigali Bulk Surface Water Supply project (Figure A B.1) is the first large scale water treatment facility financed through a public private partnership model in Sub-Saharan Africa (excluding South Africa), and one of the first water infrastructure projects established through a Build Operate and Transfer arrangement. The 27-year public-private partnership agreement, which includes a 2-year grace period for project development and construction and 25 years of operation and maintenance, benefits from a guarantee from the Ministry of Infrastructure of Rwanda. The agreement is funded via a tiered capital structure, which means that Kigali Water Limited (KWL), a fully owned subsidiary of Dubai-based Metito, will build, maintain, and operate the treatment plant and sell drinking quality water to WASAC, Rwanda’s public water utility in charge of the transmission and distribution and sole off-taker of the project. At the end of the 27 years period, Metito will transfer KWL over to WASAC, which will maintain and operate KWL.

The EAIF, itself a blended finance fund, is the mandated lead arranger of the financing. EAIF provided USD 19 million in senior debt and USD 2.6 million in junior debt to KWL, and crowded in an additional loan of USD 19 million from the African Development Bank, covering USD 40 million in debt facilities with 18-year tenors out of the total project capital investment of USD 60.9 million. A USD 6.25 million technical assistance grant was provided by PIDG’s Technical Assistance Facility (TAF) to cover the viability gap, reduce up-front costs, and allow the government to increase the number of households connected to the piped water supply system without raising tariffs. The USD 11 million remaining balance was provided by Metito as equity finance. DevCo supported and advised the Government of Rwanda in assessing the feasibility of the project and in determining the most suitable public-private partnership structure in line with the development objectives of the Rwandan government.

Figure A B.1.  The Kigali Bulk Water Supply financing structure

Source: Authors.

The discrepancy between the currency of the loans and equity (USD), and the local currency with which revenue is generated (Rwandan francs, RWF), can have implications for the overall cost and level of risk of the project. The blended package was denominated in US dollars, a hard currency that both matched construction costs (also in USD), and allowed for cheaper debt than would be locally available due to concessional rates and/or longer maturities. However, foreign financing also entails a higher level of currency risk. As the revenue generated from the utility will be in RWF, a free floating currency, foreign investors can incur losses in the event of currency fluctuations (e.g. local currency depreciation). In the case of the Kigali project, currency negotiations led to significant delays. From a government perspective, the ultimate risk is that costs resulting from currency depreciation could be passed on to customers. Concessional development interventions, such as the provision of guarantees, can play a role in mitigating this risk while increasing the investor’s confidence that profits will remain stable in the event of currency depreciation.

In the case of the Kigali Bulk Water Supply project, some of this risk was addressed by minimising project costs and maximising efficiencies with the decision to separate the distribution infrastructure from the plant under a distinct concessional loan. On top of the contribution of wells, a water treatment plant, and two pumping stations, the project initially included the transmission and distribution infrastructure necessary to maximise the impact of the project - three reservoirs, distribution pipelines, and a pumping station. However, it was subsequently agreed that greater efficiency could be achieved by allocating that infrastructure to the municipal utility, WASAC, under a separate arrangement with funding from the Government of Rwanda and the African Development Bank. This enabled each of the water production and distribution projects to independently find the most suitable financing solutions and maximise their impact on operational efficiency and benefits to end users, and to reduce the overall cost of the project from USD 79 million to USD 61 million.

In many developing countries, maintaining water and sanitation tariff affordability is necessary to ensure access for all. In fact, as part of the negotiation process, Rwanda’s regulators did not support a proposed increase in the water and sanitation tariffs (which was later abandoned). Further investigation, which resulted in delays in the implementation of the project, highlighted that the currency risk was not the only cost-raising factor. The break-down of the water tariff revealed that high electricity costs and taxes were significantly raising costs. As these are set by the Government of Rwanda, they were beyond the control of Metito and the lenders. In a public private partnership arrangement, it is recommended that the private sector be transparent towards the Government, regulators, and the national water utility about the composition of the tariff in order to avoid “hidden” profits. Increased transparency not only raises the confidence of all stakeholders, it can also shed light on hidden costs.

Expected impact

Upon completion of the project, which is still on-going, the resulting infrastructure is expected to produce and supply 40 mega-litres of clean, drinking quality water every day to over half a million Rwandans (40% of Kigali’s water supply needs).

Jamaica’s Credit Enhancement Facility: Establishing innovative financing mechanisms for the sustainable financing of wastewater management

Development Finance

In this project, development finance came from Global Environment Facility (GEF)-funded Caribbean Regional Fund for Wastewater Management project (CReW), an innovative approach that aimed at reducing the negative impacts of untreated wastewater on the environment and human health in the Wider Caribbean Region. The USD 20 million fund was dedicated to the implementation of innovative financing in wastewater management in 13 countries (Antigua and Barbuda, Barbados, Belize, Costa Rica, Jamaica, Guatemala, Guyana, Honduras, Panama, Saint Lucia, Saint Vincent and the Grenadines, Suriname, and Trinidad and Tobago) between 2011 and January 2017. The fund aimed at addressing three challenges: i) bridging the funding gap for investments in wastewater collection and treatment; ii) supporting reforms in legislative, regulatory, and policy frameworks to facilitate greater investment in wastewater management; and iii) foster peer learning among key stakeholders in the Wider Caribbean Region. The Inter-American Development Bank and United Nations Environment Programme jointly managed the implementation of the CReW project along five components: (1) Investment & Sustainable Financing; (2) Reforms for Wastewater Management; (3) Communication, Outreach & Training; (4) Monitoring & Evaluation; (5) Project Management.

Commercial Finance

Commercial finance came from the National Commercial Bank, which disbursed a loan to the National Water Commission (NWC), the largest provider of potable water and wastewater services in Jamaica.

Challenge

Wastewater management has been a significant challenge for countries in the wider Caribbean region. Water supply is often prioritised at the expense of wastewater management infrastructure in this frequently water-stressed region. On the one hand, governments in the region have traditionally not put into place funding mechanisms, including tariffs, sufficient to develop, operate, and maintain adequate wastewater collection and treatment systems. This leads to difficulty in accessing financing, such as commercial loans, for investments in the sector. On the other hand, with the exception of Jamaica, which has applied wastewater tariffs to recover the operation and maintenance costs of its facilities, attempting cost-recovery through customer charges would significantly increase tariffs to a level that may pose affordability issues. Combined with a lack of financing, this resulted in insufficient investment. As of 2011, 85% of wastewater discharge in the Caribbean Sea remained untreated, over half of the population in the region lacked connection to a sewer system, and only 17% was connected to an adequate wastewater collection and treatment system. Before the implementation of the Jamaican Credit Enhancement Facility (JCEF), 80% of Jamaica’s population had access to piped water in 2010, whereas just about 18% had a sewer connection, and little over 7% of effluent sewer was treated (WHO/UNICEF, 2019[6]),

Governments recognise that land-based sources of pollution from domestic, industrial and agricultural uses have significant negative impacts on marine resources, putting economic development and human health and well-being at risk. In Jamaica, the government of took steps in addressing wastewater treatment issues. From 1995 to 2010, 5 wastewater treatment plant were built. In 2013, the government passed the wastewater and sludge regulation, to ensure that effluent waters are adequately treated, to make it mandatory to connect new developments to NWC’s sewer system and to support the National Environment and Planning Agency in taking enforcement action against non-compliant wastewater operators and developers. Further demonstrating its commitment to reducing pollution from untreated wastewater, Jamaica ratified the Cartagena Convention2 and the Protocol Concerning Pollution from Land-Based Sources and Activities (hereafter, the LBS protocol) in 2015. By the time the country ratified the Convention and Protocol, national wastewater treatment standards stemming from the 2013 regulation were more stringent than the LBS protocol standards (UNEP, 2015[7]).

Nevertheless, although regulations supported better performance, a significant proportion of the country’s wastewater facilities kept on operating below required standards. The NWC, a statutory organisation tasked with providing water and wastewater services island-wide, operates more than 70% of the country’s sewage treatment facilities, with small private and community-based water and sewerage providers servicing the rest of the market. Prior to the JCEF project, 44 of the NWC’s 70 wastewater facilities were in need of rehabilitation to meet national effluent standards, and a significant proportion of them had been in operation for over twenty-five years, outliving their estimated economic lifespan and experiencing declines in operational efficiency. At the same time, the NWC had been experiencing high rates of non-revenue water due to leakage and illegal connections. In 2013, non-revenue water was estimated at nearly 70% of all water produced that year. There was thus a need to invest in the rehabilitation of deteriorating infrastructure.

Adequate long-term financing, particularly with tenor exceeding ten years commensurate with the long-lived capital investment required, is rarely available from commercial banks in Jamaica. To address the lack of financing, in 2008, the Office of Utilities Regulation of Jamaica allowed for NWC’s tariffs to include the K-Factor programme, a pre-determined surcharge collected monthly from customers. The K-Factor revenues capitalise a special account earmarked for priority water and wastewater investment projects. In the initial phase, it was envisioned that NWC would secure loans for selected projects against the expected K-Factor cash inflows and the inflows used to repay these loans. This model was not fully operational and a hybrid format was implemented (loans as well as direct payments were taken from the monthly deemed amount). Despite the gap, efficiency improvements resulting from these investments have been reflected as an X-Factor amount (a “give back” to the customers for the efficiency gains derived from the use of the K-Factor funds) on the customers’ bills. The X-Factor is set by the Office of Utilities Regulations and this amount has fluctuated from around 5% (from 2009 to 2013) down to 0% in 2014, and up to 6.2% in 2018. Despite these efforts, the NWC continued to face difficulty in accessing the capital needed to expand and upgrade its water and wastewater services.

Solution

The CReW was an innovative approach to provide financing for investments to reduce the negative impacts of untreated wastewater on the environment and human health in the wider Caribbean region. The Global Environment Facility developed the CReW to address three significant challenges: i) strengthen the enabling environment by supporting policy and legal reforms; ii) increase access to financing; and iii) raise the priority placed on wastewater treatment. As part of its initial phase of implementation - Investment and Sustainable Financing, the CReW project selected four countries in which to implement Pilot Financial Mechanisms: revolving funds in Belize, Guyana and Trinidad and Tobago, and a credit enhancement facility in Jamaica. The objective of these locally defined pilot projects was to determine innovative financing strategies that could then be applied to other CReW participating countries.

To support local commercial bank financing of wastewater project, the CReW fund selected Jamaica’s proposal to create a credit enhancement facility. Following approval from the Ministry of Finance, the NWC established the Jamaica Credit Enhancement Facility (JCEF) in October 2012 as a USD 3 million guaranteed fund, which was placed in a reserve account at the National Commercial Bank of Jamaica in January 2013 (Figure A B.2). In August 2015, the NWC signed a loan agreement with the bank to obtain commercial funding from local financial institutions of the local currency equivalent to USD 12 million (JMD 1.4 billion3) for a period of at least 12 years. With a 4:1 leverage of financial resources, the JCEF allowed for the fund capitalised by the USD 3 million CReW grant to provide secondary collateral against loans disbursed to the NWC. The initial collateral and source of payment for the loan came from annual K-Factor revenue. This instrument reduced the default risk initially associated with the borrower (NWC) and allowed greater access to commercial capital through the provision of a steady revenue stream earmarked for investments in priority wastewater and water supply projects. The total amount of K-factor revenue that is needed to service the debt is approximately JMD 51 billion, with an average yearly amount of JMD 4.1 billion.

Figure A B.2.  The Jamaica Credit Enhancement Facility financing structure

Source: Authors.

Impact

Of the 44 wastewater facilities to be upgraded by K-Factor funds prior to the JCEF, 13 were initially selected to be rehabilitated or replaced under the CReW project to meet national effluent compliance standards. One reason for the initial selection of a subset of projects was to ensure that the loan reflected only a portion of the K-Factor, such that K-Factor revenues were approximately 60% higher than annual debt servicing for the loan. This over-collateralisation of the loan reduced the credit risk, an important step to build local banks’ confidence as the JCEF was a fist-time structure in Jamaica. These 13 facilities were regrouped in four packages. However, three challenges contributed to increasing costs constrained the CReW to reduce the number of packages down to three. First, a lack of co-ordination among stakeholders on the JCEF’s objectives and planning, and lengthy negotiations over the currency of the loan to minimise foreign exchange risk caused the loan agreement to be signed 34 months after the establishment of the JCEF. Second, there were significant delays in the procurement process, partly because of the issuance of an inadequate tender (design and build rather than rehabilitate) in an attempt to speed up the process. Finally, the project’s timing collided with Jamaica’s required servicing of international debt, leading to a lack of fiscal space to uphold project obligations.

A total of eight facilities were eventually selected to participate in the CReW’s initial phase of implementation through the JCEF: i) two wastewater treatment plants were rebuilt; ii) three plants were set to be decommissioned and connected to the central sewer system through the design and construction of new conveyance systems; and iii) three plants were set to be rehabilitated. These plants follow national effluent standards and the CReW mandate enabled for more effective wastewater management and for greater financial sustainability of the NWC, contributing to reducing the contamination water bodies and risks to public health.

The first package (replacement of two wastewater treatment plants) was completed by December 2016 and handed over to the NWC for operation. The work undertaken as part of the second package (design and construction of three conveyance systems and decommissioning of three wastewater treatment plants) was estimated to be 94% complete as of June 2019. The third package (rehabilitation of three wastewater treatment plants) is also nearing completion, estimated at 87% completed as of June 2019.

In 2018, the NWC secured a bond of JMD 15 billion, of which JMD 12.5 billion was guaranteed by the K-Factor funds. The capital raised will be used to settle K-Factor related loans as well as to finance other capital / K-Factor projects that were previously approved by the Office of Utilities Regulations. Additional financial support has been provided from the bond to facilitate shortfalls in the second and third packages’ work contracts as a result of unforeseen increases in material and labour costs.

Moving forward, Jamaica is working to build on lessons learned from the JCEF to further develop and upgrade the water and sanitation infrastructure. The NWC still experiences high systemic inefficiencies, with an estimated 49% of all water produced lost to leakage and theft. Of the initial 44 facilities targeted, there remains at least 25 in need to be decommissioned, rebuilt, rehabilitated or constructed. Several wastewater treatment plants are being packaged for bid invitations and are proposed to be financed by the recently acquired bond.

Blended finance solutions to expand utilities’ services in Indonesia

Development finance

Water.org, a non-governmental organisation funded by philanthropic donations, partnered with the Batang District Water Supply Company Indonesian, an Indonesian regional water supply company located in Central Java, Indonesia, in 2016 to support the expansion of urban utility water and sanitation services. Regional companies, or Perusahaan Daerah Air Minum (PDAMs) in the Bahasa language, are mandated to provide clean water and are monitored by their respective regional government. Water.org also partnered with the microfinance institution (MFI) Koperasi Mitra Dhuafa (KOMIDA) from late 2018.

Commercial finance

KOMIDA provides debt as microfinance loans to low-income households seeking a connection to a piped water supply or a sanitation system.

Challenge

The Batang District is located in Central Java Province and consists of 15 sub-districts (“Kecamatan”) comprising 248 villages with a total population just over 700 000, of which 16% is urban and 84% is rural. The PDAM serves nearly 42% of Batang District’s population and is driven by its mission to, among other things, increase service coverage and provide clean water supply services to the community. To achieve these goals, the PDAM faced the dual challenge of attracting the commercial finance needed to expand its services into poorer areas, and adapting their array of services to better attract and retain poorer clients, which have a distinct set of financial needs.

Solution

Batang District PDAM partnered with Water.org in September 2016 with a special focus on growing the number of low-income clients it served.

One component of achieving that goal was client-facing: not only offering a wider range of financing options that catered to the needs of low-income households, but also alerting potential clients to these newly-available financing options through targeted advertising efforts. Batang District PDAM was already offering some financial services in-house to its clients – a system in which the up-front connection cost is paid over a series of instalments that are incorporated into a water client’s monthly utility bill – but sought Water.org’s technical assistance to increase its efficiency in this activity and also advertise its availability. Additional finance options for PDAM clients who are existing clients of KOMIDA are available through the MFI’s dedicated water and sanitation loans. This provides KOMIDA clients with a greater variety of financial options from which they can connect to Batang District PDAM services. Additional technical assistance on market analysis and demand generation was also provided to the PDAM.

The second component of serving more low-income clients required expanding pipelines and services to more areas where this population lived. Batang District PDAM again sought technical assistance from Water.org, which came in the form of assistance in the development of Standard Operating Procedures for financial service offerings, financial recordkeeping and reporting, and human resources recruitment. Having these procedures in place positioned the PDAM as more attractive to investors when applying for the credit they needed to expand. Figure A B.3 illustrates the financing structure.

Figure A B.3.  The Water.org – PDAM – KOMIDA financing structure

Source: Authors.

Impact

As of August 2018, nearly 5 000 new households were connected to the Batang District water supply system. Notably, 1 650 of those households (approximately 34%) benefitted from internal financing options provided by the PDAM, while the majority of others were able to self-finance the connection. Batang District PDAM increased their clients utilising internal PDAM financing from approximately 70 per month in 2015–16 to 248 in June 2017.

In addition to this new client acquisition, Water.org’s assistance in preparing a detailed engineering design report helped the PDAM secure approximately USD 50 000 in grant funding from the Indonesian government to extend their pipeline in 2018, enabling them to serve an additional 5 000 households. The goal over the final year of their formal partnership is to secure commercial finance to continue extending the distribution network and scale in-house financing.

To summarise, the PDAM utilised concessional support from Water.org to build its client base. A few of those new clients financed their connections via loans available through Water.org interventions with MFIs, but many are financing through the PDAM itself or through their own means. Simultaneously, the PDAM also improved its internal processes to successfully apply for public grant support. Those fundamental improvements also serve to assist Batang District PDAM in eventually being successful at attracting commercial investment.

Blended finance solutions to support rural Filipino utility service expansion

Development finance

The Municipal Development Fund Office of the Philippines Department of Finance, Provincial Government of Palawan, provided the Nara Water utility; Water.org partnered with the utility to increase the number of customers connected to the network and extend its paying customer base.

Commercial finance

Water.org partnered with the following microfinance institutions to extend their portfolio to offer microloans earmarked for water and sanitation projects: ASA Philippines, Negros Women for Tomorrow Foundation; Taytay sa Kauswagan, Inc.; Community Economic Ventures Inc.

Challenge

Narra Water - a newly-constituted municipal economic enterprise for Narra Municipality, Palawan Province, the Philippines, and owned by the Narra Local Government Unit, took a 20-year loan valued at USD 2.46 million with 6% interest per annum in 2015. The purpose of the loan was to build out the Narra Water Supply System to cover the 23 villages of the municipality, a significant expansion beyond the three villages (approximately 1 400 households) that were being served at the time. The loan was provided on concessional terms by the Municipal Development Fund Office, which manages the second-generation funds from foreign-assisted projects (Narra Water would not have qualified for a loan from a commercial bank). Construction of new facilities began immediately, but active recruitment of new paying customers for the services was not prioritised.

In 2017, Narra Water realised that rapid client acquisition was needed to generate the revenues required for meeting the instalment payments on the loan. The company faced the challenge of repaying their concessional loan with revenues generated from a potential client base that not only needed to be convinced to connect to the network, but also might face challenges paying for that connection.

Solution

Water.org collaborated with Narra Water starting in September 2017 along two fronts. First, it worked with the utility to improve its capacity in customer acquisition. This included mapping the community to understand where new potential clients were located and developing outreach strategies for these prospective customers. Water.org also provided technical assistance to the utility staff on financial management. This included analysis to determine that a monthly revenue of one million Philippine Pesos (approximately USD 18 460) per month was required in order to cover the loan instalments while they were still in the grace period of the loan. This revenue could be achieved only when 4 300 households were connected and paying water tariffs.

On the second front, Water.org involved its existing WaterCredit partner, the microfinance institution ASA Philippines, in the Narra opportunity. As a WaterCredit partner, ASA Philippines offers water and sanitation loans to low-income borrowers. It sources the capital it lends locally but receives technical assistance from Water.org in developing and marketing viable water and sanitation loan products. Approved clients receive the water and/or sanitation loan and repay it at market rates. Over time, three other microfinance institutions offering WaterCredit loans also became involved: Negros Women for Tomorrow Foundation, Taytay sa Kauswagan, Inc. and Community Economic Ventures Inc.

Making a connection between a utility actively working to expand its business and a lender looking for clients interested in taking a loan to finance the cost of connecting to the local water utility benefits the utility, the lender, and the clients, who now have access to a reliable source of drinking water. Figure A B.4 illustrates the Narra Water financing approach.

Figure A B.4.  The Water.org - Narra Water financing structure

Source: Authors.

Impact

Before the alliance with Water.org in September 2017, Narra Water was serving approximately 2 000 households. After one year of collaboration, 1 500 new households were connected to the system. Approximately 9% of the new connections were realised through microloans to low-income households, and those who did not take loans for the connection fee paid for it directly, mobilising more than USD 15 000 of revenue from low-income households. As a result, Narra Water’s revenue has increased by 138%. Expansion efforts brought the utility much closer to the 4 300 households needed to cover operating expenses and make debt service payments during the grace period, and to reach the total of 6 000 connected households needed ensure timely payment of principal and interest dues by 2020. The Provincial Governor has been so encouraged by the speed at which Narra Water has been connecting new households to municipal water services that in August 2018, he called for this model to be replicated across all towns with water projects in the Palawan Province.

This case study highlights the at times complex intertwining of actors and approaches that blended finance solutions can take to create positive outcomes. Narra Water received a concessionary loan from the Department of Finance, for which it requires revenue from its clients to repay. Assistance identifying those potential clients and marketing to them came through Water.org at no cost to Narra Water, and a portion of the new clients had the finances available to connect due to a loan provided from local microfinance institutions, which are offering this loan as a result of its participation in the WaterCredit initiative. While ASA Philippines received technical assistance and a small project preparation grant from Water.org to develop the water and sanitation loan product, the loans disbursed to aspiring Narra Water clients were sourced through local Filipino banks, and the Narra Water customers pay their water tariffs and (where applicable) loan instalments from their private funds.

Thus, blending can happen at multiple levels. It likely would have been preferable for the utility to develop a plan for repaying its debt in advance before taking a loan for infrastructure expansion. A blended finance approach could have been adopted in the design and early implementation stages, which could have avoided the scenario. Nevertheless, even at a later stage Water.org and Narra found avenues for bringing in private financing at a later stage to extend and improve services and to enable the utility to get back on track with its debt obligations, and the technical assistance they provided helps ensure that Narra Water will have such financial plans in place before taking another loan.

The Philippine Water Revolving Fund: bridging the rural-urban divide in access to water utility services

Development finance

The Japan International Cooperation Agency (JICA)4 provided a concessional loan to the Development Bank of the Philippines (DBP) through the Environmental Development Project. Through this project, an innovative pooled financing mechanism called Philippine Water Revolving Fund (PWRF) was established. JICA’s concessional loan to the DBP was backed by a sovereign guarantee from the Government of the Philippines Department of Finance. The PWRF is a co-financing facility designed to encourage private sector participation in water and sanitation financing as well as make such financing affordable through blended finance. An initial financing mix of 75%-25% between JICA/DBP funds and participating commercial finance institutions, respectively, was adopted under PWRF, which also has a revolving feature for the ODA component ensures sustainability.

Commercial finance

To encourage the participation of commercial financiers, participating private banks benefit from a partial guarantee from the Local Government Unit Guarantee Corporation (LGUGC) which is backed by a co-guarantee from the United States Agency for International Development’s (USAID) Development Credit Authority.

Challenges

The Philippines made progress in increasing the proportion of people with basic access to water, from 86% in 2000 to 91% in 2015 (WHO/UNICEF, 2019[6]). However, the country remained behind other countries in the Southeast Asian region, including Thailand (98%), Malaysia (96%) and Vietnam (92%) in terms of access to piped water supply. Basic access to sanitation has also improved, from 67% in 2000 to 75% in 2015 nationally. Nevertheless, about a fifth of all municipalities had less than 50% water supply service coverage, and there was a decline in the rate of access to piped water nationwide from 47% in 2000 to 43% in 2015 (WHO/UNICEF, 2019[6]).

There is a lack of information on the total number of water service providers in the country. However, based on survey commissioned by the World Bank in 2015 through the National Water Resources Board, water districts and local government units make up 3% and 17% of the total water supply service providers of the country, respectively. The majority of water service providers is managed by small-scale water and sanitation associations, co-operatives, or unnamed providers (66%) or other sources (15%) that offer only point source water service.

In terms of credit availability, private banks, while endowed with sufficient liquidity, lack experience in lending to water service providers, thus offer short tenors (7 to 10 years) and are reluctant to lend to the water and sanitation sector. The financial environment when the PWRF was conceptualised was also characterised by high market-driven variable interest rates (9-12% per annum). Moreover, some water districts and local government units’ inability to meet loan requirements further contributed to lack of investments in the sector.

Solution

The PWRF (Figure A B.5) was created to provide water service providers access to private finance through the blending of ODA funds channelled through the DBP with commercial finance from private banks. The PWRF was implemented alongside two market-enabling components: a credit rating system to inform investors and a water project appraisal training to lenders with little prior experience lending to the sector.

Figure A B.5.  The Philippine Water Revolving Fund financing structure

Source: Authors.

The PWRF is an innovative financing facility developed in consultation with the Government of the Philippines to improve access to financing in the water and sanitation sector. The PWRF was implemented in the context of co-operation efforts between the USAID and JICA. This was triggered by the US-Japan Clean Water for People Initiative launched in 2002 to support the Millennium Development Goals on water and sanitation targets. Henceforth, extensive consultations were held among the Government, USAID and JICA supported by studies commissioned by both development partners to establish the viability of the PWRF and develop its framework.

At the same time, policy reforms were being implemented in the water and sanitation sector, including Republic Act 9275, which supports the implementation of the Clean Water Act and Executive Order 279, which required a shift of financing of creditworthy utilities to market and cost-based lending from banks. In 2004, a pilot PWRF account was implemented to identify strengths and weaknesses in the conceptual approach, forming a basis for the final design and implementation of the PWRF. In particular, the pilot highlighted the need for PWRF to: i) provide affordable loans at fixed, below market interest rates and longer tenors (15-20 years); ii) incentivise all stakeholders for loans to be arranged by a single entity rather than multiple parties; and iii) for the project to be aligned with public policy goals and support both refinancing and new investments.

In September 2008, JICA and DBP signed a loan agreement where the PWRF financing window was incorporated. With its blended financing element, other key features of the PWRF include:

• a liquidity risk cover is provided to local banks through a stand-by credit line from DBP and the Municipal Development Fund Office with a take-out feature offered to borrowers who cannot afford the bank’s short tenor. Loans are disbursed on 7-year tenors, and are retired at the end of the period if the cash flow can support the repayment schedule. If not, whilst the 7-year tenor is maintained, the principal will be amortised over 20 years. The local bank will have an option to extend the maturity beyond 7 years, but if they choose not to, it can opt to be taken out by the either the DBP or the Municipal Development Fund Office or one of those entities can assume the loan and pay the local bank a balloon payment of the outstanding balance5. These loans become effective the day the local bank’s loan expires and the balloon payment is triggered. With the stand-by credit line, local banks agree to amortise the loans over a 20-year period with a balloon payment by the end of the 7^th year, and to exercise the option to renew the loan for another 7 years under the same terms and conditions. The stand-by credit line thus allows for a lower amortisation schedule for the water utility loan and provides an opportunity to test local banks’ willingness to apply longer tenor on their loans;

• a credit risk guarantee providing partial guarantee from the LGUGC, a private entity, covering a maximum of 85% of commercial banks’ exposure against a 1% guarantee fee, backed (up to 50% of the LGUGC’s exposure) by a co-guarantee through the USAID-Development Credit Authority. The LGUGC guarantee provides credit risk enhancement to commercial banks thus reducing their credit risk exposure;

• a revolving feature, through a ring-fenced revolving account capitalised by principal repayments of borrowers on the ODA loan component to ensure sustainability of fund managed by the DBP.

Initially, JPY 1.5 billion (USD 13.4 million) was allocated by JICA to finance the PWRF window with concessional terms of 30-year maturity (inclusive of a 10-year grace period) at a fixed interest rate of 1.4% per annum.6 The initial loan (from JICA to DBP) subsequently increased to JPY 7.6 billion (USD 67.8 million), and was fully disbursed by the end of the project in January 2017. By that time, the PWRF had financed 17 sub-projects totalling PhP 3.3 billion (nearly USD 65.5 million).

Impact

The PWRF was conducive to the expansion of utility services in the Philippines, and engaged private financial institutions in the provision of loans to water service providers. The sub-projects financed through PWRF resulted in an estimated 216 872 new household connections to water services as of January 2017. Financing terms of local banks have also improved, with tenors increasing from 7 years to between 15 and 20 years at lower, fixed interest rates.

Facilitating Access to Finance for water and sanitation infrastructure in Cambodia through blending solutions at multiple entry points

Development Finance

The French Development Agency (AFD) set up a concessional credit line with the Foreign Trade Bank (FTB) alongside a partial risk-sharing guarantee (ARIZ). The AFD also managed grant funding from the European Union (EU) to provide two kinds of technical assistance. The first one was dedicated to support the FTB structuration and knowledge on water and electricity infrastructure services. The second one was focused on small-scale private water operators aiming to develop a viable local intermediary ecosystem providing business brokering, engineering assistance and capacity building services. Part of the grant was also used to finance output-based subsidies to extend water and electricity services provided by small-scale private operators in small towns of Cambodia. To initiate the program, the World Bank Water Sanitation Program pre-funded the business plan preparation and engineering technical assistance in support of 20 small-scale private operators.

Commercial Finance

The Foreign Trade Bank (FTB) is a local commercial bank that was willing to diversify its portfolio by offering loans adjusted to the needs of water and electricity service providers.

Challenge

Access to piped water supply is lower in Cambodia than in most Southeast Asian countries, with a national average of 21% of the population having access to piped water supply in 2015 (Figure A B.6). There are significant inequalities in terms of both access and type of water provider between urban and rural areas, with 72% and 8% of the population having access to piped water supply respectively in 2015. Public utilities tend to serve large urban areas, including the capital Phnom Penh, while small-scale private water operators tend to serve rural areas. Remarkably, over the past two decades, a large amount of small-scale private operators have invested “spontaneously” in unstructured water supply and electricity utilities. The Cambodian case is relatively unique considering the number of small enterprises involved, the level of financial investments, their demonstrated initiatives and the financial risks taken. There are an estimated 300-400 small-scale water operators in the country, who rely on a full cost recovery system without access to public financing. The main factor preventing these private operators from upgrading and expanding their services is a lack of access to commercial financing. In Cambodia, water service providers tend to be business entrepreneurs with experience in finance and business management and little technical knowledge of the sector, which results in low quality infrastructure, and a low asset value. Moreover, the quality of infrastructure planning, design, financing and the capacity to prepare business plans are rather low. Additionally, when lending to the water sector, banks in Cambodia often do not conduct feasibility studies that account for economic and technical considerations of the projects, but instead consider the perceived capacity of the borrower to repay. Commercial banks also still consider water supply and electricity businesses to be risky. As a result, the few local and regional banks that lend to private water operators request: i) prohibitive collateral requirements, with values sometimes exceeding 200% of the loan, in the form of land and buildings; ii) high interest rates (from 8% to 15%); and iii) short tenors (up to 5 years) with no grace period. Furthermore, small-scale private operators do not have a clear incentive to deliver efficient levels of investment due to a very fragmented market; nor do they have incentives to deliver high quality water for that reason. This often leads to poor performance and further restricts their access to financing.

Figure A B.6.  Access to piped water supply, Southeast Asia, 2015

Source: Authors’ elaboration based on (WHO/UNICEF, 2019[6]).

Solution

To facilitate access to finance of small-scale private water and electricity providers in rural areas of Cambodia, the AFD created the Access to Finance Project in 2014 (Figure A B.7). The Foreign Trade Bank of Cambodia (FTB) became the main commercial partner of the project by agreeing to take a concessional loan from AFD and risk-sharing guarantee (ARIZ) to expand its lending portfolio to the water and electricity sectors. The access to finance project aims at i) restructuring the financial sector to provide small-scale private operators with adequate loan products, and building their capacity to evaluate investment proposals; ii) reducing the risk associated with water service provision projects by improving business-brokering and engineering services in order to obtain large-enough loans; and iii) incentivising water operators to facilitate the connection of low-income households to reliable and safe water supply.

Figure A B.7.  Access to Finance Project Cambodia financing structure

Source: Authors.

The AFD established a non-sovereign USD 15 million concessionary line of credit with FTB for loans in the water and electricity sectors, coupled with a risk-sharing guarantee (ARIZ). This allows the FTB to borrow from the AFD at lower costs compared with local financial options and reduces the collateral requirement in volume and in kind (formerly traditional mortgage-based lending were pooled with assets value and net present value) when lending to water and electricity operators.

The concessional nature of the credit line ensures that the financing is affordable to small and medium scale operators, with interest rates set at 6%-8% per annum on 10-year tenors inclusive of a 12-months grace period. To ensure that some of this fund is invested in the water sector, the FTB agreed to reserve one-third of the credit line for water operators. This agreement was later re-adjusted to two-thirds of the credit line (USD 10 million) because of high demand for water sector loans.

To securitise this line of credit, and lower the collateral requirements for small-scale borrowers, the AFD also set up a risk guarantee scheme through ARIZ, its mechanism to share loan portfolio risk between the AFD and FTB. The guarantee was set to USD 5 million in order to secure up to 50% of a USD 10 million loan portfolio.

Prior to the setting up of the credit line, the World Bank pre-financed the preparation of the business plan of the FTB providing grant funding to support water operators applying for FTB loans in developing business plans and engineering assistance. The World Bank also provided grant funding to improve the regulatory environment to improve transparency in the tariff and licensing practices of water operators.

The EU provided three kinds of grant, managed by the AFD:

i) A USD 0.7 million grant (EUR 0.6 million) to support TA (provided by Enclude) for FTB structuration, which aims at: i) improving the FTB’s management capacities on commercial and technical skills required for the appraisal of infrastructures projects, particularly the methods for assessing the economic and financial rates of return; ii) improving of marketing, communications and information tools to supports the bank in developing an appropriate access-to-finance support service package dedicated to small-scale private water operators; iii) the development of the Environmental and Social Risk Management (ESRM) to be integrated in the bank’s procedures.

ii) A USD 1.4 million grant (EUR 1.2 million) to finance technical assistance to small-scale private operators, aiming to foster an ecosystem of business-to-business services providers (engineering, business plan development, brokerage services) to drive small operators towards increased quality and professionalism. Several service providers were involved, led by GRET, including Innovative Services, Engineering and Advisory, Emerging Markets Consulting, and SeeSaw. These providers carried out support to the small-scale operators during the loan application process and ensured the quality of the business plan and overall project proposal.

iii) A USD 0.9 million grant (EUR 0.8 million) provided as a subsidy to encourage water operators to reduce and cap the cost of connecting poor households to a piped water supply system to USD 30 (the average connection fee stands at USD 64). Small-scale operators can choose to reduce this amount according to their marketing strategy, for which they can also receive assistance through the grant. The operators only receive the subsidy once the poor household is connected to a functioning metered connection. The grant also serves in assisting operators to improve their water quality management practices (i.e. conducting water quality analyses twice a week for 2 years) and in subsidising water quality equipment.

Moving forward, as the project nears completion, stakeholders are elaborating a strategy for the phasing out of the concessional finance. In order to transition from the blending of development finance with commercial financing towards less reliance on development finance, there is a need to cover critical technical assistance costs via the lending process itself. Before a loan is approved, it had to successfully get through the pre-financing process, organised along 3 stages: i) the water operators estimate their financial needs and request a loan to the FTB; ii) the FTB negotiates the loan amount based on the bankability of the project and risk profile of the operator, which are determined following a field visit and key indicators (business plan, balance sheet, financial statement). Once the agreement is reached, iii) water operators receive training on technical aspects, including to ensure the quality of the infrastructure resulting from the investment. The FTB may reject the loan request up to that stage. Technical assistance is thus key to reducing the risk of the project, however it is too costly for water operators to bear that cost. There is thus a need to diffuse that cost between the lender and the borrower without significantly raising the cost of the loan.

Impact

As of May 2019, most of the credit line had been consumed with a total of USD 10 million in water project loans disbursed across 30 projects, 27 of which were successfully completed.

The initiative led to:

• An increase in the performance and service quality of the projects financed, thanks to technical assistance funded by EU and to the pre-financing process followed by FTB to select sound projects. As a result, financed projects delivered better outcomes that were more aligned to the banks’ expectations, which increased the bank’s confidence in lending to the sector.

• Observed changes in lending practices as a result of the project, with the FTB adjusting its collateral requirement to not only include assets such as land or buildings, but also part of the appraised value of water infrastructure assets and part of the value of expected future revenue. This practice remains unique to the FTB in Cambodia.

• The creation of a new loan product in the market adapted to the needs of water service providers, with reduced interest (less than 8% per annum), a reduced collateral requirement from 200% to 100% of the loan thanks to the ARIZ risk sharing mechanism, and longer tenors (up to 10 years instead of 5 years).

• An increase in the number of households connected to a piped water system, including poor households. As of October 2018, 75 000 households benefited from water service improvements, of which an estimated 18 000 received new connections to a piped water system, including 8 000 poor households.

  Although the project successfully achieved development objectives in terms of increasing access to piped water, the commercial financier had not fully addressed risk aversion to lending to water service providers. The project revealed that despite the liquidity risk cover and several layers of technical assistance offered to the bank and water operators, the attrition rate remained high (69%) between the number of loan requests (USD 32 million requested) and the rate of approval (USD 10 million disbursed). This resulted from the bank applying the same due diligence to loans of different amounts, and an average period of 6 months between the date of the loan request and that of the loan disbursement, conducive to a high rate of drop outs. Moving forward, there is a need to adapt the due diligence requirements based on the amount of the loan requested. These results also show the added value of an innovative business model, including a private business broker and technical assistance, which contributes to the creditworthiness of small-scale private operators. Finally, it shows how important confidence building is to the emergence of a mature investment environment in Cambodia.

Notes

← 1.  EAIF is a member of PIDG that mobilises public and private funds to lend to public and private infrastructure projects in Sub-Saharan Africa.

← 2.  The Cartagena Convention, adopted in 1983 and implemented in 1986, is a legal agreement between countries of the wider Caribbean region for the protection of the Caribbean Sea. The LBS protocol is one of three technical agreements supporting the convention, alongside the Protocols on Oil Spills and on Specially Protected Areas and Wildlife.

← 3.  Official exchange rate, 2015 period average, International Monetary Fund, International Financial Statistics.

← 4.  JICA merged with the development assistance section of the Japan Bank for International Cooperation (JBIC) on October 1, 2008.

← 5.  The source of the balloon payment will be a take-out loan from the Municipal Development Fund Office for Local Government Unit loans, and from DBP for Water District loans, executed under the same terms as the local bank’s loan.

← 6.  The effective cost of borrowing for the ODA component was higher due to a 1% sovereign guarantee premium; a 3% foreign exchange cover; a 0.25% gross receipts tax; and a 3% mark up of DBP.