Crowding-in Commercial Financing to Water Supply and Sanitation Utilities

This is a guest blog by RWSN Members Lance Morrell and Michael Ashford.

Achieving SDG6, clean water, and sanitation for all by 2030 requires estimated investments of US$114 billion per year. The present value of the total investment needed is US$1.7 trillion, and these estimates do not include costs of operation and maintenance. At three times current levels, this far exceeds the financing capacity of the entire public sector and donor community, combined.  

We in the development community need new tools and approaches to address this gap. Using donor and public funds to “crowd-in” private investment can help. USAID’s recently announced Private-Sector Engagement (PSE) Policy, for example, recognizes the urgency of using development funding to attract private sector capital into development of infrastructure and services around the world. Similarly, USAID’s Water, Sanitation and Hygiene Finance (WASH-FIN) program is developing and piloting specific interventions to increase private and public investment in WASH. The World Bank’s Public-Private Infrastructure Advisory Facility (PPIAF) is another important source of information and successes on how to leverage the public and donor sectors’ financial power to increase private investment in public infrastructure and services. In all cases, the policies and prescriptions call for the use of market-based approaches as the only sustainable path to sustainably support communities in achieving development and humanitarian outcomes.

While “billions and trillions” of capital for WASH feels overwhelming, outside of 20th century Soviet-style economies, public infrastructure was never meant to be financed, funded, and operated with public resources alone. Commensurate with the growing financing gaps, there is today a glut of private sector capital looking for reliable investments that meet their investment criteria. Globally, pension funds, insurance companies, sovereign wealth funds and commercial banks hold approximately US$100 trillion in assets. In this light, the global financial system is out of balance, and the challenge is to attract private capital and other types of private sector participation into the water and sanitation sector. Development professionals, working with their government counterparts, must now “put skin in the game” without sacrificing the broader objective of shared, public benefits and economic growth.

Changing Project Funding to Crowd-In Private Investments

If the private sector has the capital needed to expand and improve the performance of the WASH sector, why haven’t governments been able to access it? How do we crowd-in the private sector?

The first step is to stop crowding-out private investment with donor funds. Governments and donors crowd-out private investors by providing grants or ill-designed concessional financing against which the private sector cannot compete. Financing and funding are products that banks and donors, respectively, want recipients to “buy;” the price is the interest rate. Free or cheap money from donors is not something private capital can beat.

There are numerous real-world examples of crowding-out in development, which follow the same basic scenario: Donor X works with a government to develop a project that will use public and donor funds to attract commercial financing to the project. In order to attract – or crowd-in – the commercial financing, government will work with financiers to understand their concerns and design appropriate risk mitigating measures. To crowd-in the private sector, the project designers require time to develop both the demand and the supply side. As this project preparation is proceeding and nearing agreement, Donor Y approaches the government and offers grant financing for 100 percent of the cost of the project, and crowds-out the private sector.

In contrast, as USAID’s PSE policy emphasizes, governments must engage and collaborate with the private sector, and the private sector must be allowed to manage its level of risk and to earn a reasonable profit. Adhering to an enterprise-driven development model, USAID and other donors are aiming to play a catalytic role in achieving results, rather than fully funding and managing the majority of its projects. The PSE model recognizes that the private sector represents nearly 90 percent of the direct foreign investment to developing countries, and the model represents a strategic approach through which USAID would consult and collaborate with the private sector for greater scale, sustainability and effectiveness. Under this approach, USAID will attract, or crowd-in, the private investors.

Increasing Government Commitment

Government is the key stakeholder in attracting private sector financing to the WASH sector. To effectively express these commitments, government officials need to understand the benefits and costs of the WASH sectorfrom the perspective of commercial finance. Some of the potential policies and actions include the following, with the commitment type identified in parentheses:

  • Sharing capital costs or providing limited guarantee of recovery of capital costs (lump sum);
  • Guaranteeing continuous payments during project performance to recover capital costs overtime or sharing in expected revenue from tariffs to cover financing costs (revenue flows);
  • Indirect market development by requiring improved operational performance of the utility, whether publicly or privately owned, to reduce expenses and increase revenue, so the utility can enter into direct lending arrangements (regulatory enforcement);
  • Contractually transferring asset management of utilities, if owned by government, through performance-based contracting with private sector service providers (give up control of asset).

Developing a business relationship between governments, utilities and commercial lenders takes time and patience, and the path forward should be gradual to allow all parties to develop trust and confidence. For example, commercial lenders could start with financing smaller projects that enhance revenue for the utility, such as new or upgraded water meters or increasing customer connections. If the utility then dedicates the additional revenue attributable to the project to the private investor, the private investor’s and utility’s interests align around ensuring performance during operation. After the loan is paid off, the additional revenue accrues back to the utility. Once the utility passes this kind of test with private investors, it can expand follow-on borrowing to finance further extensions of the water supply system –again using new cash flow that is “ring-fenced” to repay next the loan.  Meanwhile, scarce public funds are protected and can be used for projects which have high economic value but low financial viability, such as a new sewage treatment system. Overall, the goal is to create more incentives for private capital to partner with donors and government toward shared development goals.

About the authors

  • Lance Morrell is a financial specialist with more than 35 years of professional experience, and is the Founder and Managing Director of FEI Consulting;
  • Michael Ashford is senior clean energy and infrastructure professional with more than 20 years of experience, and is the Global Practice Lead for the Water, Energy, and Sustainable Cities practice at Chemonics International.

This blog post represent the views of the authors and does not necessarily represent the views of Chemonics. Photo credit: Gerardo Pesantez / World Bank.

Author: RWSN Secretariat

RWSN is a global network of rural water supply professionals. Visit https://www.rural-water-supply.net/ to find out more

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