Achieving universal access to water and sanitation by 2030 – how can blended finance help?
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Today, 2.4 billion people still live without access to improved sanitation; about one billion people defecate in the open; and more than 640,000 people lack improved drinking water sources.With the adoption of the Sustainable Development Goals on water and sanitation (SDG 6), countries of the world committed themselves to change this situation by achieving universal access to safe water and sanitation while addressing issues of water quality and scarcity to balance the needs of households, agriculture, industry, energy, and the environment over the next 15 years.
Recent estimates by the World Bank’s Water and Sanitation Program (WSP) indicate that the present value of the additional investment in the water and sanitation sector alone needed through 2030 will exceed US$1.7 trillion. Existing funding falls far short of this amount; .
At present, most water sector actors in developing countries rely on government lending and concessional financing from national, bilateral or multilateral development banks (MDBs) to mobilize financing for capital investment. These financial sources alone will not be sufficient to finance investments on the scale that is called for by the SDGs. It is therefore essential to mobilize up-front financing from commercial sources as well.
National governments and donors must use their funds in a catalytic manner, as part of broader financing strategies that mobilize funding from sector efficiency gains, tariffs, domestic taxes, and transfers to crowd in domestic commercial finance. If they are able to do so, countries will be much more likely to access the resources they need to improve and expand the infrastructure needed to deliver and sustain universal coverage of water and sanitation services and achieve SDG 6.
However, In a newly published paper - Achieving Universal Access to Water and Sanitation by 2030: The Role of Blended Finance, we suggest that “blended finance” can help lift the constraints that are limiting the mobilization of commercial financing for the water sector.
What is “blended finance”?
OECD refers to blended finance as ‘the strategic use of development finance and philanthropic funds to mobilize private capital flows to emerging and frontier markets’. Blended finance in the water sector has the potential of mobilizing private sector financing for credit-worthy or close to credit-worthy investments. This would allow reallocating public funds to other areas where public subsidies are likely to be needed.
Commercial finance usually brings requirements for greater investment discipline and transparency, which in turn could support improved efficiency in the sector, an objective for most water sector reform efforts around the world. Domestic commercial finance in particular can be mobilized in local currency, which reduces the foreign exchange risk and can bring down transaction costs, particularly for smaller scale investments to improve efficiency that can generate rapid returns (such as replacing meters or fixing leaks).
Blended finance has traditionally been used as a tool to stimulate interest from the commercial financial sector, with the use of concessional finance then tapering off over time to avoid distorting markets. Given the embedded distortions in the WSS sector in developing countries, where financing is predominantly based on subsidized public funds, it will be necessary to move towards mobilizing more commercial funds over time. Blended finance can be a stepping-stone in that transition.
We also pulled together nine case studies on how blended finance has been used in facilitating access to water and sanitation in developing countries so far. These case studies include diverse experiences reflecting different levels of financial market development and targeting different sector needs -- from facilitating access to microfinance for households to invest in water and sanitation in Cambodia or Bangladesh, all the way to setting up a revolving fund for utility investments in the Philippines.
The case studies shed light on how grants, concessional lending and various forms of credit enhancement (such as guarantees or revenue intercepts) have been used to address constraints on accessing finance so that more households would have access to drinking water, an adequate toilet and a suitable place to wash their hands by 2030.
Do you know of other examples where blended finance approaches have been successful in catalyzing investment in the water and sanitation sector? What about other sectors? Let us know in the comments! Or write to us at [email protected] and [email protected].
We are also co-convening a session on Water Finance during World Water Week 2016 in Stockholm. For more information, visit: Cracking the Water Finance Puzzle: Crowding in Private Finance
My concern is that concessional finance makes money too cheap and that it threatens to undermine the scope for private investors. Is this not the more significant flaw in the so-called development finance model? After all, grants are grants and for thast reason legitimate, but concessional finance is a wolf in sheep's clothes
While blending is in fact cheaper than straight, conventional commercial finance, the reality is that private money in the water sector makes up less than 10% of the total private finance investing in infrastructure. Blending supports an incremental approach which starts the process towards commercial finance. The water sector in many emerging markets is completely dependent on grants, government resources or donor finance. Efforts to start tapping into domestic capital, even in relatively small amounts, is a first step to diversifying the sources of finance desperately needed to close the financing gap in the sector.
Adopting the SDG 6 is a positive move in many countries, but there seem to be an institutional support gap between the adoption mechanism and full implementation of the SDG 6 in some countries. Adoption of the SDG 6 by some counties is largely in political talks than in action moves. For other countries (my country Zambia included) the efforts by policy makers seem to be going in the right direction. But their exist unclear monitoring and evaluation tools for water related concepts.
The concept of blended finance has caught up unaware some countries in their development agenda. With or without adequate expert knowledge, other national policy makers have gone into inclusive water business. The goodness with this is that many private entities have jumped on board in the water business. And the badness maybe that many of these private stakeholders largely provide substandard water products. It's assumed cheap and easy capital venture for anyone to take part, mainly with little regard on the source of the water they want to trade in.
Tapping into domestic finance makes sense regardless of whether the management of water delivery rests with the public or private sector. Rather it’s an additional financing source to help close the infrastructure gap. Admittedly, tapping into those markets requires special skills, but many of the fundamental requirements to achieve credit worthiness are the same skills necessary to provide clean, safe, dependable water and sanitation services to the entire population. Good and poor delivery experiences over the years have occurred in both the public and private sector; just as successful ventures have been implemented by public and private providers. Yet no matter what delivery mechanism is used, key characteristics such as competent staff, transparent regulations, clear service objectives and standards, benchmarketing standards, and a concerted effort to serve the poor are common characteristics.
Good post.
Forgive me for thinking aloud and/or being too blunt or naive, but... whether it is though bonds, equity investments, or bank loans, who would want to invest in a water utility??
Are there particular track records of safe investments that could be pointed out?
Just looking at the typical large African city utility, common characteristics are (very roughly)- relatively few connections (a small percentage of city's population getting piped water directly), poor revenue collection, high physical loss rates, etc.
Surely, there is a threshold of efficiency and profitability at which a water utility is a decent/safe investment. I would love to know what those IBNET parameters would be.
(Water utilities would be competing for funding, so there must be a calculation of relative investability as well, I would imagine... )
Lastly, it would be useful to hear thoughts on financing on the demand/household end as well. To what extent is subsidizing extensions and connections into less lucrative neighborhoods even feasible these days?
Ed Bourque
WASH Consultant
http://www.edbourqueconsulting.com/
Thank you for your comments and questions. You raise a number of good points.
First, private investors DO invest billions into the water sector as debt. The issue is that those are well run service providers/utilities that operate efficiently, have transparent governance structures, operate within the framework of legal regulatory regimes, collect revenue, maintain their infrastructure, and are ultimately credit worthy. However, you are correct in noting that without these inputs and conditions, it’s likely that private commercial finance in the form of debt will find its way to the water sector. Blended finance is a way to begin this process for providers who are trying to improve their operations.
We recently looked at a sample of the IBNET service providers and found that only 15% of some 700 providers had an operating ratio above 1.2; meaning that they would likely have the ability to service some debt. However, if you could reach 100% revenue collection, cut non-labor costs by 15% (in other words increase efficiencies), cut Non Revenue Water to 25%, and increase revenue by 10%, over 75% of the service providers/utilities would have operating ratios above 1.2.
Finally, there have been microfinance institutions that have lent to households for sanitation programs in Asia and Africa and, while the evidence is just emerging, there are some encouraging results. Linking Results Based Finance or Output Based Aid to those programs has been used to reach the poorest members of those communities.
The private sector water, and sanitation in particular, has a low participation in Africa. As a private sector actor in Zambia, I can state this is even more pronounced here.
The need for FInancing in the sector is something we have noted but from the perspective of the need for consumer financing. Indeed governments need to play a part as a catalyst for commercial banks who have no understanding or appetite for the sanitation sector.As Joel has stated the focus of financing has been in capital investment and water, but from our perspective a number of the infrastructure investment projects will have low utilisation if the front end is not matched by the backend, which is uptake by the consumer.
The sanitation gap is increasing and therefore it remains for the private sector to take up the initiatives by identifying Angel or impact investors and philanthropic capital to the market as first movers. Commercial Bank money is too expensive for low to middle income households to put themselves on the sanitation ladder to avert, amongst other issues, a public health crisis of deriorating groundwater quality.
We believe a sound business oppourtunity exists. What remains a challenge is matching the need to the capital. We look forward to feedback.
K-V Musakanya
CEO - Toilet Yanga Ltf
Lusaka, Zambia
Thank you Kapumpe,
You raise several good points and let me try and clarify.
First is the role of the private sector, whether you are a small, country based NGO or a large multilateral. In either case, the private sector in these situations tend to be involved in the delivery of the service rather than the financing. While early PPPs tended to try and structure transactions where the private sector was responsible for securing financing, today most transactions require the public sector to provide the capital expenditures or secure financing.
Second, regardless which modality is used to deliver services, there is a role for commercial finance and that finance can be used and/or managed by either public sector entities or private groups managing the delivery of water and sanitation services.
Finally, while much of the focus has been on raising large level of finance for the sector from commercial banks, pension funds, and/or insurance companies, there are also large opportunities for smaller financial institutions. In Bangladesh and other countries with robust microfinance industries we’ve seen a growth in opportunities to support small scale sanitation and water entrepreneurs as well as household loans which enable families to finance sanitary facilities or water connections. Blending opportunities arise when Output Based Aid has been used to write down some of the financing once the infrastructure is in place and verified. Likewise, venders or suppliers of pumps or solar pumping system are, in some instances, willing to finance their equipment, particularly in situations where additional revenues can be realized quickly and the additional revenue can be ring-fenced and used for repayments. In conclusion, blended finance isn’t only for large scale financiers.