Case studies

Water Solutions

Case 15: Challenging the Myth of Public Penury: Alternative Financing Mechanisms

Introduction

One of the most enduring myths of the public-private water supply debate is the notion that public finance is insufficient, and that private capital – in some form – is the only solution to the world’s water supply crisis. ********* The partial retreat of the private sector from specific regions (such as Africa) and specific types of contracts (rural areas, small cities) over the past few years has led some proponents of private sector involvement to suggest the need for the subsidization of private capital through direct aid transfers, risk mitigation guarantees and other risk mitigation strategies (such as the Camdessus Report’s proposed “Devaluation Liquidity Backstop Facility,” designed to mitigate or eliminate currency risk for water multinationals (Winpenny, 2003). Politically unfeasible and arguably technically impossible, the Camdessus proposals have met with limited support, although some are currently being developed. Financial building. Photo credit: HanneoriaAlternative financing mechanisms, however, may provide new – and in some cases, unexpected – sources of preferred investment. The evolution of financing of the British water industry since privatization in 1989 is a good example. By 2001, water companies had begun openly arguing that equity was an expensive source of finance, and that other sources of finance – in particular debt finance – were more viable in the long term. Following this argument, the majority of British water companies restructured their financing using long-term debt (such as bonds), which required protecting the low-risk, low-return monopoly water business from riskier, equity-financed activities. This directly contradicted one of the key arguments in favour of privatization: that equity investment is the most desirable because it creates pressure on managers to make efficiency gains that offset the increased cost of capital. In contrast, opponents of privatization argue that debt, and in particular government debt, is so much cheaper than equity that any efficiency gains under private ownership would not be outweighed by an increase in the cost of capital. If private finance is increasingly being acknowledged to be of limited viability, and the cost of providing and replacing basic urban environmental infrastructure far exceeds likely private investment and international aid flows combined, then alternative methods of mobilizing finance must be considered. Such financing methods exist, of course, in most developed countries. Perhaps best known is the United States’ Clean Water State Revolving Funds program, which provides states with concessional finance – which may be leveraged to generate additional capital for loans – for investment in infrastructure to improve water quality (Travis, Morris, & Morris, 2004). Other models – such as the Netherlands Water Boards levy and Bank “self-financing model” – follow similar principles: concessional finance with strict investment criteria, focused on comprehensive water management goals in addition to urban water infrastructure construction (Uijterlinde, Janssen & Figueres, 2003). Water pipes. Photo credit: Flippy RiceThe success of these and similar initiatives has been such that USAID and the Environmental Protection Agency have recently created a program to extend the State Revolving Funds model to developing countries (particularly middle-income countries, with high rates of savings and availability of domestic capital). Under this program, new strategies for fostering and accessing local public capital markets (such as issuing municipal bonds) have been successful in countries such as India and Mexico. Most importantly, the local finance used in these cases has advantages (avoidance of currency risk; greater accountability; the catalytic role of bond finance in broad-based, urban governance reforms) that outweigh the cost of overcoming the potential hurdles and barriers (such as legislative barriers, the small-scale nature of many urban infrastructure projects, the lack of local bond rating capacity). The joint USAID-JBIC “Clean Water for People” initiative has built upon this model, for example, by supporting the development of State Revolving Fund–type financing in the Philippines and India (in the states of Karnataka and Tamil Nadu), together with grant support and local currency investment guarantees (designed to encourage local financial institutions to lend to new sectors and under-served areas) as appropriate. Most importantly, the USAID model overcomes the lack of access to capital markets and eliminates the currency risk to which private, multilaterally- and bilaterally-funded projects are subject. importantly, the USAID model overcomes the lack of access to capital markets and eliminates the currency risk to which private, multilaterally- and bilaterally-funded projects are subject.

Questions

  • Should water justice movements be working towards “public debt” instead of “private debt” for water financing? What are the obstacles, risks and opportunities of this shift?
  • What northern government development agencies are more hospitable to the aims of the water justice movement?
  • Where do we as water justice movements draw the line when it comes to types of private participation – is the acceptance of a loan from a private creditor acceptable? What type of participation is not?

Notes and Links

  • Concerning the USAID-JBIC initiative, see http://usinfo.state.gov/xarchives/display.html?p=washfile-english&y=2005&m=May&x=20050503125027TJkcolluB0.1300318
  • For more on microcredit initiatives, see this article from from WELL.
  • For the “watercredit initiative,” see the WaterCredit page on water.org.