The water sector needs to secure much greater investment, but also to direct this at the most appropriate solutions and to build creditworthy utilities. This offers a key role for IWA. By Kala Vairavamoorthy.
There are great and growing needs relating to water, made clear in the commitments and aspirations set out in the UN Sustainable Development Goals and the Paris Agreement. We also know that the solutions to these needs require investment. An estimate figure of $114 billion annual capital investment is needed to achieve the water supply, sanitation and hygiene goals of SDG 6.1 and 6.2.
Such a scale of investment may seem out of reach, especially for the least developed countries of the world. The question then is how we bridge that gap, between needs and the investment required to meet those needs. And how can the IWA contribute to answering this essential question of our time.
Financing follows the flow
A fundamental point to keep in mind in any discussion on financing is that investment needs flow from the actions and solutions we seek to implement.
IWA’s most powerful contribution is, perhaps more than anything else, its role in helping frame the view on exactly what is the gap to be bridged. This means asking what the investment needs are, which are a function of what is being invested in. It means asking what is most appropriate and cost-effective for delivering the end goals.
This means questioning where and when to invest in traditional solutions of hard infrastructure built with timescales of multiple decades in mind, or where to break from this and pursue alternatives.
Today, cities all over the world are facing a range of dynamic regional and global pressures, such as climate change and urbanisation. We cannot continue to invest in water infrastructure that is unsuited to future societal needs. We need to find new ways of catering for more people, with greater needs, with the same quantity of water. All of this has to be achieved while reducing our ecological footprints.
“We cannot continue to invest in water infrastructure that is unsuited to future societal needs”
We need to change our automatic response to anticipated growth, which has been that the only solution is to expand our water resources, with intrusive and capital-intensive projects that capture and store water far from where it is needed.
Instead, we need to start thinking about the productivity of water – what it is we want it to do for us – so that we can then match the quantity and quality to its intended use. This outlook leads to investment in efficiency, diversification of water sources, and a rethink of the way water is used and reused – ensuring it is used multiple times, cascading from higher to lower-quality needs.
In this context, financing needs to do more than deliver investment in new approaches, but to actively incentivise transition to a new normal.
An example, in a case where an infrastructure base is in place, could be a decision on investing in a new reservoir versus addressing leakage and water loss. The latter represents sound management, so should be pursued in the first instance. It involves different investment needs, different investment periods, and different payback periods compared to the reservoir option. Network improvements may also bring in other types of technology, such as digital technologies, that we can expect to be overtaken within a relatively short period of time. All of this changes the frame for financing.
Going further, our water systems need to be far more able to cope with the uncertainties and increased variability resulting from global change pressures. This means incorporating elements that are modular, offer redundancy, or distribute functionality, for example. These need to be brought forward as options for investment. As part of this, the value of the flexibility these elements bring needs to be better quantified too, so brought into the financing equation as well. We need to understand better the real savings that result from the ability to rapidly expand or shed capacity, as well as quantifying the benefits associated with the timing of expenditures.
This is all about a need to articulate a new paradigm for water management – one that also works for investors. This is a need to which IWA is ideally placed to respond. It covers moves to the circular economy in which water providers become resource miners. It covers the uptake of nature-based solutions. It also covers innovation in models of service delivery, especially the great opportunities for approaches such as social franchising to expand the delivery of decentralised sanitation massively. These ideas are all being discussed and shared in IWA’s network, meaning we can help catalyse a transition of the water sector to the new normal.
A creditworthy sector
This view of what the water sector needs to invest in has to connect with needs at a country and, ultimately, a utility level. Utilities need to know how much they have to invest, and why. This clarity of thinking should be part of the wider competence of running and managing a utility.
This connects with another crucial aspect of financing. Discussions are often framed around the need for more investment in the water sector as though this issue is down to a shortage of money, nothing more. Where investment is backed by borrowing, loans need to be repaid. This puts the creditworthiness of utilities at the heart of the financing conundrum.
“In many developing countries, service providers are not sufficiently creditworthy”
The problem we face in many developing countries is that the service providers are not sufficiently creditworthy. This is because we typically have highly bureaucratic utilities, with poorly performing systems and a lack of staff motivation. This combination makes the deterioration of services over time unavoidable.
It doesn’t have to be like that. We have good examples of public utilities in the developing world, as in Uganda (NWSC), where strong leadership coupled with staff incentives helped improve performance and creditworthiness.
Strong political leadership is essential if creditworthiness is to be enhanced. It is needed to bring about the sector-wide interventions that improve governance and build technical and administrative capacity at scale. By supporting the right policies, institutional arrangements and regulatory frameworks, governments can incentivise service providers to improve operational and commercial efficiency, leading to improved service sustainability and enhanced credibility. This will be essential to help unlock the much-needed finances.
All of this gives IWA, as an organisation and as a network, a key place in the financing jigsaw. We are engaged in the process of building highly competent utilities. We do this through our support of initiatives such as AquaRating. We also do this through IWA’s Utilities Leaders Forum, where we encourage peer support partnerships in which knowledge and tools are shared. This helps strengthen and empower utilities to implement operational and organisational changes that will in turn lead to better and more sustainable services.
Incidentally, the need for competence and creditworthiness has and will motivate the involvement of the private sector in water services. That certainly has its place. At the same time, these are disciplines that are equally valuable for public sector organisations.
Seen in its broadest terms, this contribution around creditworthiness means IWA has a vital task of helping to make the sector an investible one.
In this wider context, it is clear that there is a gap between our water needs and what finance we can realistically expect governments and development finance institutions to make available. There are however opportunities to bridge this gap. With global attention turned to the question of how to meet the 2030 deadline of the SDGs, there is a whole suite of sources and mechanisms being eyed as options to help fund development needs. These run from ‘green’ and ‘blue’ bonds, and use of guarantees, to social impact bonds and debt for nature swaps, through to impact investing, crowdfunding, and enterprise challenge funds.
Such sources all have their appeal, although it is also important to keep in mind the two-way relationship involved with financing, including the need to demonstrate performance or provide returns to investors. Issues might include the risk of introducing perverse incentives, but, at a very basic level, there needs to be a strong evidence base to support the case for investment. For example, the evidence base still needs to be much stronger around the attribution of WASH interventions to key health and social outcomes. We need to argue for further rigorous research on the impact of WASH interventions if the sector is going to attract investors.
In terms of specific financing options, one of the clearest opportunities lies with blended finance. It is an established option where different sources are brought together in strategic combinations in which leverage is key. The finance that governments and development finance institutions, public and private, can muster is of fundamental importance. It can signal the importance or relevance of an investment. It can apply criteria that strengthen the investment opportunity or security. This then allows it to act as a catalyst to leverage other sources of finance into a blended solution, bringing together different sets of knowledge and managing risks in order that investment returns can meet the expectations of markets.
The European Commission, for example, has used blended approaches to a considerable extent in support of water-related infrastructure. According to UNDP, blended finance is maturing into a recognised best practice for mobilising additional public and commercial capital for development projects. “In the current context of transformation put forward by the 2030 Agenda, blended finance (when done well) represents an opportunity to mobilise considerable additional resources, especially for ‘big ticket’ items such as sustainable infrastructure investments,” it has stated. OECD also sees great opportunities for use of blended finance in the water sector (see accompanying article).
There are, nonetheless, still questions around blended finance. For example, the growing enthusiasm for it may result in the diversion of Official Development Assistance from Low Income Countries (LICs) to Middle Income Countries, as there are fewer ‘investible’ projects in LICs. In addition, mobilisation targets may create perverse incentives that shift the emphasis away from prioritising development impact. Also, the application of blended finance gets expressed in terms of what may look like appealing leverage ratios – the amount of investment drawn in compared with the core government or development finance support. However, these ratios do not, in themselves, establish that additional overall private investment has taken place, or reveal the effects of the blended finance. There are questions around the whole methodology of calculating leverage ratios too.
So policy makers might be advised to rein in some of their enthusiastic expectations as to what blended finance may be able to contribute to progress on the SDGs. As stated in a recent ODI report (Blended finance in the poorest countries – the need for a better approach, 2019), “there is a significant disconnect between policy rhetoric (‘billions to trillions’) and the operational reality of blended finance (‘billions to billions’).”
That said, blended finance no doubt has an important contribution to make. What is needed is for outcomes to be tracked using specific metrics and for these results to be reported and communicated to build the blended finance evidence base. Similarly, there is an opportunity for greater standardisation in this area, again to connect approaches and experiences better.
The range of financing options includes less well-developed options, too. Here, one that may well have a strong fit with the water sector is the use of Islamic finance. This features core principles such as inclusiveness, equitable growth, accountable institutions, and sustainability, and is based on a few key contractual structures. Of particular interest are sukuk, financial certificates commonly referred to as ‘sharia-compliant’ bonds.
Malaysia is one of the countries taking a lead in this area. It partnered with the World Bank in 2017 to launch what is said to be the world’s first green sukuk. The United Arab Emirates and Saudi Arabia are other Islamic finance hubs, and water needs are one of the potential beneficiaries of this approach.
Sukuk activity to date has included an issue in 2016 in Senegal to cover developments including drinking water supply, while in 2017 the first-ever Malaysian ringgit sukuk on water infrastructure was issued by a Chinese state-owned enterprise.
UNDP notes that the Islamic Development Bank is the leading player with this type of financing, and has observed that “Islamic bonds or sukuk contracts are increasingly being used by governments and international development agencies to raise large-scale capital for socially responsible projects”.
These various approaches to financing are very much the domain of the financial community, especially the development banks. But IWA has a vital role to play here too, not least because of the need and opportunity for the different mechanisms to be pursued and adapted in multiple countries around the world, and for these experiences to be shared and for this sharing to inform further use.
Our opportunity is to create a critical space to connect key communities, especially the financial organisations and utilities. Given this opportunity, IWA will establish some kind of platform, such as a Community of Practice, as a practical step. This will help create awareness among our members about developments in financing, and how these relate to the water solutions they need. This will also provide a tangible means for IWA to engage with those who develop innovative financial instruments, and provide a mechanism for them to share new and relevant developments.
Outlook and involvement
Across these opportunities, IWA has a role to play, particularly in helping share experiences, both of success and of failure. Local conditions do determine outcomes, but aspects will be transferrable, especially in the globally connected world of finance.
We should however see these financing opportunities as part of a wider outlook that includes the solutions that need to be deployed, the creditworthiness of utilities, and the potential for other models for delivery.
These are all needed whatever the source of financing.
The value and impact of direct government support and any development finance that can be accessed needs to be maximised, so they are vital whether these are the sole source of support or, as is increasingly likely, they are providing a foundation for other sources.
The same applies as far as user fees are concerned. These ultimately underpin investments, and it must be a core mantra for the sector to deliver value for money to the end users.
And they are certainly needed where other sources of finance need to be sought – both to secure that finance in the first place, and to deliver the sustainable service needed to ensure loans can be repaid over time.
Finance will be crucial to our efforts to create a water-secure future. I encourage all in the IWA network to become more financially literate. Equally, there is a wider leadership role in which we can all play a part to deliver on this goal.