270 privatesector P U B L I C P O L I C Y F O R T H E NUMBER NOTE 2004 Output-Based Aid in Water APRIL Franz Drees, Jordan Lessons in Implementation from a Pilot in Paraguay Schwartz, and Alexander Bakalian Paraguay's aguateros--small private water companies--form an important part of the water sector, serving about 9 percent of the total population Franz Drees (fdrees@worldbank.org) (or about 17 percent of those with piped water supply). But until is a sector leader, and recently they operated only in urban areas, where water resources are Jordan Schwartz (jschwartz3@worldbank.org) abundant and they could choose customers based on their ability to pay is a senior infrastructure PRESIDENCY the full costs of providing service. A new World Bank­funded initiative specialist, in the World seeks to attract aguateros and construction firms active in the water VICE Bank's Latin America and the Caribbean Region. sector to unserved rural areas and small towns by providing an output- Alexander Bakalian based aid subsidy, awarded through competitive bidding. The initiative is (abakalian@worldbank.org) is a senior water supply the first attempt anywhere to apply this approach to rural and small- DEVELOPMENT specialist in the World town water sector investment. This Note reviews the early lessons. Bank's Middle East and North Africa Region. SECTOR In the late 1990s water and sanitation officials in SENASA, responsible for providing water and Paraguay, together with the World Bank, began to sanitation service to rural communities with fewer consider the most cost-effective way to expand water than 10,000 inhabitants, has reached about PRIVATE service coverage. The government first looked to its 37 percent of that population segment (or about national water and sewerage utility (Empresa de 18 percent of households nationwide). In the Servicios Sanitarios del Paraguay, or ESSAP), respon- process it has created more than 1,000 water users sible for urban areas, and its rural water agency associations, which assume responsibility for ser- GROUP (DirecciónGeneraldeSaludAmbiental,orSENASA). vice provision in their community. SENASA the- The national utility offers piped water to less oretically contributes only 40 percent of the cost BANK than 30 percent of households nationwide--only of constructing systems in larger communities half those in its service area, defined as cities and andabout82percentinsmallsettlements.Butthe towns with populations of more than 10,000. actual subsidies it provides are far larger, since Constrained by heavy debt service obligations, communities often fail to make agreed cash con- WORLD ESSAP is unlikely to be able to serve as a vehicle for tributions or to service their debt. expandingservicetoParaguay'sunconnectedperi- SENASA, in considering the water users asso- THE urban communities anytime soon. ciations as a vehicle for expanding service, O U T P U T - B A S E D A I D I N W A T E R L E S S O N S I N I M P L E M E N T A T I O N F R O M A P I L O T I N P A R A G U A Y recognized that many found it difficult to charge Quality and scope of service. What service qual- tariffs recovering full costs. As a result, reliance ity and characteristics would be required? on public financing remained high. Public sub- Incentive structure and subsidy design. How sidies for rural water and sanitation systems have could private providers be enticed to serve amounted to an estimated US$300­400 per con- the targeted communities with a mandate for nection. At the current level of public financing, universal or near-universal access? If public Paraguay would need more than 20 years to subsidies were needed, how could they be reach 85 percent coverage in rural areas. structured so as to minimize the cost to the Alongside the two public entities, small pri- government and the community while maxi- 2 vate providers known as aguateros supply water to mizing the likelihood of sustainable service? about 500,000 people in periurban areas, Bidding process and variable. How would the mainly in the greater metropolitan region of bidding be structured, and what variable Asunción. Aguateros have constructed piped would it be based on? water supply systems over the past 20 years with Legal, regulatory, and contractual framework. no public financing. Indeed, many have not reg- Given the water sector's legal structure, who istered as businesses, operating as part of would have regulatory responsibility for tar- Paraguay's active informal sector. Paraguay's iffs and service quality? How would that aguateros have an average age of about 12 years, responsibility be reflected in contracts? while the oldest have been operating for more than 20. Their systems average around 300 con- Quality and scope of service nections, but some have as many as 3,000.1 To meet the minimum requirements of safe, reli- Altogether, aguateros serve around 9 percent of able service, it was decided that the private opera- Paraguay'spopulation--orabout17percentofall Paraguayans with piped water supply. In some Minimum subsidy bidding in output- departments aguateros provide water for more Box based aid schemes 1 people than the two public entities combined. A 2002 survey of 1,000 households served by Over the past decade several Latin American governments have sought to induce private operators to make socially aguateros found that 90 percent were satisfied desirable--though not always financially viable--invest- with the service and 75 percent were unwilling ments in rural areas by offering one-time subsidies cover- to pay more for better service.2 The overall cus- ing part of the capital costs. The private operators recover tomer satisfaction with lower rates and a some- the rest of their costs through user tariffs. To minimize what lower level of service led to a conclusion costs, governments use competitive bidding based on the that, subject to suitable groundwater condi- minimum subsidy offered. Chile pioneered this approach in tions, aguateros represented a viable alternative telecommunications in 1994­95. Several low-income coun- for expanding service into periurban areas. tries (Colombia, Guatemala, Peru) have followed suit, extending the approach to such sectors as transport, rural The output-based aid pilot electricity, and water and sanitation. Given the constraints of the state water utility In parallel, development agencies such as the World and the traditional water users association Bank began to explore ways to move from financing inputs (typically, physical assets) to financing outputs (serv- model, Paraguayan officials concluded that pri- ices provided or results achieved) to ensure the best use vate providers would be the best means of reach- of public funds while achieving development objectives. ing unserved communities and rapidly They devised a subsidy approach--output-based aid-- expanding rural coverage. SENASA agreed to using public funds to reimburse private operators for part implement a pilot output-based aid program to of their investment after they demonstrate that they have attract aguateros and local construction compa- delivered the service contracted for. The reimbursement nies to small towns, large villages, and periurban method may range from cash paid per connection out of communities (box 1). The program was to be an offshore escrow account (as in Guatemala's rural elec- implemented in several phases so that lessons trification program) to vouchers given to consumers for could be incorporated along the way. use as payment to private operators. Still, several questions remained: tors would be contracted to build water networks to the technical requirements and offered the low- that included a borehole, a system for disinfection, est connection fee would be declared the winner. an elevated or pressurized ground storage tank, Onceselected,operatorscouldchargeusersforthe and a distribution system with household connec- connection fee in installments at a defined interest tions. Meters could be installed at the discretion of rate. Operators would recover their costs from the the operator unless a customer requested one. connectionsubsidy(paidbySENASA)andthecon- Standards for water quality, pressure, and hours of nectionchargeandtariff(bothpaidbyusers).Each service would be set out in a contract between the town would have the right to reject the winning bid community and the operator. Perhaps most if it considered the connection fee too high. 3 important, the operator would be required to con- The lowest bid emerging from the first round nectanyhouseholdwithinthedefinedservicearea of competition was extremely competitive, com- that requested a connection and paid the fee. mitting the winning consortium--two construc- tion companies and an aguatero--to build systems Incentive structure and subsidy design in all four towns at US$200­217 per connection Inthefirstphaseofthepilotitwasdeterminedthat (table 1). The commitment from the towns a per-connection subsidy would be needed to ranged from US$50 to US$67 per connection. To attract operators to the four participating com- make it easier for poor residents to pay, the win- munities. To assure SENASA that the subsidy costs ning consortium hired them during construction would be less than the traditional cost to the state (mostly to dig pipe trenches), paying them with of rural water supply systems, the subsidy was fixed cash and with vouchers to reduce their connec- at US$150 for each connection up to the maxi- tion fee. In addition, many residents opted to pay mum number of connections set for each com- the connection fee in installments at a "social" munity'sservicearea.Thissubsidywaslessthanthe interest rate not to exceed 24 percent a year (with current theoretical one of about US$200 per con- payments in guaraníes). nection and far less than the actual subsidies that Thesuccessofthefirstroundofbiddingshowed SENASA paid in some communities. Tariffs for SENASA that there would be enough competition metered and unmetered connections were set in for the right to build the systems. That allowed the agreement with the communities and incorpo- bidding in the second phase to be structured so rated into the bidding documents. that towns would not have to assume the risk, with the bidding variable changed from the connection Bidding process and variable charge paid by users to the connection subsidy. Private operators would be invited to bid on the fee Connection charges as well as tariffs were negoti- they would charge users up front to connect to atedbySENASAandthewaterusersassociationfor their system. The bidder that was both responsive the participating towns and incorporated into the Table The bidding process 1 Phase 1 Phase 2 Fixed components Subsidy to private operator of US$150 Per-connection charge of US$80 for households and per connection US$112 for businesses and institutions Tariffs paid by users Tariffs paid by users Bidding variable Connection charge to users Connection subsidy from the government Winning bid US$200­217 per connection To be determined Party assuming risk of uncompetitive bid Community Government Preliminary design provided in bidding documents? Noa Yesb a. Bidding documents specified simple borehole, disinfection, storage, and single-settlement distribution system. b. Preliminary design specified surface water intake, filtration and disinfection systems, elevated and ground storage tanks, and multisettlement distribution system. O U T P U T - B A S E D A I D I N W A T E R L E S S O N S I N I M P L E M E N T A T I O N F R O M A P I L O T I N P A R A G U A Y bidding process. The maximum connection sub- pletes components of the system. Given the sidy that bidders could request was capped to pre- difficulties small construction companies vent excessive costs to the state. face in mobilizing investment capital, this staggered release of payments should allow Legal and regulatory framework greater competition for contracts. viewpoint Paraguay's water sector law of 2000 assigns the SENASA and the water users association. This con- right to operate water supply systems to the exec- tract sets out SENASA's agreement to provide a utive branch of government, which may delegate subsidy for system construction once the water is an open forum to it to municipalities or departmental governments. users association has signed the concession encourage dissemination of Service provision by the private sector and water contract with the operator. public policy innovations for users associations is regulated through 10-year Operator and the water users association. This simple private sector­led and permits in systems of less than 2,000 connections concession contract defines the service area and market-based solutions for (around 10,000 people) and concessions of up to sets coverage targets. It also provides the opera- development. The views 30 years in larger systems. Permits can be awarded torwithexclusivityinthisarea,defineswaterand published are those of the through simple bidding procedures, while con- service quality standards and penalties for non- authors and should not be cessions require national (or international) com- compliance, provides adjustment formulas for attributed to the World petitive bidding. tariffsandfees,andestablishescompensationfor Bank or any other affiliated Regulations adopted in October 2002 match early termination of the contract. organizations. Nor do any of tariffs to different service levels to allow for differ- To ensure that the water users associations the conclusions represent ences in the characteristics of service providers. At understand their obligations as signatories to official policy of the World the minimum service level the regulations require the two contracts, a local institute has been pro- Bank or of its Executive that water meet chemical and bacteriological viding training in contract administration. Directors or the countries safety standards. Failure to comply with the stan- they represent. dards can trigger the suspension of a permit in Results addition to penalties. The winning bidder in the first phase, awarded its To order additional copies contract in August 2002, has nearly completed contact Suzanne Smith, Contractual arrangements three of the four systems and is already supplying managing editor, Under the terms of the pilot and the water sector water. But it never started the fourth system Room I9-009, law, communities (through the water users asso- because of a legal dispute between the community The World Bank, 1818 H Street, NW, ciations) contract private operators to build and and an aguatero holding an operating permit for Washington, DC 20433. operate water supply systems in their area under part of the service area. This community has been 10-year permits. SENASA manages the construc- replaced with another. The response from the Telephone: tion phase and acts as an arbitrator between the communities that have received service has been 001 202 458 7281 community and the operator during the opera- overwhelmingly positive thanks to the rapid Fax: tion phase. Supporting this structure is a triangle progressfromconceptiontoconstruction,allwith- 001 202 522 3480 of mutual obligations set out in contracts govern- out up-front cash contributions from the commu- Email: ing the relationships between the three parties: nities. In the second phase bids for an integrated ssmith7@worldbank.org SENASA and the operator. This contract, based system supplying three towns were received in late on the standard World Bank bidding docu- February 2004 and are now being evaluated. Produced by Grammarians, ment for small works, governs the construc- Inc. tion phase (defining the technical standards, supervision, subsidy, guarantees, and the Notes Printed on recycled paper like). In the first phase of the pilot all subsidy 1. Consorcio Asociación Euroestudios-Hidrocontrol, payments (apart from an advance) were with- "Revisión de la Estrategia de SENASA, Informe Final" held until the operator had demonstrated (SENASA, Asunción, Paraguay, 2001). that it had successfully provided the connec- 2. The survey was designed with a 95 percent confi- tions, forcing the private sector to mobilize dence interval and 3 percent margin of error. most of the construction financing. In the second phase shares of the total subsidy pay- ment will be released as the operator com- T h i s N o t e i s a v a i l a b l e o n l i n e : h t t p : / / r r u . w o r l d b a n k . o r g / V i e w p o i n t / i n d e x . a s p