The Guinea water lease : five years on, lessons in private sector participation

Viewpoint The World Bank May 1996 Note No.78 The Guinea Water Lease-Five Years On Lessons in private sector participation PenelopeJ. Brook Until the late 1980s, Guinea had one of the In the contract's first five years, connections in- Cowen least developed urban water supply sectors in creased from 12,000 to 30,500. (But as many as West Africa. Less than 40 percent of urban 10,000 are now inactive as a result of nonpay- dwellers had access to piped water through ment.) Metering has increased from about 5 per- either connections or standpipes. Where con- cent to 95 percent of all connections. Investments nections existed, service was often interrupted, in new supply capacity (external to the lease), and water treatment inadequate. To improve combined with rehabilitation and maintenance, this situation, the government of Guinea in 1989 have brought about a substantial increase in the entered into a lease arrangement for private population with access to safe water, from 15 sector operation of water services in the capi- percent in 1980 to 52 percent in 1994. And with tal city, Conakry, and sixteen other towns.' progressive tariff increases, the average tariff (US$0.90 per cubic meter) now more than cov- Two organizations are central to the lease ar- ers costs. SEEG's water revenues rose almost rangement: a state-owned national water au- tenfold between 1989 and 1994, and the oper- thority, Societe Nationale des Eaux de Guinee ating ratio (the ratio of operating costs to oper- (SONEG), and a water management company, ating revenues) improved from 122 percent to Soci&te d'Exploitation des Eaux de Guinee 71 percent. In an environment in which earlier (SEEG). SONEG owns the water supply facili- attempts to secure reliable access to safe water ties in the cities and towns covered by the lease. had foundered, and in which financial sustain- It is responsible for sector development, in- ability had seemed unreachable, these achieve- cluding planning and implementing new in- ments are truly impressive. vestments, and for servicing sector debt. SONEG also has responsibility, for setting tar- Ongoing issues and problems iffs. SEEG is jointly owned by the state (49 per- cent) and a foreign private consortium (51 Despite these gains, two broad concerns arise percent). SEEG holds a ten-year lease contract about the performance of Guinea's lease con- with SONEG under which it is responsible for tract. First, the water supply system, particularly operating and maintaining urban water supply in Conakry, has not improved and expanded as facilities, billing customers, and collecting fast as had been hoped. Unaccounted-for water charges. The private partner provides manage- remains high, at about 47 percent. New con- ment services to SEEG through a separate man- nections to the system have been added slowly agement contract. At the start of the lease, the -though the lease did not specify targets. Sec- consumer tariff was raised from US$0.12 to ond, the relationship between SONEG and SEEG US$0.25 per cubic meter. This tariff was still has not been smooth, lessening the efficacy of too low to cover operating and debt servicing SONEG's monitoring and regulation. costs, so in the initial years of the lease the difference between tariff revenues and costs Physical progress was funded by an International Development Association (IDA) credit. This subsidy has de- Both SEEG and SONEG have some capability clined stepwise as tariffs have increased.2 to influence the rate of new connections and of NW Private Sector Development Department . Vice Presidency for Finance and Private Sector Development  The Guinea Water Lease-Five Years On reduction in unaccounted-for water. But each In Guinea, the government has had limited suc- tends to attribute slow progress to failures by cess in bringing clear commercial incentives to the other. For example, SONEG attributes the bear on the private sector company in its op- slow pace of new connections to SEEG's reluc- eration and maintenance roles. Weakness in tance to make connections from existing exten- SONEG's monitoring of SEEG could have broad sions to the network, while SEEG argues that repercussions. For example, in the absence of much of the demand for new connections is in adequate reporting and monitoring, SONEG will areas where SONEG has yet to invest in net- have difficulty assessing the soundness of SEEG's work extensions. For unaccounted-for water, requests for increases in the overall tariff and in SONEG's slowness in procuring rehabilitation its share. To the extent that SONEG responds works is probably a factor, but SEEG's incen- passively to proposals from SEEG for tariff in- tives to reduce losses have almost certainly been creases, SEEG's commercial risk is lessened. At weakened by its low production costs. Commer- the limit, if the tariff is set on a cost-plus basis, cial losses are rising as tariff increases lead to the lease will approximate a management con- more defaults on bills and stronger incentives tract (and one without specific performance tar- for illegal connections. Nonpayment by govern- gets and enforcement mechanisms) and ment departments was a major problem in 1995. commercial risk will be borne exclusively by the government. (In practice, tariffs have risen Attempts to improve coordination between steadily. The current US$0.90 tariff is high by SEEG and SONEG are unlikely to resolve con- the standards not only of developing countries, cerns about unaccounted-for water and new but also of industrial countries.) connections. The coordination of new invest- ment with operation and maintenance will re- A second cost of weak monitoring and enforce- main problematic as long as commercial risks ment is a reduced capacity to enforce separation are shared between the two entities and SONEG between SEEG's extension and rehabilitation remains the principal financier of works that activities and its operation activities. For ex- contribute to SEEG's effectiveness as an op- ample, where monitoring is weak, financial erator. The problem is further aggravated by a transfers between activities putatively subject lack of clear separation between SEEG's ac- to commercial risk and those performed on a tivities as an operator, for which it theoreti- cost-plus basis might go undetected. Again, the cally bears some commercial risk, and its result could be a reduced capacity by SONEG activities as a service contractor to SONEG for to control its own commercial risk. rehabilitation and extension works, which are performed on a cost-plus basis. Lessons Institutional efficacy The Guinea lease represents an innovative, broadly successful attempt to draw on the Lease contracts require a high level of adminis- strengths of the private sector to improve water trative capacity, and solid political will to en- services. It would be unfair, and inappropriate, force their letter and spirit. They are not to use hindsight to criticize arrangements that necessarily easier to administer and regulate than are a major advance over earlier attempts to im- contracts for more fully fledged private sector prove water service delivery in low-income involvement, such as concessions. A lease may countries and that have produced real gains for be simpler to administer than a concession be- consumers. But hindsight can provide guidance cause the administrator does not need to define for ongoing improvements in Guinea and for or monitor investments by the lessee. But leases future projects in other countries. Many low- require coordination and the allocation of com- income countries, from the transition econo- mercial risk between the government, as inves- mies of Central Europe to African nations such tor, and the private sector, as operator. as Angola and Mozambique, share Guinea's  problems in improving water services. Im- planned. The risk sharing implied by a step- proving and expanding service requires large wise process has proved difficult to implement investments. The government's capacity to un- and enforce, with the result that gains to con- dertake the required investments directly or to sumers have been less than hoped for and oversee their implementation is limited. Pass- much suspicion remains between the public ing as much investment responsibility to the and private sectors. The question then arises private sector as possible-as soon as possible as to what other countries might do to repli- -is thus highly desirable. cate the gains of the Guinean approach while avoiding some of its shortcomings. Two broad Private sector companies, however, have been options present themselves: privatization by less assumed to be unwilling to make large invest- ambitious steps than were attempted in Guinea, ment commitments in the water sector in very or an altogether bolder, larger step toward poor developing economies. Water sector as- privatization. sets amortize over long periods and have lim- ited or no resale value. Where capital markets Privatization in small steps are underdeveloped, an investor who wants to sell out may have limited ability to dispose of The key to an effective gradual move to pri- his shares. On top of this, the water sector is vate participation is, at each stage in the pro- prone to government intervention. In this kind cess, a realistic and enforceable allocation of of environment, the credibility of the govern- functions and risks between the parties. Func- ment as a long-term contractual partner or regu- tions and risks should be allocated in accor- lator, or both, is critical to the willingness of dance with the comparative advantages of the private companies to invest in the sector, and parties in performing the functions and man- to the price tag that the private sector will, one aging the risks. For example, if exposure to way or another, place on its involvement. commercial risk is the primary source of per- formance incentives for a private partner, that Guinea sought to resolve these problems by in- risk should be borne by the private partner. If troducing private sector involvement and com- the private partner is unwilling to take on any mercializing the water business in a gradual, substantial commercial risk, a lease or a con- stepwise manner. Using a lease arrangement, cession should be abandoned in favor of a man- rather than a full-fledged concession or asset agement contract with few, largely indisputable, sale, meant that the private sector was not re- performance targets (as is proposed, for ex- quired to commit any investment funds. Using ample, for Angola). an IDA credit to smooth the process of tariff increases meant that the operating business If government agencies lack the capacity to could function on a quasi-commercial basis from monitor and enforce contracts with the private the beginning. The government's minority share sector, the factors to be monitored should be in the operating company presumably gave as- as simple as possible. This again favors a man- surances that there would be some local share agement contract over a lease. Industrial coun- in the benefits of commercialization, beyond the try blueprints for regulatory structures and benefits from improved services. The expected functions should be avoided in favor of care- benefits were twofold: early and lasting gains ful analysis of the minimum administrative and in the availability of services and the efficiency regulatory functions required, and of the com- of service delivery, and, in the medium term, parative advantage of different agencies in per- the creation of an environment more attractive forming these functions without undue political to private sector investment and risk taking. interference. One option is to contract out parts of the monitoring function to private sector The Guinean approach, while producing im- auditors. (This approach has been proposed, portant gains, has not worked out exactly as for example, in Albania.)  Ea The Guinea Water Lease-Five Years On If investment needs are substantial and require isting assets, to the establishment of a credible some contribution of government (or multilat- regulatory authority, to the development of eral) funds, the contractual arrangement cho- passably liquid domestic debt and equity mar- sen should be cognizant of the tradeoff between kets. The question that then must be asked is the costs of relatively inefficient government ad- whether the benefits of these actions exceed ministration of investments and the risks of con- their combined costs and the costs imposed tracting with the private sector to administer by delays in mobilizing the incentives for the investments it does not fund. If investment re- private sector to improve efficiency. Welfare sponsibility is passed to the private sector, rela- might be increased more by immediate, full tively sophisticated monitoring may be required privatization, even if that requires a subsidy, to control profit transfers between investment than by postponing privatization while using and operation activities and to minimize gold- various government instruments to make things plating. Realistically, the private sector partner better. Full private involvement is likely to bring must be expected to take some rents. Monitor- larger and more immediate welfare gains, for ing will not eliminate these rents, but it can help example, if the private sector partner is in a keep them within socially acceptable bounds. better position than the government to rapidly improve and use information about the utility's Is a big jump better-or even possible? physical and commercial status or to develop risk management programs. Such an approach Two arguments might be made for a stepwise may never be politically attractive, but it is an approach to private sector participation. First, alternative that should be recognized when- a stepwise process may be necessary if no repu- ever gradualism is advocated. table private sector company is willing to in- The Note series is an open forum intended to vest in the water sector in poorer developing In arguments for gradualism in involving the encourage dissemina- countries. Second, a stepwise process may private sector in water, there is an implicit ten- tion of and debate on improve the terms of private sector involve- dency to gamble more on the likely benefits of ideas, innovations, and best practices for ment from the perspective of consumers. government initiatives than on the likely ben- expanding the private efits of private initiatives. Policy advisers have sector. The views The first argument can be put to a market test. traditionally been more concerned about pri- published are those of the authors and should A likely result in many low-income countries vate sector rent seeking at the expense of not be attributed to the is that no experienced private sector water com- customers than about the costs, failures, or rent- World Bank or any of its pany will take on full operational and invest- seeking activities of government utilities. In prac- affiliated organizations. Nor do any of the con- ment responsibilities unless it is paid to do so, tice, the most feasible and least risky strategy is clusions represent because of the high risk. Such a payment may rarely that which relies least on the private sec- official policy of the well be politically infeasible. Still, the need to tor. Market testing of the kinds of deals that the ExecutiveWDirectofs subsidize entry does not in itself mean that a private sector is prepared to take on, and of or the countries they stepwise process would be objectively better their price, is essential in continuing to identify represent. than a "big jump." A negative valuation of a the best options for the neediest countries. Comments are welcome. water company by private bidders might re- Please call the FPD flect a compound of expectations and risk as- Lease arrangements are discussed by Pierre Guislain and Michel Note line to leave a sessments-about the relation between the Kerf in "Concessions-The Way to Privatize Infrastructure Sector message (202-458-1111) tariffs that the government would likely allow Monopolies" (FPD Note 59, October 1995). or contact Suzanne 2~~~~~~~~~~~~~~~~~ Thelma Triche, '-Private Participation in the Delivery of Guinea's Smith, editor, Room and the costs of establishing a reasonable level WaTer SupplyServices," Policyt Research Working Paper 477 (World G8105, The World Bank, of service, about the uncertainty over the gov- Bank, Washington, D.C., 1990). 1818 H Street, NW, Washington, D.C. 20433, ernment's future regulatory behavior, and about or Internet address the salability of the private company's stake. PenelopeJ. Brook Cowen, Private Sector ssmith7@worldbank.org. Thus, to secure a positive price, the government Development Specialist, Transport, Water, &Printed on recycled might need to take actions ranging from inten- and Urban Development Department (email: paper. sive information gathering on the state of ex- pbrook@worldbank.org)