India - Water resources management sector review : urban water supply and sanitation report (Vol. 2 of 2) : Annexes

WORLD BANK Report No. 18321 INDIA - WATER RESOURCES MANAGEMENT SECTOR REVIEW URBAN WATER SUPPLY AND SANITATION REPORT VOLUME II - ANNEXES JUNE 26, 1998 Rural Development Unit South Asia Region World Bank In Cooperation with: Ministry of Urban Affairs and Employment, Government of India; and UK Department For International Development (DFID)  EXCHANGE RATE Exchange Rate: US$1.00 -Rs. 36.17 (October 1997) ABBREVIATIONS AND ACRONYMS BOO Build-Own-Operate BOOT Build-Own-Operate-Transfer BOT Build-Operate-Transfer DFID Department For Int'l Development (UK), named ODA before July 1997 EGCIP Expert Group on Commercialization of Infrastructure Projects EMOS Empresa Metropolitana de Obras Sanitarias, the Santiago, Chile UWSS agency Fl Financial Internediary FIRE Financial Institutions Reform & Expansion GOI Government of India HUDCO Housing and Urban Development Corporation of India ICICI Industrial Credit and Investment Corporation of India IDBI Industrial Development Bank of India IDFC International Development Finance Corporation IFCI Industrial Finance Corporation of India kl Kiloliter MCH Municipal Corporation Hyderabad MOUAE Ministry of Urban Affairs & Employment MWSSB Maharashtra Water Supply & Sewerage Board NEERI National Environmental Engineering Research Institute NFI National-level Financial Institution NGO Non-Governmental Organization NIPFP National Institute of Public Finance Policy NIUA National Institute of Urban Affairs NTADC New Tiruppur Area Development Corporation O&M Operation and Maintenance ODA Overseas Development Agency of the UK (now named DFID) PHED Public Health Engineering Department PPAR Project Performance and Audit Report PSP Private Sector Participation PWSSB Punjab Water Supply & Sewerage Board RCUES Regional Center for Urban and Environmental Studies RWSSC Regional Water Supply & Sewerage Company SEBI Securities and Exchange Board of India SFC State Financial Commission SFI State-level Financial Institution SPARC Society for Promotion of Area Resources Centers SRA State-level Regulatory Agency STF State-leveL Task Force TA Technical Assistance UBSP Urban Basic Services for the Poor UFW Unaccounted For Water USAID United States Agency for International Development UPSS Urban Poor Service Syndicate (Hyderabad) UWSS Urban Water Supply and Sanitation WRM Water Resources Management (acronym for the India Water Sector Review Program of the World Bank and GOI, of which this report is a component) WSSB Water Supply and Sewerage Board  TABLE OF CONTENTS VOLUME II ANNEX 1. International Experience in Decentralization and Private Sector Participation ..........................................................1 1 Overview of International Experience ......................................................... 1 1I.1 Introduction ..........................................................1 1.2 Decentralization ..........................................................1 1.3 Private Sector Participation ..........................................................2 2 South Africa ......................................................... 19 2.1 The Old System in South Africa ......................................................... 19 2.2 The Water and Sanitation Law Review ......................................................... 19 2.3 Boosting Municipal Capacity ......................................................... 20 3 Brazil ......................................................... 22 3.1 The Old System in Brazil ......................................................... 22 3.2 Brazil's Reforms ......................................................... 22 4 Puerto Rico ......................................................... 23 4.1 Introduction ......................................................... 23 4.2 Rationale for PSP ......................................................... 23 4.3 Industry and Market Structure and Details of the Contract ............................. 24 4.4 Process of Contract Award ......................................................... 25 4.5 Conclusions ......................................................... 26 5 Trinidad and Tobago ......................................................... 27 5.1 Introduction ......................................................... 27 5.2 Rationale for PSP ......................................................... 27 5.3 Industry and Market Structure and Details of the Contract ............................. 27 5.4 Process of Contract Award ......................................................... 28 5.5 Evaluation of PSP ......................................................... 29 5.6 Conclusions ......................................................... 29 6 Guinea ......................................................... 30 6.1 Introduction ......................................................... 30 6.2 Rationale for PSP ......................................................... 30 6.3 Industry and Market Structure ......................................................... 32 6.4 Details of the Contract ......................................................... 33 6.5 Process of Contract Award ......................................................... 35 6.6 Evaluation of PSP ......................................................... 35 6.7 Conclusions ......................................................... 38 7 Ostrava (Czech Republic) .................................................. 40 7.1 Introduction ......................................................... 40 7.2 Rationale for PSP ......................................................... 40 7.3 Industry and Market Structure ......................................................... 43 7.4 Details of the Contract ......................................................... 46 7.5 Process for Contract Award ......................................................... 48 7.6 Evaluation of PSP ......................................................... 50  7.7 Conclusions ............................. 51 8 Buenos Aires (Argentina) ............................. 53 8.1 Introduction ............................. 53 8.2 Rationale for PSP ............................. 53 8.3 Process of Contract Award ............................. 54 8.4 Industry and Market Structure ............................. 55 8.5 Details of the Contract ............................. 56 8.6 Evaluation of PSP ............................. 57 8.7 Conclusions ............................. 58 9 Manila (Philippines) .............................. 59 9.1 Introduction ............................. 59 9.2 Rationale for PSP ............................. 59 9.3 Industry and Market Structure ............................. 60 9.4 Details of the Contract ............................. 60 9.5 Price Regulation and Renegotiation ............................. 61 9.6 Process of Contract Award ............................. 62 9.7 Lessons for India ............................. 62 ANNEX 2. Indian Experience in Community Participation .63 ANNEX 3. Municipal Bonds Experience from the USA .71 ANNEX 4. UWSS Workshop 11 & 12 April 1997, New Delhi, India .77 ANNEX 5. Report from the World Bank/GOI National UWSS Workshop June 9 & 10, 1997, New Delhi, India .91 ANNEX 6. Supplementary Indian UWSS Statistics .95 ANNEX 7. Selected List of Persons Met .101 LIST OF TABLES Table Al- 1.1. Longer and Shorter Arrangements - Advantages and Disadvantages. 5 Table Al-1.2. Options for Private Sector Participation. 6 Table AI-1.3. Impact of PSP on Performance .13 Table Al -1.4. Overcoming Constraints to PSP in India .14 Table Al-4.1. Overview Information on Puerto Rico .23 Table A1-4.2. Summary of the Contract .24 Table Al-4.3. Links Between PSG and PRASA .26 Table A1-6.1. Summary Statistics for Guinea, 1993 .30 Table A1-6.2. Summary of Guinea Water Contract .31 Table A1-6.3. Allocation of Responsibilities in Guinea .34 Table Al-6.4. Performance Indicators Before and After PSP in Guinea .36 Table A1 -7.1. Summary Statistics for the the Czech Republic .40 Table A1 -7.2. Summary of Ostrava Water Contract .43 Table Al-7.3. Allocation of Responsibilities in Ostrava .47 Table Al -8.1. Overview Statistics of Argentina & Buenos Aires Metropolitan Area.... 53  Table A1-8.2. Process for Awarding Contract ......................................................... 54 Table Al1-8.3. Relative Price Bids by Final Bidders in Buenos Aires ............................ 54 Table A1-8.4. Summary of the Contract .......................................................... 55 Table Al -9.1. Overview Information on the Philippines ................................................ 59 Table A2-1. Isssuers, Purpose and Investors in the US Municipal Bond Market . 74 Table A4-1. Problem Analysis .80 Table A6-1. Plan Outlays on UWSS .95 Table A6-2. Plan Otlays and Expenditure for UWSS - Eighth Plan .96 Table A6-3. Total Infrastructure Investment Projections .96 Table A6-4. Performance of Water Sector in Selected Indian Cities .97 Table A6-5. Water Bills and Coping Costs of Intermittent Water Supply - Dehra Dun .98 Table A6-6. Tariff Increases Through HUDCO Influence .98 Table A6-7. Prevailing Rates for Consumption-based Charges - Domestic Uses. 99 LIST OF FIGURES Figure Al -4.1. The Structure of the Water Sector in Puerto Rico .................................. 24 Figure Al -6.1. Structure of the Water Sector in Guinea ................................................. 33 Figure Al -7.1. Structure of the Water Sector in North Moravia (illustrative only) ....... 42 Figure A1-7.2. Institutional Structure of the Water Sector in North Moravia ................ 42 Figure Al-7.3. Structure of the Water Sector in Ostrava ................................................ 44 Figure Al -8.1. Industry Structure in Argentina ......................................................... 56 Figure Al -9.1. Industry Structure After Letting the Concessions ................................... 60 LIST OF BOXES Box Al-1.1. Letting a Two-Stage Contract ......................................................... 9 Box AI -1.2. Structure of the Water Sector in Ostrava ................................................... 10 Box Al-1.3. Concession Arrangements in Buenos Aires ...............................................1 1 Box Al-1.4. The Manila Concession .........................................................1 I Box A3-1. Size and Structure of the US Municipal Bond System .............................. 71 Box A3-2. General Obligation versus Revenue Bonds in the USA ............................. 73 Box A3-3. Credit Enhancement Structures for Revenue Bonds .................................. 73 Box A3-4. State-level Arrangements for Bond Issuance in the USA .76  Annex I International Experience in Decentralization and Private Sector Participation ANNEX 1 International Experience in Decentralization and Private Sector Participation 1. Overview of International Experience 1.1 Introduction The recommendations in this report are focused on developing an enabling strategy for the urban water sector in India, that will provide the incentives to improve operational efficiency and effectiveness. The key element in this strategy is the democratic decentralization of the responsibility for water and sanitation services through municipalization. We have developed a framework for the implementation of this enabling strategy. As part of this, we have emphasized the need to promote PSP in the sector to assist in enhancing efficiency, and to provide access to additional sources of capital. Both these elements are part of the consensus for reform that is emerging within India. However, concerns remain over the practicalities of implementing these measures in a developing country as diverse as India. This annex draws on international experience of decentralization and private sector participation in the water sector to provide examples of how these constraints can be overcome, and of the benefits that decentralization and increased PSP can offer to India. The following sections summarize international experience and highlight some of the main lessons that arise. The annex concludes with a number of case-studies covering decentralization and PSP in South Africa, Brazil, Puerto Rico, Trinidad and Tobago, Guinea, the Czech Republic, Buenos Aires and Manila. 1.2 Decentralization Internationally, municipal responsibility for water and sanitation services is .a common arrangement. It is the dominant mode of service provision in Australia, France, Germany, New Zealand and the USA, to name a few examples. Most developing countries reforming their water service industries have chosen to do so through the devolution of the responsibility for services to the municipal level. The majority of the former command economies within Central and Eastern Europe have chosen to follow this route, as have Brazil and South Africa. In decentralizing the responsibility for water services, each country had to develop answers to the problems of: overcoming the constraints imposed by limited capacity at the municipal level; and defining the role of existing regional and bulk service providers in the new structure, and reforming them appropriately. India will face these same problems in the process of decentralization. In those countries reforming their water sector, there has been a general move to separate the functions of bulk water provision from that of distribution. The water sector in South Africa is dominated by regional water boards, who are responsible for both bulk water provision and the distribution of water. Under legislation currently being prepared, these functions will be separated, and municipalities will be obliged to sign a contract with a service provider for water and sanitation services within their area.  Anne-x I International Experience in Decentralization and Private Sector Participation Alternatively, municipalities may also provide these services o01 their own behalf. Municipalities will be given incentives to cooperate in providing these services. The existing regional water boards will be corporatized and can continue to provide distribution services, but must do so under contract with the relevant municipality. They may also provide other services as agreed with the Minister of Water Affairs. These are expected to include the continuing provision of capacity-building assistance to municipalities where this is requested. In line with the new commercial orientation of the boards, this will be done under contract with the municipalities, where such assistance is not of commercial interest to the board. Within Brazil, state water boards have historically received the majority of resources devoted to the sector. Consequently, they have been able to expand from their initial functions as bulk water providers into distribution services, edging out less well resourced providers. States are now devolving the responsibility for water services to municipalities, who contract with a service provider for distribution services within their areas. As a result, state water boards are being forced to redefine their roles as municipalities increasingly opt for alternative service providers, including private sector providers. Similarly, in the Czech Republic, the existing 10 regional water bodies were broken up and the responsibility for service delivery devolved to municipalities. There are now 74 companies serving individual and groups of municipalities. The extent and nature of the break-up varied from area to area. For example, in North Moravia the existing regional provider continues to provide distribution water services to smaller municipalities, as well as retaining the responsibility for bulk water provision. The largest municipality, Ostrava City, has taken over the provision of distribution services within its area. Ownership of the regional provider has been vested in the municipalities it serves, with each receiving shares in proportion to the use it makes of the services provided. This approach has succeeded in devolving the responsibility for service provision, whilst overcoming problems of low capacity at the municipal level through the retention of the existing service provider. The case studies provide further details of these examples. 1.3 Private Sector Participation In looking at the international experience of PSP, it is important to remember that this takes various forms. The first part of this section therefore outlines the main options for PSP in the water sector. The second part covers the lessons of experience of PSP, internationally, in overcoming similar problems to those faced by the Indian water sector. 1.3.1 Options for Private Sector Participation We divide PSP into those options which leave management of the system in public hands, but make the private sector responsible for discrete functions or assets, and which give the private sector responsibility for managing the entire system. Private sector participation in discrete functions The public operator can contract out discrete functions, such as meter installation, meter reading, billing and collection, and accounting, to private sector companies operating under service contracts. These are 2  Annex 1 International Experience in Decentralization and Private Sector Participation relatively common internationally. Examples include Mexico City, and Santiago, Chile. Such contracts generally result in the service being provided at lower cost and higher quality than before contracting out. However they can create a co-ordination and quality control challenge for the public entity. A similar concept is to contract out operation of existing treatment works. Again this is quite common internationally. One example is Puerto Rico, where contracts to operate treatment works preceded the current management contract. In India, Chennai has contracted out the operation and maintenance of a number of sewage pumping stations and boreholes and the de-silting of sewers, with great success. A number of other municipalities have contracted out various maintenance functions. A more ambitious approach is to contract out finance, construction and operation of new treatment works or similar discrete pieces of infrastructure. Such contracts are called BOO contracts (Build Own and Operate). The private operator recovers its costs through a contract with the public entity for the services it supplies. BOOT contracts, in which the private operator transfers ownership of the infrastructure to the public operator after it has recovered its capital costs (typically between 10 and 30 years), are also possible. Contracts of this general type have been used in many countries, including Thailand and Australia. South Africa is in the process of letting its first BOOT contract in the water sector. BOO/T contracts are extremely common in the power sector, where they are frequently used to provide new generating capacity in the form of Independent Power Producers (IPPs). Within India, a number of IPPs are under negotiation, and construction has begun on others - notably Enron's Dahbol plant in Maharashtra! A related concept, likely to be important in India, is the Rehabilitate, Operate and Maintain (ROM) contract. This is like a BOO, except instead of building a new plant the private operator takes over responsibility for an existing plant, provides the investment needed to rehabilitate it, and sells its services on contract to the public entity. Private sector participation in management of the system Metering, billing, collections, and maintenance and operation of the distribution system are often among the most important problems in current operations. These aspects are all inter-related. This means the greatest potential for overall efficiency gains will often come from options which involve the private sector in the management of the entire system. Options used internationally include: * management contracts - typically these run for 3 to 5 years. The private operator takes over responsibility for managing the existing system and staff. The public entity is usually responsible for rehabilitation and new investment. The management company receives a fee, which may be partly related to performance. Puerto Rico and Trinidad and Tobago are good examples of management contracts; * lease contracts - typically these run for around 10-20 years. The operator is not paid a management fee. Instead, it is responsible for both collecting revenues and meeting all The original contract was signed in 1994. Subsequently, a new state government reopened the contract negotiations and significant changes were made, including a reduction in tariffs charged and an equity stake in the project being reserved for the State Electricity Board. 3  Annex I International Experience in Decentralization and Private Sector Participation operating and maintenance costs, retaining any surplus for itself. The operator may pay Government a lease fee for use of the assets. Responsibility for financing new investment remains with the Government. Guinea in West Africa, and Ostrava in the Czech Republic, are both examples of lease contracts; * concession contract - this is like a lease, except that it typically runs for around 20-30 years, and the operator is responsible for new investment during the life of the contract. Since the operator must fund new investment, the lease fee paid to the Government may be reduced or eliminated. Buenos Aires is one of the best-known examples of a concession. Manila, in the Philippines, has just let two concession contracts, each covering half of the city; * asset sale (regulated) - the Government sells the infrastructure and the operating company to the private sector. Tariffs and service standards may regulated, in which case privatization can be thought of as similar to a concession which runs in perpetuity. England and Wales is the only example of this approach we are aware of; and * asset sale (unregulated) - it is also possible to sell the assets and not regulate the resulting private water operator. In theory, this option could be expected to provide the most efficient outcome.2 We are not aware of any examples, probably because the high water charges which would result would be politically unpopular. However, if water consumers were given the shares in the company, what they paid in higher bills they would get back in dividends. Areas with no or minimal service currently could also benefit from this approach, since unregulated private supply would certainly be better than no service at all. In summary, there is a continuum of options from management contracts with a duration of 3 years and upwards, through to privatization through asset sales, which lasts for ever. Typically, the longer the contract the more responsibility for investment the private sector takes, and the more risk. On the other hand, shorter contracts mean more frequent competition for the market, and more flexibility. Table Al_1.1 summarizes the advantages and disadvantages of longer and shorter arrangements. Table Al-1.2 provides a summary of the allocation of responsibilities under various options for PSP. 2 P Brook Cowen (World Bank) & T Cowen (George Mason University), The Feasibility of Unregulated Privatization for Natural Monopolies: A Proposalfor Water Policy, (draft) unpublished. 4  Annex 1 International Experience in Decentralization and Private Sector Participation .Tab.l.e. . A i..L.n.r.and Soter.Arr....... - A vantages.and. D dntage X . Longer Shorter Investment Private sector is responsible for Govemnment funds or controls investmnent investrnent Competition for Non-existent or infrequent Frequent the market ..................................................................................................................... ..........................;; Long term focus Increased. Managers who are Reduced. Managers who are in place for responsible for the business for a long only a short time will concentrate on short- time will aim to maximize the long term term gains efficiency of the business ............................................... .............................................. ........................................... ................................................................................................................ Efficient Increased. Managers who are If the Government is responsible for balancing of responsible for investments as well as investment, managers may push for investment and operations will make good trade-offs inefficient investments to reduce operating operating needs between investment and operating costs costs. Risk Private sector bears more risk Government bears more risk Flexibility Reduced Increased 5  Annex I International Experience in Decentralisation and Private Sector Participation ,~~~~~~~~~ .... .. ... ..... ...... . . . ,,,, ....., , . ,, ,..,. ....... .... .. ....... ......... . . . .___............_- . . .. . . . ... . :- ... ...... . .. .. .. . - - - , , ,, . . - . . .. ...... , . - . .. . ..~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~. . .. . . . -......Table A1-1.2. tions for Private Sector Participation .. ,, , ,, , ,,, .,,,, ,,,, ,, . .: ....~.. ....... . _, ,....... . . .. .....,...... ... . . .. ... .. . .... Option Example Operation Management Maintenance Investment Ownership of Duration of system assets (Years) a b c Planning Financing .......................... ........ .... ............... . ----- - j- - - - Y>i------- Service contract Chennai Public sector 1-5 BOOT Thailand Company- 10+ (new assets) ~~~~~~~~~~~~~~~~~~~~~~~~Public sector Management Puerto Rico, Public sector 3-5 contract . Trinidad & Tobago ~~~~~~~Tbg gg g..... - -. ......... ..................... ...................... . . . . ............................ --------------------- . ................. Lease Guinea, Public sector 10 20 Ostrava (Czech) ........................................ ........................ ........................ ............................ Concession Buenos Aires, Public 20 30 Manila sector 2 ....................................... ...................................... . ...................................rt.r ;r ;;.; :.............................. Asset sale England & Company Perpetuity Wales Notes: Three different functions exist: planning (a), carrying out the work (b), and financing the maintenance (c). 2 The assets are transferred to the concessionaire for a fixed period of time but are owned by the State. Key: Solid shading: responsibility lies with the private operator Clear: responsibility lies with the public sector Diagonal shading: responsibility varies according to the contract 6  Annex I International Experience in Decentralization and Private Sector Participation 1.3.2 Lessons from experience This section looks at the success of PSP in the water sector, both in India and internationally, in overcoming the problems faced by the Indian water sector. These include: commercial and operational inefficiency reflected in indicators such as high staff-connection ratios and high levels of unaccounted- for-water (UFW); financially non-viable utilities, with tariffs below cost-recovery levels, and limited access to investment finance; and poor service coverage and quality of service. The text also provide illustrations of means of overcoming constraints to PSP in the sector. These include: a lack of basic information, which is likely to deter the private sector from involvement; tariffs below cost recovery levels and/or political influence in tariff setting which makes it unlikely that the utility will be financially viable and increases private sector risk; political concerns over private and/or foreign control of the water industry; and a lack of capacity in smaller municipalities to manage the process of PSP. Within Europe, there is a long history of PSP in the water sector in France. In England and Wales, a number of smaller private water companies have operated for over 100 years. In 1989, the larger state- owned utilities were privatized through an asset sale. In Central and Eastern Europe, both the Czech Republic and Hungary have introduced PSP at the level of municipalities. There are also a number of BOOT-type projects underway across the region. French-influenced West Africa also has a number of examples of PSP through lease and concession arrangements in Cote d'Ivoire (the only example of a concession in a developing country that has been re-let), Guinea and recently in Gabon. In South Africa, as part of the reform of the sector, private service providers will be encouraged, and the first contracts are currently being let. The USA has a large number of private water service providers. Latin America has moved to embrace the private sector, with the Buenos Aires concession being one amongst a number of similar contracts awarded in the region. A number of Caribbean islands have also introduced PSP, and both Trinidad and Tobago and Puerto Rico have let management contracts. In Australia, a number of cities have reformed their water utilities, and introduced new capacity through the use of BOOT projects. For example, in Sydney, all new treatment capacity will be constructed through BOOT contracts. A number of these examples of PSP are discussed in the text. More detailed case studies are included in at the end of this Annex. Table A1-1.3 provides a summary of the outcomes in some of the case studies. Table Al-1.4 summarizes means of overcoming constraints to PSP, with examples of their use internationally. Service Contracts Service contracts are relatively widespread, in India and internationally. In India there are a number of examples of service contracts being let for various municipal services such as toilet construction in Delhi and Faridabad. Chennai and a number of other municipalities have also let service contracts for the operation and maintenance of sewage pumping stations and sewers, and New Mumbai has contracted out maintenance of its water supply system. The experience to date has been that these offer significant gains in efficiency. Santiago, Chile, since 1979 has placed extensive reliance on the use of service contracts with the private sector to achieve efficiencies. Partly as a consequence, EMOS, the public water and sewerage utility in Santiago, is today the best-performing water utility in Chile. As an example, the ratio of staff per 1,000 7  Annex I International Experience in Decentralization and Private Sector Participation water connections is only 1.9,3 and UFW has fallen from 28% in 1990 to 22%. The impact on the labor force was limited by encouraging existing employees to form companies to bid for contracts. Management Contracts In Puerto Rico, Government dissatisfaction with the performance of the state utility, PRASA, led to the award of a management contract to Professional Services Group (PSG) in 1995. This contract was sole- sourced to PSG, and was the latest stage in a relationship between PRASA and PSG which has developed since PSG offered to mediate in labor negotiations. PSG subsequently won service contracts for the operation and maintenance of new and existing treatment plants. Throughout the relationship, the emphasis on both sides has been on the development of credibility as a partner in the sector. This appears to have paid off in allowing PRASA to rely on PSG's reputation as a guarantee that it will not exploit its position as sole bidder for the management contract, and similarly for PSG to feel secure with PRASA as regulator. This contract is also notable for the incentives it contains for improved performance by PSG. In Trinidad and Tobago, a management contract came into operation in April 1996. This is part of a two- phase approach to PSP, after 3-5 years the management contract will be converted into a long-term concession. After years of poor service, in 1994 the Government decided to involve the private sector as quickly as possible in the water sector. The preferred option was a long-term concession. However, to let such a contract would require amending the legislation governing the utility and the establishment of new institutional arrangements to regulate the sector. These would take more time than the Government wanted to wait. In addition, basic information on the condition of the water system and consumption patterns was lacking. Without this, the Government was unable to establish an effective tariff-setting regime, and given the resulting risks, the private sector would be unlikely to bid. The Government therefore decided to let a 3 to 5-year management contract initially, as part of which the operator would be required to provide the information the Government required. Various performance targets were specified as part of the contract, and once these were met either the Government or operator could request a switch to the concession. The operator would be given first rights to negotiate on the concession. Box Al_1.1 discusses the implications of such an arrangement: 3 However, personnel costs are still 57% of total operating costs, compared to a ratio of 40% in most developed country utilities. 8  Annex I International Experience in Decentralization and Private Sector Participation Box AlLI. Letting ae Cotratis :;ltwed If the c ssi is wadedn the basisan wmpetitivebidding process, then Xt existing private operto lne he maaeet cotrc hasFa sgnfiat informational advntag. Thiswill detr One possi su t bltod ie w f emanagement contt from bidding for the to bid for he managmn otat Aniothr alrtive ol io pre nl tsbid forthe concession to tie winner of the mana ni con i is opted i i However, some commentators have arguedthat,as arltG n t fed tdevote almost as many resources to letting lie management contac as It wod havit had let a logterm concession immediately. Lease Contracts Lease or affermage contracts are well established in France and are increasingly so in French-influenced West Africa. For example, Guinea has had a lease contract in place since 1989. This contract is notable for the mechanism adopted to guarantee the financial viability of the utility whilst tariffs are gradually increased to cost reflective levels. The primary aims of this contract were to improve efficiency in the urban water sector, expand service coverage and make the sector financially viable. Following a competitive bidding process, in which bidders were evaluated on the reduction they offered against a benchmark tariff calculated by consultants, a consortium of two French water companies took a 51% share in the operating company (SEEG) holding the lease contract. The winning bid offered a discount of 30% on the benchmark tariff. The Government retained the remainder of the shares, and also 100% ownership of a separate holding company (SONEG) which owns the sector's assets, receives the lease payment from SEEG and finances investment. Initially, tariffs were well below cost recovery levels. To allow time for service improvements to reduce opposition to tariff increases, and for households to adjust, tariffs were increased gradually to cost recovery levels. In the interim, the World Bank Group provided a declining subsidy to cover the difference between costs and revenues. This provided the necessary guarantee for the private sector that revenues would be sufficient to cover costs. The utility is now financially viable, with a ratio of operating costs to operating revenues of 71%, compared with 122% in 1988. However, tariffs have now increased to around Rs. 32/m3 (US$ 0.90/m3), a level which is higher than that of many developing countries. As a result, approximately one-third of connections are inactive. A lease arrangement has also been adopted for Ostrava municipality in the Czech Republic. As part of this, an innovative ownership structure has been adopted which enables the private sector to have a degree of control over the utility and therefore control its risks, whilst also retaining ownership of the 9  Annex I International Experience in Decentralization and Private Sector Participation infrastructure and an element of control over operations in public hands. Box Al-1.2 provides a summary of the ownership structure adopted in Ostrava. Box A1-1.2. Structure of the Water Sector in Ostrava In Ostrava, the municipality wanted to introduce a foreign operator into the water sector, to provide the necessary expertise that it lacked. However, it was also concerned to retain ownership of the sector in public hands, and to ensure that the domestic private sector was able to participate in some form. Under the structure adopted for the sector, ownership of the infrastructure was retained by the municipality. A separate operating company, OVAK, was created which signed a 30-year lease agreement with the municipality to operate the infrastructure. The municipality retains a 20% stake in the operating company. A further 31% is owned by the municipality's chosen partner, Lyonnaise des Eaux (LDE) of France. A shareholders agreement, valid for 10 years, between the municipality and LDE provides for them to seek each others agreement on all major decisions affecting the sector. LDE also provides support to the operating company, under a technical assistance agreement. The remaining 49% of the operating company is held by private individuals, including employees, and investment funds. To date, this structure has proved successful in satisfying the municipality's objectives for PSP, and all parties feel that the relationship is working well. The diagram below illustrates the structure in Ostrava. [ Sliareliolders Ostrava City reelnent Lyonnaise des (Municipality) Eaux _ r- Lease TA _ _ i - Contract Agreement ,. / OVAK (Operating Compay Owns Operates Assets Customers Concessions Concession type arrangements are also well established in France. Outside France and West Africa, concessions have also been let in a number of countries in Latin America, and one was recently awarded in Manila. Box Al-1.3 discusses the concession arrangements in Buenos Aires, perhaps the best known recent concession arrangement. Box A 1-1.4, which immediately follows, considers the Manila concession. 10  Annex I International Experience in Decentralization and Private Sector Participation Box A1-1.3. Concession arrangements in Buenos Aires In 1991, the Government took the decision to privatize the Greater Buenos Aires system in order to improve efficiency and attract private sector financing frthe large investments that the sector required. The need for the private operator to undertake investments dictated the choice of a concession as the means to introduce PSP. To reduce the risk to bidders, detailed information on the current status of the system was collected by a team of consultants and made available as part of the bidding documents. Evaluation of bids was made on the basis of the lowest water rate offered, whilst meeting stipulated service levels and performance targets. The winning bid, by an international consortium Aguas Argentinas (AA) was almost 27%/o below the current tariff level at the time of bidding. The concession contract contained a number of performance targets, covering the extension of water and sewerage coverage, increases in sewage treatment and reductions in UFW. The performance of the concession to date has been impressive. An additional 500,000 water connections and 400,000 sewerage connections have been added, metering has increased from 30,000 to 170,000 connections and UFW has fallen from 43% to 25%. Staff numbers have been substantially reduced through early and voluntary retirement schemes. The ratio of staff to water connections fell from 6.4 to 3.3 per 1,000 connections. The utility has also moved to a profit, after previously making substantial losses. There have been disputes between AA and the regulator for the sector, ETOSS, centering around the issue of investment. Following a requirement by ETOSS that AA speed up its agreed investment program, AA demanded a revision of tariffs under a contract provision that an increase in costs of more than 7% would lead to a rise in tariffs. Subsequently, tariffs were increased by 13.5%. Whilst they remain about 17% below levels at the time of privatization, this increase was extremely unpopular, particularly as the cause was not well understood. Additionally, AA has accused ETOSS of being too rigid in requiring it to stick to the investments defined in the concession contract, rather than allowing it to look for alternative approaches. Box A1-1.4. The Manila concession The Manila concession was awarded in January 1997. An interesting feature is that, to increase the scope for comparative competition, the decision was taken to let two separate concessions, one for the East Zone of the city and one for the West Zone. To ensure that competition took place, bidders could only be awarded one concession, although they could bid for both. Bids were awarded on the basis of the tariff offered. Current tariffs in Manila average around Rs 12/m3 (US$ 0.33/m3). The winning bid for the East Zone was far lower, at Rs 3/m3 (US$ 0.09/in3). In the West Zone, the winning bid was again far lower than the existing tariff. However, the winning bid was submitted by the same consortium awarded the East Zone contract, and the contract was therefore awarded to the second-lowest bidder. The tariff level submitted, of Rs 7/mi3 (US$ 0.19/m3), is, however, more than twice that for the East Zone and this has resulted in a political outcry, and the threat of legal action against the process. Summary At present, there are few examples of long-term experience of PSP in the water sector in developing countries. Table A 1-1.3, summarizes the experience to date in Guinea and Buenos Aires, where PSP has been in place since 1989 and 1993 respectively. It is clear from these that PSP can deliver substantial  Annex I International Experience in Decentralization and Private Sector Participation gains in efficiency, reflected in improvements in physical performance, improved financial viability and reduced tariffs. The extent of efficiency gains possible enable the private sector to make the high retums it requires in compensation for the risks it assumes, while still delivering improvements for customers and the public sector. Table Al -1.4, provides examples drawn from international experience, of how the constraints, identified in the main text of the report, on the promotion of PSP can be overcome. 12  Annex 1 International Experience in Decentralization and Private Sector Participation . . . ~ ~~~ . ...... . . .. ....... ... . . .. Example . Contract . ServiceCoverage Metering . Staff ..Unaccounted-For- Financial Viability Type . Water ...... ~~~~~~~~~~~~~~. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .................... . Buenos Aires IConcession . Water coverage Rose from . Staff per 1 ,000 .Reduced from 43% /. Utility is now profitable. increased from . 30,000 .water connections to 25% . Tariffs initially reduced by 70% to 80% connections to . reduced from 6.4 . . 27% from level at time of bid. Sewerage 17,0 to3. Subsequently increased, but coverage increased .. still 17% lower from 58% to 66%o Guinea ..Lease Number of Rose from 5% to ..n/a After peaking at .Ratio of operating costs to j . connections rose . 95% of all ... 62% reduced to . operating revenues reduced ..from 16,500 to ..connections ..47% r .om 122% to 71% * ..33,500 ................................... ....... . ............ ----------.. .. ........................... .................................... ........................................ ............................................................. Sources: D. Riviera, 1996, Private Sector Participation in the Water Supply and Wastewater Sector: Lessons from Six Developing Countries, World Bank. P. Brook Cowen, 1996, The Guinea Water Lease - Five Years On, Public Policy for the Private Sector No 91, World Bank. London Economics' own research. 13  Annex I International Experience in Decentralization and Private Sector Participation Table A1 vercomi Co i t PSia i.c.. .. .. ... .. ... o .... r:I n ..... .. . - ~~~~~~~~~~. - -. ....-:.:-. -.-. . - I :: .... . - .:- . .... ... ........-...- ..-..... .. .... .. .... . : .... -.--... ... Constraint Option Advantages Disadvantages Lack of basic Employ consultants to gather as Opens the way to long term Gathering the information is expensive and tise- information much inforpnation as possible, arrangements and risk sharing consuming. (makes it impossible to then call for bids (e.g. Buenos from the start, which can Consultants generally will not guarantee the specify arrangements ieforration provided, reducing bidders' comfort in which are long term or relying on it. transfer ~slares Botwan has doetitnbemreetniepiaeeh raiain transfer risk to the ~~~~~~~~~~~~Experience in Buenos Aires and UK shows that pnvate ~ ~ ~ ~ ~ ~ ~ ~~~~~~sco invlveenolaer successfully.r) infonexation provided may be inadequate or inaccurate. Contract for specified skills. For A relatively quick and easy way Weak incentives on managers. exarple, senior management to boost performance. tative dialoge withath management, team, ant pofilow w iould go o Resulting gains in efficiency hired, not a team. btetat'onally, and paod depends ~ ~ ~ ~ an onrato satisfactould interationally competitive en'.informatensys te Does not directly address institutional weaknesses in salaries. Botswana has done this senabltore i vexense leriv the organization. successfully. scoinovmtlae.If expatriates are employed, care will be needed to select people who can operate effectively in Indian conditions and culture Management contract with low- Brings in a new management Requires capacity in the public sector to sustain a co- powered incentives. An example team with incentives to do a operative dialogue with the management team, and to of low-powered incentives would good job, but with acceptable develop a reasonable judgmnent on whether be that 'continuation of contract risk levels. performnance is satisfactory depends on satisfactory performance'. 14  Annex I International Experience in Decentralization and Private Sector Participation .:. -..-'.'-'.''-,'"'......... . w ; -i,,.,,i ..RRRR ii E..... " J....... .E., EE ,i -,:1T,-,, .....'.....'.... : - ~ . I IED I i? IE E-:-.::.-.:I: -:...... t t T V I.......:: Management contract focused on Relatively quick, and yields What to do with the management contractor when preparing for longer term PSP. quick improvements, bids for the long term arrangement are called? If the The management contractor is Effective preparation for more management contractor is allowed to bid, it will have required to both improve extensive PSP an unfair advantage, deterring other bidders. If the performance, and gather management contractor is precluded from bidding, information necessary for the fewer companies will compete for the management longer-term, risk-sharing PSP contract. arrangement. Trinidad followed In Trinidad, some commentators have argued that the this approach. time and expense involved in preparing for the management contract were similar to that involved in preparing for a longer term arrangement from the start. For any of the management contract options, can supply discrete new capital projects through BOO schemes in conjunction with management contract. Tariffs below cost Explicit Government subsidy to Makes many kinds of PSP Availability of subsidies can make it hard to measure recovery make up the forecast gap possible, leading to efficiency the performance of the private entity. This problem between costs and revenue. This and service gains, which will in can be reduced if the subsidy is set at a pre- approach has been used in Puerto turn contribute to financial determined level. Rico and Guinea, viability. The subsidy may entrench non-cost-reflective tariffs. This problem can be reduced by specifying in advance a progressive reduction in subsidy. In Guinea, the World Bank's involvement in financing the subsidy helped make the transition path credible. Commit to tariff path which leads If tariffs are raised and Likely only to be feasible if tariffs are already close to to cost recovery. efficiency increased over the cost recovery levels, or the losses at the start would be life of the PSP, profits toward too large. the end of the period may be Hard for the Government to commit to such a plan, enough to offset losses at the since it will always have an incentive to prevent tariff start. This could make many increases once PSP has started and initial investments forms of PSP possible without have been made. subsidy.. 15  Annex I International Experience In Decentralization and Private Sector Participation . ......... .......~~~~~~~~~~~~~~~~~~~~~~~~ : ~~~~~~~~~~~~~~~~. :....: ...... ..... .:. :. ..: :.: -:-. --...............-,:-,- ,D,:-. :T bk A ~,4(ot) vroming: ConstrittoPPnId ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~. .,., .,,.. ,,.. . . .... : .. ,; .,........ .. ............ :.:.: :--- ..... Political interference Tariff setting procedures set out Contracts enforceable under Difficulties in specifying long term complete in tariff setting in contract normal contract law will often contracts, especially given the lack of information and (leads to risk which be the best protection for the unpredictable developments facing the sector deters PSP) private sector. This facilitates rational and cost-reflective tariff setting, which is a benefit in itself Independent regulator sets tariffs Facilitates rational and cost- Problem in achieving real independence and reflective tariff setting. professionalism for the regulator. Compared to a contract approach, a regulator may be better able to respond to unpredicted developments. Poor operational and Involve the private sector in the Greatest scope for efficiency Uncertainty and risk are usually highest for operation commercial efficiency, operation and maintenance of the gains often lies in operation of of the existing distribution system high UFW existing distribution and the existing distribution system commercial systems, not just in specific new schemes. 16  Annex I Internadonal Experience In Decentralization and PrltaJe Sector Participation iEE-:iR E- . iES iERE: i--iEE.- EDERiEiE:- iER:.:E....... ........ ............ ....... ...:: .............. .:: ..... ...........: E .: ...-..:::.. :.. ..-: :.-:.-.- ......................~ ~ ~ ~ ~ ~ ~ ~ ~~~~~~: ...: ........ ...... ... ... :::-..::.. .: . ..: .. ..... : . ...... . :,,:E .C::: :E:,ER::: iRRiL .,, :::0:-::: , ::: EE::! fE::i T Able1A 4 iA (cent.) Ovromn Cosrit .to PSP in India Political problems Retamn the assets in public Helps reassure the public, and May not satisfy all concerns. For example, unions with private ownership, contract out only their politicians will still oppose privatization of operations ownership operation. Emphasize thatathe Continued Government involvement may reduce public sector: efficiency retains responsibility for water supply, but has simply delegated its management; continues to control tariffs and service standards. Most countries which have involved the private sector have used this approach. Retain partial Government Helps reassure the public, and Continued Government involvement may reduce ownership of the operating politicians, efficiency company. Oseta in the zch By partially align ing May create a conflict between the Government's roles Repbhip,cois ragoo ea lyeio Government interests with as regulator and owner ownershipoperthis n.EmphasizetattheContthose of the private investors, may reduce risk for the private sector 17  Annex 1 International Experience in Decentralization and Private Sector Participation ~~~~~~~~~~~~~~~. . :: . . ........ . ... .. ..: ...... ...... :-::.-:,, ,,,,,, .- . ..... . ::........ . Ta. .. ble- . :( t.). vrcomi C.onstran t $ in kia:: . , ......... ........ - ... : . ,,, . - --.. ........ . .. -. . . ... ... . .. ........... ... . * ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~.--. .,,,,-:::.:::..-. . ....: ..:: . ^ . .... Desire to involve the Privatize by creating an operating Ensures a good balance More costly to implement local private sector contract for a municipally owned between international and local (there is often a concern operating company, then selling participation that international shares in the operating company operators will dominate, to local investors as well as an and a desire to ensure international strategic partner. opportunities for the Ostrava in the Czech Republic is local private sector) a good example of this Contract out a range of functions Allows participation of 100% Does not in itself address overall system management which local private operators can local firms problems bid for. These will include Promotes competition May lose the benefits of international expertise operating particular plants, meter installation, billing. these problems could be removed if small contracts of this sort were combined with private participation in managing the overall utility Lack of capacity in Provide external assistance Provides ready access to Expensive and time-consuming smaller municipalities through use of consultants in international and domestic Only a short-term solution. Municipality will still to manage private letting contract etc. experience and expertise lack capacity to monitor and regulate operator once participation contract is let Set up long-term assistance to Provides continuing assistance May hinder development of internal capacity municipality through twinning after contract awarded Requires careful selection of any expatriate staff arrangement etc. Select operator on basis of Requires limited capacity to Hinders new market entrants from competing reputation rather than through a select operator competitive bidding process Imotnefrpuaincs g Importance of reputation acts Lack of formal competition makes it difficult to pentiveor evaluate operators' proposals perform well 18  Annex I International Case Studies in Decentralization: South Africa 2. South Africa - Case Study in Decentralization The South African experience provides lessons in moving from a system where decision-making power is centralized to one where responsibility is held at the local level. India can learn from South Africa particularly in the areas of: customer consultation; reform of regional water boards; and assisting in developing municipal capacity without taking away responsibility. 2.1 The Old System in South Africa As is the case in India, South Africa has a tradition of strong centralization of control and responsibility throughout many sectors of the economy, including water and sanitation services. Under the old system, rules and regulations were set in Pretoria and services provided through a combination of the government department (the Department of Water Affairs), public water boards and municipalities. There was little public input into decision-making at any level and what little transparency existed was achieved through heavy reliance on statute and regulation. As a part of the political process, regulation-setting tended to be cumbersome and the decision-making underlying it, incremental. The system worked because of the technical (i.e. engineering) skills of the central administrators in the Department of Water Affairs and because there was little concern for the majority of the population. 2.2 The Water and Sanitation Law Review In 1994, the Government of South Africa initiated a fundamental review of the water and sanitation law. There has been strong political support for wide-ranging reform of the water and sanitation sector, particularly from the Minister of Water Affairs and Forestry. The key themes to emerge from the South African review are: (i) customer consultation though decentralization - devolving responsibility for provision of water and sanitation services to individual municipalities; (ii)reform of the regional water boards - strengthening the boards' commercial focus through making their functions and objectives explicit; and (iii) boosting municipal capacity without taking away responsibility for provision of services. 2.2.1 Customer consultation Under the new constitution, the provision of water and sanitation services is now a responsibility of individual municipalities. This means that the municipalities must ensure water and sanitation services are provided, not that they must physically supply water and sanitation services themselves.4 Each municipality will achieve this through a public consultation and planning process culminating in the publication of a document called a "development plan". The customer consultation process will involve: providing citizens with information on the implications of different service options; seeking the views of the community as to the cost/quality of services they wish to receive; entering into contracts with water and sanitation service providers, or where the services are provided by the municipality itself, some form of agreement of the services to be provided and costs to be incurred; and publicly reporting against the development plan. The development plan will set out: the cost and quality of the services to be provided, and who will provide them; and the processes by which these levels can be altered, such as tariff-setting mechanisms. 4 There will be a duty on municipalities to provide water and sanitation services to the agreed standard in the lowest-cost way. 19  Annex I International Case Studies in Decentralization: South Africa 2.2.2 Reform of the regional water boards The regional water boards are public bodies which currently fill a variety of roles that commonly include provision of: bulk water services; water and sanitation distribution services; employment services (that is, the boards will deliberately over-staff* to increase local employment); skill-building services to municipal water and sanitation providers; and catchment management services. Consequently, like traditional parastatals around the world, the boards tend to lack accountability for service delivery. Boards announce the services they will provide-there tends to be little consultation (let alone negotiation) and no effective reply when a board fails to deliver as promised. The Boards also lack governance. That is, they lack accountability for the scope of their activities and overall efficiency; and, consequently, there is likely to be considerable room to improve their efficiency in delivering water and sanitation services. Under the reforms, several key changes are expected: * the roles of the boards will be made explicit. Boards will be responsible for the efficient delivery of bulk water services, with any other distinct services being provided under contract. For example, where a board operates a distribution system, in future it will be able to do so only under contract to the municipality or municipalities responsible for those water and sanitation services; the boards will be accountable to their customers for the bulk water services they provide. Boards will enter contracts for bulk water supply with the municipalities and/or distribution service providers they serve; the boards will be accountable for their activities and efficiency through a governance relationship between the Minister of Water Affairs and the Board of Directors of each board. The Board of Directors will publish documents stating its intentions for the coming periods and, at end of each year, reporting against those intentions; and, boards will be given autonomy to make operational management decisions. That is, boards will be allowed to select the mix of inputs, such as staff levels, to produce their services as efficiently as possible. 2.3 Boosting Municipal Capacity A critical impediment to effective local empowerment is the widespread lack of managerial and technical capacity in the municipalities. This gap is a legacy of the previous policy of Apartheid and therefore it is not surprising that the most effective water and sanitation sector organizations are those at the center- the Department of Water Affairs and Forestry and the regional water boards. Many municipalities have called on their local regional water boards for capacity-building assistance. A key challenge in designing the reforms has been to facilitate provision of that assistance without transferring responsibility for provision of services back to the center and without diluting the water boards' new requirement to be efficient in the provision of bulk water services. Under the review proposals, boards will be required to agree to the scope and nature of their activities with the Minster of Water Affairs. This agreement could, (and is expected to), include the approach each board will take in responding to municipalities' requests for capacity-building assistance. Where the 20  Annex I International Case Studies in Decentralization: South Africa request for assistance is not of commercial interest to a board and the costs of providing the assistance would impact significantly on the board's efficient performance of its functions, the board would be able to enter into a contract with the municipality to provide the services. 21  Annex 1 International Case Studies in Decentralization: Brazil 3. Brazil - Case Study in Decentralization The Brazilian experience provides lessons for India in managing decentralization in a large federal country. 3.1 The Old System in Brazil Like India, and the former system in South Africa, decision-making authority in the Brazilian water sector was previously very centralized. The majority of the resources for the water sector flowed from the central agency which, in order to maintain adequate controls, provided the bulk of resources to state water boards. The state water boards, due to their better access to resources, in comparison with other providers, were able to gradually expand their functions into distribution services, consequently cutting out local involvement. But the state system didn't work and it was widely regarded as inefficient and non-responsive to local requirements. 3.2 Brazil's Reforms Following the 1988 Constitution, tariff setting responsibility was devolved from federal to state level, with guidelines for the sector which called for decentralization of the provision of services wherever possible. Most states now have or are in the process of devolving responsibilities to municipalities. In turn, the municipalities are meeting their responsibilities through letting contracts to providers (who are either state and/or private firms). The first contracts to private sector providers are now being let. To date, the financial health of the sector has gradually improved since decentralization began. Regulators at the municipal level have a clearer understanding of local needs and conditions (such as ability and willingness to pay tariffs), and are able to facilitate public participation in decision-making by regulatory bodies. There remain, however, a number of concerns associated with decentralizing regulatory functions in their entirety to municipalities. These include: the relative lack of resources and, in particular, the necessary skills at municipal level. Of particular concern is the likelihood of relatively inexperienced and under-resourced municipalities agreeing concession contracts with major international operators in the water sector; the potential for conflicts of interest in cases where the municipality has a direct or indirect link with the service provider, and is also the regulator; and the regulation of systems of common interest, for example, water networks that are greater in extent than any single municipality they serve. 22  Annex I International Case Studies in Private Sector Participation: Puerto Rico 4. Puerto Rico - Case Study in PSP 4.1 Introduction Puerto Rico introduced private participation in its water and sewerage sector in 1995 to improve efficiency and access to investment finance. This case is of interest to India because: it is an example of a situation where the private sector has been successfully introduced in a step-by-step approach; it is unusual for a management contract, inasmuch as some risk sharing has been agreed; and it is notable for the emphasis placed on good labor relations. 4.1.1 Information on the Country General background information on Puerto Rico is provided in Table A 1-4. 1. Table L-4A. vervie inforationon Puerto.R]io Indicator Value ............................................................................................ ................ ................................................................................................................ GNP per capita (1993,$) 7,000 ........................................I.................................................................... ................................................................................................................ Population (millions, mid-1993) 3.6 .............................................................. ................. ............................ ................................................................................................................ Urbanization (1993, %) 73 4.2 Rationale for PSP Until 1995, water and sanitation services were provided by the Puerto Rico Aqueduct and Sanitation Authority (PRASA), a state-owned utility. PRASA delivered a little less than a million cubic meters of water per day. There were over 1 million water connections, supplying water to 98% of the population. Fifty percent of the population had sewerage connections, and all sewage discharged by PRASA received at least primary treatment. Tariffs were regulated by the Governor. The US Environmental Protection Agency, supplemented by Puerto Rican agencies, regulated drinking water and effluent standards. Three deficiencies of the public system mainly influenced PRASA's decision to introduce private sector participation in Puerto Rico's water and sewage sector: * water shortages: during 1994 a drought led to severe water shortages, with many areas receiving water for only 12 out of every 48 hours; * environmental standards: many of PRASA's sewage treatment plants failed to comply with strict EPA and local environmental standards; and * finance requirements: PRASA was a financial drain on the Government. For example, in 1994 it made a loss of over US$64 million, in spite of an operating subsidy of almost US$30 million, a contribution of over US$79 million to service long term debt, and capital expenditure subsidies of $53 million. 23  Annex I International Case Studies b Private Sector Participation: Puerto Rico The root cause of these problems was poor management, itself a product of political appointments and lack of incentives for good performance. PRASA had fallen into a vicious cycle of low expectations and low achievement on the part of both managers and staff. Asset maintenance, productivity, commercial operations and investment planning all suffered. Unions eroded management prerogatives such as promotion decisions, and contributed to over-staffing and inefficient work practices. PRASA chose to let a management contract with the aim of overcoming these problems. The contract was let to Professional Services Group (PSG) of the USA with whom PRASA had developed a close relationship. A contract summary is provided in Table A1-4.2. able A -4.2- Summay -of the Co-tra ct Area Comment Objectives Improving efficiency and management of investmnent ....... .............. .................. .................. ....................................................................................... .............. IIpoigefcec ngreto Option Management contract ................................................................................................... .................................................................. Coverage Water and sewerage throughout Puerto Rico ................................................................................................... ............................................................................................................................. First let 1995 Fi stlet ......................................................................... Length 5 years 4.3 Industry and Market Structure and Details of the Contract The structure of the water sector in Puerto Rico is summarized in Figure Al_4. 1. Government of | Puerto Rico l Puerto Rico Aqueduct Management Professional Services And Sewage Authority Contract Group (PSG) (PRASA) (US) .-Operates Owns ... Ow-nership o Contractual Relationship