Ukraine - Municipal Water and Wastewater : Sector Study

Document of The World Bank FOR OFFICIAL USE ONLY DRAFT CONFIDENTIAL Report No.13434-UA UKRAINE MUNICIPAL WATER AND WASTEWATER SECTOR STUDY May 15, 1995 CATALOGUERS/FILE CONFIDENTIAL Report No: 13434 UA Infrastructure Division Type: SR Central Europe Department Europe and Central Asia Regional Office rhis Document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. UKRAINE MUNICIPAL WATER AND WASTEWATER SECTOR STUDY CURRENCY EQUIVALENTS Currency Unit = Karbovanets (Krb) US$1 = 130,100 (April 14, 1995) WEIGHTS AND MEASURES Metric System US System 1 liter (1) - 0.264 US gallons 1 cubic meter (m3) - 264 US gallons ABBREVIATIONS AND ACRONYMS DBC = Dnepro Basin Commission MAC = Maximum Acceptable Concentrations MEP = Ministry of Environmental Protection MOF = Ministry of Finance SARU = Sector Assistance and Reform Unit SCH = State Committe for Hydrometerology SCHME = State Committe of Housing and Municipal Economy SCWR = State Committee of Water Resources FISCAL YEAR January 1 - December 31 UKRAINE WATER AND WASTEWATER SECTOR STUDY Table of Contents Executive Summ ary................................................. i-vii I. INTRODUCTION ............................................ 1 II. THE PRESENT SITUATION - ISSUES AND CONSTRAINTS - NEED FOR ACTION - THE CHALLENGEAHEAD .............................. 3 A. The Present State of Water Resources ............................ 3 B. Water Resources Management Institutions and Policies ................. 4 C. The State of Municipal Water Supply and Wastewater - Coverage and Quality of Service . . . . . . . . . . . . . . . . . . . . . . . . . . . ..e. . - - . . . - . -.8. . . . . 8 D. Vodokanal Performance - Policies Governing Provision of Water and W astewater Services ....................................... 10 E. The ChallengeAhead ...................................... 15 III. TOWARDS A MORE EFFECTIVE SYSTEM OF WATER MANAGEMENT ....... 17 A. Long Term Action: Institutional Reorganization and Redefinition of Policies . . .. 17 B. Immediate Action Dealing with Water Shortages - Conservation and More Equitable Allocation of Existing Resources ......................... 18 C. Immediate Action Dealing with Water Pollution - Interim Policy based on Cost Effectiveness, Priority and Affordability of Investments .................. 19 D. Implementation of Reforms - Next Steps .......................... 21 IV. RECOMMENDATIONS FOR A PROGRAM OF VODOKANAL STRENGTHENING AND REFORM OF THE MUNICIPAL WATER AND WASTEWATER SECTOR ... 22 A. The Vodokanal of the Future and Outline of Reforms Proposed ............ 22 B. Vodokanals and Enabling Institutional/Regulatory Framework ............. 23 C. Cost Recovery Pricing and Commercial Practices ..................... 28 D. Mobilizing Resources for Investments ............................. 31 E. Investment Selection, Prioritization and Implementation ................. 31 F. Utility Business Support ..................................... 36 G. Implementing the Proposed Reforms - Next Steps .................... 37 V. ASSISTANCE OF INTERNATIONAL DONOR COMMUNITY - A CRUCIAL ELEMENT FOR SUCCESS IN VODOKANAL REFORM ................... 39 This report was written by Task Manager, Walter Stottmann, Principal Sanitary Engineer, EMTIE assisted by Sumeet Thakur, Financial Analyst, EMTIE. The report is based on information collected by a World Bank Mission that visited Ukraine in May 1994. Other mission members who contributed to the report were Vilma Horinkova, Water Institutional Specialist, EMTWU, William Lane, Environment Specialist, EC41N, Don Cullivan, Dennis Robert, Dinu lonescu, Consultants. Mike Garn, TWUWS, and Tony Garvey, EMTEN were peer reviewers. UKRAINE WATER AND WASTEWATER SECTOR STUDY EXECUTIVE SUMMARY 1. Recent political and economic reforms have a profound effect on water management and municipal water and wastewater. Fiscal constraints have severely curtailed the government's ability to provide the large subsidies which have in the past kept water and wastewater services operating and expanding. Likewise, financial resources to address pressing water resources problems - water shortages and pollution - have become severely constrained. Municipal water and wastewater enterprises (Vodokanals) require assured provision of adequate resources to prevent further deterioration of existing water and wastewater systems and dire consequences for public health and the standard of living of the population. The ongoing reforms - particularly the transfer of municipal services to local governments and the recognition that the costs of these services must increasingly be assumed by the consumers - provide the opportunity of introducing new, more efficient ways for managing water resources and municipal water and wastewater services. Resolute deepening and acceleration of the reforms of sectoral institutions and policies based on decentralized sector management, cost recovery from users and cost effective use of financial resources is recommended to energize communities to improve water and wastewater services through a locally owned and supported effort and contribute to the country's fiscal stabilization by reducing reliance on the national budget. PRESENT SITUATION AND CHALLENGE AHEAD Water Resources Management 2. Water shortages and Pollution. Properly managed and conserved, Ukraine's water resources appear to be sufficient to support the country's water needs. The uneven distribution of surface water resources creates water shortages in some regions of the country, particularly in the Crimea, the far eastern and some western regions. The absence of convenient water sources makes it difficult and expensive for some cities to supply sufficient water to their population and industry. Much of the country's surface and ground water resources are polluted by insufficiently treated domestic and industrial wastewater and by agricultural runoff. Of particular concern are toxic materials released by industry. 3. Institutions and Policies. Present institutional arrangements and policies can be improved significantly to allow more cost effective water management. Rigid and ambitious norms for water consumption don't induce water conservation and lead to economically inefficient water allocation. Exaggerated and fixed ambient water quality and effluent standards make it difficult to address water management problems in a phased and prioritized manner. Fees and fines charged to water users are too small and do not generate resources for reinvestment. Overlapping institutional responsibilities and limits on human resources and operating budgets hinder coordinated and decisive action. The present set of policies, institutions, regulatory instruments and planning practices are incompatible with the principles of efficient water management expressed in the Lucerne Resolution' which endorses a gradual, phased and priority based investment strategy for pollution clean up and in the Dublin Statement on Water and Sustainable Developmente which recommends a holistic, participatory and economics based approach to water management. JI/ See "Environmental Action Program for Central and Eastern Europe", presented at the Lucerne, Switzerland, meeting of European governments on March 30, 1993. 2/ International Conference on Water and the Environment in Dublin, Ireland, January 26 - 31, 1992 ii 4. Need for action and reform. Failure to address water shortages would perpetuate an already difficult situation in the afflicted cities and regions by depriving the population from receiving adequate water service. Likewise, failure to check water pollution would make it ever more difficult and expensive to produce water fit for human and industrial consumption and accelerate the destruction of aquatic ecosystems. Resolving Ukraine's water resource problems will require a sustained effort over decades. Alleviating water shortages and cleaning up the country's water resources is as much an efficiency, institutional and policy problem as it is a financial one. Introducing modem water management policies and practices following the recommendations of Lucerne and Dublin would greatly enhance the prospects of resolving water resources problems faster and more cost effectively. Municipal Water Supply and Wastewater 5. Service coverage and quality. In the larger cities virtually everyone is served through a house connection. However, service coverage drops in smaller cities and rural areas. Throughout the country consumers complain about service reliability - low pressure, service interruptions - and quality - taste and order problems or worse contamination by pathogens, heavy metals, trihalomethanes. As in water, sewerage coverage is best in the larger cities, but connection rates drop off significantly in smaller cities and rural areas. In many cities, old deteriorated sewer systems suffer from excessive infiltration and inflow. The level of biological wastewater treatment in the larger cities is reported to be above 80% on average, but many wastewater treatment plants need better maintenance and operation to achieve adequate waste removal efficiencies. Poor sludge management and disposal is a particularly pressing problem everywhere. In many cities, industries discharge large quantities of often insufficiently pre-treated waste which causes problems for municipal wastewater systems. 6. Vodokanal Performance. Following the Local Self Government Act of 1992 and other related legislation, the responsibility for providing water and wastewater services and asset ownership has been transferred to local governments, and municipal and regional (oblast) water and wastewater enterprises (Vodokanals) have been converted into independent state owned companies. This change in institutional responsibilities is, however, by no means complete as the stakeholders involved are still trying to adjust to the new situation. The performance of Vodokanals varies, but compared to international standards, they suffer from low productivity and operational inefficiencies, most of which can be traced directly to the misguided sector management policies of the past. These manifest themselves in: a questionable public service agenda (generation of profits, yet insufficient resources for maintenance; involvement in risky commercial ventures); inefficient organization, management and administration; poor planning; over staffing; limited financial capacity; severe imbalance between low domestic and very high industrial tariffs; poor maintenance and inefficient operation (high electricity requirements; excessive water consumption; high water losses); inefficient investment selection; and low quality equipment, materials and construction.. 7. Need for action and reform. Ukraine's Vodokanals will have to raise large resources to rehabilitate and repair existing systems, make their operation more efficient, improve the safety and reliability of service and improve and expand the treatment of municipallindustrial wastewater. Failure to do so risks the continued deterioration of water and wastewater services and accelerated contamination of water resources. This would further decrease the standard of living of a population which has already seen its living conditions eroded precipitously over the past years. Again, improving municipal water and wastewater services is only partially a financial problem. Failure to introduce efficiency and cost effectiveness in Vodokanal management, administration, operation and investment selection and to address the underlying root causes for poor Vodokanal performance would perpetuate wasteful use of scarce resources. iii The Challenge Ahead 8. The political and economic reform process already initiated by the government provides the opportunity to replace the old order with new structures and ideas in the water and wastewater sector as well. Fortunately Ukraine is blessed with a large number of highly qualified sector professionals of whom many are ready for change. The challenge for the government is to work together with the country's sector community to put in place the policies and incentives which would lead to: * the introduction of water management policies and practices which promote water conservation, more equitable and economically efficient allocation of water, better environmental protection and more cost-effective use of financial resources; and * the development of efficiently managed and operated financially self-reliant water and wastewater enterprises capable of providing safe and reliable water and wastewater services at a cost affordable to the population. TOWARDS A MORE EFFECTIVE SYSTEM OF WATER MANAGEMENT 9. Unless the present system of water management with its reliance on unattainable standards and norms and insufficient regard for economic and efficiency concerns is reformed, making sufficient water available for the country's industries and citizens and at the same time checking the degradation of the aquatic environment will be difficult. A two pronged strategy for improving water management is proposed: one aims at comprehensive long term reform and the other suggests immediate action. Long Term Action: Comprehensive Reform of Water Management Institutions and Policies 10. The design and implementation of a new balanced system of regulatory instruments, laws and institutions, the introduction of comprehensive and participatory river basin planning and the development of an adequate professional capacity to make the new system work will take a long time, possibly a decade or more. However, the work towards the design of a new system of water management could be initiated immediately. To this effect the Ministry of the Environment (MEP) may consider the creation of an inter agency water management task force to: devise a new comprehensive framework of new institutions and policies meeting the criteria of modern water management; draw up a plan of action to implement the new framework; and facilitate, guide and monitor the implementation of the new system. While, the water management task force maps out a new framework of policies and institutions, interim approaches can be adopted to deal efficiently and pragmatically with water shortage and pollution. Immediate Action - Deal with Water Shortages Through Water Conservation and Efficient Allocation of Water Resources 11. With costly water resources development schemes out of the question, less expensive and affordable solutions are required. Identifying such solutions for dealing with poor water supply in water short areas should begin with the definition of the root cause of the problem. Inadequate service may be traced to a capacity and/or efficiency problem related to Vodokanal operations (excessive water consumption or system losses, for example) or to an allocation problem caused by excessive consumption of competing users. Once the problem is defined pragmatic, cost effective and affordable interventions can be determined. This might involve one or a combination of the following interventions: improving Vodokanal operations to reduce water losses and consumption; reallocating water to the Vodokanal from other less valuable uses; and developing local as yet untapped water resources using innovative and iv affordable approaches. Defining the most cost effective solutions will require comprehensive technical, financial and economic analysis of the entire regional water management situation in terms of supply, demand and use. To enable such analysis, present planning practices and norms must be replaced with pragmatic and situation appropriate planning and design approaches. Immediate Action - Deal with Water Pollution by Selecting Investments in Wastewater Treatment Based on Priority, Cost Effectiveness and Affordability 12. The following principles may be considered to arrive at more cost effective investment decisions for wastewater treatment: (a) concentrate investments on "hot spots", i.e. discharges with an irreversible and particularly negative effect on the economic value of a water resource; (b) avoid investments in advanced treatment, unless compelling reason exists; providing lower levels of treatment in more locations is most likely more cost effective than higher levels of treatment in less locations; (c) minimize wastewater treatment investments by upgrading existing plants rather than expanding or building new ones, least cost phasing of construction, decrease hydraulic loadings on treatment plants by reducing water consumption and infiltration/inflow; (d) use appropriate, low cost, but proven technology; and (e) tighten control of discharges from industry into municipal wastewater systems. 13. Polluters, Vodokanals and others, should be expected to make a determined effort to provide wastewater treatment, but within the limits of affordability. This would require them to: properly maintain and operate existing treatment plants; provide at least primary treatment to all of its wastewater within a specified period of time; and come to more secure arrangements with industry with respect to toxic discharges. "Hot spot" polluters facing unaffordable investment requirements should receive financial assistance from the environmental funds through the collection of fees and fines. Pollutant discharges should continue to require permits, but with phased, affordable compliance targets negotiated with the appropriate environmental authorities. Polluters should be required to pay meaningful, but affordable fees for using water resources and charged stiff fines for non compliance with new relaxed permit conditions. In support of these principles MEP should issue interim policies and guidelines which encourage pragmatic and affordable action free from existing standards and norms. RECOMMENDATIONS FOR A PROGRAM OF REFORM FOR THE MUNICIPAL WATER AND WASTEWATER SECTOR 14. To bring about Vodokanal reorganization and strengthening and more cost effective use of financial resources a six point sector reform program is proposed. Encourage Entry of Private International Utility Operators 15. Transferring Vodokanal management and operation to experienced private utility operators would be the fastest and surest way to turn them into efficient utilities. Although still hesitant to do business in Ukraine, such operators might be willing to undertake pilot operations. These initially would be most likely management contracts which would expose them to a minimum of financial risk. The government and prospective international private operators should seek to conclude incentive based management contracts in a few reform minded cities to demonstrate the feasibility and effectiveness of private sector participation. Corporatize Vodokanals under the Regulatory Control of Local Government. 16. For the foreseeable future, the management of the great majority of Ukrainian Vodokanals will remain in public hands. The public, but corporatized utility is recommended as a model for Vodokanals V not able to engage private operators. The success of this model depends on a clear definition and division of responsibilities and authorities among the main stakeholders involved: 17. Vodokanals: manage and operate water and wastewater systems: constituted as self-financing, commercially oriented corporate entities Vodokanals work as quasi-private utilities with wide autonomy under a public service agenda. To become more efficient, Vodokanals require reorganization and institutional strengthening and the development of a new sense of mission based on personal accountability and initiative of management and staff. 18. Local Governments: regulate the actions of Vodokanals: responsible for a service with natural monopolies features, local governments set the policies and objectives under which Vodokanals operate. They supervise Vodokanal performance and retain approval power over key decisions such as tariffs and investment programs, but do not micro manage Vodokanals. The responsibilities and obligations of Vodokanals and local governments are delineated in performance agreements and business plans with monitorable targets. Local governments must acquire the technical capacity to supervise and monitor Vodokanals properly. 19. Central Government: sets policies,guides and facilitates sector reform and strengthening: under the decentralized system of sector management central government acquires the obligation to: define strategic sectoral policies and development objectives, set ground rules for institutional relationships; define principles of cost recovery and resource mobilization; regulate intra-municipal matters; monitor sector development; facilitate the sector reform process; and coordinate and guide international assistance. 20. Consumers: pay for service: in return for safe and reliable service efficiently, consumers pay the full cost of services. Non-payment of service leads to cut off. Public participation arrangements give consumers a voice in important decisions. Introduce More Effective Cost Recovery and Commercial Policies and Practices 21. To replace past government subsidies, Vodokanals need to increase tariffs to assure reliable and safe service. The Cabinet of Ministers Resolution No. 23 of February 15, 1994 is a good start to establishing required local control, but local governments need more freedom to adopt the following key policies in formulating tariffs: (a) gradual scheduled tariff adjustments towards full cost recovery, including automatic tariff indexing for price escalation; (b) gradual closing of gap between domestic and industrial rates over the medium term; (c) linking charges to actual water consumption; (d) cut off policy for non paying customers. 22. Low domestic tariff levels - less than .5% of monthly family income - need be increased significantly to allow Vodokanals revenues to provide adequate services to its consumers. Substantial tariff increases appear realizable for all but the poor, who should be afforded a safety net, in spite of expected increases for other services (rent, heating, electricity). Fairness and the need for water conservation require universal consumption metering. Retrofitting individual apartments in large housing complexes is prohibitively expensive and impractical. Innovative approaches such as block or stairway metering may prove to be effective. Better coordination between Vodokanals and Municipal Housing Authorities (Zheks) is needed to introduce successfully new tariff policies, facilitate billing and collection and the repair of leaking fixtures. Before embarking on a specific course of action Vodokanals may be well advised to undertake tariff and socio-economic studies and pilot experiments with public participation. vi Facilitate Access to Credit to Vodokanals for Urgent Priority Investments 23. In the future, Vodokanal investments must come from internal cash generation, private equity, and prudent borrowing from commercial sources. The absence of domestic sources of credit would prevent Vodokanals from raising funds, even if they had some financial capacity to borrow. To augment domestic resources, the government may consider using its guarantee authority to mobilize foreign loans or guarantees for private investors from International Financial Institutions (IFIs). The capacity of these institutions will, however, not be sufficient to deal directly with all Vodokanals which might have an interest in borrowing. To provide IFI credit to a larger number of Vodokanals, the government might consider the creation of an intermediary arrangement for municipal credit under which IFI and other resources could be on lent for projects which meet preestablished eligibility criteria. Introduce More Cost Effective Investment Policies and Practices 24. Cost effectiveness, priority and affordability must govern the choice of future investments. Some suggestions which might lead to more cost effective investment choices include, including: (a) rehabilitation and efficiency improvements of existing systems, better maintenance, reduction of water losses and water consumption through water demand management efforts will be more cost effective than system expansions; (b) life cycle costing, least cost phasing, use of low cost and appropriate technologies and flexible design parameters would reduce costs of new facilities; and (c) concentrating investment resources on priorities identified in multi-year investment plans compatible with the Vodokanals's capacity to raise investment resources would increase cost effectiveness of investments. Responsibility for the entire investment cycle should be transferred to Vodokanals. Autonomous utilities, dependent on their own revenue generation would have the greatest incentive in making cost effective investment choices. Strengthen Utility Business and Support Environment 25. To function effectively, Vodokanals depend on a business environment and supplier industries which can provide quality inputs for utility management and operation. To build this support, the government should facilitate: (a) strengthening of the sectoral human resource base by adjusting educational policy and curricula content to introduce new skills required for modem utility management and operation; (b) the emergence of an effective consulting capacity by transforming state design institutes into private organizations offering their services on a competitive basis and encouraging joint ventures with foreign consultants to facilitate the transfer of know how; (c) the development of an efficient sectoral industry by introducing more demanding technical specifications; privatizing state owned enterprises; requiring competitive procurement; and (d) the development and strengthening of non- governmental organizations to become instrumental players in the development in the sector. Implementing the Proposed Reforms - Next Steps 26. Many of the reforms aimed at Vodokanal reorganization and strengthening can be initiated by Vodokanals with the support agreement of local government. Other reforms, particularly those dealing with cost recovery and resource mobilization, depend on action by the national government. A two pronged implementation strategy is proposed. Medium Term Action: Define and Implement a Comprehensive Country Wide Program of Sector Reform 27. To initiate and implement full fledged sector reform country wide, the national government, led by the State Committee of Housing and Municipal Economy (SCHME), should: (a) map out a vii comprehensive framework of future sectoral policies; (b) disseminate the new policies and recommended practices throughout the sector community based on the six point program outline above; (c) translate sector reform policy into a strategic 1996 -2000 sector investment program with realistic annual targets for service coverage and improvements, investment cost estimates, and a financing plan; and (d) make government support for investments contingent on Vodokanal reorganization and strengthening and the presentation of cost effective, prioritized and affordable investment programs. 28. Decisions on some crucial reform proposals (e.g. tariff setting or the allocation of subsidies) are outside of the jurisdiction of SCHME. The creation of an intra-government sector reform task force comprised of representatives of the main stakeholders in municipal water and wastewater (local government, SCHME, SCWR, MOF, river basin agencies, professional organizations, non governmental- organizations) is recommended. The task force under the leadership of SCHME could serve as a forum to debate and decide on the country's future policies regarding the municipal water and wastewater sector. To lead the work on sector reform definition and the subsequent dissemination and implementation effort, SCHME might consider creating a special office dealing with sector reform and strengthening. Immediate Action: Support Projects with Reform Minded Local Governments and Vodokanals. 29. Many of the proposed reforms, for example Vodokanal reorganization and strengthening and operational improvements could be initiated immediately by reform minded Vodokanals and local governments. The national government and the international donor community should support such efforts, including the conclusion of management contracts with private utility operators, supporting Vodokanal institutional strengthening programs and funding of properly prepared and justified urgent investment projects. International Assistance 30. Many of the new policies and practices proposed under the sector reform effort are new in Ukraine. Assistance from the international donor community will allow Ukraine to address urgent needs in a time of transition and enable them to implement needed reforms faster. International donor agencies and international, financial institutions are strongly encouraged to support the country's sector reform effort by funding programs of technical assistance and provide financing for urgent priority investments. This support would be particularly needed for: 31. Technical assistance to MEP for: preparing and implementing the proposed long term reform of Ukraine's water management systems; identifying and ranking water pollution "hot spots"; and preparing and implementing interim policies for dealing with water management and water pollution. 32. Technical assistance to SCHME for: preparing and implementing a country wide program of sector reform, including mapping out new framework of new sectoral and policies, dissemination of new policies to sector community, and preparation of 1996 -200 strategic investment program. 33. Assistance to local governments and Vodokanals for: broad based institutional reorganization and strengthening programs; the preparation of least cost, affordable, priority investment programs in cooperation with potential financing agencies; priority, least cost, affordable investments justified through appropriate studies; and advice and preparatory work in support of incentive based management or concession contracts with private international utility operators. UKRAINE: WATER AND WASTEWATER SECTOR STUDY Outline of a Suggested Program of Institutional and Policy Reform Nature of Reform Objectives Action/Responsibility Time Frame COMPREHENSIVE REFORM Municipal Water and Wastewater 'Strengthening of Vodokanal performance and Inter agency task force led by SCHME to define new Convene task force in Definition and implementation of productivity. framework of policies, short term. comprehensive program of Sector SCHME to disseminate new policies and best practice and Complete program of reform and Vodokanal (VK) Creation of an enabling environment of policies facilitate imlementation of programs of Vodokanal reform and sector restructuring strengthening country wide and insitutions for the development of efficiently strengthening. within medium term 4- operated, financially self reliant, autonomous International assistance agencies to provide support. 6 years. Vodokanals operating under the regulatory control of local government. Water Management and Environment Bring about more cost effective use of scarce Ministry of the Environment (ME) to convene Inter agency task Convene task force in Definition and implementation of resources for water resources management and force to prepare and implement comprehensive reforms of the short term. comprehensive program for water pollution control. water management policies and institutions. Complete program of management International assistance agencies to provide support. reform within long term (6-8 years). SPECIFC ELEMENTS OF REFORM Transform Vodokanals into Strengthen Vodokanal operation and productivity National Government to define appropriate legal/regulatory Initiate demonstration autonomous, self-financing, corporate by creating sense of ownership, acountability. self arrangements and facilitate implementation. projects in the short entities in charge of all aspects of reliance and initiative. Local government to provide Vodokanals with corporate term. management and operation structure under appropriate legal/regulatory arrangements. Great majority of under the regulatory control of local International assistance agencies to support programs of Vodokanals to be government. Vodokanal reorganization and strengthening. corporatized within medium term. Engage qualified private utility Improve Vodokanal management, operation and National government to define appropriate legal framework and Initiate demonstration operators to manage and operate productivity through introduction of performance encourage entry of private utility operators. projects in the short Vodokanals under management, lease, based management principles. Local governments to conclude contracts with private utility term. or concession arrangements Effect transfer of modern utility management and operators with expert advice. operation principles. Private utility operators to offer services. International assistance agencies to support private sector entry. Nature of Reform Objectives Action/Responsibility Time Frame COMPREHENSIVE REFORM Introduce new tariff policies based on Empower local governments and consumers to National government to set framework tariff policies and Define new policy and full cost recovery, consumption based choose service standards in accordance with transfer tariff autonomy to local government. decentralize tariff charges, equity, affordability and affordability and willingness to pay. Local governments to exercise tariff control based on autonomy in short willingness to pay Provide VKs with financial independence. performance agreements with Vodokanals. term. Make VKs accountable for raising own funds. International assistance agencies to support tariff reform Introduce tariff structures allowing demand through technical assistance and conditioning financial management and water conservation. assistance on appropriate tariff action. Close gap between domestic and industrial tariffs. Introduce policy of Service shut off for non paying customers. Facilitate credit to Vodokanals for Allow Vodokanals to undertake urgent investments Government to decide on appropriate mechanisms for providing Government to decide urgent, priority investments to keep water and wastewater systems operating credit to Vodokanals. and establish credit and to undertake most urgent investments in system Government to consider obtaining financing from private and facility in the short rehabilitation, improvement of operational official international financing institutions to fund most urgent term. efficiency and expansions. investments. International financing International assistance agencies to work with government on institutions ready to creating appropriate credit mechanisms and providing funds for provide financial investments. support immediately. Introduce new investment selection Make better use of scarce resources by SCHME to define and disseminate best practices in preparing Demonstration projects criteria based on cost effectiveness, concentrating on priority and urgent investments and selecting cost effective investment programs. to be initiated in short priority and affordability based on coost effective multi year Vodokanal Government to condition financial support to Vodokanals on term. investment programs- presentation of cost effective financially viable investment Stress importance of system rehabilitation, more programs. efficient operations, and water conservation. Vks to be in charge of all aspects of investment cycle. Apply market economy approaches for identifying International assistance agencies to support reform minded Vks cost effective investment programs affordable to in the preparation and financing of urgent, cost effective the population. investments. Improve quality of support for Provision of better quality and more cost effective Government to encourage the privatization of key services to Reform/privatize Vodokanals regarding services to Vodokanals. Vodokanals, i.e. engineering services, contracting and service industry in the consultinglengineering services, supply equipment supply. medium term. of equipment and materials and civil Strengthen technical specifications. Facilitate foreign entry works contracting. Competitive procurement and recourse for poor service. in the short term. Encourage joint ventures with foreign firms to improve performance and introduction of better technologies and know how. UKRAINE WATER AND WASTEWATER SECTOR STUDY I. INTRODUCTION 1. Municipal water supply and wastewater - a sector in transition. Since declaring independence in August 1991, Ukraine has been undergoing a difficult period of transition on its march towards a market economy. So far this process has been slow and accompanied by a deteriorating economy and fiscal constraints as the country moves to shed Soviet Era policies and adopt a new economic and political order. Reforms so far have had both negative and positive effects on water management and municipal water and wastewater. On the down side, fiscal constraints have severely curtailed the government's ability to provide the large subsidies which have kept water and wastewater services operating in the past. As a result, the country's water and wastewater enterprises (Vodokanals) suffer from large financial shortfalls. Much needed maintenance and rehabilitation work cannot be undertaken and investments in new facilities have come to a virtual halt. Unless ways are found to provide Vodokanals with adequate resources, existing water and wastewater systems, already in bad shape, will continue to deteriorate. Further deterioration of services would decrease the standard of living of the Ukrainian people and pose a threat to public health. This would add to the social tension and dissatisfaction of a population which has already seen its living conditions eroded precipitously over the past years. Another consequence would be worsening contamination of the country's already heavily polluted water resources. 2. Changes already under way provide opportunity, but resolute continuation of the reforms is essential. On the positive side, the ongoing economic and political reforms have opened the way for the introduction of new, more efficient ways for managing water resources and municipal water and wastewater services. Most important among the reforms already being initiated is the transfer of responsibility for municipal services, water and wastewater among them, to local governments; the other is the recognition that the state no longer can finance these services and service beneficiaries will increasingly have to bear their costs in the future. These reforms have just begun, but their nature and consequences are not fully understood nor accepted by many political decision makers and the public. Today many of the actions taken by sector officials and political decision makers point to uncertainty. For Vodokanals to acquire the institutional, financial and technical capacity required to efficiently provide safe, reliable and affordable services to the population, the reforms need to be deepened and their pace accelerated. This will require, as this study sets out to show, more fundamental changes to the present institutional and policy framework and the acceptance and implementation of new ideas and attitudes by those managing the sector. The challenge ahead is characterized by the need to: transfer the responsibility for financing water and wastewater services from the central government to service beneficiaries through the adoption of cost recovery policies; improve the productivity of the institutions involved; create credit facilities accessible to Vodokanals; introduce mechanisms to ensure wise use of scarce investment resources; and promote private sector involvement in the management and operation of water and wastewater services and financing of investments. 3. Objective and focus of the study. The objective of this study is to assess the present performance of the sector, identify main development issues and constraints and propose a new, market based framework of sector management and present recommendations for institutional and policy change. The emergence of well managed, efficiently operated and financially self-sufficient Vodokanals is the most important condition for improving municipal water and wastewater services. The performance of Vodokanals is largely determined by policies and institutions which govern the provision of municipal infrastructure services on the one hand and those which govern water resources management and environmental protection on the other. Thus, the study will focus primarily on Vodokanals, their performance and their relationship with local and national government and other stakeholders, but also deal with water management institutions and policies which determine the conditions under which 2 Vodokanals use water resources, i.e. abstractions of raw water and discharge of wastewater. 4. Sectoral reforms support the country's overall political and economic restructuring process. The direction and implementation of sectoral reforms will depend to a large extent on progress of the country's overall political and economic restructuring process. Macro stabilization, market liberalization, economic recovery and growth, decentralization of responsibilities from the central to the local level, public enterprise reorganization and the involvement of the private sector are issues of relevance for the economy as a whole. Progress in these areas will determine the speed with which the sector can adopt a new, more efficient system of management, but there are many opportunities to improve sector performance independent of overall reform. The continued, resolute pursuit of sectoral reforms is not only an integral part of the country's ongoing political and economic restructuring effort, but can contribute to this process by leading the way on the sectoral level. The transfer of responsibility for funding sector investments from the national budget to service beneficiaries would not only provide relief for the national budget, but also promise to energize individual communities to improve water and wastewater services through a locally initiated and owned process. This may show the way for reforms in other areas of municipal infrastructure (district heating, for example). 5. Organization of the study. Following the review and assessment of the present state of water resources and municipal water and wastewater services in their physical, institutional and policy dimensions in Chapter II. Chapter III presents recommendations for making water management more efficient. Chapter IV and outlines a new framework of institutions and policies for municipal water and wastewater. Chapter V provides suggestions as to the role of international financial and assistance agencies in helping in the reform process. 3 II. THE PRESENT SITUATION ISSUES AND CONSTRAINTS - NEED FOR ACTION - THE CHALLENGE AHEAD A. The Present State of Water Resources Quantity Aspects 6. Uneven distribution of water resources causes regional shortages. Ukrainian rivers yield an average of about 50 billion md per year. In dry years (about one in four) this yield may decrease to about 30 billion m/year. This translates into a per capita availability of about 1000 m/year on average and about 600 ml/year in dry years. While these yields do not place Ukraine amongst the water rich countries in Europe, they appear to be sufficient to support the country's water needs if managed carefully. A complicating factor is that water resources are geographically unevenly distributed and have large seasonal variations. The northern and northwestern parts of the country generally possess sufficient water as do the communities located in the Dniepro valley. Over the last 50 years the government has spent enormous resources to harness the resources of the Dniepro river, one of the large rivers of Europe, to supply water to deficient areas. Some 1000 reservoirs have been constructed to regulate river flow and store water for the dry season. A large system of inter basin transfers has been put in place to distribute Dniepro water to water deficient parts of the Ukraine. Today some 30 million people (nearly 70% of the population) and almost all of the country's industries are dependent on Dniepro water. In spite of these large efforts, acute water shortages persist in several regions of the country, particularly in the far western and eastern parts and the Crimean peninsula. Several large Ukrainian cities, among them Lviv, Berdicher and Shitomir suffer from water resource scarcities. Data provided by the State Committee for Housing and Communal Services suggest that up to 33% of the population (over 15 million people) live in "water deficient" areas. In many places, the severity of water shortages is exacerbated by excessive water consumption by consumers and leakage from water supply networks. 7. Ground water is a less valuable resource due to poor natural quality. Ground water is found in most parts of the country. Much of it, however, is of poor quality due to high mineralization (average chloride concentration of 3,500 mg/1, and high concentration of dissolved iron). This makes ground water a resource less valuable than surface water. As a result, ground water is not used extensively except in areas of surface water shortage. Data provided by the State Committee of Housing and Municipal Economy (SCHME) show about 70% of municipal water coming from surface and 30% from ground water sources. All larger cities almost exclusively (except Lviv) depend on surface water. Ground water is an important source for smaller cities and rural areas. Given the limitations on surface water, the use of ground water as a source for municipal water supply inevitably will become more important in the future. With the introduction of appropriate extraction and treatment technologies ground water can contribute more to the country's water needs than it has done in the past. 8. Industry and agriculture dominate water use. Almost 90% of the nation's water resources are dedicated to industry and agriculture and only 10% to municipal water. Clearly, making sufficient water available for municipal consumption will require a rethinking of present water resource allocation policies which tend to favor industrial and agricultural use. 4 Quality Aspects 9. Surface waters are heavily polluted from a number of different sources. Available studies' present a picture of wide-spread surface and groundwater pollution. Pollution of surface water stems from untreated or insufficiently treated domestic and industrial wastewater, agricultural runoff and waste dumps and tailings and wastewater treatment sludge. Of particular concern are toxic materials (dissolved metals, oils, phenols, etc) released by chemical, metallurgic, and paper industries. Although there is widespread consensus that much of the country's water resources are heavily polluted, there is uncertainty regarding the exact origin, nature and extent of the pollution and the effect it has on water quality and the aquatic ecosystems. The Chernobyl accident and its affect on water quality is still a sensitive issue. There is fear that flooding in the areas contaminated by outfall from Chernobyl might sweep radioactive pollutants into the Dniepro river system. 10. Ground water quality is also compromised by pollution. A significant portion of the ground water resources has been contaminated by the infiltration of pollutants. The pollution is most heavy around industrial facilities and in areas with high intensity agricultural use. Leaching of often toxic materials from waste dumps and slag pilings are a major source of ground water pollution. In some rural areas, groundwater quality is compromised by pollution due to poor handling of agricultural chemicals and intensive farm practices, including heavy use of pesticides and chemical fertilizers and the spread of liquid wastes from animal farms. The Task Ahead 11. Addressing water management issues is important for economic and environmental reasons. The present status of Ukraine's water resources causes concern in two respects. One relates to the uneven distribution of water resources in the country and the inability of Vodokanals to obtain sufficient water to meet the demands of their customers. Failure to address water shortages would perpetuate an already desperate situation in the afflicted cities. The lack of sufficient water not only deprives the population from receiving a reliable and safe water supply, thereby increasing discontent and jeopardizing public health, but it also retards prospects for overall economic development and growth. The other concern, the contamination of water resources, diminishes the value of the resource in economic as well as environmental terms. Treating polluted water for human consumption increases costs significantly. In many situations, even extensive and costly treatment may not be enough to make the water attractive to the consumer as taste and odor problems may persist. Worse, the treatment may not succeed in removing toxic materials (heavy metals, carcinogenic substances, for example) with long term negative implications for human health. The environmental consequences of water pollution and its effect on the aquatic ecosystem are well known and don't need to be further elaborated. Resolving problems created by water resource shortages and pollution will require the expenditure of large financial resources and a sustained effort over decades, as is the case in Western Europe or in North America where water problems are still far from being resolved in spite of the enormous resources which have been spent over the past forty years protecting the aquatic environment from pollution. B. Water Resources Management Institutions and Policies 12. Improving water management will be a major challenge for the future. The policies under which the government addresses water shortages and pollution have an important effect on all water users. 1/ A detailed assessment of water pollution is presented in "Suggested Priorities for Environmental Protection and Natural Resource Management", a joint Government of Ukraine and World Bank study dated September 20, 1993. 5 These include municipal water and wastewater enterprises (Vodokanals) whose financial and technical capacity is affected by the conditions under which they are allowed to abstract raw water and discharge wastewater. The effectiveness of water management depends on the policy and institutional framework in place, standards, regulatory instruments, planning practices, institutional capacity and division of responsibilities. Norms and Standards 13. Rigid and overambitious norms contribute to poor water resources management. During the Soviet era and still today water resources management decisions regarding the allocation of raw water and the discharge of wastewater are determined by a set of ambitious, rigid and often unattainable standards and norms. These norms, defined by a central bureaucracy removed from technical and financial ground realities and insufficiently concerned with notions of efficiency and economy, are one of the reasons for the poor state of water resources today. The following examples may illustrate this point. 14. Water use and allocation norms. Raw water allocations are made in accordance with norms which define how much water a theoretical water user would need, and how much water would have to be left in the stream to maintain "ecological and sanitary norms." It is hard to see how these norms could produce efficient water allocation decisions and meet environmental requirements simultaneously. First, water consumption norms for water users - industries, agriculture, drinking water supply - are generally very high, often a multiple of what comparable water users would receive in Western Europe and North America. Lack of incentives to conserve water allows existing users to continue to "waste" water, at the expense of other, possibly economically higher valued water uses. Second, rigid norms ignore the specific hydraulic and biological characteristics of each water body that is targeted for abstraction. Clearly, existing norms and allocation algorithms for water should be replaced by arrangements which promote economically efficient use of water as a resource for consumption as well as for maintaining aquatic ecosystems. 15. Ambient water quality standards. Under the former Soviet system still in use in Ukraine today, about 1350 chemical and biological indicators are used to characterize ambient water quality. The country's surface water resources are assigned five different water use categories ranging from those fit for providing drinking water to those for industrial use. Each category carries a set of maximum acceptable concentrations (MAC) of chemical and biological constituents. Many of them are more stringent than those used in Western Europe and Western Europe for equivalent water use. Standards are fixed, thereby preventing any phased and priority oriented strategy for gradual water quality improvements over time. At present, few, if any, of the country's water resources meet the MACs assigned. To bring water up to the standards required would require enormous investments in waste water treatment, domestic and industrial, which under present economic circumstances are simply unaffordable. Even if the funds were available, the high costs involved would in many cases outweigh the economical benefits in terms of ecological improvements and savings in water treatment costs. 16. Effluent standards. Ambitious ambient water quality standards lead to equally ambitious effluent standards for wastewater treatment plants. The effluent standards required today from municipal water and wastewater enterprises (Vodokanals) are among the most demanding in the world. For example, the standard for Biological Oxygen Demand (BOD), the most commonly used indicator of water quality, is generally set in the 3mg/I to 6mg/I range and phosphorus removal down to 1.5 mg/1 is required. Standards for other pollutants are similarly high. Achieving them would demand advanced (tertiary), costly treatment technology and high operation and maintenance standards and costs. The present financial capacity of Vodokanals, local governments and the national budget prohibit even coming close 6 to raising the resources needed to meet the effluent requirements imposed on Vodokanals. The requirement of raising these resources becomes particularly problematic in that it may divert financial resources from higher priority objectives such as providing safer and more reliable water services. 17. Wastewater treatment plants design norms. The design of wastewater treatment plants is based on preset norms of wastewater production by domestic and industrial users. The real volume produced in a particular system may be very different from that stipulated by the norm. Likewise, pollutant loadings are determined by norms and not by the actual output of polluters. Under these circumstances, wastewater treatment may be overdesigned or underdesigned depending on the extent to which hydraulic and pollution loads based on norms are consistent with actual output. Higher technologies seem to have preference over less costly alternatives (lagoons, for example). Different climatic conditions do not seem to be reflected in the technology chosen. 18. Drinking water standards. Vodokanals have a difficult time to meet drinking water standards which in many ways are more demanding than EU standards. To meet these standards, Vodokanals feel compelled to upgrade their treatment plants, often favoring high tech and expensive solutions (ozonation, for example). While these treatment technologies would certainly be appropriate in richer countries, Vodokanals in Ukraine today just do not have the resources to pay for costly treatment plant upgrades. Even if they had the resources, these may be spent more cost effectively in higher priority investments such as upgrading the safety and efficiency of water distribution networks. While a Vodokanal's obligation to provide a biologically safe water supply can never be compromised, they should not be forced into undertaking investments unless they are essential to maintaining public health. Also, claims for high tech solutions are often based on inconclusive information of raw water quality. Before making costly investments, it would be advisable to verify the pollution levels through careful analysis. Another even more cost effective way might be to eliminate or reduce pollution from the source upstream. 19. Unattainable standards and norms stifle action and lead to inefficient use of financial resources. There is wide awareness that norms and standards are unattainable and therefore don't elicit constructive behavior by polluters. The unwanted consequence of existing standards is that they have become so complex, unaffordable and unenforceable that often even logical and useful standards are ignored or treated too lightly. Addressing water shortage problems and the clean up of Ukraine's water resources will have to proceed in stages. Billions of US$ have to be spent over decades. The present set of standards and norms - rigid, ambitious and largely unaffordable under the country's present economic conditions - does not meet cost effectiveness criteria, i.e. meeting a reasonable objective with a minimum of effort and expense. It is incompatible with the adoption of a gradual, phased and priority based investment strategy for cleaning up water resources which was endorsed by the governments of Central and Eastern Europe during their recent meeting in Lucerne, Switzerland'. Legal/Institutional Framework, Regulatory Instruments, Planning 20. Present system of regulatory instruments, permits, fees, fines is flawed. Water users and polluters operate under permits which define the conditions for water abstractions and wastewater discharges, including: limits on volumes and pollutant concentrations, fees for resource use and fines for incompliance with permit conditions. Income from fees and fines is distributed among national (10%), local (70%) and regional (20%) governments to finance the activities of environmental agencies and fund pollution abatement investments. Apart from the fact that, as discussed above, the standards and norms 2/ See "Environmental Action Program for Central and Eastern Europe", issued at the Lucerne, Switzerland, meeting on March 30, 1993. 7 on which permits are based are among the root causes for inefficient water management, the present system of economic incentives, namely fees and fines, is flawed in its own right. First, fees and fines are too small to make any difference. Even if they were higher, the financial capacity of Vodokanals and other water users would not be sufficient to make the investments which would be required to meet permit conditions. Second, enforcement mechanisms for paying fees and fines are inconsistent; in some places, Vodokanals have been able to negotiate arrangements with environmental authorities which exempt them from any payment. Thirdly, the resources from fees and fines which have been paid to environmental funds have not led to any reinvestment so far. Small to begin with, they are subject to high inflation which leads to fast erosion of the value of the money collected, and environmental funds don't have the capacity to allow identification of and support for promising investment opportunities. 21. Many institutions deal with water management without sufficient coordination. Ukraine has a plethora of institutions in planning and regulating water use, including: the Ministry for Environmental Protection (MEP), clearly the dominant institution for water management, in charge of policy setting, permitting water abstractions and wastewater discharges, standard setting, monitoring and enforcement; the State Committee of Water Resources (SCWR), downgraded from ministerial status in 1990, responsible for controlling abstractions from surface waters, hydrologic analysis, preparing regional water balances, participating in the water allocation/permitting system; the Dnepro Basin Commission (DBC), formed in 1992 under the auspices of MEP, dealing with water pollution in the Dnepro Basin; the State Committee for Hydrometerology (SCH), responsible for monitoring hydrologic and water quality parameters; the Ukraine Geological Service in charge of ground water management; the Ministry of Health (MH) which controls the quality of drinking water quality through an extensive network of Sanitary-Epidemiological stations; and numerous research and design institutes involved in providing analyses and studies related to water management and monitoring of water quality. 22. The effectiveness of the legal/institutional framework is compromised by institutional inconsistencies. The often unclear relationships between these organizations have created confusion and turf battles which add to the already difficult job of dealing with the complex issues surrounding water management. The following examples highlight present institutional/regulatory problems. Legal uncertainties: many of the laws governing water management inherited from the former Soviet Union are still valid today, although they are being gradually replaced by new laws. A new water code is under consideration. The mix of new and old, often contradictory laws and regulations provide a shaky legal basis for decision making and enforcement. Inconsistencies in the distribution of responsibilities and authority: MEP concerned with water conservation is the institution issuing water use permits, while having very little capacity and expertise in water resources management. SCWR, in charge of interbasin transfers and operational matters is responsible for establishing stream flow regimes to maintain ecological balance and "sanitary norms." Overlapping and uncertain decision making between municipal and regional agencies with their parent institutions at the center: While there is a clear recognition that decision making and enforcement should be delegated to the lowest appropriate of government, lack of guidelines, inexperience and trust still move many decisions up to Kiev. Overlapping monitoring responsibilities: This leads to duplication of effort and makes coordinated data collection and analysis difficult. Inconsistent enforcement: Water users, including Vodokanals are in permanent incompliance with permits and in arrears in the payment of fees and fines. As most water users are not able to meet permit conditions, regulators have little enforcement capacity, and enforcement has become a matter of negotiations with inconsistent rules. 23. Capacity and instruments for participatory River Basin Planning to arrive at cost effective investment allocation are lacking. In large and complex river basins like that of the Dnieper with its hundreds of different users and demands and its own complex hydraulic and self cleaning characteristics, allocating water among competing users and defining investment priorities for wastewater treatment 8 becomes a rather difficult task. The externalities associated with water management investments and the existence of many stakeholders with different agendas demand a comprehensive, river basin oriented approach to decision making and resource allocation which integrates the technical, institutional, economical and political dimensions of water management. The Dublin Statement on Water and Sustainable Development' defines three conditions essential for successful water management: (a) an holistic approach, linking social and economic development with the protection of natural ecosystems, land and water uses across the whole catchment area or groundwater aquifer in terms of both water quantity and quality aspects; (b) the management of water as an economic good as an instrument for achieving efficient and equitable use, and of encouraging conservation and protection of water resources; and (c) a participatory approach, involving users, planners and policy makers at all levels with decisions taken at the lowest appropriate level, and public consultation and involvement of users in the planning and implementation of water projects. The present policies and institutional structure for water management in Ukraine do not allow water management as articulated in the Dublin Statement. In fact, the present system of standards and norms, permits, fees and fines and planning mechanisms works against cost effective water management. 24. Lack of technical and fmancial capacity limits effectiveness of water management institutions. Many of the ideas to improve water management - gradualism, priority setting, cost effectiveness, flexibility, transparent objective - represent fundamental departures from the "old" system of water management. The present leadership charged with making and implementing water management policies, most of them highly educated engineers and scientists, do not have the knowledge and experience to embrace and promote modern, market oriented water management policies and techniques. Environmental agencies, particularly the Ministry of the Environment which plays the lead role in water management, do not have the financial resources to acquire the staff nor the equipment or the operating budget needed to develop and introduce new water management policies and planning. If Ukraine wants to make efficient use of its water resources, it has no choice but to embrace new ideas and initiate reforms to the present system. Chapter III presents suggestions for an agenda of reform to make water management more efficient. C. The State of Municipal Water Supply and Wastewater - Coverage and Quality of Service Water Supply 25. Service Coverage is high in urban areas, lower in rural areas. Currently about 71% of Ukraine's 52 million people are connected to a public water system and receive water through house connections (see Table 1). In the larger cities virtually everyone has access to a house connection. Even in the smaller towns, almost 90% of the people are served by a house connection. In rural areas, service coverage drops to 22%. In reality this figure is probably much higher as services provided by local enterprises such as collective farms or agro-industrial enterprises and individual wells are not included in the statistics supplied by the State Committee of Housing and Municipal Economy (SCHME). 26. Service reliability is a widespread source of complaints. The reliability of water services varies widely throughout the country. SCHME estimates that some 70% of the people connected to a public system are subject to water rationing. Even in some of the country's larger cities (Lviv, Shitomir, Odessa, for example) portions of the population receive water only six hours per day. Low pressure in the upper floors of apartment buildings is a serious problem in many cities. In general, the reliability 3/ Formulated at the International Conference on Water and the Environment in Dublin, Ireland, January 26-31, 1992. 9 of service is inversely related to the community size. The smaller the town the greater the incidence of intermittent supply. The reasons for these deficiencies vary, but they deficiencies can be traced to a combination of several different causes. In some cities (Lviv and Shitomir, for example) and in many small cities throughout the country, water resource shortages are identified as the direct cause for poor water service. In many others, it is insufficient capacity of treatment plants and/or of the water storage, conveyance and distribution system. Capacity constraints are often caused or exacerbated by high water losses, excessive domestic and industrial consumption rates, or hydraulic inefficiencies in system layouts and operation. Table 1: Estimated Water and Sewerage Service Coverage in 1994 (% of total Population) SERVICE COVERAGE WATER SOURCES WASTEWATER TREATMENT Service Area Population Water Sewerage Ground Surface Primary Secondary Million % % Water Water Treatment Treatment LARGE CITIES 12.6 100 86 12 88 93 83 > 500,000 Kiev 2.6 100 95 15 85 100 100 Odessa 1.1 100 90 0 100 100 65 Donetsk 1.1 100 90 0 100 100 96 Kharkiv 1.6 100 87 7 93 100 100 Dnipropetrovsk 1.2 100 85 2 98 80 60 Lviv .8 100 80 100 0 100 90 Zaporozhye .9 100 92 0 100 63 63 MEDIUM CITIES 100,000 - 500,000 8.1 95 85 66 34 83 80 SMALL CITIES 20,000 - 100.000 14.7 88 55 82 18 60 40 RURAL AREAS 16.9 22 12 96 4 10 5 < 20,000 TOTAL 52.2 71 53.5 31 69 55.7 53 Source: Information provided by the State Committee for Housing and Municipal Economy (SCHME) 27. Water contamination is a persistent and often justified fear. Although there is little official information, there are indications of public health problems related to contaminated water supplies. There are persistent reports of water contamination endangering public health, for example: recurring cholera incidents in Odessa and other places which might have been caused by contaminated drinking water; and cases of hepatitis in the Dniepropetrovsk area (Krivoj Rog and Pavlograd). Some of these problems may be attributable to the inflow of contaminated ground water during periods of service interruption. In some cities poor raw water quality and inadequate treatment result in taste and odor problems. Heavy chlorination used to treat polluted raw water has raised concern about Trihalomethanes and associated cancer risks. There is suspicion of heavy metals being present in the water supply. In the wake of the 10 Chernobyl disaster, concern of radionucleid contamination exists, particularly in the cities drawing their raw water from the Dniepro river. In rural areas ground water contamination raises concern, specifically with regard to nitrates. Throughout the country the quality of water has become an issue of public concern, as evidenced by occasional protests and the many plans for stepping up the distribution of bottled water to the population. Wastewater 28. Coverage for wastewater collection mirrors that of water supply. Overall, about 53% of Ukraine's population is connected to a sewer system; as in water, coverage is best in the larger cities where it is higher than 85%. Connection rates drop off significantly in smaller cities to 55% and in rural areas to approximately 12%. These low rates are not necessarily a problem as in many of these areas individual solutions such as latrines, septic tanks or soaking pits are probably more appropriate than conventional water born sewerage systems. There is, however, concern about the efficiency and state of repair of sewer networks. The age of many sewer systems and lack of maintenance encourage large infiltration of groundwater that evacuates both wastewater and rain water runoff. Overflows from combined sewer systems contribute to water pollution even in areas where wastewater treatment plants exist. 29. Wastewater treatment coverage is relatively high, but compromised by poor operation and maintenance. In the larger cities the level of biological wastewater treatment is 83% on average, ranging from almost 100% in Kiev to about 65% in Odessa and Zaporozhye. In medium sized cities the level of treatment is 80%. In small cities and rural areas the level of treatment goes down considerably, but as in wastewater collection, this may not be important as conventional wastewater treatment in rural areas may not be the most appropriate and cost effective solution. The state of repair and operation of many treatment plants are deficient. Many plants could be operated and maintained better to achieve higher removal efficiencies. Sludge management is an unresolved problem throughout the country. Lack of sludge stabilization and poor disposal practices lead to untreated sludge entering surface water and leaching into ground water and contribute significantly to the pollution of the aquatic environment. 30. Inadequate handling of industrial wastewater poses a particularly dangerous threat. On average 30%, in some places up to 80%, of the wastewater entering municipal wastewater systems is of industrial origin; it is often released with insufficient or no pre-treatment and as a result interferes with municipal wastewater treatment processes not geared for treating industrial waste. Also, municipal treatment plants are not designed to remove toxic substances; these then pass through the plant and are released into the environment in the effluent and sludge stream. D. Vodokanal Performance - Policies Governing Provision of Water and Wastewater Services 31. Traditionally, municipal or regional water and wastewater enterprises (Vodokanals) have been responsible for maintaining and operating water and wastewater services. Vodokanals may operate in one or several, smaller municipalities. Some of them function also as bulk water production and transmission enterprises providing water to other municipal or regional Vodokanals. The performance of Vodokanals varies, but compared to Western European and North American utilities, they suffer from low management productivity and operational inefficiencies. The following assessment reviews present Vodokanal performance and identifies the main issues and constraints, internal and external, which prevent Vodokanals today from becoming more efficient and productive institutions. 11 Governance Relationships and Issues 32. Local Governments have assumed control over water supply and wastewater services. The present institutional status of Vodokanals is determined by: the law of September 27, 1991 which establishes Vodokanals as legally independent state owned enterprises in charge of maintaining and operating water and wastewater; and the Local Self Government Act of 1992 which transfers responsibility for municipal services to local governments (Decree of March 12, 1994). These laws have brought about dramatic changes to the Soviet Era assignment of powers for sector management. The prime responsibility for providing services now rests with local governments. The decentralization process, however, is by no means complete. The State Committee of Housing and Municipal Economy (SCHME) and its regional (Oblast) agencies, before the decentralization clearly in charge of sector development and Vodokanals, have lost their former executive powers, but retain considerable influence, as SCHME still sets norms and standards for Vodokanal performance and is influential in the allocation of state subsidies. In most cities asset ownership and control over Vodokanals have been transferred to municipal governments, but there are many exceptions. In some cities (Dnipropetrovsk, Kharkiv, for example) regional (oblast) governments have assumed control over Vodokanals. In Donetzk, the state mining enterprise is providing water and wastewater services; in rural areas and smaller towns services are often provided by local organizations such as state farms or industrial enterprises. In several cities (Kharkiv and Poltava, for example) Vodokanals provide water services only, while wastewater services are operated by the municipal government directly. The decentralization also has raised issues of governance regarding the role and mission of Vodokanals and their relationship with local government and other stakeholders. 33. In spite of legal independence Vodokanal autonomy remains severely curtailed. The majority of Vodokanals now operate under charters which provide for legal independence, but they continue to have limited say on many matters that are crucial to their functioning. These limitations are remnants of the old system of central planning and pervasive state control, for example: (a) personnel policy is determined by national regulations and constrained by the presence of strong workers councils; (b) tariff setting is controlled by local and national governments; (c) funding of investments, and thereby investment decisions, are the responsibility of local and national governments - in fact Vodokanals are prohibited from investing in new facilities; and (d) state design institutes, construction enterprises and suppliers of equipment and materials work with little accountability to Vodokanal management. Also, in spite of their legal independence, most Vodokanal managers clearly remain subaltern to local government administrations. 34. Yet Vodokanals have unexpected opportunities which may jeopardize public interest. In spite of limited Vodokanal autonomy and wide control powers of local government, present legislation allows entrepreneurial Vodokanals managers to embark on initiatives which are not compatible with the public service obligations associated with the provision of water and wastewater. Two examples may illustrate this. One is that Vodokanals are allowed to retain up to 30% of revenues as "profits" to be distributed among Vodokanal management and employees, while they do not have the funds to maintain water and wastewater systems properly. The other is that some Vodokanals are pursuing commercial ventures - banks, hotels, real estate developments, bottling plants, for example - which run the risk of being money losers to the detriment of Vodokanal's primary responsibility. These actions point to a dangerous misunderstanding by Vodokanal management and municipal governments alike concerning the obligations and responsibilities inherent in the provision of public service with natural monopoly features. The notion of Vodokanal commitment and accountability to the public interest - the provision of safe and reliable services to the population at the lowest possible cost - is largely absent from the present debate on the future respective roles of Vodokanals and municipal government. This is reinforced by the fact that Vodokanal charters do not include any performance obligations that commit them to efficiency and public 12 service. Clearly, the definition of the respective role and obligations of Vodokanal and local government is a matter of urgent priority to safeguard the interests of the rate paying public. Organization, Management and Administration 35. Organization: Production oriented and highly centralized. Vodokanals understand themselves as purely technical production oriented organizations. They employ significant numbers of generally well prepared technical specialists, often doing an admirable job of keeping old facilities running in spite of insufficient funding for repairs and replacement. Non production related activities - planning, financial and commercial management, for example - are small by comparison and have lower priority in the organization. The Vodokanal internal command structure is highly centralized and line managers have limited autonomy and few incentives to perform well. 36. Staffing: Compared to international standards, Vodokanals are severely overstaffed. The ratio of employees per 1000 population served ranges from 2.5 to 4.0, compared to ratios below 0.5 for efficient utilities in market economies. Some of the overstaffing is caused by Vodokanal involvement in non-core activities: for example, large construction departments or production facilities for equipment and materials and social services for their employees. These activities, incompatible with market economy principles, should be spun off to the private sector as soon as a market develops, or turned over to social agencies. Other reasons for high Vodokanal staffing include: low level of automation, inefficient administration and the state mandated requirement to provide jobs for otherwise unemployable people. Staff reductions, absolutely necessary to improve Vodokanal productivity, will require lifting various restrictions and norms which today force Vodokanals to employ many more people than needed. Overstaffing is not a pressing financial issue today, but it will become one in the future as Vodokanals have to raise wages to retain and attract quality personnel. 37. Wages: Low wages lead to loss of most valuable employees. The average wage for a Vodokanal worker is around US$ 20.0 per month; management salaries are in the US$ 30.0 to US$ 40.0 range. Total remuneration, including benefits, may be three times as much. Labor costs account for only 5% - 10 % of total costs for most Vodokanals. While the low wages keep operating costs down, they don't allow Vodokanals to retain high quality labor. Unless Vodokanals increase wages and improve their personnel policies to make employment conditions more attractive, they run the risk of loosing their best workers and not being able to replace them. 38. Management and Information Systems: Inadequate in providing timely and adequate information for planning and control. Most Vodokanals still operate accounting, management information and financial systems manually. These systems do not generate the information needed for modern utility management. The introduction of appropriate computer based management and control system, particularly accrual type cost accounting systems meeting international standards, would enhance Vodokanal management and administration. 39. Planning: In this area Vodokanals are particularly deficient. During the Soviet era and still today, a set of rigid, often unattainable, centrally decreed norms, which translated into the "plan, " have governed all aspects of Vodokanal management and operation. Today, the ills of the old planning system are magnified by the uncertainties facing Vodokanals (high inflation, unclear tariff policy, availability of investment resources). Under these conditions, planning beyond the short term has largely meaningless exercise. The introduction of multi-year business planning, based on reliable data and realistic expectations, is among the most important prerequisites for better Vodokanal performance. 13 Finances and Tariffs, Customer Relations 40. Finances: Revenues do not cover operations and maintenance expenses, yet Vodokanals report "profits." Vodokanals hardly raise enough revenues to pay their employees and fund the most urgent operating expenses. Vodokanals today lack the financial capacity to meet even the most pressing obligations. Yet many Vodokanals report up to 30% "profits" on revenues generated by underfunding maintenance and operation and by foregoing payment of bills to other state enterprises. "Profits" are used primarily to augment the income of Vodokanal management and staff through bonuses or funding of social benefits. Clearly, the notion of "profits" needs to be reexamined within the discussion of future Vodokanal governance. 41. Operating costs: Costs need to rise dramatically, but the rate of growth could be checked by increased Vodokanal productivity. For many Vodokanals, electricity costs represent the highest cost element and may amount to up to 70% of total operating cost. Maintenance and repair costs account for about 30% of total cost, while low wages keep personnel costs to as low as 5% of total expenditures. In the future, Vodokanal expenditures are likely to rise dramatically for all cost categories. Electricity prices will increase further as energy costs continue their climb to international levels. More funds need to be devoted to improve maintenance and to repair existing facilities. Personnel costs will have to increase to retain and attract qualified managers and staff. Productivity gains through for example, staff reductions and improving operational efficiency (reduction of water consumption and system losses, energy savings) have a large potential to reduce the growth of operating costs. 42. Tariffs: A huge discrepancy exists between domestic and industrial tariffs. Table 2 shows May 1994 tariff levels for some cities. Domestic tariffs controlled by the national government are very small - less than US$ .01/m? equivalent -, while industrial tariffs, under the control of local government, tend to be exorbitantly high by comparison - up to US$ .68/rn equivalent. Domestic consumers, using on average more than 50% of the water produced, contribute only some 5% of Vodokanal revenue. The high degree of subsidy by industry to domestic consumers is the reaction to price controls on domestic tariffs and the perception that raising industrial tariffs is politically less painful. As most industries stay afloat only through government subsidies and loans, many Vodokanals are in reality funded by government subsidies via industry. As many industries are likely to loose their present subsidies or may have to fold all together, Vodokanals cannot keep relying on industry as the main source of their income. Table 2: May 1994 Water and Sewerage Tariff Schedule (Kbr/m3) City Domestic Industry Communal Average Cost Donetsk 170.0 6000.0 6000.0 624.0 Dnipropetrovsk 138.0 7380.0 3690.0 n.a. Kharkiv 135.0 17420.0 7080.0 978.0 Kiev 151.0 30710.0 3810.0 n.a. Lviv 130.0 21300.0 2880.0 1291.1 Zaporozhye 131.0 8876.0 3405.0 997.0 14 43. Excessive reliance on industrial tariffs create conflict of interest. In many cities, industry is the predominant customer of Vodokanals for water supply and wastewater, with a built-in conflict of interest problem. On the one hand industry is the only reliable revenue source which keeps Vodokanals afloat; on the other hand it makes it more difficult to enforce industry's obligation for proper treatment of industrial waste. The consequence is that toxic materials in industrial wastewater, not removable by Vodokanal wastewater treatment plants, reach the country's water resources. Clearly, the present lopsided Vodokanal - industry relationship must be reexamined to allow Vodokanals better enforcement power over industrial wastewater discharges. 44. Government plans to increase domestic tariffs: an important step in the right direction, but not enough. The Cabinet of Ministers Resolution, No. 93, dated September 15, 1994 proposes gradual tariff increases to allow domestic tariffs to cover the full cost of production (operating costs without investments) by 1996. While this is certainly a step in the right direction, domestic tariffs must be increased further turn Vodokanals into financially viable institutions capable of maintaining and operating facilities adequately and raising resources for investments for improving services to the population. 45. Access to Credit: Lack of credit poses a major obstacle for Vodokanals to raise funds for urgent investments. The economic downturn and fiscal constraints have led to a virtual disappearance of investment funds for Vodokanals. The national and local governments still include investment subsidies to Vodokanals in their budgets, but scarcity of resources limits disbursements. The absence of any domestic credit facilities makes it next to impossible for Vodokanals to raise financing for investments, even if they had the financial capacity to qualify for loans. Unless the government finds ways to open up credit to Vodokanals, there is the risk that water and wastewater services will deteriorate to the point that public health and economic activity requiring water are in danger. 46. Customer relations: Vodokanals have no direct link to domestic customers. The great majority of people in the cities live in large apartment blocks administered by municipal housing authorities (Zhecks) who inter alia collect fees for water from individual tenants and pay Vodokanals. Individual apartments are unmetered, and water bills are based on normative rather than actual consumption. Traditionally, Zhecks have been slow in paying Vodokanals and negligent in repairing leaky sanitary fixtures, a major cause of excessive water consumption by domestic users. Absence of consumption metering and a cut off policy for non payment prevents Vodokanals from undertaking water demand management efforts to encourage more careful water use by domestic consumers. Innovative approaches will have to be devised to introduce consumption based billing to generate more revenues for Vodokanals and reduce water wastage by domestic consumers. Maintenance and Operations 47. Insufficient maintenance is partly responsible for premature deterioration of facilities. The Soviet era system of planning and allocation of resources favored the construction of new facilities and increasing capacity at the expense of maintenance. As a result, most Vodokanals are saddled with poorly functioning and badly deteriorated systems in dire need of rehabilitation. The desperate financial situation of Vodokanals precludes funding for urgent maintenance/repair requirements, with the consequence that many systems may be allowed to deteriorate to a point where the only choice is replacement. 48. Inefficient operation drives up both operating and investment costs. Insufficient concern for efficiency in operations expresses itself in a variety of ways, including: excessive system leakage - Most Vodokanals loose 30% to 50% of their water through leaks caused by deteriorated pipe networks; high rates of water consumption - Domestic and industrial users consume significantly more water than their 15 counterparts in many Western European countries (Vodokanals report per capita consumption levels of up to 450 1/day, while most Western European water utilities provide 200 1/cap/day or less); inefficiency of water system - Throughput of water networks is impaired by hydraulic inefficiencies which lead to high energy requirements; excessive inflow/infiltration (I/I) into sewer systems - Many sewer systems suffer from high I/I which in turn diminishes system capacity and increases the hydraulic load on wastewater treatment plants; low input and process efficiency of plants - Water and wastewater treatment plants have high input requirements (electricity and chemicals) which can be traced to inefficient equipment and insufficient process control; and poor sludge handling and disposal practices - an important source of surface and ground water contamination throughout the country. 49. Causes for inefficient operations. The poor state of system repair and functioning is the result of several interrelated factors, including: (a) systematic underfunding of maintenance and repair in Vodokanal budgets; (b) insufficient concern for system efficiency created in part caused by low costs of inputs - electricity and chemicals; (c) inappropriate designs with insufficient attention given to efficiency of operations and disregard of life cycle costing principles; and (d) use of poor and inappropriate equipment and materials and substandard construction. System rehabilitation, operational improvements and better maintenance will have to become important priorities in future resource allocation. They have the potential for yielding significant returns by reducing the growth of operating costs and allowing the postponement of system expansions. Realizing these return will, however, require addressing of the root causes which prevent Vodokanals from adapting more cost effect resource allocation strategies: institutional relationships encouraging responsibility and accountability and investment policies grounded in cost-effectiveness considerations. E. The Challenge Ahead 50. There is a need to raise and allocate resources efficiently in a period of political transition and resource scarcity. Ukraine will have to spend large resources over the extended future to prevent the further deterioration of existing municipal water and wastewater systems, maintain and expand adequate services to its people, deal with water shortages and protect surface and ground water from further pollution. These investments, US $ billions over the foreseeable future, will have to be initiated in a difficult period of Ukraine's history. Improving water and wastewater services, water management and environmental protection are important, but only one of the many crucial issues which need to be addressed and which require financial resources. Given the resource scarcities that will face the Ukrainian economy for years to come and the need for fiscal responsibility, investments for water and wastewater will have to be selected carefully with cost effectiveness and affordability as overriding criteria. This will require the formulation of clear and realistic objectives, making choices and selecting priorities and identifying investments which meet these objectives at the least possible cost. 51. Cost effective decision making requires appropriate incentives in terms of institutional responsibilities and sectoral policies. The ability to make cost effective choices depends on the capability of institutions with responsibility for the water sector and the policies and practice which determine their decision making. The preceding assessment of institutional performance and policies governing municipal water and wastewater and water resources management points to the urgent need for reforms of present attitudes, institutions and policies. The political and economic reform process already initiated by the government provides the opportunity to replace the old order with new structures and ideas which promise more efficient sector performance in the future. Fortunately Ukraine is blessed with a large number of highly qualified sector professionals ready to absorb new ideas and work hard towards a more efficient system of water management. Also, the international donor community is becoming increasingly more prepared to lend assistance in this endeavor. The challenge for the 16 government is then to create the policies and incentives which would lead to: * the introduction of water management institutions and policies which lead to more equitable and efficient allocation of a scarce resource, better environmental protection and cost-effective use of financial resources. * the emergence of well managed, efficiently operated and financially self-reliant Vodokanals capable of providing safe and reliable water and wastewater services at a cost affordable to the population; 52. Failure to reform would lead to continued service deterioration and inefficient use of scarce resources. Failure to remove the obstacles and constraints which today inhibit the development of a more efficient water management and municipal water and waste sector would have disastrous consequences. Failure to invest in system repair, maintenance and proper operations brings the risk of premature physical collapse of existing systems and continued deterioration of present facilities. This would lead to public health problems and accelerated contamination of the country's water resources. Failure to introduce efficiency and cost effectiveness in Vodokanal management, administration, operation and investment selection would lead to unnecessary waste of scarce resources. Likewise, failure to channel investments in water management to the highest priority undertakings results in the misuse of funds. Raising the resources necessary to maintain and improve water and wastewater will have to become the responsibility of service beneficiaries. Refusal by the government to allow Vodokanals to charge appropriate rates to domestic consumers would condemn these same consumers to poor service. Dedicated reform towards efficiency would benefit both the government and the consumer as it would lead to more productive use of financial resources and reduces "waste." 17 III. TOWARDS A MORE EFFECTIVE SYSTEM OF WATER MANAGEMENT 53. Fundamental reforms are needed to introduce more effective and cost conscious management of water resources. The assessment of the water management presented earlier in this study (Section II. B) points to the need for wide reform of the present policies, regulations and institutions. Unless the present system of water management with its reliance on unattainable standards and norms and insufficient regard for economic and efficiency concerns is reformed, making sufficient water available for the country's industries and citizens and at the same time checking the degradation of the aquatic environment will be impossible. The following provides suggestions for how the reforms could be devised and implemented. A two pronged strategy is proposed: one aiming at comprehensive long term reform and the other for bringing about action in the immediate term. A. Long Term Action - Institutional Reorganization and Redefinition of Policies 54. Inter agency task force to derme and guide implementation of future water management system. The present water management system needs to be reorganized in its entirety to allow the "best use"of water resources. The design and implementation of a new balanced system of regulatory instruments, laws and institutions, the introduction of comprehensive and participatory river basin planning and management as proposed at Dublin in 1993 (para.23) and the development of an adequate professional capacity to make the new system work will take a long time, possibly a decade or more. But the work towards the design of a new system of water management could be initiated immediately. To this effect the Ministry of the Environment (MEP), the agency with primary responsibility for water management, may consider the creation of an inter governmental water management task force to discuss and decide on a future framework for water management. The task force, under the leadership of MEP, would be comprised of representatives of the main stakeholders in water management - water users, local government, SCHME, SCWR, MOF, river basin agencies, professional organizations, and non governmental-organizations. The responsibility of this Task Force would be to: * devise a comprehensive framework of new institutions and policies meeting the criteria of modem water management; * specify a plan of action with a time table to implement the new water management institutions and policies and practices; and * guide and monitor the implementation of the new system (programs of institutional reorganization and strengthening, training of personnel, etc). 55. Implementation requires sustained effort over years and foreign assistance. Mapping out the new system of water management and implementing it will take years to accomplish. It will involve the passing of new laws and regulations, creation and strengthening of new institutions and building professional capacity. Also, as many of the concepts of water management are new to Ukraine, it would depend on advise from abroad. In the mean time, urgent problems related to water shortages and water pollution need to be addressed. The following presents suggestions for pragmatic and cost effective approaches to deal with them. 18 B. Immediate Action Dealing with Water Shortages- Conservation and More Equitable Allocation of Existing Resources Define the Extent and Cause of the Problem and Develop Affordable, Cost Effective Solutions 56. Shortage of financial resources prohibits expensive water resource developments. Many communities located away from major rivers or water diversion schemes attribute poor water services to lack of adequate water resource. With costly water resources development schemes - large dams or interbasin transfers - out of the question for lack of financial resources, less expensive solutions must be found to satisfy the people's demand for adequate water supply and the needs of other water users. These solutions, based on the realization that water short regions will have to make do with the water resources available, will require innovative and possibly second best solutions. 57. First step is to define the causes of inadequate water supply. The first task towards a solution would be to clearly define the problem at hand. Insufficient supply of water for domestic use can be attributed to a variety of reasons which alone or in combination are the causes of the poor supply. They may be a: (a) a capacity problem (treatment, transmission, distribution, storage) unrelated to the availability of raw water; (b) a water quality problem either induced by pollution of existing resources or related to natural contamination of sources, frequently the case of ground water; (c) an efficiency problem (excessive amount of water use) in which case bringing down water consumption by demand and fixing leaks may go a long way to make existing sources go further; (d) a resource problem (there is just not enough water available, even if none of the above problems exist); and (e) an allocation problem, as competing water users don't leave enough water. 58. The solution depends on the cause of the problem. If the cause of poor supply is a capacity or an efficiency problem internal to the Vodokanal, measures correcting these problems are in all likelihood the most effective solution. In this case, actions that can be taken by Vodokanals themselves - expanding the capacity of the existing water system and reducing water consumption through water demand management and leak reduction - are an obvious first step. If the cause is a water quality problem, insufficiently treated industrial or domestic wastewater discharges which render existing water source unusable, the indicated solution may be removing or lessening the pollution. If the cause is an allocation problem, i.e. industry and agriculture crowding out municipal water supply, reallocation of water may be needed to free water for domestic consumption. Only after proper analysis has ascertained that poor water supply is indeed the result of a resource shortage, is the solution left to develop more water resources. This may require reliance on as yet untapped water resources within the envelope of financial resources available, construction of local impoundments to store surface water or tapping ground water sources, even if treatment is needed. Any decision would require detailed study of the regional hydrologic conditions, water use patterns and the efficiency of the local Vodokanal. Undertake Programs to Assist Afflicted Cities and Regions 59. SCHME, MEP, SCWR and international donors to cooperate to provide relief. To remedy water supply problems presumably caused by water shortages may be possible through the coordinated effort of: * SCHME by dealing with Vodokanal inefficiencies; * MEP and SCWR and other agencies involved in water management by undertaking a detailed study of hydrologic and water use patterns and identifying cost effective solutions to make more water available, if indeed poor water supply is a resource supply problem; and 19 * the international donor community by funding studies, technical assistance programs and urgent investments. 60. Implementing the most cost effective solution most likely will involve water resource reallocations and liberation from present norms. Most likely resolving the problem will involve a combination of the partial solutions outlined above. Thus, improving water supply services depends on the concerted action of all of the stakeholders involved, including other water users which may be required to give up some of their traditional water allocation and Vodokanals which should undertake water demand management and leak reduction programs. This approach demands an integrated and innovative way of looking at water management which is incompatible with prevailing norms and practices. Therefore, a prerequisite for cost effective water management will be the replacement of present norms and standards with more flexible and realistic design parameters appropriate for local conditions. C. Immediate Action Dealing with Water Pollution- Interim Policy based on Cost Effectiveness, Priority and Affordability of Investments Selecting Investments on the Basis of Cost Effectiveness 61. While the inter agency task force (para. 54) defines future water management policies, an interim policy for identifying and funding investments in wastewater treatment is proposed. This policy would be based on the principles of priority, cost effectiveness and affordability. 62. Pool resources for investments on priorities, "hot spots". The issue is to determine how scarce resources available for investments in wastewater treatment can be allocated to obtain optimal benefits in terms of downstream water use and environmental concerns. In place of the present uniform ambient water quality and effluent standards approach, it would be more cost effective to pool resources to concentrate investments on removing the most urgent pollution discharges, "hot spots." A pollution "hot spot" denotes discharges which have an irreversible and particularly negative effect on the value of a water resource, for example: toxic waste with direct effect on public health and irreversible consequences for the environment; severe pollution upstream of important raw water intakes; or pollution to areas of special environmental concern, nature reserves or tourist areas. Most likely, "hot spots" are associated with toxic industrial wastes or large scale domestic pollution from large cities. Domestic waste discharges from smaller cities most likely don't fall into the "hot spot" category. Once identified, "hot spots" can be ranked in terms of the severity of their impact on downstream water quality and use. It follows that scarce investment resources available for wastewater treatment should be allocated in accordance with a list of ranked "hot spots". 63. Identify and rank "hot spots", an immediate task for environment and water resources agencies. Although dispersed and often inconsistent, there is a large body of information on water pollution, ambient water quality and discharges. Carefully collected and analyzed and enhanced by additional monitoring, this information could provide a good picture of water pollution and its origin. Some of this work is already going on with the assistance of foreign donors, most notably USAID and CIDA. What is needed now, however, is to use this information to identify "hot spots" and rank them in accordance with the degree of negative impact they have on water use. Ideally mathematical water quality modelling should be employed to accurately evaluate the effect of pollution on receiving water and water use, but careful qualitative analysis could provide a reasonable first identification and ranking of "hot spots." MEP with the coordination and cooperation of other agencies involved in water management should undertake the assessments and analyses needed to produce a list of ranked "hot 20 spots". 64. Avoid investments in advanced treatment unless special justification exists. The marginal benefits of wastewater treatment tend to diminish with the marginal cost of wastewater treatment. In an environment where available resources are not sufficient to address even the most urgent "hot spots" simultaneously, this means it is most likely more cost effective to provide more "hot spot" locations with less advanced treatment than less locations with more advanced treatment. For example, in Zaporizhzhza, it would most probably be more cost effective to provide secondary or even primary treatment to the 50% of the wastewater that does not receive any treatment today than providing tertiary to the other 50% of the wastewater which already receive secondary biological treatment. As a general principle investments in costly advanced treatment should be avoided, unless special justification exists. The resources advanced treatment would require can probably be applied more effectively by supporting lower level treatment where none exists today, upgrading and improving the operation of existing plants or tackling particularly damaging sludge problems. 65. Minimize investment costs for municipal wastewater treatment plants. Other means of making investments in wastewater treatment plants more cost effective that should be considered include: * upgrading existing plants rather expanding or building new ones: many Vodokanals operating secondary treatment plants report BOD reductions down to the 20 mg/l to 30 mg/l range. With better operation and process control the treatment efficiency of existing plants could be reduced further without the need for capacity expansions, while at the same time lowering operating costs; * phase any investments to avoid spedding scarce resources on over capacity; * reduce hydraulic load on wastewater treatment plants by encouraging Vodokanals to reduce water consumption through demand management and infiltration/inflow into the sewer system; this could be a clear win-win strategy as it would reduce operating costs and postpone the need for expansions of both the water supply and wastewater system; and * use appropriate and working technology, particularly with respect to sludge stabilization and disposal, to increase plant reliability and reduce operating and investment cost. 66. Better control of discharges from industry into municipal wastewater systems. As industries discharging into municipal wastewater are among the worst offenders special attention is necessary. Insistence and enforcement of pretreatment requirements are crucial. Also end-of-pipe solutions should be avoided and win-win strategies employed: for example, restructuring an industrial process to reduce wastewater emissions may be more cost-effective than treatment; investing in adequate industrial waste pretreatment may be preferable to upgrading municipal treatment to accommodate industrial waste. Specific Policies Regarding Vodokanals 67. Vodokanals expected to make reasonable effort within the limits of affordability. Vodokanals should be exempted from the present excessive effluent requirements which they are not able to meet for lack of financial resources. They should, however, be expected to use their own resources to: (a) properly maintain and upgrade the performance of their existing treatment plants to meet best technology standards; (b) provide at least primary treatment to all of their wastewater within a specified period of time; (c) provide full secondary biological treatment of all wastewater in the longer term future, when their financial capacity permits; (d) design and implement measures for environmentally friendly sludge handling and disposal; and (e) come to more secure arrangements with industry to ensure adequate 21 pretreatment of industrial waste entering municipal wastewater systems. 68. Vodokanals identified as "hot spot" polluters to receive government assistance. Vodokanals would not be expected to commit themselves beyond the obligations spelled out above. If a Vodokanal discharge is, however, classified as a " hot spot" - for example, a large city without secondary treatment discharging into sensitive receiving waters - and investment requirements exceed the present financial capacity of the Vodokanal, environmental funds should provide financing. 69. Permits, fees and fines. Vodokanal obligations regarding investments in wastewater treatment should be confirmed in permits issued by environmental authorities. In negotiating these permits Vodokanals and environmental authorities should recognize the principles outlined above. Vodokanals would be expected to pay meaningful, but affordable fees for using water resources and charged stiff fines in case they violate the new less ambitious standards for wastewater treatment. 70. MEP to issue interim policies and guidelines. The proposed policies are fundamentally different from existing policies and practices. However, their adoption is essential to acknowledge limits on Vodokanal finances and to signal the need for cost effectiveness in allocating funds for wastewater treatment plants. The Ministry of Environmental protection should develop interim policies and issue guidelines to that effect. D. Implementation of Reforms - Next Steps 71. MEP, the lead agency for dealing with water resources management and water pollution should initiate the reforms outlined above. Specifically it should: * convene the Inter Agency Water Management Task Force and elaborate the comprehensive plan for the long term institutional restructuring and policy reform of water resources management (para. 54) and guide its implementation, in accordance with a plan of action; * identify and rank "hot spots" using qualitative analysis based on an inventory of polluters and ambient water quality and water use criteria; * prepare and issue interim policies and guidelines dealing with water resources management (paras. 56 -59), investments in municipal wastewater treatment (paras. 62 - 66) and Vodokanals (paras. 67 - 69); and * assisting individual Vodokanals in the upgrading of wastewater treatment facilities and controlling industrial pollution. 22 IV. RECOMMENDATIONS FOR A PROGRAM OF VODOKANAL STRENGTHENING AND REFORM OF THE MUNICIPAL WATER AND WASTEWATER SECTOR A. The Vodokanal of the Future and Outline of Reforms Proposed 72. The purpose of the "future" Vodokanal would be to provide reliable and safe water and wastewater services to the people at the least possible cost. The Vodokanal of the future would strive to be an efficient institution in terms of its management, administration and operation. It would have a streamlined management structure with clearly defined lines of accountability providing employees with the incentives to work with productivity and initiative. The Vodokanal of the future would have far less people than it has today, but it would maintain a competitively paid high quality staff. It would have a computer based management system and use multi year business planning to guide and control its operations. It would concentrate on its core business - water and waste water - and not get involved in risky commercial ventures. The new Vodokanal would be a commercial enterprise. Consumers would be expected to pay a fair price for safe and reliable services. Vodokanals would strive for high system efficiencies, reduce water losses and, together with consumers, work towards conserving water, all in an effort to keep operating costs as small as possible. The new Vodokanal would have wide autonomy over its investments and undertake only least cost and priority works. 73. Vodokanal internal reform and strengthening and sectoral policy adjustments are needed to realize goals. The definition, design and implementation of the institutional restructuring and strengthening measures which would be needed to turn Vodokanals into the model enterprise depicted above will require a sustained effort which can be divided into two broad categories. The first comprises those actions which Vodokanals can undertake on their own authority and initiative. Examples for such actions are the introduction of a computerized information system or the implementation of a leak detection and reduction program. Expert technical assistance may be needed to accomplish these tasks efficiently, but such efforts would be within the present decision making capacity of most Vodokanal managers. Most of the actions, however, will be impossible without changes to the set of policies and practices external to Vodokanals. For example, Vodokanals cannot acquire sustained financial viability without a change in the prevailing tariff policy. The second category of action, therefore, comprises adjustments to those circumstances which are out of the reach of Vodokanals management or even local government. Strengthening the institutional capacity and efficiency of Vodokanals can be successful only if carried out in an environment which enables and encourages change. Without this enabling environment the most sincere efforts of Vodokanals to improve their management and operations, the best conceived and executed technical assistance program, will bring only marginal results. 74. Main elements of a program of sectoral institutional and policy reform. To provide the incentives for Vodokanal reorganization and strengthening, the following broad changes to the present institutional and policy framework are suggested: * creation of an institutional framework enabling Vodokanal reorganization and strengthening, including the participation of the private sector; * adoption of cost recovery, commercial policies and practices which allow Vodokanals to become financially self-sustaining institutions; * creation of credit facility to provide finance for priority investments; * introduction of investment planning, selection, design and implementation policies and practices 23 based on cost effectiveness and affordability; * improvement of support services to Vodokanals, including human resources, consulting and contracting, material and equipment supply and non-governmental organizations; * adoption of more cost effective and affordable water resource management and environmental protection policies, as already outlined in the preceding Chapter. B. Vodokanals and Enabling Institutional/Regulatory Framework Choosing the Most Appropriate Institutional Option 75. Public vs. private options: Engaging private sector operators would be the fastest way to improve Vodokanal efficiency, but not yet a generally available option. There are three main options for ownership of sector assets and responsibility for service management and operation: (a) public ownership and management; (b) public ownership with operation contracted out to the private sector; and (c) private ownership and operation under a regulatory framework provided by government. Throughout the world, there is a strongly growing trend towards the increased participation of the private sector in the management and operation of water and wastewater enterprises and increasing reliance on private finance for sector investments. Numerous examples of past failure in public provision, combined with growing evidence of more efficient and user friendly management by private sector operators, argue for a significant increase in private involvement in management and financing. Engaging international utility operators to help in the reform and strengthening of Vodokanals would certainly be the fastest and surest way to turn them into the efficient organizations depicted earlier. However, such operators are reluctant to enter business in countries in transition, including Ukraine, for lack of a private sector friendly business environment. Also, the country's sector community, unaware or skeptical of the advantages private operators can offer, still shies away from supporting private entry in the management and operation of Vodokanals. 76. Nevertheless, the Government should promote pilot operations involving international private sector operators. In spite of the absence of a private sector friendly environment, some international operators are prepared to undertake pilot operations with reform minded local governments. Most likely, the preferred mode of involvement would be initially a management contract (i.e. a private operator takes on the management and operation of a Vodokanal under contract with local government). Among the many options of private sector involvement (Box 1), such a contract would be the most attractive as it exposes the operator to a minimum of financial risk. Other options, concession contract or BOT arrangements which would require bringing in private investment funds, will not be attractive and feasible, at least not until the Ukrainian economy stabilizes and provides incentives and securities for foreign investment. Concluding a few, or just one management contracts would greatly enhance the future development of the sector. It would not only bring immediate benefits in terms Vodokanal productivity improvements in the cities undertaking the effort, but as importantly introduce foreign expertise and know how which can be observed by and transferred to other Vodokanals. Private operators customarily will retain staff and invest heavily in training them for their new tasks. This way existing Vodokanal managers and staff are given the chance to be trained in modern utility management and operation practices, which they could spread to other Vodokanals. 24 Box 1: Options ror Private Sector Participation In Municipal Water Supply and Wastewater Services Private sector companies can be brought in to manage, operate and provide investment capital for the development of water and wastewater services in different ways. These vary by their scope and the extent of responsibilities and risks assumed by the private firm and the contracting authority. The number of arrangements involving the private sector have risen dramatically in recent years, as local governments responsible for service provision have increasingly come to realize that private management and operation of water and wastewater systems can bring better services and higher productivity and private investors can provide capital for investments under attractive terms. Under a service contract, a utility hires a private firm to carry out specific tasks (eg. leak detection, meter reading, water quality measurements) while retaining full responsibility and risk for service provision. Subcontracting is especially advisable for activities that have large peaks (for instance, construction), or when the in-house level of activity is insufficient to reach an efficient scale of operation (for instance, water quality laboratory, or vehicle fleet maintenance). Even for other activities (for instance, meter reading) private contractors working under competitive pressure are often more cost-effective than utility departments. A management contract is a service contract where the utility or its local government owner hire a management team from a private firm. It can be used to bring in new management systems, organization and skills, or as a preliminary step to restructure a dilapidated utility before a concession. Compensation is cost-plus-fee, and the contracting municipality retains most of the operational and commercial risks of the utility, though some risk-sharing may be built into the contract using performance bonuses or contingent fees. In a lease contract, a private firm takes over the operation and maintenance of the system, collects user charges, and is compensated with an agreed portion of the revenues. The municipality remains responsible for system expansion and replacement of major assets and recovers part or all of its costs from its own share of user charges. The lease holder may also administer investment funds as agent to local government without taking related financial risks. In concession or build-operate-transfer (BOT) and similar schemes, private investors arrange the financing and construction (or rehabilitation) of either a self-contained facility (eg. a treatment plant) or a complete water/sewerage system, then operate it for the period of the concession. For a treatment plant-type BOT. the investor is compensated by the public utility under a "take-or-pay" obligation, and the public utility retains the commercial relationship with the end- users and assumes the related risks. In a system-wide concession, the investor bills and retains user charges for the concession period. Full private ownership (the model in England and Wales), involved the sale of all utility shares to private investors. A national agency regulates the performance of the private utilities and has jurisdictions over tariffs. Joint-venture companies in which local government and a private company share ownership have gained considerable popularity in Central and Eastern Europe. The joint venture may either own the assets or (most often) be given a franchise by the local government as in one of the lease or concession arrangements described above. An issue with joint venture arrangements is a built-in conflict of interests with the local government being on both ends of the franchise contract, as regulator, owner of the infrastructure and also a key shareholder in the operating company. The main issue here is how local governments would react to breech of contract by a firms that is panly owned by it. Nevertheless joint ventures seem to be the only feasible alternative for political reasons and there are some successful experiences with mixed-capital water enterprises, especially in Spain (eg. Alicante, Murcia). 77. The claim by some Vodokanals to have acquired "private status" is misleading. Some Vodokanal managers claim that with legal independence and gaining asset ownership - for example, by distributing vouchers for part or all of the assets to Vodokanal management and personnel - their organization would acquire private status. In practice, this notion is incorrect as such Vodokanals lack many of the characteristics fundamental to private enterprise: a competitive business environment; commercial risk taking; full responsibility for decision making; ability to raise capital. Providing Vodokanals with a large measure of autonomy, and even asset ownership, has the potential for raising productivity and initiative and should be encouraged. But Vodokanals will have to continue to work within a framework of accountability to local government to ensure that their actions are compatible with 25 a public service agenda. Also, private sector status, as claimed by some Vodokanals, is not enough in itself to make a Vodokanal work more efficiently unless it is accompanied by appropriate know how and technology. To provide this know how, the involvement of international operators is, at least initially, of prime importance. 78. General Recommendation: transform Vodokanals into public corporations under the regulatory control of local government. While the conditions in Ukraine are not yet ripe for turning Vodokanal management and operations over to the private sector, sector management will remain in the public domain. Experience throughout the world demonstrates that the public administration of services is most successful under quasi-private arrangements which allows management under commercial principles, wide decision making autonomy and financial independence. The public utility model meets these criteria best. The success of this model depends foremost on a clear definition of responsibilities and authorities among the main institutional actors and stakeholders involved and the existence of a framework of checks and balances which induces each of these actors to perform its obligations responsibly. The main actors and stakeholders involved are: (a) Vodokanals; (b) local government; (c) central government; (d) service beneficiaries/consumers; and (e) agencies providing services to Vodokanals. The following delineates the division of the main functions, responsibilities and obligations of these stakeholders. Annex 1 presents the suggested division of responsibilities in matrix form. Vodokanals - Manage and Operate Water and Wastewater Services under the Control of Local Government 79. Vodokanals are to function as autonomous quasi private agencies under the regulatory control of local government. Under a charter provided by local government, Vodokanals would manage and operate water and wastewater services as quasi private businesses, striving to become the efficient, financially self reliable and consumer friendly institution described earlier. Essential ingredients for autonomy include management control over: the company's internal organization, including the allocation of resources, financial and staff between departments and tasks; employment policies, hiring and firing, promotions, pay scales; financial management, budgetary matters, setting of tariff levels and structures; the investment cycle from planning through implementation; and contracting of services. 80. A corporate form of organization is recommended. To assure management independence Vodokanals should operate under a corporate form of organization - in the form of a limited liability or joint stock company. Even with Vodokanal shares in the hands of municipal government, such corporate status would subject Vodokanals to legal requirements similar to private firms. They would become subject to commercial and tax law and accounting principles and private labor laws and regulations. A corporate status would clearly establish Vodokanal independence while at the same time reaffirming the ownership role of local government. Except for very small towns, where the scale of operation (eg. 20 employees or less) does not justify creating a corporate structure, non corporate arrangements, such as direct management by administrative departments of the local or regional government, represent the worst possible institutional setup. Such an institutional structure should be avoided since it does not foster the accountability and ownership which Vodokanal management needs to perform efficiently and invites pervasive political interference. 81. Vodokanals need technical assistance to improve their productivity. The transformation of Vodokanals into well managed and efficiently operated water and wastewater enterprises requires not only require a new organizational structure or modem control and planning systems and training of management and staff, but also the introduction of new attitudes and an institutional culture promoting personal accountability and initiative. Efforts at institutional strengthening should thereby proceed under a strategic comprehensive plan and objectives which cover all facets of Vodokanal management and 26 operation. Limited action in one area of concern will not resolve the underlying structural problems and therefore ensure sustained efficiency gains. For example, the introduction of the most sophisticated accounting system is useless unless management has the knowledge, incentive and freedom to make the sometimes painful decisions which the information generated by such systems may suggest. Water and wastewater utilities throughout the world have undertaken large efforts to develop the efficient management systems and techniques now in use. There is no need to duplicate these efforts. The systems available to Western utilities can be imported and adjusted for local conditions and requirements through well focused technical assistance programs provided by foreign consultants or through twinning arrangements with foreign utilities. 82. Preserve/encourage economies of scale. Under the decentralization policy, even smaller towns now served by regional Vodokanals, could claim the right to run their water and wastewater systems independently. Economies of scale suggest, however, that regional Vodokanals continue to provide services to smaller cities. Economies of scale and the need for close coordination also suggest that water and wastewater services be provided by the same entity. Likewise, economies of scale argue for the preservation of regional Vodokanals as bulk suppliers of water to other Vodokanals. Similarly, regional solutions for dealing with wastewater - a regional Vodokanal could be the least cost solution to treating wastewater produced by local collection utilities - should be considered. Regional Vodokanals could be corporatized just like municipal Vodokanals under the collective regulatory control of the local governments they serve. The success of such arrangements is, of course, possible only if regional utilities can charge member municipalities fees sufficient to meet operating and investment costs. Local Government - Regulate and Supervise Vodokanals 83. Local government regulation is needed. Water and waste water services are natural monopolies which, in the absence of competition, require regulation by government to protect the peoples right to a good and cost effective service. Local government, as representative of the people, therefore has the obligation to exercise this control by: * setting the policies and objectives to ensure that Vodokanals operate efficiently and pursue a public service agenda; * supervising the performance of the Vodokanal with a right to intervene in case of poor or negligent conduct; and * retaining approval power over key decisions such as tariffs and investment programs; 84. Explicit performance agreement is the best vehicle for defining mutual obligations between Vodokanals and local Government. As the only or main shareholder of a corporatized Vodokanal, local governments retain large powers. It is vital that they exercise their control in a restrained fashion, concentrating on strategic matters. The corporate status of a publicly owned utility contributes to, but cannot guarantee, Vodokanal autonomy. Politically motivated interference and micro-management by local government are the main reasons why so many public utilities throughout the world are unable to fulfill their obligations for efficient service delivery. A successful way of keeping both Vodokanals and local governments to their roles is to anchor the obligations of both parties in performance agreements. Such agreements would contain multi-year business plans with specific monitorable targets such as service coverage, service quality, financial performance, investment objectives, rate levels, and operating efficiency indicators. An important element of the performance agreement would be automatic inflation indexing of tariffs to avoid frequent and open ended tariff reviews and provide Vodokanals with a predictable revenue stream. Such performance agreements, based on multi-year business planning, have 27 been found successful in structuring constructive utility - local government relationships in many cities throughout the world. 85. Local governments need to attain appropriate regulatory capacity. To negotiate and monitor compliance with performance agreements, it is essential that local governments acquire the technical capacity to supervise and monitor Vodokanals. To professionalize the regulatory oversight function as much as possible, local governments may consider entrusting these functions to professional advisory committees or utility commissions which can work out of the direct political spotlight. To acquire the regulatory capacity, local governments will need technical assistance. Box 2: Main Areas of Technical Assistance for Vodokanal Reform and Strengthening To develop into efficient water supply and wastewater utilities. Vodokanals will require extensive reorganization and strengthening which could be most effectively achieved by turning to the private sector or, if Vodokanal management is kept in the public domain with the help of appropriate external technical assistance and training programs. The main areas requiring attention include: Governance Relationships: Definition of appropriate corporate structure, elaboration of statutes, mission statement, performance agreements and multi-year business plan; if necessary development of action plan to shed non-core activites and contracting out of ancillary activities; Organization and Management: Restructuring of Vodokanal organization to introduce corporate culture with decision making power decentralized and stressing individual initiative and accountability; Management Information, Control and Planning Systems: Introduction of computerized accounting system meeting intemational accounting conventions; upgrade of all management, control and planning systems; initiation of multi-year business planning (technical, financial and institutional) as guide for Vodokanal reform and improving performance under transparent objectives. Staffing and Employment: Change of skills mix to strengthen non-engineering capacities such as accounting. financial management, planning, commercial and customer services; introduction of modern personnel management systems, including staff training; definition of employment conditions sufficiendy attractive to retain existing and acquire new qualified staff; Finance, Tariffs and Commercial: Installation of consumer friendly commercial systems (billing and collection) based on consumpton based billing; elaboration of financial and socioeconomic studies to define and implement appropriate tariff levels and structures, definition and initiation of demand management programs to reduce water consumption: elaboration of program to gradual introduction of metering for domestic water consumption Maintenance and Operation: Introduction of mechanisms and programs to institutionalize cost effective maintenance and operational practices, including energy and input audits to reduce input cost, rehabilitate and repair existing systems (leakage reduction and repair in water networks; control of infiltratiortlinflow in sewer networks; improve operational efficiency of systems and facilities; Investment Selection and Implementation: Creation of in house capacity to elaborate and evaluate investnent programs using modern investment selection techniques and manage implementation, including procurement and contract supervision. Central Government - Set Basic Policies and Facilitate Sector Development 86. Under the decentralized system of sector management central government acquires new functions. These include: (a) the definition of strategic sectoral policies and development objectives - investment strategies, cost recovery, resource mobilization, for example; (b) setting legal and regulatory 28 ground rules for the Vodokanal - local government relationship; (c) regulate inter-municipal matters - for example, policies and principles for water resources management and environmental protection and drinking water standards; (d) retain last resort authority to protect consumers against misuse and Vodokanal performance of monopoly position by Vodokanals and local government; (e) monitor sector development; (f) guide and facilitate the sector reform process by providing assistance to Vodokanals and local governments towards institutional reorganization and strengthening; and (g) coordinate and guide international assistance to ensure that such assistance is properly focused and supports the principles of sector reform. Service Beneficiaries/Consumers 87. Consumers pay cost covering tariffs in return for safe and reliable service. Consumers must pay for the services they receive and expect to be cut off for non payment. In return, it is the obligation of Vodokanals to provide a safe and reliable service at the least cost possible. Inefficient Vodokanal management and operation and wasteful investment choices lead to higher than necessary cost, which service beneficiaries should not be asked to pay. Consumers should have access to public information on the actions and performance of Vodokanals and the opportunity to voice their displeasure with poor performance and demand improvement. In cases of gross violation of efficiency principle they should be able to seek intervention from the national government. Support Services 88. Contract enterprises provide cost effective services fully accountable to Vodokanals. Enterprises, state owned or private, providing services to Vodokanals - planning and design, supply of equipment and materials, civil works - would be expected to provide a quality product at a competitive price. This can be achieved best under competitively procured contracts with Vodokanals. To ensure quality service, such contracts must clearly specify the quality of work expected and provide for recourse - penalties stiff enough to guarantee acceptable contractor performance. C. Cost Recovery Pricing and Commercial Practices Outline of a New Tariff Policy 89. Tariffs should provide for full cost recovery. Financing water and wastewater services from government budgets rather than user charges does not make them "cheaper;" it just moves the burden from the individual user to the taxpayer. Relying on subsidies from taxes tends to have undesirable effects in terms of equity and efficiency. Wealthier people who tend to use more water receive a larger subsidy per capita than poorer people using less water. Not requiring beneficiaries to pay the full cost of water leads inevitably to wasteful use. The high per capita consumption found in Ukraine and other central and eastern European countries illustrates this. In market economies covering the full cost of services directly from users through consumption related charges is widely recognized as the most equitable and efficient way to manage water and wastewater services. Some exceptions to this norm may be justified. For example, investments that have important external benefits, such as wastewater treatment at hot spots, may be subsidized by the state, or targeted subsidies may be required to keep an essential service affordable to the poor segment of the population. 90. Financial requirements, and therefore the tariff effort required, will be different for each Vodokanal. Most Vodokanals will need to increase tariffs significantly to address a growing backlog of deferred maintenance, address system inefficiencies and provide better service. The magnitude of these 29 increases will be different for each Vodokanal and depend on local conditions, such as: the current level of efficiency of administration and operations; the state of repair and need for rehabilitation; external standards and norms, particularly for waste-water treatment which Vodokanals will be forced to meet; ambitions and priorities of local governments and Vodokanals, as they choose the quality of service they want to provide to their constituents; the cost effectiveness of the investment program; and subsidies provided by local and national government. 91. Objectives of new tariff structure. In setting tariff levels and structures, utilities in market economies try to meet multiple objectives, including: * generation of revenues sufficient to fund maintenance, operation and investment cost; * signalling the cost of services to all consumer groups; * promotion of water conservation; and * assurance that low-income households can afford a lifeline consumption. 92. Main Elements of proposed tariff policy. The following lists the key policies and practices around which the new tariff policy should be formulated: * tariff setting authority is fully vested in local government; * increase tariff levels gradually towards full cost recovery; * link charges to actual water consumption to make tariffs equitable and induce water conservation; * progressive tariff structure to reinforce water conservation by consumers; * gradual reduction of difference between industrial and domestic tariffs; * depoliticization of tariff setting process by introducing formula based automatic increases to account for rising costs. Dealing with Affordability Constraints 93. Affordability will be an important constraint, but room for domestic tariff increases exists. The water and sewerage bill for an unmetered household of four, based on the standard monthly allowance of 280 Ipcd ranged between US$0.07-0.10/month (May 1994 values). This is about 0.4% - 0.7% of the average monthly income of urban households in Ukraine. This suggests that there is significant room for increasing domestic rates, despite arguments that current economic hardships make any increases unfair and inviable. The headroom is limited however in light of the price increases for other communal services such as heating, rent, electricity and hot water. Tariff increases for water and wastewater obviously cannot be decided in isolation from other increases in municipal services. 94. Mitigate effects of tariff increases to the poor through direct subsidies. Among the Ukrainian population income levels differ widely. Setting tariffs based on the ability to pay of the poorer segments of the population not only reduces the Vodokanal revenue generating capacity unnecessarily, but also leads to inequities as wealthier households which tend to consume more water would receive the highest subsidy. There are several ways of protecting the poor from unaffordable tariffs. One is to charge a low 30 rate for a "life line volume", perhaps for the first 10 m3 per month consumed by a poor household. As this strategy requires consumption metering, it is probably not applicable in most parts in the country, at least for the time being, the other strategy would require direct financial assistance by the government to those who can demonstrate need. The advantage of such a subsidy arrangement, although cumbersome to administer, is that tariff levels are not held hostage to the affordability limits of the poor population. The government is considering a scheme along these principles in the Cabinet of Ministers Resolution No. 23, dated February 15, 1994, on tariff adjustments. Metering and Commercial Practices 95. Introduction of universal metering of domestic consumption is a medium term goal, but difficult to achieve soon. Metering consumption is of crucial importance for improving Vodokanal efficiency and reducing water consumption. While installing meters for industrial consumers and single family houses is relatively inexpensive, retrofitting individual apartments in large apartment complexes is prohibitively expensive and impractical, as up to four meters would have to be installed to capture consumption of cold and hot water because of vertical plumbing arrangements. Innovative, unconventional ways must be found to meter apartment buildings. A first, relatively easy step would be to meter each apartment block and bill the block for water actually consumed, possibly using a progressive tariff structure prorated for the number of people living in the block. Another way might be to install a meter for each stairway (12-15 households) and apportion the water bill among households. Success depends on the willingness of individual households to cooperate towards water conservation as a common goal. Block metering in condominiums in Western Europe have shown that it can be successful in controlling consumption. To what extent this experience can be transferred to Ukraine remains to be tested. 96. Vodokanals and Municipal Housing Authorities (Zhecks) need to work together more effectively. In the absence of any realistic alternative to reaching individual households, the Vodokanal's ability to undertake block metering, introduce higher and possibly progressive tariffs and obtain payment will depend on the cooperation of the Zhecks, now responsible for maintaining sanitary installations, collecting utility bills and paying Vodokanals. The relationship between Vodokanals and Zhecks must be spelled out more clearly to make them more accountable to each other. This may mean higher incentive based payments to Zhecks for services in return for improved performance, collection efficiency, repair of leaky fixtures, campaigns to promote water conservation, for example. 97. Cut-off for non payment is essential. Discontinuing service to non-paying customers is standard practice for utilities in market economies. As a result, collection-to-billings ratios normally exceed 98%. In countries where cut off for non paying is not a credible threat, utilities are plagued with severe collection losses. Such losses can only be offset by imposing excessive charges on those customers who honor their utility bills, or by letting the service deteriorate. Cutoff for non-payment must become a real element of the Vodokanal-customer relationship. The Zhecks, Vodokanals and consumers, as they move toward a more market oriented environment, will have to come to terms with the fact that disconnecting non paying customers is the only practical way to recover costs without imposing an unfair burden on punctual customers. 98. Undertake appropriate studies and involve the public in making decisions on tariffs and commercial practices. The acceptance of higher tariff levels and new structures and new commercial practices depends on local circumstances and the reaction of service beneficiaries. Willingness to pay and affordability are main considerations. While the general principles presented in this chapter may guide future actions, specific decisions must evolve from a cooperative effort between a Vodokanal, local government and its customers. Before embarking on a specific course of action, Vodokanals may be well advised to undertake tariff and socio-economic studies and pilot experiments with public participation. 31 To avoid a negative reaction by the population, any tariff increases would have to be phased in gradually, particularly in areas where people are discontent with present services. D. Mobilizing Resources for Investinents 99. Ultimately, all investments should be self financed through internal cash generation and borrowing. The ability of the government to provide grant funding for sector investments has severely diminished and, as a result, sector investments have come to a virtual standstill. Even if the present economic crisis eased, going back to the old ways of subsidy financing wouldn't be efficient. The introduction of cost recovery from users remains an essential ingredient for the stabilization and recovery of the country's economy. In the future, the investment requirements of municipal services, including water and wastewater, must be met by a combination of Vodokanal cash flow, private equity, and prudent borrowing from commercial sources. The current weakness of Vodokanals, the absence of a private sector and the non-existence of domestic financial markets preclude these options for the time being. 100. Absence of local sources of finance for Vodokanals: a major obstacle for sector development. Even if Vodokanals were to be able to generate more local resources, the absence of any domestic sources of credit would prevent Vodokanals from raising funds even for their most urgent investments. Experience in other countries facing similar constraints has shown that this may lead to undesirable developments, some of them already taken place in Ukraine. Pressure on local governments and Vodokanals to invest may lead them to resort to unfinanced deficits and subsequently appeal for bailouts. Another possibility is the creation of municipal or enterprise owned banks. Experience with similar banks in Latin America has been disastrous on both investment quality and fiscal grounds. There is also the danger that Vodokanals and local governments eager to display initiative may enter into commitments with foreign suppliers for investments of dubious priority and excessive cost. 101. The present financial gap could be bridged temporarily by international financing institutions. To augment locally available resources, the government may consider using its guarantee authority to mobilize foreign loans from official multilateral, bilateral and possibly private sources. Obviously, such loans should be assumed only for the most urgent and highest priority projects which generate fast payback. The capacity of international lending institutions, such as the World Bank (IBRD), the Eastern European Development Bank (EBRD) or the European Investment bank (EIB), will not be sufficient to deal directly with all Vodokanals which might have an interest in borrowing. While they can work directly with a few selected Vodokanals, financial assistance to the remaining Vodokanals requires an intermediary arrangement. If the government wishes to make international funding available to more than just a few Vodokanals, it might consider the creation of a Municipal Credit Program designed to channel international funding to Vodokanals and local government. Under such a program, international loans and other resources would be provided to a local intermediary financing agency which would onlend external resources for projects meeting pre-agreed eligibility criteria. Such programs could fund not only investments in water and wastewater, but also in other municipal infrastructure. E. Investment Selection, Prioritization and Implementation 102. Resource constraints will force more cost conscious investment decisions based on urgent priorities. The old ways of selecting investments and allocating resources is no longer sustainable. Rather than emphasizing investments in new capacity, cost effectiveness and priority must govern the choice of investments. The more effectively resources are spent, the more efficiently the water and wastewater systems can be made to work, the faster will be the progress in providing better services to 32 the Ukrainian people. The following suggests some techniques and practices which could be considered in making future investment choices. Ways to Improve the Cost-Effectiveness of Future Investments 103. Making better use of existing systems. Rehabilitation and improvements in the operations of existing systems in many cases will be the most cost-effective option. The measures described below may not only decrease, or at least slow down, the growth of operating costs (particularly for inputs like chemicals and electricity), but also postpone future investments in capacity expansions: * reduce leakage from the pipe system through sustained programs of leak detection and pipe replacement and repair; * reduce domestic and industrial water consumption and thereby water production, transmission and distribution requirements' through programs of demand management; * reduce Infiltration/Inflow (I/I) into sewer systems to increase the carrying capacity of sewer networks and reduce capacity requirements for pumping stations and wastewater treatment plants; * improve energy and process efficiency of water and wastewater treatment plants - better process control and more efficient operations would reduce energy consumption and provide higher quality output; * improve hydraulic efficiency of pipe networks to promote energy savings and improved throughput capacity; and * improve maintenance - increased emphasis on maintenance may increase operating costs, but may save resources by reducing system downtime and by giving facilities a longer useful life. 104. Use cost effectiveness criteria in determining capacity expansions. The following practices promise cost savings: * integrated Vodokanal - industry planning: Industry internal investments to reduce water needs or pretreatment of waste may be more cost effective than Vodokanal solutions; * life cycle costing; looking at both capital and operating cost in the long-term may lead to the use of better materials and higher quality of construction and technical solutions which will be more cost effective in the long run; * least cost phasing of investments avoids investments in overcapacity; * * improve designs and introduce more appropriate and cost effective technologies: Avoid costly high tech solutions (ozonation, sophisticated system automation) which may divert resources from other higher priorities; * choose appropriate and flexible design parameters: Use norms appropriate and affordable for local conditions without compromising safety concerns. 4/ For example, reducing water demand from 250 1/c/d to 150 I/c/d through programs of demand management and leak repair would be equivalent to a 40% capacity expansion. 33 Box 3: Demand Management and Leak Detection and Repair Programs of demand management and leak reduction can lead to significant decreases in water consumption and thereby savings in operating and capital costs. Such programs are carried out successfully by many utilities throughout the world as an effective means of reducing costs. They are also already under way in many cities in the transition economies of Central and Eastern Europe. Good results are already being achieved. The most striking of these examples are perhaps found in the former German Democratic Republic where demand management and leak repair initiatives has reduced water production requirements by up to 40% in some utilities in a time of less than three years and has eliminated the need for capacity expansions, once thought unavoidable. Demand Management The objective of water demand management is to reduce the consumption of water by all user categories. Reductions in water consumption promise reduced operating costs, as less water has to produced and distributed and lowering of capital costs, as installed system capacities can be decreased. Successful demand management requires a sustained effort with a number of mutually reinforcing actions to be carried out simultaneously, including: * introduction of progressive tariffs and billing based on metered consumption; * programs offering domestic users assistance in repairing leaking sanitary in-house fixtures: * programs to reduce water consumption from high water use industries by defining least cost solution to provide water, including water conservation through process changes and recycling; * programs of public relations to promote water conservation; * programs to detect and incorporate ilegal connections. Leak Detection and Repair Like water demand management, leak reduction can lead to substantial cost savings. Successful leak reduction programs are usually carried out in two stages Stage I involves an initial concentrated effort lasting two to three years to: * Implement a crash program to repair "obvious' leaks; * system inspection and metering to gain a good understanding of network functioning and origin and magnitude of system leakage; * prepare a itrategic medium term plan for reducing system leakage based on system knowledge and least cost analysis (repair and replacement of pipes and appurtenances, pressure reduction, etc;). Stage 11 involves a continuous routine effort of keeping leaks at a minimum through sustained programs involving: * leak surveillance and reporting; * metering and system analysis to detect changes indicating increased leakage; * programs of routine leak repair and pipe maintenance. The success of demand management and leak reduction programs depends foremost on Vodokanal commitment to iniate them and then continue with them as a matter of routine operation. Isolated activities without a strategic and comprehensive underpinning and without full management backing are likely not sustainable. For example, the sale or donation of leak detection equipment alone without a deep commitment by the utility usually does not lead to lasting results. 34 105. The case of uncompleted works. Under the old system, the slow disbursement of funds often led to very long construction periods. The disappearance of funding has caused work stoppage. Throughout the country, there are now numerous partially completed water and wastewater projects. It is tempting to conclude that the completion of these projects should have high priority. This may indeed be true in many cases, but only if it can be proven that completing such projects would be cost effective. However, such decisions should be approached with caution. Many of the unfinished works probably shouldn't have been started in the first place and should not be completed as originally designed, as they were conceived on assumptions which no longer hold true (slower growth of water demand, for instance), the technology applied no longer is appropriate (high energy intensive plants), or there are other investments needs of higher priority. In principle, the decision of whether or not to complete a particular investment should be based on the opportunity cost of capital with past investments being considered a sunk cost. There is no reason to complete an investment solely because it has been started. Identification of Priority, Least-Cost and Affordable Investment Programs 106. Selecting investment priorities. Making informed choices requires a clear understanding of objectives, investment alternatives and a realistic appreciation of a Vodokanal's financial capacity. As a general principle, each investment should be judged by its cost and associated benefits. Careful weighing of costs and benefits then leads to a ranking of investment projects. While specific investment needs will vary from Vodokanal to Vodokanal, the following general order of priorities seems indicated: * institutional restructuring and strengthening: the cornerstone for more efficient Vodokanal performance is better management and administration; * water supply: from a public health and customer satisfaction point of view a safe and reliable water supply is most important; * wastewater collection: public health considerations dictate adequate sanitation services. In dense urban areas well functioning sewerage systems are a must, while in less densely populated ares on site facilities may be a more cost effective solution; * wastewater treatment: while investments in wastewater treatment plants are desirable from an environmental perspective, the above areas would generally be awarded priority, as they most directly improve public health and standard of living. 107. Investment decisions should be made on the basis of multi-year investment programs rather than individual projects. Investment decisions should not focus on single projects, a water or wastewater treatment plant, for example. Undertaking such investments without having a clear view of other investment needs and Vodokanal financial capacity may lead to poor investment decisions. Instead investment decisions should be based on multi-year investment programs which, being part of the Vodokanal's business plan, are demonstrated to be compatible with the Vodokanals's capacity to raise investment resources. 108. Traditional masterplanning is not indicated at this time. The planning methodology traditionally employed in market economies, masterplans and feasibility studies, would be inappropriate given the present uncertainties regarding the country's economy, Vodokanal ability to raise resources and the lack of reliable technical information on Vodokanal facilities and operations. Conventional masterplan and feasibility studies would be too costly, and valuable time would be lost in beginning to address the urgent problems at hand. 35 109. Instead adopt a "plan and implement as you go approach" to investment selection and implementation. Rather than waiting for the completion of costly masterplans, Vodokanals should concentrate on institutional strengthening and using scarce investment resources on investments which promise to bring immediate service improvements and fast payback. This approach requires a radical departure from traditional planning and design practices. Engineers and planners, aware of financial limits and unencumbered by norms and standards, should work towards identifying and implementing flexible and innovative "small" rather than "big" solutions which promise to bring fast relief and payback. 110. Vodokanals to be put in charge of the investment cycle. A precondition for implementing the new approach will be to streamline the present system of diffused and overlapping responsibility. The primary responsibility for all phases of the project cycle (preparation of studies and designs, financing and resource mobilization, and implementation) should be transferred to the new autonomous Vodokanal. Such an institution, responsible for its actions, accountable to local government and largely dependent on its own revenue generation, would have the greatest interest in making frugal investment decisions and the most ability to make and carry out decisions fast. Box 4: Suggested Outline of Urgent Vodokanal Investment Programs Objective: execution of short term investment programs to solve urgent priority problems with emphasis on small, fast payback investnents emphasizing rehabilitation and operational improvements of existing facilities. Strategic Investment Priorities: * strengthening of institutional capacity; * provision of safe and reliable water supply services; * improvement of sanitation through rehabilitating/expanding sewer systems or on site solutions in less densely populated areas; and * wastewater treatment. Investment Components: * institutional restructuring and strengthening, i.e. the creation of autonomous Vodokanals and technical assistance to improve their management, administration and operation; * specific, urgent, easily identified investments clearly needed to improve system functioning and operations which can be justified without major studies, fbr example, the replacement of non functioning pumps in a pumping station; * initiation of systematic programs for system rehabilitation and repair, demand management, leak detection and repair and improving system and plant operation; Execution Responsibility: autonomous Vodokanal in charge of all investment cycle activities under regulatory control of local government Preparation Strategy: Expert consultant services for: * defining new institutional setup needed to create "autonomous Vodokanal" and design of institutional restructuring and strengthening program; * financial analysis (tariffsil) to determine amount of investment resources available to Vodokanal; * identification and design of specific urgent investments; * planning and design of program for system rehabilitation and operational improvements. 36 F. Utility Business Support 111. To function effectively, Vodokanals depend on a business environment and supplier industries which can effectively provide the inputs which are needed for utility management and operation. To build this support, the following actions are recommended: 112. Strengthen and expand Vodokanal human resource base. The theoretical education that Ukrainian engineers and technicians receive is quite impressive. However, technical personnel need to upgrade their skills in areas such as investment planning and selection techniques, integrated water resource management, and modem maintenance and operation techniques. Particularly, modem utility management and financial planning skills need to be introduced. To increase the supply of well trained manpower, the government, sectoral agencies, academic institutions and foreign donor agencies should work together to gradually improve the situation by: (a) adjusting present educational policy and curricula content for new students; (b) providing training and retraining opportunities for those already working in the sector (seminars, formal adult training courses, professional meetings, international trade shows, educational tours); and (c) requiring foreign consultants to provide transfer of knowledge as an integral part of their assignment. Above all, Vodokanals should adopt employment conditions which attract new, and retain good, professionals. The existence of autonomous utilities free to offer compensation packages competitive with the private sector and employment conditions with advancement based on merit will be the greatest motivator for many individuals to prepare themselves for a career or to remain in the water and wastewater industry. 113. Build a private consulting capacity. Although the professional and scientific qualifications of Ukrainian engineers tend to be high and often outstanding, there is still limited experience in doing comprehensive planning bringing together technical, financial and economic analysis or institutional strengthening. In their present form, design and research institutes are not likely to adapt easily to the new demands on engineering services. The government may consider adopting programs to: (a) promote the gradual transformation of the research and design institutes into private organizations offering their services on a competitive basis; and (b) encourage joint venture arrangements between foreign and local consultants to facilitate the transfer of knowledge. 114. Build a private industry for the supply of equipment/materials and civil works construction. Ukrainian utilities require the provision of more modem, higher quality and a wider range of equipment. This demand cannot be fulfilled by existing Ukrainian equipment manufacturers and suppliers. Domestic civil works enterprises have the reputation of uneven work quality and not meeting contracting schedules. The suggested solution for the medium term is to: (a) introduce more demanding technical specifications to foster the manufacture of better equipment and higher quality civil works; (b) put the presently state owned firms into private hands, possibly in joint venture with foreign companies and let them compete for contracts on the basis of price and quality; and (c) Vodokanals should procure equipment, materials and civil works under competitive selection procedures based on quality and price. 115. Strengthen non-governmental organizations. Organizations such as the Association of Hydraulic and Sanitary Engineers, other professional associations, manufacturers and contractors associations should play an instrumental role in the development in the sector. To be effective, these organizations must widen their field of interest and action beyond the technical and engineering concerns which were dominant in the past. Areas such as utility management, financial analysis, commercial management, and issues regarding maintenance and operation must become important elements of the agenda. Ukrainian NGOs should build bridges with sister organizations abroad, national professional associations of Western Europe and North America as well as international organizations. The Ukrainian 37 government should provide support to these organizations. International and foreign professional organizations should reach out to their Ukrainian counterparts and offer support in the reform process. G. Implementing the Proposed Reforms - Next Steps 116. Implementation Strategy: medium term and immediate action. The proposed program of sector reform suggests fundamental changes to the present system of sector management and operation. Many of the concepts are unfamiliar to Vodokanal managers, officials in local and national government and most of the sector community. Many of the reforms aimed at Vodokanal reorganization and strengthening can be initiated by Vodokanals with the consent of local government. For example, there are no national regulations against negotiating performance contracts or institutional strengthening programs and preparing and implementing cost effective investments programs. The main constraint on the local level is unfamiliarity with the reform ideas and lack of capacity to define and implement them. Other reforms, particularly those dealing with cost recovery and resource mobilization depend on action by the national government. A two pronged implementation strategy is proposed to initiate action directed at both the national level and local level. One element of this strategy is for the national government, led by the State Committee of Housing and Municipal Economy (SCHME), to prepare a program of comprehensive sector reform and facilitate its implementation country wide over the medium and long term. The other element comprises demonstration activities with reform minded Vodokanals and local governments. These two elements would reinforce each other and initiate the reform process as expeditiously as possible. Medium Term Action - Laying the Ground Work for and Implementing Comprehensive Sector Reform Country Wide 117. To initiate and implement full fledged sector reform country wide, the national government should consider undertaking the following phased tasks. 118. Map out a comprehensive framework of future sectoral policies - along the lines proposed in Sections IV. B - IV. F - aiming at setting the ground rules under which Vodokanals and local governments would be expected to undertake sectoral reforms, i.e. division of institutional relationships, particularly between Vodokanals - local government; cost recovery and tariffs; selection of cost effective investment projects; and resource mobilization for investments and private sector participation. 119. Disseminate the new policies and recommended practices throughout the sector community (Vodokanals, local government, enterprises contracting with the sector, academic institutions, non governmental organizations) through: public information campaigns; issuance of guidelines, best practice manuals, instructional materials, model terms of reference; seminars; and "hotline" type of advice to interested parties. 120. State future sector development policy in form of a strategic 1996 -2000 sector investment program. To obtain a realistic idea of how sector development would proceed in the future, the Government should prepare a strategic and indicative water and wastewater sector investment plan for the medium term. Based on an assessment of the present situation of water and wastewater in the country, the program should specify, separately for water, sewerage and waste-water treatment and for each year 1996 - 2000, the following key elements: (a) targets for service coverage and service improvements by geographical region; (b) estimates of investments required to reach targets using new investment selection principles; and (c) financing plan, distinguishing between the different funding 38 sources-Vodokanals, local government, national government, loans and grants from international funding agencies. Such a plan would convey a sense of reality to those Vodokanal managers, local and national government officials who cling to the belief that the government will eventually provide the resources to implement their ambitious investment plans. It would also be an instrument to express future government policy for investing in the sector and signal where the resources for investments would come from. 121. Link future Government subsidies to progress on reforms. In spite of the country's fiscal constraints, the government will have to continue to support some of the most urgent investments until local financial capacity improves. This support may come through direct subsidies for specific projects or, if the government wishes to use the resources of International Financial Institutions in the form of sovereign guarantees. Such government support, although substantially less than in the past, will remain for some years an important driving force of sector investments. This fact puts the national government in a prime position to determine the direction of sector development in the future in terms of where, and for what purposes, subsidies will be provided. To support sector reform such subsidies should be made contingent on: (a) Vodokanal/local government willingness to initiate institutional and tariff reform; and (b) the existence of a cost effective, priority investment program in harmony with the Vodokanals's financial capacity. 122. Definition of sector reforms and future resource allocation policy requires inter agency effort. Decision making on many of the proposals for institutional and policy change, for example policies regarding cost recovery, tariff setting, investment selection and financing suggestions, private sector participation, effluent requirements or utility accounting standards, and sector investment strategy, will be outside of the jurisdiction of SCHME. Other government agencies such as the Ministry of Finance, for matters of resource allocation, and the Ministry of the Environment, regarding effluent standards, must be participants of the deliberation and decision making process. Therefore, the creation of an intra-government sector reform task force comprised of representatives of the main stakeholders in municipal water and wastewater (local government, SCHME, SCWR, MOF, river basin agencies, professional organizations, non governmental-organizations) is recommended. The task force, under the leadership of SCHME, would serve as a forum to debate, recommend and decide on the country's future policies regarding the municipal water and wastewater sector. To lead the work on sector reform definition and the subsequent dissemination effort, SCHME might consider creating a special office, the "Sector Assistance and Reform Unit" (SARU), which staffed initially with three to four of SCHME's most dynamic and reform minded staff, would take the lead on sector reform. Immediate Action: Pilot Projects with Reform Minded Vodokanals/Local Governments 123. Reform minded Vodokanals and local governments should initiate pilot projects. While the new policy framework is being worked out by the national government, many of the policy reforms can be implemented immediately on the local level. Reform minded Vodokanals and local governments should be encouraged to undertake their own programs for Vodokanal reorganization and strengthening, prepare cost effective investment programs aimed at rehabilitating, upgrading and improving the operation of existing systems and bring down water consumption through programs of demand management and leak reduction. Also Vodokanals and local governments may want to explore the possibility of concluding management or concession type contracts with private international utility operators. 39 V. ASSISTANCE OF INTERNATIONAL DONOR COMMUNITY - A CRUCIAL ELEMENT FOR SUCCESSFUL SECTOR REFORM 124. International donors to fund technical assistance and not urgent investments. Many of the new policies and practices proposed are new in Ukraine, but well understood and developed in the market economies of Western Europe and North America. Assistance from the international donor community will allow Ukraine to address urgent needs in a time of transition and enable them to implement needed reforms faster. International donor agencies and international financial institutions are strongly encouraged to support the country's sector reform effort by funding programs of technical assistance and provide financing for urgent priority investments. This support would be particularly needed for the following: * technical assistance to MEP for: * preparing and implementing the proposed long term reform of Ukraine's water management systems; and * identifying and ranking water pollution "hot spots"; * preparing and implementing interim policies for dealing with water management and water pollution; * technical assistance to SCHME for preparing and implementing a country wide program of sector reform, including mapping out a new framework of new sectoral and policies, dissemination of new policies to sector community, and preparation of 1996-2000 strategic investment program; * assistance to reform minded local governments and Vodokanals by funding: * broad based institutional development and efficiency enhancement programs with individual utilities; * the preparation of least cost, affordable, priority investment programs in cooperation with financing institution; * priority, least cost, affordable investments justified through appropriate studies, including those addressing urgent water shortage or pollution situations; * advice and preparatory work in support of management or concession contracts with private international utility operators. 125. Careful coordination of foreign assistance is important to avoid duplication and keep reform focus. Over the past four years, foreign assistance has already been initiated, and over time such assistance is going to increase. Experience in other countries which are ahead of the Ukraine in the transition process and have already received a large amount of assistance (Poland, for example) shows the need for carefully coordinating technical assistance such the such assistance supports the reforms advocated by the government and focusses on priority tasks. SCHME and MEP, the two lead agencies in the reform effort, are provided with the responsibility for: (a) setting guidelines for and coordinate foreign assistance to avoid overlaps and ensure focus; and (b) coordinating work with international multilateral and bilateral organizations. Annex 1 UKRAINE: WATER AND WASTEWATER SECTOR STUDY Suggested Functions and Responsibilities of Main Institutions Involved in the Municipal Water and Wastewater Sector Local National National Consumer Vodokanal (VK) Government Mun. Infrastr. Instit. Water Mgt. Instit. Main Function Manager/Operator of Municipal or Responsible for service; Formulate sectoral policies, Define water management Have voice on Regional Water and Wastewater Owner of assets; legal/regulatory framework; policies and regulations; decisions Systems Regulator/Supervisorof VK; Facilitate, guide, monitor sector Set conditions under which VKs regarding water performance; abstract and discharge water; and wastewater Water resources and envir. services; planning; Governance Operates under governance Selects corporate status of VK; Provides legal/regulatory Sets framework for interaction Arrangements option selected by local Gvt. in Defines charter and performance framework for VK - local Gvt between VK and environmental accordance with performance agreement; relationship; agencies agreement and business plan; Regulates/supervises VK Provides/facilitates assistance to Concentrates on core business; performance; Local Gvt and VK; Management Strives for maximum Sets goals/ strategies Provides/facilitates assistance to Administration. efficiency and productivity; expressed in business plan; Vks; Chooses most appropriate and Supervises compliance with plan; effective organizational structure and Appoints executive board and management systems; approves top management; Personnel Chooses personnel freely; Sets goals/ strategies for personnel Provides legal framework and Wages Rewards competence and initiative; matters expressed in business regulations on labor matters; Provides training; plan; Gives,facilitates advice; Pays competitive wages; Supervises compliance with plan; Maintenance Commitment to system rehabilitation Sets goals/ strategies Promotes good maintenance, Monitors compliance with permits voices Operation and operational efficiency expressed in business plan; rehabilitation and efficiency for water abstractions and waste complaints in improvements; Supervises compliance with plan; Registers user complaints as last discharges; case of poor Meets water quality and effluent resort agency; Collects fees and fines service; discharge standards; Gives, facilitates advice Controls industrial discharges; Responds to customer complaints; Vodokanal (VI) Local NNational Consumer oI Government Mun. Infrastr. istit. Water Mgt. Instit. Financial Manages finances efficiEntly; Sets financial goals/strategies Sets general financial policies Management Depreciates assets correctly; based on full cost recovery (cost recovery), legal and Pays taxes as req'rd; expressed in business plan; regulatory framework; Reinvests cash surplus; Supervises compliance with plan; Gives, facilitates advice; Adopts adequate financial systems; Provides audited financial statements Tariff Enacts tariff levels and structures Sets tariff policy based on full cost Sets general policy and legal Provides input Setting approved by local Gvt and set out in recovery; framework for tariffs; in public business plan; Agrees to indexed tariffs and Provides last resort hearings on rate Adjusts tariffs in accordance with price cap; backstopping in case of discussion formula agreed in business plan; Reviews and decides on tariff complaints; Requests and justifies tariff adj requests by VK; Gives, facilitates advice; ustments; Tariff Collects under contract with each Sets legal basis for tariff Provides policy and legal Pay cost Collection consumer; collection; framework, cut off regulations; covering tariffs Maintains up to date cadastre; Provides safety net for poor Provides safety net for poor Collects with maximum efficiency; households households; Cuts off non paying customers Investment Proposes multi-year least cost priority Sets investment goals/strategies; Promotes principles of cost Provides planning input with Participates and Selection and affordable investment program Reviews investment program effectiveness, priority and regards to water management; provides input to based on goals set by local Gvt; proposed by VK; affordability; Reviews investments in light of public debate on Contracts out studies and designs to Supervises execution of investment Sets affordable standards; applicable standards; proposed private consultants; program; Gives, facilitates advice Provides permits; investments Investment Funds investments from internal Sets policies expressed in business Provides policies and legal Allocates funds for investments Financing generation, borrowing, equity plan; framework; in pollution control; contributions; Approves financing transaction Facilitates credit; Receives targeted government above threshold; Supports selected investments to subsidies; Provides transparent budget encourage sector reform; contributions for specific Provides guarantees for IFIs; investments Investment Carries full responsible for Sets policies and regulations; Provides policies and Revises completed wastewater Implement. implementation; Supervises VK investment regulations to encourage treatment plants to ensure Procures contracts under competitive implementation practices; emergence of private support compliance with permit conditions; industry for the sector; conditions Supervises performance of contractors Sets policies and regulations for public procurement