Innovative PPP Financing: Performance Based Annuity

1. Innovative PPP Financing: Performance Based Annuity Water PPPs Workshop GoMP and ADB Bhopal February 27, 2009

2. Significance of the Sector • ADB’s report “Asia Water Watch 2015” estimates that a minimum investment of $8 billion will yield a $54 billion annual return. • Re 1 invested in “access to water” yield Rs. 6 in health, livelihood and education benefits. • 10th Five year plan took note of Millennium Development Goals • MDG was set in September 2005 at General Assembly in UN • the MDGs are a set of numerical and time-bound targets to measure achievements in human and social development • To achieve these ends, access to water is most important means • India need Rs. 74,000 Crores for basic urban services by 2020

3. Financing water • Traditionally it was public financed • Since 1991, alternatives are being explored • Municipal Bond • Pooled financing • Commercial Borrowing • PPP • E.g. Revolving Water Community Funds: • providing interest free loans to Community Based Organizations (CBOs) • Repayments used for additional connections or other schemes (hence revolving)

4. Need for alternative financing • Cash crunch at ULBs • the lack of reliable sources of equity funds in purely public schemes and the • lack of depth in local debt markets which precludes sourcing long-term financing to render tariffs afford afford-able • Private investment in public projects getting difficult

5. Water Project Development • In house: Traditionally done by departments of government • Outsourced • Contract for construction and separately for the maintenance • Public Private Partnership on BOOT, DBFO formats • Annuity based • User Fee based • Community based PPP involving public at actual usage level during O&M phase. • Involves payments to the private sector

6. Input, Processes, Output and Outcomes • Inputs are the resources consumed in producing and delivering a service—such as labor, technology, or physical materials. • Process, which are in place to carry out the service delivery • Outputs are the immediate results of the service provider’s activities—such as the number and quality of the health, education, or infrastructure services provided. • Outcomes are the ultimate effects of services on the community—such as improvements in health or in educational attainment. Outcomes may be influenced by factors other than the activities of the service provider, which distinguishes them from outputs.

7. The trade off • Payment after output • Developer’s need for finance has already passed • Less attractive to private partner • Payment before outcome • No incentive to early and/or quality output • Completion risk with Authority • Initial payment is required for the developer to tie up raw material supply • Care must be taken that developer is not barraging hard with supplier

8. Project Development: Conventional Concept • So, what are the problems ? • Authority has no control on the construction time – Hence, time – overrun • Authority has no control on the cost –Hence Cost-overrun • Authority has to pay entire cost by the end of the construction –constraint on cash flow • Operational involvement • Multiple contractors • Admin overhead Conventional Approach Design Responsibility of Contractor 1 Installation Responsibility of Contractor 2 Operation Responsibility of Contractor 3 Maintenance

9. Contractor’s Cash Flow Investment (Outflow) Conventional Approach $ $ $ $ Construction Period Operations Period $ $ $ $ The cash out flow for O&M remains the challenge for the Authority Reimbursement (Inflow) Authority’s cash outflow

10. Conventional approach: What is overlooked ? • The attention is only to the capital cost and not Life-Cycle-Cost (Contractor tend to ensure such quality of construction that it would demand sever maintenance!) • Focus on only part of the story • Subsequent to the commissioning of the system, ULBs were not ready to take on added tasks • Not fully equipped, • No full trained manpower • Hence low collection • And strained finances

11. Project Development: PPP • So, what about that? • Authority only conceives the project • Developer would design to required specs • Developer to invest money and recover during O&M period • Either as User Fee or • As Annuity • Developer assumes risk of Cost & Time overrun and operations Concept PPP Approach Conventional Approach Design Developer’s Responsibility Responsibility of Contractor 1 Installation Responsibility of Contractor 2 Operation Responsibility of Contractor 3 Maintenance

12. Developer’s Cash Flow: Annuity/User Fee In performance based Annuity, each payment is linked to achievement of performance milestones (pre-specified maintenance standards) PPP Approach Investment (Outflow) $ $ $ $ Construction Period Operations Period $ $ $ $ $ $ $ $ $ Recovery (Annuity/User Fee) Authority’s cash outflow (In case of Annuity)

13. In a Nutshell

14. Developer’s Cash Flow-PBDPS Apart from during operations period, the payment is made during construction period also. However linked to pre-specified maintenance standards PPP Approach Investment (Outflow) $ $ $ $ Construction Period Operations Period $ $ $ $ $ $ $ $ $ $ $ $ Recovery (Annuity/User Fee) Recovery (Annuity/User Fee) Authority’s cash outflow (In case of Annuity) Authority’s cash outflow (In case of Annuity)

15. Operational Framework: PBDPS • Detailed (output) specifications for construction; • Detailed maintenance standards (processes) and • In terms of service delivery parameters (user perceived value) • Private developer’s performance to be assessed on specified performance indicators • Hence, involves regular monitoring

16. Monitoring Mechanism: Option 1 Source: Check List for OBA, Warrick Smith, World Bank

17. Monitoring Mechanism: Option 2 Source: Check List for OBA, Warrick Smith, World Bank

18. Using Performance Based Contracts • Clearly set objectives • Reached through mutual consent • Transparency and honesty • Due Diligence • Scope • Minute details to be covered beforehand • Service Area: Include a map in the agreement • Duration of the Agreement • Realistic assessment • Scope for fair returns • Lease (10-15 yrs) and Concession (20-30 yrs) • Early Termination • Triggers • Avoid general one-sided clauses favouring authority Source: Guidelines on Performance-based Contracts, OECD

19. Due Diligence • the utility's current and proposed service area; • current characteristics of service (quantities supplied, metered and paid for); • basic inventory of the assets of the utility as well as of their condition; • if any, current performance standards and the record of achievement thereof; • human resources; • tariffs (level and structure, subsidy arrangements and disconnection arrangements); and • general financial performance. Source: Guidelines on Performance-based Contracts, OECD

20. Selection of performance indicators • Which indicator best describes developer’s performance • Input based- Quality of material, workmanship • Output based- user experience, quality of service delivery etc • Whether really under control of Developer • Not too many of those; only the most crucial ones • Detailed procedure to measure the indicators • Whether, developer is allowed to invest in equipments needed to measure indicator (waste water reduction) • How much time is required to achieve the targets • Too short: difficult/impossible to achieve • Too long: wherewithal of the utility to monitor, very limited visible improvement, political risk • Flexibility to accommodate unforeseen-mutually agreed terms • Not only penalties but also incentives • Cross-subsidy: inherent self imposed obstacle to improvement Source: Guidelines on Performance-based Contracts, OECD

21. Performance Indicators: examples • Financial Performance • collection efficiency • profitability, current ratio (current assets/current liabilities); • operating ratio (operational expenses including or not depreciation/operational revenues); • accounts receivable; • salary or energy costs as a % of total operating costs; • annual income; • debt service coverage ratio (relevant in cases where the utility's activities are financed by the proceeds of a loan) Source: Guidelines on Performance-based Contracts, OECD

22. Performance Indicators: examples • Operational: • number of staff (measured against an indicator such as number of person served, area, pieces of equipment, etc.); • unaccounted for water; • pipe breaks (measured against an indicator such as time period and/or length of the pipe system); • reduction of consumer's complaints (billing error, meter malfunctioning, quality of service, etc.); • type of consumers’ complaints; • response time to consumer's complaints; and • metering coverage and metering effectiveness. Source: Guidelines on Performance-based Contracts, OECD

23. Performance Indicators: examples • Operating Performance: • average hours of service; • population served; • average water production; • average water consumption; • average pressure in the distribution system and water quality; and • water quality indicators. Source: Guidelines on Performance-based Contracts, OECD

24. Output Based Aid: Andhra Pradesh • The scheme involves a public-private partnership between the Naandi Foundation, a local Indian NGO, Water Health International, a water purification technology provider, and the village councils • A project supported by the Global Partnership on Output-Based Aid (GPOBA) is piloting a project providing safe drinking water to 12,500 poor households in 25 villages in three coastal districts of Andhra Pradesh: Guntur, Krishna, and West Godavari.

25. Output Based Aid: Andhra Pradesh

26. Target Parameters

27. Target Parameters

28. Thank You

29. Spectrum Conventional Finance New Approach Dams, River-lift etc Generation Public PPP Canals, Bulk Supply Lines Public PPP Transmission Last Mile Connectivity PPP/Community based Public Distribution

30. ULBs challenges: The vicious circle Poor Revenue Collection Strain on Finance for newer connections Low Control on leakages and theft Poor O&M standards Low Willingness to pay Poor Perceived value of service

31. Water Supply Sector: Issues • Political Aspects • Water usage charges – a politically sensitive issue • While charging user-fees, gross under-pricing of water • Operational Aspect (ULB level) • Commercial inefficiencies of ULBs; • Sub-optimal service-provision and asset-utilisation and • Reactive maintenance; • Private participation a tricky issue • financial viability issues, • revenue (demand) risk fully passed to the private • lack of adequate and reliable database • Community Aspects • Still considered as a ‘free good’ by the citizens and; • Low willingness-to-pay citing poor service levels- ‘chicken and egg’ problem.

32. Monitoring • Self sampling reports by developer • Surprise, spot check- audit by authority

33. Annuity Types • Equal Periodic Amounts • Spread equally over the useful life of the assets/concession period. • Front Loaded • Higher amounts in initial periods and equal periodic amounts in later part.

34. Karnataka • ADB-funded North Karnataka Urban Sector Investment Program (NKUSIP) at 25 towns of northern Karnataka • Primarily water supply, UGD, storm water drains (SWD), & roads • PPP- Performance Based Deferred Payment System: PBDPS • The developer is responsible for • good quality construction and • preventive maintenance over the period of contract • Critical aspect of regular, pro-active O&M is addressed, • Entire market risk not be passed on to developer • ULBs could partly retain the same while the project would provide funds for maintenance from the ADB-assistance and earmarked devolution from the GoK. • Project structured with larger upfront payments, so that repay most of the loan in the initial period, reducing his financing costs and also the overall costs of the project.