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Danish support to improved water quality in Central and Eastern Europe 1991-2001

Chapter 8
Financing of Projects

8.1 Strategies

When considering the financing of environmental investments, there are significant differences in the problems faced by the EU accession countries in the CEEC and the problems faced by the CIS countries.

The EU accession countries primarily need to mobilise significant internal and external resources for the investments which are necessary for complying with the EU environmental standards - the socalled Environmental Acquis.

Source: DANCEE 2001
Detailed investment estimates for water and wastewater directives in the ten accession countries

In contrast to this, the CIS countries primarily need to develop the internal regulatory and institutional framework which can enable mobilisation of sufficient funds for operating and maintaining the existing environmental infrastructure.

Concepts such as environmental investments or more broadly environmental expenditures are often problematic to compare between countries due to differences in the methodology used. In response to this problem, OECD has, with financing from among others DANCEE, contributed to establishing a common frame of reference within the area. Environmental expenditures (technically termed Pollution Abatement and Control expenditures or 'PAC') are defined by OECD as covering expenditures for operation, maintenance, and investments in relation to activities directly aimed at preventing, reducing or eliminating pollution. In general, this definition does not include expenditures in relation to water supply.

The funds for environmental expenditures in the CEEC and the CIS come from both the public budgets and the individual enterprises. In some countries national and local environmental funds are furthermore a significant source of funds for environmental expenditures.

Although environmental expenditures in the CEEC and CIS are lower in absolute terms than in the EU countries, they are on average at a comparable level to the EU when seen in relation to the income level. At the same time important differences exist between the countries in the region. Poland has a well functioning system of earmarked environmental fees and environmental funds, has been able to maintain a significantly higher environmental expenditure level. At the other end of the spectrum, a country such as Georgia, which has suffered due to political instability and low income, has only been able to mobilise very limited internal funds for environmental expenditures.

Water supply and wastewater treatment has generally represented the major share of the total environmental expenditures in most countries during the period. Air pollution interventions have however increasingly become the local priority in some of the countries towards the end of the period.

When compared to the EU, a higher share of the total environmental expenditures in the region have been operating costs, thus making only limited funds available for actual investments.
  

8.2 DANCEE as a catalyst for environmental investments

Although local financing sources have contributed with the majority of the total environmental expenditures in the CEEC and the CIS during the period, assistance from bilateral donors and international financial institutions has played a very important role in connection with actual investments in improved water environment.

In the longer term local financing will have to play an increasing role, also in actual investments in improved water environment. It is hence important for the countries to find a balance between ambitious plans for improving the water environment and realistic increases in tariffs for water supply and waste water treatment - tariffs which presently in some cases are below the long term cost of maintaining even the present infrastructure.

DANCEE's assistance is envisioned as being a means of furthering a sustainable development and local co-financing of the projects supported is therefore viewed as a priority. At the same time, DANCEE can provide full financing of preproject activities or demonstration projects where the project is expected to be instrumental in leading to a larger scale implementation financed e.g. by international financial institutions.

Some countries in the CEEC are today able to finance up to 90% of its investment in environmental improvements themselves. For other countries where the degree of local co-financing is low, the combined local and international co-financing for investment projects has often been substantial. Thus, the support provided by DANCEE has had a significant leveraging effect. This is illustrated by the graph above which shows the total costs of DANCEE financed components of investment projects distributed between DANCEE support and other funding sources.

For the period 1991-2000 the DANCEE support on investments geared a 5-6 times higher cofinancing.

The DANCEE assistance for preparing for the large EU grants including support to identifying the need for adapting local regulation to EU directives and to identify the required investments has been quite significant since 1999. This is reflected in the distribution of funds between technical assistance and investment projects in the figure below.

Distribution of funds between technical assistance(TA) and investment projects(IN)

About 150 companies have supplied equipment or expertise to the water quality projects. The result is that a number of Danish companies today have established a growing business on the Central and East European market. The largest companies within industry or/and consultancy have established subsidiaries in one or more of the Central and East European countries. For the year 2000 the total turnover on the Central and East European market for Danish companies, was estimated to be at a level of EUR 260 million. This level has been reached within a period of 10 years.

8.3 Funding

International Financing Institutions

Apart from bilateral donors, such as Denmark, a number of the international financial institutions are active in connection with the financing of improvements in the water environment in the region.

The most important actors are the Nordic Investment Bank (NIB), the Nordic Environmental Financing Company (NEFCO), the European Investment Bank (EIB), the European Bank for Reconstruction and Development (EBRD), the World Bank, and the European Union through ISPA, PHARE and TACIS.

There is a well developed cooperation between DANCEE and the international financial institutions, and Denmarks bilateral support complements the financing from the international financing institutions in an important manner. The bilateral donors such as Denmark typically concentrate on funding preproject activities and pilot projects and bilateral assistance is most often given as grants whereas the large international financing institutions such as the World Bank and EBRD typically provide long term loan financing of large scale investment projects.

The financing provided by the international financial institutions will typically be loans that in the end have to be repaid by the project sponsor in the recipient country. The international financing institutions are therefore very focussed on limiting the risk of the project running into financial troubles or otherwise failing.

The bilateral support from Denmark and other countries has an important role in insuring that the projects are well documented and well structured through support for feasibility studies and pilot projects. Without the combination of Danish or other bilateral assistance for feasibility studies and pilot projects with international financing of subsequent larger scale implementation many projects with important environmental benefits would not be implemented or their scope would be significantly reduced.

Financing of Operation and Maintenance

In the long term there is no realistic alternative to user tariffs as the source of funds for operation and maintenance of the water infrastructure.

The generally accepted international norm for household affordability of water supply and waste water treatment, in countries at the income level of the Central and East European countries, is 4% of disposable income.

However, water tariffs in the Central and East European countries are in general somewhat lower than this level. This is also the case in the CIS countries where a degree of cross subsidisation between households and industry furthermore prevails.

DANCEE has in cooperation with EBRD sponsored the development of a 'toolkit' for analysis of the demand side in connection with design of water supply and waste water treatment projects. The willingness to pay is important if additional financial resources are to be mobilised longer term through increasing involvement of the private sector in water supply and waste water treatment in the region.

Toolkit for Analysis of the Demand for Water Supply and Waste Water Treatment

Win-win project example

In countries where the tariff level is close to the international norm, there will often be a possibility for implementing win-win projects where cost rationalisation in connection with the project implementation, e.g. in the form of lower energy consumption and reduced maintenance costs, may be sufficient to allow interest and principal payments without requiring increases in the tariff levels.

Involving the Private Sector

The need to mobilise additional resources for investments in water supply and waste water treatment and in parallel increasing the operational efficiency of the water companies in the region have increasingly led local authorities and international financing institutions to consider new organisational forms of infrastructure delivery where the private sector is involved in a Public-Private Partnership (PPP).

The two most typical forms of Public-Private Partnership considered in the water sector are a management contract, where the responsibilities for operations and maintenance is transferred to the private sector, and a concession agreement, where also the responsibility for investments and finance is transferred to the private sector. The private sector can be e.g. a West European water company.

DANCEE has in cooperation with EBRD and the World Bank assisted in a number of cases with the analysis prior to decisions on Public-Private Partnerships involving water companies in the CEEC and CIS. In particular assistance has been provided to ensure that the local authorities fully understand the implications of and requirements for involving the private sector, e.g. with respect to necessary increases in tariffs to ensure financial viability of the water company.

It should be expected that the opportunities for mobilising additional resources for environmental investments through involvement of the private sector in a Public-Private Partnership will increasingly be tested in both the EU accession countries and the CIS countries in the coming years. DANCEE will be following these developments and seek to contribute constructively to ensure that such new cooperation models are implemented in a way that secures the public interest.

8.4 Environmental financing strategies

DANCEE has been the main international financing source for the development of an innovative analysis concept for financing of environmental investments - the Environmental Financing Strategies.

Environmental Financing Strategies

Environmental Financing Strategies are a practical and powerful tool in the political process as they, through an explicit inclusion of the ability to pay, forces decision makers to take necessary though difficult discussions about priorities, tradeoffs and cost efficiency in the use of limited financial resources.

A financing strategy for Lithuania's compliance with investments required in order to reach EUcompatibility in the environmental sector has recently been completed. This study also included the investments needed in the water sector.

Most water companies in the region are characterised by tariffs, which do not leave sufficient funds available for the planned increases in the service level. This problem is particularly acute in the CIS countries where tariff levels often do not even allow for maintenance of the existing service level thereby leading to continuous decline in the infrastructure.

At the same time water companies are often not solvent by international standards and hence, have no immediate possibilities for loan financing and the tight public budgets and limited national borrowing capacity preclude the public sector from assisting the water companies.

Nevertheless, political targets for future water quality and service levels are often very ambitious.

In light of this, one of the fundamental problems is to identify practical and realistic solutions which in the short and medium term can contribute to attaining realistic targets for water quality and service level. This is where the development of financing strategies is necessary.

DANCEE has in close cooperation with OECD analysed the financing of water infrastructure in selected countries in the region. The analysis documents the extremely critical situation in the water sector in the CIS. Without access to additional funds these countries will not be able to maintain the existing service level let alone increase the service level. This will imply disbursement of untreated wastewater even in the largest cities, interrupted drinking water supply, and repeated incidents of contaminated drinking water. The maintenance of existing facilities will require the implementation of ambitious reforms including in particular increasing the user tariffs for households and improving the payment record of enterprises and organisations.

References

DANCEE: The environmental challenge of EU enlargement in Central and Eastern Europe, 2001

OECD: Background Paper on Financing Strategies in Urban Water Sector in the CIS, 2000.

OECD: Transition Impact Retrospective, 2001.

OECD: Environmental Expenditures in the NIS: Overview Report, 2000

DANCEE: Lithuanian Financing Strategy, In press

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