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How to Deal with Inflation and Ensure Affordable Water and Sanitation Services? (Integrity Talk 4)

With Sanitation and Water for All


Integrity Talks are interactive discussions with WIN partners about their challenges and lessons for advancing integrity in the water and sanitation sectors. This is an edited summary of our fourth session on tariffs and inflation.


How do water providers and regulators deal with tariffs in times of high inflation?


Inflation is the rate of increase in prices over a given period of time. When acute, as is the case today in many regions, it has significant impact on the cost of living and of basic services, including water and sanitation. This is often felt most sharply by the poor, who are led to make drastic choices to secure essential services. Water and sanitation service providers must cover costs and deal with rising prices of operations and maintenance, while maintaining affordable service for all. This has its challenges.


In this Integrity Talk, panellists discussed the impact of inflation in the water and sanitation sectors with a focus on tariff setting, the ways to make water and sanitation services affordable to low-income groups, and the role of integrity in realising the human rights to water and sanitation.


With special guests: Dick van Ginhoven (WIN), Virginia Roaf (Sanitation and Water for All, SWA) James Cleto Mumbere (Uganda Water and Sanitation NGO Network, UWASNET), Rajesh K. Advani, (World Bank), Katia Ochoa Trucios (Servicio de Agua Potable y Alcantarillado de Lima, SEDAPAL).

KEY TAKEAWAYS

  • The human rights to water and sanitation obligate States to use the maximum available resources for realising human rights.

  • There is pressure to increase water tariffs to cover mounting costs of operations and maintenance.

  • Low tariffs drive a vicious cycle: insufficient financing leads to poor services; poor services exacerbate low levels of payment; this further undermines the financial health of the utility and leads to lack of investment in maintenance in particular.

  • There are significant integrity risks in the tariff-setting process: from capture to insufficient transparency or participation. High inflation has sharpened the focus on these.

  • States and local authorities need to engage with communities to understand their needs and ability to pay. Involving the community in designing and understanding tariff structures can improve transparency and accountability and help reduce petty corruption.

How does high inflation affect the provision of water and sanitation services?

Dick van Ginhoven (WIN Supervisory Board): Some economists attribute the current inflation surge to product shortages resulting from global supply chain problems, largely caused by the COVID-19 pandemic. On top of that, the war in Ukraine has increased energy prices worldwide. There are also other fundamental mechanisms triggering inflation and depreciation of local currencies. Inflation can occur when prices rise due to increases in production costs, such as raw materials and wages, or a surge in demand can cause inflation as consumers have/are willing to pay more for products. This might drive increases in, for example, the cost of energy, chemicals, housing upgrades, investment, and water.


Rajesh Advani (World Bank): Inflation in the water and sanitation sectors can be heightened by poorly allocated funding. Governments are spending $320 billion per year on water and sanitation service subsidies. From that, 56% is captured by the wealthiest populations and only 6% reaches the poorest 20%.


In utility operations, there is a financing gap when costs are higher than funding. In other words, investment, maintenance and operating costs are higher than the available funding which is obtained through tariffs, taxes, and transfers. In periods of high inflation, utilities have to spend more resources to cover the costs of electricity, staff and chemicals, which, in combination with a reduction of public funds, increases the gap.

What is the impact of low tariffs on the financing gap?

Rajesh Advani (World Bank): Low tariffs drive a vicious cycle where the higher the financing gap, the higher the requirement for additional financing. As public funds are usually insufficient, maintenance is neglected, worsening the technical performance of the utility. When water service provision is deficient, customers are not willing to pay, weakening financial performance and requiring more capital to restore the system, increasing again the financing gap.


Katia Ochoa Trucios (SEDAPAL): Peru has one of the lowest tariffs in Latin America. It is not high enough to cover maintenance costs and extend infrastructure coverage.

“When maintenance costs are not covered, water is not delivered properly, affecting directly people’s supply.”

– Katia Ochoa Trucios (SEDAPAL)

How do the human rights to water and sanitation fit in to the discussion on tariffs and inflation?

Virgina Roaf (SWA): While tariffs should be sufficient to cover costs for delivering water and sanitation, human rights require that these services be ‘affordable’ for people with low or no incomes. This also means that services must sometimes be available for free, with the costs covered by the State or through cross-subsidisation.


Nevertheless, just having a human right to water doesn’t mean that water is immediately available and that it is available for free. States need to make sure people understand this. Human rights impose obligations on States to carefully consider how they prioritise their available resources and to demonstrate that they are making adequate plans and committing adequate funds to ensure that everyone is able to enjoy all their human rights, including water and sanitation. Local governments need to know what aspects of the human right to water they still need to work on, for example: participation, transparency, and how to address corruption. Also, local authorities need to engage with the local community.


Inequalities are deepened through poorly managed tariffs and through inflation, as the poorest are least able to withstand the accompanying financial shocks, sending them into deeper poverty. Integrating human rights principles into financial thinking will ultimately improve the lives of the poorest people on this planet.

“The challenge is no longer whether the human rights to water and sanitation exist, but how they are to be implemented.”

– Virginia Roaf (SWA)

What key factors should be considered for better tariff setting?

James Cleto Mumbere (UWASNET): In Uganda, there is a legal framework where the tariff system is guided by the Constitution. Several policies clearly outline the key stakeholders in water tariff determination. For example, water utilities make proposals using statutory instruments. Then the responsible minister approves them. The current tariff structure is still hampered by two critical factors: service fees, and VAT (Valued Added Tax), which increase the tariff by about 2% and 18% respectively. Service fees and VAT should be removed from all water tariffs, especially for the poor. Furthermore, it would be important to include pro-poor performance indicators for the utilities at all levels.

“For any effective tariff guideline, collection, and payment modalities, it is important to involve the poor in tariff settings to clearly understand their challenges in accessing water.”

– James Cleto Mumbere, Uganda Water and Sanitation NGO Network (UWASNET)

Katia Ochoa (SEDAPAL): In the city of Lima, Peru, there is a differentiated tariff according to the types of use (social, domestic, industrial, and state use). The domestic tariff is further differentiated between “beneficiary” and “non-beneficiary”. Lower-income residents are under the beneficiary category and they pay according to their income. This allows for differentiated payment and benefits poor households.


The tariff is established by the regulator with the intention of providing sustainable services, which means, covering the operations and maintenance costs, service delivery, and investment in projects to expand coverage. The regulator establishes the tariff with the objective of limiting negative impact on the population. Nevertheless, challenges remain in tariff setting, mainly because the price set by the regulator does not cover the full operating costs, increasing the financing gap.

How does financing, and especially loans, affect tariffs?

Dick van Ginhoven (WIN Supervisory Board): There is a need for a clear financial position of utilities and governments. In Kenya, for example, around 50% of the water budget is spent on debt servicing, which is increasing because of depreciation. This is never going to be sustainable. We need to look at local markets to finance investment and link that investment with the regulation of tariff indexing. I suggest that existing debt may have to be restructured into local debt.

How does corruption affect tariffs?

Rajesh Advani (World Bank): Corruption happens on two levels. The first one is petty corruption causing issues both in society and utilities. Some initiatives implemented to fight corruption include using technologies, for example, payment by phone.

In Nairobi, there are multiple issues with endemic corruption but they have little tolerance for it. Utilities use technologies and engage with people by holding meetings and conferences in local areas. By encouraging communication with local stakeholders they have had success in increasing access to water and sanitation in informal settlements. There is a need to involve the community to build social capital and weaken corruption.


On the other side, there is grand corruption. When there are corrupt practices in investment planning and contracting, there is a huge impact on both the operational and financial viability of utilities. Even though there are very strict requirements regarding the procurement of all contracts in multilateral agreements, the main question we face is, what are governments doing? What is the track record of investigating and then of prosecution?

What challenges remain in tariff setting? What are the big priorities?

Virginia Roaf (SWA): Tariffs are still too low for people who can afford to pay more. People who can access the service are paying less than people who don’t have access to the service, for example, residents of informal settlements.


Katia Ochoa (SEDAPAL): Lima faces constant population growth caused mainly by migration of poor or extremely poor people to the city. These people generally benefit from a differentiated tariff and this category has seen an increase of 50% in the number of residents. There is still a deficiency in the methodology for identification of beneficiaries and non-beneficiaries of the differentiated tariff: it is sometimes inexact and very subjective. We may be supporting people who are not in need, while the provision of water services must be as efficient as possible to be able to provide affordable prices.


James Cleto Mumbere (UWASNET): I fully support the idea of more local currency financing. But I think for that to happen, utilities need to improve and build creditworthiness to make them attractive targets for the financial sector. Otherwise, banks will not be interested in lending to companies that will not repay their loans. A legal framework that allows more access to private finances is very important, as is the role of regulation.

MOVING FORWARD


Inflation has increased the costs of water and sanitation provision and maintenance. In response, a number of water and sanitation service providers have significantly raised tariffs where possible, but not always in a transparent and accountable manner.


The urban poor are more likely to suffer the effects of inflation than higher-income households as they tend to spend a higher share of their income on water and sanitation. With this in mind, a number of water providers and regulators have undertaken significant efforts to mitigate the impact of inflation and secure affordable tariffs. This Integrity Talk highlighted a number of integrity measures used to mitigate inflation and make tariffs affordable: cross-subsidisation, differentiated tariffs, and mobilisation of the human rights to water and sanitation to oblige States to use the maximum available resources for realising human rights. There is still room for improvement in many regions.


This Integrity Talk also underscored the need to take into account depreciation. Many States have taken foreign loans to improve water and sanitation services. With inflation, the debt burden has increased due to local currency depreciation. Debt relief and restructuring, as well as local currency financing are important instruments to consider better support service improvements and ensure adequate and affordable access to water and sanitation for all.




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