PPP Debate 5 Terence Lee

IMPROVING THE MANAGEMENT OF WATER SUPPLY AND SANITATION SYSTEMS IN LATIN AMERICA

Terence R. Lee
Economic Commission for Latin America and the Caribbean

The poor management of water supply and sanitation systems has been a perennial problem in all countries of Latin America and the Caribbean. Recently, however, in a few countries, drastic changes in traditional policies have achieved noteworthy improvements in management. In particular, the sector has been characterized by insufficent and irregular financing. Traditionally, the contribution to the funding of water supply and sanitation services from the income of operating companies has been very small. This situations has been a direct consequence of political interference in management which has led both to the setting of unrealistically low tariffs and to deficiencies in the billing and collection processes. The consequent already critical state of many systems has worsened with the down-sizing of government and financing needs have increased with the need to provide for sewage treatment to reduce the gross pollution of most water bodies in the vicinity of the large cities of the region. The recent reforms have covered all aspects of the management of the sector, and have included increasing private participation in the management and operation of water supply and sewerage systems (Lee and Jouravlev, 1997).

Not all countries have participated in the renovation of the sector and in those countries where reform has occurred the innovations have not been uniform. This paper will concentrate on the presentation of the Chilean experience in improving the management of water supply and sanitation operating companies, as it is both the most interesting from a policy viewpoint and the most mature. The reform of the management system for the provision of water supply and sanitation services began in Chile in the 1970’s and continues. Unlike most other countries of the region, however, the reforms have not involved the descentralization of the responsibility of the service to other levels of government, such as municipalities, or the direct privatization of the provision of the service. Instead, the reforms introduced in Chile have concentrated on the separation of the responsibility for the regulation of provision from the responsibility to operate the service, the introduction of common legislation for all providers, whether public or private, and the establishment of an efficient and realistic tariff system.

A Brief History of the Provision of Water Supply and Sanitation Services in Chile until 1990

Traditionally, water and sanitation services were provided by a variety of central and local government authorities. The sheer number of organizations, their lack of financial and administrative autonomy, the absence of any strategic planning and the failure to co-ordinate activities led to an overall poor operating performance in the sector (SSS, 1995).

Under legislation introduced in late 1977, a centralized service was created, responsible for water supply and sanitation in both urban and rural areas in all of Chile. The National Sanitation Works Service (SENDOS) within the Ministry of Public Works, became the entity responsible for "the planning, control, study, projection, construction, repair, conservation, exploitation, improvement, financing and management of water supply and sanitation works, and for the control, treatment and disposition of liquid industrial wastes, in both urban and rural areas" (Chile, 1977).

For operating purposes 11 regional agencies were established, within SENDOS, together with two state-owned companies, the Metropolitan Sanitation Works Company (EMOS) for the Santiago metropolitan region and the Valparaiso Sanitation Works Company (ESVAL) for the Valparaiso metropolitan region. SENDOS was responsible for the regulation and operation of all aspects of the activities of its 11 regional agencies and for the regulation of the two companies(Chile, 1978). The Ministry of Economics was given the responsibility for the fixing of tariffs.

The Ministry of Health retained responsibility for regulating the health aspects of the construction of water and sewage treatment works and for the control of discharges of waste waters to water bodies used as sources of water for drinking or irrigation purposes.

Once established, SENDOS adopted policies to increase the coverage of water supply and sanitation services, to achieve self-financing in each of the regions, to establish a tariff structure which would finance operating, maintenance and capital costs and to decentralize management. A National Coverage Plan was established which had as is its goal the provision by 1980 of water supply to 100 percent of the population in localities with more than 1,000 population and of sewerage to 70 percent of the population in localities with over 3,000 population.

This was the first of a number of increasingly ambitious plans which were established in Chile for the expansion and improvement of water supply and sanitation services during the International Water Supply and Sanitation Decade, 1981-1990. During the Decade, despite a major economic recession, the high priority given to expanding water supply and sanitation services was maintained. This was unusual in the region where, in most countries, the levels of investment in the sector fell sharply with the recession of the 1980s (UN/ECLAC, 1989)

Indicative of the effort made is the increase in investment which in the 15 years prior to the Decade had averaged US $62 million, but between 1981 and 1990 averaged US $105 million at 1995 prices (Figure 1). Not surprisingly, given these increasing levels of investment the proportion of the population receiving service also increased dramatically (Figure 2). By 1990, over 97 percent of the urban population enjoyed a household connection to water supply and over 80 percent a connection to a sewerage system., By the end of the Decade, the provision of services to the urban population was essentially resolved, as was the provision to theconcentrated rural population. The problem of the basic supply of services had been solved. Chile was the first, and only, country in Latin America to do so (UN/ECLAC, 1990).

The expansion of service was accompanied by a programme of rationalization of the operation of the sector, equally in SENDOS and in EMOS and ESVAL, and considerable progress was made in efficiency, the use of private contractors for many activities, in improving finances and in the institution of a realistic tariff structure. It was not possible, however, to establish financial autonomy for the sector or to generate the funds necessary for investments in the infrastructure required for sewage treatment (SSS, 1995). In consideration of the need to meet the challenges imposed by the necessity to change the emphasis in the policies adopted towards the sector from expanding the quantity of services to improvements in quality of services, a new major restructuring of the sector was undertaken between 1988 and 1990.

Seeking managerial excellence

The first step taken in the second reform of the structure of the water supply and sanitation industry was the establishment of a new system for fixing tariffs objectively. Under this new arrangement the regulator establishes a maximum tariff for each service based on the incremental development costs of that service, including the cost of capital (Chile, 1988). The tariff levels are established by the regulator on the basis of a model efficient provider and any differences of opinion between the actual company holding the concession and the regulator are to be resolved by a tripartite commission of experts. The reform allowed for the gradual adjustment of the existing tariffs to the new, higher levels. This change in the method of establishing the tariffs is the keystone to the new structure of the industry and to the success that has been achieved in the management of the services since 1990.

The other major features of the reform were the separation of the normative and regulatory functions of the State from the provision of the services, the establishment of a common body of legislation applicable to all services, whether provided by public or private companies, the definition of a regulatory framework for the sector and the introduction of a specific subsidy for the poorest households.

 

The restructuring included the creation of a new regulatory authority, the Superintendencia de Servicios Sanitarios (SSS) for all providers, transformed all the publicly owned services into 13 regionally-based limited companies where all the shares are held by the State, and are managed through the economic and industrial development agency (CORFO), exceptionally, a very small proportion, less than 1 percent, of the shares of EMOS and ESVAL are publicly held and traded on the stock market. The reform also permitted the introduction of private capital into the 13 state-controlled operating companies. This has, however, not as yet occurred and is now subject to amending legislation currently under discussion.

Under the 1990 legislation a system of concessions for the operation of the services was introduced. There are separate concessions for the abstraction and treatment of drinking water, the distribution of drinking water, the collection of sewage and for the treatment of sewage. A separate tariff is calculated for each concession held, and exercised, by an operating company. Each regional company and the majority of the private operators hold all four concessions, but this is not necessary. The concessions are permanent and transferable, but, of course, they can be cancelled if the terms are not met by the holder.

Table 1
PROVISION OF URBAN SANITATION SERVICES BY TYPE OF COMPANY, CHILE, 1995

Type of Provider

Proportion of the population served

State-owned regional companies (11)

41.5

EMOS

39.5

ESVAL

11.1

Private companies (6)

3.9

Municipal companies (1)

4.0

Source: SSS, 1995

Concessions can only be held by registered stock companies. Exceptions are made for municipalities, co-operatives and services with less than 500 connections. The state-owned sanitation companies, therefore, are required to operate under the regulations of company law, as well as, within the specific regulatory framework for the sanitation sector.

The result is that there must be, and there is, a clear separation and understanding of the specific roles of the government, through the SSS, the boards of directors of the companies, through CORFO, and of the management of the companies. The government regulates, the boards of directors, which can be removed, formulate strategic policies and plans, and the management, appointed by the directors, operates the companies with a high degree of autonomy.

The system has worked very successfully which is fortunate, given the dominance of the state-owned companies in the provision of services (Table 1). There now exist effective incentives for efficiency: the public companies wish to prove that they can be effective and profitable and the private operators, small as they are, provide some yardstick comparison. One consequence has been an explosion in the contracting-out of many operational activities by all the companies.

The companies have sub-contracted a very wide variety of activities, including the operation, management and capital investment of whole systems, as well as maintenance of all aspects of the networks, meter reading and billing. Installations are no longer the responsibility of the companies, but of the constructors of new housing. Contracting out has reduced the number of workers per connection, for example, in EMOS, there were 2.04 employees per 1000 connections in 1993. This is the lowest number in the region and indicates a labour productivity about 3 times the regional average (Yepes, 1990).

The new system has also resulted in a substantial increase in investment, more than double historical levels(Figure 2). The bulk of this investment, 92 percent for the state companies in 1995, comes from operating income, the result of the tariff increases, and the remainder from various government regional and social development funds (SSS, 1995). Since 1990, the investment has gone in part to waste treatment, some to service extension, but mainly to improving the quality of operations and services. It is indicative that, in 1995, the average level of unaccounted for water in Chilean water utilities stood at 30.6 percent, far below the regional norm of 40 to 60 percent.

On the bottom line by 1996 all 13 of the state-owned regional companies were operating profitably (Figure 3). Some of the companies are, of course, more profitable than others. Private companies find the rules for the sector equally comfortable and there is an enormous growth in the number of new private operators with 27 new services approved or in process of approval within the SSS since 1990.

What next?

The policies applied to the water supply and sanitation sector in Chile have been an undeniable success. This success is closely related to the overall adoption of effective economic and social policies in Chile which have given the country the highest and most stable growth rates in Latin America and made its economy more comparable to those of the countries of Southeast Asia than to those of its neighbours.

The success of sanitation policies, however, must be qualified for various reasons. One important qualification is the continuing low-priority given to waste-water treatment, only 14 percent of domestic sewage receiving adequate disposition in 1995 (SSS, 1995). This issue is related to another - the future role of the private sector in water supply and sanitation. The present position is that, other than as contractor, the role of the private sector is in fact marginal. The reforms introduced in 1989 and 1990 envisaged a much larger private role and permit the transfer of EMOS and ESVAL to private ownership, as well as, 49 percent of the shares in the other 11 companies. In part, it was intended that through this proposed influx of private capital that the question of adequate waste treatment would be resolved.

In fact, the two governments, since 1990, have been very reluctant to increase private presence in the sector under the existing system and have proposed substantial modifications to those aspects of the 1990 reforms governing the future management of the sector. These proposed changes, which basically consist in strengthening the regulator and permitting the transfer of only 65 percent of shares of all the state companies to private investors, have had a very difficult passage in parliament. There has been extreme difficulty in reaching a consensus, which is necessary because the opposition, which favours complete privatization and less regulation, has a majority in the Senate. The government’s own supporters, in turn, are not enthusiastic about any increase in private participation.

This delay has meant a serious delay in all the proposals to increase waste-treatment as the required investments cannot be met from revenues, the Government of Chile no longer takes loans from multi-lateral banks, and the companies are not permitted to issue debt. Proposals to resolve this difficulty through BOT arrangements have also come to nothing.

A further area of disagreement has centred on the question of water rights. Under the Water Law of 1981, water rights are private property in Chile . The water companies possess large numbers of rights and to obtain access to more water must turn to the market. It is not clear in the proposed legislation whether the existing rights held by the water companies would be transferred with a change of ownership or whether they would remain with CORFO (Gutiérrez, 1996). This is an important point, as these rights form a significant proportion of the capital value of the companies. The requirement to purchase additional rights also acts as an incentive to reduce unaccounted for water. This incentive would disappear if the companies were not allowed to own water rights. Finally, it would mean that the companies would be treated differently from all other water users.

Moreover, there has been considerable concern expressed about the common ownership of both electricity distributing and sanitation companies. The electricity companies have show considerable interest in the sanitation sector and two of them already operate sanitation companies successfully. Placing restrictions on joint ownership could not only limit private sector interest in investment in the sector, but would also deprive the sector of the considerable managerial experience of the electricity companies.

It is possible that once the new legislation has become law these contradictions will be resolved, but it is possible that they will not, as some are inherent in the government’s policies. In some respects the sanitation sector has become a victim of its own success. The performance of the publicly-owned companies has been such as to legitimately question the need to privatize them. At the same time, the government is not disposed to meet the capital needs anticipated for the building of waste treatment works and sees the incorporation of private capital as the solution.

An exemplary experience

Despite the uncertainty surrounding the future place for private participation in the water supply and sanitation sector, the Chilean experience shows that, in any country, there is a real possibility for remedying the poor performance of the sanitation sector. In Chile, systems of all sizes, serving very different communities, in diverse climatic and supply conditions, have become self-sustaining whether in private or public hands. The secret of success lies in the adoption and application of consistent policies, the development of a sound regulatory structure, and of incentives for improved management.

Improvement in the regulation and management of water supply and sanitation systems is the only means open for the resolution of the financial problems that have afflicted the sector. The Chilean experience, qualifications apart, shows that that such a policy is not only a sustainable route to achieve universal service coverage and adequate sewage treatment, but also a practical one.