SYNOPSISThere are many forces influencing thinking on private sector participation in water supply and sanitation services. These include demographics and incomes, service levels and associated backlogs in South Africa and the projected demand for new investment. They are also influenced by recent shifts in national policy on municipal services. There is considerable potential for a range of ways of private sector participation, and some experience gained so far, in the preparatory work and bidding processes for the Nelspruit and Dolphin Coast concessions, is presented.The White Paper on Water Supply and Sanitation Policy (published November 1994) acknowledges that: “The private sector represents a vast resource which must be harnessed to contribute to the implementation of this policy.” In the sub-section on Operation and Maintenance it states: “Given the growth of the private sector in this area, the Department will develop a more detailed policy both for its own use as a contractor and regulator and in order to fulfil its role as adviser to other agencies.”BACKGROUNDThe new government is committed to redressing the inequities of the past, which are significant. Estimates vary, but if we assume South Africaâ€™s population as 43,8 million in 1995, about 52% are urban, and 18% of them (4 million) have only a minimal water supply, or none at all. The equivalent figure for lack of urban sanitation is 22%. In rural areas, it is estimated that 40 – 60% of the population (8 – 12 million) do not have an adequate water supply service (in South Africa, this is defined as a reliable 25 litres/capita/day within 200 metres walking distance).The areas in which most of these people live, were systematically neglected by the previous administration, either in terms of inadequate investment, or poor operations and maintenance, or both. In the towns, the residents used their only political weapon: non-payment for services, a trend which the present government is finding it difficult to reverse, particularly since there are few signs of the services improving. There is a dual economy, with well run “white” towns next door to barely functioning “black townships”. This situation is beginning to change with the unification of previously separated urban areas, and democratically elected (legitimate) local councils, but it will take a long time, and much resources, to bring services to comparable levels.It is estimated that between 50 and 80 billion Rands are needed over the next ten years to eliminate the backlogs in services in the urban areas, depending on the level of service provided. Some of this will come in the form of government grants for a basic level of service, but the majority will need to be borrowed. To borrow funds on the open market a service supplier will need to demonstrate its capacity to repay the loan, which is not easy under present circumstances.The combining of “black” and “white” local authorities means that operating surpluses no longer exist and that capital expenditure must be externally financed. This will be through a mix of government grants (sufficient to achieve a basic level of service), concessionary finance from the DBSA and loans from the local capital market. As a development finance institution, the DBSA will not be offering much in the way of cheap loans, rather it will aim to assist borrowers to enter the capital market for their future financial needs. Over the next few years there will be much emphasis on co-financing (DBSA and private capital) until the private sector capital market is fully able, and willing, to finance all infrastructure provision. The realisation of this aim might require local authorities to review their current ways of operating, and to explore alternative arrangements for providing public services.Many local authorities are looking more closely at PSP for a variety of reasons: one because it recognises how difficult it is to borrow funds on the open market for expansion, another because it has problems with the productivity of its workforce, and others because they have lost several key technical personnel.THE POTENTIAL FOR INCREASING PSPÂ Most South African public authorities employ the private sector to design and construct public infrastructure such as water supply and sanitation systems. South Africa has a strong consulting engineering fraternity and a large contracting industry. The operation and maintenance of water and sanitation services in South Africa has almost always been a public sector function as inherited from the British system. There are many instances of contracting out parts of a service such as meter reading, sending invoices and regular maintenance activities, but contracting out or delegating a complete service is still comparatively rare.In general, where there was sufficient economic activity to pay for a reliable service, there was ample evidence of efficient and professionally run systems. However, in many parts of the country, indeed for the majority of the population, there has been consistent under-funding, leading to services which are inadequate both in quantity and quality. In these situations there have been several arrangements for contracting out services in the former homeland areas such as Kwa Zulu, where both water supply systems and sewage treatment works are managed by private sector companies.The current pressures on local authorities demand a fresh look at how things are done. It can no longer be assumed that all activities will be handled by experienced, motivated municipal employees. Where competent capacity does exist, it should be well cared for, but it might also need some retraining to meet new challenges. It is probable that much more of the local authorityâ€™s service provision may need to be “out-sourced.” There are many examples of this, ranging from meter-reading and drain-cleaning through to long term investment-linked concessions for infrastructure provision such as water supplies and wastewater treatment. Each municipality will have its own set of needs and resources. But this is not static. All aspects of service provision should be regularly reviewed, perhaps annually, to see if a particular activity could be better and more efficiently performed by a private sector contractor. Another consideration is the potential for supporting emerging contractors and suppliers through small scale contracts for services. Such businesses commonly employ labour rather than machines, and they could contribute to lowering unemployment in the area.In the water sector, in addition to the extensive use of out-sourcing work through service contracts, there is a range of options for involving the private sector. These include management contracts (lasting anything from 2 to 20 years, but typically about 5 years), renting or leasing of assets (also known by the French term “Affermage”) (lasting between 10 and 20 years), and investment-linked contracts or concessions. There are many variants of concessions: BOT (Build, Operate, Transfer), BOO (Build, Own, Operate) and BOOT (Build, Own, Operate, Transfer). Each has its strengths and is appropriate in different circumstances. They may last from 15 to 30 years or more, depending on the amount of capital investment involved. Outright privatisation of water and sanitation services (completely private ownership) is not under serious consideration in South Africa at present.WATER SUPPLY AND SANITATION – LEVELS OF SERVICEThere is a massive range in the cost of different sanitation systems which represent different levels of service (LOS). There is frequently a direct link between a particular sanitation type and the LOS for water supply. When choices are to made about LOS for water and sanitation, they should be considered as almost inseparable. Figure 1. below presents the costs of three different pairs of water supply and sanitation options. The marginal capital costs of the on-site / neighbourhood infrastructure and the necessary bulk infrastructure have been reduced to a monthly amount, based on a twenty year loan. To these have been added typical monthly running costs. The results display the massive costs differences between a basic LOS (a public standpipe for water and a VIP Latrine) and a full-service LOS (in-house water connection and full waterborne sewerage).Similar comparisons can be made with respect to the amounts of water used in the different systems. The basic LOS might generate a demand for only 25 litres per capita per day, while the full LOS could demand 150 to 300 litres per capita per day. Thus, a change in sanitation system in an area of limited water resources may even require a change of water source, whose marginal costs may be orders of magnitude higher than before. Under such circumstances, the choice of sanitation system needs to be very carefully considered.INVESTMENT AND TARIFF POLICIESIn response to the enormous backlogs and investment projections mentioned above, Government, through the MIIF and associated initiatives, has established several policy principles which will affect future investments and user charges. Key features of the policy are as follows:The government should not set national minimum standards higher than the basic level.Local authorities should be encouraged to adopt short term goals of universal coverage to a basic level.Grant finance for a basic LOS should be limited to once-off capital for on-site infrastructure (part of the housing subsidy) and discreet amounts for bulk infrastructure where a supplier cannot afford even a basic LOS from own resources and borrowing.Consumers should be enabled to choose service levels which are more expensive than the basic LOS, provided they pay the full costs of the service.Consumers as a whole should pay the full recurrent costs of services within a discreet urban area and there should be no operation and maintenance subsidy entering a supply area from outside.The tariff structure for water and sanitation should include a lifeline tariff plus a rising-block rate tariff which increases with consumption.AFFORDABILITYSuch policy principles should make possible a sustainable investment programme to reduce the service backlogs in urban South Africa. Thus for a programme to be sustainable, it must be affordable, in the broadest sense of the word; and go on being affordable until all needs are met, on a continuous basis. “All levels of government must pay attention to affordability given our commitment to fiscal discipline and to achievable goals.” (RDP White Paper)There are at least three levels of affordability to consider:at household level,at local government and local economy level, andat central government and macro-economy level.Government has clarified the limits on its grant support to local government and most households have severe constraints on their ability to pay high service charges. Local government therefore has the immense challenge of coping with these two restrictions on its income.The above mentioned investment and tariff proposals cannot all be implemented immediately, but they do indicate a trend that is essential to ensure the financial viability of urban services while addressing the dangers that excessive taxation and cross subsidies may pose to the viability of the urban economy as a whole. In future, urban infrastructure services need to be run on a commercial basis where all costs, including redemption of loans, are paid from user charges.The recurrent cost implications of rapidly increasing the proportion of low income households with a full level of service give serious cause for concern, and the likelihood of central government indefinitely “bankrolling” local authority subsidies on consumption is extremely slim. There is much investment needed to rehabilitate deteriorating systems and to extend services in low income areas. The RDP fund and the new local authorities will all be contributing to this, but it cannot be done in such a way that it builds up even greater debts through unsustainable running costs. There will continue to be grant finance available to assist with capital costs, but this will be limited by macro-constraints, so local authorities must look to the capital markets and to user charges to secure their income. They cannot rely on continued intergovernmental grants for recurrent costs.Where developing areas have been heavily dependent on grant finance for capital expenditure there has frequently been scant attention to recovering costs, often resulting in a lack of finance even for operations and maintenance. When this happens, the inevitable result is a decline in the quality of service and even less likelihood of consumers being willing to pay user charges. The White Paper on Water Supply and Sanitation Policy quite rightly draws attention to the other corollary of non-payment for services – that scarce funds are used for operating services for those who already have a supply, thus reducing the finance available to provide new supplies to those not yet served.LESSONS SO FARThe DBSA has geared up to provide local authorities with the necessary advice and assistance to consider their options in PSP and to prepare appropriate contract documentation. This activity has been supported with grants from the Department of Constitutional Development on pilot basis. The two most advanced water sector concessions are Nelspruit (bids being evaluated) and Dolphin Coast (bids due at the end of August). A swift round of interviews with involved persons and organisations has identified a number of important lessons already learnt.Firstly, all are agreed that even more preparation is needed (and less haste) to make good quality information available to bidders. Opinions vary on how prescriptive the RFP (Request For Proposals) should be. A clearly defined investment programme would increase the comparability of bids, but an RFP which defines only performance requirements leaves more scope for innovation. Obviously the latter approach needs a very astute team to evaluate the options contained in the bids, and one will need to be convinced that price differences are due to ingenuity rather than through errors, or a hidden intention to recoup losses later.Secondly, there is a need for good long term planning, especially when it comes to the choice of level of service (LOS) and the speed at which backlogs can be addressed; and the impact of these decisions on the likely future tariff. It has been proposed that an RFP should not go out before a working financial model for the concession had been prepared to the teamâ€™s satisfaction. This would be an indicator that sufficient data was then available for bidding to proceed (see previous point). It would also demonstrate to the council/authority what the financial implications would be, providing the opportunity to modify plans or investment requirements before issuing the RFP. Furthermore, local authorities should be prepared to “take the heat” by immediately (before the concession is finalised) increasing tariffs in line with the financial projections, so that the introduction of the private sector is not indelibly associated with a price rise. In fact it might make a price reduction possible, thus gaining the confidence of consumers.Thirdly, processes must be very carefully managed. Pre-qualification criteria must be clear and made public. The need for a small short-list (four, maximum five) should be agreed by all, and then ruthlessly enforced. All discussions with stakeholders, from Day One, must be recorded and notes circulated, to avoid later problems through poor recollection by some parties. All information passed to bidders must be confirmed in writing and circulated to all other bidders, and to other team members. And do not assume that all team members (both within council and their advisers) are talking to each other! Information should be tested for accuracy and consistency before being incorporated in the RFP or supplied to bidders. Late changes which may affect the funding requirement should be avoided.It must be acknowledged that the existing municipal workers are important stakeholders that must understand what is happening. Concern has been raised that the Trades Union movementâ€™s opposition could de-rail the process, but Nelspruitâ€™s experience may show the way. At a recent conference Nelspruitâ€™s Mayor said: “There are constant meetings taking place between the council and the trade unions in order to find a solution which will satisfy as many role players as possible. The basic message that the Council is getting from the National Trade Union is that there is principally an objection to private sector involvement in essential services. The local representatives have however at a number of occasions expressed understanding on the reasons why Council is following the route of involving the private sector in the project. The Council is still confident that a solution will be found in the end and strives to tie the unions in as part of the project.”One particular issue still needs more thought: how to deal with “political risk”. Does it still exist? How can it be defined? By what mechanism can politically motivated non-payment or vandalism be determined? What compensation provisions can be put in place, without removing incentives for all parties to perform? The Nelspruit RFP has no such provisions, but is it reasonable to expect a new company to manage the transition from little or no payment for services, in former homeland townships, peri-urban and rural areas, to a fully functioning commercial operation, in South Africa today? We shall see.CONCLUSIONSouth Africa has made a good start in moving towards more PSP in the water and sanitation sector. We need to continually learn from local and international experience in order to ensure that we are always doing the best for South African consumers.Despite numerous borrowings from the work of others, the views expressed here are the authorâ€™s and are not necessarily those of his employer.ENDNOTES1 Municipal Infrastructure Investment Framework, Ministry of the Office of the President and the Department of Housing, October 1995.2 Financial modelling of Rural Water Supply – Synthesis Report, Palmer Development Group for Department of Water Affairs and Forestry, March 1996.3 MB Van Ryneveld, Costs and affordability of water supply and sanitation provision in the urban areas of South Africa, Water SA, January 19954 Special thanks to Leon Hallett, Town Engineer, Nelspruit; Tony Sanders, WSSA; Patrick Vincensini, SAUR; Neil Morrison & Martin Locke, Deutsche Morgan Grenfell; David Miller, Coopers & Lybrand; J-P Labuschagne, DBSA.5 Paper delivered to the Local Government Delivery Conference by Councillor Isaiah Khoza, Mayor of Greater Nelspruit, 23 June 1997.