89326 Water Papers Water Papers May 2014 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS e Global e Partnership on Global Partnership Output-Based Aid on Output-Based Aid Water Papers are published by the Water Unit, Transport, Water and ICT Department, Sustainable Development Vice Presidency. Water Papers are available online at www.worldbank.org/water. Comments should be e-mailed to the authors. © 2014 The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202–473–1000 Internet: www.worldbank.org This work is a product of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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Acknowledgements This User’s Guide was prepared by the Water Partnership Program team comprising Diego Rodriguez (Task Team Leader), Mario Suardi, Marcel Ham, Luisa Mimmi, and Amanda Goksu with the financial support from the Global Partnership on Output- Based Aid (GPOBA) and the Water Partnership Program (WPP). The work was also made possible by the contributions of the following World Bank staff and consultants who participated in consultations and interviews: Caroline van den Berg, Xiaokai Li, Daryl Fields, Ana Silvia Aguilera, Cledan Mandri Perrot, Francois Onimus, Dominic Patella, William Savedoff, Sophie Trémolet, Luis Vaca-Soto, Olivier Knight, Rikard Liden, Josses Mugabi, Remi Trier, and IJsbrand de Jong. Special thanks to peer reviewers Carlos Velez, Xiaokai Li, Francois Onimus, Almudena Mateos, Remi Trier, and Oliver Knight. The Water Partnership Program (WPP) is a multi-donor trust fund established in 2009 supported by the governments of the Netherlands, the United Kingdom, Denmark and Austria. The WPP enables the World Bank to bring innovation and leverage investment in water, to drive change in global policy dialogue and to strengthen the results of its projects. The WPP works at the nexus of water with food, energy, environment, and human development needs to help countries achieve climate-resilient and inclusive green growth. www.worldbank.org/water/wpp GPOBA is a global partnership program administered by the World Bank. GPOBA was established in 2003 to develop output-based aid (OBA) approaches across a variety of sectors—among them infrastructure, health, and education. To date, GPOBA has signed 38 grant agreements for OBA subsidy funding for a total of US$155 million. GPOBA projects have disbursed over US$105 million based on independently verified outputs, directly benefitting approximately 7 million people. The program’s current donors are the United Kingdom’s Department for International Development (DFID), the International Finance Corpora- tion (IFC), the Directorate-General for International Cooperation of the Dutch Ministry of Foreign Affairs (DGIS), the Australian Department of Foreign Affairs and Trade (DFAT), and the Swedish International Development Cooperation Agency (Sida). www. gpoba.org. CONTENTS Acronyms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii Chapter 1: Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Brief Overview of RBF Tools . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Overview of the Document . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Chapter 2: Analytical Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Establishing Objectives-Results-Indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Identification of Objectives and Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Choice of Indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Verification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Five Preconditions for RBF . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Precondition 1. Willingness to Work with RBF . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Precondition 2. Risk Transfer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Precondition 3. Access to Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Precondition 4. Enabling Environment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Precondition 5. Capacity and Competences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Determining the Attractiveness of RBF . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Chapter 3: RBF Case Studies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Real-life Case Studies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Case 1. Tackling Water Scarcity in São Paulo (OBD Approach) . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Case 2. Increasing Household Sewage Connections in Uruguay (OBD Approach) . . . . . . . . . 23 Case 3. Improving Access to Water Services for Poor Households in Metro Manila (OBA Approach) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Case 4. Improving Access to Water and Sanitation Services for the Urban Poor in Morocco (OBA Approach) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 Case 5. Improving Irrigation in the North China Plain (Performance Improvements) . . . . . . . 31 iv APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS Case 6. Slowing Deforestation in Costa Rica (Payments for Environmental Services, PES) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Potential Future Applications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 Hypothetical Case 1. Implementing Subsidies for Irrigation Technology and Weather Microinsurance for Small-Scale Farmers . . . . . . . . . . . . . . . . . . 37 Hypothetical Case 2. Minimizing the Negative External Effects of a Hydropower Plant . . . . 40 Hypothetical Case 3. Preventing the Negative Effects of Flooding . . . . . . . . . . . . . . . . . . . . . . . . 41 Chapter 4: Main Findings and Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 Using RBF to Address Certain Categories of Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 Behavioral Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 Constrained Demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 Externalities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 Limited Supply-Uncertain Future Revenues-Market Power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49  Subpar Implementation of Infrastructure Programs or Budget Execution . . . . . . . . . . . . . . . 49 Poor Service Delivery and Operation and Maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51  Six Principles for Tailoring RBF Mechanisms to a Particular Case . . . . . . . . . . . . . . . . . . . . . . . . . . . 51  Principle 1. The Incentive should focus on the outcome . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 Principle 2. Ensure that indicators are measurable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52  Principle 3. Use a long-term perspective rather than a short-term one . . . . . . . . . . . . . . . . . . . 52 Principle 4. Create a market-like or market-based system, to the extent possible . . . . . . . . . . 52 Principle 5. Ensure a feasible allocation of risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53 Principle 6. Be aware of and avoid potential unintended incentives . . . . . . . . . . . . . . . . . . . . . . 53 Concluding Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53 Appendix A: Glossary of RBF-Related Concepts and Instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 Appendix B: Objective–Result–Indicator Chains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71 Figures RBF Instruments Can Include a Variety of Multilateral Institution-Government- . Figure 1.  Agent-User Arrangements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Figure 2.  Overview of the Analytical Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Simplified Mapping of RBF Approaches on a Results Chain . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Figure 3.  Relationship in Results-Based Financing between Objectives, Results, and Indicators . . . 8 Figure 4.  Figure 5.  Verification Process by Type of Indicator . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 CONTENTS   v Figure 6.  Institutional Arrangements for the REAGUA Project in São Paulo . . . . . . . . . . . . . . . . . . . . . 24 Institutional Arrangements for the Water Services Project in Manila, the Philippines . . . 28 Figure 7.  Institutional Arrangements for the Water and Sewage Services Project in Morocco . . . . 32 Figure 8.  Tables Table 1:   Common RBF Instruments: A Quick Reference Guide . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Table 2:  Selection of Optimal Approaches to Defining Results and Indicators . . . . . . . . . . . . . . . . . . . 10 Table 3:  Output Definitions for the REAGUA Project in São Paulo . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Connection Costs for the Water Services Project In Manila, the Philippines . . . . . . . . . . . . 28 Table 4:  Excerpt from the Annual Performance Assessment for the Nanyao Irrigation District, Table 5:  China, 1993 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Table 6:  Kinds of Issues in Water Projects and Related RBF Tools . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 Table B.1:  Water Supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 Table B.2:  Sanitation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64 Table B.3:  Irrigation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 Table B.4:  Hydropower . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 Table B.5:  Flood Protection/Prevention . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 Boxes Box 1:  Transferring Risk to the Agent: An Example of Watershed Protection . . . . . . . . . . . . . . . . . . . . 13 Box 2:  Types of Risk Related to RBF and Ways to Reduce Those Risks . . . . . . . . . . . . . . . . . . . . . . . . . 14 Box 3:  Creating Incentives to Financial Institutions to Participate in Small-Scale Irrigation . . . . . . . 16 Box 4:  RBF vs. “Traditional” Solutions as Applied to Irrigation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Box 5:  Evaluation Studies of GPOBA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Box 6:  Changing Habits in the Area of Waste Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 Box 7:  Inducing New Behavior in Hygiene . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 Box 8:  RBF for Flood Prevention . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49 Box 9:  Overcoming Supply Constraints in the Provision of Sanitation Infrastructure . . . . . . . . . . . 50 Acronyms AMC Advanced Market Commitment AusAID Australian Agency for International Development CBO Community-based Organization CCT Conditional Cash Transfers CF Carbon Finance CGD Center for Global Development COD Cash-on-Delivery CPI Consumer Price Index DfID Department for International Development (United Kingdom) ES Environmental Service FIT Feed-in Tariff GA Government Agency GHG Ggreenhouse Gas GPOBA Global Partnership on Output-Based Aid ha Hectare IBRD International Bank for Reconstruction and Development ICE Information, Communication and Education Campaigns IFC International Finance Corporation IVA Independent Verification Agent KfW Kreditanstalt für Wiederaufbauthe (Germany) LNG Liquefied Natural Gas LSMS Living Standards Measurement Study (World Bank) MDGs Millennium Development Goals MFI Multilateral Financial Institutions MW Megawatt MWC Manila Water Company Inc. (the Philippines) NGO Nongovernmental Organization ODA Official Development Assistance OBA Output-Based Aid OBD Output-Based Disbursement ODF Open Defecation Free O&M Operations and Maintenance OSE Obras Sanitarias del Estado (Uruguay) P4R Program-for-Results PBC Performance-Based Contract PBFH Results-Based Financing for Health PES Payment for Environmental Services viii APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS PPA Project and Performance Agreement PSA Pago por Servicios Ambientales (Payments for Environmental Services) PPP Public-Private Partnership RBA Results-Based Aid RBF Results-Based Financing RE Renewable Energy REAGUA São Paulo Water Recovery Project (Brazil) RUC Reference Unit Cost SHS Solar Home Systems SIDA Swedish International Development Agency ToP Take-or-Pay UfW Unaccounted for Water VIMG Village Irrigation Management Groups (China) WII Weather Index-based Microinsurance WSS Water Supply and Sanitation WUA Water Users Association Note: All currency amounts are in U.S. dollars, unless otherwise noted. Chapter 1 . Introduction Background Over the last several years, the development practice and discourse has emphasized the need to link development financing and assistance to results. This change reflects incentives internal to donor agencies, such as tighter aid budgets and increasingly pressing accountability to domestic constitu- encies. At the same time, the increasing emphasis on tying development funding to results stems from disappointment in the results achieved by decades of development assistance, which based disburse- ment mostly on “inputs,” and the subsequent discussions about the effectiveness of international aid that began taking shape in the late 1990s. In particular, various High Level Forums on Aid Effectiveness over the last decade (notably Paris in 2005, Accra in 2008, and Busan in 2011)1 brought about a critical rethinking of aid goals and modalities that concentrated on criteria like country ownership, account- ability, and management for results. In this context, increasing attention has been given to results-based forms of assistance and funding that seek to provide greater incentives for achieving development outcomes and outputs. Results based financing (RBF) mechanisms can serve as alternatives to traditional official develop- ment assistance (ODA)—grants, loans, and guarantees—which is typically disbursed in advance of delivery. There is no universally accepted definition of RBF. This commonly used label has been defined in different ways according to its objectives, the agencies involved, the level of the incentive(s), or the form of funding itself. Notably, the UK Department for International Development (DfID) identifies as result-based aid (RBA) any such approach whereby funds from bilateral or multilateral development agencies are used to incentivize developing country governments (See Pearson (2011)). By contrast, this document adopts a very broad definition of RBF (see glossary, Appendix A) and it relies on the “principal-agent” model often used in economics to describe the features of the 1  The Paris Declaration on Aid Effectiveness, adopted by ministers and high-ranking representatives from 60 partner countries and more than 50 multilateral and bilateral development institutions, reaffirmed the shared determination to implement the Millennium Development Goals (MDGs) and the commitment to meet them through donors’ harmoni- zation and recipients’ ownership. Donors and partners agreed to be measured as to whether they really have achieved the set goals. The midterm review that took place in Accra (September 2008) registered important progress but also highlighted the necessity of greater flexibility on the part of the donors to adapt to recipients’ structures and the lack of ownership and capacity in a number of partner countries. More recently, at the Busan Forum in the Republic of Korea, global development leaders reviewed progress in improving the impact and value for money and recognized the grow- ing importance of new development stakeholders such as new emerging donors, civil society, and the private sector. 2  See Pearson (2011), Savedoff (2011) and ESMAP (2013). 2 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS approach. As seen in previous works on this ●● Better quality of services because incen- topic, 2 the principal is a funder (regardless tives are placed on quality and timely whether international or local) who delegates delivery certain tasks to an agent. The agent assumes ●● Reduced corruption, due to increased responsibility for achieving pre-defined results transparency in the results-payment link through some form of contract that postpones ●● Change in culture, from budget-driven to payment until delivery. In such broad terms, RBF results-oriented can be established between multilateral orga- ●● Closer supervision as this is a necessary nizations and recipient governments; federal condition to issue payments and subnational governments; governments (or ●● Sustainability, particularly if the indicators subnational governments) and public or private are tracked throughout the project life service providers; district authorities and local ●● Increased autonomy for the implement- workers; or public programs and civil society ing agency as to “how” to deliver the organizations or families or individuals (Figure 1). results Since the main intended audience of this docu- ment is World Bank staff, the discussion and However, RBF also comes at a cost, which case studies often deal with the level of the is an argument often raised by critics of these relationship between multilateral financial insti- instruments. The most important costs are: tutions (MFIs) and client governments. However, this document may lead to valuable insights for ●● Transaction costs of developing the all practitioners dealing with RBF or exploring scheme that also requires large time potential uses of RBF. investments during project preparation The most important benefits associated ●● Higher costs of monitoring and with RBF are: supervision ●● Risk of unintended distortions caused by ill-defined incentives RBF Instruments Can Include Figure 1:  a Variety of Multilateral This document is intended to contribute Institution-Government-Agent- to a better understanding of RBF instruments User Arrangements and the conditions for success or failure of the approach in water. Given the broad variety of Donor Multilateral issues and sectors covered, concrete examples are provided in an attempt to make the document as practical as possible in guiding the design of State government future RBF schemes. The health sector has been a pioneer in imple- menting RBF efforts, followed by other sectors Sub sovereign including education, energy, and water (mostly government water supply). Bilateral financing institutions such as the British Department for International Development (DfID), German Kreditanstalt für Agency/ Operator User Wiederaufbauthe (KfW), Swedish International Chapter 1 Development Agency (SIDA), and the Australian Introduction   3 Agency for International Development (AusAID) Table 1 presents these tools, highlighting were early promoters of these instruments, their main objective and indicating the kind of together with development agencies like the Cen- incentive(s) they entail. While adopted in differ- ter for Global Development (CGD) and the Global ent sectors, these tools might be potentially rel- Partnership on Output-Based Aid (GPOBA). evant for the water sector, and water challenges Within the World Bank Group, conceptual related to climate change, as will be discussed acceptance has grown as well, and pilot forms of further in this document. results-based lending and assistance, including OBA, have been implemented in many projects around the world. For instance, in 2012, a Overview of the Document new results-based lending instrument called Program-for-Results (P4R) was launched, while Given the broad array of issues and the complex- the International Finance Corporation (IFC) has ity faced by the water sector as a whole (from supported and funded several development RBF irrigation to flood protection, to water conserva- instruments and facilitated their deployment in tion and hydropower), there is great demand several projects. for further exploring the potential of results- based financing and tackling the questions still unanswered about many of its operational Brief Overview of RBF Tools dimensions. This document takes a closer look at some The experience of RBF schemes so far has been of the practical aspects of implementing vari- somewhat selective and donor-driven. Nonethe- ous RBF water schemes. Chapter 2 provides an less, from the many successful projects that analytical framework to explore if and when RBF have closed as well as others that are ongoing, can be a viable option, shedding light on some key the development community has been accu- factors and preconditions that are necessary for mulating experience and gathering knowledge RBF to work—with the understanding that it can about the requirements and key factors of suc- be used either as an alternative or a complement cess for implementation. to a more traditional input-based funding scheme. The water sector has been part of this move- The goal of this analytical framework is to lay out ment to adopt RBF instruments. To date, experi- the most important questions that need to be ence has been limited in terms of the RBF tools faced in the design phase of an RBF approach, that have been adopted. For the most part, their including: a) How can the results be defined and application has been confined to projects dealing measured?; b) Will the agent be willing and able with water supply. Most of the RBF projects in to commit to deliver the results (i.e. comfortably the water sector use the output-based aid (OBA) bear the extra-risk linked to the RBF operations)?; approach for water supply. Some projects are also and c) What is the optimal level of the incentive to using output-based disbursement (OBD) for some the agent and how should it be funded? broader water resources management projects Chapter 3 then revisits the concepts dis- and some sanitation applications (see glossary in cussed in the analytical framework through Appendix A and case studies in Chapter 3). the analysis of various case studies of RBF Other RBF tools seem relevant and promis- approaches in different water-related areas. ing for potential application in the broader water Some of the case studies are based on actual Chapter 1 sector (outside of water supply and sanitation). projects already implemented or ongoing, while 4 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS Table 1:   Common RBF Instruments: A Quick Reference Guide Instrument Definition Main purpose Type of incentive(s) Advance A contract in which donors To encourage the Guaranteed prices (up to market or governments make development and a certain quantity, donors commitment a legally binding pledge production of affordable or governments pay a (AMC) to pay for an innovation technologies or higher price and afterward (result) if and when one procedures by creating a the developers receive a is developed (originally viable market for such new price affordable for the conceived for vaccines) technology or procedure population) Carbon Resources provided to To support actions that A reward in the form of finance (CF) projects generating (or reduce the amount of GHG carbon credits expected to generate) emissions over and above reductions in greenhouse a baseline determined a gas (GHG) emissions in the priori form of the purchase of such emission reductions Cash-on- A financing arrangement To encourage client Reward for achieving delivery aid through which donors country governments to agreed targets at a macro (COD) offer to pay recipient improve certain aspects level governments a fixed of their performance, amount for each additional but allowing those unit of progress toward a governments to decide commonly agreed goal how to achieve those results Conditional Programs that transfer To encourage the Reward for adopting new cash transfers cash to poor households beneficiaries to adopt behaviors or habits or (CCTs) that make specified new practices that tend achieving certain personal investments in the human to improve their living development goals capital of their children conditions or chances of or change their behavior growing out of poverty to promote the children’s welfare Feed-in tariff An energy supply policy To support projects Guaranteed prices, (FIT) offering long-term oriented to the adoption typically including: purchase agreements and deployment of guaranteed access to the for the sale of electricity equipment to generate grid; stable, long-term generated through electricity through RE purchase agreements renewable energy (RE) (15–20 years); and payment levels based on the costs of generating RE Output-based A mechanism to support To facilitate access to Subsidy targeted to the aid (OBA) the delivery of basic basic services for the eligible, low-income services where policy low- income segment of population. It is generally concerns justify the use the population valued in relation to the of explicit, performance- cost of providing the based subsidies service in question. Output-based A disbursement To stimulate execution of Loans to federal/national disbursement mechanism between budgeted infrastructure government disbursed (OBD) different levels of plans by lower levels of upon achievement of government for the government specified outputs delivery of clearly specified outputs (continued on next page) Chapter 1 Introduction   5 Table 1:   Common RBF Instruments: A Quick Reference Guide (continued) Instrument Definition Main purpose Type of incentive(s) Payment for A voluntary transaction To encourage the Payment for a specific environmental where a well-defined preservation of certain service, once valued and services (PES) environmental service environmental conditions rendered (ES) (or a land use likely that produce beneficial to secure that service) is results for the beneficiaries being bought by one or more ES buyer(s) from one or more ES provider(s) if and only if the ES provider secures provision of the ES Take-or-pay A commitment from To ensure a minimum Guaranteed prices and a buyer to either take revenue stream to the quantities delivery of and pay for supplier of certain goods a specified minimum or services quantity of goods or services over a specified period of time or pay for the contract value of that minimum quantity Source: Author’s compilation. Please see Appendix A for sources for each definition. others are an illustrative elaboration, given outcome, the sources of funds available, and the lack of practical cases to use as sources. the existence and quality of verification systems These theoretical constructions are based on will guide the choice of the best tool that can the experience of the authors and have been minimize the risk of unintended distortions (such discussed with expert RBF professionals and as rent-seeking or overproduction of rewarded sector specialists. The main goal is to offer some goods/services) while matching the existing concrete illustrations of the type of questions supply and demand conditions. and operational dimensions that are likely to After the review of selected case studies, arise when considering an RBF scheme in vari- lessons learned are provided. Since RBF does ous water-related schemes. The reader should not have universal application, the main recur- use good judgment to adapt such considerations ring issues encountered in the broad water to the context and case at hand. sector are used as a starting point to help nar- Chapter 4 presents some conclusions and les- row down the selection of which RBF tools may sons learned. The key challenges that are likely to be most suitable for each specific context and be encountered in designing an RBF scheme deal situation. with: the clarity and level of certainty of the rela- Appendix A presents a glossary of RBF tionships from input to output to outcomes (causal terms for those who are not yet familiar with all links); the ease and availability of measurable of the concepts and acronyms associated with indicators; and, consequently, the optimal deter- the subject. To promote an interest in develop- mination of the necessary incentive(s) to align the ing new RBF schemes or tackling issues in new goals of the principal with the agents’ deliverables. areas, specific results and indicators that could Assessing the extent to which the principal be relevant for different sectors are presented in is committed to reach the intended output/ Appendix B. Chapter 1 Chapter 2 Analytical Framework A pplications of RBF in the water sector should be assessed with regard to their suitability to a specific project. The analysis should address the following questions: 1. How can the objective(s) and results be defined and measured? 2. What are the preconditions for a feasible RBF scheme? 3. Is RBF attractive in comparison to more conventional approaches and solutions that do not use RBF? These questions are a key component of the analytical framework of this document (Figure 2). The discussion that follows answers the questions to provide guidance in exploring potential applica- tions of RBF. In real life, the reasoning sequence may differ from the one followed here. Many of the analytical aspects presented could be considered simultaneously and iteratively. Establishing Objectives-Results-Indicators The most promising features of the RBF approach aim to tie the disbursement of funds to the achieve- ment of results. This brings the identification of such results front and center. The possible ambiguity of RBF—as discussed in O’Brien & Kanbur (2013, p. 4)—is that almost anything can be regarded as a “result” (even an input). Thus there must be a clear agreement on where the desired results fall in a chain of causality from inputs to outputs to outcomes. Figure 3 shows a simplified graphic representation of the claim of RBF approaches in general. Figure 2:  Overview of the Analytical Framework Logical chain of objective-results indicators Preconditions for RBF Willingness Risk Access to Enabling Capacity and to work Transfer finance environment competences with RBF RBF Attractiveness 8 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS First and foremost, for RBF instruments Identification of Objectives and to be effective, it is vital that the desired higher Results objective (or outcome) can be translated into As projects financed using RBF instruments base clear, achievable and measurable results payments on the expected results, there must be (typically lying somewhere between outputs a strong correlation between the objective and the and outcomes).3 Second, it is essential to have expected result. For instance, if the objective of an indicators that allow the results to be measured irrigation project is to reduce the volume of water in such a way that disbursement of finance can used by the farmers, the expected result should be precise and reliably tied to results. be closely linked to such volume. Sometimes, an When the chain between these three ele- objective can be achieved by a combination of ments is not robust—meaning that the indicator results. For example, reducing water-related dis- does not adequately represent the expected eases may be the ultimate objective of a project results that are univocally linked to the objective that increases access to improved piped water. of the intervention— the scheme risks being Yet, to reach the desired goal in a disadvantaged ineffective or even counterproductive (it may area means not only ensuring that an adequate generate negative incentives). For example, allo- number of water points is built (either communal cating some form of financial incentive based on or in households), but also that water is consis- increasing irrigation infrastructure, but without tently supplied to the new infrastructure, water ensuring that water is adequately priced, may quality is safe, and adequate sanitary conditions have the unintended effect of stimulating inef- in the targeted neighborhoods and households ficient or wasteful use of water. On the other are also met. hand, when the causal relationship that links these three elements is robust, the chances for success are very high (Figure 4). 3  See the glossary in Appendix A for the distinction. Simplified Mapping of RBF Approaches on a Results Chain Figure 3:  Conventional approach RBF approach Inputs Output Outcome Relationship in Results-Based Financing between Objectives, Results, and Figure 4:  Indicators What How can progress What are the measurable towards these ultimate achievement(s) results be intended goals? best represent precisely the objective? tracked? Objective Result Indicator Chapter 2 1 Analytical Framework   9 Generally speaking, the result should there may be a chain of cascading incentives. be expressed as a concrete, tangible output Whether this is set up and what form it may take or outcome that is not subject to ambiguity. will depend on the capacity and sophistication of Some ways to define the results include a hard the client country governments. output, instances of provision of a service, or The most critical link of the chain is the improvement in certain parameters indicating relationship between objective and result living standards or income of the beneficiaries. because this link determines the effectiveness Alternatively, the result can be expressed as of the RBF financial incentive. This link is also an improvement in certain aspect(s) of the liv- at the core of the somewhat controversial ing conditions or income levels of the targeted performance-based conditionality, because it population. The baseline and way to measure is here that the potential distortion of incentives these improvements should be very clearly can happen if the principal and agent have dif- specified, ideally using or building on metrics ferent goals, or resources can be misallocated that are already used in the country statistics if the wrong results are rewarded. For example, system. the supply of water for irrigation in Bangladesh The degree of certainty of the causal link has increasingly relied on groundwater aquifers between a measurable result (number of public (reaching about 80 percent of irrigation water). water points built) and the ultimate objective Many experts now warn that overexploitation of (reduction of water-related diseases) is strictly groundwater is causing a rise in contamination sector-specific and can be strengthened by of aquifers with arsenic, which could then enter consulting literature and evidence. To the extent the food chain, increasing health hazards. It is possible, the definition of the result should cover not uncommon in South Asia to adopt volume- an outcome or provide some assurance about based subsidies to the energy tariff, which in the sustainability of the project objective. In the turn can promote over pumping of groundwater. case of results defined as hard outputs (such A sustainable RBF scheme, in this case, should as irrigation inlets, on-site sanitation facilities, promote the exploitation of the country’s vast and water supply or sewerage connections), surface water resources and also reward the the inclusion of a second result (or intermediate decrease in groundwater use. Table 2 below outcome) that will trigger additional payments illustrates why certain options for the chain should be considered. These second tier results of objectives-results-indicators have better could be technical in nature (sustained provision chances of success than others. of adequate quantities of irrigation water, regular As seen in the irrigation example in Table 2, emptying of septic tanks, satisfactory water or linking a farm’s reduction of the consumption of sewerage service) or could be related to a finan- irrigation water to the introduction of a new tech- cial aspect of the project (such as the collection nology seems too weak a link between objective of the corresponding fees). and result because new technology does not The result can be tracked at various levels: necessarily lead to lower consumption. Even if national or federal, provincial or state, com- all farmers install the new technology, they could munity, or even the individual level. The choice opt to grow a more water-intensive crop, increase of level is case-specific. In some instances, a the number of crop cycles, or cultivate a larger national program may be implemented through area in their farms, leading to higher water con- lower-level action plans, with their associated sumption. Using the “number of systems sold” Chapter 2 1 results contributing to higher-level results; thus as an indicator illustrates how the choice of the 10 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS Table 2:  Selection of Optimal Approaches to Defining Results and Indicators Problem Objective Result Indicator Comment Higher than Reduce Water-efficient Number of systems Weak link between desired consumption technology installed installed objective and result consumption of irrigation Number of systems Adds a weak indicator of irrigation water at the sold water farm level Lower volume Volume of water Strong links, but free provided to tertiary provided to tertiary rider issue needs to be canals canals addressed Reduce Conveyance system Kilometers of canals Weak link between losses in the refurbished with lining objective and result conveyance Reduction of water Volume of water lost Strong links system losses in conveyance in conveyance system system indicator itself (number of pieces of equipment ●● Specific: Closely linked to the a specific purchased) can undermine the scheme if it is area of improvement weakly linked to the ultimate objective (reducing ●● Measurable: Able to capture quantifiable water consumption). progress By contrast, when a more precise result ●● Achievable: Achievable within the life of is used—lower volume to tertiary canals—it is the project and thus suitable to trigger very clear that objective, result, and indicator payments are aligned. However, despite a strong indica- ●● Relevant: Reflect information that is tor, there still could be uncertainty about who important and helpful in tracking prog- receives the incentive and how this is defined. ress toward the intended objective Given the difficulty in measuring how much ●● Time bound. Progress can be tracked at a water goes to each individual farm, a set of rules desired frequency for a set period of time should be set to avoid the free rider problem, as some farmers may be making an effort to reduce Defining, measuring, and verifying SMART indi- consumption while others may continue with the cators are necessary conditions to the success- old practices and still reap the benefits (if paid ful preparation and implementation of an RBF to a water users association, for instance or operation. Selecting the protocol for calculating distributed uniformly among all farmers within the indicator can be just as important. This is par- the scheme). ticularly the case for complex outcomes (such as standards for treated effluent returned to water Choice of Indicators bodies) or outcomes involving sustainability. Since the value of the indicator will determine the In cases where the result is a hard output, amount to be paid to the agent, it is critical that the indicator will most likely be the number of the indicator be properly defined, unambiguous, those outputs that were produced or delivered and easy to measure or calculate (that is, the by the agent. In such cases, there should also parameters to be used in its calculation should be a reference to the standards that will be used have similar characteristics). The indicators Chapter 2 1 should be SMART:4 4  Bogue (2005). Analytical Framework   11 to verify compliance. For example, in the case of were joined every six months by an international the provision of a certain service, the number of expert. The brief note by Loening and Tineo months of satisfactory service provision or the (2012) offers some practical insight from GPO- achievement of a set period of such satisfactory BA’s experience in hiring and supervising IVAs. service provision could trigger the payment. If the scheme is using government-gener- If the objective is to reinforce the financial ated indicators to measure the results, the IVA sustainability of a service, a dual result could will need to verify the strength of the mecha- be set. A technical objective—compliance to nism to generate the indicators (information service standards—could be established, using gathering and processing). From time to time, a pass-fail indicator. If the technical objective the IVA may need to carry out field visits and was passed, the financial result could be set, in verify a sample— although this can be costly. the form of a collection rate. For schemes using discrete results to trigger When the result corresponds to a parameter payments, the agent can prepare a report show- tracked by the national statistics system, the indi- ing the results achieved in sufficient detail so the cator used in such system could be used to deter- IVA may proceed to verify samples of the total mine the amounts to be paid to the agent. Starting number of results claimed by the agent. from a baseline, also adopted from the system, The verification could be done periodically the improvements against it could then be used in (say, every three months) or any time a mini- that calculation. However, special care would need mum number of results has been achieved and to be taken to assess the strength of the system. claimed by the agent. This will depend on the Periodic verification may be warranted to ensure predictability of the number of results that can that the principal will not be paying for inflated be achieved by the agent. In general, if results results. More examples of objective–result–indi- reported are predictable and steady, a periodic cator chains can be found in Appendix B. verification schedule could be set forth. For more unpredictable situations, a minimum threshold Verification could be a convenient way to avoid costly veri- One of the cornerstones of any RBF project is veri- fication missions for low disbursement amounts fication, as disbursements will be made only after to be paid (see Figure 5). results have been independently verified. The Sample verification should be based on qualifications and independence of the person or sound practice according to inferential statistic entity that will carry out the verification process— theory. Good verification practice starts with the independent verification agent (IVA)—should the design of a proper sampling strategy that will be ascertained carefully. In practice, there may allow stakeholders to reach the desired conclu- be a tension between the quality and cost of the sions about the overall intervention area (such work done by the IVA, as it may be difficult to as “the new connections have been successfully find a qualified IVA in developing countries, and installed”) with sufficient certainty (statistical hiring an international group could be costly. significance of the test), while doing so in an It is sometimes possible to use a combination economical way (power calculations allow of local and international professionals, as was estimating the minimum sufficient sample size). done in a water supply project in rural Vietnam Devising a good sampling strategy is a complex by the Global Partnership on Output-Based Aid task because it requires a mix of theoretical (GPOBA). Quarterly verifications were carried knowledge in sampling theory and statistics, as Chapter 2 1 out by two local reputable professionals, who well as practical understanding of the measured 12 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS Figure 5: Verification Process by Type of Indicator 1) Index from the 2) Ad hoc index or discrete National statistics system (Government) outputs/outcomes Verification of Verification of processing data gathering Data gathering (and systems systems index calculation) (Agent) Optional sample verification of Periodic/threshold data gathering triggered Sample verification IVA IVA output and context. For instance, sampling a 2. The agent is capable of assuming additional homogenous universe of beneficiaries concen- risk trated in intensely populated urban slums is 3. The agent has access to finance to fund the very different (in terms of costs and logistics) project until the RBF payments are received from sampling an ethnically diverse popula- 4. The environment is suitable to the use of RBF tion located in a broad and sparse rural region. 5. The key stakeholders have the capacity and Thus it is of utter importance to procure IVA (or competences to develop and implement the external expert) that can properly comply with RBF mechanism this task. Typically, the IVA (or other agency in 5 charge) also establishes a baseline before the Precondition 1. Willingness to project start, such that the results achieved with Work with RBF the intervention may be unambiguously attrib- The willingness of the principal and agent to use uted to it and were not instead pre-existent. RBF is a condition sine qua non. The aspects of When designing the project, it is advisable novelty together with an established culture of to consider the right balance between the cost input-based ODA may be a non-trivial obstacle of each verification exercise and the amounts when piloting RBF approaches, especially in claimed by the agent. Otherwise, the verification untested sectors. This is why building a strong costs could be quite large relative to the total and convincing case to explain the benefits and amount of the project. costs of RBF to the client is a crucial first step for the RBF practitioner. This requires an analysis of all the elements in the analytical framework, and Five Preconditions for RBF specifically the assessment of the attractiveness of RBF. A growing body of evidence illustrat- Five aspects must be considered to determine ing successful examples and the potential whether it is possible to use RBF: 5  Among other resources, the World Bank’s experience with the Living Standards Measurement Study (LSMS) 1. The key stakeholders are willing to work with has generated valuable experience and tools that can Chapter 2 1 RBF assist in survey design. Analytical Framework   13 advantages of using the RBF approach may described in Box 1 show how the risk may be provide additional comfort. shifted according to what level of agency is more receptive to the incentive. Precondition 2. Risk Transfer An adequate risk analysis will have to be Shifting the funding after the delivery of the performed. The approach to it is the same as with agreed results implies assessing whether the traditional financing instruments, as it relates agent is in a position to take on the additional risk to ensuring that each risk is borne by the party and to what extent the agent can bear and man- better suited to manage it. Box 2 provides a brief age the additional risk introduced by RBF tools. summary of the main risks to consider in such an Taking on the additional risk posed by the RBF analysis. mechanism can be a problem for small service providers when they are not allowed to take on Precondition 3. Access to Finance debt to pre-finance some of their operations. Even if the agent can take on the additional risk, The main additional risk that the agent will RBF may also require that adequate resources have to take on is linked to the financial risk to are available to the agent to pay in advance for fund the cash flow gap between the project the goods and services needed to deliver the implementation costs and the RBF payments results. Agents can tap a range of sources to until the results are delivered. In most cases obtain the required funds: there are ways to reduce this risk: for instance, linking a share of the payments to intermediate ●● Internally generated cash flow: Private results or combining input-based and results- or government-owned companies may based approaches. The hypothetical scenarios be able to use the proceeds of their Box 1.  Transferring Risk to the Agent: An Example of Watershed Protection If a national government needs to increase the area of protected watershed, given an existing census of selected watersheds to be protected, a donor could reach an agreement with the country to disburse a certain amount for each percentage point increase of protected area, starting from the initial value at the time of the census: a so-called cash-on-delivery (COD) aid agreement.a Of course, the data should be reliable; so should the mechanisms to determine whether conditions have been met to consider that a new area is protected, so the result can be easily verified and the indicator calculated to define the amount to be paid. If the national government is directly responsible for protecting the watershed, a COD-type of agreement should suffice, and the national government would define how to achieve the expected results. If there are multiple reasons for protecting the watershed, and multiple levels of governments have responsibilities, the national government could sign various kinds of agreements with the state/ provincial governments to carry out the projects. These agreements could use different RBF instruments (as well as traditional ones), depending on the circumstances. If watershed protection helps regulate flows in rivers that traverse cities, reducing flood damage by lowering the peak flow, cities could pay to protect the catchment, instead of implementing other flood protection/prevention measures. A Payment for Environmental Services (PES) agreement could be used, for instance (see Appendix A). Conversely, if the protection project requires state/provincial governments to implement infrastructure works, an output-based disbursement (OBD) agreement could be the way to go. Finally, protecting a forest could also be linked to carbon finance provided that certain conditions are met. a See Appendix A for more information about COD agreements, as well as PES and carbon finance. Chapter 2 1 14 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS Box 2.  Types of Risk Related to RBF and Ways to Reduce Those Risks Performance risk: This risk must be borne by the agent for the scheme to be considered results-based financing. To reduce this risk, it is vital that the delivery of the expected results remain under the agent’s control, as much as possible. The results should fall under the agent’s area of expertise or should be the main aspect of its trade or business. Results should be defined very clearly, as well as the way progress in attaining those results will be monitored and verified. Obstacles to performance should be reduced, neutralized, or eliminated. For instance, the agent should have access to all materials, information, or other elements required in a timely manner. Payment risk: This risk can be minimized by ensuring the agent that there will be no delays or withholding of payments once the results have been delivered and verified. Selecting a trustworthy fiduciary agent and clearly defined and actionable disbursement procedures can help create confidence that delivery of results will translate in prompt disbursements reducing the financial burden for the agent. Demand risk: In some cases, the agent could take on the project and find out that there is less demand than expected for the service or product the agent committed to deliver. If the project requires high startup or fixed costs, and recovery of those costs depends on the quantity of product or service provided that is taken up by the public, demand risk could be significant. To reduce this risk, the principal can guarantee a minimum quantity to be purchased (it can also guarantee a price), ensuring a minimum revenue stream for the agent. However, this is a risk that now will be borne by the principal. Another way to minimize this risk, independently of who will bear it, is to conduct thorough demand studies, to understand the size of the market targeted by the project. Cost variation risk: In RBF projects, cost variations may pose a significant risk because the remuneration is set at the onset of the project (sometimes an auction can be held to set a unit payment while at other times this is fixed from the design stage); the agent is allowed to procure materials on services needed to deliver the results that will trigger those payments. This is a key feature of most RBF instruments, as it allows the agent to use its expertise to secure the lowest cost it can and make the most out of the project (conversely, a risk affecting the principal is the one of overpaying for the results). In projects that use traditional financing instruments, the procurement process is monitored by the financing institution; cost variations can be detected before closing the contracts and dealt with accordingly. In RBF, if there is a reasonable anticipation that, due to circumstance beyond the agent’s control, costs may vary in ways that can affect the project financial equilibrium at risk. A way to adjust the remuneration accordingly could be stated in the legal documents. The principal should consider the impact that any remuneration increase could have in the quantity of results to be delivered by the agent or the total cost of the project, if quantities are to be kept unchanged. Other risks: These include collection risk (beneficiaries are not able or willing to pay their portion of the agreed price); political risk (currency transfer restrictions, expropriation and breach of contract, war and civil disturbance); and regulatory risk (for instance, if the principal is unwilling or unable to adjust tariffs in line with increasing cost of service delivery). These risks should be dealt with in a similar fashion as in traditionally financed projects. regular business cycle as a source of ●● Loans: Commercial or government- funds to deliver the expected results. owned banks could provide funding to ●● Government budgets: An agent may start the project based on the capacity of receive government subsidies if the busi- the agent to repay the loan. Agents with ness is not financially self-sufficient and it a good financial history and solid balance is eligible for a subsidy. sheets will be in a better position to use ●● Supplier credits: An agent could receive these sources of funding. materials to be paid for later; reducing the ●● A dedicated national facility. Creat- time lag between paying for the materials ing such a facility is also an option. For Chapter 2 1 end getting paid for the results achieved instance, GPOBA supported the cre- using them. ation of the Honduras OBA Facility; the Analytical Framework   15 government provided $1 million to fund microfinance sector could be one choice. Alter- bridge loans, but only to agents imple- natively, other schemes could be tried, such as menting public projects. the sanitation lottery, which played an important role in the drive for “open defecation free” status Depending on the amounts involved and in rural villages in Bangladesh and India. available sources, the situation and analysis may The RBF financing agreement could also work vary. For instance, if a large contractor, irrigation as a guarantee instrument to negotiate loans for provider, or utility needs to access the funds for the initial funding, as the bank that could provide the project, the banking sector may be sufficient, the loan will still need to assess the capacity of if it is adequately developed. However, if the the agent to deliver the results as expected. How- banks are not use to funding this kind of opera- ever, the bank should have more certainty about tion, working with them to create confidence the availability of funds to pay back the loan given or even introducing some kind of guarantee that the RBF financing agreement indicates that scheme may be necessary. payments will be automatic once the results are There are ways to overcome financing verified. A clause stating some kind of direct pay- issues; the existence of the RBF agreement ment from the RBF fund to the lending bank once could be part of the solution, as well. When fund- the results are verified may also be introduced in ing is not easily available, the RBF design may the RBF agreement. The case of Lighting Africa, be revisited or integrated with traditional, input- presented in Box 3, illustrates how financial insti- based instruments. For example, if an irrigation tutions have been incentivized to progressively scheme ranging from primary canals to farm enter the new market of off-grid lighting solutions outlets involves an investment amount that is for poor customers. too high for the agent to pre-finance, the project could have intermediate outputs like a full stretch Precondition 4. Enabling of primary or secondary canals that will be paid Environment when finished; then the tertiary canals and The extent to which the environment can enable farm outlets can be paid based on the original an RBF approach determines the applicability of indicator. If this arrangement is not possible, the the RBF approach—or, more precisely, how far primary and secondary canals could be financed along the input-output chain the RBF mecha- through a traditional loan, while the rest could be nism can place its incentive. It also determines done using an RBF scheme. to what extent supporting measures are needed It is also important to note that the amount to overcome bottlenecks in the enabling envi- in question will generally be much less than the ronment. Accordingly, the assessment of the total cost of the project, as it will only equal the enabling environment is not static but rather amount required to deliver the first batch of dynamic and so is the range of RBF instruments results, or—more accurately—the maximum that could be applied at different points in time negative cash flow expected in any one cycle of (see the example discussed in Box 4). result delivery and payment. The measures to improve the enabling Conversely, if the scheme requires end environment can be part of the RBF mechanism. users or beneficiaries to buy and install certain For example, if a government is weak and does hardware before they can receive a subsidy or not have the current capacity to manage RBF rebate, there might be a need for a microcredit mechanisms, it can still be possible to place less Chapter 2 1 institution to be present and active in the com- emphasis on the output indicators (and more munity. If this is not the case, reinforcing the on input); define supportive measures (capacity 16 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS Box 3.  Creating Incentives to Financial Institutions to Participate in Small-Scale Irrigation Through much of Africa, the incentives for financial institutions to support irrigation and for farmers to invest in it are lacking. The provision of financial services for smaller-scale investments in irrigation is discouraged by gaps in transport and communications infrastructure, and uncertain legal frameworks, and in land and property registries. Contract enforcement and legal arrangements to facilitate leasing are often not in place. Often the only available financial institutions to support small-scale irrigation finance are commodity- based credit providers, such as exporters, input suppliers, and marketing cooperatives. Increasing the variety of financial products and services offered and extending their outreach to a wider array of rural clients would be highly beneficial. Providing a combination of financing and insurance can reduce production risk. Well-designed insurance products can substitute for traditional collateral. Leasing is often a good alternative to lending for rural finance institutions and a good alternative to borrowing for farmers, and for farmers, this is a way to gain access to equipment for small-scale irrigation, and having the equipment itself serve as collateral. Lessons from the “Lighting Africa” Experience The Lighting Africa program (see http://www.lightingafrica.org/ ) supports the development and distribution of safe, clean, affordable off-grid lighting to Africans not yet connected to a grid. The purpose of the program is to catalyze and accelerate the development of markets for affordable, modern off-grid lighting solutions. Some of the lessons learned from the program could be adopted to support investment in small-scale irrigation technology, potentially involving RBF schemes. A big challenge in mobilizing financing and investments for off-grid lighting has been the lack of knowledge about the industry and the perceived high risk of investments. The program’s effort in defining shared and verified quality standard for the lighting devices accepted under the program helped reassure financial institutions about the technology and demand for the devices. Access to finance was identified by distributors as one of the biggest challenge to scaling up the solar lighting market, constraining their ability to carry adequate stocks and extend credit to retailers. As a result, Lighting Africa offers risk mitigation instruments to commercial financial institutions in order for them to provide long-term growth capital, short-term working capital, and trade finance to manufacturers and distributors. At the consumer level, many rural consumers are deterred from buying off-grid lighting products because the upfront costs are high. Lighting Africa is providing training and creating awareness for microfinance institutions on the opportunities for consumer lending. In addition, the quality benchmarks and warranties provided by manufacturers of products that have passed Lighting Africa quality standards have provided a level of security for microfinance institutions to provide consumer loans. Possible RBF Solutions for Small-Scale Irrigation International donors could encourage local banks to offer credit to farmers, backing them up with interest rate subsidies and/or a (partial) guarantee that could be linked to the number of small farmers supported, and made conditional on independent verification. Credit could be extended for proven technologies, and require some form of collateral and investment by the beneficiaries. Banks could engage the national agricultural institute to certify the technology proposed. building); and include these in the RBF mecha- An enabling environment can also depend nism. The balance between both input and output on the availability of relevant data. An example indicators and the supporting measures can can be found in the case of weather index-based change over time, as often is the case in the World insurance used to reduce flood- related risks Bank’s recently launched Program for Results (see the discussion of Hypothetical Case 1, on Chapter 2 (P4R) approach. 1 irrigation technology subsidies and weather Analytical Framework   17 Box 4.  RBF vs. “Traditional” Solutions as Applied to Irrigation Morocco’s drip irrigation policy illustrates the importance of understanding all the contextual conditions when designing an effective policy, particularly one using RBF (see FAO (2012) and Kuper et al. (2009) for more details on such policy). In this case, the traditional infrastructure subsidy solution presented two main issues. First, drip irrigation is ideal for certain types of crops, but they are not typically grown by poor /small farmers in the country. Second, international experience shows that development of drip irrigation can lead to greater water consumption if water abstraction is not controlled. Drip irrigation tends to produce higher crop yields than flood irrigation. These greater yields require greater crop water evapotranspiration (ET) to sustain those higher yields. In Morocco, groundwater is abstracted by private farmers, with almost no control by river basin agencies (RBAs) — despite the water law, which states that all water users must register their wells and apply for an abstraction authorization. Hence, groundwater abstraction is currently much higher than the renewable volume in most aquifers. Assuming that a potentially appropriate RBF solution has been identified, the next step is to check the existence of the relevant enabling conditions. In this particular example it would be relevant to assess how much the country owns the goal of water conservation, or how much capacity the agricultural governance institution in charge has to oversee/verify the RBF conditions, and the extent to which the microfinance sector is developed in the country. Morocco Drip Irrigation Case Typical How close is Problem the indicator in Sector: Available to the desired Traditional (irrigation) Indicators outcome? solution RBF Solution Improve water Crop This indicator Universal 1) Support the supply chain in productivity in production: may not government- an adaptive manner for example irrigation in the per unit water incorporate funded through matching grants to financial context of water supply & per the aspect of subsidy for institutions that lend to new scarcity unit water efficient use of the acquisition technology supply for small farmers delivered the available of on-farm (such as in the Lighting Africa example water (ultimate drip irrigation illustrated in Box 3). goal when equipment (e.g. facing water Morocco) scarcity) 2) Continue to subsidize drip irrigation equipment but linking a % of the disbursement to long term functioning of the drip irrigation infrastructure/ optimal crop selection/water abstracted volumes (conditional on hectares of irrigated area). microinsurance for small-scale farmers, in sec- flood event— and therefore design flood-index tion 3.2.1). The literature on these schemes (for insurance. The relevant variables that must be instance, Hellmuth, Osgood, Hess, Moorhead & correlated with crop damage include the depth Bhojwani, 2009) illustrates the difference in data and duration of water discharged during the requirement between drought episodes and flood, and the timing of the flood. floods. For droughts, a single parameter (rain- The implementation of flood-index insur- fall) can be sufficient for the prediction, while a ance also requires a reliable and consistent mea- Chapter 2 composite index is necessary to fully describe a 1 sure of the index. This is why remote sensing and 18 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS geographic information systems are useful tools financial capacity to absorb the additional risk that may enable objective and accurate assess- and to obtain the funding required to deliver the ment of the extent and duration of flooding at expected results before being paid. high resolution, if the required data (topography, Capacity is a necessary precondition which hydrology, land use, farmer’s location, and infra- is highly relevant on the beneficiary’s side of the structure) are available. scheme. RBF often requires that individuals or Given the additional risk borne by the agent, households actively engage in a program (take-up the confidence in legal and regulatory frame- rate), and be willing and able to pay for their share works is critical to the success of RBF. If a gov- of the cost and adopt new practices, habits, or ernment has a strong track record of honoring technologies for the project to progress smoothly. contracts and caring about the financial sustain- For these reasons, the importance of doing sound ability of efficient service providers, the agent prefeasibility assessments in the design phase will be more lenient toward assuming more risk. for an RBF scheme cannot be overstated. Mis- In some circumstances, if there are weak reg- understanding or overestimating beneficiaries’ ulations regarding cost recovery and resolution of intention to participate in a program or pay for a disputes, the well-known mechanism of regulat- service will be much worse when the service sup- ing by contract could be used, as is often done in plier is counting on a certain level of results for the public-private partnership (PPP) agreements. investment. If end-beneficiaries will be required to Creating special vehicles for disburse- pay a portion of the cost of delivering the results, it ment, such as escrow accounts, and selecting is necessary to carry out a willingness and ability fiduciary agents that will disburse automatically to pay study during project design. When the will- once the specified conditions have been met ingness or capacity level of relevant stakeholders and verified—thereby preventing any political is determined in advance, mitigation measures intervention—will go a long way toward reduc- to increase participation can be taken before ing payment risk and giving more confidence to launching the project. In cases where behavior potential agents to enter into an RBF agreement. change is key to a successful result, as is the case in some health sector schemes, then information Precondition 5. Capacity and campaigns (about project requirements and Competences expected benefits) or other types of social mar- The principal should be in a position to admin- keting to people who will be participating will be ister the scheme and collaborate with the agent needed to ensure the success of the RBF. to resolve implementation issues. The principal should also be able to provide assurance that it has the capacity to oversee project implementa- Determining the Attractiveness tion and follow up on the verification process, of RBF starting by hiring an independent verification agent (IVA) as early as possible to guarantee that Finding incentives that can effectively and effi- there will be no delays in verifying the first results ciently influence the agent to deliver the princi- delivered by the agent; such delays can be costly pal’s expected results is undeniably an attractive in financial terms. approach. The agent should have the technical qualifi- However, the many benefits of RBF, dis- cations and capacity to deliver the results, as in cussed in Chapter 1 and illustrated by the case studies in Chapter 3, must be weighed against Chapter 2 1 input-based projects, but should also have the Analytical Framework   19 the costs. In particular, transaction costs of used—which would provide the basis for such developing and monitoring the scheme can analysis. However, there are some RBF projects be substantially higher than in a conventional, being implemented that include a component input-based scheme. 6 specifically intended to gather such evidence. Past experiences have shown that there can One such project is the REAGUA case in Brazil, be a trade-off between preparation and supervi- featured as a case study in section 3.1.1. Some sion costs, as supervision tends to be lighter initial evaluation work conducted by GPOBA in in RBF projects due to the focus on results. recent years also sheds light on these matters Moreover, transferring additional risks to the and is discussed in Box 5. agent will lead to higher pricing under an RBF Meanwhile, this document offers a contribu- approach. Importantly, however, these risks are tion by providing a series of case studies in Chap- also present in projects that are not using an RBF ter 3 that can be used as a thought-provoking approach. The question therefore is whether the illustration for development practitioners in a pricing of the risks in an RBF approach is higher case-by-case decision whether to adopt an RBF than it is in the non-RBF approach—where such approach. Chapter 4 draws on experience around pricing is often implicit. A thorough analysis must the world to date to discuss ways of overcoming consider these implicit prices. the main challenges to RBF and offers a series of The attractiveness of RBF must be assessed principles to tailor RBF arrangements for success. in comparison with other instruments such While more evidence is gathered over time, as traditional investment lending to see if RBF there are also some indirect ways to assess the works better and decide whether the additional attractiveness and suitability of RBF schemes costs (transaction costs, monitoring, and risk (see O’Brien & Kanbur (2013, pp. 19,20). One pricing) are exceeded by the additional benefits is an assessment of the strength of the results (e.g. delegation of input procurement to the framework of RBF interventions. A second agent, greater certainty of delivering results). indirect but simple proxy for overall success of a Unfortunately, conducting this analysis is scheme (given that disbursement is tied directly extremely difficult, for a variety of reasons. The to the end outcomes being sought) is the pace same challenge faces RBF projects as evaluat- and scale of disbursement (unlike an input-based ing any development project: that is, the lack of investment operation, where disbursement a counterfactual to prove that the scheme is the merely conveys that the funds have been spent). credible cause of success, as opposed to other Finally, independent evaluations of performance exogenous factor beyond the control of the can provide valuable insights, especially when evaluation. multilateral financial institutions like the World As discussed in the analytical framework, Bank run harmonized reviews and evaluation of the RBF approach may work if certain precondi- the portfolio of operations. The growing emphasis tions are verified. Furthermore, its effective- of accountability and the efforts in harmonization ness may be heavily dependent on the correct of output and outcome indicators offer promise identification of the results that can trigger a for increasing comparability among alternative payment, and the optimal level and/or pacing schemes. of the disbursements. It might be difficult to provide conclusive evidence, as there have 6  See, for example, the case study of the REAGUA project in São Paulo, Brazil, examined as in Chapter 3. A not been many comparable situations where prefeasibility engineering study was conducted as part of Chapter 2 1 RBF and input-based approaches have been that project. 20 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS Box 5.  Evaluation Studies of GPOBA While establishing a convincing counterfactual to evaluate the effectiveness of output-based aid (OBA) remains a big challenge, GPOBA has conducted some studies to collect evidence on how OBA subsidies used in various pilot projects have incentivized the supply of basic infrastructure service for low-income users. A recent impact evaluation focused on the solar home systems (SHS) program in Bangladesh, which includes result-based subsidies to microfinance-based suppliers of Solar Home Systems in rural areas. The evaluation analyzed the demand for SHS in off-grid poor rural areas. Through a simulation model, the study looked at various options to scale up this program to estimate how different subsidy levels (combined with different conditions on the government loan that is currently supporting the microfinance partners) would change the demand for solar systems in rural villages. The exercise shows what a delicate equilibrium (of household subsidy, government loans to accelerate supply, and strict verification of quality standards) has allowed microfinance agents to basically create a brand new SHS market— while ensuring that the financial burden on poor rural customers remained acceptable (Hamad et al. 2013). Another lesson yielded through a GPOBA evaluation study is that, given the increased risk for the agent (due to initial financial commitment), it is critical to center the project design on solid evidence and tested assumptions that can be collected via feasibility studies and ex ante evaluation. More specifically, a baseline household survey among slum dwellers in Mumbai, India investigated the willingness to pay (WTP) assumptions behind adopting OBA subsidies to tackle issues of affordability surrounding the connections, from informal to regular electricity connections. The survey highlighted how the targeted slum households had critical concerns about the electricity consumption fee (or the monthly bill resulting from regularization). Furthermore, some issues of slum governance greatly affected the families’ decision to enroll in the regularization program. In a similar case, correctly assessing the beneficiaries’ real WTP is a crucial determinant of their decision to enroll in the program. This, in turn, will significantly affect the agent’s revenue expectations when engaging in the RBF intervention (Mimmi 2012). Chapter 2 1 Chapter 3 RBF Case Studies Real-life Case Studies Experience with RBF in the water sector is limited in terms of the tools that have been adopted, and for the most part, has been confined to water supply projects. Most of the RBF projects in the water sector use the output-based aid (OBA) approach for water supply. However, some wider water resources management projects, as well as some sanitation projects, have used output-based disbursement (OBD). The cases that follow describe some of these experiences and help illustrate in more detail the concepts discussed in Chapter 2. Case 1. Tackling Water Scarcity in São Paulo (OBD Approach) Project Name and Time Frame: São Paulo Water Recovery Project (REAGUA), Brazil (P106703), (2008–2015) Problems/Issues: i) general water shortage in the São Paulo region, ii) poor/inadequate level of water network infrastructure, resulting in considerable water losses, iii) limited financial and technical capacity within water utilities, and iv) limited attractiveness of some types of interventions to address water scarcity. Background: The state of São Paulo is one of the world’s most urbanized areas and emblematic of the urban challenges facing Brazil. Despite relatively high coverage rates, the state faces problems of water scarcity and pollution due to the low availability of water, high level of demand, and lack of proper wastewater collection and treatment. The objective of the project is to increase the availability of clean water in the critical watersheds in the state of São Paulo, but more investment was judged insufficient without improving the efficiency and sustainability of the water supply and sanitation (WSS) systems. Although concentrating on the WSS service, the project serves three objectives: making more water available for WSS services; improving the environmental conditions in the critical watersheds; and reducing the stress on the water resources of those watersheds. Object of the RBF Incentive: The recipients of the RBF incentives are water service providers located within the selected five critical watersheds of São Paulo (in terms of water scarcity). Only three types of WSS service providers are eligible for financing: public companies, municipal-owned and state- owned companies. In order to avoid cross-subsidization and facilitate regulation and accountability, 22 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS private companies and municipalities’ own (–) Lack of institutional and technical capacity in departments that provide WSS are not eligible to some municipalities and service providers. receive funding. Definition of the RBF Incentive: Output-based Risk Allocation: Under the proposed results- disbursement (OBD) in the form of subsidies based scheme, project funds will be disbursed (partly funded by a loan from the World Bank/ to incumbent providers of water services International Bank for Reconstruction and Devel- (municipal-owned or state-owned) against opment, IBRD) from the state government to the agreed and independently verified outputs. service providers upon verification of outputs Therefore, performance and financial risks are (such as the completed wastewater treatment shifted from the state government of São Paulo plant) that are directly tied to outcomes (cubic (GESP) to the selected service providers via meters of treated wastewater). funding that is explicitly linked to the achieve- Table 3 provides a definition of the outputs ment of the project objectives (i.e. cubic meters linked to disbursement. The calculation of unit of recovered water, number and capacity of costs to price the outputs was one of the most wastewater reuse facilities built, active connec- complex aspects of project preparation. Not only tions to wastewater network built). WSS service were different sources used, but calculations providers must provide at least 10 percent in factored in the different starting levels of technical upfront financing as evidence of their com- performance, such that the unit cost would encom- mitment to increase efficiency and to achieve pass the different level of effort needed according sustainable results. to the baseline situation of the service provider. Enabling Environment for Adopting RBF- Triggers for RBF Payment: A reference unit Strengths (+) and/or Weaknesses (–) cost (RUC) has been set for every output. Pay- Encountered: ments are made as follows: i) upon delivery of an output: 70% of RUC * output measure and (+) Enabling regulation in place ii) after a period for fulfilment of sustainability (+) High-level of government ownership conditions: 30% of RUC * output measure. In the through the implementing agency, the case of the Water Loss Control and Reduction State Secretary for Water Supply, Sanita- Subprojects, the proportions are 60% and 40% tion, and Energy (SSE) instead, as for such outputs the sustainability (+) Monitoring capacity provided by SSE and factor is of utmost importance. the independent verification agent (IVA) (+) Adequate fiduciary system solidified and Sources of Funds Used in the RBF Case: The tested through the World Bank’s 25-year total project cost is estimated to be close to $108 programmatic engagement in the State’s million, including a Specific Investment Loan WSS sector (SIL) from IBRD, financing from the State Gov- (–) Delays due to complex output-based ernment of São Paulo (GESP), and pre-financing financing mechanisms that remains by water utilities (around 10% of total costs). untested in some sectors (–) Cooperation and coordination difficul- Verification Process: The process entails ties between municipalities and sector reporting by suppliers, monitoring by SSE and Chapter 3 2 1 operators regular audits by IVA. RBF Case Studies   23 Table 3:  Output Definitions for the REAGUA Project in São Paulo Activity Output Water Loss Control and Cubic meters of recovered water as measured against the baseline set forth Reduction Subprojects in the PPA Water Rational Use Water saving appliances installed and environmental campaign executed Subprojects Treated Wastewater 1. Wastewater reuse facilities (treatment plant, transport and reservoirs) Reuse Subprojects built and operational 2. Wastewater reuse facilities operating in accordance with operational standards set forth in the PPA Wastewater Collection 1. Engineering designs, required licenses and contractor’s mobilization Network Subprojects 2. Service lines and connections built 3. Active connections operating in accordance with operational standards set forth in the PPA Wastewater Transport 1. Meters of gravity wastewater pipes installed System Subprojects 2. Meters of forced wastewater pipes installed 3. Wastewater pumping stations installed 4. Wastewater transport system operating in accordance with operational standards set forth in the PPA Wastewater Treatment 1. Earthworks and foundation works completed Plant Upgrading and/or 2. Physical structure of wastewater treatment plant completed Construction Subprojects 3. Construction completed and wastewater treatment plant in testing mode 4. Wastewater treatment plant operating in accordance with environmental standards set forth in the PPA Note: PPA = Project and Performance Agreement. Institutional and Implementation Arrange- Observed Results: The project is ongoing. One ments: The state of São Paulo is the borrower, intermediate result of the project is to build a and it has delegated execution of the loan to SSE. solid monitoring framework and capacity at the The key institution responsible for the prepara- state level (for instance, the engineering models tion and implementation of the project is SSE. built to estimate unit cost of outputs). The service providers are either state-owned Sabesp or municipal-owned (Figure 6). Additional Information about this Case: The World Bank (2010); Velez & Tierney (2010). Case 2. Increasing Household Highlights of the Case Study Sewage Connections in Uruguay In OBD schemes, every output is priced ex (OBD Approach) ante using unit reference costs. Thus it is Project Name: Uruguay APL-2 Obras Sanitarias fundamental to get a reliable determination of del Estado (OSE) Modernization & Systems unit costs for funds to be efficiently spent. As a consequence, outputs must be tangible and Rehabilitation Project (P101432), (2007–12) measurable; otherwise, establishing a unit reference cost would become complex and Problems/Issues: i) The share of households unreliable. Chapter 3 2 1 with access to improved sanitation is fairly high 24 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS Figure 6: Institutional Arrangements for the REAGUA Project in São Paulo Guarantee Agreement Brazil Bank Loan Agreement GESP Project and Administrative Performance decree transferring Agreement Project and Project and the contract SSE and Performance Performance Capital Agreement Agreement Contribution Management Consulting PMU Verification Firm Agent Municipality Municipality Executor Executor Service Provider Service Provider Municipal Company SABESP Executor Service Provider Autarquia Source: The World Bank (2010). (94%), but only 48% of households are actually Contextually, a constitutional prohibition of connected to the sewerage network; ii) In addition privatization in the water sector passed in 20047 to the need to increase treated water pumping excluded opportunities for modern performance capacity, it was imperative to reduce Unaccounted based contracts and thereby constrained com- for Water (UfW), which at the time accounted for petitiveness for achieving efficiency gains with 56% of supply and one of the key reasons for low risk of political unbalances. Thus APL-2 aimed operational efficiency; and iii) OSE needed to at exploring opportunities of further enhancing improve its governance and administrative man- OSE’s internal competitiveness through perfor- agement, as well as establish clear and explicit mance incentives for OSE. incentives for economic efficiency. Object of the RBF Incentive: Specifically, via Background: The project is a continuation of the OBD portion of the loan ($ 1 million), the prior investments that began in 1988 and contin- project finances small in-house plumbing works ued with the first Adaptable Program Loan (APL) for connection of households to the sewage signed in 2000. The APL-2 project was designed network. With the OBD fund, the World Bank to span five years (2007–12) with the follow- can reimburse OSE for 60% of the predefined ing key objectives: to continue to support the modernization of OSE; to improve the efficiency 7  The 2004 constitutional amendment precluded of the utility; and to ensure that the population private sector participation (PSP), and thus outlawed the concession in Maldonado, the small concession in receives better and secure access to water and Laguna del Sauce, and 14 smaller private operators and Chapter 3 2 1 sanitation services. cooperatives. RBF Case Studies   25 unit cost, based on the number of households a low-interest rate loan repayable over 36 effectively connected to the sewerage system months, and are exempt from paying the variable (estimated at 3,600 households). cost component of their sewerage bill for up to 36 months. Households will be responsible for pro- Risk Allocation: Reimbursement will be made curing the necessary works, and might organize based on the number of connections and evi- in communities to gain economies of scale. dence of three months of consecutive billing. Households will be responsible for procuring the Definition of Outputs Linked to Disburse- necessary works services and might organize in ment: Number of connections and evidence of communities for gains of scale. three months of consecutive billing (an indicator of sustainability in the services). Enabling Environment for Adopting RBF –Strengths (+) and/or Weaknesses (–) Triggers for RBF Payment: Supporting Encountered: documentation for the reimbursement will be: presentation of an output report; certification of (+) Enabling regulation in place the connections verified and approved by OSE; (+) Adequate financial management arrange- and evidence of three months of consecutive ments for OSE, as well as skilled and capa- sewerage bills. ble staff that can carry out their fiduciary As for the definition of the payment amount, responsibilities assessing the unit cost is key for OBD to be (+) Monitoring capacity provided by the State acceptable under the World Bank conditions. Secretariat for Water Supply, Sanitation Therefore, the reference unit cost for three types and Energy (SSE) and the independent of works was defined based on three different verification agent (IVA) sources: market prices; contractors’ appraisals; (–) Delays due to complex output-based and experts’ opinion. The unit cost, calculated financing mechanisms as yet untested in for three types of in-house works, varies from some sectors $235 to $877 per household (depending on the (–) Cooperation and coordination difficul- size of the works). ties between municipalities and sector operators Sources of Funds Used in the RBF Case: (–) Lack of institutional and technical capac- Around 3,600 households are estimated to ity in some municipalities and service need in-house works, which corresponds to a providers total cost of about $ 1.7 million. The World Bank will allocate $ 1 million as an OBD fund, and will Definition of the RBF Incentive: An OBD com- pay 60% of the standard unit costs of in-house ponent was piloted to help overcome traditionally works. Through this financing mechanism, OSE low household connection rates to sewerage net- will, in effect, be providing an implicit connection works. It reduced the overall transactions costs subsidy corresponding to approximately 24% of for OSE of financing individual connections, while the connection costs.8 simultaneously enhancing the focus on results. Households wishing to connect to the network 8  The implicit connection subsidy is based on the assumption of interest rates remaining 2 points below and requiring in-house plumbing reconfiguration market rates, on average, and a 36-month waiver for the Chapter 3 2 1 works are eligible to finance these works through variable sanitation tariff. 26 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS Verification Process: Specific annual OBD  ase 3. Improving Access to Water C financing targets are indicated in the results Services for Poor Households in framework. OSE need to periodically report the Metro Manila (OBA Approach) total number of in-house works carried out dur- Project Name: Output-Based Aid in the Philip- ing specified periods per type of works. All works pines: Improved Access to Water Services for Poor need to be certified by OSE. Households in Metro Manila Project (2009–2013) Financial statements of the project are subject to an annual financial audit under the terms of ref- Problems/Issues: Many low-income households erence and by an auditor acceptable to the World in the east zone of metro Manila could not access Bank. The audit scope, in addition to standard piped water because of the excessive cost of the financial audit requirements, shall include a sample connection and, in the case of informal settlers, audit of the outputs delivered and the unit cost the requirements for proof of land ownership. As methodology used in the project. To ensure the a result, many residents must buy water in jerry functionality of the new sewerage connections, dis- cans from street vendors (sometimes at a very bursements will be made only with evidence of three high per unit cost) or walk long distances to fetch months of consecutive sewerage bill payments. water from deep wells. Illegal tapping from the Through supervision visits, the World Bank Task network is also an impending problem. Team will periodically verify that outputs reported As for the intended beneficiaries, a capacity for disbursement purposes have been physically and willingness to pay study determined that there delivered and are of requisite quality and standards. was a gap between the price to access the service as a regular customer (the connection fee) and the Observed Results: OBD allows OSE to readily pro- potential beneficiaries’ capacity to pay. vide an attractive financial package to individual households requiring in-house plumbing works, Background: The delivery of water supply and thereby providing incentives for more households to sewerage services in the east Metro Manila connect. Transaction costs for OSE will remain low. region is provided by Manila Water Company Inc. (MWC), a concessionaire that has a 25-year Additional Information about this Case: The contract and has been successful in improving World Bank (2007). the water coverage and quality throughout the city. MWC had also launched a “Water for the Community” program to speed up rollout of Highlights of the Case Study connections to poor households. However, the solution proposed to low-income areas, consist- Due to regulatory changes passed in 2004 in Uruguay, private operators were precluded ing of a bulk or community meter with shared from the provision of water and sanitation connections after the meter and shared billing, services. Therefore, there was a need for created problems due to collection issues. Some different ways (other than private competition) to stimulate the performance, efficiency, and customers were not making payments to the transparency of the OSE in a context of a community collectors, while the company was quasi-monopoly in service delivery. OBD was demanding full payment for the entire invoice. adopted as part of an alternative strategy to strengthen intergovernmental accountability, The tariff and connection fees are set by define objects and obligations, and an independent regulator, so the company establish a compelling internal performance benchmarking system. could not modify the fee conditions on its own. Chapter 3 2 1 The company did offer installment plans for RBF Case Studies   27 customers to pay the $167 connection fee. How- (+) Credible targeting of poor customers: Given ever, the lowest-income households could not that the low-income households were afford to pay to get a connection to the network. located in compact pockets within the city, In sum, there is a capable service provider with a it was easy to use geographical targeting to commercial interest in reaching 100 percent of make sure that resources were being used its customer base, and a regulator that oversees to benefit those that could not afford to pay compliance with the contract. the full connection fee. (+) Availability of independent verification Object of the RBF Incentive: The OBA grant agent: Several reputable agencies were recipient was MWC, which agreed to connect all available to perform this task, including the identified poor households using individual ser- National Engineering Center of the Univer- vice connections using its internally generated sity of the Philippines, which was selected cash flow to finance the project until receiving to provide this service. payment once the results had been verified. The beneficiaries were offered a 36-month Definition of the RBF Incentive: Output-based installment plan to pay their portion of the con- aid (OBA) grant. Local government agencies and nection fee. the MWC estimate that almost all households within the project’s target communities would Risk Allocation: The pilot was exposed to not be able to afford the connection fees (esti- demand risk given its target of serving the poor, mated to be $167), but could afford to pay for the which in turn, implied the possibility of failing to required meter and guarantee deposits (approxi- recoup its infrastructure investment (the exten- mately $36) if this could be paid in installments. sion of tertiary mainlines). Similarly, MWC bears GPOBA therefore agreed to fully subsidize the the risk for the collection of fees from its direct connection fee for eligible households. The OBA customers (individuals, groups, or communi- subsidy, at 2007 prices, was set at PHP 5,911.73 ties). Flexible payment solutions, paired with the (US$131) per unit (Table 4).9 OBA connection subsidy, mitigated these risks for the operator. To mitigate the risk of cost infla- Triggers for RBF Payment: MWC advanced the tion, it was agreed that the unit subsidy would be share of the individual household’s connection fee indexed on an annual basis in line with the con- and received reimbursement from GPOBA once sumer price index (CPI)—just like the connection connection and satisfactory service provision was fee under the terms of the concession contract. verified by the third-party auditor. The GPOBA subsidy were paid directly to MWC as a single pay- Enabling Environment for Adopting RBF ment, conditional on the independent verification –Strengths (+) and/or Weaknesses (–) of three months’ satisfactory service delivery. Encountered: Sources of Funds used in the RBF Case: The (+) Good financial situation: The utility (MWC) total cost of providing access to clean water to enjoys a strong financial situation. It had 9  In September 2008 the share of the connection fee successfully negotiated several interna- required to be paid by low-income households was tional loans and was generating positive reduced by the regulator tor to PhP 2,625 (US$58) and therefore the subsidy provided by the project to PhP cash flows. Its shares were being traded in 2,025 (US$44). The user contribution was reduced to Chapter 3 2 1 the Philippines Stock Exchange. PhP 600 (US$13), the cost of the guarantee deposit. 28 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS agent (IVA), appointed by MWC, had to confirm Connection Costs for the Table 4:  Water Services Project In the following four outputs on a representative Manila, the Philippines sample of beneficiary households: i) installed PHP US$ water meter; ii) 24-hour water supply (beneficiary Meter deposit 1,020.00 23 confirmation); iii) water pressure of at least 5 psi (pounds per square inch) (from MWC operational Guarantee deposit 600.00 13 records); and iv) water bill delivered, demonstrat- Connection fee 5,911.73 131 ing consumption/ service delivery (confirmed Source: Menzies & Suardi (2009). by beneficiary and MWC billing records). GPOBA disbursed the corresponding share of the subsidy the over 20,000 poor households amounted at to MWC upon receiving an invoice accompanied US$10.7 million, of which: MWC invested US$8.2 by the verification report. million, GPOBA provided subsidies for a total amount of US$2.07 million, and the user contri- Institutional Arrangements: These are dis- butions amounted at US$0.43 million. played in Figure 7. Under the terms of the concession agree- ment, the connection fee is indexed on an annual Observed Results: A cumulative total of 28,562 basis in line with consumer price index (CPI) data connections were delivered to households and produced by the Regulatory Office. To mitigate verified in over 76 communities. A beneficiaries’ the risk of cost inflation, it was agreed that the assessment study was carried out after project unit subsidy would be similarly indexed. completion and as part of the main outcomes the project completion report highlights the improved Verification Process: To ensure that MWC deliv- hygiene and reduced incidence of water borne ered these outputs, the independent verification diseases resulting from increased consumption Figure 7: Institutional Arrangements for the Water Services Project in Manila, the Philippines MWSS Regulatory Office MWSS GPOBA No objection to TOR and appointment Concession Regulation contract Direct payment Manila Water Independent Connections verification agent Customers Contracts Control Funds Chapter 3 2 1 Source: Menzies & Suardi (2009). RBF Case Studies   29 legal and technical hurdles to service households. Highlights of the Case Study While slum settlements were previously excluded This case illustrates ways to address the from urban planning, such areas have become lack of access to water services related to eligible for allocation of funds and expansion of the inability of disadvantaged residents of poor urban areas to pay for connections. services with the launch of the National Initiative This issue justified subsidies to bridge the for Human Development (INDH). affordability gap, under the assumption Nonetheless, utilities have had weak financial that the affordability problem could be solved with a one-time subsidy payment. A incentives to connect marginalized households financially sound and motivated utility was due to unfavourable tariff structures. Retail already committed to reach universal access to water and sanitation for its customers, as tariffs are designed as increasing block tariffs, demonstrated by the prior program, “Tubig with monthly consumption below 8 cubic meters para sa Barangay Project” (Water for the typically below O&M costs and commonly even Community). In this context, OBA seems to be the RBF instrument of choice to complement below bulk water purchase costs. Therefore, a concession in addressing affordability of new users typically cause financial losses to utili- water supply for the poor. ties. Losses are even greater for public utilities, which (unlike private concessions) have not been allowed to increase average tariff levels to reflect levels by beneficiary households and reduction the inclusion of lower-consumption households in household expenditure on water by target in their customer base or to pass through households. GPOBA and MWC are continuing to 10 increases in input costs. cooperate in developing comprehensive solutions to incorporate wastewater management. There Background: In the past decade, the govern- are plans to scale up this project and prepare a ment has launched programs to fight poverty National OBA Facility for any service provider in by improving the dire living conditions in the the country to apply for funds. urban and peri-urban slums. This provided a strong drive for municipalities and utilities to Additional Information about this Case: Men- explore mechanisms to expand access to basic zies & Suardi (2009); GPOBA (2007) infrastructure. Nonetheless, national and local governments were reticent to fund subsidy pro- Case 4. Improving Access to grams that lacked accountability or guarantees Water and Sanitation Services for results. for the Urban Poor in Morocco The grant provided by GPOBA (signed on (OBA approach) January 30, 2007) was intended to help overcome Project Name: Morocco Improved Access to traditional impediments of service expansion Water and Sanitation Services Project (P102527), programs in marginal neighborhoods, such as 2007–11 households’ inability to afford connection costs; operators’ unsustainable financing for programs Problems/Issues: Approximately 11,300 low- to expand service to poor areas; and complex income households in disadvantaged peri-urban technical and administrative obstacles to infra- and rural neighbourhoods in Casablanca, Tangi- structure development in poor, informal areas. ers, and Meknès lacked water and sanitation ser- vices. The most vulnerable were residents of ille- 10  Improved Access to Water Services in the East Zone of Metro Manila Project Implementation Completion Chapter 3 2 1 gal settlements, where operators must overcome Report, November 2013. 30 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS Purpose of the RBF Incentive: The OBA pilot was amount, specifically defined with each opera- coordinated and administered by the Ministry of tor, was paid in local currency and in two steps: Interior, and implemented by the three incumbent 60% upon verification of a working water and providers of water supply and sewerage services sewerage connection to an eligible household; in the three selected urban centers: Casablanca, and 40% percent upon verification of at least six Tangiers, and Meknès. Once the utilities had months’ sustained service. The government also connected households in the selected quartiers granted specific arrangements in poor urban (neighborhoods), and had provided evidence of and peri-urban areas to lower household contri- a functional and used connection, they would be butions for connections to water supply and/or reimbursed a pre-agreed amount. sanitation services. Risk Allocation: In terms of demand risk, ben- Targeting Mechanism: Targeting was mostly eficiaries’ participation in the OBA pilot was vol- done on a geographic basis. The socioeconomic untary; this prompted the operators to promote conditions of the target beneficiaries can be the program through educational campaigns. As extremely heterogeneous because of differences for cost variation risk, exchange rate fluctuations in the areas, operators, and the like. Thus target- of the Moroccan dirham caused unanticipated ing relied on geographic criteria, but also used sur- increases in commodity prices during the project veys and discussions with the operators to identify implementation period and thus reduced the real and reach out to the intended beneficiaries. value of the grant subsidy. Consequently, at proj- ect closing, the number of connections financed Triggers for RBF Payment: The Ministry of Inte- by the grant was slightly reduced for all operators. rior had primary responsibility for monitoring and certifying outputs; it contracted out these Enabling Environment for Adopting RBF tasks to an independent verification firm. All –Strengths (+) and/or Weaknesses (–) participating utilities had to submit requests for Encountered: disbursement for endorsement by the Ministry of Interior. GPOBA made direct payments to the (+) Solid financial status and extensive knowl- participating distribution utilities. edge in implementation of social programs in informal settlements by all utilities. Two of the Sources of Funds used in the RBF Case: The utilities (LYDEC in Casablanca and AMENDIS three pilots are funded through a $7 million grant in Tangiers) are subsidiaries of financially from GPOBA to connect 11,300 households to sound international water companies. The piped water and sanitation service in poor urban third (RADEM in Meknès) is a publicly owned neighborhoods of three cities, plus some rural utility. All three utilities had demonstrated areas of Meknès. experience in servicing informal settlements. Verification Process: The Ministry of Interior Definition of the RBF Incentive: Output-based had the ultimate responsibility for monitoring aid (OBA). At appraisal, the total GPOBA subsidy and verification. It contracted an independent requirement was intended to cover 28% of total audit firm to conduct annual ex post reviews of adjusted capital expenditures in Casablanca; the completeness, accuracy, and authenticity 23% in Tangiers; and 53% in urban areas and of documentation from utilities, as well as to Chapter 3 2 1 74% in rural areas in Meknès. The subsidy undertake ex post physical spot checks for a RBF Case Studies   31 Highlights of the Case Study This project addressed an access constraint related to supply-side financial disincentives in a context of lack of infrastructure (especially sanitation) for vulnerable urban populations. The one-time subsidy is justified by the additional costs due to extending access to water and sanitation services to marginal urban areas. Targeting allowed the adequate levels of subsidies to be identified. This level of subsidy took into consideration customers’ ability to pay. The experience in Meknès revealed that the public sector can also bear the performance risk, and that a public utility can successfully adopt the OBA methodology to ensure the provision of basic services to neglected segments of the population. Organization of awareness and information campaigns was crucial to guaranteeing the populations’ buy-in in the social program. Post-completion evaluations stressed the importance for operators to be present throughout the implementation of works and to ensure the involvement of the potential beneficiary households in the social program. The operators’ role (extending service provision to the poor) required the active involvement of the local authorities (specifically to address land titling issues in the informal settlements). Monitoring and evaluation are key to achieving a rigorous framework to measure, report, and revise the project, and especially to ensure successful replication of the pilot. Notably, the role of the IVA went beyond the scope and the responsibilities originally defined in the operating manual, as the IVA helped build the operators’ technical capacity and enhance their organizational structures through a set of recommendations that were immediately followed by the three utilities. meaningful and random sample of connections. to or higher than the average in each operator’s A reputable external auditor was appointed as service area. independent verification agent (IVA) to validate the correct selection of beneficiaries and compli- Additional Information about this Case: ance with the set service standards. GPOBA (2008); The World Bank (2012). Institutional Arrangements: These are dis- Case 5. Improving Irrigation in the played in Figure 8. North China Plain (performance improvements) Observed Results: The pilot project ensured the Project Name: Management Reform and Per- provision of subsidized access to water supply to formance Changes in Two Irrigation Districts in 10,504 households (around 52,500 people) and the North China Plain (Nanyao and Bayi) sanitation services to 9,036 households (around 45,200 people) living in the peri-urban settle- Problems/Issues: In the 1980s, the transition ments in Casablanca, Tangiers, and Meknès. from heavily subsidized irrigation managed by Surveys confirmed the high satisfaction Peoples’ Communes11 to operational and financially of beneficiary households with the service autonomous Irrigation Districts (IDs) imposed provided and the overall adequacy of the subsi- new challenges: i) the irrigated area had declined, dized connection fee compared to the targeted households’ willingness to pay (WTP). This is 11  Consisting of 10 to 15 brigades made of 10 to 20 Chapter 3 2 1 confirmed by collection rates, which were equal households each. 32 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS Figure 8: Institutional Arrangements for the Water and Sewage Services Project in Morocco Ministry of Interior/Ministry of Finance GPOBA Grant agreement with operators and Municipalities or delegating authority 5. Makes subsidy government payment per Operational 3. Reports to connection to responsibility authorities and prefinancing GPOBA operator Operator (Amendis Tanger, LYDEC, RADEM) 1. Requests 2. Prefinances connection and connection to provides requested water 4. Verifies outputs discounted supply and/or reached and makes contribution sanitation and recommendation provides service on subsidy payment Poor household living in periurban Independent technical reviewer areas without access to service Key: Fund flow Information flow Contractual relationship Source: GPOBA (2008). ii) water infrastructure was deteriorating, iii) there the two top levels of canals, VIMGs handle the were inefficient irrigation management practices, third and lower levels, clean and maintain canal iv) there was a lack of measure to ensure efficiency sections, distribute water among farmers, of the systems and practices, and v) the operation collect water charges, maintain and organize and maintenance costs of irrigation were not cov- schedules for water delivery, and protect field- ered and collection rates were low. level irrigation facilities. Background: The economic reforms that Object of the RBF Incentive: The result-based started in 1978 transformed the rural collective incentive is active at three different levels to system into a “Production Responsibility Sys- improve the efficiency of operations manage- tem.” The dismantling of Peoples’ Communes ment and the collection performance: the (1983) and the decline of government subsidies Irrigation District as a whole (in Nanyao, the ID and construction investment left the irrigation has a staff of 30 and oversees 40 VIMG); the distribution system in chaos, resulting in wors- divisions within the ID; and the individual staff ening service quality for farmers. of the ID. As a response, additional reforms were launched to encourage Irrigation Districts to Risk Allocation: With the reforms, the payment stimulate local financial and managerial auton- risk (the collection of water fees and consequent omy. Village Irrigation Management Groups ability to cover irrigation O&M costs) was shifted (VIMG) were created and given independent onto the IDs; previously, central or commune Chapter 3 2 1 governance. While Irrigation Districts manage funds could cover routine O&M costs. RBF Case Studies   33 Enabling Environment for Adopting and iii) quality of maintenance work. A rating is RBF–Strengths (+) and/or Weaknesses (–) provided based on the percentage achievement Encountered: against preset performance standards (see Table 5). Interestingly, the performance of the (+) An improved regulatory framework: In 1985, higher-level administrative unit reflects the perfor- two important regulations were introduced. mance of the lower-level administrative units. For The Regulation on Water Fees stipulated that example, the district office’s performance rating revenues for O&M for Irrigation Districts reflects the performance of its various divisions. should primarily be covered from fees col- lected from water users (locally determined, Examples of Performance Ratings on Nanyao ID: although with maximum fee ceilings) and the Regulation on Diversified Sideline Enterprises Salary bonus at the individual level: encouraged the creation of enterprises in such areas as fisheries, recreation, and food ●● If staff rating < 79%, no annual bonus is processing to create additional revenue given and salary is reduced one grade. sources to cross-subsidize irrigation. ●● If staff rating > 79%, the bonus increases (+) A stronger implementation system. Irriga- in proportion to the performance score. tion Districts were given more authority, The budget bonus is based on collection and Village Irrigation Management Groups timeliness at the VIMG level: (VIMG) were created. ●● If VIMG collects 100% of the fee by the (+) Better fees and pricing. A mix of fixed and end of March, it retains 5% of it. volumetric fees was applied for water use, ●● If VIMG collects 100% by the end of to make pricing more transparent. April, it retains only 3%. (–) Measurement problems: However, at the ●● If VIMG collects less than 100% by lower levels, measurement of volume was May, it must pay a fine of 3% of the not feasible; this undermined the transpar- remaining amount uncollected. ency of the link between water received and payment. Sources of Funds used in the RBF Case: During the era of the Communes, central and provincial- Definition of the RBF Incentive: The ID receives level funds subsidized routine irrigation costs. provincial funds based on the performance Following the reforms, they now share costs only against pre-agreed goals to build and rehabilitate for construction and rehabilitation work; thus the irrigation infrastructure. In turn, the ID adopts Irrigation Districts are completely responsible performance–based incentives (in the form for routine O&M costs. In 1992, the majority of of salary bonuses and penalties) to incentivize the annual income for both the Bayi and Nanyao individual employees’ performance. IDs stemmed from collection of water fees (93% and 96%, respectively), thus making a 100% Triggers for RBF Payment: Under the “Produc- collection rate a prerequisite for sustainability. In tion Responsibility System”, annual assessments two-thirds of the villages of Nanyao ID, the VIMG are made of the performance of the ID as a whole, collects water fees from individual farmers. In as well as of individual staff. Performance is the remainder, villages produce enough off-farm measured and rated based on: i) collection rates collective income to pay all the water fees from Chapter 3 2 1 and timeliness of collection, ii) water distribution, the village committee. 34 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS Excerpt from the Annual Performance Assessment for the Nanyao Irrigation Table 5:  District, China, 1993 Potential Points Item Planned Actual points awarded Water Delivery Total discharge (m3) 45 million 56 million 4 4 Irrigation water (m3) 20 million 21.5 million 5 5 Delivery to Yingang canal (m3) 15 million 34.5 million 3 3 Water delivery days 300 307 3 3 Total points 15 15 Maintenance Lined canals (km) 10 10 6 4 Silt clearance (km/number) 271/62 271/62 4.5 4.5 Structure maintained (number) 35 35 4.5 4.5 Total points 15 13 Source: Johnson and others (1996). Verification Process: The performance assess- and financial transparency. It also demonstrates ment of the Irrigation District is done at various that performance measures in public institutions levels: by individual staff, section offices, division can be implemented effectively. office, and district office. However, there is no information on enforcement rules. Additional Information about the Case: John- son and others (1996). Observed Results: RBF in this case was one ele- ment of a complex set of rural reforms that sig- Case 6. Slowing Deforestation nificantly changed water resource management in Costa Rica (Payments for and irrigation. Performance impacts cannot Environmental Services, PES) be assessed for RBF alone, but the case study Project Name: Costa Rica ECOMARKETS suggests that it contributed to creating financial (P052009), 2000–2006 incentives and an accountability system that enhanced water use efficiency, water delivery, Problems/Issues: Costa Rica has experienced one of the highest rates of deforestation world- wide, driven by the rapid expansion of transpor- Highlights of the Case Study tation corridors and by inappropriate policies, including cheap credit for cattle and land titling Albeit set in the past and in a particular political setting—China in transition from a communist laws that rewarded deforestation. to a more market-based system—this case is the only documented example in irrigation Background: In past decades, perverse policy (according to the authors’ literature review) that adopted performance–based incentives encouraged further deforestation. incentives for staff. Such performance-based Since the 1990s, such policies have been approaches are widely documented in the removed, and Costa Rica is now a global leader health and education fields. Chapter 3 2 1 in environmentally sustainable development. RBF Case Studies   35 Costa Rica pioneered the use of the payments to an earmarked tax and payments from for environmental services (PES) approach in beneficiaries. developing countries by establishing a formal, (+) Sound institutions to back the financing country-wide program of payments, the Pago scheme: The National Forestry Financing por Servicios Ambientales (PSA in Spanish). Fund (FONAFIFO) is a strong institution that is capable of effectively and efficiently Object of the RBF Incentive: The principal managing a complex system of payments recipients of the RBF incentives are landowners, for environmental services. who receive a payment to adopt uses of their (+) Strong legal framework and wide political land that increase the restoration and conserva- support for the PSA program through three tion of forests. Forest preservation and restora- successive administrations. tion can improve the quality of water (forests in (+) Nationwide support from civil society, watersheds produce higher-quality water, reduc- particularly small- and medium-size ing downstream water treatment costs) and landowners, as well as local and regional generate carbon sequestration benefits (driven organizations (NGOs, cooperatives). primarily by avoided deforestation). Definition of RBF Approach: revenue-capture Risk Allocation: The payment for conserving for- mechanisms to internalize the value of the envi- est is $64 per hectare (ha) per year (as of 2006). ronmental services through explicit payment There was a much higher demand from landown- schemes, with emphasis on complementary ers than the financial resources could meet—sug- services to biodiversity in forest conservation gesting that the PES actually supports land use areas (that is, hydrological services and scenic that otherwise would be too costly to adopt. beauty). Enabling Environment for RBF Adop- Sources of Funds Used in the RBF Case: The tion–Strengths (+) and/or Weaknesses (–) ECOMARKETS program followed a five- year Encountered: initial program funded by the government. The program (2000–06) was funded by: i) $8.6 (+) A strong legal and financial framework: In million per year from the Government of Costa 1996, Costa Rica adopted its Forestry Law Rica (GOCR), primarily by allocating 3.5% of the No. 7575, which explicitly recognized four national fuel tax to FONAFIFO, ii) $32.6 million environmental services provided by forest loan from the World Bank and iii) an $8.0 mil- ecosystems: mitigation of greenhouse gas lion grant from the Global Environment Facility emissions; hydrological services, including (GEF). Although the state was at the center of provision of water for human consump- the mechanism, the funding was not provided tion, irrigation, and energy production; through the country’s budget, but by means of a biodiversity conservation; and provision of tax designed for this purpose. scenic beauty for recreation and ecotour- ism. Notably, it changed the justification Triggers for RBF Payment: The PES linked the for payments from support for the timber payment to agreed behaviors that encouraged industry to the provision of environmental the conservation of existing forest. The initial services. Second, it changed the source payment could be requested at the time the Chapter 3 2 1 of financing from the government budget contract was signed, but subsequent annual 36 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS Highlights of the Case Study and PES Approach The case is one of internalizing externalities: land users usually do not receive any compensation for environmental services (such as planting trees which help regulate water flows in a watershed and reduce the risk of catastrophic flooding or landslides). As a result, they usually ignore environmental services in making their land use decisions. In a PES scheme, land users can be compensated for the environmental services they generate. Those who benefit from environmental services pay for their provision: that is, the user pays. However, to sustain benefits, the financial stream needs to be continuous. Although the PES approach is intuitively appealing, putting it into practice is far from simple. The key challenge is in understanding the scientific aspects of the environmental service at hand (whether biodiversity conservation, carbon sequestration, hydrological protection, etc.) and assigning them an economic value that is appropriate to incentivize the suppliers. payments were made after compliance had been Verification Process: FONAFIFO established verified, based on independent auditing. eight regional offices to receive applications, sign contracts, and monitor implementation. Once Institutional Arrangement: Implementing the proposed plans are approved, landowners agency: The ECOMARKETS Project was imple- begin adopting the specified practices, and mented by FONAFIFO, a semi-autonomous receive payments. The initial payment can be agency with independent legal status and requested at contract signing, but subsequent covering four modalities: forest protection; annual payments are made after verification of reforestation; forest management (suspended compliance (by the regentes). in 2003); and agroforestry (begun in 2003). Monitoring is undertaken primarily by the To manage payment, FONAFIFO developed a agencies responsible for contracting with farm- certificate instrument (Certificados de Servicios ers, including the Sistema Nacional de Areas Ambientales, or CSA) which are standardized de Conservación (SINAC), Fundación para el instruments that pay for the conservation of one Desarrollo de la Cordillera Central (FUNDECOR), hectare of forest in a specified area. and the regentes, with regular audits to verify the Demand side: On the demand side, accuracy of monitoring. With the financial sup- FONAFIFO secured agreements with many water port of the ECOMARKETS Project, FONAFIFO users to pay for watershed conservation. Water has established a state-of-the-art database to users are hydropower companies (like Energía track compliance. Noncomplying participants Global, and the state power producer, Compañia forfeit further payments. Regentes who incor- Nacional de Fuerza y Luz). Other agreements rectly certify compliance can lose their license. include bottlers, municipal water supply systems, irrigation water users, and hotels. Observed Results: ECOMARKETS has made Supply side: Landowners must present a sus- payments to nearly 2,400 landowners spanning tainable forest management plan prepared by a approximately 212,000 ha of privately owned licensed forester (regente). These plans describe forests, distributed as follows: i) protection = the proposed land use, and include information 200,798 ha, ii) reforestation = 7,551 ha, iii) forest on land tenure and physical access; topography, management = 3,394 ha, and iv) agroforestry soils, climate, drainage, actual land use, and car- (begun in 2003 and not significant). rying capacity with respect to land use; plans for Chapter 3 2 1 preventing forest fires, illegal hunting, and illegal Financial Sustainability: The World Bank harvesting; and monitoring schedules. launched a new Mainstreaming Market Based RBF Case Studies   37 Instruments for Environmental Management decreasing crop yields as a result of adverse (MMBIEM), and continued supporting the weather (such as drought) and depleting soil program. In 2005, Costa Rica expanded the use conditions. Access to funds to improve infra- of water payments by revising its water tariff structure and adopt new irrigation or farming (which previously charged water users near-zero technologies is limited, especially for poor, rural nominal fees) and introducing a conservation fee smallholders. earmarked for watershed conservation. Once fully implemented, this fee will generate an esti- Background: Lack of government support for mated $19 million annually, of which 25 percent small-scale irrigation: The irrigation sector is (about $5 million) would be channeled through not regulated, and government has tended to the PSA program. make large irrigation schemes a priority. Small farmers may remain excluded from reliable irri- Additional Information about this Case: gation services. There is some limited support www.worldbank.org/environmentaleconomics from local governments in terms of providing Pagiola (2006). access to infrastructure (local roads and market places). Access to finance: Farmers rely on credit Potential Future Applications for agricultural inputs by local traders, which basically is determined every harvesting sea- Experience with tools other than output-based aid son against crops produced. Apart from that, (OBA) and output-based disbursement (OBD) is there is limited access to (long-term) finance, fairly limited, and so is evidence of RBF extending although some banks operate branches in to applications beyond water supply and sanita- nearby towns. tion, such as water for environment, energy, irri- Beneficiaries’ situation: Farmers are orga- gation, and climate change or flood management. nized in small cooperatives, mainly to help mar- On the basis of the analytical framework and ket their produce and reach agreements with the case studies presented, can new applica- local traders on prices for agricultural inputs. tions of RBF be envisioned in the broader water Individual farmers lack the financial capacity sector? That is the question addressed in this to make long-term investments, and existing section, which presents a few hypothetical RBF cooperatives are not used to pool resources schemes to illustrate potential examples that to (partly) fund shared infrastructure or use could be implemented. This section is based on improved farming techniques. extensive consultation with experts from differ- Increasingly frequent weather shocks: These ent sectors and financial fields. adverse events can also limit the willingness of farmers to invest in measures that might Hypothetical Case 1. Implementing increase their productivity and improve their Subsidies for Irrigation Technology economic situation. and Weather Microinsurance for Small-Scale Farmers Object of the RBF Incentive: Need for funding Project: Subsidies for irrigation technology and to deliver results: To improve agricultural yields, weather microinsurance for small-scale farmers investment is needed in affordable irrigation technologies in order to make famers less reli- Chapter 3 2 1 Problems/Issues: Small-scale famers using ant on changing rainfall patterns. Furthermore, rain-fed agricultural techniques are facing innovation is needed and market knowledge on 38 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS diversifying current crops in order to improve should be triggered upon demonstration soil productivity needs to be developed and of new technology installed. Ideally, the shared. scheme can rely on existing cooperatives to share knowledge about proven and Enabling Environment for RBF Adop- affordable irrigation techniques. tion–Strengths (+) and/or Weaknesses (–) ●● B. Small farmers are encouraged to enroll Encountered: in weather index-based microinsurance (WII)13 which could reduce their vulner- (+) Favorable geography. Farmers are living ability to risks such as recurrent droughts. in a defined, limited geographical area and relatively close to exploitable water Experience has shown that demand from sources. The area is well-suited to a tar- poor shareholders is limited for WII as a stand- geted improvement in infrastructure. alone product because of a perception of exces- (+) Fitting weather conditions. The area is sive cost. WII can be more appealing when linked semi-arid. The index-based insurance to an existing development program or other model might be suitable to reduce drought- market opportunities, such as seasonal credit or induced vulnerability; a single parameter investment credit.14 (realized amount of rainfall) is sufficient.12 One practical option to bundle this scheme (+) Support from government/donors, which is the “interlinked credit-insurance arrange- are willing to support and invest in weather ment,” under which “farmers borrow money at data and agricultural statistics. a higher interest rate that includes a weather (+) Presence of a trustworthy insurer, willing to insurance premium. If a natural disaster occurs, issue the policy, accept some risk, and play then the farmers repay only a fraction of the an administrative role, and perhaps even loan, while the rest is paid by the insurer to the participate in technical education on the bank. This model reduces the risk of weather- design of weather index-based microinsur- driven default for borrowers and thus helps ance (WII) products. (–) High cost related to product distribution channels. 12  By contrast, flood-index insurance requires a com- posite index. This involves identifying the correlation between multiple attributes of a weather parameter Proposed Solution: A two-phased approach (duration, level of inundation, timing) with crop damage in a manner that allows individual as well as simultane- can consist of: ous variations of these parameters to be mapped to an indemnity payout schedule. For example, a flood-index trigger level could be determined for flood depth of more ●● A. Provide a credit scheme via local than 50 cm, with flood duration of more than five days, banks, backed with an interest rate sub- during a certain period of a crop calendar. 13  The difference (and key advantage) of index-based sidy and/or a (partial) guarantee, which insurance schemes is that indemnities are based on can be used by individual farmers to measurements of a specific weather parameter, such as rainfall or temperature, instead of actual damage. invest in affordable irrigation techniques. Therefore, the scheme does not require any damage The pay-back period would be less assessment. It offers a specific amount of payout if, for example, rainfall at a local station falls below a threshold than 36 months, to limit the risk profile. level. Index insurance mitigates moral hazard and Credit can be extended only for a set of adverse selection problems associated with traditional yield-based insurance schemes. preapproved technologies (certified by 14  See WFP and IFAD (2011) for an extensive discussion Chapter 3 2 1 the national agricultural institute). Credit of these schemes. RBF Case Studies   39 induce agricultural productivity as farmers the local intermediary to extend (subsidized) are able to use credit to switch to a higher-risk, credit. Verification services are contracted and higher-yield farming technology” (Akter, 2012, funded directly by the government/donor, to p. 11). Alternatively, “the interlinkage between ensure independency. Technical assistance credit and insurance can also be established would be provided by the donor with the sup- through ex-post premium payment as a state porting existing cooperatives through public contingent loan: in the good state of nature the awareness campaigns promoting the range of clients pay back the loan, the premium payment affordable irrigation techniques. on the insurance and the interest on both, but in the bad state of nature the clients owe nothing” Verification Process: There is a national agricul- (Akter, 2012, p. 11). tural institute with branches in provinces, which can be used as a knowledge center and indepen- Sources of Funds: Funding for the subsidy dent verification agent. Upon verification by the could come from either government or inter- independent agent, the credit subsidy would be national donors interested in promoting water provided directly by the donor to local banks. efficiency in agriculture and adaptation to climate change for poor farmers. In the case of Observed Results: The rationale behind such existing government resource mobilization for a scheme is ultimately to move from traditional disaster relief expenses, one option could be to government-funded crop subsidy to targeted allocate to these result-based subsidies some subsidies linked to technology and efficiency share of the expenses that are used to finance improvements. In the meantime, the promotion post disaster relief and rehabilitation assistance. of risk management services such as WII could While this remains debatable in terms of welfare encourage access to credit—by transferring risk distribution (if the marginalized poor in risk away from the borrower or lender—and/or the areas remain without relief funds), such option is development of savings services. worth exploring. It would entail a shift of govern- ment funds from post disaster assistance to the Additional Information about this Case: Akter support of measures that enhance prepared- (2012); WFP, IFAD (2011). ness for climate change providing necessary incentives to build resilience of sectors and the Hypothetical Case 2. Minimizing vulnerable. the Negative External Effects of a Hydropower Plant Triggers for RBF Payment: The subsidy compo- Project: 100-megawatt (MW) hydropower nent would be triggered by demonstrated adop- project tion or installation of the new irrigation technology/ equipment (previously certified as acceptable). Problem/Issue: The development of the 100- MW hydropower project in Country X involves Institutional Arrangement: The identification the creation of an artificial lake and the flooding of the intermediary and delivery channel for the of five mountain villages. The costs of running “subsidy + insurance” scheme (a rural bank, the compensation program and resettling the insurer, farmer cooperative, or microfinance 3,800 inhabitants of the area have made the institution) would depend on the existing institu- project financially unattractive to private sector Chapter 3 2 1 tional context. Donors would engage directly with investors. 40 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS Background: The 100-MW hydropower project relocate ultimately remains the responsibility of appeared to be the cheapest solution to reduce the government. Country X’s energy dependency, which remains one of the critical bottlenecks to its economic Definition of RBF Approach: An OBD mecha- development. The local government had a satis- nism. As part of the compensation program factory legal and regulatory framework in place to inhabitants are offered the choice of either: implement the project as a BOT scheme, with an i) receiving compensation from the government Independent Power Producer (IPP) and national according to the value of their current property utility EDC (Energy Distribution Company) acting when they effectively move to a new home away as the single off-taker. Interest for the project was from the project’s location; or ii) signing up for the strong among international power plant opera- subsidized resettlement scheme and receiving tors; however none of them was willing to assume a lesser amount, to be reinvested in one of the the cost of the compensation and resettlement residential areas to be built by the BOT opera- program, which involves the construction of tor around the new lake. In the latter case, they three new villages on the shores of the artificial have a choice between different apartment and lake in which inhabitants of the flooded villages house models to be built in the new residential would be relocated. Those additional costs made areas, but receive only 50% of the price. The BOT the project financially nonviable in spite of its operator receives a fixed fee per person signing strategic importance for the country. up for the program and moving out of the villages to be flooded, plus a grant amounting to 50% of Object of the RBF Incentive: The Ministry the costs of the new housing to be built. of Energy is implementing a combined com- pensation and resettlement scheme aiming at Sources of Funds: The compensation program relocating inhabitants of the area to allow the is funded entirely by the central government, hydropower project to reach operational phase. which is in effect buying up all private proper- The central government will compensate ties in the area to be flooded in order to make inhabitants signing up for the compensation pro- it available to the BOT operator. Fifty percent gram as and when they move out of their current of the costs of the resettlement program are dwelling, and also pay a fixed amount to the BOT funded by inhabitants relocated in the new operator per person moving out. As part of the residential areas, using the compensation they resettlement program, it will also compensate have received from government for their seized the BOT operator for the portion of the costs of properties. The remaining 50% is financed by the new housing estates not directly covered by a special resettlement fund provisioned by the the resettled households (end-beneficiaries). central government (30%) and EDC (20%). Risk Allocation: The BOT operator selected Triggers for RBF Payment: Payments for the through an international tender process compensation scheme are made to the opera- assumes full responsibility for the communica- tor on a quarterly basis as follows: i) 20% of the tion and implementation of the compensation fixed fee times the number of inhabitants having and resettlement programs, as well as the signed up for the compensation program during construction of the new housing compounds the period considered; and ii) 80% of the fixed according to pre-agreed detailed specifica- fee times the number of inhabitants having effec- Chapter 3 2 1 tions. The risk of inhabitants being unwilling to tively moved out during the period considered. RBF Case Studies   41 Compensation for seized properties is paid to Hypothetical Case 3. Preventing the inhabitants in one installment upon effective Negative Effects of Flooding moving from their current dwelling. Payments for Project Name: River Flood Prevention Project the resettlement scheme are made according to the following schedule: a) 40% of the cost of the Problem/Issue: In the spring, rain and melting new accommodation are paid by the resettle- snow trickling down from the mountains located ment fund to the BOT operator upon compli- in the north of Country F regularly caused the ance of a household with the requirements and three main rivers crossing the central plains to arrangements of the resettlement program; overflow, causing considerable damage to agri- b) 50% of the cost of the new accommodation cultural land and nearby villages. are paid by households themselves to the BOT operator upon delivery of the new accommoda- Background: Country F’s Ministry of Water and tion; and c) 10% of the cost of the new accom- Environment (MWE) launched an extensive flood modation is paid by the resettlement fund to the prevention initiative to tackle this problem. The BOT operator upon satisfactory inspection of the implementation of the initiative was devolved facilities two years after delivery. to local water management agencies in every flood-prone zone of the country. The river flood Institutional Arrangement: Implementing prevention project included two components: an agency is the Ministry of Energy. infrastructure component; and an emergency preparedness plan component. Verification Process: An independent verifica- The Central Plains Water Agency (CPWA), tion agent has been hired to audit the program which is in charge of supervising the safety of and its implementation on behalf of the Ministry waterways in the most problematic areas of the of Energy. The agent is in charge of checking that country, was awarded a grant from an interna- the promotion of the compensation and resettle- tional development agency to develop, finance, ment program is carried out in a respectful and and implement the program, for which an inno- transparent manner, and that compliance with vative RBF mechanism was set up. the program is done on a voluntary basis. Later in the program, the IVA will be in charge of assessing Object of the RBF Incentive: The RBF mecha- the living conditions in the new accommodations, nism aims at providing a financial incentive which will trigger the final payment to the operator. for CPWA to develop and implement both components of the project. The infrastructure Financial Sustainability: The combined component includes reinforcement of river approach to the compensation and resettlement banks, construction of floodwalls, installation of programs can make the scheme financially via- pump stations, and digging of detention basins. ble, as beneficiaries are incentivized to directly The emergency preparedness plan component reinvest the compensation money toward the includes inventory (selection of products to new real estate scheme. Expected financial stock, decision on inventory levels, and procure- revenues and economic benefits from the power ment of products), storage (decision on optimal plant will largely outweigh the initial costs borne storage locations, construction of storage facili- by the government and EDC to finance the com- ties), planning (establishment of plans and pro- pensation program and provision the resettle- cedures for dispatching resources in flood situ- Chapter 3 2 1 ment fund. ations and evacuating inhabitants) and training 42 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS (selection and training of people with necessary Triggers for RBF payment: Payments could be skills, training residents of flood-threatened made according to the following schedule: areas on evacuation procedures). ●● A fixed lump-sum amount correspond- Risk Allocation: CPWA does not generate ing to 95% of the estimated costs of the revenues and is funded via an annual budgetary infrastructure upon completion of the allocation from MWE. In that sense, MWE will works, bear the financial consequences of CPWA not ●● A fixed lump-sum amount corresponding achieving the program’s objectives and will be to the estimated costs of the Emergency absorbing all risks. Preparedness Plan upon presentation and independent validation thereof, Definition of RBF Approach: CPWA is in charge ●● A fixed lump-sum amount correspond- of developing and implementing the river flood ing to 5% of the estimated costs of the prevention program in its assigned zone. For infrastructure in five annual payments that purpose, it may draw on its own internal for maintaining pumping capacity and resources, or procure and/or outsource part of other elements of the infrastructure the tasks to be carried out, based on the national component operational at the pre- procurement laws and regulations. scribed level. Designing a satisfactory measuring tool or indicator for the flood prevention program Verification Process: An independent verifica- is somewhat difficult, as the effectiveness of tion agent can be hired by the international the infrastructure works and the Emergency donor agency to audit the program and its Preparedness Plan to provide efficient protection implementation. In particular, the IVA would be against floods can only be really tested in the in charge of monitoring progress made by CPWA case of severe natural disasters, which occur at and ascertaining that conditions for payments irregular intervals. Therefore, the RBF scheme is are met. based on pre-agreed objectives pertaining to both components of the program being delivered and Observed Results: Such a program can provide maintained up to certain performance standards. strong incentives for the government to quickly improve its flood prevention infrastructure Sources of Funds: CPWA pre-finances all as well as its response to flood disasters. The project costs via a special investment budget scheme is designed in such a way that payments allocation from MWE, and gets partly refunded are linked to specific objectives and can there- for the costs by the international donor agency fore be cancelled if objectives are not met within if and when RBF objectives are reached in due the agreed timeframe. time. Alternatively, a grant can be earmarked to A thorough preparation to identify the CPWA to assist with pre-financing. To shorten most effective way to reduce the frequency and the payment process, as we discussed, instead impacts of flood events, including hydrological of paying the implementing agency upon com- modeling of alternatives, assessing the feasibil- pletion of entire major infrastructure, they can ity of the proposed infrastructure works, and be paid when they complete each unit works (a explicitly describing outputs to serve as grant functional unit of the major infrastructure, such installments is essential to design the proper Chapter 3 2 1 as a sluice gate in a barrage). instrument. RBF Case Studies   43 The Constraint of Risk Transfer in Flood Prevention The possibilities for a results-based approach to flood prevention are mainly restricted by the extent to which an agent will be able and willing to accept additional risks. Ultimately, the relevant risks are not very manageable, particularly the risk of the occurrence of a flood event. However, one option is to incentivize the implementation of measures that can reduce the impact of such an event. Examples include developing and implementing Emergency Preparedness Plans or Asset Management Plans, as illustrated in the case study. Other innovative ideas could be to incentivize: ●● governments to set and enforce policy/permits promoting construction according to flood resilient standards and that could include flood prevention facilities such as temporary water storage, ●● the prevention of blocking of drainage canals (for example, pay NGOs or the waste manage- ment service provider to prevent dumping of waste in drainage canals), ●● dredging to keep drainage canals open up to certain standards during certain times that are more prone to flooding, ●● governments to implement measures to flood-proof key/vital infrastructure such as hospitals, ●● governments or NGOs to set up and test early warning systems (the performance criteria could be the percentage of people reached out of the total population during testing), ●● governments to plan and establish exit roads with sufficient capacity. Chapter 3 2 1 Chapter 4 Main Findings and Conclusions Using RBF to Address Certain Categories of Problems When considering the water sector as a whole, the spectrum of possible issues to be resolved is enor- mous, but categorizing the main recurring issues can help narrow the selection of which RBF tools may be most suitable for each specific context and situation. The discussion that follows considers recurrent issues encountered in water-related development projects and suggests RBF approaches that could (in principle) be implemented effectively. Table 6 presents a set of market failures and challenges and certain RBF tools that could be used to address them. The final selection and structuring of the program or project should be refined through further questioning various aspects of the specific situation, such as the ones discussed in the analytical framework presented in Chapter 2. Behavioral Issues When the intervention is at the household or individual level, the intended beneficiaries must adopt a specific behavior or change a habit. Some examples could be starting to wash hands, modifying garbage disposal practices (to prevent obstruction of drainage canals and creeks), or adopting new irrigation equipment. Often, if people receive adequate information (and training, if necessary), they become conscious of the benefits of changing their behavior and may do so without requiring any incentive. However, a very common challenge is to sustain behavioral changes over time, especially when beneficiaries do not immediately appreciate the benefits of the new behavior, or when this demands more effort than they are accustomed to (Box 6). However, because of the risks of rent-seeking or aid-dependency, it is preferable to limit the length of time over which the behavior-related incentive is offered. Ideally, this should be limited to a period of time that is enough to ensure that an educational message can be understood and retained and that the beneficiaries perceive the benefits of the new behavior and have fully adopted it. The optimal dura- tion of the incentive will be determined depending on the tradeoff between its cost and the number of repetitions (of the incentive) necessary to make the new behavior attractive to the beneficiaries. This type of behavior-based incentive is typically found in CCTs; however, it not necessarily directed to the beneficiaries of a program or the entities in charge of mobilizing their behavior change (through such means as information, communication and education (ICE) campaigns, training, or promotion). For instance, in the irrigation reform case-study in the North China districts discussed 46 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS Table 6:  Kinds of Issues in Water Projects and Related RBF Tools Issue/Market failure Description of issue Possible RBF tool Behavior/Bounded A stakeholder group should Incentive/reward to sustain users’ new rationality change habits (hygiene), improve behavior, such as conditional cash practices (garbage collection), or transfers (CCT). adopt new technologies Subsidy to make new infrastructure/ equipment affordable, such as output- based aid (OBA). Access constraints Low-income population lacks Advanced market commitment (AMC) access to certain products or can support suppliers’ investment services due to supply issues when demand is uncertain. (uncertain revenues from disadvantaged areas) or demand Take-or-Pay (ToP) offers a guaranteed issues (affordability) prices and quantities for a specified period. OBA subsidy can close the affordability gap for poor customers. Externalities External costs or benefits are Payments for Environmental generated by an activity/service Services (PES) introduce payment that affects members of society for preservation/restoration of who are not involved in the ecosystems. market transaction Carbon finance (CF) allows pricing and trading of GHG emissions. Unsatisfied demand/ Demand is not met because the Output-based disbursement (OBD) Uncertain future required investment is too risky schemes can redistribute the revenues/Market power or the future demand volume is investment responsibility among too uncertain. different levels of government. A dominant/monopolistic ToP agreements can offer guarantees position causes suboptimal to the supplier so that the optimal quantity, quality, allocation or quantity of product/service is reached. pricing of a good/service. OBA subsidies can help buy down the capital cost of the investments required. Infrastructure investment Large investments are needed to Cash-on-delivery (COD) is a hands-off programs/ Budget build infrastructure. approach that rewards governments execution for long-term results. Government needs to improve the execution of an investment OBD schemes can improve budget plan (because of low capacity, execution for large investments (lower rent-seeking behaviors, etc.). government levels are responsible for agreed outputs). Poor service delivery or A vicious cycle (often seen in Various RBF alternatives could be operation & maintenance irrigation) of inadequate service appropriate, including high-level COD, supply or administrative failures, together with incorrect pricing OBD agreements, more output-specific of goods and resources prevent OBA, or performance-based contracts the sustainable provision of water (PBC) (well-tested in health). services. Chapter 4 3 2 1 Main Findings and Conclusions   47 Box 6:  Changing Habits in the Area of Waste Management Residents of low-income areas in a city may be used to disposing of solid waste in creeks or drainage canals; this practice can produce flooding because the garbage obstructs the flow in the drainage system. It may also cause environmental damage and can have health implications on the population. Such behavior is likely due to a combination of a lack of education and a lack of alternatives because of poor infrastructure. To tackle this issue, a cash payment could be justified, conditional on residents disposing of solid waste in a specific designated area. The agent working with the community to induce the behavioral change could be paid, periodically, after verification that the new practice is being followed by the population. These payments could be made using the number of households adopting and maintaining the new behavior, defining a certain threshold beyond which an agreed amount is paid, or by checking the condition of the creek or canal and paying if it is free of garbage. However, the scheme could use one or two payments depending on the adoption of the new behavior or technology. A first payment could be made when the equipment (if needed) to start with the new behavior is acquired or installed (it is preferable to pay upon installation). A second payment could be made once that hardware is being used in a consistent manner. More information on RBF in solid waste management can be found in: World Bank (Forthcoming). in Chapter 3, behavioral incentives were used Constrained Demand (along with other measures) to improve the As the case studies in Chapter 3 illustrated, performance of employees of irrigation districts some RBF mechanisms can help overcome in collecting water fees. Linking employees’ the impediments constraining access of low- performance to salary bonuses and penalties income populations to water-related services proved particularly effective at a time when (potable water, sanitation, and irrigation ser- irrigation districts were progressively receiving vices). Sometimes, uncertainty regarding the fewer subsidies to cover irrigation costs and level of demand for certain services (like on-site needed to rely on local cost recovery mecha- sanitation) keeps providers from investing to nisms for funding (see Box 7). satisfy this demand. A commitment to procure Box 7: Inducing New Behavior in Hygiene To promote and maintain more hygienic practices among low-income households, while improving sanitation conditions, a payment could be made to those households that purchase and install the required hardware (concrete slab, rings, or similar elements) to set up their own latrine with hand washing facilities (if not already available), once it is verified that the facilities are working properly. This payment could be considered a rebate or subsidy that covers the gap between what customers can afford to pay and the cost of the hardware once installed. The households may borrow the amount to cover the gap from microcredit institutions, family members, or other schemes, and pay it back once they receive the RBF payment. This way of structuring a scheme is typical of OBA projects, where a subsidy covers the gap to facilitate access to a service. A portion of the rebate or subsidy could be withheld until the IVA verifies that the facilities are used and household members are washing their hands after doing so. A portion of an OBA subsidy is used to induce and fix a desired behavior. For more information on this topic please refer to: Tremolet (2011). Chapter 4 3 2 1 48 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS a given level of service could lead to investments provided by a development agency or contributed needed to develop and bring to the market by the government (in the form of a social RBF affordable solutions. fund or similar arrangement) or from loans or This approach emulates the advanced credits from development agencies to a national market commitment (AMC) mechanism used to or state/provincial government that is on-granted develop vaccines for developing countries (see downstream to be used as subsidies. In the latter Appendix A for a detailed explanation of AMC) case, the loans or credits could also be designed and intervenes on the supply side of the market, using an RBF structure. If the option is an RBF ensuring the provision of affordable solutions. In instrument, then that higher-level scheme could certain cases addressing both the demand and take the form of an OBD, COD, or other RBF supply sides will be required. Along with weak mechanism that follows the principles outlined in supply-side incentives, demand for a new service Chapter 2. can be uncertain because of affordability issues (an entry or access barrier). An RBF scheme, in Externalities the form of a direct subsidy to the households to Externalities, defined as costs or benefits result- pay for the portion of the connection cost that ing from an activity or transaction which affect they cannot afford can be structured and imple- a third party (uninvolved), are present in some mented. This was the instrument implemented capacity in water-related projects and programs. in the case of Manila Water illustrated in Chapter These positive and negative externalities are 3. The payment is made to the service provider typically related to the non-exclusivity and non- “on behalf” of the households. This solves two rivalry characteristics of natural public goods problems: the service provider is certain that if (such as shared water resources, forests, and it performs the agreed service it will recover the biodiversity). The distortions generated by costs, and the households pay what they can externalities can be corrected in various ways, afford and enjoy access to water. including: regulatory instruments, economic In other circumstances, if households can instruments based upon a coercive approach afford the full amount—if convenient financing (“polluter pays” principle), or economic instru- were available and the service provider, a com- ments based on the producer’s voluntary mercial bank, or a credit union would agree to a approach, without any coercive action. The lat- financing arrangement involving loans to those ter category includes PES systems,15 which have households at a subsidized interest rate—the RBF become increasingly popular in recent years in mechanism could still be used to design a program both developed and developing countries. As and/or project. This could be done by paying the illustrated in the Costa Rica case study (Chapter party providing the financing to the households 3), PES is one mechanism that falls under the the present value of the interest that will not be broad umbrella of RBF and is specifically intended paid by the households because of the reduced to tackle externalities. It could be combined with interest rate. The payment can be done upfront, carbon finance (CF), as was done in a biogas once the service is provided according to the set project in Nepal that combines an OBA scheme standards and has been independently verified. for alternative energy with a CF scheme associ- The two options described above, which are ated with the reduction in firewood consumption based on the use of subsidies, are built along the lines of an OBA mechanism. However, the funds See Laurans et al. (2012) for a detailed discussion of 15  Chapter 4 3 2 1 for the subsidy scheme may come from a grant PES. Main Findings and Conclusions   49 Box 8:  RBF for Flood Prevention A local government governs a town or city traversed by a river downstream from a forested area. If the owners of the land upstream of the town choose to develop that forested land, the vegetation cover would disappear and the land would become more impervious, reducing the concentration time in the catchment and increasing the peak flow through the city. This would put the city at higher risk of flood damage and significant capital investments would be required to prevent those damages. An agreement could be reached where the local government would use part of the revenues that otherwise would be used to build the flood protection infrastructure to pay landowners upstream from the city that agree not to develop the land or to develop it preserving, to the extent agreed, its beneficial effect on the river flow during rainfall. Depending on the information available, the transaction could consider payments related to the level of preservation of the vegetation cover, relative permeability of the land, the run-off coefficient, or a combination of these or other parameters. The local government could combine the implementation of certain infrastructure works with an agreement along the lines described above. An optimization study could be used to define the extent of the benefits of such a scheme. One objective could be to maximize the relation between the reduction of potential flood damage and the charge to be imposed on the population to implement the plan. Furthermore, the analysis could include additional revenues from changes in the allowed land uses as a consequence of the implementation of the plan, such as increased opportunities for recreation or ecotourism. that was damaging the forests surrounding the balance the risk to a point between the input- project area (see Box 8 for an example). based financing approach (in which the principal bears most of the risk) and a pure commercial Limited Supply-Uncertain Future approach where cost recovery would depend Revenues-Market Power only on the quantities actually sold at the prevail- When the level of investment required to provide ing price (and the agent bears most of the risk). a service is high, there might be a shortage of Another mechanism entails linking an RBF service providers willing to take on the risk of incentive to the creation of an operational facility building the necessary infrastructure. This may (once it has been finished, tested, and is operat- be the case in investments for the production of ing as planned) as in a sort of turnkey project. clean water, storage of water for irrigation, and However, this implies that the plans for the wastewater treatment facilities. Another com- operation, maintenance, and management of mon issue in water is that of a natural monopoly, the facility are already in place. Box 9 illustrates a preventing competition and limiting access relevant example in which the insufficient supply to potential markets. RBF instruments can be of sanitation infrastructure is overcome through design to encourage the entrance of new service a “creative” PPP arrangement. providers to the market. Although conceptually similar to AMC, a Subpar Implementation of Take-or-Pay (ToP) agreement—in which there Infrastructure Programs or Budget is a commitment from the principal to buy Execution certain quantities regardless of whether the RBF incentives can be used to assist govern- goods or services are taken or not (see detailed ment agencies at different levels (national, state, explanation in Appendix A)—could be used to local) to improve the execution of infrastructure ensure certainty of a minimum revenue stream investment plans in certain areas or sectors. Chapter 4 3 2 1 to the potential agent. Such arrangement could Understanding the underlying causes of poor 50 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS Box 9:  Overcoming Supply Constraints in the Provision of Sanitation Infrastructure Due to the low probability of full cost recovery, private investment is not attractive for sanitation infrastructure. Private suppliers are constrained to serving communities/households that have the ability to pay for the full cost of those services. Nonetheless, there are untapped opportunities for creative public–private partnerships (PPPs) that hinge on resource recovery from human waste. Murray et al. (2011) illustrates an example of a community-based biogas recovery and (co)-compost production project. In this model, a private entrepreneur builds a biogas plant for receiving faecal sludge (FS) from multiple community/public toilets. This model enables the sustainable maintenance and timely extraction of FS from toilet blocks. A “reverse tipping fee” is financed through revenues from sales of the gas. Based on local market demand for natural gas products, end uses could include bagging the fuel in transportable biogas pillows for use as a cooking fuel; conversion to electricity using a biogas-fed generator; or purification and compression for use as a transport fuel (see figure below). The initial capital investment required for biogas recovery and upgrading for sales is likely to be a major barrier to entry for small- and medium-scale entrepreneurs. As the authors suggest, microfinance or other lending institutions could be engaged to gain their confidence in such business ventures and to use them to identify and recruit new entrepreneurs to the sector. If the biogas plant is of sufficient scale, the sale of carbon credits on the international market could be another financing option. Institutional Arrangement of the Biogas Structure Community-based biogas recovery CO2 offset CERs (i.e. carbon credits) to international market Community FS toilet blocks $/ton CO2 biogas $/m3 OF, FS Private biogas Consumer plant $962,000 Organic food (OF) waste OF $124,000 + debt financing Operating expenses: e.g. labor, electricity Source: Murray et al. (2011, pp. 505–521). execution in investments will provide guidance of financial resources if such program leads to on how best to structure the RBF scheme and improvements in the performance of the subna- selected appropriate instrument(s). Among the tional governments. This would be an RBF agree- possible causes, there might be low capacity at ment along the lines of COD. In certain cases, a the agency or subnational government level, and combination of two or more instruments could the national government may be interested in be used in complementary ways. Investments in improving the situation through a capacity build- specific projects could be financed through OBD ing program. The risk to implement the capacity agreements, for instance, and a COD scheme building program could be taken by the national could be used to reward the effective contribu- government, with a commitment from a devel- tion of such project to the overall improvement Chapter 4 3 2 opment institution to provide a certain amount measured by specific indicators. 1 Main Findings and Conclusions   51 Another option could be to trigger better payment. In such situations, and depending on financing conditions (reductions of the inter- how much risk the agent is willing to assume, est rate, extension of the maturity or the grace the first OBD payment linked to the completed period) if the selected indicators improve project could cover only a portion of the costs, beyond a certain threshold. This would be leaving the remainder (plus a reward, if deemed equivalent to using the proceeds of the COD pay- convenient or necessary) to be paid once the ment and applying them to cover the difference improvement in performance can be verified or in the financing cost derived from the changes the improvement is sustained. in the loan conditions, instead of leaving it up to the government to decide how to use those proceeds. Six Principles for Tailoring RBF Several examples exist as to how to use OBD Mechanisms to a Particular to improve the implementation of investment Case programs or budget execution, notably the São Paulo Water Recovery Project (REAGUA) in Designing and implementing an RBF instrument Brazil (see Chapter 3) and the Local Government requires detailed customization and in some and Decentralization Project (DAK Reimburse- circumstances, creativity to adapt to a particular ment) project in Indonesia. situation and context, given the variety and complexity of issues; the sources of funds avail- Poor Service Delivery and able; the capacity of principals and agents; the Operation and Maintenance strength and capacity of supply and demand When addressing issues of poor service delivery sectors, as well as other stakeholders (e.g. local or lack of maintenance, it is necessary to assess financial sector and regulatory authorities); and the underlying reasons for the poor performance, plausible verification options. There is, however, so that any incentive can be better aligned to the a series of principles that should be observed improvement in the proper areas. Incentives when structuring any RBF mechanism and that could be offered at a high governance level, will assist in ensuring the design of viable and such as COD agreement, where the payment is implementable instruments. linked to improvements in indicators reflecting the progress achieved in the problematic areas. Principle 1. The Incentive Should Alternatively, an RBF incentive could be effective Focus on the Outcome at a lower governance level, where payments The development of an RBF instrument requires are linked to the completion of a specific project a strong focus on outcomes or outputs, rather agreed to in advance, possibly using an OBD than on inputs and (procurement) processes agreement. that are needed to achieve these results. The Combining the two approaches is advisable inherent risk of schemes that place such a great in situations where the link between the ultimate focus on the input side of the results chain (for objective and the results under the agent’s example, on hiring and training staff or capacity control is uncertain (as in conveyance or distri- building, the construction of a plant, etc.) is obvi- bution efficiency projects), so an agent would ously the weak influence and accountability of not accept assuming the full risk of investing in the input on the ultimate intended results. On the upgrading the network and thus fail to achieve other hand, when the existing inputs/ conditions Chapter 4 3 2 1 the agreed results, loosing part of the incentive are too frail—as in the case of underqualified or 52 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS insufficient staff—it may become unrealistic to the ultimate objective, completing the invest- incentivize output and outcomes because the ment (whether a hydropower station or an enabling capacity is simply not there. irrigation system) or meeting certain targets, When structuring the RBF instrument and (such as water supply or sanitation coverage) defining the trigger indicators the challenge is is certainly no guarantee that long-term results to remain as close to the ultimate outcome as will be delivered. Even the fairly straightforward realistically possible. The indicators must be OBA schemes have been subject to the criticism designed with the outcome in mind. Hence, it that subsidizing a one-time connection effort is is imperative to devote adequate time during no guarantee of long-term sustained services to the project design and appraisal to analyze the the poor. objective- result-indicator paradigm (as was On many occasions, the infrastructure, discussed in section 2.1 and is explained in detail once finished, has not been used as intended in Appendix B) to find the most suitable strategic or maintained appropriately; it may even have option. This leads to the second general principle. been sold or abandoned. For example, meeting quality standards for water supply service (water Principle 2. Ensure That Indicators pressure, number of hours per day that service are Measurable is available) is a more sustainable performance As commonly accepted as good practice in indicator than the number of connections. management for results, the indicators should Accordingly, when structuring an RBF mecha- be SMART: nism, it is crucial to encourage a shift of focus to the long-term objective (rather than the immedi- ●● Specific: Closely linked to the a specific ate financing gap). area of improvement ●● Measurable: Able to capture a quantifi- Principle 4. Create a Market-Like able progress or Market-Based System, to the ●● Achievable: Achievable within the life of Extent Possible the project and thus suitable to trigger On a macro level, given the shrinking resources payments available from traditional donors and multilateral ●● Relevant: Reflect information that is development banks, the trend is toward utilizing important and helpful in tracking prog- the limited lending and aid resources available as ress toward the intended objective catalysts to leverage additional financing from ●● Time bound. Progress can be tracked at a diverse sources (The World Bank, 2013). Inno- desired frequency for a set period of time vative financing approaches such as RBF can play this catalytic role to enhance the impact of Principle 3. Use a Long-Term resources from multilateral development institu- Perspective Rather Than a Short- tions and bilateral donors by supporting improve- Term One ments in the business and investment climate In financing mechanisms, there is a natural that can facilitate access to private sources of tendency to emphasize the investment that is finance. Examples include climate finance and needed to generate results. This is only logical: partial risk and partial credit guarantees. the investment directly causes the need for a On a practical level, financial incentives work financial intervention. However, although the best in a commercial or market-based system, Chapter 4 3 2 1 investment often is a precondition for reaching and not so well in the public or semi-public sector. Main Findings and Conclusions   53 Financial incentives ultimately do not influence Principle 6. Be Aware of and Avoid decision making in political governance struc- Potential Unintended Incentives tures as much as they can influence a privately Any financial arrangement intended to solve owned company with shareholders that seek to market failures can result in unintended effects maximize the value of their investments. Often or behavior. For example, a subsidy to induce market failures (asymmetric information, exter- poor farmers to acquire irrigation equipment nalities or other barriers) are the reason behind can lead to a flourishing resale market for the reluctance of the private sector to invest in irrigation equipment instead of well-functioning the water sector in developing countries. RBF irrigation systems. Therefore, in structuring mechanisms can help overcome such market an RBF mechanism, it is valuable to check for failures and create well-functioning demand and unintended incentives from the perspective of supply sides: for example, by creating market the recipient. appetite and building the capacity of operators. In structuring a market-based system, a helpful perspective is to focus on the business case of a Concluding Remarks project or program and determine what aspects need to function properly. Financing for development after the 2015 threshold is expected to become increasingly Principle 5. Ensure a Feasible constrained and exposed to changing needs Allocation of Risk within a context of protracted crises that involve RBF implies that more risk will be transferred traditional donors and recipients of development to the agent than in a conventional approach. aid alike. Given the tighter aid budgets of many This risk transfer creates, on the one hand, an donor agencies, “the transformative develop- incentive for the agent to deliver the agreed ment agenda requires that available resources results and, on the other hand, an expectation be used more effectively and strategically cata- of additional remuneration for the agent. That lyze additional financing from official and private agent should be in a position to assume the risk; sectors.”16 On the other hand, the increasing otherwise, using an RBF instrument will not be emphasis on linking development funding to possible. Incentivizing the government or opera- results will require greater country ownership, tor on the basis of performance indicators that transparency, and focus on results. In this con- are close to project objectives/outcomes implies text, new financing sources and tools are being an aggressive risk transfer. This is often not pos- explored, by both researchers and implementing sible because reaching the project objective is agencies, with increasing attention to results- dependent on a range of issues that cannot be based forms of assistance and funding. controlled by the government or operator: it may This guide aims to contribute to a better be the case that the risk allocation is inefficient understanding of RBF instruments and the con- and ineffective. In other words, whereas RBF ditions for success or failure of such approaches is based on a larger risk transfer to the agent, in the water sector. The angle chosen in writing the risk allocation should still comply with the this user’s guide is to take the position of a task principle that each risk is borne by the party best manager (or other involved stakeholder) when, suited to manage it. Therefore, the move toward RBF demands a thorough analysis of risk alloca- Chapter 4 3 2 1 tion and risk mitigation measures. 16  The World Bank (2013, p. 3) 54 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS at the design stage of a development project, he Hopefully, the analytical framework used in or she is looking for a nonconventional solution to this guide, combined with the case studies, will specific problems and recurrent policy issue(s) provide some useful insights for practitioners or market failure(s) in the respective water sub- who are dealing with RBF or are exploring the sector. Thus, the guide discusses the process potential use of RBF. Ideally, the ever-growing of categorizing the type of issue as a first step in potential of data collection, such as remote sens- identifying a potentially suitable RBF scheme. ing and other geographic information systems Through the detailed discussion of various (GIS), can trigger even more exploration of inno- case studies (both real and hypothetical) span- vative ways to include goals to adapt to climate ning diverse contexts and sectors, concrete change in the RBF incentive schemes. examples are provided to illustrate cases Developing this user’s guide and interview- where an RBF scheme has been or could be ing numerous Task Team Leaders (TTLs) of the adopted. The case studies clearly document World Bank and RBF experts has provided some how there is no generalized rule or arrangement useful suggestions with respect to the potential to implement an RBF scheme; rather, a careful for application of RBF schemes in water sub- assessment of the coexisting contextual fac- sectors, including those linked to climate change. tors can point to which specific RBF could be The main ones can be summarized here: feasible. Such factors (extensively discussed in the analytical framework) include the willingness ●● RBF schemes should focus on longer- of stakeholders to work with RBF; risk transfer; term results, instead of “just” connec- access to finance options; various determinants tions for water supply projects. of an “enabling environment”; and the existing ●● The output-based aid (OBA) approach capacity and competences of involved agents. seems promising not only for water For example, a reliable ex ante definition supply, but also for applications in the of output unit costs is fundamental for OBD sanitation and irrigation sectors. schemes. When Uruguay’s regulatory changes, ●● For large-scale irrigation projects, the passed in 2004, precluded private operators RBF mechanism seems most promising from water and sanitation supply services, OBD if reflected in a public-private partnership became an alternative strategy to strengthen (PPP) structure with a private operator, intergovernmental accountability and establish a because financial incentives on larger compelling internal performance benchmarking schemes work better in a commercial system. In the case of lack of access to water environment. among pockets of poor urban households in the ●● For small-scale irrigation projects, there Philippines, a one-time OBA subsidy payment is room to explore the potential replica- justified subsidies to bridge the affordability gap, tion of an experience such as the “Light- given the demonstrated commitment of the sup- ing Africa” program to foster the creation plier to reach these disadvantaged customers. In of an enabling environment offering the similar water or sanitation provision cases, vari- financial and institutional conditions for ous OBA pilot projects implemented have shown adopting innovative irrigation techniques. how result-based subsidies can guarantee better ●● In hydropower, RBF mechanisms offering targeting (by virtue of the verification require- incentives to effectively deal with elimi- ment) and, as such, are more easily acceptable nating ‘externalities’ are within reach and Chapter 4 3 2 1 considering the logic of welfare equilibrium. promising. Main Findings and Conclusions   55 ●● In the area of flood prevention, the move Although this guide focuses on RBF and to a completely output-based approach the concept seems very promising in terms of will not be achievable, but there are many broadening future applications to water-related opportunities to make small steps in that issues, it is important to place RBF in its proper direction. perspective. The RBF approach is not a goal in ●● It is advisable to create opportunities to itself but rather a means to creating more effec- make loan schemes (instead of grants) tive and results- oriented financing schemes. more results based, along the lines Ultimately, RBF will not replace traditional ways described in this user’s guide. of funding development projects; rather, it will complement them. Chapter 4 3 2 1 Appendix A Glossary of RBF-Related Concepts and Instruments Basic Concepts This section explains some concepts that may apply to the financing arrangements or tools described and analyzed throughout this document. The explanation starts with a definition from a dictionary (in italics), and is followed by a definition that is tailored to the context of the subject under analysis. Incentive: Something that motivates or encourages someone to do something. An incentive is the promise of a reward (or the fear of a punishment) that encourages cer- tain behaviors and discourages others. Every society has institutions that provide such incentives to individuals in different parts of their lives, including rules for hiring workers and remunerating them, obeying traffic and tax laws, participating in community activi- ties, or fulfilling family obligations. These institutions and associated rules also create an environment of incentives for businesses, corporations, government officials, agencies, and other organizations. Development programs enter these contexts bringing their own complexities, and introduce new incentives that may work with or against some of the prevailing incentives (Savedoff, 2011). Input: What is put in, taken in, or operated on by any process or system. Inputs are the financial, human, and other resources mobilized to support activities undertaken by a project. Examples would include loan/credit funds and staff (OPCS Results Secretariat – World Bank, 2007). Outcome: The way a thing turns out; a consequence. A project outcome is the uptake, adoption, or use of project outputs by the project beneficiaries (OPCS Results Secretariat – World Bank, 2007). Output: The amount of something produced by a person, machine, or industry; the action or pro- cess of producing something; the power, energy, or other results supplied by a device or system. The supply-side deliverables, including the events, products, capital goods, or services that result from a development intervention (such as the construction of a school). The key distinction between an output (a specific good or service) and an outcome is that an output typically is a change in the supply of goods and services (supply side), while an outcome reflects changes in the utilization of goods and services (demand side) (OPCS Results Secretariat – World Bank, 2007). 58 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS Result: A thing that is caused or produced by something else; a consequence or outcome. Results are the outputs, outcomes, or impacts (intended or unintended, positive or negative) of a development intervention. The World Bank encourages results that sup- port sustainable improvements in country outcomes: that is, evident changes in people’s lives or the behaviors of targeted households, firms, or institutions (OPCS Results Secre- tariat – World Bank, 2007). Subsidy: A sum of money granted by the state or a public body to help an industry or business keep the price of a commodity or service low; a sum of money granted to support an undertak- ing held to be in the public interest; a grant or contribution of money. Public funding used to fill the gap between the total cost of providing a service to a user and the user fees charged for that service. The use of subsidies may be justified by policy concerns such as improving basic living conditions for the poor or reducing disease (Mumssen, Johannes, & Kumar, 2010). The financial value of a subsidy is equal to the money that the utility loses by providing the subsidy. Specifically, it is the difference between the cost of providing the service and the payment made by the household to receive that service (Komives, Foster, Halpern, & Wodon, 2005) (pages 53 and 116). From a demand-side (consumer) approach, which relies on household survey data— including data about consumption of water and the price paid for it—the subsidy amount is computed as the difference between what the consumer actually paid and the price that “should have been paid,” given observed consumption and a “normal” price” (Le Blanc, 2008). From a supply-side (utility) approach, where the point of view is that of the government and the unit of observation is the utility, subsidies to consumers are calculated as the difference between transfers from the government to the utility, minus all the losses incurred by the utility due to inefficiencies. The government provides a transfer to the utility to help it cope with current expenditure requirements (either to break even or to achieve a profit). The proportion of this amount that goes to end-consumers is reduced by any loss of efficiency occurring from production, distribution, billing, or collection of payments. The problem is then to measure these losses. The latter two types of losses can be measured directly; the former two can be estimated by benchmarking (Le Blanc, 2008). A distinguishing feature of water and sanitation subsidies is whether they seek to reduce the cost of consumption or the cost of connecting to the network. Consumption subsidies help make service less expensive to existing utility customers on a continuing basis. Consumption subsidies may operate through the tariff structure (as a reduction in the price faced by all or some households), may appear as a percentage discount applied to customer bills, or may take the form of a cash transfer to reimburse households for utility expenditures. Connection subsidies are one-time subsidies that reduce or eliminate the price that customers pay to connect to the system. (Komives, Foster, Halpern, & Wodon, 2005) (pages 8–10). Chapter 4 Appendix3 2A 1 Glossary of RBF-Related Concepts and Instruments   59 Concepts Specific to Results- Emission Reductions Purchase Agreement Based Financing (ERPA): An agreement that governs the pur- chase and sale of emission reductions. Advance market commitment (AMC): A contract in which donors make a legally binding Certified Emission Reductions (CERs): A unit pledge to pay for a service, such as a new vaccine, of greenhouse gas emission reductions issued if and when one is developed (Advance Market pursuant to the Clean Development Mechanism Commitment Working Group, 2005). Advance of the Kyoto Protocol, and measured in metric market commitments for vaccines aim to encour- tons of carbon dioxide equivalent. age the development and production of afford- able vaccines tailored to the needs of developing Carbon credit: A certificate showing that a gov- countries. Through a forward-looking binding ernment or company has paid to have a certain contract from donors and international agencies amount of carbon dioxide removed from the guaranteeing a viable market for target vaccines, environment (Collins English Dictionary). AMCs encourage vaccine makers to develop or build manufacturing capacity for urgently needed Cash-on-delivery aid (COD): A financing arrange- vaccines. The binding contract guarantees a ment through which donors offer to pay recipient pre-agreed price for the first doses of vaccines governments a fixed amount for each additional sold to developing countries, so that companies unit of progress toward a commonly agreed goal: can recoup their investment costs. In exchange, for example, $200 for each additional child who participating companies must guarantee to sup- takes a standardized test at the end of primary ply vaccines for the long term at a pre-agreed school. That is, the donors pay “cash” only upon sustainably low price that developing countries “delivery” of the agreed outcome. There are five can afford (GAVI Alliance Secretariat, 2010). key features of this proposal: (1) the donor pays only for outcomes, not for inputs; (2) the recipient Carbon finance (CF): Resources provided to has full responsibility for and discretion in using projects generating (or expected to generate) funds; (3) the outcome measure is verified by an reductions in greenhouse gas (or carbon) emis- independent agent; (4) the contract, outcomes, sion in the form of the purchase of such emission and other information must be disseminated reductions (World Bank Carbon Finance Unit). publicly to assure transparency; and (5) this approach is complementary to other aid pro- Greenhouse gases (GHGs): Gases released by grams. (Birdsall, Savedoff, & Mahgoub, 2010). human activity that are responsible for climate change and global warming. The six gases listed in Conditional cash transfers (CCTs): Programs Annex A of the Kyoto Protocol are carbon dioxide that transfer cash, generally to poor households, (CO2), methane (CH4), and nitrous oxide (N20), as on the condition that those households make well as hydrofluorocarbons (HFCs), perfluorocar- pre-specified investments in the human capital bons (PFCs), and sulfur hexafluoride (SF6). (health, education, and welfare) of their children (Fiszbein, et al., 2009). Emission reductions (ERs): The measurable reduction of release of greenhouse gases into Feed-in tariff (FIT): An energy supply policy the atmosphere from a specified activity or over focused on supporting the development of new Chapter 4 3 2A 1 a specified area, and a specified period of time. renewable energy (RE) projects by offering Appendix 60 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS long-term purchase agreements for the sale of OBA draws on the experience and tools RE electricity. These purchase agreements are of public sector performance contracting and typically offered within contracts ranging from 10 private infrastructure schemes. Service delivery to 25 years and are extended for every kilowatt- is delegated to third-party providers under con- hour of electricity produced. To better reflect tracts designed to provide incentives for efficient, actual project costs, the payment levels offered well-targeted service delivery, in part by tying a for each kilowatt-hour can be differentiated by significant part of the compensation to delivery technology type, project size, resource quality, of specified outputs or results. Public funds from and project location. Policy designers can also external donors or domestic tax revenues may adjust the payment levels to decline for installa- complement user fees. (Brook & Petry, 2001). tions in subsequent years, which will both track and encourage technological change. In an alter- Output-based disbursement (OBD): A mecha- native approach, FIT payments can be offered as nism for disbursements between federal gov- a premium, or bonus, above the prevailing market ernments and their regional/provincial govern- price. Successful feed-in tariff policies typically ments that involve loans to federal governments, include three key provisions: (1) guaranteed which in turn make disbursements to regional/ access to the grid; (2) stable, long-term purchase provincial governments for the delivery of clearly agreements (typically, 15–20 years); and (3) pay- specified outputs (Sustainable Development ment levels based on the costs of RE generation Network, 2006). (Couture, Cory, Kreycik, & Williams, 2010). Output-based disbursement (OBD) mecha- nisms utilize a similar but distinct approach Output-based aid (OBA): A mechanism to (to output-based aid (OBA). OBD specifically support the delivery of basic infrastructure and applies to government or public entities that do social services where policy concerns justify the not operate on a commercial basis: to be precise, use of explicit, performance-based subsidies. they do not meet the definition in Paragraph 1.8 These policy concerns could include; positive (c) of the World Bank Procurement Guidelines. In externalities (a merit good such as health, this case, World Bank loans to the government sanitation, or education); or the inability of are disbursed upon the achievement of clearly certain segments of society to pay for a service specified outputs (Global Partnership on Output essential to maintaining basic human dignity Based Aid (GPOBA) and Procurement Policy and (such as consumption of a minimum level of safe Services Department (OPCPR), 2008). and clean water or energy) and achieving the Millennium Development Goals. At the core of Payment for Environmental Services (PES). the OBA approach is the contracting out of ser- A voluntary transaction where a well-defined vice provision to a third party—usually a private environmental service (ES) (or a land use likely to operator, but also possibly a publicly owned one secure that service) is being “bought” by at least or a nongovernment organization (Sustainable one ES buyer from at least one ES provider—if Development Network, 2006). and only if the ES provider secures provision of OBA ties the disbursement of public fund- the ES (conditionality). The five most common ing in the form of subsidies to the achievement types of ES are listed below, along with examples: of clearly specified results that directly support improved access to basic services (Mumssen, 1. Carbon sequestration and storage (an elec- Chapter 4 3 2A 1 Johannes, & Kumar, 2010). tricity company from a developed country Appendix Glossary of RBF-Related Concepts and Instruments   61 pays farmers in the tropics to plant and The following definition adds another dimen- maintain additional trees) sion: the impact on the market. Payment for Eco- 2. Biodiversity protection (conservation donors system Services (PES) is a market-conforming, pay local people to set aside or naturally innovative mechanism for allocating funds from restore areas to create a biological corridor) the beneficiaries of ecosystem services to the 3. Watershed protection (downstream water providers of these services. PES mechanisms users pay upstream farmers to adopt land may be considered as a pragmatic response to a uses that limit deforestation, soil erosion, and certain number of problems faced by traditional flooding risks) environmental policies, as discussed in the 4. Landscape beauty (a tourism operator pays a introduction: inadequate action with regard to local community not to hunt in a forest where land occupancy, low government budgets, com- tourists come to view wildlife) (Wunder, 2005). plex instruments that are not in proximity with 5. Forest conservation (where, as in Costa Rica, actors and territories, and the multiplication of new tree plantations, the development of regulatory and normative instruments (Laurans, related activities, and sustainable felling and Leménager, & Aoubid, 2012). the like are remunerated). PES schemes require the valuation of selected ecosystem services, the identification PES has been developed as a response of beneficiaries and providers of the services, to the failure of previous responses to envi- and the set-up of a payment scheme that regu- ronmental degradation as remediation or lates the transfer of payments from beneficiaries regulation. PES also be defined as a system (in to providers in return for maintaining the supply which land users are paid for the environmental of the ecosystem service (Wageningen, 2006). services they generate by those who receive the services. Results-based financing (RBF): Any program Ecosystems can provide a wide variety of that rewards the delivery of one or more out- services. The environmental services derived puts or outcomes by one or more incentives, from forest ecosystems, for example, typically financial or otherwise, upon verification that the include (but are not limited to): agreed-upon result has actually been delivered. Incentives may be directed to service providers ●● Hydrological benefits: Controlling the (supply side), program beneficiaries (demand timing and volume of water flows and side), or both. Payments or other rewards are not protecting water quality made unless and until results or performance ●● Reduced sedimentation: Avoiding dam- are satisfactory; and they are not used simply age to downstream reservoirs and water- to buy recurrent inputs—although the service ways and so safeguarding uses such as providers who receive the payments may use hydroelectric power generation, irriga- the funds to purchase inputs. In many cases, tion, recreation, fisheries, and domestic RBF payments are additional to the traditional or water supplies current sources of financing for inputs, as when ●● Disaster prevention: Preventing floods providers continue to receive salaries and are and landslides also eligible for results-based bonuses. To fur- ●● Biodiversity conservation ther enhance capacity or quality, supplemental ●● Carbon sequestration (Pagiola & Platais, investment financing may be made available for Chapter 4 3 2A 1 2002). some inputs, such as training and equipment. Appendix 62 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS Verification that results were actually obtained provider, payer, or consumer of health services is an essential feature. The ideal is perhaps for after predefined results have been attained and verification to be undertaken by a neutral third verified. Payment is conditional on the undertak- party, even if the principal pays the correspond- ing of measurable actions (Musgrove, 2011). ing costs, but many arrangements are possible. Ex ante verification (before payment) can be Take-or-pay: Under a take-or-pay provision, complemented by ex post assessment. The a buyer is obliged to either take delivery of definitions of results or objectives and rewards (and pay for) a specified minimum quantity of are embodied in contracts between one or more goods over a specified period of time (such as X principals who provide the incentives and one or amount per year), or pay for the contract value more agents who contract to deliver the speci- of that minimum amount. The phrase “take-or- fied results, outputs, or outcomes. The contract pay” is therefore slightly misleading, as the core may also specify varying degrees of collabora- concept is that the buyer “pays regardless of tion between principal and agent, supervision of whether it takes.” Such clauses are often used the agency by the principal, or other aspects of in circumstances where the supplier of goods how the results are produced, such as protocols or services requires certainty on the minimum to be followed or targets to be met. income stream it will receive. RBF is an umbrella term because the Take-or-pay clauses have been widely used definition is general and characterizes various in the energy industry, particularly in long-term programs in many countries. Different labels gas or liquefied natural gas (LNG) supply or exist for essentially the same concept or are throughput agreements and gas transportation associated with different incentives and pay- agreements, as well as in some power purchase ment arrangements (Musgrove, 2011). agreements. They are often required by lenders to project-financed projects to ensure that the Results-based financing for health (PBFH): A project company has confidence that it can ser- cash payment or nonmonetary transfer made to vice its debt obligations from project revenues a national or subnational government, manager, (Ashurst LLP, 2012). Chapter 4 Appendix3 2A 1 Appendix B Objective–Result–Indicator Chains Table B.1:  Water Supply Demand Creation RBF tool that is Objective Indicator(s) triggering payment Provider potentially suitable People Households adopting the use of clean Nongovernmental OBD understand the water. organizations benefits of using (NGOs) CCT clean water Households connecting to the water network. Community- based 0rganizations (CBOs) Government agencies (GAs) Have effective WUA established. NGOs OBD Water Users Associations WUA participates in decision making CBOs (WUA) (determination of water charges, periodic discussions on subjects like GAs operation and maintenance activities, service standards, etc.). Abstraction Build and operate Infrastructure built according to Users OBD abstraction standards (individual pumps, intakes, infrastructure deep wells, etc.). Utilities Tariff structure/tariff regime Infrastructure properly operated and maintained according to standards. Reduce volume Volume abstracted reaches an Users OBD abstracted agreed figure. Utilities Tariff structure/tariff Volume abstracted is maintained at regime the agreed level. Performance-based incentives/payments (continued on next page) 64 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS Table B.1:  Water Supply (continued) Transport and Distribution RBF tool that is Objective Indicator(s) triggering payment Provider potentially suitable Build and operate Conveyance system built according Utilities OBD transport and to standards. distribution Performance-based systems Conveyance system properly incentives/payments operated and maintained according to standards. Reduce Losses in the conveyance system Utilities Performance-based conveyance reach a certain agreed level. incentives/payments losses Losses in the conveyance system are kept at or below the agreed level. Reliability of Percentage compliance with the Utilities Performance-based the conveyance agreed service standards (service incentives/penalties system interruptions, quality standards). Service Connection Facilitating access Number of water service connections Utilities OBA to piped water to eligible households. service OBD Facilitating access Number of standpipes, water points, Utilities OBA to communal etc. water service NGOs OBD Other Improving Percentage collected out of total Utilities OBD collection of water billing. supply fees Performance-based incentives Table B.2:  Sanitation Demand Creation RBF tool that is Objective Indicator(s) triggering payment Provider potentially suitable Increase the number Number of households with adequate NGOs OBD of households seeking latrines being used by its members to improve sanitation CBOs CCT conditions in their homes GAs Increase the number of Village or community is ODF. GAs CODA villages or/communities achieving Open Village or community remains ODF. NGOs OBD Defecation Free (ODF) status and maintaining it Improve hygienic Number of people adopting hygienic GAs CODA behavior of households practices (washing their hands with soap after using latrines) (continued on next page) B A Chapter 4 Appendix 3 2 1 Objective–Result–Indicator Chains   65 Table B.2:  Sanitation (continued) Collection/access RBF tool that is Objective Indicator(s) triggering payment Provider potentially suitable Facilitate access to Number of households with new Users OBD on-site sanitation adequate latrines (and septic tanks) NGOs OBA CBOs GAs Vendors Adequate servicing Number of latrines/septic tanks Users OBD of on-site sanitation emptied for eligible households. facilities NGOs OBA Volume of waste removed. CBOs GAs Vendors Facilitate access to Number of new sewer connections to Utilities OBA sewerage services eligible households providing adequate service OBD Facilitate access Number of community toilets built. NGOs OBA of communities to adequate sanitation Number of community toilets properly CBOs OBD services operated and maintained. Utilities Number of eligible users. Vendors Transport Ensure that waste is Number of latrines emptied for eligible Utilities OBD transported to adequate households. treatment facilities or Vendors OBA discharge point Volume of waste transported to approved location. Number of transfer stations built and in adequate operation after a given period. Volume of septage collected at transfer stations. Length of new or rehabilitated sewerage systems. Treatment Build, maintain, and Volume of waste collected at plant and Utilities OBD operate decentralized treated to required standard wastewater treatment Performance-based facilities incentives/penalties Build, maintain, and Volume of waste collected at the plant Utilities OBD operate principal and treated to required standard wastewater treatment Performance-based plants incentives/penalties (continued on next page) B A Chapter 4 Appendix 3 2 1 66 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS Table B.2:  Sanitation (continued) Safe Disposal/Reuse RBF tool that is Objective Indicator(s) triggering payment Provider potentially suitable Build and maintain Number of ecological/biogas toilets NGOs OBA ecological toilets or installed/used. biogas facilities CBOs OBD Volume of productive agricultural inputs generated. Vendors Energy generated. Treat waste to standards Volume (or percent) of waste reused Utilities OBD required for reuse and deliver it to locations as Performance-based required incentives Other Objective Indicator(s) triggering payment Provider RBF tool potentially suitable Region obtaining ODF Number of communities/villages GAs CODA status and maintaining it obtaining ODF status. Number of communities/villages retaining ODF status. Improve financial Increased collection of sanitation fees Utilities OBD viability of service measured in percentage points of the providers total billing Source: Tables adapted from Tremolet (2011). Irrigation This reasoning is linked to the idea that, whenever possible, the beneficiaries should decide Following the value chain and the associated which way to achieve the ultimate objective—pro- services, the potential objectives and associate vided that an adequate decision making framework indicators listed below can be identified, before is in place. In this case, if the ultimate objective moving on to selecting one or more as the one(s) is the extension of the irrigated area, a certain that will trigger payments. amount could be paid for each hectare added to Many of these objectives could be an end the irrigated system, provided that the aquifer objective or become an intermediate objective is protected (either by keeping the abstraction to achieving another one further down or up volume fixed or setting the adequate abstraction the chain. For instance, getting the farmers to rate if currently underexploited, and verifying the adopt a new technology could be an objective situation from time to time); then farmers, Water that could lead to different higher objectives, Users Associations (WUAs), government agencies, such as reducing abstraction from certain and other stakeholders will decide how to achieve aquifers or freeing water to extend the irrigated the objective. In so doing, they may set a specific area (or both). way to assign resources and make disbursements. B A Chapter 4 Appendix 3 2 1 Objective–Result–Indicator Chains   67 They may adopt, for instance, a results-based The stakeholders could decide to set approach within the framework of the initial, higher objectives and indicators for the way selected level agreement described above. Potential ways to and set a payment system based on them. achieve the higher level objective could be: However, stakeholders might lack the capacity to select the preferred option and would prefer ●● Increasing abstraction of an underex- the full system be designed and embedded ploited aquifer; in the financing agreement with the lending ●● Lining canals, thus reducing conveyance institution. In such case, the design of the losses and rising domain; lending project could follow the same outline ●● Adopting less water-intensive crops; indicated above, only disbursements from the adopting more efficient irrigation tech- financing institution (the World Bank or others), nologies; or would take place when each of the objectives is ●● A combination of the above. fulfilled. Table B.3: Irrigation Demand Creation Indicator(s) triggering RBF tool potentially Objective payment Provider suitable Farmers understand Farmers adopt crops irrigation NGOs OBD the benefits of irrigation (and other associated and drainage (other elements). CBOs CCT topics could be added like selection of most Farmers maintain adequate Gas valuable crops, use of irrigation and farming adequate fertilizers in practices. the right quantities, etc.) Have effective Water WUA established. NGOs OBD Users Associations (WUA) WUA participates in decision CBOs making (determination of irrigation charges, supervision Gas of operation and maintenance activities, priorities for training of farmers, etc.). Farmers adopt new New technology or irrigation NGOs OBD technologies or practice is in place. irrigation practices CBOs CCT (new, more efficient Equipment is properly used (solar) pumps, drip and maintained and/or new Gas irrigation, etc.) practices are continued (continued on next page) B A Chapter 4 Appendix 3 2 1 68 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS Table B.3: Irrigation (continued) Abstraction/storage Indicator(s) triggering RBF tool potentially Objective payment Provider suitable Build and operate Dam built according to Irrigation OBD irrigation dams standards. companies/ authorities Tariff structure/tariff Dam properly operated and regime maintained according to standards. Build and operate System built (pump installed, Users OBA individual irrigation internal piping or canals built) systems Vendors Reduce volume Volume abstracted reaches an Users OBD abstracted agreed figure. Irrigation Tariff structure/tariff Volume abstracted is companies / regime maintained at the agreed level. authorities Performance-based incentives/payments Maintaining the storage Dam capacity measured Irrigation OBD capacity of irrigation periodically remains at the companies/ dams agreed level. authorities Performance-based incentives/payments Dam capacity remains above certain minimum level and below a maximum level. Amounts paid depend on the actual capacity between those two levels. Reliability of abstraction Daily volume of water available Irrigation OBD system at the intake of the conveyance companies/ system meets the agreed figure authorities Performance- based incentives / payments Transport and Distribution Build and operate Conveyance system built Irrigation OBD transport and according to standards. companies/ distribution systems authorities Performance-based Conveyance system properly incentives/payments operated and maintained according to standards. Reduce conveyance Losses in the conveyance Irrigation OBD losses system reach certain agreed companies/ level. authorities Performance-based incentives/payments Losses in the conveyance system are kept at or below the agreed level. Reliability of the Number of farmers receiving Irrigation OBD conveyance system irrigation water as agreed companies/ authorities Performance-based incentives/payments B A Chapter 4 3 2 1 (continued on next page) Appendix Objective–Result–Indicator Chains   69 Table B.3: Irrigation (continued) Farm Intake/internal Irrigation System Indicator(s) triggering RBF tool potentially Objective payment Provider suitable Connecting farmers to Number of farmers connected Irrigation OBA the irrigation system to the irrigation system companies/ authorities Farmers adopt new New technology or irrigation WUAs OBD technologies or practice is in place. irrigation practices NGOs CCT (new, more efficient Equipment is properly used (solar) pumps, drip and maintained and/or new CBOs irrigation, etc.) practices are continued. Gas Irrigation companies/ authorities Reduce water Volume of irrigation water used Users OBD consumption reaches a certain agreed level. Irrigation Tariff structure/tariff Volume of irrigation water used companies/ regime remains at a certain agreed authorities level. Performance-based incentives/payments Water reuse Volume of water reused Users OBD Irrigation CCT companies/ Authorities Avoid salinization of the Level of salts in soil is kept at a Users OBD soil certain level Have a proper drainage Drainage system built Users OBD system Drainage system maintained Irrigation OBA companies/ authorities Other Objective Indicator(s) triggering payment Provider RBF tool potentially suitable Improving collection of Percentage collected out of Irrigation OBD irrigation fees total billing companies/ authorities Provision of extension OBD services B A Chapter 4 Appendix 3 2 1 70 APPLYING RESULTS-BASED FINANCING IN WATER INVESTMENTS Table B.4:  Hydropower RBF tool Objective Indicator(s) triggering payment Provider potentially suitable Minimize negative Environmental protection plan in place. Authorities OBA environmental impact Completion of environmental compensation Developers PES measures. Utilities Completion of development activities according to environmental protection plan. Smooth Number of inhabitants having signed up for Developer OBD resettlement the compensation program during the period considered. agency / utility Number of inhabitants having effectively moved out during the period considered. Completion Number of completed new accommodations. Developer OBD resettlement Satisfactory inspection of the new Agency/ accommodations two years after delivery. utility Table B.5:  Flood Protection/Prevention RBF tool Objective Indicator(s) triggering payment Provider potentially suitable Reduce chances Policy/permits stimulating building Authorities OBA of occurrence of a according to flood resilient standards in flooding event place and enforced. Developers PES Policy/permits stimulating building that Utilities include some flood prevention facilities in place and enforced. Percentage of kilometers drainage canals open up to certain standard during certain time. Reduce the impact Measures to flood-proof key/vital Authorities OBA of a flooding event infrastructure (hospitals, etc.) in place. Set-up and tested early warning systems. Percentage of people reached out of total during testing. Emergency preparedness plans in place. Percentage of available capacity exit roads in place out of capacity exit roads required. B A Chapter 4 Appendix 3 2 1 References Advance Market Commitment Working Group. ESMAP (Energy Sector Management Assistance 2005. Making Markets for Vaccines – Ideas Program). 2013. Results-Based Financing in to Action. Center for Global Development. the Energy Sector–An Analytical Guide. E. Akter, S. 2012. 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