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Defining Investment, Funding, and Financing

The term “investment” is generally used to describe the economic value creation processes in which productive assets yield benefits over a future period. In the water context, investment therefore also includes the funding and financing perspectives (Fig. 1). Funding corresponds to income or cashflows that water projects generate which mainly comes from “3Ts”, which stands for tariffs, taxes, and transfers (Tool D2.03). Financing, in turn, refers to accessing resources for capital investments and covering operational and maintenance costs which are paid back with funding sources. The choice of funding and the flows of financing depend on political environment, regulation framework, institutional arrangements, as well as conditions of capital markets. Funding and financing are mutually dependent when efficient finance reduces the funding requirement for water-related projects, and credible funding streams help secure low-cost finance (WWC and GWP, 2018). 

Figure 1. Sources of funding and financing. Source: SWA (2020). 

The cost of this investment needs to be funded in various ways through private and public funds or a mixture of both – charging water users, investments from government budgets, and external aid. Most of the water infrastructure investment traditionally comes from the public domain. However, in recent times, there is a growing involvement of private commercial entities in sharing these costs (e.g., using water tariffs to protect watersheds through investment vehicles such as water funds). 

Full-Cost Recovery Principle

Stemming from one of the Dublin Principles that water is an economic good, the concept of full-cost recovery should be integrated into the decision-making of the water-related investment process. The full cost of providing water consists of the full economic cost and the environmental externalities, which are not easy to assign a monetary value for. Estimating the full economic cost may be the basis to start with, including full supply cost (operating and maintenance expenditures and capital charges), as well as the opportunity costs and the economic and environmental externalities (Fig. 2). 

Figure 2. General principles for costing water. Source: Agarwal et al. (2000). 

There is a need to ensure that water resources management agencies and water utilities have resources to be financially independent for them to reach the desired level of effectiveness. As a minimum, full supply costs should be recovered to secure sustainability of investment. 

Dublin Principles state that water should also be taken as a social good, which generates social concern due to high supply costs. Marginalised populations whose incomes cannot afford to pay for full-cost recovery tariffs are in need of direct subsidies based on distributional decisions. Targeted subsidies need to take into account adequate revenue collection systems, mechanisms to identify the vulnerable groups, as well as the capacity to monitor and evaluate (Agarwal et al., 2000) – all of which are characteristic of a strong governance system. 

 

Governance as a Prerequisite

Underinvestment in water is caused not only by a mismatch between finance and projects but also by the institutional instability, which hinders bringing about a favourable setting to obtain long-term returns for either public or private investors. Successful water projects with stable long-term flow of returns and high social outcomes depends on delicate institutional designs (Guerrero et al., 2016). Robust institutional arrangements and participation (Tools B) can protect consumers and investors, enhance efficiency, and help with risk sharing – all of which promotes the long-term financial sustainability in the water sector (Fig. 3).  

Figure 3. Model of financing water supply and sanitation services

New Opportunities for Water Sector Investments

The last decade has witnessed a growing interest in reforming the water sector to attract more capital investments from public and private sources to achieve better water service provision, balanced allocation for multiple economic uses, and conserve natural ecosystems, and fight climate change. Recommendations on how to enhance opportunities for water sector funding and financing include (WWC and OECD, 2015, WWC 2018a; Heather et al., 2020; GWP and WWC, 2018):  

  • Alignment of water sector’s goals with the national sustainable development strategy is a prerequisite to access international funds and private capital (Tool D2.02).  
  • Good governance, stable and modern regulation frameworks, and efficient and transparent management of water utilities are key aspects to achieve stable flows of financing resources.  
  • Adoption of risk management strategies and instruments paves the path for attracting potential investors (Tool D2.04).  
  • Multipurpose water infrastructure offers a new business plan and investment category for financiers.    
  • The use of competition, research, and development can lead to new ways of value recovery and disruptive technologies in terms of lowering costs and increasing benefits, paving the way for new investments.   
  • Public finance is and will continue to be the main source of funding for the water sector and should leverage private investments in the form of blended finance (Tool D2.05).  
  • Adaptation to climate change is the new frontier of water financing, a perfect opportunity to try new financial structures and instruments (Tool D2.06).  
  • Purpose financing offers new investment opportunities for the water sectors, including for instance, climate finance (e.g., green bonds); corporate investment (e.g. sustainability bonds); and regional initiatives (e.g. China’s One Belt, One Road).  
  • More funding can be unlocked by revisiting the composition and sharing arrangement between the tariff, tax, and subsidy structures (e.g., cross user subsidies used to pursue social or industrial development) (Tool D2.03).  
  • Repackaging and scaling up of microfinance and microinsurance can lead to increase financing especially in rural areas traditionally out of the sight of commercial financiers.     
Sub-section Overview

The Tools in this Sub-section aim to provide insights on how to enhance funding and financing for water, including through:  

  • Integrated National Financing Frameworks (Tool D2.01): discusses the opportunity of using the SDG framework as mechanism to attack more funds towards the water sector.  
  • Strategic Financial Planning (Tool D2.02): gives practical recommendations on how to develop a comprehensive framework for evaluating the investments needs of the entire water sector over a medium to long term basis.  
  • Generating Basic Revenues (Tool D2.03): introduces the “3Ts” model for generating steady revenues for water.  
  • Repayable Sources of Finance (Tool D2.04): highlights the different sources of repayable finance for water, including a detailed description of loans and bonds instruments.  
  • Blended Finance (Tool D2.05): highlights how public or philanthropic funds can be used as de-risking mechanism for crowding in commercial finance.  
  • Climate Finance (Tool D2.06): provides an overview of how water actors can tap into various climate funds.   
  • Transboundary Finance (Tool D2.07): looks at sources of investment, models, and best practices for financing transboundary water cooperation.   
D2 Financing Strategies and Principles
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