Financing Water Supply, Sanitation and Flood Protection

4. The capacity to finance projected investment needs across member states

Abstract

This chapter discusses the capacities of EU member states to cover the financing needs presented in the previous chapter. The focus is on revenues from tariffs for water supply and sanitation services, public expenditure and commercial debt. The chapter concludes by ranking EU member states based on the severity of the financing challenge they face, as regards water supply, sanitation and, in different ways, flood protection.

The subsequent chapter discusses a range of options to address the financing challenge.

This part of the report discusses the capacities of 28 member states to finance projected expenditure needs to comply with the revised Drinking Water, Urban Waste Water and Flood Directives. It discusses in succession affordability constraints that affect the capacity to raise additional through tariffs for water supply and sanitations services; capacities to raise additional public finance to cover water-related expenditure needs; and experience with - and opportunities for - mobilising commercial debt. The situation in each country is characterised and used to benchmark EU member states’ relative capacity to finance projected expenditure needs to comply with the three Directives mentioned above.

The next part of the report explores options to minimise financing needs, make the best use of existing assets and financial resources, and harness additional sources of finance, as required.

4.1. Financing capacity

Projecting future volumes of available financing would be both a highly challenging and uncertain exercise. The approach taken to assess countries’ financing capacities in this study was to consider three sets of complementary indicators – on the share of water bills in households’ disposable income, public debt as a share of GDP, and domestic credit to the private sector as a share of GDP - thereby highlighting possible or likely latitude and constraints. Annex A provides further information about the data sources used for each indicator.

4.1.1. Raising tariffs for WSS services

With one exception in Europe, revenues from tariffs are considered a reliable source of finance to cover at least some of the costs of water supply and sanitation services. As shown in Part 2 of the report, the level of recovery of costs through revenues from tariffs vary. Affordability concerns are claimed to constrain a progressive move towards higher (full) recovery of costs of service provision through revenues from tariffs.

Figure 4.1 simulates the impact of passing on the additional expenditures for WSS to households (in this case for the disposable household income of the top-end of the lowest decile). This is based on current levels of expenditure for water supply and sanitation, augmented by projected additional level of effort (as a share of current level of expenditure; see Figure 3.6 above) and compared with the current households’ disposable income. Obviously, this leads to an overestimation of affordability constraints, as households’ disposable income is set to increase, driven by economic growth. However, projections of increase in income are too hazardous to be reflected in this discussion. Environmental and resource costs of service provision are not factored in. As mentioned above, data is not available for Croatia and Sweden. Ireland is in its own league as a vast majority of the population does not pay a water bill.

The Figure suggests that the 10% poorest households in 5 or 6 countries face affordability issues. But half of EU member states would face affordability issues for at least 5% of the population. This shows different levels of vulnerability to tariff increases across countries, and affects the way accompanying measures should be designed to mitigate the social consequences of higher prices.

Figure 4.1. Projected affordability issues – constant households disposable income

Note: Lack of household expenditure data for Croatia and Sweden. Known underestimate of total expenditures for Finland and Sweden. Households’ disposable income is constant at 2011-15 level.

Source: EUROSTAT household expenditures and income data (2011-2015).

To complement a solely price-based analysis of affordability, Figure 4.2 adds a variable reflecting the percentage of the population at-risk of poverty. The top right corner of the scatter plot is obviously the least desirable position to be in as there is a higher risk in these countries that a significant share of the population becomes poor, thus raising more concerns about affordability.

Figure 4.2. Affordability of water supply and sanitation compounded by risk of poverty

Note: Known underestimate of total expenditures for Finland and Sweden.

Source: Joint Research Centre, European Commission for prices (based on latest available year), EUROSTAT for household expenditures (2011-2015).

4.1.2. Increasing public spending

It is assumed that public spending for WSS may be increased based on either taxes or borrowing. Figure 4.3, therefore, combines countries’ current level of taxation and indebtedness (both consolidated across various levels of public authorities and expressed as percentage of GDP).

A high percentage of taxes in GDP may both highlight a country’s demonstrated ability to use taxation as an instrument to finance public expenditures as well as indicate a constraint to further increase taxes moving forward (and conversely for countries with a currently low percentage). Depending on its level, a high percentage of public debt may indicate a possible or likely budgetary constraint, which could prevent the country from increasing public spending and from borrowing at a reasonable cost.

Figure 4.3. Ability to increase public spending based on raising taxes or borrowing

Source: EUROSTAT (2016).

Given the heavy reliance of most member states on borrowing to finance part of their overall expenditures, Table 4.1 puts in perspective the consolidated public debt indicator displayed in Figure 4.3 above, by listing member states’ current sovereign credit rating. In essence, the sovereign rating indicator illustrates whether a country is in a position to easily borrow and to do so at a reasonable cost. While the two indicators are coherent for quite many member states, it can be observed that some countries with relatively higher level of indebtedness are nevertheless assessed as slightly more risky (and vice versa).

Table 4.1. Sovereign credit rating

Rating	Description	Member States
AAA	Highest rating assigned by S&P. The obligor's capacity to meet its financial commitments on the obligation is extremely strong.	Denmark, Germany, Luxembourg, Netherlands, Sweden
AA	Only differs from the highest-rated obligations to a small degree. The obligor's capacity to meet its financial commitments on the obligation is very strong.	Austria, Belgium, Czech Republic, Estonia, Finland, France, Slovenia, United Kingdom
A	Somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligations in higher-rated categories. The obligor's capacity to meet its financial commitments on the obligation remains strong.	Ireland, Latvia, Lithuania, Malta, Poland, Slovakia, Spain
BBB	Adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to weaken the obligor's capacity to meet its financial commitments.	Bulgaria, Croatia, Cyprus, Hungary, Italy, Portugal, Romania
BB	Faces major ongoing uncertainties or exposure to adverse business, financial, or economic conditions that could lead to the obligor's inadequate capacity to meet its financial commitments.
B	More vulnerable to non-payment than 'BB', but the obligor currently has the capacity to meet its financial commitments. Adverse business, financial, or economic conditions will likely impair the obligor's capacity or willingness to meet its financial commitments.	Greece

Source: Standards and Poors (2019).

In most EU member states, sub-sovereign entities and local authorities play an important role in covering financing needs in water supply, sanitation and flood protection. Available data sources do not allow monitoring their level of spending for flood protection. And they do not allow a robust assessment of room for manoeuvre to mobilise additional finance from these public authorities.

4.1.3. Tapping into private finance

As already illustrated in Part II some member states have been partly relying on debt financing to finance (mainly) upfront capital investments. In order to provide a more general indication of each country’s ability to tap into domestic commercial debt financing, Figure 4.4 presents domestic credit to private sector as a percentage of GDP, compiled by the World Bank. This refers to financial resources provided to the private sector by financial corporations, such as through loans, purchases of non-equity securities, and trade credits and other accounts receivable, that establish a claim for repayment. A relatively high percentage may indicate that commercial debt is readily available in the country for financially sustainable WSS projects (and vice versa).

Figure 4.4. Domestic credit to private sector

(as % of GDP, 2015)

Source: World Bank’s Ease of Doing Business Index database (2017), World Bank’s Global Financial Development Database (2017).

The capacity to access commercial debt financing is unevenly spread among project owners within countries. For instance, while large utilities and operators typically have access to debt financing, a potential barrier relates to the fragmented nature of local authorities and the small size of projects. Further, the domestic credit to private sector as a percentage of GDP may not be an appropriate indicator e.g. for countries with disproportionate banking sectors compared to the size of the economy or with debt-financed real estate “bubbles” (e.g. Cyprus).

4.2. Preliminary conclusions

Table 4.2 below characterises the challenges member states face to finance projected investment needs for water supply and sanitation. Because expenditure needs to protect against flood risk could not be monetised, they are not considered in this Table.

Countries are ranked according to the additional level of effort required, compared to the baseline. The share of the baseline in GDP captures the current level of effort.

• Topping the list, Romania and Bulgaria face severe financing challenges as the projected additional level of effort is very high and rooms for manoeuvre for financing appear limited.

• Finland ranks high in terms of additional level of effort compared to current level of expenditures, but i) this reflects low level of effort in recent years and ii) Finland has room for manoeuvre to cover these additional expenditures.

• Slovakia and Estonia may face similar levels of effort in the future but Estonia is better placed to cover them, as public finance look less strained, should they need to be mobilised.

• Latvia, Poland and Portugal face similar levels of efforts in the future, but have distinct capacities to cover them. Affordability issues are relatively less severe in Portugal and access to private debt is easier.

• The ranking of Greece and Slovenia begs questions. The additional level of effort is probably underestimated, reflecting excessive reliance non IAS. A reassessment of additional financing needs would translate into severe challenges, as financing capacities are limited for both countries.

• The Netherlands and Germany are in privileged situations, as the additional level of efforts is comparatively limited and financing capacities are strong.

Previous parts of the report have signalled caveats and data limitations. While more detailed and accurate data may be available for any given country, the indicators and proxies used in the report are the best available to compare robust data across 28 EU member states, which is the level of ambition of the Table below. The Table has been used to identify countries which face the most severe challenges to finance projected expenditure needs to comply with the DWD, UWWTD and Floods Directive. Bulgaria, Croatia, Cyprus, Lithuania, Poland, Romania, Slovakia, Slovenia, and Spain were selected on that basis. The OECD and the European Commission then convened dedicated workshops in each of the selected countries, to fine-tune the understanding of the challenge and explore policy options to address it. Part V below captures the main outcomes of that stage of the project.

Table 4.2. Member states’ capacity to finance projected investment needs for WSS

Country	% increased investment needs	% current expeditures in GDP	Raising tariffs	Raising public spending	Accessing domestic debt
Romania	178%	0.80%
Bulgaria	97%	1.10%
Finland	86%	0.20%
Slovakia	63%	0.70%
Estonia	60%	0.50%
Malta	55%	1.00%
Sweden	54%	0.30%
Croatia	51%	0.90%
Spain	49%	0.50%
Luxembourg	47%	0.80%
Latvia	47%	0.70%
Poland	46%	1.10%
Portugal	45%	0.70%
Austria	44%	0.50%
Hungary	42%	1.10%
Ireland	40%	0.70%
Lithuania	40%	0.60%
Belgium	36%	0.60%
Italy	34%	0.70%
United Kingdom	34%	0.70%
Denmark	34%	0.50%
France	30%	0.80%
Czech Republic	29%	1.30%
Cyprus	28%	1.20%
Netherlands	28%	0.90%
Greece	28%	0.80%
Slovenia	26%	1.40%
Germany	24%	0.80%

Source: Authors’ calculation and interpretation.

The situation is more complex when financial needs to protect against flood risks are considered. The following clusters derive from the analyses of projected flood-related risks above:

• Member states listed in Category 4: France, the Netherland, the UK.

• Member states listed in Category 3: Belgium, Germany, Italy, Poland.

None of the countries listed in Category 4 stand out as facing particularly dire challenges related to financing future investment needs for water supply and sanitation. Poland and, to a lesser extent, Italy feature in Category 3 and at the same time are projected to face difficulties meeting financing requirements for water supply and sanitation.

Such a crude assessment of countries’ capacities to cover financing needs for water supply, sanitation and flood protection is considered a basis for discussion only. More fine-grained analyses in selected countries can help to check whether projections reflect the actual situation. Preliminary discussions signal that the current level of effort does not reflect a potential backlog for investment. Assessment of distance to compliance or efficiency of water supply services only partially capture the performance of existing assets and the need to further invest. Anecdotal evidence suggests that in selected countries, ageing networks are likely to be the single biggest driver for investment in water supply and sanitation (see WAREG, 2017). The appropriate level of effort can only be known with accuracy when member states compile robust knowledge on the state of the assets.

More fine-grained analyses can also support exploration of options to minimise financing needs and harness additional sources of finance. The following part of the report discusses some of them.

Such options can reflect how much water contributes to - and benefits from - broader economic development. They can also reflect how investments in other sectors contribute to water; this is potentially the case for land use and urban development; energy supply and climate change mitigation; or adaptation to climate change.

On-going work under the umbrella of the Roundtable on Financing Water can support such analyses. In particular, the way water is valued in society and the economy can drive investment decisions and willingness-to-pay of stakeholders who benefit from improved access to water supply and sanitation, flood protection, and more generally good ecological status of water bodies.

References

WAREG (2017), An Analysis of Water Efficiency KPIs in WAREG Member Countries, WAREG