Municipal Financing series by Mr. Aldo Baietti – Part 2 of 2: Challenges of Municipal Finance

Challenges of Municipal Finance

Can you list from your perspective, the most common challenges a water utility or municipality will face when it comes to financing?

First, many don’t have the capacity to go out to access market finance. So, they are reliant on budgets that their ministries give them. And, often those funds are not only limited but also not reliable. That’s the crux of the problem. As the process goes on, service levels and the utility’s performance deteriorate. It’s a vicious cycle (see graphic below) that continues to worsen to the point where the utility is no longer performing. And any funds that it may receive are mostly going to pay for performance problems rather than providing good service to customers. And when customers don’t feel that they’re getting good value for their money, they stop paying their bills. Or, they exit the system if they can develop their own water substitutes.

This vicious cycle often starts with a governance problem. In this case, utilities can’t convince their oversight agencies of their competency to function on their own. And, as a result, these agencies do not trust the utilities to handle funds.  This initial governance problem is what creates the problem of funding. And this ultimately leads to poor performance of the utility.

When you said lack of capacity, are you referring to human capacity or the creditworthiness capacity of the service providers?

The problem is that credit capacity requires a utility to be striking on all cylinders. A commercial entity is not going to lend money without assurances that they’re going to get paid back. And, when you go to a utility in most developing countries, they are limited in their skillset. They’re more technically oriented in running that part of the utility’s operations. They have limited capacity in the accounting or finance functions. A utility’s accounting function is often more designed to meet the needs of the oversight agencies (e.g. protection against fraud).  This results in problems. For example, a lack of management reports and capacity in organizational planning.  The better alternative for a utility is capacity to provide the data managers need to run a business.

The focus on those softer skills is not there. For example, in many countries there’s no organizational sense. Everyone does their own task, without consideration for what others are doing, and the big picture. The top manager(s) and maybe some close to the manager make most of the decisions. Very little delegation is provided. And, they blame the lower rungs of the ladder when things go wrong.  Hence, there is a real need to upgrade the skillsets of these utilities. This includes improving management capacity, delegation and accountability.

From the technical point of view, parts of Africa have some of the most difficult situations. But, even in Southeast Asia with larger utilities, management could be much better than it is.  Although some of their systems are probably managed a little bit better than what you see in Africa, there are still significant gaps with those soft skill areas. I find that utilities, even the large ones in South Asia, don’t often know where their management data is.  Different staff seem to have their own secured pieces of data. If you’re looking for an investment plan for the utility for example, it does not exist in one place.  So, you have to ask each project manager individually to provide the information they have and to assemble all this information to come up with one plan for the utility. And of course, if this information is derived from the bottom up, it will surely will not result in a cohesive plan.  Then, you look at key information (e.g., information on production, operations, commercial activity) to effectively manage operations, and it’s often not correct, not properly used and not effectively reported to different levels of management.  Nor does it tie into the audited financial statements. With these kinds of problems, it’s very difficult to run a business enterprise effectively.

As a last point but certainly not the least important is that most utilities don’t have an effective corporate planning process that utilizes a dynamic projection model.  Most corporate plans are simply budget allocations. So, there is a lack of these skills in most organizations but more critically in smaller ones.

What are the most common mistakes that water utilities and municipalities make with regards to trying to access finance?

The most common mistake is that they don’t understand the requirements of commercial lenders. It’s thus up to partner organizations to illustrate what they realistically need. Second, is that they lack robust financial/business plans.

The third major mistake is a lack of prioritization for their investment requirements. Most utilities are totally focused on infrastructure expansion. Maybe this is in part due to this drive for meeting the SDG targets by providing more access or maybe it has to do with more nefarious reasons of profiting from large contracts.

Quite often the utilities focus more on expansion than on performance improvement. I have seen this in so many countries and I still cannot understand why.  In some countries I have seen this focus on expansion with upwards of 98 percent non-revenue water.  How can one advocate for new water capacity when they can’t account for where their existing water goes? It is ironic, but many utilities don’t realize that expansion of service only deteriorates your financial situation if you are not recovering at least your O&M costs.  And unfortunately, there are too many utilities that require operational subsidies to stay afloat.  What’s important is to first improve operations and start functioning well before undertaking expansion strategies.

In one of my training programs I discuss the difference between a traditional utility and a modern utility concerning values such as trust, competence, and fairness. There are several values that need to be brought out to show a level of competence to gain trust. Then, it’s also important for the governing agency to be fair to their utility when they make mistakes.

For traditional utilities, management would be punished severely for making mistakes. These values must allow for the relationship between the oversight agency and the utility to improve. But, in most cases, trust is extremely limited. And as such, the authority provided to the utilities is also limited. Hence, oversight agencies tend to do a lot of the work, because they don’t trust their utilities.

The idea that corporatization would improve things is not always the correct because the oversight agency can put its own people on the Board and change nothing. So, a mindset change is what really needs to happen.  And that mindset requires work on both sides. The utilities must become more competent in what they’re doing. They must provide reliable reports to the oversight agency so that the agency is comfortable with the operations of utilities. On the other hand, the oversight agency must respect the utility management and give it more leeway in decision making and must reward staff appropriately.

In Cambodia they implemented a personnel incentive system tied to performance improvement. The system trickled down to all staff, not just at the top. The system was instrumental in weeding out corruption in the organization because, all of a sudden, that type of activity went against the staff’s own financial interests.  As the utility staff was rewarded on profit performance, they would call out corruptive practices if they saw somebody scamming the system. Incentive based systems are approaches that are often neglected during the reform process, but I have found that they are extremely important for its success.