Innovative Water Finance in Africa: Economics and Principles of Financial Innovations for Water Managers 3031382331, 9783031382338

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Innovative Water Finance in Africa Economics and Principles of Financial Innovations for Water Managers Edited by Cush Ngonzo Luwesi Atakilte Beyene

Innovative Water Finance in Africa The first editions of this book aimed at informing about the context and mechanisms of the creation and application of innovative financial instruments in the water sector in Africa, one of the most water-challenged regions of the world. This piece of work focuses on conceptual approaches and case studies for funding water as a critical resource therein to ensure resilience. This new book invites investors, managers and policy-makers to expand their knowledge and apply novel financial instruments to support the development and management of their water businesses in Africa. Please, give it a try. —Prof. Nathanial Matthews, Program Director, the Global Resilience Partnership, Sweden This book addresses the issue of development of innovations in the finance sub-sector of water resources in Africa. The proposed topic is highly relevant and important for the future water developments through corporate investments by governments and public administrations (policy-makers) with the support of international organizations, who are responsible for the choice and implementation of suitable water finance instruments. Based on the current knowledge and practices on finance and markets of water investments, I highly recommend this timely and focused piece of work. —Dr. James Mrombedzi, Chief, African Climate Policy Center (ACPC)/ UNECA, Ethiopia Rather than just defining financial innovations and the theoretical economic principles of these innovations, the authors have laid to bare what one can expect in the current conversations surrounding the selected contexts and determinants of financing water projects in Africa. This innovative book unravels both the bottlenecks and market incentives for improving access to finance in the water sector and hasten potential avenues for financing water in Africa in the near future. Easy to read and delivered by expert voices from the African continent, this book is a significant reference document for African and global water managers and policy-makers. Therefore, I recommend the donor community and banking system, policy-makers, managers, and practitioners of water management as well as the academia to source for these innovations here and now. —Dr. James Kinyangi, African Development Bank (AfDB), Cote-d’Ivoire

Cush Ngonzo Luwesi · Atakilte Beyene Editors

Innovative Water Finance in Africa Economics and Principles of Financial Innovations for Water Managers

Editors Cush Ngonzo Luwesi University of Kinshasa Kinshasa, Democratic Republic of the Congo

Atakilte Beyene Nordic Africa Institute Uppsala, Sweden

ISBN 978-3-031-38233-8 ISBN 978-3-031-38234-5 (eBook) https://doi.org/10.1007/978-3-031-38234-5 © The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors, and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. Cover illustration: © Harvey Loake This Palgrave Macmillan imprint is published by the registered company Springer Nature Switzerland AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland Paper in this product is recyclable.

Preface

Water has become increasingly central to addressing multiple development and environmental objectives in the course of climate change. Exploring the multiple dimensions of water governance, policy and management in a holistic way is thus imperative for financial innovations to take place in the water sector. This book on “Innovative Water Financial in Africa” constitutes, first of all, a reference document allowing investors, managers and policy-makers in Africa to broaden their knowledge of financing strategies and tactics in order to raise fund for water services provision and water resources development. But we also hope that global managers and policy-makers will take advantage of this book to review their agenda on water and sanitation services in order to give water resources development a place in their funding structures. The book presents and discusses the context in which contemporary instruments of financing water services provision and water resources development are emerging in Africa. In this regard, it addresses at depth the three major thematic areas recognized as key: (i) a coverage of the basic economic principles and contexts subtending water financing innovations; (ii) an assessment of economic determinants and mechanisms pertaining to financial innovations in the water sector; and (iii) a sample of cases of applications of innovative water financing mechanisms based on scale formation and adoption practices. The principles of economic profitability and financial sustainability are highlighted throughout the book. v

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PREFACE

Chapter 1 portrays the basic economic principles subtending financial flows to create awareness on financial sustainability in the water sector. It underscores the need to recognize water as a good that can be “economized” for profitable and efficient water businesses as well as sustainable water provision and its equitable distribution for all competing uses. Chapter 2 introduces financial instruments and operations into water management and development. It surveys the major finance packages available to an organization or a business based on the length of time over which the finance is required (i.e., in relation to the short-, medium- and long-term). Chapter 3 focuses on a detailed novel apparel of the financial instruments and contractual arrangements for risks allocation, operations support and efficiency maintenance. It shows how these schemes are adapted to market operations to accelerate access to commercial credits and other climate funds from the international donor community. It unveils other mechanisms that complement commercial finance and maximize the benefits of efficient water finance management. These encompass building partnerships with the banking sector, microfinance, NGOs and private companies as well as governmental agencies, bilateral and multilateral development partners. Chapter 4 goes beyond economic and business theories to reveal “determinants of access to credit for irrigated agriculture credits” by “building models that work for the rural poor in Northern Ghana”. It comes out with an innovative model for “Community Empowerment, Savings and Credit Associations” (CESCAs). Chapter 5 presents an innovative application of conventional yet probabilistic benefit-cost valuation methods for the economic viability of agricultural water investments in the Arid and Semi-Arid Lands (ASALs) of Kenya. Chapter 6 brings another innovation in the economics literature by presenting and discussing contingent benefit-cost valuation of Payments for Watershed Services (PWS) in the ASALs of Kenya. The chapter focuses on nonmarket methods used for the valuation for the financial flows accrued from investments in PWS.

PREFACE

vii

Lastly, Chapter 7 presents a sample of cases of applications of innovative water financing mechanisms in Kenya based on scale formation and adoption practices as well as the ability of Water and Sanitation Companies (WASCO) for achieving enhanced creditworthiness and a snowball effect in borrowing. These cases include Murang’a, Nyeri and Embu WASCO, notably for their exemplary leadership and the use of technological innovations, as well as marketing and communication strategies to build Public-Private Partnerships (PPPs) and raise capital and debt. Of course, this is a book of essays drawn from scholarly works on water finance innovations and workshops that we facilitated in November 2011 in Mombasa (Kenya), October 2013 in Nairobi (Kenya), August 2015 in Tamale (Ghana), April 2018 in Johannesburg (South Africa), June 2018 in Antananarivo (Madagascar), July 2019 in Eswatini (Swaziland) and in October 2022 in Windhoek (Namibia), which were organized in partnership with the Bavarian School of Finance (BfZ), the International Water Management Institute (IWMI), the Network for Capacity Building in Integrated Water Resources Management in Southern Africa (WaterNet) and East Africa (WaterCap), the University for Development Studies (UDS), Strathmore University (SU), Kenyatta University (KU), the Kenya Water Institute (KEWI) and the Namibia University of Science and Technology (NUST). Hence, the book does not, by any means, pretend to replace practice based on country policies and local realities. As the reader goes through the book, he/she realizes that most of the contributions come from East and West Africa, basically from Kenya and Ghana, and to some extent, from Ethiopia, Mali, Namibia and Lesotho. As it stands, we hope the collections in the book make modest contribution to the current discussions on financial innovations in the water sector in Africa. At times, the reader will need to reflect on the “Lessons Learned”, at the beginning of each chapter, and customize them to the realities of his/her country. After receiving such feedback from the readers, we will be able to improve on the book every year, so that, at some time in the near future, “Innovative Water Finance in Africa” will truly become a trustworthy guide for all the managers and policy-makers working in the four corners of the African continent, as well as those who want either to service the water sector in Africa or to invest in the development of its water resources. Therefore, in perfecting this book, we welcome the

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PREFACE

comments and criticisms of our readers. Their suggestions will allow us to keep at the disposal of African managers and policy-makers a full guide, as accurate as possible, and as a faithful reflection as possible of financial innovations being experienced in the African continent, as of late, little known or not fully understood. Kinshasa, Democratic Republic of the Congo Uppsala, Sweden June 2023

Cush Ngonzo Luwesi Atakilte Beyene

Economics Principles of Financial Innovations for Water Managers

Water has become increasingly central to addressing multiple development and environmental objectives in the course of climate change. This book explores the economic dimension of innovations in finance, which is imperative for efficient investments and effective management to take place in the water sector. It addresses at depth the principles of economic profitability and financial sustainability to provide a trustworthy guide for all the investors, managers and policy-makers working in the four corners of Africa. It does also examine both market and non-market methods of economic valuation for accrued financial flows and investments, either to service the water sector or develop its water resources in Africa.

ix

Contents

1

2

Basic Economics Behind Sustainable Financial Flows in the Water Sector Mamudu Abunga Akudugu, Cush Ngonzo Luwesi, Beaujolais Bofoya Komba, Atakilte Beyene, and Samia Satti Nour 1.1 Introduction 1.2 The Paradox of Water and Diamond Values 1.3 The Producer Behaviour 1.4 Water Market Negotiations and Equilibrium 1.5 Full Cost Recovery in Water Services Management 1.6 Water Valuation Methods 1.6.1 Economic Water Valuation 1.6.2 Financial Valuation Methods for Water Services 1.6.3 Environmental Economic Valuation for Water Projects References Introduction to Financial Instruments and Operations for Water Management and Development Philip Wambua Peter, Cush Ngonzo Luwesi, Jane Wanjira Njuguna, Floribert Ntungila Nkama, Atakilte Beyene, and Honoré Mbantshi Mingashanga 2.1 Introduction 2.2 Financial Goals, Organization and Management

1

3 7 8 9 12 14 14 16 18 20 25

27 31 xi

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CONTENTS

2.2.1

Corporate Versus Infrastructure Project Finance Management 2.2.2 Organizational Goals for Achieving Financial Performance 2.3 Business Operations and Instruments Used in the Financial System 2.4 Securing Finance Through Borrowing and Grants 2.4.1 Business Loans 2.4.2 Grants for Capital Development 2.5 Concluding Remarks References 3

Innovative Instruments and Contractual Arrangements to Offset Bottlenecks for Financial Flows in the Water Sector Cush Ngonzo Luwesi, Mamudu Abunga Akudugu, Philip Wambua Peter, Floribert Ntungila Nkama, Atakilte Beyene, and Honoré Mbantshi Mingashanga 3.1 Introduction 3.2 Evolving Financial Sources in the Water and Sanitation Sector 3.3 Privatization and Concessions for Financing Water and Sanitation 3.3.1 Private Financing Sources 3.3.2 Public–Private Partnerships (PPPs) for Water and Sanitation Finance 3.4 Emerging Mix Financial Products for Financing Operations 3.4.1 Project Facilities 3.4.2 Guarantees and Insurance Products 3.4.3 Pooled Financing and Transfers of Repayment Capacity 3.4.4 Commercial Financing 3.5 Capital and Debt Raising from the Stock Exchange Market 3.6 Green Bonds Issuance Versus Green Funds Grant in Africa: The Bottlenecks

31 37 39 44 44 47 49 50

55

57 58 59 59 60 61 61 61 62 62 63 66

CONTENTS

3.7

Financing Rainwater Harvesting Systems in Africa 3.7.1 Overview of Rainwater Harvesting Systems and Financial Needs 3.7.2 Economic Valuation of Rainwater Harvesting 3.7.3 Rainwater Harvesting Financing Schemes 3.8 Conclusion and Recommendations References 4

5

Business Models That Improve Rural Poor Access to Credit for Irrigated Agriculture in Northern Ghana Prosper Glitse, Ben Vas Nyamadi, and Mamudu Abunga Akudugu 4.1 Introduction 4.2 Literature Review 4.3 Materials and Methods 4.3.1 Study Area and Data 4.3.2 Empirical Model Specification 4.4 Results and Discussion 4.5 Credit Model for the Rural Poor 4.6 Conclusion and Policy Implications 4.6.1 Summary of the Findings and Conclusion 4.6.2 Recommendation References Conventional Valuation of the Economic Viability of Agricultural Water Investments in Arid and Semi-Arid Lands Cush Ngonzo Luwesi, Seham D. Zaky Dawoud, Chris Allan Shisanya, Remy Bolito Losembe, Joy Apiyo Obando, and Nelson H. Were Wawire 5.1 Introduction 5.2 Economic and Financial Approaches for GWS Schemes 5.2.1 Conventional Economic Models for Efficiency and Profitability 5.2.2 Probabilistic Benefit-Cost Analysis 5.2.3 Hydro-Economic Inventory Modelling 5.3 Methodological Approach of the BCA Conducted in Muooni 5.3.1 Water Situation with and Without GWS Schemes

xiii

71 71 71 72 75 76 81

83 85 89 89 90 94 104 106 106 107 107

111

113 114 115 118 118 121 121

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CONTENTS

5.3.2

Describing Costs and Benefits over the Project Period 5.3.3 Valuating Cost and Benefit Streams over the Project Period 5.3.4 Discounting Net Project Flows 5.3.5 Adjusting Discounted Net Flows to Climatic Risks 5.3.6 Sensitivity Analysis 5.3.7 Prospecting Direct and Indirect Outcomes of GWD Schemes 5.4 Results of the BCA Conducted in Muooni 5.4.1 Status of Blue Water Supply “with” and “Without” GWD Schemes 5.4.2 Costs and Benefits over the Projection Period 5.4.3 Cost and Benefit Streams Under BAU and NAUB Scenarios 5.4.4 Discounted Project Values Under BAU and NAUB Scenarios 5.4.5 Discounted Net Flows Adjusted to Drought and Flood Risks 5.4.6 Sensitivity Analysis 5.4.7 Direct and Indirect Prospective Impacts of GWS Schemes 5.5 Discussion on the BCA Conducted in Muooni 5.6 Conclusion and Recommendations References 6

A Contingent Valuation of Payments for Watershed Services for Financing Green Water Development Cush Ngonzo Luwesi, Nelson H. Were Wawire, Joy Apiyo Obando, Essam O. Badr, Remy Bolito Losembe, and Chris Allan Shisanya 6.1 Introduction 6.2 Novel Approaches for the Valuation of Investment in Green Water Saving 6.3 Applied Contingent Valuation Methods 6.3.1 Materials and Methods 6.3.2 Calibrating the WTP and WTA Bids 6.3.3 Treating the WTA Bids

122 122 124 126 128 129 129 132 132 133 133 134 136 136 137 139 140 147

149 151 155 155 156 157

CONTENTS

6.3.4 Validating the WTP–WTA Bids 6.3.5 Aggregating Contingent Benefits 6.4 Results and Discussion 6.4.1 Introduction 6.4.2 Willingness To Pay for GWS Services by Muooni Farmers 6.4.3 Farmers’ Willingness To Accept Compensation for Their GWS Services 6.4.4 Validation of the Contingent Benefits’ Valuation 6.4.5 Aggregation of Contingent Benefits Versus Conventional Benefits 6.5 Discussion on Contingent Benefits’ Valuation (CBV) 6.6 Conclusion and Recommendations References 7

Innovative Water Financing in Africa: Lessons Learned from Kenya Floribert Ntungila Nkama, Cush Ngonzo Luwesi, Atakilte Beyene, Dzigbodi Adzo Doke, and Philip Wambua Peter 7.1 Introduction 7.2 MUWASCO: Combining Leadership and Innovations for Creditworthiness 7.2.1 Case Study Rationale 7.2.2 Major Impactful Reforms Outcome 7.2.3 Prospective Outcome of the Reforms 7.3 EWASCO: A Showcase of Strategic Leadership in Credit Finance and Grants 7.3.1 Case Study Rationale 7.3.2 Leadership in Resource Mobilization and Innovations in Investments 7.3.3 Prospective Outcome of the Reforms 7.4 NYEWASCO: When Endurance Is Needed to Capitalize Long-Term Benefits of a Loan 7.4.1 Case Study Rationale 7.4.2 Endurance in Resource Mobilization Calls for Sustained Governmental Support 7.4.3 Prospective Outcome of the Reforms

xv

158 159 160 160 160 166 170 172 173 176 177 183

185 185 185 187 189 189 189 190 191 194 194 195 198

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CONTENTS

7.5

Grundfos-Mpesa Integrated Technology for Financing Water Services 7.5.1 Grundfos-Mpesa Integration for Water Provision 7.5.2 Bhungroo for Out Scaling Grundfos-Mpesa Technologies in Irrigation References Index

198 198 201 202 205

Editors and Contributors

About the Editors Cush Ngonzo Luwesi is a Professor of Quantitative Techniques in Economics and Environment, and the Director of Postgraduate Studies (online) for Francophone Africa at Ballsbridge University, Curaçao (The Netherlands) (ODeL). He does as well teach at the American University of Kinshasa, the University of Kinshasa and at the Health College of Kenge (DR Congo). He is also a member of the scientific advisory committee on Climate Research for Development (CR4D) of the United Nations Economic Commission for Africa (ECA). During the last five years, he has been the Director General of the Health College of Kenge (ISTM-MRP Kenge) and the Focal Region Manager of the CGIAR Research Program on Water, Land and Ecosystems (WLE), at the International Water Management Institute (IWMI), Ghana. He attained Ph.D. and M.Sc. of Integrated Watershed Management (IWM) from Kenyatta University

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EDITORS AND CONTRIBUTORS

(Nairobi) and does also hold M.A. and B.A. in economics from the University of Kinshasa. He has over 80 publications and a dozen of international awards with the UN, NSF (US), IDRC (Canada). Atakilte Beyene is a Senior and Independent Consultant on Rural Development. He holds a Ph.D. from the Swedish University of Agricultural Sciences. He has worked in universities and research institutes in Sweden, Tanzania and Ethiopia, including the Nordic Africa Institute (NAI), at University of Uppsala, Sweden He has both coordinated and worked on interdisciplinary research projects in Nordic and African countries. His research focuses on agrarian and rural institutions, natural resource management, food security and gender studies. His current research includes large-scale agricultural and irrigation investments in Africa, and their implications for local economies.

Contributors Mamudu Abunga Akudugu University (UDS), Tamale, Ghana

for

Development

Studies

Essam O. Badr Damietta University, Damietta, Egypt Atakilte Beyene Nordic Africa Institute, Uppsala, Sweden Seham D. Zaky Dawoud Damietta University, Damietta, Egypt Dzigbodi Adzo Doke Department of Environmental Science and Natural Resource Management, University for Development Studies, Tamale, Ghana Prosper Glitse Ghana Irrigation Development Authority, Accra, Ghana

EDITORS AND CONTRIBUTORS

xix

Beaujolais Bofoya Komba University of Kinshasa, Kinshasa, Democratic Republic of the Congo Remy Bolito Losembe University of Kinshasa, Kinshasa, Democratic Republic of the Congo Cush Ngonzo Luwesi University of Kinshasa, Kinshasa, Democratic Republic of the Congo Honoré Mbantshi Mingashanga University of Kinshasa, Kinshasa, Democratic Republic of the Congo Jane Wanjira Njuguna School of Business, Economics and Tourism, Kenyatta University, Nairobi, Kenya Floribert Ntungila Nkama University of Kinshasa, Kinshasa, Democratic Republic of the Congo Samia Satti Nour University of Khartoum, Khartoum, Sudan Ben Vas Nyamadi Ghana Irrigation Development Authority, Accra, Ghana Joy Apiyo Obando Kenyatta University, Nairobi, Kenya Chris Allan Shisanya Kenyatta University, Nairobi, Kenya Philip Wambua Peter School of Business, Economics and Tourism, Kenyatta University, Nairobi, Kenya Nelson H. Were Wawire Kenyatta University, Nairobi, Kenya

List of Figures

Fig. 1.1 Fig. Fig. Fig. Fig. Fig. Fig.

1.2 1.3 1.4 1.5 2.1 2.2

Fig. 4.1 Fig. 5.1 Fig. 7.1 Fig. 7.2

Public water price (dark) versus vendors’ price (coloured) (in $US/ m3 ) (Source Clarke and King 2004) The demand curve The average and marginal cost curves The market equilibrium price Equilibrium in monopoly The traditional and basic WSS financial instruments Global water financing transfer facility (Source Adapted after Oliver et al. 2016) Community Empowerment, Savings and Credit Associations (CESCAs) Model Decision tree for adjusting discounted net flows to capability (Source Luwesi [2013]) Schematic view of money transfer mechanism via MPESA payment platform (Source Nkpeebo et al. [2016]) Modeling integrated Grundfos/Bhungroo irrigation technologies with payment via MPESA (Source Luwesi et al. [2017])

6 8 9 10 11 28 29 105 127 199

200

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List of Tables

Table 1.1 Table 1.2 Table 1.3 Table 2.1 Table 2.2 Table 2.3 Table 2.4 Table 4.1 Table 4.2 Table 4.3 Table 4.4 Table 4.5 Table 5.1

Rivalry and exclusion among sectors in the use of water resources Collection time in minutes by 30-minute threshold and type of source Price negotiations in the water market Financial instruments used for corporate business and projects Sample balance sheet for XYZ, Ltd. as of 31 December 2016 Describing a financial system functional operations and actors Classification of grants Determinants of access to credit by smallholder irrigators in northern Ghana (n = 432) Determinants of access to credit by smallholder irrigators in Bawku West district (n = 108) Determinants of access to credit by smallholder irrigators in Nabdam district (n = 108) Determinants of access to credit by smallholder irrigators in Kassena-Nankana (n = 108) Determinants of access to credit by smallholder irrigators in Kumbungu (n = 108) The valuation of costs involved in Green Water Saving schemes

4 5 11 35 40 41 48 95 98 100 101 103 120

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LIST OF TABLES

Table 5.2 Table 5.3 Table 5.4 Table 5.5 Table 6.1 Table 6.2 Table 6.3 Table 6.4 Table 6.5 Table 6.6 Table Table Table Table

6.7 6.8 7.1 7.2

Operations involved in the implementation of GWD schemes Blue water saving projects’ benefit-cost ratio in Muooni Green water development schemes’ benefit-cost ratio in Muooni The cost and revenues of GWD schemes in Muooni (FY-2010) WTP utility function for Muooni downstream farmers Performance of the WTP prediction model for Muooni downstream farmers Residual statistics for WTP bids in the lower Muooni WTA utility function predicted for upstream Muooni farmers Performance of the WTA prediction model for upstream Muooni farmers Residual statistics for upstream farmers’ WTA bids in Muooni Monthly valid WTP and WTA bids for Muooni farmers Monthly benefits expected from GWS schemes in Muooni Increased EWASCO assets (2005–2011) Strengthened EWASCO Operations (2005–2011)

123 130 131 133 162 164 165 167 170 171 172 172 192 192

CHAPTER 1

Basic Economics Behind Sustainable Financial Flows in the Water Sector Mamudu Abunga Akudugu, Cush Ngonzo Luwesi, Beaujolais Bofoya Komba, Atakilte Beyene, and Samia Satti Nour

Abstract Water is generally considered as a public good owing to its wide availability. Yet, water is naturally a scarce resource, that is indispensable for living beings. Its additional value in production leads to sectoral rivalry and social exclusion, thus portraying water as a good that can be “economized” for profitable and efficient water businesses. This chapter presents

M. A. Akudugu (B) University for Development Studies (UDS), Tamale, Ghana e-mail: [email protected] C. N. Luwesi · B. B. Komba University of Kinshasa, Kinshasa, Democratic Republic of the Congo A. Beyene Nordic Africa Institute, Uppsala, Sweden S. S. Nour University of Khartoum, Khartoum, Sudan © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 C. N. Luwesi and A. Beyene (eds.), Innovative Water Finance in Africa, https://doi.org/10.1007/978-3-031-38234-5_1

1

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M. A. AKUDUGU ET AL.

the basic economic principles subtending financial flows. It creates awareness on the financial sustainability needed for a sustainable water provision and its equitable distribution among competing uses. Keywords Economic principles of water demand · Supply and profitability · Water investments financing

Box 1.1: Lessons Learned • Water is generally considered as a social and public good owing to its wide availability, and a right because it is indispensable for living beings. • However, it deserves also to be treated as an economic good due to its natural scarcity, its value added within the production chains, and its sectoral rivalry and social exclusion for access in a changing environment. • As an economic good, water has a value in use, an exchange value, a value in capital, a value added and a benefit resulting from either its production and consumption, or its distribution in the market. • Where there exists no market price for water, new investors can use non-market techniques to value water resources. These include (i) residual imputation of shadow prices; (ii) hedonic method; (iii) travel cost method; (iv) avoidance cost method; (v) benefit transfer method; and (vi) contingent valuation method. • Public water management services are essential for ensuring water resources protection and sustainability as well as the regulation of water and sanitation services among competing private businesses. • Water consumer and producer behaviours shall be based on rational choices to allow application of water pricing instruments (taxes, tariffs, penalty charges and fees), and efficient recovery of the full cost of operations and maintenance of water and sanitation services. • Thence, the government shall explore different ways of ensuring both equity and fair prices in water valuation to enable service providers attain full cost recovery. This will enable the latter make substantial income for savings and infrastructure development.

1

BASIC ECONOMICS BEHIND SUSTAINABLE FINANCIAL …

3

• Both PSPs and private WSPs shall embrace a societal marketing culture to apply strategies that create awareness on water scarcity, and “user pays” and “polluter pays” principles to enable smooth enforcement of water charges and fees.

1.1

Introduction

“Water has an economic value in all its competing uses and should be recognised as an economic as well as a social good”.1 As a social good, water is the most crucial and highly demanded resource on earth. Yet, the natural water resource is finite and vulnerable. The global freshwater reserve is estimated to only 0.4% of available rainfall across the globe. Another part of freshwaters is locked in glaciers and ice lands (2.1%). The remainder of rainfall inputs translated in surface runoff is mainly salty and found in oceans and lakes (97.5%).2 That is why there exists a high competition among sectors for production (agriculture, livestock, industries, power generating plants), and among human beings (for consumption and livelihoods) and the majority of living biological systems. The high competition often results in rivalry among sectors that leads to exclusion of those who are supposedly not entitled from water use (Box 1.2; Table 1.1). For achieving the sustainability of freshwater resources, there is a need to recognize water as an economic good so that it can be “economized”; otherwise, it will be suicidal for humankind, both the present and future generations, to use the limited water inefficiently.3 The main reason is that the world businesses and populations are growing at a very fast pace to the extent that there is not enough water for production and consumption.4 This explains why in some regions women and children have to undertake long and lasting daily journey for fetching water from safe sources.

1 Rogers et al. (1998), Whittington et al. (2013). 2 Mathenge et al. (2014), Wouters (2013). 3 Daly (2017). 4 Ericksen (1998).

4

M. A. AKUDUGU ET AL.

Table 1.1 Rivalry and exclusion among sectors in the use of water resources Management steps

– Resource planning/ management, collection/ utilization, monitoring/ evaluation – Resource collection/ utilization – Resource planning/ management, monitoring/ evaluation – Resource planning/ management, monitoring/ evaluation

Management properties Nature of goods

Use characterization

Examples

Public/private goods

1. Exclusion

2. Rivalry

Water value use/ ecological services

Public good

No exclusion

No rivalry

Pollution control/ protected areas

Private good

Exclusion (technically)

Rivalry

Cooking/ drinking water

Mix good (Communal)

No exclusion (technically)

Rivalry

Farming/grazing land owned by a community

Mix good (Club)

Exclusion

No rivalry

Private aesthetic/ recreational spaces

Source Adapted after Luwesi and Beyene (2019)

Box 1.2: Definitions of Rivalry and Exclusion Rivalry: A good or service is said to be rival in consumption, if one person’s use thereof in some sense precludes or prevents uses thereof by other individuals or businesses. It refers to the nature of the consumption process. Food, for example, is a typical rival good, as consuming one unit of bread implies that one fewer unit of bread is available for the rest of potential consumers. Light from the sun (to some extent) has low or no rivalry, as consumption by one does not necessarily reduce availability for others. Exclusion: This refers to the possibility of excluding persons who are not entitled from using the good or service. A good is excludable if there is some mechanism (physical or institutional) that restricts potential users from consuming it at some time or place. Property rights are institutional

1

BASIC ECONOMICS BEHIND SUSTAINABLE FINANCIAL …

5

devices to restrict or exclude potential consumers (or users) from goods or resources, which are generally supported by some physical mechanism to restrict access by third parties (fences, access codes, etc.). Land is generally an excludable resource, whereas “air” (not necessarily clean air) is a resource with very low, or no, excludability. Source Young (1996) quoted by Cap-Net (2008)

Cassivi et al. (2018) revealed that in many countries across Africa, appreciable proportions of households use more than 30 minutes to access water (Table 1.2). The distance that has to be covered in search for water justifies why poor people spend much money on water vendors to have access to water with their tiny incomes. Furthermore, in the course of climate change, Table 1.2 Collection time in minutes by 30-minute threshold and type of source Average collection time in minutes (Standard error) Country

Burkina Faso Burundi Central African Republic Chad Democratic Republic of the Congo Haiti Liberia Madagascar Malawi Mozambique Niger Nigeria Rwanda Sierra Leone South Sudan Togo Uganda Source Cassivi et al. (2018)

Households with collection time > 30 minutes (%)

National

Type or source Improved

Unimproved

15 26 33 31 33

20 28 33 37 32

(±19) (±25) (±40) (±48) (±31)

20 26 32 30 27

(±19) (±24) (±44) (±40) (±33)

20 35 36 44 38

(±20) (±26) (±31) (±54) (±28)

23 11 4 17 27 35 17 32 10 37 17 40

28 17 14 19 35 43 21 30 16 39 22 44

(±34) (±19) (±38) (±23) (±70) (±54) (±29) (±28) (±19) (±52) (±29) (±49)

22 (±30) 17 (±21) 9 (±20) 18 (±24) 23 (±67) 35 (±47) 19 (±28) 27 (±27) 14 (±21) 36 (±44) 17 (±22) 42 (±49)

33 17 18 25 44 58 24 39 20 45 30 49

(±37) (±15) (±43) (±25) (±71) (±63) (±31) (±30) (±16) (±63) (±37) (±47)

6

M. A. AKUDUGU ET AL.

many people have to face social and environmental externalities due to walking long distances to carry water, meeting high cost of energy, being internally displaced as a result of vulnerability to natural disasters and poverty.5 Hence, if considered as a “res communes ” (communal resource), there will be no prospect of valuing water economically to derive both its intrinsic and market values. Economic instruments used to value water entail rational rules, known as “economic principles”. These are incentives that influence the behaviour of both consumers and producers to allocate optimally their resources for demand and supply in the market. They also involve standard methods of pricing the existing plenty water products available in the market, which prices are generally arbitrary.6 These include water from unprotected and protected springs and freshwater lakes, wells, boreholes, standpipes, taps and bottled mineral water (Fig. 1.1).

Water Vendors price

Public water price

5 0.02

1.1 0.02

Mongolia Cambodia

COUNTRY

Indonesia Philippines Pakistan

1.4 0.02

1 0.02

1 0.02 0

1

2

3

4

5

6

WATER PRICE (in $US/ m3) Fig. 1.1 Public water price (dark) versus vendors’ price (coloured) (in $US/ m3 ) (Source Clarke and King 2004)

5 Shisanya and Khayesi (2007). 6 Shisanya (2005).

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BASIC ECONOMICS BEHIND SUSTAINABLE FINANCIAL …

7

The Paradox of Water and Diamond Values

Arbitration on water value is the first ever raised economic problem by Sir Adam Smith (1723–1790). He wondered why necessary commodities such as water always had lower prices compared to prices of luxury commodities such as diamond. Yet, it is not “necessity” or “luxury” that determines the price in the market but demand and supply game.7 So, what’s the problem? Water has high demand than diamond! Does it not seem odd to see its price being insignificant compared to that of diamond? This enigmatic question known as the “paradox of value” was solved two (2) centuries later by looking at the main driver behind the market demand curve, which is the “marginal utility”.8 In effect, the satisfaction someone receives from consuming commodities is called his/her “utility”. The consumer’s “marginal utility” is the satisfaction received from consuming an additional unit of the commodity under consideration. That is the utility obtained from consuming one unit more or one unit less of the total basket. The higher the marginal utility, the higher the motivation to purchase such an item will be. Yet, water marginal utility is insignificant compared to that of diamond. In fact, water consumption goes up by equal steps as water utility goes up by diminishing small steps until it becomes null and this is the “law of diminishing marginal utility”.9 Though water has to some extent a price, many people get it free of charge, and they finish by consuming it in an unsustainable manner. This happens when the utility of its additional units turns to nothing. At that moment, their taps will run unwarily because these incremental doses are without any use. At this point of disutility, water does not have any value, and its price cannot match that of diamond whatsoever. It shall be noted that each consumer expresses his/her purchase to the market in terms of a “value” that depends on his/her marginal utility and the price elasticity of demand.10 The demand curve is an aggregate of all households’ desired purchases at each possible market price. The high the market demand, the lesser individual prices will be (Fig. 1.2).

7 2iE (2020). 8 Lipsey and Steiner (1978). 9 Shackle (1968). 10 Harvey (1985).

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Price Y4 Y3 Y2

Demand

Y1 0

Quantity X1

X2

X3

X4

X5

Fig. 1.2 The demand curve

1.3

The Producer Behaviour

Producers express their supply (quantities and prices) according to the “law of increasing marginal cost (MC)” of their inputs, which particularly depends on the total variable cost (TVC).11 In fact, water production goes up by equal steps as its marginal cost goes up by augmenting small steps. So, the producer has to section the increasing part of the marginal cost where the average cost is very low. The supply curve shown in Fig. 1.3 first declines and then goes up at some point. This is mainly explained by the variations of the short-run marginal cost (MC) curve, which needs to intersect the average total cost (ATC) and average variable cost (AVC) curves at their minimum points to achieve the optimum.12 As a matter of fact, the demand of inputs obeys the law of diminishing marginal product of the capital , which depends on finance, namely the demand of capital.13 The latter depends on the interest rate and the law of diminishing returns that states that as one type of production input is added, with all other types of input remaining the same, at some point, production will increase at a diminishing rate. Therefore, suppliers will tend to set high prices for higher production quantities, and low prices for lower production quantities, respective of increasing marginal cost of inputs and diminishing rate of marginal product of capital.14 11 Swarp et al. (2007). 12 Nicholson (1992) 13 Hardwick et al. (1994). 14 Nicholson (1992).

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BASIC ECONOMICS BEHIND SUSTAINABLE FINANCIAL …

Unit cost $4

9

MC ATC AVC

$3 $2 $1

ATC

0

Quantity X1

X2

X3

X4

X5

Fig. 1.3 The average and marginal cost curves

After getting right his economic calculus, each individual supplier will have to go to the market to meet a corresponding demand. It is only then that the true sale price will come out.

1.4

Water Market Negotiations and Equilibrium

To the finale, after variable bargains from competition of individual prices set by sellers and proposals by buyers, a general price rises, each time there is a new demand or supply (e.g. P1 and P2 ). This is known as the market equilibrium price (Fig. 1.4). It is the result of aggregated demands of buyers and computed supply of all the sellers, which finally determines the exchange value of water.15 The above description of market negotiations is known as “pure and perfect competition”, whereby many suppliers and many demanders offer/ demand exactly the same product and under the same market conditions.16 In such a situation, the market determines the prices based on the law of supply and demand, independently of the consumers’ and producers’ behaviours. It is up to them to determine the assortment of goods they want to consume (according to their marginal utilities) or produce (at the lowest section of the average costs that equals their marginal costs).17 15 Karlan and Murdoch (2014). 16 Lipsey and Steiner (1978). 17 Harris (2008).

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Unit cost $5

Equilibrium

Supply 2

$4

Supply 1

$3 $2 $1

Demand 2 Demand 1

0

Quantity X1

X2

X3

X4

X5

Fig. 1.4 The market equilibrium price

However, contrary to the above description, prices in the water sector are generally set by either one powerful supplier or a few of them, most of whom are public utilities. The demand side is literally weak, since there are actually too many water demanders. These two cases of imperfect competition are well-known as “monopoly” and “oligopoly”, respectively.18 The water market is more or less a “monopoly” since there is only one main supplier, a public utility, which operates a large water treatment plant, and has to face many uncoordinated demanders of the same product (water consumers). The monopolist tends to dictate the price and consumers have to adjust their quantities to that price (Fig. 1.5). Where water producers are in a very limited number while demanders are many, there is “oligopoly”. Actually, the few water providers will tend to aggregate their supply to form a cartel in the water sector. This leading group will exert its power on the market, deciding on the quality and quantity of water to be supplied, and then determine the market price after assessment of its productive costs and of the price elasticity of water demand.19 Other cases of imperfect competition in the water sector include monopsony, duopsony or duopoly and oligopsony. These are very obvious in cases where Water Service Providers (WSPs) are purchasing water meters, pipes and some other special devices. Also, when hiring workers (demand for

18 Karlan and Murdoch (2014). 19 Meier (1990).

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Price Equilibrium

$6 $5

MC (Supply)

$4 $3 $2

MR2 (Demand)

$1

MR1 (Demand)

0

Quantity X1

X2

X3

X4

X5

Fig. 1.5 Equilibrium in monopoly

labour), WSPs are involved in a monopsony labour market. Its equilibrium is determined by the market wage rate (market labour supply curve) and the marginal revenue product of labour (market labour demand curve). The latter shall be equal to the marginal cost of labour for the market to attain its equilibrium. Table 1.3 summarizes all possible negotiations over water price. In a nutshell, the valuation of the private water services abides to the following steps: (1) expression of a need in a situation of scarcity; (2) rational choice of a product (good or service); (3) expression of a demand in a competitive market; (4) market negotiations involving the demand– supply game of pricing; (5) a market deal at the equilibrium price; (6) payment of the agreed price and delivery of the product; and (7) rational use and consumption of the product. Table 1.3 Price negotiations in the water market A single water user

A few water users

Many water users

A single water user A few water users

Duopoly/duopsony Oligopoly

Monopsony Oligopsony

Many water users

Monopoly

Oligopsony Oligopoly/ oligopsony Oligopoly

Pure and perfect competition

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1.5 Full Cost Recovery in Water Services Management Private water users and providers seldom interact in competitive markets to form an equilibrium price for their water demand and supply. This type of competitive market does not fit to the operation of water service providers, owing to the fact that water is a public right and a social good. Nonetheless, WSPs are encouraged to account fully for both operating and structural costs to enable a full cost recovery for water services provision and optimize their efficiency.20 A full cost recovery involves the integration of all costs of transaction (CT), an opportunity cost (OC), a cost of saving (CS) water (under ANOR: above normal rainfall regime) and a shortage cost (SC) of water (under BNOR: below normal rainfall regime).21 The cost of transaction (CT) encompasses both direct and indirect costs of operations and maintenance of the water service. These include part of the permit charges, raw water volume charges, administrative charges, monitoring and evaluation charges, watershed management charges, charges for amortization of the investment cost, etc.22 The opportunity cost (OC) needs also to be included in the total cost due to the failure of adopting the best available alternative of using water, owing to unfavourable combination of circumstances (e.g. inflation, foreign exchange fluctuation, long distance from place of provision…) or to the unaccounted for water (UFW).23 Though not usually included in the full cost recovery for fairness, it has proven to be a useful to guide water authorities in looking for better water allocations and prioritizing future investments in the water sector. It is expressed as the “regret benefit” or the loss of projected profitability from the best next sale (Eq. 1.1)24 :

20 Rogers et al. (1998), Whittington et al. (2013). 21 Luwesi et al. (2011). 22 GW•MATE (2011). 23 Swarp et al. (2007). 24 Luwesi (2010).

1

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BASIC ECONOMICS BEHIND SUSTAINABLE FINANCIAL …

OC = r Y

(1.1)

where r = the water service provider opportunity loss rate Y = the water service provider income. The cost of saving (CS) water is a cost incurred by accumulation of exceeding water storage, notably for opportunity lost, and amortization of operating and structural costs. This generally occurs, especially in irrigation, during the above normal rainfall regime, when farmers receive more than enough rainfall to water their crops. Any demand of water during and shortly after that period will be charged with a cost of saving water. Algebraically, the CS can be expressed as an opportunity cost plus the loss of actual profitability due to excess storage loss25 : ∏ C S = rY + l (1.2) where ∏ is the water provider profit, computed in absolute values • • l is the loss of profitability under ANOR calculated as “r − 1”. Water shortage cost (SC) is incurred by accumulation of acute insufficient storages, eventually due to deficient rainfall regimes. Any demand of water during the period of drought is actually over-charged due to the shortage cost and the high demand expressed by the market. It is generally computed as an opportunity cost and the loss of actual profitability due to shortage26 : ∏ SC = r Y + l ∗ (1.3) where •

∏

is the water provider profit, computed in absolute values

25 Luwesi et al. (2012a). 26 Luwesi et al. (2012b).

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• l * is the loss of profitability under BNOR calculated as “1 − r”. The shortage cost is generally referred to as an “arbitrary fee” and results in rationing when the government intervenes.27 For efficiency, water providers need to use skilful ways of purchasing their inputs and materials (at a low cost), and act rationally in using these inputs and materials in the production, without offsetting the process thresholds. They also need to employ a production-mix that yields high utilities and outputs, and maximizes the total benefit.28 For these reasons, WSPs need: (i) an effective financial management of recurrent revenues to sufficiently cover all charges; (ii) a technological management of non-revenue water to avoid wastage and loss; (iii) sustainable long-term cost recovery policies; and (iv) public awareness creation to mobilize more resources using societal marketing strategies .29

1.6

Water Valuation Methods 1.6.1

Economic Water Valuation

Water has an intrinsic value, a quantity measured or an assigned quality that makes it something desirable (or valuable) for consumptive and productive uses by mankind (value in use). It has also an economic value arousing from rivalry and exclusion on its specific and competing uses, the amount that its users are willing to pay, and the benefit that its service providers expect from their services. Water valuation is thus a numerical or quantitative method used to determine, compute, measure or assign a certain value to water.30 For instance, hydrologists estimate water quantity in the world; geomorphologists are able to quantify the number of sediments or silts from erosive processes in water flows; and, biochemists certify water quality for human uses by quantifying the number of acceptable pollutants. Economists use the market price to value any scarce commodity: that is its value in exchange. For that reason, “early economists were struck by

27 WSP (2012). 28 Doyle (1992). 29 Martinsen (2008). 30 Cap-Net et al. (2010).

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15

the outstanding contrast between the cheapness of such absolute necessities of bare physical existence as air and water, and the dearness of such fripperies as diamonds or ostrich feathers”.31 They perceived that air and water could be gotten with little or no toil, while gold and precious stones must be laboriously searched for and mined. This led them into thinking that the value of a thing is its value in exchange. It can be expressed as the number of units of something else which one of its own units will fetch. This was wholly accounted for when the following question was properly answered: “How many times as much effort is required to produce one unit of this thing, as is required to produce a unit of the thing we are going to exchange it for?”.32 After two centuries of research, economists provided a basis for calculation of water value in exchange, and which results from its marginal utility (on the demand side) and its marginal cost, on the supply side.33 As described above, water value in exchange is primarily measured from its utility (value in use) for agricultural and industrial production, livestock keeping, power generation, human consumption and for other livelihoods. The utility obtained from consuming one unit more or one unit less of the total water reserve is the consumer’s “marginal utility”. When expressed in terms of price elasticity of water demand, the marginal utility measures the water exchange value from the consumer’s perspective. Likewise, the exchange value of water from service providers’ perspective is determined by the lowest section of the average cost that is equal to the “marginal cost “of its production and distribution (supply). The market determines a general price of water based on the “law of supply and demand”, independently of the consumers’ and producers’ behaviours. It is up to each individual consumer and producer to determine the quantity of water to consume or supply, according to his/her own budget or capital. That general price or “market general equilibrium price” results from an aggregated demand of water users and the computed supply of water service providers.34 The “law of diminishing marginal utility” states that water consumption goes up by equal steps as water utility goes up by diminishing small

31 Karlan and Murdoch (2014). 32 Shackle (1968). 33 Lipsey and Steiner (1978). 34 Harvey (1985).

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steps until it becomes null.35 So, if given water free of charge, people will use it in an unsustainable manner, the additional units having absolutely no utility or value in use at all. Yet, water services have a cost that determines the provider’s ability to bring water up to the user’s tap. To set a balance between water as a public right or a social good and an economic good, the government shall set a price (tariff, fee or charge) that should normally disadvantage neither the consumer nor the provider, without withstanding automatically the demand–supply market game.36 Sadly, prices in the water sector are often set by state monopolies, which are public utilities with huge water treatment plants. In some other cases a few powerful service providers, both public administrations and private vendors, form cartels to shape the water market. Water users have more often to bear the heavy burden of arbitrary fees set by these cartels, particularly the price set by private water vendors during periods of drought, while public administrations incur deficits by abiding to insignificant statutory tariffs.37 If governmental charges or tariffs do not meet the cost of provision, this is likely to result in challenges in terms of both quality and quantity of water services delivered by public utilities. Such a situation gives rise to informal vendors to practise arbitrary prices (see Table 1.3). These are some of the imperfections of the water market that make it either a quasi-free commodity in some places or a luxury in others.38 1.6.2

Financial Valuation Methods for Water Services

There are other methods for water valuation based on the trends of financial market. These include the computation of water services value in capital, value added, and benefit, to name but a few methods. Most of these processes are basically based on revenue generated, which is formulated in terms of income and expenses.39 Operational researchers and accountants are able to determine water value through the full costing

35 Shackle (1968). 36 Karlan and Murdoch (2014). 37 Fürst et al. (2000). 38 Harris et al. (2017). 39 Wawire and Thuo (2007).

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17

of water services. This assists managers in the computation of the value in capital and value added of water services. The value of water in capital is its ability to generate future utilities (in terms of income) through additional investments.40 Water value in capital is measured in terms of the cost of storage and distribution of infrastructure and other materials and the balance of the re-evaluation of the mobilizable used by water service providers to treat and recycle water. The present value of water in capital (PV) will likely determine its “future value” (FV) to cater the needs of the growing world’s population and mitigate the threats of climate change after accumulation of “values added” (VA).41 Water value added (VA) is the difference between water price and the cost of all its inputs used during the treatment and recycling process.42 Water value added determines its high price and contribution to the macro-economy through notably the value added tax (VAT). “The term ‘value added’ relates to the successive amounts of profit added to a product as it proceeds down the distribution chain from original supplier to final consumer”.43 As values are added, water services are likely to climax with a “benefit ” or a “profit”, meaning a surplus or excess revenues over all expenses (overheads and variable costs included). This is the final result that a water service provider (WSP) can expect in order to increase its future “value in capital”. A cost–benefit analysis is thus needed to evaluate the viability of a projected investment of water services in the long run.44 The cost–benefit analysis (CBA) is a necessary and sufficient step towards rational decision-making to adopt a certain price, buy a technology, acquire materials and infrastructure or make any other kind of investment that will improve the water service provider’s business. This analytical method considers the costs that the investment will incur and the benefits that will accrue to it after the decision has been made. It is mainly based on an estimation of “benefits” resulting from the investment

40 Harvey (1985). 41 Dodge (1993). 42 Lipsey and Steiner (1978). 43 Dodge (1993). 44 Savenije and van der Zaag (2002).

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(“present value”) and its long-term “future value”, if the intervention was adopted or implemented in the present conditions.45 1.6.3

Environmental Economic Valuation for Water Projects

As elucidated above, the science of economics abounds in both jargons and formulae for valuing water, where it is supposedly known as scarce commodity in the market. How can we then know the actual economic value of a water project in areas where such a project does not exist? Environmental economists use several tools to determine the non-market value of water, including statistical and econometric methods for contingent valuation. Other methods include the residual imputation of shadow prices, hedonic price method, the travel cost method, avoidance cost method and benefit transfer method.46 This list is not exhaustive but indicative of some of the methods used for the environmental economic valuation of water. Residual imputation of shadow prices is used to value water in processes where it is not directly consumed but it enters the productive process as intermediate good.47 This is the case for water used in agriculture, industry or hydroelectric power generation. In such a situation, the producers’ demand for water will depend on its marginal value of product (MVP), which is here replaced by “shadow prices”, since there exists no formal market. The residual imputation approach derives water value from the difference between the total cost of production and the cost of all other inputs, based on estimated production data and prices of non-water inputs.48 Hedonic price method is also used where no water price exists, especially in rural areas and in production sectors using water as an intermediate good. This method suggests that one’s valuation of water is based on its characteristics rather than the resource itself. Based on the theory of consumer behaviour, it may be possible to estimate water users’ Willingness To Pay (WTP) after identification of factors that affect hedonic

45 Reitbergen-McCracken and Abaza (2000). 46 Waswa (2006). 47 Harris et al. (2017), Cap-Net (2008). 48 2iE (2020).

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19

prices, notably e.g. taste, colour, door, distance from house, and time to fetch water.49 The travel cost method is used to value water from its users’ expenditures associated to recreation activities, especially the cost of travel to a swimming pool, lake or river. The value of water in this case is not simply the entrance fee but the amount of money the water user incurs in enjoying the benefits of the resource. This method takes into account the number of visits, the cost of each trip and the entrance fee paid. These are indicators of the extent to which individual water users are willing to pay (WTP) for quality water services.50 Avoidance cost method is mainly used to prevent the adverse effects of water pollution or drought. It takes into account the cost that individual water users incur to prevent or avoid water polluted or water shortage, and thus measures the social cost of water stress disutility. For instance, people near a river have to walk long distances to fetch potable water from protected springs because the river nearby is polluted by industrial or human wastes. Others use purification methods to avoid waterborne diseases.51 Benefits transfer method consists of transferring knowledge from studies conducted in other areas to the place where decision in water value is to be made. It is used to value preferences expressed by other people on the effect of a certain intervention on water resources. For instance, if a coffee factory is planned to be established in a certain watershed, results of studies on water pollution by similar industries from other locations can be availed to local people to allow them make a rational decision. Yet, attention shall be paid on certain aspects of the study that could not be generalized or applied locally.52 Contingent valuation method (CVM)53 is the most popular method applied to estimate both the value in use and non-use value of new water projects or regulations. To measure the value in use, water users’ Willingness To Pay (WTP) is estimated along with water users’ Willingness To Accept compensation (WTA) for damages or watershed management 49 Wawire and Thuo (2007). 50 Zyl et al. (2000). 51 Smyth et al. (2004). 52 Rogers et al. (1998), Whittington et al. (2013). 53 Arrow et al. (1993).

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services. This will inform on potential economic benefits or damages that the project is likely to bring to the people, based on their own perception. But non-use value cannot be assessed using implicit prices. Thus, CVM suggests a proposed or contingent value based on: (i) an option value; (ii) a bequest value; and (iii) an existence value. The suggested value will be evaluated by local water users based on their knowledge of the water environment.54

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Meier, G.M. 1990. Leading issues in economic development. New Delhi: Oxford University Press. Nicholson, W. 1992. Microeconomic theory. Orlando: The Dryden Press. Obando, J.A., C.N. Luwesi, J.M. Mathenge, W. Kinuthia, P.P. Wambua, M.M. Mutiso, and E.O. Bader. 2015. Performance assessment and evaluation of community participation in water sector governance—The case of NgaciumaKinyaritha catchment, Mount Kenya region. In Agricultural water institutions in East Africa. Current African Issues 63, ed. A. Beyene, Chap. 2, 23–42. Uppsala: Nordiska Afrikainstitutet. Reitbergen-McCracken, J., and H. Abaza, eds. 2000. Environmental valuation: A worldwide compendium of case studies. London: Earthscan Publications Ltd. Rogers, P., R. Bhatia, and A. Huber. 1998. Water as a social and economic good: How to put principle into practice. GWP Technical Advisory Committee (TAC) Paper No. 2. Stockholm: GWP [Global Water Partnership]. Available at: http://www.gwpforum.org/gwp/library/ (Accessed on 11 September 2011). Savenije, H.H.G., and P. van der Zaag. 2002. Water as an economic good and demand management, paradigms with pitfalls. Water International 27 (1): 98–104. Shackle, G.L.S. 1968. Economics for pleasure, 2nd ed. London: Cambridge University Press. Shisanya, C.A. 2005. An analysis of accessibility and pricing of water supply in rural watersheds: A case study of Kakamega District, Kenya. FWU Water Resource Publications 5: 161–172. Shisanya, C.A., and M. Khayesi. 2007. How is climate change perceived in relation to other socio-economic and environmental threats in Nairobi, Kenya. Journal of Climate Change 85: 271–284. Smyth, A.W., G. Altay, G. Deodatis, M. Erdik, G. Franco, P. Gukan, H. Kunreuther, H. Lus, E. Mete, N. Seeber, and O. Yuzugullu. 2004. Probabilistic benefit-cost analysis for earthquake damage mitigation: Evaluating measures for apartment houses in Turkey. EERI Earthquake Spectra 20 (1): 171–203. Swarp, K., P.K. Gupta, and M. Mohan. 2007. Operations research. New Delhi: Sultan Chand & Sons. Waswa, P.F. 2006. Opportunities and challenges for sustainable agricultural land management in Kenya. In Environment and sustainable development, vol. 1, ed. F. Waswa, S. Otor, and D. Mugendi, 52–65. Nairobi: School of Environmental Studies and Human Sciences, Kenyatta University. Wawire, N., and D. Thuo. 2007. Economic environmental valuation. In Environment and sustainable development, vol. 2, ed. F. Waswa, S. Otor, G. Olukoye, and D. Mugendi, 67–83. Nairobi: School of Environmental Studies and Human Sciences, Kenyatta University.

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WSP [Water and Sanitation Program]. 2012. Sustainable services for domestic private sector participation using credit ratings to improve water utility access to market finance in Sub-Saharan Africa. WSP Briefing (February issue). Washington: WSP [Water and Sanitation Program]. Whittington, D., C. Sadoff, and M. Allaire. 2013. The economic value of moving toward a more water secure world. GWP Technical Committee Background Paper No. 18. Stockholm: GWP [Global Water Partnership]. Wouters, P. 2013. International law—Facilitating transboundary water cooperation. GWP Technical Committee Background Paper No. 17. Zyl, H.V., T. Store, and A. Leiman. 2000. Valuing time spent collecting water in a Kenyan town. In Environmental valuation: A worldwide compendium of case studies, ed. J. Reitbergen-McCracken and H. Abaza, 23–34. London: Earthscan Publications Ltd.

CHAPTER 2

Introduction to Financial Instruments and Operations for Water Management and Development Philip Wambua Peter, Cush Ngonzo Luwesi, Jane Wanjira Njuguna, Floribert Ntungila Nkama, Atakilte Beyene, and Honoré Mbantshi Mingashanga

Abstract Water resources development in Africa shall be treated as an urgent agenda due to its growing scarcity, sectoral rivalry and social exclusion for access in the course of climate change. This chapter introduces financial instruments and operations into water management and development. It surveys the major finance packages available to an organization or

P. W. Peter (B) · J. W. Njuguna School of Business, Economics and Tourism, Kenyatta University, Nairobi, Kenya e-mail: [email protected] C. N. Luwesi · F. N. Nkama University of Kinshasa, Kinshasa, Democratic Republic of the Congo e-mail: [email protected]

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 C. N. Luwesi and A. Beyene (eds.), Innovative Water Finance in Africa, https://doi.org/10.1007/978-3-031-38234-5_2

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a business based on the length of time over which the finance is required (in relation to short, medium and long term). Keywords Financial needs · resources and operations · Project finance · Corporate finance · Water finance management

Box 2.1: Lessons Learned • Water resources development in Africa deserves to be treated as an urgent agenda due to its growing scarcity, sectoral rivalry and social exclusion for accessing to it, as well as its value added in the production chains in the course of climate change. • This infrastructure development and the provision of its related services for drinking, sewerage and irrigation as well as public water management require a lot of funding that goes beyond revenue from Tariffs, public budget Taxes and Transfers from development partners (3Ts). • Hence, most small-scale water companies have turned to private businesses to get finance that is tailored to their needs, including microfinance loans, joint venture capitals, investment from different types of concessions and a mix of financial products that require blending traditional 3Ts sources with public–private partnerships (PPPs). • Some companies do not shun to recourse to commercial loans so long as they are able to generate sufficient cash flows and return for full cost recovery, and enable them meeting the financiers’ requirements for collateral. • For finance to work properly it needs a predictable and stable environment as it largely revolves around risk and return. That

A. Beyene Nordic Africa Institute, Uppsala, Sweden H. M. Mingashanga University of Kinshasa, Kinshasa, Democratic Republic of the Congo

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is what makes good governance and justice systems so crucial to the functioning of any financial system, where corruption, political interference and the lack of transparency and accountability are forbidden. • Besides, WSPs shall choose adequate and efficient financial instruments to ensure the sustainability of their services based on a risk assessment and mitigation of the length of their projects (long and increasing risk by nature), the rate of return (generally low for public goods), and contractual risks (because of long duration), etc. • Finally, PSPs and WSPs shall embrace a societal marketing culture to apply strategies that create awareness on water scarcity, and “user pays” and “polluter pays” principles to enhance revenue collection from the enforcement of water charges and fees.

2.1

Introduction

Water is a critical input for economic production and growth, and development of rural systems within the context of agrarian livelihoods. The latter decide the fate of most communities living in the developing countries in a changing global environment.1 Yet, most countries in Sub-Saharan Africa face serious challenges related to water availability owing to insufficient development of water infrastructure. Food insecurity and poverty outreach are corollaries of the mismanagement of natural resources, owing to bad governance and financial inconveniences. Elagib and Abdu (1997)2 thus observe: “With few exceptions (Bahrain is one), aridity is only one aspect of a situation in which water availability combines with other factors - including ease of access to water, the efficiency with which resources are used, the capacity of people to benefit and the health of the environment - determine what is known as “water poverty”. There is thus a need for a planned and well administered watershed development. This involves deliberate decisions to invest, manage, maintain and conserve water and related land resources across various subsectors of the rural economy.3

1 OECD (2012). 2 Elagib and Abdu (1997). 3 AGRA (2022).

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Investing in the water supply and sanitation (WSS) sector requires adequate financial sources. A systematic financing process would help the sector source for funding and allocate it in a rational way such that water resources are developed and managed adequately in order to achieve planned targets in the WSS sector.4 The WSS sector is basically financed through the traditional “3Ts” and innovative finance mechanisms. Traditional water finance (“3Ts”) encompasses tariffs charged by water utilities; taxation collected by municipal authorities and other governmental agencies; and transfer by development partners5 (Fig. 2.1). Tariffs are usually money recovered by water utilities from their operations and maintenance. The Treasury needs some more money to be directed to utilities through the ministry of water and irrigation. That money is raised from the public through taxation, and from development partners via transfer. Tax-money is essential for capital development of assets in urban and rural areas. It may not be sufficient for the whole water sector, owing to competition for resources with other sectors. Moreover, governmental budget allocations are based on political decisions but not solely on evaluation of needs and demonstration of performance.6 Thus, incoherent

Taxes

Tariffs

Money from tax paid by workers in the country. It is very limited and has to be used strategically.

A project has to reduce the risk associated to financial costs or opportunity cost of financing decisions

Money from bills paid by service users to the water facility. It depends on the return on investment and requires efficient and effective management.

Transfers

A project has to cover life cycle costs: 20% design/ build; 44% O&M; 36% financing costs

Unpredictable and unsustainable donor based financing services. It can be 50% or more of African countries’ budget

Fig. 2.1 The traditional and basic WSS financial instruments

4 Mahajan (2010). 5 Bushee (2014). 6 Kareem and Krishnan (2011).

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Fig. 2.2 Global water financing transfer facility (Source Adapted after Oliver et al. 2016)

disbursements of tax-money from the Treasury often lead to absorption problems. That is why governments in developing countries often turn to development partners for assistance on a bilateral or multilateral basis.7 Funds obtained from the latter are recorded as Transfers to the national economy. Figure 2.2 illustrates how funds dedicated to specific water projects are generally provided at specific times. Figure 2.2 also exemplifies how world and national leaders may cooperate in addressing water scarcity and the depletion of land resources, both in quantity and in quality. It also compels them to put in place a management system that would be based on performance so as to adapt water development targets to the local government plans.8 This came out as an urgent need after the 1990s democratization process that took place in Africa, following the advent of the perestroika in the former Soviet Union.9 It unveiled several challenges facing governments in the region, including acute economic and financial problems. The latter were mostly featured by poor infrastructure development, inefficient and ineffective delivery of public services, heavily indebted finances, and lack of sufficient internal resources to meet the increasing demand for public services.10 One of the main reasons evoked by experts why public finance is not always easy to be transferred to private entities is that it takes a lot of time 7 EU (2014). 8 Mathenge et al. (2014). 9 Banchirigah (2006). 10 Luo (2011), Solo et al. (1993).

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to prepare, design, submit and negotiate the proposals and finally disburse the money. Sometimes, it might be challenging for local stakeholders to deal directly with the donors and have access to the fund, unless mandated by the central government.11 For instance, the World Bank set five (5) preconditions that determine the attractiveness of a proposal for water investment financing, namely: (i) the willingness to work with RBF (result based financing); (ii) a reliable and sustainable guarantee for risk transfer; (iii) a good history of access to finance; (iv) the existence of an enabling environment; and (v) the capacity and competences of the proponent.12 These specialized skills needed for accessing finance, implementing and managing water investments are mostly lacking in the African continent. Hence, there is a great need for ad hoc training for all the stakeholders in the water sector. Notwithstanding these constraints for accessing funds, most water sector actors declare that funds received are not sufficient to build the infrastructure required to effectively meet the demand for water services. Consequently, governance structures have been weakened at the lower levels, mostly due to their over-reliance on traditional sources of WSS funding, especially the central government budget.13 Since the legal and institutional frameworks that govern business at the lower levels of governance structures are weak and overlapping, the preparation of the government budget requires very few inputs from local stakeholders.14 This is usually justified by the fact that local stakeholders do not have sufficient capacity in planning and business development. They also lack the culture of generating sufficient cash flows to recover the costs incurred in water services, deeming low returns on investments and high risk of capitals.15 To achieve sustainable cash flows, the 3Ts have to be bridged with attractive and innovative private investments in the water and sanitation sector.16 Innovative finance, which is grounded on the Results Based Financing (RBF) paradigm, came as a response to this unfavourable 11 McLaney (2014), Kareem and Krishnan (2011), Mcgill (2006). 12 World Bank (2014). 13 IMF (2014). 14 World Bank (2006). 15 Dorward (2009), Harvey and Ferson (1991). 16 Kroszner (1999).

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situation, leading to a number of reform programmes in the public sector, including the Public Service Reform Programme (PSRP) and the Economic and Financial Sector Reform Programmes (EFSRP).17 Hence, water management and water development in Africa require not only financial innovations for funding the growing demand in infrastructure and water resources but also a good governance enabling water availability to all, anywhere and at any time. Innovative finance mainly involves private actors to facilitate project preparation, blending grants and repayable finances, mainstreaming microfinance alongside output-based aid, guarantees and insurance products (for risk mitigation), pooling several other sources of financing, and commercial financing in a heavily political public sector.18 In this chapter, we will survey the major finance packages available to an organization or a business. Since these vary with the length of time over which the finance is required, we shall examine them in relation to medium to long-term options and them the short-term possibilities.

2.2 Financial Goals, Organization and Management 2.2.1

Corporate Versus Infrastructure Project Finance Management

Businesses and organizations need funds to run their operations and make investments at different periods, for operations and maintenance in the short term (less than one year), or for investments in the medium term (one to five consecutive years) and the long term (more than 5 years).19 Various financial instruments are used to raise money to finance activities (of both operating and capital nature). These innovative instruments are introduced by corporate businesses and infrastructure project managers to finance their structural (investment) and operational (functional) needs. However, the difference between the two types of financial management lies along their sources of finances and investments, dimensions, structures, size, costs and the basis for evaluation. These distinctions are not as neat as one would expect as both financial and economic objectives may be met in a single instrument, water tariffs being a clear case in point. 17 FSB (2013), A. Dorward (2009), Banchirigah (2006). 18 Briceño-G et al. (2008), A. Dowla (2006), de Aghion and Morduch (2005). 19 AGRA (2022), Carter et al. (1997).

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Also, both corporate businesses and infrastructure projects are primarily concerned with generating income that would cover the economic and financial costs of their activities.20 Corporates source for permanent but flexible types of financing, including equity and bonds. They broadly participate in equity based on the conditions prevailing in the market at that time, because shares are permanent funds for a business (Box 2.2).21 Corporates have no commitment to pay any return to the shareholders, especially when the business does not make profits.22 Their investments target deep secondary markets (stock exchange markets) to improve on their financial position (balance sheet) and cashflow (loss and profit) while taking advantage of lower capital cost and transaction costs.23 Corporates make good use of multi-purpose organizations’ financing from autonomous investors and creditors to make their management decisions, which are opaque in nature but based on easily duplicable financial ratios and equations translated into routinized and short turnaround mechanisms established to face competition. Thus, the return on the investment is seen as an increase in both the share price and the shareholders’ dividend.24

20 Heckinger and Mengle (2013). 21 Droms and Wright (2010). 22 McLaney (2014). 23 Barrows and Smithin (2009), Business Finance (2007). 24 B. J. Bushee (2014), Barrows and Smithin (2009).

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Box 2.2: Financing Capital Through Equity Participation Equity Participation25 The net assets usually shown in the balance sheet equal the third part of the balance sheet, which is known as the shareholders’ equity. It comprises: (1) issued capital and reserves attributable to equity holders of the parent company (controlling interest); and (2) non-controlling interest in equity. Formally, shareholders’ equity is part of the company’s liabilities. They are funds “owed” to shareholders, after payment of all other liabilities. Usually, “liabilities” are used in a more restrictive sense to exclude shareholders’ equity. The balance of assets and liabilities (including shareholders’ equity) is not a coincidence. Records of the values of each account in the balance sheet are maintained using a system of accounting known as double-entry bookkeeping. In this sense, shareholders’ equity by construction must equal assets minus liabilities, and are a residual value of the company’s capital. Regarding the items in equity section, the following disclosures are required: (i) numbers of shares authorized, issued and fully paid, and issued but not fully paid par value of shares; (ii) reconciliation of outstanding shares at the beginning and the end of the period; (iii) description of rights, preferences, and restrictions of shares; (iv) treasury shares, including shares held by subsidiaries and associates; (v) shares reserved for issuance under options and contracts; and (vi) a description of the nature and purpose of each reserve within owners’ equity. Equity participation—Providing an incentive to make a loan26 Equity participation gives the lender an incentive to make a loan because they share in the increased equity of the business. If the lender feels that the business has a good model with plenty of potential, they can have a stake in the company and will see an increase in profits as the company grows. The level of participation can be calculated from a variety of things including gross receipts, net income, or with an EBITDA valuation model, the model that values multiple Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA).

25 Sharma (2015), Les Dlabay and Burrow (2007), Carter et al. (1997). 26 A. Damodaran (2016), Amadeo (2016).

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Equity participation transactions provide the lender with additional incentive to make more money through loans and can make the process of obtaining a business loan more viable by providing innovative and structured loan programmes. These loans are effective tools for lenders and allow greater access to finance the capital needed. To make the search for capital as easy and effective as possible, merchant bank intermediaries match the funding requested against sources of business financing available from investors and lenders in their database. By simply telling them about a business idea, they are able to tell the amount needed and where to obtain the capital necessary for a successful business.

However, project finance relies on a single entity pursuing immediate pay-out in one time horizon for financing needs that are highly tailored to a single life cycle of the project.27 Capital investment decisions are very transparent to creditors and based on fixed dividend policy without reinvestments. This requires novel contractual arrangements based on critical credit evaluations as well as technical and economic feasibility studies to drain mass financing with highly tailored structures that cannot generally be re-used. Owing to the higher learning costs of the project installation and implementation, the cost of capital and transaction costs are thence higher than in corporate finance (Table 2.1). As a means of illustration, a commercially oriented water utility would set tariffs to meet its economic and financial objectives by adequately covering operations, maintenance and capital costs. The utility’s performance would be measured by various financial indicators, such as net profit, return on capital, creditworthiness (or ability to service loans).28 By contrast, the economic indicators are set to assess the contribution of tariffs to a combination of water sector objectives, not just limited to ensuring adequate service delivery to existing water consumers, but also requiring equitable allocation, efficiency improvements and ensuring environmental sustainability to increasing performance and people’s accessibility to water at a lower cost. An independent regulator with adequate

27 Heckinger and Ruffini (2013). 28 BIS (2012).

• Fixed Income

• Mixed

2

• Hybrid

• Loans

• Bonds

Corporate bonds, green bonds

Subordinated bonds • Syndicated project Direct/ loans co-investment lending to • Direct/ infrastructure co-investment project lending to infrastructure project • Syndicated project loans • Securitized loans (ABS) • CLOS • Subordinated project • Subordinated loans/bonds bonds • Convertible • Mezzanine finance bonds • Preferred stocks

• Municipal sovereign bonds • Green bonds, Sukuk

• Project bonds

Corporate balance sheet/other entities

Infrastructure project

Asset category

Instrument

Infrastructure finance instrument

Modes

Financial instruments used for corporate business and projects

1

No

Table 2.1

• Mezzanine debt funds (GPs) • Hybrid debt funds

• Loan indices • Loans funds

Debt funds (GPs)

• Bonds indices • Bonds funds, ETFs

Capital pool

(continued)

Market vehicles

2 INTRODUCTION TO FINANCIAL INSTRUMENTS …

35

3

No

• Equity

• YieldCos

• Direct/ co-investment in infrastructure project equity • Public–Private Partnerships (PPP)

• Listed

• Unlisted

• Listed infrastructure and utilities stocks • Closed-end funds • RETTs, ITTs, MLPs • Direct/ co-investment in infrastructure corporate equity

Corporate balance sheet/other entities

Infrastructure project

Asset category

Instrument

Infrastructure finance instrument

(continued)

Modes

Table 2.1

• Unlisted infrastructure funds

• Listed infrastructure equity funds, indices, trusts, ETFs

Capital pool

Market vehicles

36 P. W. PETER ET AL.

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powers is thus needed to ensure that the financial orientation of a water utility is not tempered by the economic or national interests.29 2.2.2

Organizational Goals for Achieving Financial Performance

Financiers provide adequate financial incentives in terms of monetary financing of investments, human, institutional and social capitals by leveraging local stakeholders and development donors’ support. Their ultimate goal is to maximize returns on investment.30 This endeavour requires a set of realistic financing goals and targets. For that reason, organizations need to create a budgeting system that links budgeted needs with available funding opportunities. Clear financing goals will help to determine what funds the organization requires to ensure sustainable implementation of its plan. The following factors should be considered when identifying organizational goals for appropriate finance policies and strategies to attract funding to the water sector. First, there shall be a diverse set of public and private financing options based on their estimated returns and risks of loss within a specified timescale and space.31 This will place water development organizations in a viable position for ensuring an enabling environment for sustainable supply of water, food and other resources found in the watershed. Second, there shall be a clear boundary between the owners’ finance and the business finance so that a confusion between the two does not lead to the collapse of the business. In effect, business organizations come in all shapes and sizes, but there is a key distinction between unincorporated business and incorporated businesses. Unincorporated businesses are principally sole traders and partnerships where there is no legal distinction between the owners and their businesses, and the personal assets of the business owners and the assets of the business are treated as one.32 However, incorporated businesses are those where the business owners and the business itself are legally separate, with the personal assets of the owners being treated as distinct from the business assets they own.

29 Hui et al. (2011), Braun and Selway (2008). 30 R. Mcgill (2006). 31 Heckinger and Ruffini (2013). 32 Graham and Harvey (2001).

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This is the case with private limited companies (plcs) and Public Limited Companies (PLCs).33 Limited companies are companies with limited liability, and they can be either privately owned (plcs) or have publicly traded shares (PLCs), like in the United States. However, the shares of a private limited company cannot be freely sold in the stock exchange market. PLCs can offer shares to the general public whereas private limited companies cannot. As a consequence, the owners of incorporated business are shareholders in that business.34 Ownership is spread among, possibly, a very large number of individuals, each of which owns a proportion of the business, as defined by the number of shares held. Shareholders enjoy limited liability restricted to their shareholding. This means that should an incorporated business run into financial difficulties, the responsibility of the shareholders towards the business failure cannot be established over and above their shareholding. The company is liable to the extent of its business assets, but the owners are only liable for their stake in the company. They stand to lose their investment in the shares, but nothing further.35 Third, the financial manager shall, in liaison with his marketing counterpart, play key roles in fundraising, taxation and auditing of the company accounts, as well as monitoring and control of the state of all aspects of the financial situation. The financial manager is in a good position to advise the board of directors on pricing and fundraising policies, to raise the capital that is needed for new investments.36 He controls the inward and outward flows of cash, and prepares detailed information for monitoring the implementation of all the budgets, ranging from master budgets for the whole organization to departmental budgets.37 For that reason, he does estimate future costs and profits, projects future risks and opportunities, plans forward for the implications of such financial estimates on the sustainability of the organization, and suggests financial policies and strategies to contain the organization’s weaknesses and the threats of its external environment.38 Hence, the financial management 33 Hui et al. (2011), Berman et al. (2006). 34 J. P. Mahajan (2010), L. Coleman (2009). 35 Bekaert and Harvey (2007). 36 Brav et al. (2005). 37 Mahajan (2010), Barrows and Smithin (2009). 38 Cardone and Fonseca (2006).

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department is a key institution towards achieving performance in water development and management. However, we need first recall the types of business organization and their importance in the whole financial system as they relate to the raising of finance.

2.3

Business Operations and Instruments Used in the Financial System

Financial systems and tools are devised to track the monetary value of all possible kinds of assets, liabilities and equity consolidated in the accounts of the organization. For that reason, the balance sheet, and profit and loss accounts are generally prepared in accordance with IFRS principles, to provide a clear understanding of the organization’s financial health.39 Table 2.2 shows a consolidated balance sheet prepared in accordance with IFRS principles, without necessarily following their accounts’ order. The balance sheet does neither show monetary values nor indicate the summary rows (totals). Likewise, not all possible kinds of assets, liabilities and equity are shown but the most usual ones only. Table 2.3 provides a detailed description of the components of the global financial system with reference to business operations. In general, the financial system comprises finance providers at the domestic level and the international arena. They help local organizations to operate and invest in their businesses through a systematic process of sourcing and allocating financial resources known as “Financing ”. The latter determines how much money is needed to achieve planned targets and match the available resources of the company or institution.40 The International Financial System (IFS) is solely the business terrain of bilateral and international cooperation agencies, development funds and banks as well as international money transfer agencies. The Domestic sub-system is divided into 3 parts, namely the micro-, meso- and macrosystems. The micro-system is dominated by microfinance organizations and foreign exchange bureaus, the local government development funds and trust funds. The meso-system encompasses operations conducted by commercial banks and national development banks, funds and insurances, stock exchange market, as well as other long-term funding facilities and 39 Bradshaw et al. (2010), J. P. Mahajan (2010), Ball (2006). 40 Agarwal (2016), Mahan (2010).

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Table 2.2 Sample balance sheet for XYZ, Ltd. as of 31 December 2016 Assets

Liabilities and shareholders’ equity

Assets

Liabilities

Current assets Cash and cash equivalents

Current liabilities Creditors (amounts falling due within one year) Accounts payable

Accounts receivable (debtors) Less (allowances for doubtful Accounts) Inventories Current income tax payable Prepaid expenses Current portion of loans payable Investment securities (held Short-term provisions for trading) Other current assets Other current liabilities, e.g., unearned revenue, deposits Non-current assets (fixed Non-current liabilities assets) Non-current liabilities (creditors: amounts falling due after more than one year) Property, Plant and Loans payable Equipment (PPE) Less: accumulated Issued debt securities, e.g., depreciation notes/bonds payable Investment securities Deferred tax liabilities (available for sale/ held-to-maturity) Investments in associates Intangible assets (patent, copyright, trademark, etc.) Less (accumulated Provisions, e.g., pension amortization) obligations Goodwill Other non-current assets, Other non-current liabilities, e.g., deferred tax assets, lease e.g., lease obligations receivable

Shareholders’ equity

Paid-in capital Share capital (ordinary shares, preference shares) Share premium Less: treasury shares Retained earnings

Revaluation reserve Accumulated other comprehensive income Non-controlling interest

Source Adapted after Luwesi and Beyene (2019), Les Dlabay and Burrow (2007), and Carter et al. (1997)

– – – – –

– – – – –

Domestic Micro-system

Domestic Meso-system

Commercial banks (e.g., City Bank) Stock exchange market National development funds (e.g., National development banks (e.g., Insurance companies (e.g., Old Mutuals,

Microfinance institutions (MFIs) Savings and loans cooperatives (SACCO) Bureau de Change Domestic money transfer (e.g., M-PESA) Local govt development/trust funds (e.g., ADF, ALTF, CDF, WSTF)

Actor

(continued)

– Provide micro-credits, micro-saving services and mutual insurances to any interested party – Supply small credits, saving services and mutual insurances to its members – Exchange foreign currencies locally – Provide small loans, saving and money transfer services to mobile phone subscribers – Provide small grants/loans for local development projects – Provide services related to savings, loans and investment – Provides a platform for trading and participation to equity – Secure long-term funding for development projects (> 5 years) – Cover social and business risks

Functions

Describing a financial system functional operations and actors

Scope of funding

Table 2.3

2 INTRODUCTION TO FINANCIAL INSTRUMENTS …

41

Actor

– Central bank – Tax revenue authority – Ministry of Finance, Economy and Planning

– International money transfer (e.g., Western Union, MasterCard, MoneyGram) – Bilateral development funds (e.g., AFD, BTC, CIDA, DANIDA, DFID, GIZ, SIDA, JICA, USAID) – International development funds (e.g., ADF, EDF, IFCN – International development banks (e.g., The World Bank Group, The BRICS, ADB, AfDB, EDB)

Scope of funding

Domestic Macro-system

International Financial system

Source Mcgill (2006)

(continued)

Table 2.3

– Regulate the monetary system, supply bank accounts, cash and valuables security for financial institutions – Collects taxes and other revenues for the State treasury – Define the monetary, financial and development policies for the country – Send and receive money transferred across the world – Donate and lend grants and other financial facilities to development projects in partner countries – Lend long-term loans/facilitate aids and borrowing from foreign countries and international organizations

Functions

42 P. W. PETER ET AL.

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securities. The macro-system is the realm of the central bank, the tax revenue authority, and customs and excises as well as the ministries of finance, economy and planning.41 Major providers of finance packages to the water companies include clearing banks, merchant banks, venture capital funds and companies, and trade suppliers, to name but a few intermediaries. Almost all water businesses have a bank account or possibly a considerable number of different accounts, with clearing banks, depending on the nature of their businesses. As the main financial institution with which a business is connected, the clearing bank is invariably the first stop in the search for finance. These banks can provide overdraft and loan facilities. Then come merchant banks. Although most of the clearing banks have merchant banking divisions, merchant banks are very different from high street banks. They essentially wholesalers-as opposed to being retailers-in the sense that they dealing directly with businesses but not individuals, to provide commercial loans and investment. Venture capital funds are useful sources of finance for businesses that present a high risk for capital investment, which makes it difficult for them to raise money through the conventional channels.42 “High-tech” businesses like “www.dot.com” companies, especially in the light of the collapses of many such companies in early 2000s or firms with highly innovative products such as “cryptos”, are particularly targeted by venture capital funds, which recourse to crowdfunding , start-up financing , “AltFinance” and several other innovative schemes.43 Finally, trade suppliers are the other main suppliers of business finance in the sense that they are businesses and can offer trade credit to their customers, even though they may be looking for finance themselves.44 In the new finance order, the government has to provide a clear regulatory framework, and ensure that the poor are served and users are protected from excessive costs. The main reason is that the water finance sector is dominated by private companies and banks, who play a key role in financing water supply and resource development, even though commercial banks and other financial institutions, such as the World Bank

41 Van Bork et al. (2015). 42 Boyneclarke Lawyers LLP (2013), Les Dlabay and Burrow (2007). 43 Boyneclarke Lawyers LLP (2013), Leonhardt (2011). 44 P. Sharma (2015), McLaney (2014), Cap-Net (2008).

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may play a similar role in financing both public and private water service providers. The private sector has ventured into investments in infrastructure and the delivery of water and sanitation services, including drinking water, sewerage and irrigation, especially when the source for water is groundwater. This private sector also invests in environmental protection as a response to regulation, legislation and specific incentives.45

2.4

Securing Finance Through Borrowing and Grants 2.4.1

Business Loans

All major banks offer a range of business loans ranging from few months up to 25 years. Some loans are at a fixed rate of interest agreed at the start of the loan period and applied throughout the period of the loan. Other types of loan may have a variable rate of interest. Here, the interest may fluctuate over the period of the loan in line with interest rates in the economy.46 Banks will usually tailor a loan package to suit the requirements of individual business and will also carry out a risk assessment on the business before going ahead with the loan. Depending upon the outcome of the risk assessment, the lender will normally require some form of security (either business or personal assets) to guarantee the loan and may require the business to issue a debenture to the bank.47 From the viewpoint of businesses, all the other types of borrowing follow the patterns of bank loans in the sense it will be compulsory to meet interest payments and make provision to repay the loan itself. In this section, we focus on two (2) major types of borrowing: loan stock and commercial mortgages. Then will follow a discussion on gearing and grants. a. Loan Stock As an alternative to making a share issue, a PLC can issue loan stock. The purchasers of this stock will not become shareholders, but will be creditors. They have lent their money to the business and expect to receive 45 Schindler (2010). 46 Oppenheimer and Hollingsworth (2014), Boundless.com. (2011). 47 Berman et al. (2006).

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regular interest payments and eventually their money back when the loan stock matures.48 The very best companies will not usually have to offer any security against their loan stock issue. Their track record of success is all the security that is necessary for them to access the loan through debentures, for instance, without securing physical assets or collateral. However, others may have to put up assets as security and run the risk of not getting any takers at all, depending on the attractiveness of the security.49 Why is it so? Lending is usually rewarded in the form of interest rate payable on a loan. As long as the loan remains unpaid, interest charges are due and will have to be paid out of the business income. This can be a serious matter if a business has substantial loan debts.50 Interest rates are always expressed as a particular percentage rate per annum (% p.a), regardless of how long the loan is due to. Thus, a loan of $10,000 for one year at an interest rate of 12% would mean that the business will have the full use of the $10,000 for the whole year and does not need to repay it until the whole year has elapsed. But he must repay the borrowed sum ($10,000) plus interest ($1,200) at the end of the year. Assuming that the business had a capital of $10,000 only and at the end of the year achieves a deficit of $200, it might be difficult for it to reimburse the $11,200 required for the loan unless it sells some of its assets. That is the essence of security. In most cases, lenders will want some sort of security from a borrower. All lending involves risk and security is designed to reduce the lender’s risk. If the business cannot repay the loan or keep up the interest payments, the lender can seize the security and sell it to recover the loan. Business assets which meet this criterion include buildings and stock. However, if the business itself does not have sufficient value of security to back the loan, the personal assets of the business owners might fill the gap.51 It happens that the lender did not request for a security from the borrower prior to the lending and that the latter is incapable to service the loan. In one sense, if this happens, it means that the lender may have

48 Droms and Wright (2010). 49 Coleman (2009), Berman et al. (2006). 50 Atieno (2001). 51 Hui et al. (2011), Harvey and Ferson (1991).

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made a mistake in lending to the business in the first place. Something has gone wrong with the risk assessment process. The whole purpose of risk assessment is to ensure the lender that the borrower is likely to repay any loan. Security, then, is simply a form of insurance should the assessment go wrong.52 But what makes a security effective? Not all assets are good security. For an asset to be good security it must have a number of features: (i) there should be an organized market for the type of asset involved in case it needs to be sold; (ii) the value of the asset should be something which can be calculated; and (iii) the asset’s value should not be subject to big changes over the loan period.53 b. Commercial Mortgages Some companies may own the freehold of real estate premises in the form of factories, office accommodation or warehouses. As we shall see later, these assets will have a value in the company’s accounts. If the business wants to raise a capital sum for investment in new assets, it could take out a commercial mortgage with a property company. Normally the maximum mortgage will be between 60 and 70% of the property value. The premises themselves are used as security, and the mortgage loan will usually be for the long term.54 The advantage of this arrangement is that the business can continue to use the premises as before, but must service the commercial mortgage in terms of interest payments and eventually repaying the capital sum. Another plus is that any increase in property values over time still belongs to the business and not the property company to which it has been mortgaged.55 c. Gearing The gearing of a company refers to the balance between owners’ funds and borrowed funds. More strictly, it is the proportion of loan finance to total capital employed or the ratio of fixed assets to interest and fixed 52 Hui et al. (2011), Kareem and Krishnan (2011). 53 Signoriello (1991), R. Atieno (2001). 54 Bushee (2014), Signoriello (1991). 55 Boundless.com (2011), F. J. Fabozzi and P. P. Drake (2010).

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dividend capital. That is the ratio of debentures plus preference shares to ordinary share capital (equity) plus reserves.56 The company issuing a gearing may have to pay important debenture interests regardless of profitability. The sources of finance used by companies to raise funds will, therefore, be affected by its current gearing. 2.4.2

Grants for Capital Development

Governments and their development partners will provide financial support to businesses in certain circumstances in the form of development aids and other subsidies for capital development. The main advantage of grants is that they constitute free finance—there are no interest charges or repayments of capital.57 However, depending on the circumstances, individual government’s policies may be constrained by wider considerations when it comes to international development cooperation. For example, the UK governments’ politics must not contravene European Union rules. The major grants are related to international policies without sidelining regional and national policies. Priority is given to regions of a country that lag behind others in terms of development, employment and living standards. This may be explained by the fact that the predominant industry in the region is in decline. Businesses that are located in these regions may get grants, to enable them acquire new investment and keep them in the region, in case they threaten to relocate. Nonetheless, there are usually conditions attached to grants, including guarantees of continued business and the creation of jobs.58 Table 2.4 gives an overview of different types of grants available for development activities. It shall be noted that financing water utilities requires realism. The traditional “3Ts” (Taxes, Tariffs, Transfers) are finite and remain the main sources of financing governmental entities. Taxes and tariffs take many forms and are collected in many ways. Public utilities only have income from tariffs or budget allocations (tax). Foreign aid has increased but is limited and unpredictable; it has thus to be used strategically. They are increasingly becoming Output-based Development Aid (ODA) and remain

56 Droms and Wright (2010), Signoriello (1991). 57 Kareem and Krishnan (2011). 58 Kareem and Krishnan (2011), Fabozzi and Drake (2010).

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Table 2.4 Classification of grants Scope of funding

General current grants

Capital grants

Domestic

– Development aids and other subsidies – Loans to private companies, NGOs and individuals – Loans to local governmental institutions and corporations – Treasury bills – Long-term securities e.g., Notes/ bonds payable – Other types of lending to local governmental institutions and corporations – Development aids and other subsidies – Loans to foreign governments and corporations’ loans to private Co, NGOs and individual – Treasury bills held abroad – Long-term securities e.g., Notes/ bonds payable abroad – Other lending to foreign governments’ institutions and corporations

– Shares/capital stock in private enterprises and joint ventures locally – Shares/capital stock held in public enterprises locally – Other types of equity participation locally

Abroad

– Shares/capital stock held in foreign governmental corporations abroad – Share/capital stock held in private Co and joint ventures – Other types of equity participation abroad

Source Adapted after Droms and Wright (2010) and Mcgill (2006)

very limited financing sources in terms of portfolio. Also, these transfers from development partners are drawn from taxes paid by workers in donor countries and loans have to be paid back from taxes or tariffs in the host country. But the government face stark choices: • • • • •

Renege on commitments? Access more ODA? Raise more tax and/or divert it from other uses? Increase tariffs for water services? Attract private investment and thus raise tariffs?

These are some of the bottlenecks that the government has to address prior to planning for capital development in the water and sanitation sector.

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Concluding Remarks

Financial organizations need a predictable and stable environment to allow them work properly. The latter is largely featured by low investment risks and high financial returns. That is why good governance and justice systems make finance more attractive and are crucial to the functioning of any financial system. Commercial lenders are more concerned about the reimbursement of their money. Therefore, they have to minimize the risk of the borrower becoming bankrupt or the loan being declared dubious loan.59 They have to request that collateral or security be provided for the loan in order to ensure equitable charge on the assets for the running period of the loan. In such a case, debentures can be issued to tackle the ongoing concern. To ensure risk mitigation n the issuance of a loan, commercial lenders have to scrutinize the level of operation (i.e. town, municipal city, county, etc.), the size of the company (i.e. turnover, number of connections, licence area, etc.), the degree of corporatization (i.e. owners observation or interference of arms-length principle, professional team running operations, etc.), creditworthiness (which depends on cost recovery), legal status (e.g., validity and running period of the licence), the potential for cost coverage and surplus, the allowed ambit of operation in the regulated sector, and any other relevant information for securing the capital return.60 Hence, PSPs and WSPs are thus urged to adequately select efficient financial instruments to ensure the sustainability of their services based on a risk assessment and mitigation of the length of their projects (long and increasing risk by nature), the rate of return (generally low for public goods), and contractual risks (because of long duration), etc. They shall also embrace a societal marketing culture that enhances revenue collection through the enforcement of water charges and fees and the application of awareness creation strategies focusing on water scarcity, and “user-pays” and “polluter-pays” principles.

59 Moser (1998). 60 Les Dlabay and Burrow (2007), FASB (1998).

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Dowla, A. 2006. In credit we trust: Building social capital by Grameen Bank in Bangladesh. The Journal of Socio-Economics 35: 102–122. Droms, W.G., and J.O. Wright. 2010. Finance and accounting for nonfinancial managers: All the basics you need to know. New York: Basic Books. Elagib, N.A., and A.S.A. Abdu. 1997. Climate variability and aridity in Bahrain. Journal of Arid Environments 36 (3): 405–419. EU [European Union]. 2014. Making the best use of EU money: A landscape review of the risks to the financial management of the EU budget. Luxembourg: ECA [European Court of Auditors], Publications Office of the EU [European Union]. Available at: http://www.eca.europa.eu/Lists/ECADoc uments/LR14_02/QJ0614039ENN.pdf (Accessed on 17 May 2015). Fabozzi, F.J., and P.P. Drake. 2010. The basics of finance: An introduction to financial markets, business finance, and portfolio management. Hoboken, NJ: Wiley. FASB [Financial Accounting Standards Board]. 1998. Statement of Financial Accounting Standards No. 133: Accounting for Derivative Instruments and Hedging Activities. Norwalk, CT: Financial Accounting Foundation. FSB [Financial Stability Board]. 2013. OTC derivatives markets reforms, Fifth Progress Report. April 15. Available at: www.financialstabilityboard.org/pub lications/r_130415.pdf (Accessed on 17 May 2015). Graham, J.R., and C.R. Harvey. 2001. The theory and practice of corporate finance: Evidence from the field. Journal of Financial Economics 60 (2): 187– 243. Harvey, C.H., and W. Ferson. 1991. The variation of economic risk premiums. Journal of Political Economy 99: 285–315. Heckinger, R., and D. Mengle. 2013. Derivatives overview. In Understanding derivatives: Markets and infrastructure, FRBC [Federal Reserve Bank of Chicago]. Chicago, IL: Federal Reserve Bank of Chicago. Available at: https://www.chicagofed.org/publications/understanding-deriva tives/index (Accessed on 02 August 2015). Heckinger, R., and I. Ruffini. 2013. Hedging. In Understanding derivatives: Markets and infrastructure, FRBC [Federal Reserve Bank of Chicago]. Chicago, IL: FRBC. Available at: https://www.chicagofed.org/publications/ hedging/index (Accessed 02 August 2015). Hui, Y.C., H. Genberg, and T. Chung. 2011. Funding liquidity risk and deviations from interest rate parity during the financial crisis of 2007–2009. International Journal of Finance and Economics 16: 307–323. IMF [International Monetary Fund]. 2014. World Economic Outlook 2014— Recovery strengthens, remains uneven. Washington, DC: International Monetary Fund, Publications Service. Available at: file:///C:/Users/ naistip2/Desktop/IMFWorld%20Economic%20Outlook%202014-text.pdf (Accessed on 17 May 2015).

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Kareem, A., and C. Krishnan. 2011. Public finance. Malappuram: Calicut University. Available at: http://www.universityofcalicut.info/SDE/BA_eonomics_I_ em_ublic_Finance.pdf (Accessed on 18 July 2013). Kroszner, R. 1999. Can the financial markets privately regulate risk? The development of derivatives clearing houses and recent over-the-counter innovations. Journal of Money, Credit and Banking 33 (August): 569–618. Leonhardt, D. 2011. The paradox of corporate taxes. Economic Scene, February 1. Available at: http://www.nytimes.com/2011/02/02/business/economy/ 02leonhardt.html (Accessed on 09 November 2012). Les Dlabay, J., and J.L. Burrow. 2007. Business finance. Mason: South Western. Luo, M.M. 2011. A bright side of financial constraints in cash management. Journal of Finance Corporate 17 (2011): 1430–1444. Luwesi, C.N., and A. Beyene, eds. 2019. Innovative water finance in Africa: A guide for water managers, vol. 2. Uppsala: Nordiska Afrikainsitutet. Mahajan, J.P. 2010. Business organisation and management. Mumbai: Himalaya Pub. House. Mathenge, M.M., C.N. Luwesi, C.A. Shisanya, I. Mahiri, R.A. Akombo, and M.N. Mutiso. 2014. Community participation in water sector governance in Kenya: A performance based appraisal of community water management systems in Ngaciuma-Kinyaritha catchment, Tana basin, Mount Kenya region. International Journal of Innovative Research and Development (IJIRD) 3 (5): 783–792. Mcgill, R. 2006. Achieving results: Performance budgeting in the least developed countries. New York: UNCDF [United Nations Capital Development Fund]. McLaney, E. 2014. Business finance. New York, NY: Pearson Education Limited. Moser, J. 1998. Contracting innovations and the evolution of clearing and settlement methods at futures exchanges. Working Paper, No. 98-26. Federal Reserve Bank of Chicago. Available at www.chicagofed.org/digital_assets/pub lications/working_papers/1998/wp98_26.pdf. OECD [Organisation for Economic Co-Operation and Development]. 2012. OECD Environmental Outlook to 2050—The consequences of inaction. Paris: OECD Publishing. Available at: https://doi.org/10.1787/978926412224 6-en (Accessed on 17 May 2015). Oliver, P., F. Mazza, and D. Wang. 2016. Water financing facility—Lab instrument analysis. London: Climate Policy Initiative, Global Innovation Lab for Climate Finance, June 27. Available at: http://climatefinancelab.org/wpcontent/uploads/2016/01/160623-Lab-WFF-Report.pdf (Accessed on 13 March 2017). Oppenheimer, L., and D. Hollingsworth. 2014. A primer on borrowing. Available at: http://www.thirdway.org/publications/506 (Accessed on 05 May 2014).

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Schindler, K. 2010. Credit for what? Informal credit as a coping strategy of market women in northern Ghana. Journal of Development Studies 46 (2): 234–253. Sharma, P. 2015. Notes on company shares: definition, types and classification. Available at: http://www.yourarticlelibrary.com/accounting/share/notes-oncompany-shares-definition-types-and-classification/70440/ (Accessed on 13 March 2017). Signoriello, V.J. 1991. Commercial loan practices and operations. New York, NY: Bankers Publishing Company. Solo, T.M., E.P. Eduardo, and S. Joyce. 1993. Constraints in providing water and sanitation services to the urban poor Office of Health. WASH Technical Report No. 85 (WASH Task No. 338). Washington, DC: USAID [U.S. Agency for International Development], Bureau for Research and Development. van Bork, G., H. Gietema, I. van de Velde, and M. Zwart. 2015. Innovative financing and positioning of the water sector—A toolbox with practical cases for Aid & Trade and water sector practitioners. Rotterdam: Netherlands Water Partnership, TRAID. World Bank. 2006. Approaches to private participation in water services—A toolkit. Washington DC: PPIAF [Public-Private Infrastructure Advisory Facility] & The World Bank, IBRD [The International Bank for Reconstruction and Development]. Available at: http://siteresources.worldbank.org/ INTINFNETWORK/Resources/ApproachestoPrivateParticipationWaterServi ces.pdf (Accessed on 17 May 2015). World Bank. 2014. Applying result-based financing in water investments. Washington, DC: Water Partnership Program and GPOBA [Global Partnership on Output-Based Aid], The World Bank Group, Water Papers 89326, May. Available at: http://documents.worldbank.org/curated/en/862681468326999 086/pdf/893260WP0Box380ng0Water0Investments.pdf (Accessed on 17 May 2015).

CHAPTER 3

Innovative Instruments and Contractual Arrangements to Offset Bottlenecks for Financial Flows in the Water Sector Cush Ngonzo Luwesi, Mamudu Abunga Akudugu, Philip Wambua Peter, Floribert Ntungila Nkama, Atakilte Beyene, and Honoré Mbantshi Mingashanga

Abstract This chapter focuses on a detailed novel apparel of the financial instruments and contractual arrangements for risks allocation, operations support and efficiency maintenance. It shows how these schemes are adapted to market operations to accelerate access to commercial credits and other climate funds from the international donor community. It unveils other mechanisms that complement commercial finance and maximize the benefits of efficient water finance management. These

C. N. Luwesi University of Kinshasa, Kinshasa, Democratic Republic of the Congo M. A. Akudugu University for Development Studies (UDS), Tamale, Ghana P. W. Peter Kenyatta University, Nairobi, Kenya

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 C. N. Luwesi and A. Beyene (eds.), Innovative Water Finance in Africa, https://doi.org/10.1007/978-3-031-38234-5_3

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encompass building partnerships with the banking sector, microfinance, NGOs and private companies as well as governmental agencies, bilateral and multilateral development partners. Keywords Borrowing · Concessions · Pooled finance · Public–Private Partnerships

Box 3.1: Lessons Learned • Water infrastructure has a value added in irrigation and the production chains. That is why its finance creates rivalry and social exclusion among sectors suffering from climate change. Finance is a scarce resource in the water and sanitation sector, and Water and Sanitation Providers (WSPs) have to cope with unpredictable and unstable finances, which are largely risky for returns. • Investment in urban and rural water projects attracts high cost of capital for lenders, who often attempt to maximize their profit through higher interest rates and collaterals, while reducing the likelihood of default on loans. However, WSPs whose access to loans are collateralized may be obliged to pay back the loans in a timely manner to avoid confiscation of their assets. • Where the credit market requirements are unable to meet, borrowers have designed some blended and alternative sources of finance to minimize the cost of capital and increase access to credit, owing to

F. N. Nkama University of Kinshasa, Kinshasa, Democratic Republic of the Congo e-mail: [email protected] A. Beyene Nordic Africa Institute, Uppsala, Sweden H. M. Mingashanga University of Kinshasa, Kinshasa, Democratic Republic of the Congo e-mail: [email protected]

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adverse effects of climate change on water investments. Such schemes include the issuance of green bonds and the raising of equity from the Stock Exchange Market, mutual revolving funds, group microcredits, solidary loans or bound lending from the “table banking” to develop technological solutions for water harvesting and supply…. • Additional funding may be obtained from blending traditional 3Ts with joint ventures to raise capitals through PPPs (public–private partnerships). Some companies have recourse to commercial loans so long as they are able to generate sufficient cash flows and return for full cost recovery, to meet their financiers’ requirements for collateral. Many other novelties were introduced in recent years to make the finance flowing in the water and sanitation sector including pooled financing, guarantees and insurance for borrowing, transfers of repayment capacity, and modern concessional arrangements. • There is thus a need for foresight, good governance and fairness for water and sanitation provision to ensure the 3As in finance (Availability, Accessibility and Affordability) through adequate planning, development and management so as to mitigate the risk of the investments. The government should explore different ways of ensuring access to water infrastructure credit, in order to avoid credit rationing caused by the need for heavy collaterals, which are generally required by formal financial institutions.

3.1

Introduction

Nowadays, the financial system evolves around the private sector to ensure the sustainability of finance allocated to water companies and other organizations managing related resources: that is a great innovation. The growing involvement of the large and/or international private sector in water development and management is justified by various motives, namely financial risks, political effectiveness, technological efficiency, and strategic and operational support. Besides showing how finance has evolved in the water sector, this chapter responds to the following questions: • • • •

How do you do a joint venture to raise capitals in PPPs? What types of modern concessions exist in the water sector? What mix of financial products can be used instead of the 3Ts? How to raise equity from Stock Exchange Market?

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3.2 Evolving Financial Sources in the Water and Sanitation Sector Water resources development in Africa deserves to be treated as an urgent agenda due to its growing scarcity, sectoral rivalry and social exclusion for accessing to it, as well as its value added in the production chains in the course of climate change. This infrastructure development and the provision of its related services for drinking, sewerage and irrigation as well as public water management require a lot of funding that goes beyond revenue from Tariffs, public budget Taxes and Transfers from development partners (3Ts). Besides, due to the weak governance structures dominated by corruption, political interference and lack of transparency and accountability in financial matters, the water sector stems as unproductive and is given low priority by central governments. Hence, most small-scale water companies have turned to private businesses to get finance that is tailored to their needs, including microfinance loans, joint venture capitals, investment from different types of concessions and a mix of financial products obtained from blending traditional 3Ts sources with public–private partnerships (PPPs). However, some large-scale companies do not shun to recourse to commercial loans so long as they are able to generate sufficient cash flows and return for full cost recovery, and to meet the financiers’ requirements for collateral.1 Hence, nowadays, the financial system evolves around the private sector to ensure the sustainability of finance allocated to water companies and other organizations managing related resources: that is a great innovation. The growing involvement of the large and/or international private sector in water development and management is justified by various motives, namely financial, political, technological and strategic reasons.2 First, companies find it easier to recourse to the private sector to fill the gap in some component of the project cost, since governments often pass on the cost and work of raising funds. Besides, private companies are typically better at handling risks, hence partnering with them enables water companies share their risks (Financial reasons). For political reasons, it is necessary for water companies to hide from politicians, whose unpopular reform agendas (e.g., raising tariffs, collecting unpaid

1 Beyene and Luwesi (2018). 2 AGRA (2022), Taylor (2016), Mahajan (2010).

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bills, reducing the workforce) tend to undermine the profitability of these private companies.3 Moreover, many water companies, if not large or international, lack the necessary expertise to bring innovations and essential know-how in some technical and economic fields (technological and strategic reasons).These companies receive facilities from the private sector to boost their businesses. However, the involvement of these “Small-scale” or communitylevel private sector in financing the water sector often depends on government economic policies, which shall enable access to finance by the poor. It is in such a context that microfinance and community-led banks allow poor people to finance small-scale water infrastructure, for both domestic and agricultural use.4

3.3 Privatization and Concessions for Financing Water and Sanitation The main type of private involvement in the water sector is known as “privatization” or “Public–Private Partnerships” (PPPs) in water services provision. These include private financing sources and such schemes as contracting out, leasing, traditional and modern types of concessions, joint ventures and divestiture.5 3.3.1

Private Financing Sources

WSPs are urged to adequately select efficient financial instruments to ensure the sustainability of their services based on a risk assessment and mitigation of the length of their projects: the longer the period, the higher and increasing the contractual risk will be, the lower the return rate (especially for public utilities), the higher the credit risks with the long duration, etc. To ensure risk mitigation in the issuance of a loan, commercial lenders are more concerned about the reimbursement of their money.6

3 De Aghion and Morduch (2005). 4 Taylor (2016), UN (2015). 5 Van Bork et al. (2015), Trabacchi and Mazza (2015). 6 Cap-Net (2008), Moser (1998).

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Therefore, water companies have to minimize the risk of the borrower becoming bankrupt or the loan being declared dubious loan. They have to request that collateral or security be provided for the loan in order to ensure equitable charge on the assets for the running period of the loan. In such a case, debentures can be issued to tackle the ongoing concern. Commercial lenders have to scrutinize the level of operation (i.e. town, municipal city, county, etc.), the size of the company (i.e. turnover, number of connections, license area, etc.), the degree of corporatization (i.e. owners observation or interference of arms-length principle, professional team running operations, etc.), creditworthiness (which depends on cost recovery), legal status (e.g. validity and running period of the license), the potential for cost coverage and surplus, the allowed ambit of operation in the regulated sector and any other relevant information for securing the capital return.7 3.3.2

Public–Private Partnerships (PPPs) for Water and Sanitation Finance

Public–Private Partnerships (PPPs) in the water and sanitation sector include traditional subcontracting and concessional types, joint ventures and divestiture. Contracting out is the least controversial form of private sector involvement in the public sector, and occurs when a public work sub-contracts certain functions to private firms, e.g. management or construction. Leasing is relatively common in French-speaking countries and occurs when the water system remains in public ownership, but is leased to private operators.8 Traditional types of concessions entail that the use of the system is conceded to private operators for a certain period of time (e.g. 20– 25 years), while the assets remain for public ownership; the private operators are expected to invest in specified improvements and expansion of the supply system. However, modern types of concessions include such schemes as the BOT (Build, Operate, Transfer) and BOOT (Build, Own, Operate, Transfer), BOL (Build, Operate, Lease) and BOS (Build,

7 Les Dlabay and Burrow (2007). 8 World Bank (2006).

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Operate, Sell). They are usually conceded for new facilities, which are handed over to a public organization after a specified number of years.9 Joint ventures occur in operating companies, when a business entity is created by two or more parties, with a shared ownership, shared returns and risks, and a shared governance. Finally, divestiture is an extreme form of privatization, in which full ownership of assets of a large-scale company is transferred to private shareholders, with stringent public regulations, as it is the case in England and Wales.10

3.4 Emerging Mix Financial Products for Financing Operations 3.4.1

Project Facilities

Due to delays in the design and submission of proposals for grants, donors have resolved to award grants to WSPs for project preparation facilities and enable them prepare and submit bankable projects in an accelerated manner. These grants also help in establishing institutions at the national level which can channel funds from both private and public institutions to the water sector, in order to finance small projects using flexible methods.This has proved to be a very useful tool for strengthening the governance and institutional frameworks of all the water sector operators so as to inspire confidence in an investor.11 3.4.2

Guarantees and Insurance Products

Guarantees and insurance products are useful for risk mitigation and are another set of innovative finance, fairly suitable for large projects. Guarantees are a form of risk mitigation that can be used with debt or equity to provide coverage against political, regulatory and sovereign risks associated with large-scale projects at the national level. They improve the creditworthiness of a borrower and may lower the cost of debt. Yet, very few lenders accept guarantees for borrowing by WSPs, owing to political interference in the increase of tariffs and the weak governance of

9 Taylor (2016), GWP (2005). 10 AGRA (2022), Cardone and Fonseca (2006). 11 Bekaert and Harvey (2007).

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WSPs, leading to low-cost recovery. The requisite counter-guarantee by government may also lead to interference with a country’s debt ceiling.12 3.4.3

Pooled Financing and Transfers of Repayment Capacity

Pooled financing constitutes the sixth set of financing innovations wellknown in assisting small operators to access finances, which would not otherwise be available to them. It helps in strengthening the balance sheet of undercapitalized water operators. Basically, these are grouped financing vehicles enabling a large number of small borrowers with small projects to access finance for combined use. They often require transfers of repayment capacity, making a hallmark and raising equity. Transfers of repayment capacity are done to the portfolio rather than to individual projects. Hallmark is the creation of a reserve fund to mitigate the risk of cash flow problems.13 3.4.4

Commercial Financing

Commercial financing is intended to increase creditworthiness of water and sewerage companies. They are innovative financing sources involving regular loans from the commercial banks or direct lending from public and private financiers (GWP 2005). Commercial borrowing is only good for bridging the gap from 3Ts’ finance, owing to its covenants (contractual restrictions placed on a borrower) and the market interest rates. Classes of covenants include restrictions targeting operating activities, investment expenditure, asset sale, cash pay-outs, limitations on debtlike contracts or changes in capital structure (financing), reporting and disclosure, preservation of collateral or seniority, management control and ownership, and ongoing financial concerns (liquidity, debt and leverage, and cash flow).14 These commercial financing covenants have positive and negative aspects that set minimum standards for borrower future conduct and performance. Negative covenants entail that the borrower is restrained

12 AGRA (2022). 13 GPOBA (2016). 14 Oppenheimer and Hollingsworth (2014).

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from particular actions such as new borrowing, expenditure on unauthorized items while positive covenants encourage the borrower to meet certain standards, such as discharging license requirements, providing information, paying taxes.15 Consequently, borrowers with no credit record are overburdened with heavy restrictions and discouraged to seek loans from commercial banks, while those with strong credit history attract fewer covenants. In all the cases, the violation of covenants leads to action by the lender, which may accelerate loan repayment or lead to penalties or imposition of constrictions in operations.16

3.5 Capital and Debt Raising from the Stock Exchange Market The financial market has been designed to attract new savings and placements in order to facilitate the development of the company’s assets. It encompasses two principal clusters or compartments, namely the monetary market and the capital market . These financial markets are mainly designed to ensure that the financing of short-term assets, equity (capital shares) and other long-term stocks (monetary gold and bonds) are availed in time and size. While the monetary market accommodates the financing of short-term reserves and assets through the formal banking system, cooperatives, saving schemes and microfinance institutions, the capital market constitutes a place where economic agents having long-term financing needs can meet those having finances in excess to find a suitable remuneration.17 The capital market comprises two chambers, the primary market , where new stocks or notes are issued, and the Stock Exchange Market (brokering system), where the already issued stocks are negotiated and rated. Individual suppliers (savers) intervene in an indirect way in the primary market; their savings are being converted onto stock in the exchange market by their stock-brokers (managers) and part of it covers securities, especially when it comes to new companies issuing the shares

15 GPOBA (2016). 16 Oliver et al. (2016). 17 Asteriou and Siriopoulos (2000).

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or bonds. These are mainly institutional investors, with heavy financial powers, who play a significant role in this market. That is why the Stock Exchange Market, the secondary financial market, ensures the direct meeting between the savers, on the financing supply side, and the economic agents seeking funds (individual or private companies, and State or public organisms), on the financing demand side.18 Generally, these institutional investors mainly consist of insurance companies, pension funds and public saving and investment organizations created by the financial institutions and banks. These organizations can also massively intervene in the secondary market to control the courses of stocks and avoid a throughfall, for instance. That is why they are referred to as the police of the Stock Exchange Market.19 The Stock Exchange Market enables a change in the financial structure of the large companies, including the distribution of capital among different shareholders. This allows for alliances to form, reorganizations, fusions and acquisitions to take place, as well as the repurchase of companies and the IPOs (Initial public offer) to be tendered. Equity is raised to strengthen the balance sheet and provide a sound basis for leveraging additional finance. It shall be noted that investors may swap debt for equity. In such a case, payment service providers (PSP) would contract equity contributions for risk premium to build expected returns so that they do not lead to unfavourable tariff increases.20 African stock markets are characterized by high stock volatility indices with very little diversity of products, relatively lower sizes and higher risks than similar markets. On a global scale, the weight of these African stock markets remains insignificant. According to the Corporate Council on Africa, African markets are all micro-markets, except for the Johannesburg Exchange Market. Their capitalization level does not go beyond 1% of the global capitalization and less than 0.3% of the global volume of transactions. The primary equity markets are generally not very active and are characterized by a weak transfer of the capital shares on the market, a majority of capital cessions being done by private arrangements or through privatisations.21

18 Heckinger and Mengle (2013). 19 Atje and Jovanovic (1993). 20 Les Dlabay and Burrow (2007). 21 G. Lakhotia (2017), Azam et al. (2001).

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Besides, the African equity markets are very illiquid and characterized by a very weak turnover rate. As a result of this illiquidity, the African exchange markets lag behind the evolutions of global stock exchange markets. In such kind of environment, very few companies dare transacting shares and more unlikely green bonds and other debt stocks in the exchange market, and it shall not be otherwise said of water and sanitation companies. Yes! Very few public water utilities dare raising capital from the Stock Exchange Market. The major reasons are liquidity risks burden with higher structural and operational costs, lower tariffs and decreasing trend of profits, thus resulting in poor financial performance.22 As a matter of illustration, we examine how Namibian Water Utility (NamWater) managed to transact in the stock exchange market, unlike other African water utilities. In effect, NamWater passes on its costs fully to its customers. Consequently, water tariffs in Namibia are among the highest in Africa. At its inception, some customers failed to pay their water bills, and the company recorded poor performances. But since 2003, NamWater has turned to the Namibian stock market for financing its capital and improve its management, by cutting its operational costs. Nowadays, NamWater bears a large share of its expenses and refinances its cost to a large extent through issuance of notes (stocks) in the Namibian stock market. As of 2015, interest paid on five year notes issued in the same year was 9.05 percent and the company has been rated BBB by Fitch agency. To maintain its stand in the stock market, NamWater has consolidated his tariffs, besides managing carefully its costs. The first block of the residential water tariff in Windhoek costs N$13.86 (USD 0.92) per cubic meter in 2016. The water tariff includes a fixed monthly charge of N$74.43 (USD 5), which is independent of consumption. The first consumption block includes a basic consumption of 200 litres per household and per day, an amount that is high for small households but can be low for large households. Higher consumption is charged at a higher tariff that was N$20.93 per cubic metre (USD 1.40) in 2015. The municipality bills water together with electricity, solid waste collection and the property tax. Residents of informal settlements receive water through public standpipes equipped with prepaid water meters. Prepaid customers pay about

22 Sacerdoti (2005), Winpenny (2003).

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USD 1.9 per kilolitre (cubic meters) or about USD 0.038 per 20-litre container. Water tariffs in other municipalities vary. Large municipalities receiving bulk water from NamWater have to recover their costs using tariffs. These include the cost of bulk water supply and that of water distribution to the customers through the networks. A few smaller municipalities that have their own water sources are not subject to this constraint. For example, the municipality of Oranjemund provides water for free and thus has by far the highest water use in the country with an astonishing 2,667 litres/ capita/day. Bulk water tariff charged by NamWater vary slightly across the country depending on the cost of supplying a specific location, but these differences are not fully passed on to municipalities. Thus, NamWater effectively cross-subsidizes localities with high supply costs with surpluses from localities with lower supply costs.

3.6 Green Bonds Issuance Versus Green Funds Grant in Africa: The Bottlenecks The Green Bond Principles (GBP) define a “Green” asset or project as the one that can be financed thanks to a Green Bond issuance. A Green bond is a debt instrument issued by a company (financial or non-financial) or a public entity (city, region, government, development bank, etc.) on the financial markets to solely finance projects or assets that positively contribute to the environment. Green investors and green bonds issuers thus orient their businesses towards sustainable activities to finance their path to ecological transition through a new debt instrument. As a new financial instrument serving a novel approach of sustainable financing, Green bond issuances spark diversified reactions in the investors’ community. For some, green investors credibly signal their commitment towards the environment and sustainable financing of their businesses by issuing green bonds. But for others, it is irrational for a company to recourse to borrowing and reduce its profits in order to limit its environmental footprint, in a globalized world where competition between companies is becoming more and more intense over time.23 The academic literature on Green Bonds is more recent but there is evidence of their issuance, the market interpreting a debt issuance

23 Lebelle et al. (2020).

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in the water and environment sectors as a favourable new factor for corporate financing (Box 3.2). Almost all of the published articles focus on the significance of abnormal returns from green bonds versus traditional (non-Green) bond issuances with regard to the firm characteristics, notably profitability, growth opportunities, asset tangibility, size, managerial ownership… and the resulting stock market reactions. If their market processes and technicalities remain the same as that of conventional bonds, green bonds focus on an environmental perspective, the use of proceeds that enable positive externalities for the environment, and the commitments made by the issuer to support sustainable development.24 Box 3.2: Project Bond Case Study—South Africa’s Towsrivier Solar Project The 2008 financial crisis has resulted in stricter regulations disenabling banks to fund infrastructure projects using traditional lending and debt requirements alone. Recent surveys suggest that infrastructure is being viewed as an asset on its own and funds allocation to this investment class is expected to increase under the Green Bonds scheme. The Touwsrivier Solar Project Bond is an innovative example of using fixed income capital markets to finance infrastructure projects. South Africa has a developing financial system with a growing base of institutional investors worth ZAR 3 trillion in assets under management according to Deloitte Reports (2015, 2022). The bond was issued in the local South African Rand currency (ZAR) with a face value of 1 billion. It was designed to finance the construction of a 44 MWp Concentrated Photovoltaic Plant in an economically impoverished part of the country, which qualifies to be called as a “Green Bond”. The bond that was issued with a 15-year maturity and 11% coupon had an amortizing repayment structure similar to a mortgage, which made it an innovative feature. As mentioned earlier, the bullet structure of typical project bonds can be difficult to adapt to project finance and can create a refinancing risk. This structure effectively deals with this risk. Another novelty is that there were some incentives in financing this project through South Africa’s REFIT programme, which allows the national electric utilities to purchase power from renewable sources at predetermined prices through the backing of South African Department of Energy. This has an advantage of raising the creditworthiness of the borrower and

24 Deloitte (2022), Lebelle et al. (2020).

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the quality of the bond issued. Hence, this bond was rated Baa2 by Moody’s at issuance. Since then, it has opened up new financing avenues for infrastructure development by reducing the costs passed through the Internal Return Rate (IRR) of such projects through access to institutional bond market. What an innovative way of financing climate infrastructure projects! Source Deloitte (2015, 2022)

More recently introduced in the US market in 2007 by the World Bank a “climate-aligned bond”, this new public offering of convertible debt or exchangeable bonds, encompassed a set of new corporate finance practices dealing with cutting industrial pollution and other environmental externalities, where the natural environment is financially material to the company operations, using funding from a long-term debt raised on the Stock Exchange Market. Hence, these innovative bonds help limit a firm environmental footprint over the short and medium terms while remaining competitive in the market so as to improve its profits in the long run. These green bonds finally attract an investor clientele that is sensitive to the environment.25 Hence, Flammer (2018) concludes that green bonds yield positive announcement returns and the overall results indicate that green bonds are effective to long-term value creation in climate-friendly project. As this value and operating performance improve in the long run, many companies are keen to invest the proceeds in projects that improve their environmental footprint. The resulting higher environmental ratings and lower CO2 emissions contribute to an increase of capital ownership and green investments ownership in the long run. This provides an incentive for increased green innovations and green investments in corporate management in the long-term. The Climate Bond Initiative (CBI) was first the only entity recognized by the World Bank to certify a bond as “climate-aligned”. This international organization struggled to mobilize the capital market for climate change solutions and the issuance of such bonds from supranational entities, development banks and agencies for almost a decade, until the publication of the first version of the Green Bond Principles (GBP) 25 Flammer (2021).

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in 2014 by the International Capital Market Association (ICMA). Since then, Green Bonds have been generally recognized in the western capitalist countries as a serious and an interesting financing tool to finance environmental-friendly purposes and address the sparkling issue of climate change.26 However, African countries like most developing countries are still fighting increased poverty levels and low access to basic needs (food, water and energy), with an ever-growing population. They do not recognize “green borrowing ” as a fair mechanism to fight climate change. Rather, they believe that they are the world’s poorest bearing the largest burden of the global warming, to which their contribution has remained insignificantly below 5%.27 Thus, their push for a mix of “green grants” from rich to poor countries to meet the cost of adaptation through reinsertion of climate refugees, support of losses and damages from climate impacts, transfer of technology for rehabilitation of carbon sinks and ecological systems, etc. It is alleged that the Kyoto protocol enabled a transfer of $303.8 billion from rich countries to poor countries over the period 2006–2018 through the Clean Development Mechanisms (CDM), while the Green Climate Fund (GCF) from the Paris Agreement amounted to $18.2 billion over the period 2014–2021.28 Most of climate finances mainly comprise mitigation funds from the energy sector (over 90%), adaptation funds and others (less than 10%). These sources of finance encompass a set of grants and compensations, like those generally pooled under the Global Environment Facility (GEF) and other related international institutions, including Adaptation Funds (AF), “Green Climate Funds” (GCF), the Green Water Credits (GWC), Payments for Environmental Services (PES), “Clean Development Mechanisms’’ (CDM), Clean Technology Funds (CTF), Climate Investment Funds (CIF), Forest Investment Funds (FIF), funds for Reducing Emissions from Deforestation and forest Degradation (REDD+) and other Mitigation Funds (MFs). Whereas most of the mitigation funds are acquired through payable loans, African countries receive about 20%

26 UNFCCC (2018). 27 Trabacchi and Mazza (2015), Sacerdoti (2005). 28 GCF (2022).

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of the funding, while most of the recipients are concentrated in a few countries, including South Africa, Morocco, Nigeria, Egypt, Kenya, etc.29 Even where a country has to borrow climate funds, there are some bottlenecks from the donors, the governments and the proponents that hinder Africans to have easy access to the loans. Challenges for channelling climate-based finances in Africa include the lack of adequation between climate financial needs (vulnerability) and financing allocation (recipiency); the low level of adaptation portfolio compared to mitigation (less than 10% versus over 90%); donor commitments without subsequent disbursements; opaque public procurement process (tendering, licensing, selection, contracting, etc.); the lack of capacity for assuring resource mobilization (including low lobbying capacity); excessive conditionalities for proposal writing, which are unfavourable for the least developed countries and communities with low affordability capacity; the lengthy processing of proposals and readiness processes; the interference of international brokers; the higher service of debts; the excessive cost of project management; the insignificant technological efficiency of projects implementation … to name but a few.30 During most of the Conferences of the Parties (CoPs) organized by the UNFCCC, and most specifically the 27th CoP at Sharm El Sheik (Egypt), African countries have always pushed for funding losses and damages from climate impact disruption while their developed countries’ counterparts insist on green borrowing to ensure transactions from the market to curb climate impacts and vulnerable environments. For the interest of Africa’s poor populations, there is a need for balancing portfolios to ensure that finances are trickled down to the most vulnerable, so that climate justice is done to the poor. African governments shall keep part of the 3Ts to address their moral hazard for the adaptation of their poor citizens, while the private sector will be fetching for grants and loans to mitigate climate impacts.31 This is clearly illustrated by the financing of Rainwater Harvesting (RWH).

29 UNFCCC (2022), Akombo et al. (2014), World Bank (2014). 30 GCF (2021a, b). 31 PACJA (2022), Luwesi (2022), OECD (2010).

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3.7 Financing Rainwater Harvesting Systems in Africa 3.7.1

Overview of Rainwater Harvesting Systems and Financial Needs

Agriculture and irrigation, livestock production and domestic water use worldwide quite often rely on rainwater harvesting (RWH). Water harvesting techniques, especially in the arid and semi-arid lands (ASALs), encompass such systems as roof catchments, pans, water holes, runoff diversions, storage ponds, small dams and reservoirs, bounded basins or capturing seasonal floodwater from local streams…. Therefore, the RWH management has led to increasing demand for technologies pertaining to RWH for common urban and rural water use at household level, crop and livestock production, etc. These water/land use practices require land, human resources and capital, which can be translated into investment fund for financing the construction and maintenance of roof catchments and other rainwater harvesting systems using gutters and aerial tanks, surface and underground reservoirs. But the sustainability of the financing of these RWH structures relies on an economic analysis and evaluation of their resources. 3.7.2

Economic Valuation of Rainwater Harvesting

This economic analysis and evaluation of RWH resources are needed to explore the economic costs and benefits involved in building the systems prior to investing and implementing RWH management. This defines the scope of economic feasibility of water harvest and availability within the framework of a cost–benefit analysis (CBA) of investments in roofcatchment or any other harvesting technique for domestic use, economic production and ecological sustainability. This is a perquisite for better management of productive resources, including such factors as capital, labour and land. The most commonly used economic valuations of RWH are based on cost–benefit analysis methods that evaluate the “with” RWH scenario versus “without ” RWH scenario, and “before” RWH and “after” RWH situations. This economic evaluation of RWH mostly ranges from simple comparisons of technologies based on yields and gross margins to investment analyses. Other more sophisticated techniques are normally limited

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by availability of data and include risk analysis methods, such as stochastic dominance and time series analyses. This will ensure the full productivity of water systems, promote low-cost RWH systems, reduce the risks due to the unpredictability of rainfall and improve soil and water management practices. Moreover, prior to financing RWH systems in an economy of scale, investors look at a classical economic production model. The latter shows how more water input leads first to increased outputs then to lower outputs after attaining a maximum water output. The average product for water (APW) is derived from the average product of the capital (APK) to measure the average cost-efficiency of resource use, while the marginal product for water (MPW) can be derived from the marginal product of the capital (MPK) invested in RWH system. The latter (“MPW”) measures the technological efficiency due to a change in output as a result of an increase of a unit input. To these functions are associated a price and an Average Cost of Water (ACW) as well as a Marginal Cost of Water (MCW) to shed light on the sales turnover and profitability of the projects. These are basic indicators of the economic viability of RWH systems for their sustainable financing.32 3.7.3

Rainwater Harvesting Financing Schemes

Water is a public resource as well as a private good. For that reason, both the government and private organizations shall link up to source for funding for building of the RWH systems. As a public good, governmental water policies shall attend to water governance and management to prevent communities from many damages and disasters. This argument was strongly supported by Paul Samuelson in the 1950s. He argued that public goods do not suffer of any rivalry nor exclusion and are thus, well designed to meet the needs of the whole population without bearing the risk of a moral hazard. A product, good or service for which the conditions of no-exclusion and no-rivalry are not met, will bar some people from access notably because of affordability and saturation. This good or service, in particular, is a private property, and enhances the risk of moral hazard.33

32 Luwesi and Beyene (2019). 33 Luwesi (2021).

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Regarding water, as long as everyone’s welfare is on stake, government shall ensure the 3As (its Availability, Accessibility and Affordability), using the 2Ts public resources (taxation and transfers) to finance such kind of goods. In this regard, “green taxes ”, “ecotaxes ” and “green subsidies ” may well be used to encourage the construction of RWH systems all over the country and discourage activities that exhaust water resources or contribute much to environmental degradation. And as a homework, householders may be given the opportunity to choose between paying taxes and receiving subsidies as far as they take adequate measures for water and energy conservation, harvesting and supply technologies that are sustainable and environmentally friendly as well as other practices that respect the threshold of the environmental resilience.34 The collection of these public funds is deemed necessary to design policies that facilitate economic production and ecosystems services that secure and sustain domestic and economic water use through the protection and/or conservation of water sources and bodies as well as the construction of RWH systems (small dams and reservoirs) to conserve rainwater and surface runoff, the disposal of wastes and the control of water disasters. Such policies would require finances to support educational programmes that promote RWH knowledge generation and sharing among communities; to design economic and regulatory systems for monitoring environmental flows of water, ecosystems and biodiversity; to allocate user rights and polluter tax burden; secure social, economic and ecological values of water systems, including valuing RWH systems; to improve the quantity and quality of water ecological flows. Understanding the costs of transaction and externalities related to drastic changes in rainfall and surface water flows leads to a strong support of these public interventions in financing RWH systems for adaptation to climate change.35 Arguing against Samuelson’s support for public finance of RWH systems, Ronald H. Coase suggested in 1960, the development of a “finance mix”, including regulatory and extension services as well as inputs dealer/commodity supplies, rural and urban poor credits, other RWH customized loans, marketing… to enable resource mobilization by private entities. In effect, R. H. Coase affirmed that the attribution

34 Luwesi (2022). 35 Luwesi (2021).

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of the rights of RWH systems ownership will lead to an optimal solution with a minimum risk of adverse selection of individuals who are not really concerned by the issue on stake. Though a public good offset the risk of moral hazard, it does not matter who receives its benefits, yet there is actually a lot of costs of transaction, limited number of parts for consumption and limited capital for green investments. Hence, sustainable financing will require cost recovery.36 The cost of investment in RWH is too high and requires collaterals to access to credit from microfinance and commercial banks, and part of the funding may come from external supporting donors, including governmental and international development agencies, NGOs or CSOs. Low-income householders, especially rural farmers and women, may not afford to purchase materials and equipment involved in the production of RWH systems. To overcome their poverty trap cycle, many communities have initiated innovative schemes to raise the necessary capital for building RWH infrastructure.37 These opportune financial innovations require first that water users be organized into communities of interest similar to “saving and credit cooperatives ” (SACCO) to mobilize financial support for building small dams, wells or ponds and for acquiring such items as reservoirs, UG tanks, gutters and pipes…. This will help them sharing the cost of constructing individual RWH systems on a rotational basis at community level. Sometimes, local stakeholders may be organized as “mutual revolving funds ” to contribute labour, cash or any other commodity needed for the construction of a RWH system for individual ownership by each member. The community may also organize itself to gather security for soliciting “group micro-credit ” or “solidary /bound loans ” from the “table banking ” system. This table banking enables a pool of rotational funds that will finally be awarded to each member at small interest rate or none at all. That is how innovative RWH finance has resolved the critical issue of collaterals through novel arrangements with banks and other funders to ease access to group or bound credits.38

36 Luwesi and Beyene (2019). 37 Beyene and Luwesi (2018). 38 AGRA (2022), Odonkor et al. (2018).

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Finally, beyond the finances for Samuelson’s public goods and Coase’s private permits, Thiébout (1956) suggests a middle-of-the-road solution in terms of “local public goods ”, which are to be provided by a local administrative authority or a municipality through a “local consumer taxes ” and “Public–Private Partnership” (PPPs). This municipalization of private goods is otherwise argued by Atkinson and Stiglitz (1980), to take into account consumer’s choice in the provision of the local public goods and taxation. Derycke and Gilbert (1988) and Scotchmer (1994) suggest that municipal or local administrative authorities design financial instruments that are more or less limited and effectively fundable by local taxpayers, usable under the limits of the designated geographical areas and manageable by the local authorities with involvement of infra level officials and communities.39

3.8

Conclusion and Recommendations

Water resources sustainability in Africa requires adequate financing for infrastructure development to assure the provision of related services for drinking, sewerage and irrigation as well as public water management. This deserves to be treated as an urgent agenda due to the growing water scarcity in the continent, its sectoral rivalry and social exclusion for accessing to it, as well as its depleting value added in the production chains in the course of climate change. There is need for more than the funding from Tariffs, public budget Taxes and Transfers from development partners (3Ts). Emerging innovative sources of financing water and sanitation projects have led to a democratization of borrowing and lending to the wider stakeholders. They have created new incentives for WSPs and PSPs to penetrate new financing markets and expand their assets by raising equity and issuing green bonds in the Stock Exchange Market, acquiring concessional loans and grants from development banks as well as flexible loans suitable for households and small-scale WSPs from commercial banks and microfinance institutions. This has enabled them blending microfinance with grants to result in “Output-based Development Aid” (ODA) in implementing water projects, including RWH systems. Such projects may involve a complex of operating costs and high transaction costs needed for accessing finance through a combination

39 Luwesi (2021).

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of pre-financing from the community, guarantees from the government, grants from development partners and borrowing from lenders. For the interest of Africa’s poor, there is a need for balancing portfolios to ensure that finances are trickled down to the most vulnerable, so that climate justice is done to the poor. African governments shall keep part of the 3Ts to address their moral hazard responsibility to ensure the adaptation of these poor citizens, while the private sector will be fetching for loans and grants to mitigate climate impacts. It is only then that finance in the water sector will become Accessible, Available and Affordable (3As).

References AGRA [Alliance for a Green Revolution in Africa]. 2022. Innovative financing initiative. Available at: http://www.agra-alliance.org/section/work/finance (Accessed on 03 January 2022). Akombo, R.A., C.N. Luwesi, C.A. Shisanya, and J.A. Obando. 2014. Green water credits for sustainable agriculture and forestry in arid and semi-arid tropics of Kenya. Journal of Agri-Food and Applied Sciences (JAAS) 2 (4): 86–92. Asteriou, D., and C. Siriopoulos. 2000. The role of political instability in stock market development and economic growth: The case of Greece. Economic Notes 29 (3): 355. Atje, R., and B. Jovanovic. 1993. Stock markets and development. European Economic Review 37: 632–640. Azam, J.P., B. Biais, M. Dia, and C. Maurel. 2001. Informal and formal credit markets and credit rationing in Cote d’Ivoire. Oxford Review of Economic Policy 17 (4): 520–534. Bekaert, G., and C.R. Harvey. 2007. Emerging equity market volatility. Journal of Financial Economics 43 (1): 29–77. Beyene, A., and C.N. Luwesi, eds. 2018. Innovative water finance in Africa: A guide for water managers, vol. 1. Water Finance Innovations in Context. Uppsala: Nordiska Afrikainstitutet. Cap-Net. 2008. Economics in sustainable water management, training manual and facilitators guide. Available at: capnet.org (Accessed on 11 September 2011). Cardone, R., and C. Fonseca. 2006. Innovative financing: Experience with secondary urban centre water supply and sanitation service delivery. UNHabitat Report on the Water and Sanitation in Secondary Urban Centres: Paper 1. Nairobi: United Nations Human Settlements Programme (UNHABITAT).

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de Aghion, A.B., and J. Morduch. 2005. The economics of microfinance, 1st ed. Boston: MIT Press. Deloitte. 2015. Deloitte report on Project bonds: An alternative source of financing infrastructure projects. Available at: www2.deloitte.com/za. Deloitte. 2022. Deloitte Africa impact report. Available at: www2.deloitte. com/za. Flammer, C. 2018. Corporate green bonds. GEGI Working Paper No. 023, 11/ 2018: 1–22. Flammer, C. 2021. Corporate green bonds. Journal of Financial Economics 142 (2): 499–516. GCF [Green Climate Fund]. 2021a. Independent synthesis of the Green Climate Fund’s accreditation function. Report of the Meeting of the Board 16— 19 March 2021 (GCF/B.28/16). Available at: https://www.greenclimate. fund/. GCF [Green Climate Fund]. 2021b. Independent evaluation of the adaptation portfolio and approach of the Green Climate Fund. Report of the Meeting of the Board 16–19 March 2021 (GCF/B.28/17). Available at: https://www. greenclimate.fund/. GCF [Green Climate Fund]. 2022. Status of pledges (IRF and GCF-1). April. Available at: https://www.greenclimate.fund/document/status-pledges-allcycles. GPOBA [Global Partnership on Output-Based Aid]. 2016. Annual report 2016—Supporting the delivery of basic services in developing countries. Washington, DC: WSP [Water Partnership Program], The World Bank Group. GWP [Global Water Partnership]. 2005. Role of private sector—IWRM toolbox, section B.1.8, P. IWRM toolbox version 2, section B.18. Available at: www. gwp.org (Accessed on 12 July 2007). Heckinger, R., and D. Mengle. 2013. Derivatives overview. In Understanding derivatives: Markets and infrastructure, FRBC [Federal Reserve Bank of Chicago]. Chicago, IL: Federal Reserve Bank of Chicago. Lakhotia, G. 2017. Shareholders vs. debentures holders—Knoji consumer knowledge. Available at: https://investments-investing.knoji.com/shareholders-vsdebentures-holders/ (Accessed on 06 March 2017). Lebelle, M., S.L. Jarjir, and S. Sassi. 2020. Corporate green bond issuances: An international evidence. Journal of Risk and Financial Management 13 (25): 1–21. Les Dlabay, J., and J.L. Burrow. 2007. Business finance. Mason: South Western. Luwesi, C.N. 2021. Economie et Gestion de Ressources en Eau. Séminaire aux apprenants du Programme de Master International en Ressources en Eau (PMIRE) de l’Ecole Superieure de l’Eau (ESE). Faculté des Sciences Agronomiques et de Gestion des Ressources Naturelles, Université de Kinshasa.

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Luwesi, C.N. 2022. Foresight in agriculture, food and nutrition for planning freshwater in the course of climate change in Africa. Journal of Food Technology & Nutrition Sciences 4 (4): 1–4 (ISSN: 2754-477X). Luwesi, C.N., and A. Beyene, eds. 2019. Innovative water finance in Africa—A guide for water managers, vol. 2. Uppsala: Nordiska Afrikainsitutet. Mahajan, J.P. 2010. Business organisation and management. Mumbai: Himalaya Pub. House. Moser, J. 1998. Contracting innovations and the evolution of clearing and settlement methods at futures exchanges. Working Paper, No. 98-26. Federal Reserve Bank of Chicago. Odonkor, E., L. Hamasi, F. Muthoni, M. Khau, and M. Mutiso. 2018. Gender in water finance: Perspectives for a paradigm shift in water finance management. In Innovative water finance in Africa—A guide for water managers, vol. 1, ed. C.N. Luwesi, and A. Beyene, 140–159. Uppsala: Nordiska Afrikainsitutet. OECD [Organisation for Economic Co-Operation and Development]. 2010. Innovative financing mechanisms for the water sector. Paris: OECD Publishing. Available at www.sswm.info (Accessed on 17 May 2015). Oliver, P., F. Mazza, and D. Wang. 2016. Water financing facility—Lab instrument analysis. London: Climate Policy Initiative, Global Innovation Lab for Climate Finance, June 27. Oppenheimer, L., and D. Hollingsworth. 2014. A primer on borrowing. Available at: http://www.thirdway.org/publications/506 (Accessed on 05 May 2014). PACJA [Pan African Climate Justice Alliance]. 2022. In our own words and actions—A decade of movement building, deepened democracy and transformation, 2010–2021. Nairobi: PACJA Continental Secretariat. Available at: www.pacja.org. Sacerdoti, E. 2005. Access to bank credit in Sub-Saharan Africa: Key issues and reform strategies, IMF Working Paper No. 05166. Taylor, B. 2016. Private sector involvement in water: Global lesson. Durham, UK: The Springfield Centre for Business Development. Trabacchi, C., and F. Mazza. 2015. Emerging solutions to drive private investment in climate resilience. Venice: CPI [Climate Policy Initiative], June. UN [United Nations]. 2015. Private sector investment and sustainable development—The current and potential role of institutional investors, companies, banks and foundations in sustainable development. New York, NY: UN Global Compact, UNCTAD, UNEPFI and PRI. UNFCCC [United Nations Framework Convention on Climate Change]. 2018. Achievements of the clean development mechanism. Available at: https://unf ccc.int/sites/default/files/resource/UNFCCC_CDM_report_2018.pdf.

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UNFCCC [United Nations Framework Convention on Climate Change]. 2022. United Nations Framework Convention on Climate Change. Available at: cdm.unfccc.int. van Bork, G., H. Gietema, I. van de Velde, and M. Zwart. 2015. Innovative financing and positioning of the water sector—A toolbox with practical cases for Aid & Trade and water sector practitioners. Rotterdam: Netherlands Water Partnership, TRAID. Winpenny, J. 2003. Financing water for all: Report of the world panel on financing water infrastructure. Marseille: World Water Council (WWC), 3rd World Water Forum (3WWF) and Global Water Partnerships (GWP). World Bank. 2006. Approaches to private participation in water services— A toolkit. Washington DC: PPIAF [Public-Private Infrastructure Advisory Facility] & The World Bank, IBRD [The International Bank for Reconstruction and Development]. Available at siteresources.worldbank.org (Accessed on 17 May 2015). World Bank. 2014. Applying result-based financing in water investments. Washington, DC: Water Partnership Program and GPOBA [Global Partnership on Output-Based Aid], The World Bank Group, Water Papers 89326, May. Available at documents.worldbank.org (Accessed on 17 May 2015).

CHAPTER 4

Business Models That Improve Rural Poor Access to Credit for Irrigated Agriculture in Northern Ghana Prosper Glitse, Ben Vas Nyamadi, and Mamudu Abunga Akudugu

Abstract Investments in water and agriculture are recognized as a major strategy for poverty reduction. Irrigation has a value added in agricultural production chains, and its use of water creates rivalry and social exclusion among sectors suffering from climate change. This chapter unveils business models that work for access to “irrigated agriculture credits” in the rural poor Northern Ghana. It comes out with an innovative model for “Community Empowerment, Savings and Credit Associations” (CESCAs).

P. Glitse (B) · B. V. Nyamadi Ghana Irrigation Development Authority, Accra, Ghana e-mail: [email protected] M. A. Akudugu University for Development Studies, Tamale, Ghana © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 C. N. Luwesi and A. Beyene (eds.), Innovative Water Finance in Africa, https://doi.org/10.1007/978-3-031-38234-5_4

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Keywords Agricultural credits · Business models · Irrigated agriculture savings · Northern Ghana

Box 4.1: Lessons Learned • Irrigation has a value added in the production chains, and its use of water creates rivalry and social exclusion among sectors suffering from climate change. • Investment in agricultural water is recognized as a major strategy for poverty reduction and overall transformation of the country’s economy, because it allows higher profit margins from irrigation (compared to rain-fed agriculture), hence there is a higher probability of repayment of the capital or loan invested. • To minimize the adverse effects of climate change on agricultural production, investments are required in water harvesting technologies to promote sustainable agricultural intensification through irrigation. • The implication is that agricultural intensification is capital intensive, while most smallholder irrigation farmers are resource poor and require working capital support in the form of credit to be able to intensify production activities. • Some farmers and householders are thus rationed out of the credit market if they are unable to meet the collateral conditions of banks. Besides, some smallholder irrigation farmers are likely to lack access to credit, for a number of reasons, including: membership of a group, irrigable landownership, size of irrigable farm, income, experience in irrigated agriculture, literacy level, access to agriculture extension services and marital status. • Due to the quantity and quality of their social connections, rural people prefer to take out credit from the informal sector, even though formal financial institutions are known to charge lower interest rates than informal ones. This is because, in lending credit to rural people, the informal sector relies on mutual acquaintances, trust and reputation. This denies some individuals access to credit entirely, or are not offered the full amount they ask for. • This study recommends the adoption of a model based on Community Empowerment, Savings and Credit Associations (CESCAs) for

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the design and implementation of gender-sensitive financial interventions • This would enhance access to credit by smallholder irrigators and enable them to invest in their production activities and hence improve their output and income levels. That would result in a reduction in poverty.

4.1

Introduction

Agriculture is an important sector in the socio-economic transformation of rural areas of most developing countries. With the limited alternative employment opportunities, majority of rural dwellers depend on the agricultural sector as the main source of livelihood. In the specific case of Ghana, in 2020 agriculture employed about 38% of the active population and contributed about 20.5% to GDP.1 Thus, investment in agriculture is recognized as a major strategy for poverty reduction and overall transformation of the country’s economy. Indeed, investment in the agricultural sector has a ripple effect on the growth in service and industrial sectors. It is, therefore, central to the drive towards the achievement of national development goals.2 The central role of agriculture in Ghana’s transformation agenda is, however, constrained by the current menace of climate change. To minimize the adverse effects of climate change on agricultural production, investments are required in water harvesting technologies to promote sustainable agricultural intensification through irrigation.3 The provision of irrigation infrastructure—especially across the northern part of the country, with its uni-modal rainfall patterns—is crucial to the drive towards the intensification and commercialization of farm products. Irrigation will facilitate the transformation of agricultural systems from low-energy extensive production to high-energy intensive systems deployed over less land. The provision of irrigation facilities— alongside the sowing of improved crop varieties and an increased sustainable use of fertilizers and agro-chemicals—will bring about increased

1 GLSS 7 (2019) and MoFA (2021). 2 NDPC (2021). 3 Sivakumar and Stefanski (2008).

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cropping intensity and productivity.4 The implication is that agricultural intensification is capital intensive, while most smallholder irrigation farmers are resource-poor and require working capital support in the form of credit to be able to intensify their production activities for improved livelihoods. Thus, credit is a fundamental factor in driving investment in irrigated agriculture and in increasing cropping intensity and productivity. Access to credit has been reported to have positive and significant effects on agricultural commercialisation, which is critical for socio-economic transformation in Ghana and Africa generally.5 Access to credit is necessary in order to speed up the development of rural areas and reduce poverty. The available evidence suggests that credit enables farmers to access productive inputs, such as improved seeds, fertilizers, pesticides and new technologies that can help increase overall agricultural production. According to the Food and Agriculture Organization (FAO) the limited access to credit by smallholders, occasioned by poorly functioning credit markets, may prevent farmers from boosting their production, and thus providing much-needed supplies on the domestic and global markets and increasing their income.6 Although there is a growing body of literature on access to credit for agriculture in general,7 there has been little or no research conducted specifically into the determinants of access to credit for irrigated agriculture in northern Ghana. In order to develop models that enhance rural people’s access to credit for irrigated agriculture, there is a need to identify and describe the factors that determine access to credit by smallholder irrigators, especially in areas where poverty is endemic. The key objective of this study was to bridge the knowledge gap by providing empirical evidence on the factors that determine access to credit for irrigated agriculture. An innovative irrigation-financing model that would work for the rural poor was built based on the evidence recorded on the ground. The model was designed to help the poor and vulnerable ones to escape pressures of climate change and variability through irrigation. The remainder of this chapter is organized into four main sections: a review of the empirical literature; methodological issues; discussion of the key findings; and conclusions and recommendations based on the findings.

4 Tichenor (2011). 5 Akudugu et al. (2021a, b), Sekyi et al. (2020). 6 Kiros and Meshesha (2022) and FAO (2011). 7 Akudugu (2012).

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Literature Review

Agricultural finance is the provision of financial services for farm production, processing and marketing. Credit is crucial in the agricultural sector to enhance agricultural productivity and access to it obviously enhances productivity, especially in developing countries. A number of studies on determinants of access to credit in developing countries have generally shown that sex, age, membership in a financial solidarity group, sown area, marital status, type of association and interest rate are the main significant variables influencing the demand for formal credit directly.8 For a number of reasons, subsistence agriculture is challenged by its limited access to credit finance because of a kind of credit rationing facing most stakeholders in the agricultural sector. According to Boucher and Guirkinger (2007), credit rationing is a condition in which individuals who need credit are not able to apply for it, or else they are not offered the full amount they ask for. Credit rationing can take different forms, including quantity rationing , risk rationing or self-selection and transaction cost rationing . There are two types of quantity rationing: micro rationing, which places limits on borrowers (below first-best levels), and macro rationing, which randomly denies certain borrowers access to any credit.9 Another form of credit rationing to the agriculture sector is risk rationing or self-selection. In fact, farmers may need credit for their productive activities, but do not apply for it—thus engaging in what is commonly referred to as self-rationing. Farmers will self-ration themselves out of the credit market if they consider the risk and transaction cost associated with the facility to be too high, and so do not apply for the credit. Stiglitz and Weiss (1981) reported that rural credit markets are imperfect and characterized by information asymmetry. To cover the cost of collecting the information necessary to reduce risk, lenders increase interest rates, which can lead to adverse selection. The authors assumed that lenders attempt to maximize profit by employing interest rates and

8 Kiros and Meshesha (2022), Julien et al. (2021; as cited in Kiros and Meshesha 2022), Masaood and Keshav (2020), Rizwan et al. (2019), Nyaga and Nzulwa (2017), Anang et al. (2015), Baiyegunhi and Fraser (2014), Sebatta et al. (2014), Chauke et al. (2013), Muhongayirea et al. (2013), Nouman et al. (2013) Dzadze et al. (2012), and Amjad and Hasnu (2007). 9 Ghosh et al. (2000).

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collaterals, thereby reducing the likelihood of default on their loans, while many potential borrowers attempt to maximize profit through their choice of projects. Moreover, lenders are unable to distinguish between ‘good’ and ‘bad’ borrowers. Additionally, borrowers may decide to shift from safe projects that yield normal profits to high-risk projects with high potential gains, but with a low likelihood of success. Yet, the lenders have no control over such decisions by borrowers. The resulting high interest rates affect the profitability of low-risk borrowers, and they opt out of the credit applicant pool. There are some farm households that are rationed out of the credit market for being unable to meet the collateral conditions of banks. However, households which access loans that are collateralized may be obliged to pay back loans in a timely fashion to avoid confiscation of their assets.10 Another important determinant of access to credit, especially in rural settings, is social capital. In a bid to reduce the risk associated with rural borrowers, mainly due to information asymmetry, formal financial institutions tend to rely on physical collateral. But rural borrowers often lack sufficient physical collateral. They prefer to exploit the quantity and quality of their social connections to take out credit with the informal sector, which relies on social capital and the threat of social sanctions as a form of collateral.11 Although formal financial institutions are known to charge lower interest rates than informal lenders, borrowers perceive the formal credit application procedures to be cumbersome. Therefore, again they prefer to take out loans with informal sources. Higher interest rates mean that farmers tend to take out less credit, so that they have less to repay. The implication of this is that most farmers end up reducing the quantities of recommended inputs applied to their production, which may affect productivity negatively at the end of the season.12 The farmer is then faced with the challenge of high interests, while their yields are low. Thus, even with the high interest rates, farmers are more comfortable with the informal sources of credit because of social capital and less cumbersome application procedures. Social capital and informal credit

10 Olomola and Gyimah-Brempong (2014). 11 De Aghion and Morduch (2005). 12 Agunuwa (2015).

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access go hand-in-hand. This is because informal lenders rely on mutual acquaintances, trust and reputation when they lend to rural people.13 The nature of agriculture presents a number of challenges that may determine access to credit. According to Jia (2008), seasonality and geographical dispersion of agricultural production may present a daunting task in accessing credit, especially in rural areas. Thus, it is more expensive to provide financial services in rural areas, with typically less-dense economic activity, poorer infrastructure than in urban areas and greater risk from weather and agricultural price fluctuations.14 These challenges do not, however, apply to irrigated agriculture, because irrigators are located on contiguous plots, at specific locations and using the same irrigation scheme. Accordingly, the transaction costs and the cost of monitoring the loans are shared among irrigators. Moreover, the risk of total crop failure resulting from lack of water is largely eliminated in irrigated agriculture. It is also possible to plummet triple the cropping intensity per unit area and to synchronize crop maturity with periods of peak market demand. At the same time, it is easier to incorporate yield-enhancing inputs—such as improved seed, fertilizers, pesticides and rodenticides—to increase profit margins in irrigated agriculture than in rain-fed agriculture, thus increasing the likelihood of the loan repayment. The mode of credit delivery can also affect access. Most agricultural credit facilities employ the Grameen Bank (GB) model. Founded by Professor Muhammad Yunus in 1976 in Bangladesh, the GB model of credit delivery relies on voluntarily formed groups of people who provide mutual, morally binding group guarantees, instead of the collateral required by conventional banks. It was developed based on the fact that credit is regarded as a stepping stone to break the vicious cycle of poverty and unlock the inherent potential of people in abject poverty. A prominent feature of GB is its emphasis on women. Moreover, members of the group are jointly liable not only for their individual loans, but also for the loans taken out by other members of the group.15 GB has successfully reversed conventional banking practices by removing collateral requirements, and has developed a banking system based on mutual trust, accountability, participation and creativity. It is deduced from the

13 Khanh (2011). 14 Olomola and Gyimah-Brempong (2014). 15 Sarma and Mehta (2014).

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above that the key determinants for accessing credit through this model are group membership and gender. The second model is MC2 , a model derived from Einstein’s energy field equation and promoted by Dr Paul K. Fokam16 : VP = M xC xC = MC2

(4.1)

where VP is victory over poverty, M is means, and CxC = C2 is Competences and Community. MC2 is a community-based micro-bank, created and managed by people—mostly the under privileged, who endeavour to be self-reliant and who strive to create wealth with the aim of improving their living conditions in a sustainable manner. The model has two versions: a rural version, MC2 , and an urban version dubbed MUFFA. The urban version of the model is exclusively for women, because studies and personal research by the founder have shown that women in urban areas are among those mostly hit by poverty. Women in MUFFA have easy access to financial services, which help them to start job-creating and wealth-generating small business activities.17 The Village Bank (VB) model is yet another. Village banks are community-managed organizations with voluntary membership, open to all registered residents of a village or community without regard to gender, age or ethnic origin. They have the objective of ensuring the selfreliance of members within three years. Villagers can become members by signing up and opening a savings account. The VB offers the option of either individual or household membership. All members are recorded in the VB register. Lending is restricted to members who are of legal age, have no criminal record and are committed to observing the VB’s regulations.18 According to Brown (2011), VBs have two main sources of funds: the external account and the internal account. The external account represents capital provided by an external source that is lent to 16 Fotabong (2011). 17 Rudrabhatla et al. (2015). 18 GIZ (2014).

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the members of the ‘bank’, while the internal account is made up entirely of the savings of the group members, which can also be lent to other group members. The number of members per group ranges from 30 to 50, and the loans are repaid on a weekly basis. The credit union model is also a popular model used in credit delivery. A credit union is a non-profit financial cooperative owned and democratically controlled entirely by its members, with the purpose of providing financial services such as loans and savings. A credit union can provide some training to support its members. Credit union membership is based on a common bond, a linkage shared by savers and borrowers who belong to a specific community.

4.3

Materials and Methods 4.3.1

Study Area and Data

The study was conducted in four districts across two of the three traditional regions of northern Ghana. The districts studied were Bawku West, Nabdam and Kassena-Nankana Municipality (KNM), all in the Upper East Region, and Kumbungu in the Northern Region. The strategic location of these districts—along the White Volta and its tributaries— makes irrigation a key livelihood activity in these areas. All the districts experience uni-modal rainfall pattern, starting in May and ending in late October, with average annual rainfall of 1,000 mm. The vegetative cover in all districts is either Guinea Savannah or Sudan Savannah, consisting of short drought-resistant trees and grassland. The major economic tree species include sheanut tree, dawadawa and mango. They provide essential ecosystem services, such as food and medicine to the people.19 Empirical tools of population sampling, data collection and analysis were utilized in the study. A multi-stage sampling technique was used to select communities, households and respondents, with a sample size of 432 irrigators. Both qualitative and quantitative methods were used to investigate factors that determine access to credit for irrigated agriculture. Qualitative research tools encompassed guides for focus group discussions (FGDs), key informant interviews and in-depth interviews. The quantitative research tools used included a questionnaire. Questionnaires were administered to 108 irrigators each at small-scale irrigation sites in 19 FAO (2005).

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Nabdam and Bawku West, and at medium- and large-scale irrigation sites in Kumbungu and Kassena-Nankana, respectively. Two communities with notable irrigation schemes or activities were randomly selected, giving a total of eight communities across the four districts. Both irrigators and non-irrigators were interviewed. The qualitative data were analysed using thematic, content and discourse analyses. These enabled the researchers to sort the key issues into themes, and to examine the content of each theme and the discourse thereof. The researchers thus had an opportunity to better understand the issues under consideration from different perspectives. The quantitative data were analysed using the logistic regression model to estimate the factors that determined access to credit for irrigated agriculture. This enabled the researchers to quantify, where possible, the factors that determined access to credit by smallholder irrigators across northern Ghana and the country generally. By combining the qualitative and quantitative methods, it was possible to triangulate data and results from different viewpoints, in order to tell a holistic story regarding credit access by smallholder irrigators. The analytical framework of the quantitative data analysis and the choice of variables for the empirical model estimation are presented in the following subsections. 4.3.2

Empirical Model Specification

Access to credit for irrigated agriculture is binary in nature, since a respondent can only have access to credit or not have access—not both. Therefore, access to credit by smallholder irrigators is defined by the logistic model (Eq. 4.2): Yi = β X i + εi > 0

(4.2)

where Y is access to credit, which is equal to 1 if the irrigator has access, and 0 otherwise, i is the ith farmer having access or not to credit for irrigation, X is a vector of characteristics of the ith irrigator, β is the parameter to be estimated, and ε is the error term.

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The probability that the ith irrigator had access to credit (Y i = 1) is written as Eq. 4.3: P(Y = 1) =

exp(β X i ) 1 'X = −β 1 + exp(β X i ) 1+e

(4.3)

The probability that the ith irrigator had no access to credit (Y i = 0) is expressed as Eq. 4.4: 1 − Prob(Yi = 1) =

1 1 + exp(β X i )

(4.4)

The empirical model is specified as Eq. 4.5: ) ( pi = β0 + β1 Age + β2 Gender + β3 Marital status log 1 − pi + β4 Literacy level + β5 Extension access + β6 Irrigation experience + β7 Rain − fed area cropped + β8 Irrigated area cropped + β9 Irrigable landownership + β10 Groupmembership + β11 Householdsize + β12 Total household income + β13 Savings + εi

(4.5)

The explanatory variables specified in the empirical model were selected on the basis of a review of the relevant literature on access to credit and the experience of the authors, who have, over the past ten years or more, worked on irrigation development and agricultural finance in Ghana. For example, Sekyi et al. (2020) report in their study that credit access is affected by education, age, nonfarm business equipment, multiple crop production and group membership. For Kiros and Meshesha (2022), the significant determinants of access to credit are sex of household head, family size, extension contacts, off-farm income, interest rate, lending procedure, group lending and Rapid Repayment Period. Age is an important determinant of access to productive resources, especially in rural Ghana, where socio-economic and politico-cultural configurations do not allow people of certain ages to make decisions to access resources such as credit. The age of farmers is measured as a dummy variable and assigned 1 for irrigators aged 36 years and above, and 0 otherwise. It is assumed that older irrigators are more likely to

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have access to credit than their younger counterparts. This is because the older irrigators are considered mature and have the potential ability to utilize and repay credit.20 This virtue has a positive impact on irrigators’ access to credit. Gender is important in accessing credit and other productive resources. This variable is denoted 1 if the irrigator is male and 0 otherwise. Male farmers are more mobile, participate in different meetings (which is a prerequisite for the success of public irrigation schemes) and have more exposure to information than female irrigators. This variable is expected to have either a positive or a negative influence on the probability of accessing credit for irrigated agriculture. The marital status of irrigators is denoted 1 if the irrigator is married and 0 otherwise. Married irrigators are hypothesized to have better access to credit, because couples are presumed to be able to complement each other with resources and to combine inputs better on their farms, which improves their ability to repay credit. Level of literacy influences the decision to access credit from formal sources for irrigated agriculture. It is defined as the number of years of formal schooling. Education enhances irrigators’ ability to better combine productive resources and venture into more lucrative enterprises. Literate irrigators keep proper production records, which can be used for the acquisition of loans. It is, therefore, hypothesized that level of literacy positively influences irrigators’ chances of obtaining loans from formal financial institutions. It is assumed that irrigators with nine or more years of formal education are literate and they are assigned a dummy variable of 1; otherwise, 0. Related to this is access to agriculture extension by irrigators. This is denoted 1 if irrigators have access to extension services and 0 otherwise. Access to extension services enables farmers to make use of innovative technologies to improve production. The coefficient of this variable is, therefore, expected to be positive. Experience in the type of livelihood activity that borrowers are engaged in might determine whether they are granted credit by lenders. This is a measure of the number of years that the farmer has been actively involved in irrigated agriculture. It is expected

20 Akudugu (2012).

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that the greater the number of years, the better the chances of accessing credit to finance irrigation activities.21 Farm size (measured in hectares) under rain-fed and irrigation regimes was included because it affects the potential income of the borrower, which in turn impacts positively on access to credit for irrigated agriculture.22 Ownership of irrigable land is also an important factor that determines the level of investments needed on that land, which implicitly influences the decision to access credit. It is measured as a dummy variable, with 1 for irrigators who own the land that they irrigate, and 0 otherwise. It is hypothesized that ownership of irrigable land improves access to credit, and this is, therefore, expected to have a positive impact on access to credit for irrigated agriculture. Membership of social group is a prerequisite for some credit schemes designed for small borrowers. It is important in accessing credit from formal sources, as it acts as collateral for poor borrowers. It is, therefore, hypothesized that irrigators who belong to a group are more likely to have access to credit than those who do not. Irrigators who belong to a group are denoted 1 and 0 otherwise. Farm household size is considered as an important factor in making credit access decisions. This is the total number of persons living in the irrigator’s household. It is expected that as the size of an irrigator’s household increases, so is its consumption requirements, which puts pressure on the limited resources of the household, resulting in the need to access credit. Thus, assumption was made that irrigators with a smaller household headcount have lower probability of having access to credit. The expected sign for the coefficient of this variable is, therefore, positive. Total income obtained from income-generation activities by a farmer may influence the decision to access credit. Irrigation farmers with higher total annual income will be able to sustain their families well and to finance their production activities, and may decide not to access credit. On the other hand, given the high-income levels, such farmers may be able to make savings with the financial institutions and this improves their chances of accessing credit. It is, therefore, expected that income might have a positive or a negative influence on the probability of accessing credit for irrigated crop production.

21 Baffoe and Matsuda (2015). 22 Akudugu (2012).

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Savings with a formal financial institution influence credit access. Akudugu (2012) reported that savings are a proxy for the net worth of the farmer. Savings can be in cash or in kind. They improve the likelihood of paying back any loan. This is measured as a dummy variable, with 1 for irrigators who make savings, and 0 otherwise. Savings are expected to have a positive influence on the probability of farmers accessing credit.

4.4

Results and Discussion

The objective of the study was to examine the factors that determine access to credit for irrigated agriculture by smallholder farmers. The logit was used to quantify a mixture of qualitative and quantitative data, mainly from questionnaires, focus group discussions and key informant interviews. The factors modelled included age, gender, marital status, level of literacy, access to extension services, experience of irrigated agriculture, area cropped under rain-fed farming and irrigation, irrigable landownership, membership of a social group, household size, household income and savings. These factors were modelled at two levels. The first was the aggregate level, in which data from all the sites were pulled together and analysed. The second was the district level, where data were analysed at the site or scheme level. The aggregate level logit regression results produced an adjusted Pseudo R-squared of about 0.24, which means that all the explanatory variables included in the model were able to explain about 24% of the variations in probability of irrigators having access to credit for their irrigation activities. The log likelihood ratio (LR) statistic was found to be significant at 1%, and this implied that all the variables included in the logit model jointly influenced the probability of irrigators accessing credit. Table 4.1 indicates that some parameters explaining access to credit for irrigation in northern Ghana were successful at 99% (or 1% significance level), while others were pertinent at 95% (or 5% significance level) or 90% (or 10% significance level) confidence level. The first batch included location at Nabdam (in comparison with Kumbungu district, the reference group), education, extension services, experience in irrigation, irrigable land ownership and savings, and they were significant at 1% (or 99% confidence level). However, irrigated area and group membership were pertinent at 95% (that is 5% significance level), while location at Bawku West (in comparison with the reference group in Kumbungu district),

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marital status and income were significant at 10% (that is 90% confidence level). The predicted probability was found to be about 0.46, which means access to credit by smallholder irrigators across the four study sites, given the factors modelled is about 46%. There is, therefore, low access to credit by smallholder irrigators in northern Ghana. Specifically, the aggregate logit regression results show that irrigators in the Bawku West district who irrigate using water from the White Volta basin are more likely to access Table 4.1 Determinants of access to credit by smallholder irrigators in northern Ghana (n = 432) Variable Bawku West Nabdam KNM Gender Age Marital status Education Extension services Experience in irrigation Rain-fed area Irrigated area Irrigable land ownership Group membership Household size Ln (Income) Savings Constant LR Chi-square (16) Prob > Chi-square Log likelihood Pseudo-R 2 Predicted probability

Coefficient

Std. Err

z

P>IzI

Marginal effects

0.633* −0.667*** −0.179 0.376 −0.420 −0.506* 1.255*** −1.222*** 0.038***

0.377 0.211 0.138 0.259 0.262 0.265 0.279 0.269 0.014

1.682 −3.162 −1.296 1.452 −1.600 −1.907 4.504 −4.540 2.716

0.093 0.002 0.195 0.147 0.110 0.056 0.000 0.000 0.007

0.1569503 −0.16552 −0.0444661 0.0929011 −0.1038715 −0.1256074 0.3031196 −0.2959711 0.0093947

0.003 0.337** −0.658***

0.065 0.142 0.239

0.039 2.371 −2.759

0.969 0.018 0.006

0.0006243 0.0834713 −0.1620936

0.617** −0.032 0.633* −0.667*** −0.179 144.56 0.000 −227.131 0.241 0.455

0.250 0.064 0.377 0.211 0.138

2.465 −0.491 1.682 −3.162 −1.296

0.014 0.623 0.093 0.002 0.195

0.1515377 −0.0078324 0.1096013 0.0187336

Notes *Parameter that is pertinent at 90% confidence level (or 10% significance level) **Parameter that is pertinent at 95% confidence level (or 5% significance level) ***Parameter that is pertinent at 99% confidence level (or 1% significance level) Source Field survey data, 2015

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credit to finance their irrigation activities than those of the Kumbungu district, used as the reference category, at 10% significance level. Results from the focus group discussions and key informant interviews with irrigators in the Bawku West district revealed that farmers are able to access credit from different sources, particularly microfinance institutions including the Toende Rural Bank Ltd, and even informal sources such as moneylenders, input dealers, agricultural commodity traders, friends and relatives. Irrigators indicated that they are able to enter into financial arrangements with informal lenders who provide their financial needs under agreed terms and conditions for repayment after harvest. The logit results further revealed that irrigators in the Nabdam district are less likely to access credit than are those in the Kumbungu district, the reference category, and the difference is statistically significant at 1%. The focus group and key informant interview results indicate that irrigation in the Nabdam district is not as commercialized as in the Kumbungu district, and this explains why irrigators in the former are less likely to access credit. Access to credit by irrigators in the KNM is not significantly different from access in the Kumbungu district, the reference category. This is probably because the two schemes are government-owned and have similar patterns of production profiles, governance structure and management strategies. The logit results reveal that marital status failed to meet the a priori expectation of positive influence on access to credit for irrigated agriculture, but is significant at 10%. This means that irrigators who are married are less likely to access credit than those who are not married. This finding is inconsistent with that of Sekyi et al. (2020) who found that being married had a positive but insignificant influence on the probability of accessing credit. Level of literacy conformed to the a priori expectation of a positive effect on access to credit for irrigated agriculture and is significant at 1%. This implies that irrigators who received at least nine years of formal education are more likely to access credit for irrigated agriculture activities than are those with less formal schooling. This finding is inconsistent with the findings of Sekyi et al. (2020) who reported that education has a significant negative effect on the probability of accessing credit. However, access to agriculture extension services failed to meet the a priori expectation of a positive effect but was pertinent at 99% confidence level, meaning that irrigators who had access to extension services were less likely to access credit for irrigated agriculture. This finding is

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consistent with that of Kiros and Meshesha (2022) who found negative relationship between extension contact and access to credit. Experience in irrigated agriculture met the a priori expectation and is a significant determinant of access to credit at 1%. This means that the more years of experience in irrigated agriculture, the higher the likelihood of irrigators accessing credit. Income conformed with the a priori expectation of a positive influence on access to credit by smallholder irrigators and was pertinent at 90% confidence level. This is because income obtained from rain-fed agriculture increases the total income of the farmer, which further affects access to credit for irrigated agriculture positively. Similarly, size of irrigated land cropped met the a priori expectation and was significant at 5%. This means that, as irrigated area cropped increases, so the probability of accessing credit also increases.23 Ownership of irrigable land failed to meet the a priori expectation of a positive relationship, but was a significant determinant of access to credit at 1% significance level. This means that irrigators who own the land they irrigate are less likely to access credit than are those who do not own the land. This is because most owners of irrigable lands across the study areas rent out the land to other people, who rather irrigate as a business. Membership of a group is a significant determinant of access to credit at 1% and has a positive relationship with access to credit for irrigated agriculture. It emerged from the focus group discussions that farmer groups exist at the irrigation sites, and these serve as security for the acquisition of loans. This finding is consistent with that of Sekyi et al. (2020) but inconsistent with that of Kiros and Meshesha (2022). Savings have significant influence on access to credit for irrigated agriculture (at 99% confidence level) and was found to positively related to the probability of accessing credit for irrigated agriculture. Table 4.2 presents the logit results at the district level for Bawku West. It shows an adjusted Pseudo R-squared of about 0.25 with a log LR statistic of −61, which was significant at 99% confidence interval. This means that all the explanatory variables included in the model explain about 25% of the variations in probability of irrigators having access to credit for their irrigation activities. The log LR statistic was found to be significant at 1%, implying that all the variables included in the logit model jointly influence the probability of irrigators accessing credit in Bawku 23 Masaood and Keshav (2020; as cited in Kiros and Meshesha 2022), Gbigbi (2017), Dube et al. (2015), Kiplimo et al. (2015), and Muhongayirea et al. (2013).

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West. The model yielded a predicted probability of 0.68, meaning that about 68% of the smallholder irrigators who participated in the study had access to credit. As predicted, gender was found to be positively related to access to credit, but in an insignificant way. Additionally, Table 4.2 indicates that three parameters explain access to irrigation credit in Bawku West at 99% confidence level (notably age, extension services and income), and only one is significant at 10% (that is experience in irrigation). The remaining parameters are not pertinent for explaining access to irrigation credit in Bawku West. Age is a significant determinant of access to credit for irrigated agriculture at 1%, but this Table 4.2 Determinants of access to credit by smallholder irrigators in Bawku West district (n = 108) Variable

Coefficient

Std. Err

z

P>IzI

Marginal effects

Gender Age Marital status Education Extension services Experience in irrigation Rain-fed area Irrigated area Irrigable land ownership Group membership Household size Ln (Income) Savings Constant LR Chi-square Prob > Chi-square Log likelihood Pseudo-R 2 Predicted probability

0.719 −1.527*** −0.615 0.748 −2.503*** 0.049*

0.518 0.551 0.556 0.633 0.803 0.027

1.387 −2.770 −1.105 1.181 −3.118 1.801

0.165 0.006 0.269 0.238 0.002 0.072

0.1560917 −0.2901027 −0.1289142 0.1462412 −0.375607 0.0105619

−0.129 0.549 −0.599

0.099 0.694 0.500

−1.300 0.790 −1.196

0.194 0.429 0.232

−0.027898 0.1184564 −0.1288941

0.553 0.125 0.275 0.638 1.724

0.608 0.428 2.927 −0.424 −1.519

0.543 0.668 0.003 0.672 0.129

0.0738008 0.0115178 0.1738296 −0.0565441 –

0.336 0.053 0.805*** −0.270 −2.619 40.62 0.000 −61.011 0.250 0.685

Notes *Parameter that is pertinent at 90% confidence level (or 10% significance level) **Parameter that is pertinent at 95% confidence level (or 5% significance level) ***Parameter that is pertinent at 99% confidence level (or 1% significance level) Source Field survey data, 2015

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was not in conformity with the a priori expectation. This implies that irrigators below 36 years of age in Bawku West have a higher probability of accessing credit than do those aged 36 and above. Education is not a significant determinant of access to credit. Even though access to extension services did not meet the a priori expectation, it is a significant determinant of access to credit at 1%. This implies that irrigators who do not access extension services are more likely to access credit. As anticipated, the analysis revealed that income is a significant determinant of access to credit at 1% and met the a priori expectation of a positive influence on access to credit by irrigators. Likewise, the experience accumulated in irrigated agriculture met the a priori expectation and is a significant determinant of access to credit at 10% significance level. This suggests that farmers who have more years of irrigated agriculture experience are more likely to access credit than are those with fewer years of experience. This was evidenced during FGDs and key informant interviews with irrigators, which revealed that the rich experience in irrigated agriculture, together with other factors, enable them to move from subsistence to commercial production. Table 4.3 presents the logit results for Nabdam district. It exhibits an adjusted Pseudo R-squared of about 0.36, implying that all the explanatory variables included in the model were able to explain about 36% of the variations in probability of irrigators having access to credit for irrigated agriculture. The log LR was found to be significant at 1%, implying that all the variables included in the logit model jointly influenced the probability of irrigators accessing credit in Nabdam. The model yielded a predicted probability of 0.13, meaning that about 13% of the smallholder irrigators who participated in the study had access to credit. Moreover, Table 4.3 only singles out two parameters that explain pertinently access to irrigation credit in Nabdam district at 99% confidence level, namely education and group membership. All the other parameters are insignificant. As predicted, level of literacy and group membership met the a priori expectation and was significant at 1%, which was an indication that irrigators who had at least nine years of formal education and belonged to an irrigation scheme or farmer group were more likely to access credit for irrigated agriculture in the Nabdam district than those who had less than nine years of formal education and did not belong to a formal irrigation scheme or farmer group.

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Table 4.3 Determinants of access to credit by smallholder irrigators in Nabdam district (n = 108) Variable

Coefficient

Std. Err

z

P>IzI

Marginal effects

Gender Age Marital status Education Extension services Experience in irrigation Rain-fed area Irrigated area Irrigable land ownership Group membership Household size Ln (Income) Savings Constant LR Chi-square Prob > Chi-square Log likelihood Pseudo-R 2 Predicted probability

1.400 0.965 0.702 2.136*** −0.914 −0.025

0.895 0.728 0.739 0.700 0.660 0.071

1.564 1.326 0.950 3.051 −1.385 −0.345

0.118 0.185 0.342 0.002 0.166 0.733

0.1687531 0.1090078 0.0704668 0.3315945 −0.1151346 −0.0027505

−0.075 0.279 −0.767

0.317 0.284 0.617

−0.237 0.982 −1.244

0.814 0.325 0.214

−0.0083835 0.0313935 −0.088213

0.637 0.209 0.310 1.457 2.766

2.874 −1.218 1.591 0.714 −2.317

0.004 0.223 0.112 0.475 0.021

0.2555001 −0.0286118 0.0554034 0.0879134 –

1.832*** −0.255 0.493 1.041 −6.408** 41.44 0.000 −37.182 0.358 0.129

Notes *Parameter that is pertinent at 90% confidence level (or 10% significance level) **Parameter that is pertinent at 95% confidence level (or 5% significance level) ***Parameter that is pertinent at 99% confidence level (or 1% significance level) Source Field survey data, 2015

Table 4.4 presents the district-level logit analysis for Kassena-Nankana Municipality (KNM). Table 4.4 produced an adjusted Pseudo R-squared of about 0.23, which meant that all the explanatory variables included in the model were able to explain about 23% of the variations in probability of irrigators having access to credit for their irrigation activities in the municipality. The model also produced a predicted probability of about 0.44, meaning that access to credit by smallholder irrigators in KNM was about 44%. The log LR statistic was found to be significant at 1%, implying that all the variables included in the logit model jointly influenced the probability

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Table 4.4 Determinants of access to credit by smallholder irrigators in KassenaNankana (n = 108) Variable Gender Age Marital status Education Extension services Experience in irrigation Rain-fed area Irrigated area Irrigable land ownership Group membership Household size Ln (Income) Savings Constant LR Chi-square Prob > Chi-square Log likelihood Pseudo-R 2 Predicted probability

Coefficient

Std. Err

z

P>IzI

Marginal effects

0.348 −1.090* −1.451* 1.266** −0.968* 0.068**

0.610 0.567 0.762 0.551 0.554 0.031

0.571 −1.922 −1.905 2.296 −1.747 2.188

0.568 0.055 0.057 0.022 0.081 0.029

0.0855789 −0.2638473 −0.3441971 0.306012 −0.2374222 0.0166642

−0.137 0.134 −1.130**

0.127 0.328 0.495

−1.078 0.410 −2.280

0.281 0.682 0.023

−0.0337925 0.0331482 −0.2718587

0.612 0.125 0.215 0.665 1.582

0.550 0.237 1.830 1.314 −1.312

0.582 0.813 0.067 0.189 0.189

0.0828661 0.0072775 0.0971527 0.2036927 –

0.337 0.030 0.394* 0.874 −2.075 34.70 0.001 −57.647 0.231 0.442

Notes *Parameter that is pertinent at 90% confidence level (or 10% significance level) **Parameter that is pertinent at 95% confidence level (or 5% significance level) ***Parameter that is pertinent at 99% confidence level (or 1% significance level) Source Field survey data, 2015

of irrigators accessing credit. Additionally, Table 4.4 indicates that three parameters can pertinently explain access to irrigation credit in KNM at 5% significance level, which are education, experience in irrigation and irrigable land ownership. However, four parameters are significant at 10% only. The latter encompass age, marital status, extension services and income. The remaining parameters are not pertinent for explaining access to irrigation credit in KNM. The logit results revealed that age did not meet the a priori expectation, but turned out to be a significant determinant of access to credit at 10%. This meant that irrigators who were less than 36 years of age were more likely to access credit for irrigated

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agriculture in KNM than were those aged 36 and above. In the same vein, marital status did not conform to the a priori expectation, implying that married couples were less likely to access credit for irrigated agriculture; yet, this was found to be a significant determinant of access to credit by irrigators at 10%. Level of literacy met the a priori expectation and was significant at 5%, which indicated that irrigators who had at least nine years of formal education were more likely to access credit for irrigated agriculture in KNM than were those who had less than nine years of formal schooling. Though access to extension services had a negative relation with access to credit by smallholder irrigators, it was significant at 10%. Experience in irrigated agriculture met the a priori expectation and was significant at 5% level. During FGDs and key informant interviews, it was revealed that experience, knowledge and skill gained from cropping over the years all help to boost farmers’ production, which enhanced their ability to repay loans. Finally, ownership of irrigable land was a significant determinant of access to credit in KNM, but did not meet the a priori expectation; but income met the a priori expectation and was found to be a significant determinant of access to credit for irrigation at 10% level. Household size was not a significant determinant of access to credit, but was consistent with the a priori expectation (Table 4.4). Table 4.5 presents the logit results for Kumbungu district. The analysis of Table 4.5 displays an adjusted Pseudo R-squared of about 0.33, which meant that all the explanatory variables included in the model were able to explain about 33% of the variations in probability of irrigators having access to credit for their irrigation activities in the district. The predicted probability was found to be about 0.63, which meant that access to credit by smallholder irrigators in Kumbungu was about 63%. There was, therefore, a high level of access to credit by smallholder irrigators in this district. The log LR statistic was found to be significant at 1%, implying that all the variables included in the logit model jointly influenced the probability of irrigators accessing credit. The logit results revealed that the gender of respondents did not meet the a priori expectation and was not a significant determinant of credit access by irrigators. This result implies that female irrigators in Kumbungu were no more or less likely than male irrigators to access credit for irrigated agriculture.

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Table 4.5 Determinants of access to credit by smallholder irrigators in Kumbungu (n = 108) Variable

Coefficient

Std. Err

z

P>IzI

Marginal effects

Gender Age Marital status Education Extension services Experience in irrigation Rain-fed area Irrigated area Irrigable land ownership Group membership Household size Ln(Income) Savings Constant LR Chi-square Prob > Chi-square Log likelihood Pseudo-R 2 Predicted probability

−0.404 0.083 −1.117* 1.089* −1.556** 0.039

0.821 0.697 0.660 0.623 0.632 0.036

−0.492 0.119 −1.692 1.749 −2.464 1.096

0.623 0.905 0.091 0.080 0.014 0.273

−0.0930207 0.0192497 −0.2434743 0.2386858 −0.3295664 0.0090383

0.461** 1.020*** −0.779

0.198 0.387 0.604

2.327 2.633 −1.290

0.020 0.008 0.197

0.1069698 0.23678 −0.1746928

0.641 0.208 0.266 0.734 2.352

1.466 −0.372 1.755 −1.298 −1.448

0.143 0.710 0.079 0.194 0.148

0.2230342 −0.0179939 0.1082026 −0.2012144 –

0.940 −0.078 0.466* −0.953 −3.407 42.86 0.000 −44.088 0.327 0.634

Notes *Parameter that is pertinent at 90% confidence level (or 10% significance level) **Parameter that is pertinent at 95% confidence level (or 5% significance level) ***Parameter that is pertinent at 99% confidence level (or 1% significance level) Source Field survey data, 2015

The result of the hypothesis test conducted on the explanatory variables reveals that irrigated area alone can pertinently explain access to irrigation credit in Kumbungu district at 1% significance level, and those two parameters and three others can explain it at 5% and 10% significance level, respectively. The first batch includes extension services and rainfed area (significant at 5%) while marital status, education and income are significant at 10%. The remaining parameters are not pertinent for explaining access to irrigation credit in Kimbundu district. Areas cropped under irrigation and rain-fed conditions were significant determinants of access to credit for irrigation at 1% and 5% significance level, respectively,

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and both met the a priori expectations. Marital status was significant at 10% but negatively related to credit access by irrigators, and thus did not meet the a priori expectation. This implied that married couples were less likely to access credit for irrigated agriculture than were unmarried irrigators at 10% significance level. Level of literacy met the a priori expectation and was significant at 10%. That was an indication that irrigators who had at least nine years of formal education were more likely to access credit for irrigated agriculture in Kimbundu than were those with less than nine years. Access to extension services was a significant determinant at 5%, but failed to meet the a priori expectation. Income supported the a priori expectation and was at the same time a significant determinant of access to credit for irrigation at 10% significance level.

4.5

Credit Model for the Rural Poor

Based on the results and the review of literature, the following credit model is proposed for the delivery of credit to the rural poor. This model takes into consideration two main weaknesses identified in the credit models reviewed earlier in the chapter. The first weakness is that the nature of cash flows of irrigators is such that compulsory weekly repayments and savings are two criteria that they would find hard to meet. Their crops take time to mature and are not harvested weekly to enable them to generate enough income to meet such requirements. The second weakness is that the use of groups as social collateral for lending or joint liability of members for loans borrowed by other group members means that there is some form of group screening and self-selection, which may further lead to exclusion of the poor. Our proposed model is, therefore, built for the rural poor to improve their savings mobilization capacities for enhanced access to credit for irrigation and other livelihood activities. Known as Community Empowerment, Savings and Credit Associations (CESCAs), the underlying and operating principle of the model is that it must be established by the people, be owned by the people, be controlled by the people and be managed by the people, bearing in mind their values, traditions, customs and reality. This leads to strong community identity and ownership for empowerment. The model is cyclical in nature and is made up of five main stages, as presented in Fig. 4.1.

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Sensitization and awareness creation

Implementation of social development activities

Internal and external resource mobilization

Financing of common-interest economic activities

Fig. 4.1 Community (CESCAs) Model

Empowerment,

Financing of individual irrigated agriculture and other activities Savings

and

Credit

Associations

Stage 1—Sensitization and awareness creation of community members Through community gatherings, the poor should be sensitized and made aware of the importance of savings and of the fact that, while they expect assistance from external sources, there is a need to be self-reliant and proud in taking their destiny into their own hands. Stage 2—Mobilization of internal and external resources At this stage, savings and resources—often referred to as the engine of development—are mobilized: by getting stakeholders committed, by raising the start-up capital, paying individual share subscription and fees, and registering the micro-bank, and by having individual accounts opened. Digital financial platforms such as

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Mobile Money Services provided by Telecommunication Companies should be leveraged for seamless mobilization of internal and external resources. Stage 3—Financing of individual irrigated agriculture and other activities At this stage, the micro-bank begins granting credit to individuals for irrigation activities and other income-generating activities, using the resources mobilized. Again, delivery of credit should be through the digital financial platforms (e.g. Mobile Money Services) to reduce transaction costs. Stage 4—Financing of common-interest economic activities This stage of the micro-bank development involves financing community development projects, such as market infrastructure, schools, health centres, police posts and public places of convenience, which is done only after attaining administrative and financial autonomy (salaries, electricity and telephone bills and other consumables). Stage 5—Implementation of social development activities At the final stage, community social activities are financed and undertaken with the resources generated at stages 3 and 4. At this stage, the community would be empowered to take critical decisions that affect the common good, and this further creates awareness of the existence and importance of such an association, thereby reinforcing the cycle.

4.6

Conclusion and Policy Implications

4.6.1

Summary of the Findings and Conclusion

Credit is a fundamental factor in driving investment in irrigated agriculture and allows farmers to access productive inputs such as seeds, fertilizers, pesticides and new technologies that can help increase overall agricultural production. This chapter used a logit model to estimate the factors that determine access to credit by smallholder irrigators across northern Ghana, and proposed an innovative credit model that will work for the rural poor, especially smallholder irrigators along the White Volta Basin of northern Ghana. Different techniques, including focus group discussions, key informant interviews and household surveys, were used

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for data collection. The quantitative and qualitative data were processed and analysed using logit regression and thematic analyses, respectively. Results from the qualitative and quantitative analyses show that membership of a group, irrigable landownership, size of irrigable farm, income, experience in irrigated agriculture, literacy level, access to agriculture extension services and marital status are the factors that significantly determine access to credit by smallholder irrigators. 4.6.2

Recommendation

It is recommended that development agencies including national governments, especially in Africa that seek to promote inclusive and sustainable rural development should incorporate “Community Empowerment, Savings and Credit Associations” model in the design and implementation of their interventions. The model is transformative and when used appropriately in financial interventions will enhance access to credit by smallholder irrigators, to enable them to invest in their production activities and improve their output and income levels, resulting in poverty reduction.

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Gbigbi, T.M. 2017. Are there road blocks to access micro-credit from selected microfinance banks in delta state, Nigeria? Implications for small scale farmers sustainability. Journal of Food Industry 1 (1): 1–16. https://doi.org/10. 5296/jfi.v1i1.11613. Ghana Living Standards Survey Seven (GLSS 7). 2019. https://www.statsghana. gov.gh/gssmain/fileUpload/pressrelease/GLSS7%20MAIN%20REPORT_ FINAL.pdf (Accessed on 8 October 2022). Ghosh, P., D. Mookherjee, and D. Ray. 2000. Credit rationing in developing countries: An overview of the theory. In A reader in development economics, ed. D. Mookherjee and R. Debraj. London: Blackwell. GIZ [German International Cooperation]. 2014. Handbook operating village banks. Microfinance in rural areas—Access to finance for the poor. Available at: https://www.giz.de/en/downloads/giz2014-en-operating-village-bankshandbook-annexes.pdf (Accessed on 23 June 2016). Jia, X. 2008. Credit rationing and institutional constraint: Evidence from rural China. Frankfurt: Peter Lang GmbH International Verlag der Wissenschaften Frankfurt am Main, Development Economics and Policy 59. Julien, H., A. Kossi, and E. Aklésso. 2021. Analysis of factors influencing access to credit for vegetable farmers in the Gulf Prefecture of Togo. American Journal of Industrial and Business Management 11: 392–415. https://doi. org/10.4236/ajibm.2021.115026. Kiplimo, J.C., E. Ngenoh, W. Koech, and J.K. Bett. 2015. Determinants of access to credit financial services by smallholder farmers in Kenya. Journal of Development and Agricultural Economics 7 (9): 303–313. https://doi.org/ 10.5897//JDAE2014.0591. Kiros, S., and G.B. Meshesha. 2022. Factors affecting farmers’ access to formal financial credit in Basona Worana District, North Showa Zone, Amhara Regional State, Ethiopia. Cogent Economics & Finance 10 (1): 2035043. https://doi.org/10.1080/23322039.2022.2035043. Khanh, H.L.P. 2011. The role of social capital to access rural credit. A case study at Dinh Cu and Van Quat Dong Village in Coastal area of Thua Thien Hue Province. Master’s thesis, Hue University of Agriculture and Forestry, Faculty of Extension and Rural Development, Rural Development Department, Vietnam. Masaood, M., and L. Keshav. 2020. Factors affecting farmers’ access to formal and informal credit: Evidence from rural Afghanistan. Journal of Sustainability 12 (1268): 1–16. MoFA [Ministry of Food and Agriculture]. 2021. Facts and figures: Agriculture in Ghana, 2020. Accra: SRID [Statistics, Research and Information Directorate]. Available at: https://srid.mofa.gov.gh/sites/default/files/Agr iculture%20In%20Ghana%20Facts%20%26%20Figures_%202020%20FINAL. pdf (Accessed on 8 October 2022).

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Muhongayirea, W., P. Hitayezub, O.L. Mbatiac, and S.M. Wangiad. 2013. Determinants of farmers’ participation in formal credit markets in rural Rwanda. Journal of Agricultural Science 4 (2): 87–94. https://doi.org/10.1080/097 66898.2013.11884706. NDPC [National Development Planning Commission]. 2021. Agenda for jobs II: creating prosperity and equal opportunity for all 2022–2025. MediumTerm Development Policy Framework. Accra: Government of Ghana Publications. Available at: https://ndpc.gov.gh/resource_and_publications/dow nloads (Accessed on 8 October 2022). Nouman, M., M.F. Siddiqi, S.M. Asim, and Z. Hussain. 2013. Impact of socioeconomic characteristics of farmers on access to agricultural credit. Sarhad Journal Agriculture 29 (3): 469–475. Nyaga, J., and J. Nzulwa. 2017. Determinants of procurement performance in state corporations in Kenya. The Strategic Journal of Business & Change Management 4 (2): 865–888. www.strategicjournals.com. Olomola, A. S., and K. Gyimah-Brempong. 2014. Loan demand and rationing among small-scale farmers in Nigeria. Discussion Paper 01403. Washington, DC: IFPRI [International Food Policy Research Institute]. Rizwan, M., Q. Ping, S. Iram, A. Nazir, and Q. Wang. 2019. Why and for what? An evidence of agriculture credit demand among rice farmers in Pakistan. Asian Development Bank Institute. http://hdl.handle.net/11540/11125. Rudrabhatla, R., S. Roy, and S.K. Bose. 2015. Role of microfinance and microfinance institutions models in improving quality of life—A critical review. IASIR [International Association of Scientific Innovation and Research] Journal 12 (1): 70–76. Sarma, S.K., and M.H. Mehta. 2014. The Best model for micro-lending: Selfhelp group or joint liability group? Journal of Rural Development 33 (3): 247–260. Sebatta, C., M. Wamulume, and C. Mwansakilwa. 2014. Determinants of smallholder farmers’ access to agricultural finance in Zambia. Journal of Agricultural Science 6 (11): 63–73. https://doi.org/10.5539/jas.v6n11p63. Sekyi, S., B.M. Abu, and P.K. Nkegbe. 2020. Effects of farm credit access on agricultural commercialization in Ghana: Empirical evidence from the northern Savannah ecological zone. African Development Review 32: 150– 162. https://doi.org/10.1111/1467-8268.12424. Sivakumar, M.V.K., and R. Stefanski. 2008. Climate change mitigation, adaptation and sustainability in agriculture. Geneva: WMO [World Meteorological Organization]. Stiglitz, J.E., and A. Weiss. 1981. Credit rationing in markets with imperfect information. American Economic Review 71 (3): 393–410. Tichenor, N. 2011. Agricultural intensification: Past successes, lessons learned and future potential. Available at: http://sites.tufts.edu/nicoletichenor/ files/2012/09/Tichenor_2011_Sustainable-Intensification.pdf (Accessed on 23 June 2013).

CHAPTER 5

Conventional Valuation of the Economic Viability of Agricultural Water Investments in Arid and Semi-Arid Lands Cush Ngonzo Luwesi, Seham D. Zaky Dawoud, Chris Allan Shisanya, Remy Bolito Losembe, Joy Apiyo Obando, and Nelson H. Were Wawire

Abstract There is an urgent need for developing “Green water” resources in Africa, which represent the two thirds (2/3) of water reserves kept by plants underneath. Yet, the “Business as usual” interventions consist of investing heavily in “Blue water saving” through large dams,

C. N. Luwesi (B) University of Kinshasa, Kinshasa, Democratic Republic of the Congo e-mail: [email protected] S. D. Z. Dawoud Damietta University, Damietta, Egypt C. A. Shisanya · J. A. Obando · N. H. W. Wawire Kenyatta University, Nairobi, Kenya R. B. Losembe University of Kinshasa, Kinshasa, Democratic Republic of the Congo © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 C. N. Luwesi and A. Beyene (eds.), Innovative Water Finance in Africa, https://doi.org/10.1007/978-3-031-38234-5_5

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water tanks and pipelines as well as rationing water and regulating its inter-basin transfer and price. This chapter presents an innovative application of conventional yet probabilistic benefit-cost valuation methods for the economic viability of agricultural water investments in the Arid and Semi-Arid Lands (ASALs) of Kenya. Keywords Arid and Semi-Arid Lands (ASALs) · Benefit-cost analysis (BCA) · Green water development (GWD) · Blue water saving (BWS)

Box 5.1: Lessons Learned • A business as usual (BAU) policy intervention towards solving water crises consists of blue water supply (BWS) through investments in large dams, water tanks and pipelines as well as inter-basin transfer, rationing and price regulation. • “Blue water” actually represents only a third (1/3) of the total rainwater input in the soil; the remaining two thirds (2/3) represents the reservoir of “green water” that is kept by plants for their own use. • Hence, to get to “business not as usual” (BNAU), we need to develop agricultural water by implementing “Green Water Development” (GWD) schemes through consensual agreements between upstream farmers and downstream water users for a “Payment for Environmental Services” (PES). • To know the extent to which these schemes are beneficial to farmers and attractive for investments, bankers and other financiers need to analyze their economic cost-effectiveness, efficiency and profitability using a productive efficiency model such as “Cobb–Douglas”. The latter provides technical and scale efficiencies based on the elasticity of production vis-à-vis given factors of production at a particular time. • Though accurate and reliable, agro-economists agree that the economic efficiency and benefit-cost ratio (BCR) computed using these classical models are fairly true if carried out under a normal economic conjuncture (Normal scenario) but they can easily be

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challenged in the course of climate change, due to unpredicted environmental changes. • Most environmental economists often rely on nonconventional methods for cost-efficiency, cost-effectiveness and benefit-cost analyses to unveil the economic efficiency, effectiveness and BCR of new investments in GWD schemes versus traditional BWS projects under conditions of water excess loss (Flood) and water shortage (drought) or normal conditions. • Water service providers and resource managers shall always blend investments in technological equipment for green water development and know-how in blue water supply. This would enable farmers harvest and store more rainwater during flooding periods for use under conditions of drought.

5.1

Introduction

The twentieth century bubbled with global debates on rural water development that have led to reforms of national policies on food, energy and water (FEW) security as well as environmental conservation. Prominent were the 1997 debates on the use value of huge dams. For that occasion, critics and champions of large dams met to discuss about enhancing water storage viability for sustainable livelihood using dams. These discussions led to creation of the World Commission on Dams (WCD) in the year 2000. Participants to the discussions recognized that a dam is the best investment for achieving poverty alleviation policies and environmental sustainability. Yet, they did not deter challenges related to building large dams, owing to multiple economic, social and environmental risks in the face of climate change. They also acknowledged the need for computation of a cost-benefit ratio (CBR) prior to venturing into investment to avoid extra cost of conducting rigorous processes pertaining to socio-economic and environmental impact assessments. Among other guidelines, they proposed participatory consultations for viable and sustainable new investments in dams.1 Similarly, a joint team from the World Bank and its partners met in June of 2001 to discuss about the promotion of Agricultural Water

1 Scherr et al. (2011), Ledec and Quintero (2003), and WCD (2000).

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Development (AWD). Strategic plans for investment preparation were designed in order to revitalize interest in agricultural water investment in Sub-Saharan Africa. These discussions, which later brought on board the New Partnership for Africa’s Development (NEPAD) saw the development of a Comprehensive Africa Agricultural Development Programme (CAADP). The latter gave an impetus to State members of the African Union to increase their investments in agricultural water within their National Medium-Term Expenditure Frameworks.2 A part from building large dams, the “business-as-usual” policy intervention has been translated into increased investments in water tanks to save “blue water”, which actually represents one third (1/3) of the total rainwater input in the soil. Also, the use of inter-basin transfer, rationing and pricing regulation for water vendors in time of drought as well as climate information and early warning systems have also shaped the thinking of policy-makers towards solving crises in the water sector. Yet, two thirds (2/3) of rainwater infiltrate the soil to find a sanctuary in grasslands, woodlands (forests), marshlands, farms (crops) and arid land covers. These land cover types represent the reservoir of “green water” that is kept by plants for their own use. Hence, “the great challenge we face is to get to business not as usual ” for agricultural water development to alleviate poverty and drive economic growth. The implementation of “Green Water Development” (GWD) schemes is likely to be innovative towards enhancing sustainability in water resource management through consensual agreements between upstream farmers and downstream water users for a “Payment for Environmental Services” (PES).3 But to what extent are these schemes beneficial to enable bankers and other financiers invest in them?

5.2 Economic and Financial Approaches for GWS Schemes Economic and financial literature abound in methodological approaches for valuing the economic viability and financial sustainability of new investments. This chapter presents and discusses conventional economic

2 Van der Bliek et al. (2014), AGRA (2009), and World Bank et al. (2008). 3 Berntell (2008), Wunder (2007), Rockström (2003), Subramanian (2001), and

Reisner (1993).

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models used to predict financial flows in water investments. A focus is put on the application of a probabilistic Benefit-Cost Analysis (BCA). 5.2.1

Conventional Economic Models for Efficiency and Profitability

Whether socially and politically performing well, a GWS scheme needs to meet basic requirements for achieving economic efficiency and profitability. This would enable farmers to drain sufficient financial resources and minimize productive and distributive inefficiencies in their agricultural production. Enhanced technological, allocative, scale and costefficiency will enable the scheme to assure its full cost recovery. Traditional approaches were used to inform on the weight of revenues over costs through computation of a Benefit-Cost Ratio (BCR) resulting from discounted investment values. This was likely to determine the status of cost-efficiency. In the last century, economists and statisticians have devoted so much time and effort to provide adequate measurement for productive efficiencies. In a nutshell, three major methods have been used to that effect: (i) statistical analysis of time-series data; (ii) statistical analysis of cross-section data; and (iii) technical information supplied by engineers and other agricultural scientists.4 Most literature in agricultural economics generates productive efficiency from the so-called Cobb-Douglas model. The latter provides technical and scale efficiencies based on the elasticity of production visà-vis given factors of production at a particular time. In effect, in the 1930s, C.W. Cobb and P.H. Douglas, two American economists, found a remarkable constancy in the share of wages (about 75%) and profits (25%) in the total National Product for many years.5 They used a power production function to derive the shares of labour and capital remunerations, represented by α and β coefficients, respectively, in their model. The model first assumed that there was perfect competition in the market. Secondly, the value of output was to be exhausted so that neither the capitalist nor the workers nor anyone else could claim any residual product. This fact was earlier demonstrated by Leonard Euler, who enunciated this theorem6 :

4 DFT (2011), Anandajayasekeram et al. (2004), and OAS (1991). 5 Nicholson (1992). 6 Hardwick et al. (1994).

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Given a production function with constant returns on scale, payments to factor owners on the basis of their marginal products will just exhaust the total product

The Cobb-Douglas model was therefore disseminated in agriculture economics to perform different types of predictions on farming production.7 The most cited production function is the one for New York dairy farms’ production, which extends the capital in the Cobb-Douglas model to the amount of land used (A), equipment used (E), livestock and feed used (S) as well as other resources used (R) in addition to labour used (L). Though accurate and reliable, agro-economists today agree that one of the difficulties of this model is related to the formulation of a valuable technology that fits to the ever-increasing returns to scale of dairy farms’ production function. Economists also agree that, depending on the type of the production technology, a Cobb-Douglas model may have more than two or three variables. Moreover, it is admitted that, under a pure and perfect competition, the returns on scale are expected to be constant (that is when the sum of all the parameters is equal 1); otherwise, they will be increasing (the sum of all the parameters is superior to 1) or decreasing (the sum of all the parameters is inferior to 1).8 The increasing interest raised by the Cobb-Douglas model led other economists to develop a more general model of product flow to be used even in case of technological change, whereby returns on scale are not constant. The latter is known as “Constant Elasticity of Substitution” (CES) model. It was developed in the 1960s by the pioneering group composed of the Nobel laureates R. Solow and K.J. Arrow along with H.B. Chenery and B.S. Minhas.9 : The CES model introduces a technological choice factor (for ε ≥ 0) and a distributor parameter or factor of total flow share (0 < δ < 1) given a regression parameter (ρ ≤ 1), which indicates the total flow share of a factor of production and determines the

7 Mansfield (1991). 8 Hardwick et al. (1994), Lipsey and Steiner (1978), and Shackle (1968). 9 Arrow et al. (1961) and Solow (1956).

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elasticity of substitution (σ ) between K and L given by Eq. (5.1)10 : σ=

1 1−ρ

(5.1)

The economic efficiency and benefit-cost ratio (BCR) computed using these classical models is fairly true if carried out under a normal economic conjuncture (Normal scenario), where market prices are stable, a fair and perfect competition prevails, and a proper sensitivity analysis is provided. Brown (2001) and Stern (2007) noted that traditional methods for assessing economic efficiency could easily be challenged in the course of climate change, due to unpredicted environmental changes. The resulting estimates have proved useful in many contexts, but their limitations should be noted. In particular, since they equate the effects of technological change with whatever increase in output is unexplained by other inputs, they may not isolate the effects of technological change alone. In addition, they may contain the effects of whatever inputs may have been excluded from the analysis because of convenience, lack of data, ignorance, or some other reason.11

Jones et al. (2004) and Barah (2009) suggest randomization for such modelling to take into account probabilistic effects of environmental disasters. The use of Data Envelopment Analysis (DEA) and other probabilistic models is commonly recommended in classical economics for the analyses of economic efficiency and benefit-cost.12 Even where the use of these probabilistic models has been tested, environmental economists often rely on nonconventional methods for cost-efficiency, cost-effectiveness and benefit-cost analyses to unveil the economic efficiency, effectiveness and BCR of new investments. A compendium of techniques for economic valuation of environmental benefits and costs is provided by Reitbergen-McCraken and Abaza (2000) and Venkatachalam (2003). The following sub-section focuses on these extended methods of benefit/cost and efficiency ratio valuation.

10 Nicholson (1992). 11 Mansfield (1991). 12 Oduol et al. (2006).

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5.2.2

Probabilistic Benefit-Cost Analysis

This study uses a probabilistic benefit-cost approach adopted from British Department For Transport (DFT) (2011) and adapted after OAS (1991) and Anandajayasekeram et al. (2004). The latter suggests a 7-step approach for a BCA, which encompasses: (i) the specification of water situation “with” and “without” Green Water Development (GWD); (ii) the description of costs and benefits over the project period; (iii) the valuation of cost and benefit streams; (iv) the computation of the discounted project values; (v) the adjustment of discounted values to risk and adaptive capacity values; (vi) sensitivity analysis; and (vii) the prospection of tangible and intangible socio-economic and biophysical outcomes of GWS schemes. Costs and benefits generated confirmed the economic feasibility and reliability of GWS schemes. This study conducted a Benefit-Cost Analysis (BCA) to test the economic viability of agricultural water supply, where GWD schemes existed on one hand, and where they did not, except Blue Water Supply (BWS) projects, on the other hand.13 This BCA eagerly followed the DFT (2011) framework to appraise and evaluate GWD schemes vis-à-vis their BWS project counterparts. It was used to validate the hypothesis that biophysical, economic and socio-political risks leading to farming vulnerability were attributed to the failure of BWS projects. The latter were considered to be inadequate for sustaining present and future needs of all ecosystems and human beings in the course of climate change.14 The BCA approach also provided an alternative to the Cost-Efficiency Inventory (CEI) by taking into consideration the various forms of market distortions not dealt with, such as the inflation rate, the foreign exchange rate and the economic growth rate. This gave rise to hybrid BCA models under different hydro-economic inventory scenarios that support fluctuating economic viability with the changing climate. 5.2.3

Hydro-Economic Inventory Modelling

Hydro-economic inventory models were used in the study to determine GWD schemes’ efficiency ratios computed from the marginal

13 Treasury (2011). 14 Perret et al. (2006).

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costs of farming water under ANOR, NOR and BNOR climatic and socio-economic conditions (EOQ, LAC and MES).15 A key assumption was set on the correlation between water losses and agricultural water use efficiency through increased costs of production. The total farming water cost under the NOR regime was said to be a combination of respective costs of transaction (C t ) and opportunity costs (C o ), while it was hypothesized to be loaded by the costs of water saving (C s ) and by water shortage costs (C s * ) under the ANOR and the BNOR climatic and socio-economic conditions, respectively. It was also assumed that the farming activity under the NOR scenario was neither profitable nor unprofitable. Farmers were bearing only normal costs of transaction and opportunity costs, thus leading to Constant Returns on Scale (CRS). However, the farming activity under ANOR and BNOR scenario was to result in Variable Returns on Scale (VRS).16 Significant profits and losses were to be expected, as farming water costs were overloaded by or alleviated from important costs of water saving and shortage costs. For the convenience of this study, it was assumed that the quantity of inputs for producing a cubic metre of water remained constant over time in the catchment under the three climatic scenarios. Hydro-Economic Risk Analysis and Management (HERAM) was used to simulate agricultural water demands and productivities under the above three scenarios of rainfall fluctuation.17 Using hybrid inventory models, the analysis specifically sought to compute an Economic Order Quantity (EOQ), Limit Average Cost (LAC) and Minimum Efficient Scale (MES) of farming water demand and productivity under above normal (ANOR), normal (NOR) and below normal (BNOR) climatic and socio-economic conditions, respectively. Table 5.1 summarizes this hydro-economic modelling process for cost-efficiency and the economy of outputs. Projections of water demand, supply, income and related costs by the year 2030 were based on the computation of hydrologic and socioeconomic data for the year 2010. Calculations for the base year (2010) were done using MS Excel spreadsheet, while projections for the period

15 Luwesi (2021). 16 Luwesi et al. (2012). 17 Luwesi et al. (2011).

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Table 5.1 The valuation of costs involved in Green Water Saving schemes Rainfall regime

Total cost of farming water Cost of Crop water demand

External costs

Normal (NOR)

Cost of transaction

Opportunity cost

Above Normal (ANOR)

Cost of transaction

Opportunity cost

Saving cost

Below Normal (BNOR)

Cost of transaction

Opportunity cost

Shortage cost

Optimum (first order conditions) Limit Average Cost (LAC) √ r no = 2q/Q Economic Order Quantity (EOQ) r√an = 2q/(2Q − q) Minimum Efficient Scale (MES) √ r bn = 2

Source Luwesi (2010)

from 2011 to 2030 were done through the Water Assessment and Development Planning (WADeP) system.18 The WADeP system processes a wide range of operations using iterative linear programming algorithms. These encompass the simulation of streamflow, groundwater and reservoir storages, sector water demands, ecological baseflow requirements and project costs and benefits.19 These processes result in rating curves for daily water supply (Ws ), demand (Wd ), their total costs (TCs and TCd ) and the total revenue from supply (Rw ) under the three climatic scenarios: ANOR, BNOR and NOR. The latter are expressed in terms of Future Value (FV)20 : FV = PV(1 + r )t

(5.2)

where, FV the future value of an investment under a normal water economy 18 Luwesi (2013). 19 SEI (2005). 20 Adrianto and Yoshiaki (2002).

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PV the present value of an investment at the base period (t = 0) r growth rate to be superior to 10% per annum and over a period of t years After an incremental analysis is conducted on these FV rating curves, the analysis will assist in deriving the optimum levels of rationalization of crop water use and agricultural yield under ANOR, BNOR and NOR climatic scenarios and socio-economic conditions.

5.3 Methodological Approach of the BCA Conducted in Muooni 5.3.1

Water Situation with and Without GWS Schemes

GWD Schemes are designed as “Not As Usual Business” (NAUB) projects. They are innovative ways for sustainable management of water resources, which involve all stakeholders, both upstream and downstream.21 In general, water resources are implemented in the context of upstream-downstream management of “blue water” supply rather than “green water” saving. “Blue water” is defined as freshwater resource that can be tapped, from rivers and streams, or groundwater”.22 It represents one third of the total soil moisture, the remaining two thirds being held in the soil by plants, as “green water”, for their own use.23 Blue water supply (BWS) projects mostly collapse due to the heavy costs of flooding and droughts brought about by climate change. Therefore, developing green water is rationally the best option for sustainable water resources management. In this study, the installation of a Grundfos Lifelink’s automated water pump (borehole drilling, operating and maintenance)24 was considered as “Business As Usual” (BAU) to fit in the study areas in case of drought. In such a situation, the alternative “Not As Usual Business” (NAUB) project would be a set of soil and water conservation measures (GWD schemes). The latter were limited to agro-forestry, grass waterways, runoff cut-outs

21 Berntell (2008). 22 Wilschut (2010). 23 Dent and Kauffman (2007). 24 Karago (2009).

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and terraces.25 The following sub-sections illustrate the sequential steps involved in the description of the nature of costs and benefits for a BCA of investments in GWD schemes. 5.3.2

Describing Costs and Benefits over the Project Period

The description of the expected costs and benefits resulting from the implementation of both BWS and GWD projects is provided below. The cost of investment of the BWS projects was limited to the estimates of the biophysical consequences of the drilling height of a borehole, while its expected revenue was based on an estimate of its daily pumping capacity over time. Other costs included the expenditure on the equipment and the personnel to be employed for operations and maintenance (O and M).26 GWS schemes were expected to result in increased agricultural water productivity due to the avoidance of income loss in case of water excess or shortage. However, there was a need to invest in a set of soil and water conservation measures on a parcel of the farmland for the implementation of the schemes.27 Table 5.2 illustrates the types of items required for implementing each scheme. 5.3.3

Valuating Cost and Benefit Streams over the Project Period

Information and data on the biophysical consequences of the two projects were transformed into costs and incomes to derive cash flows (benefits) for each project over its lifespan and assess their financial returns (cost-effectiveness), economic feasibility and social acceptability. The analysis also predicted some critical macroeconomic indicators of the Kenyan economy, including the economic growth rate (%), the inflation rate (%), the interest rate (%) and the foreign exchange rate (KES/US$).28 Projected blue water prices (US$/m3 ) and quantities (demand, supply and unmet demand in m3 ) were retrieved from the WADeP system analysis to form a basis for the costing and for the computation of expected incomes per project.

25 Kauffman et al. (2007). 26 Howe (1971). 27 Harris et al. (2017). 28 Harris et al. (2017).

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Table 5.2 Operations involved in the implementation of GWD schemes No

Scheme

Area (hectares)

Activities Involved

Projected water productivities (e.g.)

1

Agro-forestry

• datum • datum

Tree seedling, crops, manure/fertilizers, and O&M labour

2

Contours

• datum • datum

Grass, manure/ fertilizer, and O&M labour

3

Runoff cut-outs

• datum • datum

Excavation + levelling labour, grass, manure/fertilizers, and O&M labour

4

Terraces

• datum • datum

Excavation labour, grass, manure/ fertilizer, and O&M labour

• Eucalyptus (Tons of wood/ m3 ) • Miraa (Kg of leaves/m3 ) • Cassava (Kg of roots/m3 ) • Irish potatoes (Kg of roots/ m3 ) • Mango (Kg of fruits/m3 ) • Banana (Kg of fruits/m3 ) • Maize (Kg of grains/m3 ) • French beans (Kg of grains/ m3 )

Source Luwesi et al. (2012)

It shall be noted that the WADeP system analysis was based on three climatic scenarios (BNOR, ANOR and NOR) and the base year for calculation was 2010 while the forecast period extended from 2011 up to 2030. The years 2019 and 2029 were predicted as La Niña or drought periods (BNOR scenario); and 2020 and 2030 were considered as El Niño or flooding periods (ANOR scenario), while the remaining years were considered as normal climatic periods (NOR scenario). Therefore, hydro-economic inventory models were applied to estimate the actual cost of each project (cost of transaction) and its externalities (opportunity cost, cost of water saving and shortage cost). The study applied the “game theory” criteria of “minimax” and “maximin” in the selection of incomes and costs of GWD schemes, respectively.29 The study thence selected the scheme that had the least benefits and the “most-damaging” cost scenario among the four options aforementioned (see Table 5.2). 29 Howe (1971).

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This helped avoiding beatific expectations that could lead to overestimation of what the project was worth.30 Once all costs and incomes were computed, it was hence possible to determine the “benefits” of each project by deducting costs from revenue in each time period. The next step was to discount future values (FV) of costs and benefits to measure “net present values” (NPV). 5.3.4

Discounting Net Project Flows

The discounting of future values revealed what the project was worth today, both in dollars (USD) and Kenya Shillings (KES).31 It aimed to derive an “internal rate of returns” (IRR) from “net present values” (NPV). However, by tradition, investors arrange data in such a way that a “Benefit-Cost Ratio” (BCR) is deducted from discounted future costs and discounted future benefits. The BCR is thus the project’s equivalent IRR computed as Eq. (5.3)32 : BCR =

NPV(Benefits)GWS NPV(Costs)GWS

(5.3)

For analytical purpose, present values (PV) were retrieved from Eq. (5.2) above as Eq. (5.4)33 : PV =

FV (1 + b) p

(5.4)

where, r the discount rate p the period of forecast (in years) b the borrowing interest rate (predicted from the banking system of Kenya)

30 ADPC (2005). 31 Bush et al. (2008). 32 Young (1996). 33 Adrianto and Yoshiaki (2002).

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Though an opportunity cost of capital would have been the best estimate for discounting FV and determine the net present values (NPV) (or cash flows), the study instead derived a borrowing interest rate (b) from the Kenyan market as computed in Eq. (5.5)34 : b=

g−m 1−m

(5.5)

where, m the inflation rate discount rate g the nominal economic growth rate (calculated from Eq. 410.2) Happily, the said discount rate was in fit with the opportunity cost of capital mostly used for developing countries, which ranges between 8 and 15% in real terms.35 The net present values (NPV) for benefits resulting from GWD schemes were computed from Eq. (5.6)36 : ∫ NPV(Benefits)

GWS

=

20

t=0

[

] P(t)BtGWS − BtBWS e−r t dt

(5.6)

where, B t the stream of local benefits per intervention. P(t) the probability that a farmer would have adopted a GWD scheme to secure an average benefit level in period t, which was estimated from Equation (5.7)37 as follows: P(x) = π(1) +

x ∑ t=2

with,

34 Smyth et al. (2004). 35 OAS (1991). 36 Luwesi (2013). 37 Meier (1990).

π(t)

t−1 ∏ s=1

[1 − π(s)]

(5.7)

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P(x) the probability that a farmer has been previously enrolled in a water saving scheme and would likely adopt a GWD scheme within average period of x years after the start of the scheme. π(1) the ratio of blue water supply relative to the total water demand requirements at the starting of the GWD scheme in the whole catchment. π(s) the ratio of blue water supply relative to the total water demand requirements at any time period of the implementation of the GWS scheme in the local sub-catchment (upstream or downstream). Unlike net present benefits, the net present values (NPV) for the cost of GWD schemes were computed following their present values in accordance with Eq. (5.8)38 : ] 20 [ NPV(Costs)GWS = ∑ TCGWS (1 + b)−t t=1

(5.8)

Hence, the BCR was calculated as the ratio of NPV(Benefits)GWS by NPV(Costs)GWS . This paved the way for a Cost-Benefit Risk Analysis (CBRA), which encompassed a financial analysis into economic analysis by redoing all the steps above with the modifications enunciated in the following sub-sections. 5.3.5

Adjusting Discounted Net Flows to Climatic Risks

Disaster risks decrease chances of higher benefits while increasing expected costs.39 However, the opposite happens when farmers develop good adaptability values to face disaster risks. This study needed to factor in the occurrence and non-occurrence of the predicted biophysical Climate Impact (CI), Social Impact (SI) and Economic Impact (EI) to the variations of the farming community adaptive capacity (FCV). A premium was added to the discounted rate of benefits and costs to increase chances for higher internal rates of returns (IRR) in case of low risks for investing in GWS schemes.40 That premium was estimated from a scaling factor of drought risk (scenario 1) and of flood (scenario 2) based on the water 38 Adrianto and Yoshiaki (2002). 39 Smyth et al. (2004). 40 Howe (1971).

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shortage cost ratio (for drought) and the cost of water saving ratio (for flood). The latter were finally used to adjust the discount rates of costs and benefits under hypothesized drought or flood. A “decision tree” showing the computation of expected costs, benefits, discount rates and BCR under the scenarios of flood and drought is presented in Fig. 5.1.

Fig. 5.1 Decision tree for adjusting discounted net flows to capability (Source Luwesi [2013])

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5.3.6

Sensitivity Analysis

A Sensitivity analysis was conducted to test the variations of the NPV and BCR under assumptions of alterations of operating costs and expected benefits under the hypothesized drought or flooding.41 First, expected NPV were computed on the basis of expected GWS total cost [E(TC)], expected GWS total benefit [E(B)] and BWS total benefit [(benefit)BWS ], discount rates [E(b)] and NPV [E(NPV)] estimated above. Then the adjusted BCR value was estimated under drought risk and flood risk scenarios. Its variability to drought and flood under normal climatic conditions was also predicted. Cumulative frequencies of these BCR variabilities enabled the computation of “switching values” (for which the NPV of the project would become zero) following Eq. (5.9)42 : 0=

20 [ GWS ∑ (I − C GWS ) t

p=1

t (1 + b) p

−

BtBWS (1 + b) p

] (5.9)

where, BtGWS = ItGWS − CtGWS = BtBWS

(5.10)

with I t GWS , the stream of GWS schemes’ annual incomes The sensitive BCR derived from BWS benefits was finally computed as Eq. (5.11)43 : 20 [ ∑

BCRGWS sensitive =

p=1

BtBWS (1+b) p

]

NPV(Costs)GWS

(5.11)

The “switching values” were expressed in terms of percentages of the variation of the sensitive BCRs in comparison with the original BCRs. Finally, a conditional “constant loss probability” in case of drought or 41 Fujiwara and Campbell (2011). 42 Zyl et al. (2000). 43 Zyl et al. (2000).

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flood was computed under the assumption of 10% probability. This meant that it was expected a La Niña drought and an El Niño flood every 10 years, thus leading to a 10-year return period in a century. These results were finally plotted as “Loss Exceedance Curves” (LEC) under ANOR and BNOR scenarios.44 5.3.7

Prospecting Direct and Indirect Outcomes of GWD Schemes

The prospects of GWD schemes success in Muooni area were assessed from the farmers’ viewpoint (direct or tangible outcomes) and that of the Government of Kenya (indirect or intangible outcomes). Direct and tangible benefits meeting local stakeholders’ expectations were assessed against 5 key performance measurements, namely: (1) business success; (2) economic development; (3) environmental sustainability; (4) social equity; and (5) institutional development. However, benefits accrue to the government were perceived in terms of contribution to macroeconomic stabilization, employment creation, poverty alleviation and compliance to national rules and policies, especially the user/polluter pays principles and other water sector rules.45

5.4

Results of the BCA Conducted in Muooni

The main findings of the study conducted in 2011 in Muooni catchment of Machakos County, Kenya, are provided below. Tables 5.3 and 5.4 illustrate the computation of the BCR for BWS and GWS projects in Muooni under a normal climatic scenario (NOR). Detailed explanation of each of these results is supported by the WADeP hydro-economic equations, which enabled the tabulation of the actual and operational benefit and cost streams of GWD schemes and BWS projects. Conclusions are made following a discussion of these results. This enabled recommendations for further advisory of public officers, farmers and researchers on investments in climate resilient management systems for agricultural water development in Arid and Semi-Arid Lands (ASALs) of Kenya.

44 Smyth et al. (2004). 45 Luwesi et Beyene (2019).

(1) FV Revenue

66,881 66,613.476 66,347.0221 66,081.63401 65,817.30747 65,554.03824 65,291.82209 65,030.6548 64,770.53218 64,511.45005 64,253.40425 63,996.39064 63,740.40507 63,485.44345 63,231.50168 62,978.57567 62,726.66137 62,475.75472 62,225.8517 61,976.9483 61,729.0405 1,349,718.914

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2022 2022 2023 2024 2025 2026 2027 2028 2029 2030 SUM BCR

66,881 59,127.88567 52,273.54352 46,213.78426 40,856.49665 36,120.24735 31,933.0431 28,231.2364 24,958.55801 22,065.26165 19,507.36784 17,245.99535 15,246.77026 13,479.30337 11,916.72835 10,535.2933 9313.99976 8234.283473 7279.732238 6435.836419 5689.768394 533,546.1354

(2) Discounted Revenue 14,169 14,112.324 14,055.8747 13,999.65121 13,943.6526 13,887.87799 13,832.32648 13,776.99717 13,721.88918 13,667.00163 13,612.33362 13,557.88429 13,503.65275 13,449.63814 13,395.83958 13,342.25623 13,288.8872 13,235.73165 13,182.78873 13,130.05757 13,077.53734 285,943.2021

(3) FV Total Cost 14,169 12,526.47257 11,074.35353 9790.569955 8655.607736 7652.214899 6765.139392 5980.897244 5287.567597 4674.611509 4132.711755 3653.631198 3230.087585 2855.64285 2524.605254 2231.942866 1973.207078 1744.464983 1542.239591 1363.456979 1205.399566 113,033.8241

(4) Discounted Total Cost

Blue water saving projects’ benefit-cost ratio in Muooni

Year

Table 5.3

0 7485.590326 14,073.47857 19,867.84975 24,960.81082 29,433.7909 33,358.77899 36,799.4184 39,811.97417 42,446.1884 44,746.03641 46,750.39528 48,493.63481 50,006.14008 51,314.77333 52,443.28237 53,412.66161 54,241.47125 54,946.11947 55,541.11188 56,039.27211 816,172.7789

(5) NPV Revenue = (1)–(2) 0 1585.851428 2981.521178 4209.08125 5288.044864 6235.663091 7067.187086 7796.099928 8434.321587 8992.390117 9479.621865 9904.253087 10,273.56516 10,593.99529 10,871.23433 11,110.31336 11,315.68012 11,491.26667 11,640.54914 11,766.60059 11,872.13778 172,909.3779

(6) NPV Cost = (3)–(4)

0 5899.738899 11,091.9574 15,658.7685 19,672.76596 23,198.1278 26,291.5919 29,003.31847 31,377.65258 33,453.79828 35,266.41455 36,846.14219 38,220.06965 39,412.14479 40,443.539 41,332.96901 42,096.98149 42,750.20458 43,305.57033 43,774.51129 44,167.13434 643,263.401 3.720234314

(7) NPV Benefits = (5)–(6)

130 C. N. LUWESI ET AL.

(1) FV revenue

8703.9 8669.0844 8634.408062 8599.87043 8565.470948 8531.209065 8497.084228 8463.095891 8429.243508 8395.526534 8361.944428 8328.49665 8295.182663 8262.001933 8228.953925 8196.038109 8163.253957 8130.600941 8098.078537 8065.686223 8033.423478 175,652.5539

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2022 2022 2023 2024 2025 2026 2027 2028 2029 2030 SUM BCR

8703.9 7694.90893 6802.884159 6014.266486 5317.068542 4700.692587 4155.769409 3674.015916 3248.109225 2871.575349 2538.690793 2244.395553 1984.2162 1754.197883 1550.844214 1371.06412 1212.124856 1071.610471 947.3850784 837.5603924 740.4670254 69,435.74719

(2) Discounted revenue 15,100.87 15,040.46652 14,980.30465 14,920.38344 14,860.7019 14,801.25909 14,742.05406 14,683.08584 14,624.3535 14,565.85608 14,507.59266 14,449.56229 14,391.76404 14,334.19698 14,276.8602 14,219.75275 14,162.87374 14,106.22225 14,049.79736 13,993.59817 13,937.62378 304,749.1793

(3) FV total cost 15,100.87 13,350.31646 11,802.69412 10,434.47838 9224.871705 8155.487501 7210.070611 6374.250248 5635.32154 4982.052418 4404.512878 3893.924042 3442.524717 3043.453416 2690.644064 2378.73379 2102.981408 1859.195351 1643.669954 1453.129126 1284.676558 120,467.8583

(4) Discounted total cost 0 974.1754705 1831.523903 2585.603945 3248.402406 3830.516478 4341.314819 4789.079975 5181.134283 5523.951185 5823.253635 6084.101097 6310.966464 6507.80405 6678.109711 6824.97399 6951.129101 7058.99047 7150.693459 7228.125831 7292.956453 106,216.8067

(5) NPV revenue = (1)–(2)

Green water development schemes’ benefit-cost ratio in Muooni

Year

Table 5.4

0 1690.150063 3177.610538 4485.905059 5635.830196 6645.771593 7531.983446 8308.835594 8989.031958 9583.803666 10,103.07978 10,555.63825 10,949.23932 11,290.74357 11,586.21613 11,841.01897 12,059.89234 12,247.0269 12,406.12741 12,540.46904 12,652.94722 184,281.321

(6) NPV Cost = (3)–(4)

0 −715.9745929 -1346.086635 −1900.301114 −2387.42779 −2815.255115 −3190.668627 −3519.755619 −3807.897675 −4059.852481 −4279.826147 −4471.53715 −4638.272859 −4782.939518 −4908.106421 −5016.044976 −5108.763235 −5188.036428 −5255.433948 −5312.343213 −5359.990767 −78,064.51431 −0.42361599

(7) NPV Benefits = (5)–(6)

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5.4.1

Status of Blue Water Supply “with” and “Without” GWD Schemes

BWS projects have collapsed over years mostly due to the costs of flooding and droughts brought about by climate change. As a result, many communities would opt for the construction of a small dam or the drilling, operation and maintenance of a borehole (like the Grundfos Lifelink type with an automated solar pump) as BWS project to face with water disaster. The analysis considered this strategy as a “Business As Usual” (BAU) compared to a set of Soil and Water Conservation (SWC) measures, hereby “GWD schemes”, which would be alternative “Not As Usual Business” (NAUB) option to curb the effects of drought in the study area. The latter was limited to agro-forestry, runoff cut-outs, terraces and grass waterways. Five among the 6 remaining BCR computation steps aforementioned are specifically detailed below. The last one encompasses a general prospection of the outcomes of GWD schemes in Kenyan ASALs. 5.4.2

Costs and Benefits over the Projection Period

The study considered the drilling, operation and maintenance of 10 automated boreholes of Grundfos Lifelink’s type as the BAU project, pumping water in the whole Muooni area using solar panels. The total cost of this investment amounted to US$797,317.64, with annual maintenance costs and average variable operating costs predicted to US$256,015.70 and US$0.51/m3 , respectively, and the approximate average water price being US$2.57/m3 . Regarding the NAUB scenario, the study selected agro-forestry’s costs and incomes for GWS schemes instead of terraces, runoff cut-outs and grass waterways. This was the result of the “game theory” criteria of “maximin” and “minimax”. Table 5.5 displays the projected costs of implementation of GWD schemes in Muooni. It shall be noted the cost of investment represented 96% of the maximum cost of agro-forestry implemented on 177 hectares in the whole Muooni area. The remaining 4% was attributed to maintenance costs. Average variable operating costs for water supply were approximated to US$0.019/m3 . The analysis assumed that the variable water price per m3 was identical to the cost, since the scheme was set by farmers for their own water provision.

5

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Table 5.5 The cost and revenues of GWD schemes in Muooni (FY-2010) Type of cost and revenue

Cost (US$)

Revenue (US$)

Investment (US$ annual share) Fixed/maintenance (US$) Variable/farming operations (US$/m3 ) Variable/blue water operations (US$/m3 ) Total Cost (Revenue)

2,166.62 1,805.52 5,432,341.94 – 5,436,314.08

– – 2,973,744.91 159,659.99 3,133,404.9

5.4.3

Cost and Benefit Streams Under BAU and NAUB Scenarios

Under the “Business As Usual” (BAU) scenario, the following WADeP rating curves were used to estimate daily blue water supply volumes, costs and revenues in Muooni (t = 0 for the year 2010): Ws (t) = 28,338(0.995)t

(5.12)

T Cs (t) = 14,169(0.996)t

(5.13)

Rw (t) = 66,881(0.996)t

(5.14)

Streams of benefits were derived from the difference between water revenue (R w ) and the total cost for water supply (TC s ). Similar computations were done under the “Not As Usual Business” (NAUB) scenario, using the following rating curves for daily green water supply: Ws (t) = 23,404.14(0.995)t

(5.15)

T Cs (t) = 15,100.87(0.996)t

(5.16)

Rw (t) = 8,703.90(0.996)t

(5.17)

Streams of benefits were likewise derived from the difference between water revenue (R w ) and the total cost for water supply (TC s ). 5.4.4

Discounted Project Values Under BAU and NAUB Scenarios

The next step of the analysis was to discount Future Values (FV) from the project’s costs and benefits to measure what it was worth at the time of

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analysis in terms of “Net Present Values” (NPV) in US$ (dollars). Operational costs and benefits were discounted at a real interest rate of 12.7% per annum. The latter was derived from the analysis of the opportunity cost of capital in the Kenyan borrowing market. This discount rate fitted with the opportunity cost of capital mostly used for developing countries, and which ranges between 8 and 15% in real terms (OAS 1991). Under the BAU scenario, the discounted costs and benefits presented a sum of NPV (Benefits) of 643,263.4 against a sum of NPV (cost) of 172,909.38, thence leading to a BCR of 3.72 (Table 4.3). This ratio meant that blue water businesses were economically cost-effective in a water scarce area like Muooni under normal climatic conditions. Under the NAUB scenario, GWD schemes did not prove to be promising under normal economic circumstances (Table 4.4). The computed BCR resulted in a negative ratio of −0.42, with sums of NPV (benefits) and NPV (costs) approximating US$−78,064.51 and US$184,281.32, respectively. These results gave an insight on the types of water projects expected in a water scarce area like Muooni under normal circumstances. GWS schemes might not be the right economic options therein, while BWS projects may prove more economically viable in such circumstances. These results corroborate with a Cost-Efficiency Inventory (CEI) conducted earlier by Luwesi (2010).46 5.4.5

Discounted Net Flows Adjusted to Drought and Flood Risks

The WADeP hydro-economic inventory models assisted to determine operational functions for water supply costs, revenues and benefits under the BAU and the NAUB scenarios. For that reason, the water turnovers (r) simulated under drought and flooding were derived from discharges of Muooni river observed during the La Niña drought of November 2009 (r bn = 0.050) and the El Niño rains of December 1981 (r an = 1.826). Under the BAU scenario, the following rating curves were derived from BWS projects data for Muooni under drought:

46 Luwesi (2010).

T Cs (t) = 22,639(0.999)t

(5.18)

Rw (t) = 113,193(0.967)t

(5.19)

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NPV (benefits) and NPV (costs) for BWS projects generated sums of US$681,200.21 and US$286,825.1, respectively, with a BCR of 2.38. This BCR demonstrated once more that water businesses were still costeffective in Muooni area under drought just like under normal economic and climatic circumstances. Under expected El Niño flooding conditions, the following rating curves were obtained for BWS projects in Muooni: T Cs (t) = 16,341(0.974)t

(5.20)

Rw (t) = 20,053(0.974)t

(5.21)

Estimated sums of NPV under conditions of flooding rose up to US$34,548.49 (for benefits) and US$152,089.67 (for costs), with a positive BCR of 0.23. This ratio showed that BWS businesses were not economically viable in Muooni under conditions of flooding. Here is where GWD schemes excelled (the NAUB scenario) and were found to be economically feasible. The rating curves for the NAUB scenario below fit to GWD schemes under flooding conditions: T Cs (t) = 27,568.93(0.974)t

(5.22)

Rw (t) = 167,982.73(0.974)t

(5.23)

GWD schemes’ sums of NPV were estimated to US$1,306,865.42 (for benefits) and US$256,590.74 (for costs), thus leading to a positive BCR of 5.09 under conditions of flooding. This ratio showed that GWS schemes were highly economically viable in Muooni area under expected El Niño conditions rather than drought. The following rating curves were derived from operating costs and revenues of GWD schemes (NAUB scenario) in Muooni under an expected La Niña drought: T Cs (t) = 304,230.94(0.999)t

(5.24)

Rw (t) = 1,191.99(0.967)t

(5.25)

NPV sums generated for benefits and costs amounted to US$− 3,844,263.89 and US$3,854,457.77, with a negative BCR of −0.997.

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This BCR confirmed once more that GWD schemes were not costeffective in Kenyan ASALs under conditions of drought. 5.4.6

Sensitivity Analysis

A Sensitivity analysis was conducted to test the variations of NPVs and BCRs of GWD schemes under a hypothesized alteration of normal operating costs and expected benefits owing to the occurrence of an unpredicted drought or flood. Expected sums of NPVs obtained after occurrence of a flood event were estimated to US$1,306,865.42 (for benefits) and US$152,089.67 (for costs). Subsequently, the BCR obtained after flood occurrence amounted to 8.59. These schemes displayed switching values nearing twice the previous BCR, in case flood. However, switching values for the drought event were 13 times less than the previous one. In effect, the expected sums of NPV (benefits) and NPV (cost) were approximated to US$−3,844,263.887 and US$286,825.1, respectively, thus leading to a re-evaluated BCR of −13.4. The study hence concluded that GWD schemes were more economically feasible under conditions of flooding rather than drought in Muooni area. 5.4.7

Direct and Indirect Prospective Impacts of GWS Schemes

GWD schemes’ prospects of success in Muooni were assessed from the farmers’ viewpoint (direct or tangible outcomes) and that of the Government of Kenya (indirect or intangible outcomes).47 Direct and tangible benefits meeting local stakeholders expectations included: (i) For environmental sustainability: sustained crop growth and high yield; increased land cover and ecosystem diversity; reloaded soil stability; and enhanced water availability; (ii) For business success: increased farming outputs and market share; and increased efficiency in water use and the use of land and farming inputs; (iii) For economic development: high farming returns on capital; (iv) For social welfare: improved social inclusiveness, justice and mutual support; and (v) For institutional development: improved water sector policy and governance, and water management at farm level. Definitely, from the government viewpoint, these schemes are intended to eradicate poverty and augment compliance to water use charges and

47 R. Howe (1971).

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effluent discharge thresholds. They would also contribute to improving water availability and accessibility in the catchment as well as its sustainable use in farming.48 Owing to increased water productivity and profitability, local stakeholders may be more inclined to pay their public duties and taxes. This would lead to the creation of new employments and improved macroeconomic conditions such as stable prices of goods and services, and foreign exchange rate in the agricultural market resulting in increased balance of payments.

5.5

Discussion on the BCA Conducted in Muooni

Saving green water is not a panacea to all water problems facing Kenyan farmers. The results of the BCA conducted in Muooni area of Machakos County have shown that the GWD schemes were more efficient upstream and economically feasible under conditions of flooding rather than normal climatic and socio-economic conditions and drought. However, projects that were supplying blue water were more efficient downstream and economically feasible under normal and drought conditions rather than flooding.49 This situation was explained by the lack of sufficient technological equipment and know-how enabling farmers to harvest and store more rainwater during flooding periods for use under conditions of drought. Yet, Water Services Providers (WSP) use dams developed by the government and their own storages (like tanks) to store blue water resources. That is why these water vendors are able to take advantage of the catchment vulnerability to drought to shoot up their prices.50 Farmers need therefore to combine both efficient GWS schemes and BWS projects to achieve an “Economic Order Quantity” (EOQ) of their GWS services under conditions of flooding (ANOR) and a ‘Minimum Efficient Scale” (MES) under drought conditions (BNOR).51 Many farmers in the Arid and Semi-Arid Lands (ASALs) of Kenya are unable to meet the natural water requirements of their plants, especially under BNOR rainfall regime (drought) and sometimes under normal conditions of rainfall (NOR). High water prices feature successful and

48 Luwesi (2010). 49 Shisanya et al. (2014). 50 Fürst et al. (2000). 51 Akombo et al. (2014).

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profitable for BWS businesses in these areas, even under periods of overflow (ANOR), but they add a burden to most farmers. This situation is predicted to worsen by the year 2030. Yet, most hydrologists believe that rainfall in Kenya can supply six to seven times its population.52 ,53 ,54 Thus, the apparent little endowment in water is not the main cause of water shortage in Kenya but the failure by the government to develop surface and groundwater resources, which in turn exacerbates the country’s vulnerability. Consequently, there is very little stored water per capita so when severe droughts occur water storage areas are rapidly drawn down.55

A Technical Paper on climate change and water by the Intergovernmental Panel on Climate Change (IPCC)56 strengthens that point: Water management is a critical component that needs to adapt in the face of both climate and socio-economic pressures in the coming decades. Changes in water use will be driven by the combined effects of: changes in water availability, changes in water demand from land, as well as from other competing sectors including urban, and changes in water management. Practices that increase the productivity of irrigation water use – defined as crop output per unit water use – may provide significant adaptation potential for all land production systems under future climate change. At the same time, improvements in irrigation efficiency are critical to ensure the availability of water both for food production and for competing human and environmental needs.

There is a need for a paradigm shift in the course of climate change. UNEP’s water division programme believes that the problem of Kenya is not rainfall but the storage and distribution of water resources57 :

52 Ngigi et al. (2005). 53 Terer (2004). 54 Hoff et al. (2010). 55 Mumma et al. (2011). 56 Bates et al. (2008). 57 B. sprit!. (2008).

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UNEP believes rainwater harvesting could be a cheap and effective way to ‘climate-proof’ some communities and go some way to achieving its millennium development goal to provide water for half of those people who don’t have access to water today.

Without considering lifeline alternatives for surface water (mainly rainwater storage), Kenya will face further water challenges in this century. Though Integrated Water Resources Management (IWRM) has provided various cost strategies and tools for achieving both cost-effectiveness and efficiency in saving “blue water”, particularly in the ASALs, it is believed that much effort shall be put on investing in green water development. This would contribute to increased accessible blue water in streams and lakes.58 “Green Water Development” (GWD) will be used as an alternative strategy to sustaining water running off in order to boost a “green revolution” in the ASALs, notably by increasing their low vegetation cover and thus enhance their low soil moisture content. This strategy will thence address the ever-widening gap between water demand sites and supply sites in most ASALs, especially in Kenya and elsewhere in Africa.59

5.6

Conclusion and Recommendations

Dependence on surface water resources, land degradation and the weak management of water resources will increase farmers’ vulnerability to water shortages by the year 2030. These factors combined with low investments in water infrastructure, high operations and maintenance costs may lead to severe water stress and insecurity. Besides, most governmental programmes focus on the supply and saving of surface blue water. Without considering lifeline alternatives for surface water (mainly rainwater storage) and exploiting the full potential of green water development (GWD), Kenya will face serious water challenges by the year 2030. Hence, farmers need to balance their cropping methods to avoid excessive farming water demands under the BNOR, which increase the cost of water for agriculture. For efficiency, rational crop selection and specialization to more or less 3 improved crops like Marama beans, buffalo

58 Meijerink et al. (2007). 59 Reij et al. (2009).

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gourds and sorghum or millets, are well indicated.60 The acquisition of water storage facilities (like tanks and dams) and automated boreholes (like Grundfos Lifelink solar pumps) may supplement substantial water to farmers. However, GWD schemes would be needed to save water under ANOR scenario, especially downstream, to meet increased crop water requirements under NOR and BNOR climatic and socioeconomic conditions. They would also be a need for water allocation plans to allot available water resources and supplement the deficit with excess rainwater stored under the ANOR regime to maintain actual crop water requirements under the BNOR scenario. This would reduce significantly excessive opportunity and external costs due to shortage under droughts and average water saving costs during floods. That is how GWD schemes would improve the farming BCR under fluctuating climatic and socio-economic conditions.

References ADPC [Asian Disaster Preparedness Center]. 2005. A Primer Disaster Risk Management in Asia. Bangkok: ClungWicha Press Co. Ltd. Adrianto, L., and M. Yoshiaki. 2002. Developing economic vulnerability indices of environmental disasters in small island regions. Environmental Impact Assessment Review 22: 393–414. AGRA [Alliance for a Green Revolution in Africa]. 2009. AGRA: Early Accomplishments, Foundation for Growth. Available at: http://www.agra-allian ce.org (Accessed on 29 January 2010). Akombo, R.A., C.N. Luwesi, C.A. Shisanya, and J.A. Obando. 2014. Green water credits for sustainable agriculture and forestry in arid and semi-arid tropics of Kenya. Journal of Agri-Food and Applied Sciences (JAAS) 2 (4): 86–92. Anandajayasekeram, P., Van C.J.. Rooyen, and F. Liebenberg, eds. 2004. Agricultural projects planning and analysis: A source book. Ghent: University of Ghent. Arrow, K.J., H.B. Chenery, B. S. Minhas, and R.M. Solow. 1961. Capital-labour substitution and economic efficiency. Review of Economics and Statistics. The MIT Press 43 (3): 225–250. b. sprit!. 2008. All about Water. b. sprit! 17 (September–October 2008): 12–22.

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Barah, B.C. 2009. Economic and ecological benefits of system of rice intensification (SRI) in Tamil Nadu. Agricultural Economics Research Review 22 (July–December): 209–214. Bates, B.C., Z.W. Kundzewicz, S. Wu, and J.B. Palutikof, 2008. Climate Change and Water. A Technical Paper of the Intergovernmental Panel on Climate Change (IPCC). Geneva: The IPCC Working Group II Technical Support Unit, IPCC Secretariat. Berntell, A. 2008.Getting to business not as usual. Stockholm Water Front, No. 1, April 2008, 1–2. Brown, L.R. 2001. Eco-Economy—Building an economy for the Earth. New York, NY: W.W. Norton and Company Ltd. Bush, G., S. Colombo, and N. Hanley. 2008. Measuring the demand for naturebased tourism in Africa: a choice experiment using the “cut-off” approach. Stirling Economics Discussion Papers 2008-06. Dent, D., and S. Kauffman. 2007. The spark has jumped the gap: Green Water Credits proof-of-concept. In Green Water Credits Report 7 , ed. D. Dent. Wageningen: ISRIC—World Soil Information. DFT. 2011. Cost Benefit Analysis, Transport Analysis Guidance (TAG)-Unit 3.5.4. London: Department for Transport (DFT). Available at: www.dft.gov. uk/webtag (Accessed on11 September 2011). Fujiwara, D., and R. Campbell. 2011. Valuation techniques for cost benefit analysis: Stated preference, revealed preference and subjective well-being approaches. London: HM Treasury, Department for Work and Pensions. Available at: http://www.hm-treasury.gov.uk/d/green_book_valuationtechniques_250 711.pdf (Accessed on 07 November 2011). Fürst, E., D.N. Barton, and G. Jiménez. 2000. Estimating the willingness to pay for water services in Haiti. In Environmental valuation: A worldwide compendium of case studies, ed. J. Reitbergen-McCracken and H. Abaza, 172–181. London: Earthscan Publications Ltd. Hardwick, P., B. Khan, and J. Langmead. 1994. An introduction to modern economics. Singapore: Longman Group Ltd. Harris, J.M., B. Roach, and A. Codur. 2017. The economics of global climate change. In Environmental and Natural Resource Economics: A Contemporary Approach, Chap. 12 and 13, ed. J.M. Harris and B. Roach. Available at: http://www.ase.tufts.edu/gdae/pubs/ (Accessed on 13 March 2022). Hoff, H., M. Falkenmark, D. Gerten, L. Gordon, L. Karlberg, and J. Rockström. 2010. Greening the global water system. Journal of Hydrology 384: 177–186. Howe, C.W. 1971. Benefit-cost analysis for water systems planning, water resources—Monograph 2. Washington, DC: American Geophysical Union. Jaetzold, R., H. Schmidt, B. Hornetz, and C. Shisanya. 2007. Farm management handbooks of Kenya: Natural conditions and farm management information, vol. 2, part C, subpart C1. Nairobi: Ministry of Agriculture and GTZ.

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Wunder, S. 2007. The efficiency of payments for environmental services in tropical conservation. Conservation Biology 21 (1): 48–58. Young, R.A. 1996. Measuring economic benefits for water investments and policies. World Bank Technical Paper No. 338. Zyl, H.V., T. Store, and A. Leiman. 2000. Measuring the costs of rainforest conservation in Cameroon. In Environmental valuation: A worldwide compendium of case studies, ed. J. Reitbergen-McCracken and H. Abaza, 64–77. London: Earthscan Publications Ltd.

CHAPTER 6

A Contingent Valuation of Payments for Watershed Services for Financing Green Water Development Cush Ngonzo Luwesi, Nelson H. Were Wawire, Joy Apiyo Obando, Essam O. Badr, Remy Bolito Losembe, and Chris Allan Shisanya

Abstract “Blue water saving” (BWS) projects are not the best options for agricultural water development, poverty eradication and environmental sustainability. This chapter brings another innovation in the economics literature by presenting and discussing contingent benefit-cost valuation of Payments for Watershed Services (PWS) in the ASALs of Kenya. The

C. N. Luwesi (B) · R. B. Losembe University of Kinshasa, Kinshasa, Democratic Republic of the Congo e-mail: [email protected] N. H. W. Wawire · J. A. Obando · C. A. Shisanya Kenyatta University, Nairobi, Kenya E. O. Badr Damietta University, Damietta, Egypt

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 C. N. Luwesi and A. Beyene (eds.), Innovative Water Finance in Africa, https://doi.org/10.1007/978-3-031-38234-5_6

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chapter focuses on non-market methods used nowadays for the economic valuation for the financial flows accrued from investments in PWS. Keywords Benefit-cost analysis (BCA) · Contingent valuation methods (CVM) · Payments for Watershed Services (PWS)

Box 6.1: Lessons Learned • Discussions on solving water crises generally focus on enhancing water storage and distributive system for sustainable livelihood. They recommend building dams, pipelines and drilling groundwater as key water investments. Yet, these “Blue Water Saving” (BWS) projects are not the best options for agricultural water development, poverty eradication and environmental sustainability. So, “the great challenge we face is to get to business not as usual” by adopting “Green Water Development” (GWD) schemes to increase the one-tenth accessible blue water by at least 50% and usher in a green revolution in arid semi-arid lands (ASALs). • Yet, catchment managers and water users are not incentivized to recognize GWD schemes and reward their services through Payments for Watershed Services (PWS). Conventional valuation methods for the economic viability and financial sustainability of new BWS projects are common in the water sector. However, contingent valuation methods (CVM) are mostly recommended for non-market products and investments like PWS schemes. • This study uses CVM to unveil the economic viability of GWD schemes. It has shown that upstream farmers’ Willingness To Accept compensation (WTA) is far beyond the Willingness To Pay (WTP) of their downstream counterparts, and thus a consensual agreement between upstream and downstream farmers would be quite impossible to enable a fair Payment for Watershed Services (PWS). This is supported by BCA results for both BWS and GWD projects, which show that GWS schemes lack the ability to ensure cost recovery and generate economic efficiency in time of drought, compared to BWS projects. However, they are economically efficient and profitable under above normal rainfall regimes.

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• This high discrepancy between WTP and WTA bids led the NOAA (1993) “blue ribbon” panel of economics Nobel Laureates to recommend some restrictive assumptions to enhance CVM results validity for legal use. These include the ex-ante use of dichotomous questions, usually found in most referenda, or interrogating respondents to validate or invalidate one particular level of taxation… • This study has suggested the use of an ex-post Provision Point Mechanism (Ppm ) to close up the gap between higher WTA and lower WTP. To enable a fair agreement for Payments for Watershed Services (PWS), there is need for a fair pricing of GWD services for these schemes to take place. Downstream farmers need to show a high WTP that can reasonably compensate the high WTA demands of their upstream counterparts (WTA) for GWD services.

6.1

Introduction

The agricultural production in most tropical arid and semi-arid lands (ASALs) is significantly affected by the changing weather patterns, possibly due to human induced activities and other anthropogenic factors. In most African ASALs, rain-fed agriculture has become highly vulnerable to climate change and deforestation, which are increasingly depleting the little “blue water” available in springs, streams, lakes and groundwater. Climate Change has triggered desertification and water crises in the ASALs by increasing evapo-transpiration, thus resulting in three possible outcomes: (i) too little water; (ii) too much water; (iii) too dirty water.1 The uncontrolled population growth and economic expansion, especially irrigation for meeting food and feed demands, exacerbate “water poverty”. The latter is said to be a materialization of the depletion of “green water”, which is a part of soil moisture kept by plants for their own use. It is being depleted due to a wide scale deforestation due to human induced activities.2 This plant water crisis is the major cause of agricultural inefficiency, food insecurity and poverty escalation in Kenyan ASALs.3

1 Kundzewicz (2007) and Downing (2003). 2 Bates et al. (2008), Clarke and King (2004), and Cosgrove and Rijsberman (2000). 3 Luwesi (2022), Scherr et al. (2011), and Oduol et al. (2006).

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Hence, there is need for agricultural water development to ensure food security and poverty alleviation in the rural Kenya. “Business-as-usual” policy interventions tend to solve water crises by increasing investments in dams and water tanks to save blue water. The use of inter-basin transfer, rationing and regulation of water vendors’ prices in time of drought as well as climate information systems and early warning systems have also shaped the thinking of policy-makers in the water sector. Yet, these “blue water” focused interventions have failed to address the widening gap between water demands and its supply for productive use. The reason is that blue water actually represents a third (1/3) of the total rainwater in the soil, the remaining two thirds (2/3) being found in grasslands, woodlands (forests), marshlands, farms (crops) arid lands and other land cover types representing the reservoir of “green water”.4 “Green Water Development” (GWD) is likely an innovative approach towards enhancing sustainability in water resource management through co-operation between upstream and downstream stakeholders in a “Payment for Environmental Services” (PES) scheme.5 Grieg-Gran et al. (2006) precisely notice that a PES scheme encompasses various Environmental Services (ES) including “watershed services, carbon sequestration, biodiversity conservation and landscape beauty”. A PES scheme that is implemented within the limits of a catchment area and for the sole purpose of rewarding watershed services is virtually a “Payment for Watershed Services” (PWS) or a “Green Water Credit” (GWC) scheme. PWS schemes involve market mechanisms in order to pay, reward or compensate upstream and midstream landowners to incentivize them to maintain the catchment or modify a particular land use that was affecting the availability and/or quality of water resources downstream. They have been successfully tested at a global scale and found to be practically effective, biophysically possible, socially acceptable and economically feasible. They are flexible and farmer friendly investments on “Soil and Water Conservation” (SWC) measures and have the potential of increasing the accessible “blue water” in streams and lakes as well as groundwater by

4 Paul (2017), Rockström (2003), Subramanian (2001), and Reisner (1993). 5 Luwesi (2022), Malesu et al. (2007), and Kauffman et al. (2007).

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at least 50% through increased water table and finally extensive surface runoff. Henceforth, the implementation of PWS is likely to be innovative towards enhancing sustainability in water resource management through consensual agreements between upstream farmers and downstream water users for a PES.6 But to what extent are these schemes beneficial to enable bankers and other financiers to invest in them? This chapter focuses on non-market methods used nowadays for economic valuation for the financial flows accrued from investments in PWS.

6.2 Novel Approaches for the Valuation of Investment in Green Water Saving Water resources vulnerability in marginal and dry areas (or ASALs), on one end, and their unsustainable use on the other have led many economists to question the “noneconomic” value attributed to water and other natural resources.7 Sir Adam Smith was the first to have that insight when he said: “Nothing is more useful than water but it will purchase scarce anything”. Ironically, with a small carat of diamonds, which is often referred to as “ice”, and “a few ounces of gold, one can get serious income to pay for a Limousine.8 This has been referred to as the “paradox of value”, which can also be stated as follows: Water may save your life in the desert, but even the lowliest of industrial diamonds carries a certain sexiness that invariably outstrips the redoubtable H2O…Perhaps the value of water could become more of a straight line rather than a plunging roller coaster that largely ignores the relationship between consumption and marginal utility.9

Hence, Benjamin Franklin (1706–1790), American philosopher and statesman cautions:

6 Shisanya et al. (2014), Ortega-Pacheco et al. (2009), and Wunder (2007). 7 Houde and Todd (2011), Belsky and Gilovich (2009), Cap-Net (2008), Shell (2009),

O’Rourke (2007), and Hardwick et al. (1994). 8 Harris et al. (2017) and Lipsey and Steiner (1978). 9 Goetz (2013).

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Many people think that water comes from the tap in the same way milk comes from the cow…When the well is dry, we learn the worth of water.10

The 1992 Dublin International Conference on Water and Environment, and the Rio UN Conference on Environment and Development (UNCED) held later the same year, fully recognized the economic value of water, besides upholding its socio-cultural value.11 Hence, water resources would no longer be simple res communes; rather all stakeholders would have to accept to pay for their use and misuse, if they appreciate the full cost of renewing these life-giving necessities or “God–given provisions”. Applying a price to water is not only done because of cost recovery but is equally important as a tool to change behaviour and make sure that water is distributed more fairly.12

Whether socially and politically accepted, a GWD scheme needs to meet basic requirements for achieving economic efficiency and profitability. Both economic and financial literature abound in conventional methodological approaches for the valuation of the economic viability and financial sustainability of new investments in the water sector. However, Jones et al. (2004) and Barah (2009) suggest randomization for such modelling to take into account probabilistic effects of environmental disasters. The use of Data Envelopment Analysis (DEA) and other probabilistic models is commonly recommended in classical economics for the analyses of economic efficiency and benefit-cost.13 Even where the use of these probabilistic models may be tested, environmental economists often rely on nonconventional methods for cost-efficiency, cost-effectiveness and benefit-cost analyses to unveil the economic efficiency, effectiveness and Benefit-Cost Ratio (BCR) of new investments. The UK Treasury (2011) Green Book provides two main avenues. Environmental economists conduct social cost benefit analyses and compute 10 Cyber-nook.com (2011). 11 Luwesi and Beyene (2019), Ngonzo et al. (2010), and Savenije and van der Zaag

(2002). 12 Cap-Net (2008). 13 Oduol et al. (2006).

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stated/revealed preferences to determine the cost and benefit of a nonmarket commodity. These techniques are generally based on the satisfaction that a person gets from consumption of a good, or to the change in the welfare or well-being of that person. A Social Cost Benefit Analysis seeks to assess the net value of a policy or project to a society as a whole, including health, educational success, family and community stability, and environmental assets. Even though they cannot be inferred from market prices, the latter shall not be neglected in policy making, owing their important social impacts. Typical SCBA applications encompass time-savings, health benefits, prevented fatality, design quality and the environment. However, other non-market-based approaches seek to elicit stated preference and revealed preference in an attempt to attach a monetary value to social goods. First, revealed preference techniques involve the inference of an implicit or shadow price placed on a good by consumers after examining their behaviour in a similar or related market. Residual imputation of shadow prices, hedonic pricing, travel cost, avoidance cost and benefits transfer methods are examples of such approaches.14 However, the market simulation of change in local stakeholders’ utility or revealed preference is widely based on Contingent Valuation Method (CVM). The CVM is the most popular method in environmental economics perse.15 It is often applied to estimate both the value in use and nonuse value of new water projects or regulations. To measure the value in use, water users’ Willingness To Pay (WTP) is estimated along with water suppliers’ Willingness To Accept compensation (WTA) for the outputs or outcomes of the project. Wawire and Thuo (2007) note that the assessment of non-use value does not use implicit prices but a proposed or contingent value based on: (i) an option value; (ii) a bequest value; and (iii) an existence value. The suggested values will be evaluated by local water users based on their knowledge of the water environment. Lastly, stated preference techniques are based on special questionnaires that are designed to describe a hypothetical choice within a hypothetical market in order to elicit estimates of the WTP or WTA for a particular outcome.16 When using stated preferences, the main choice is between

14 Cap-Net (2008) and Arrow et al. (1993). 15 Zyl et al. (2000a). 16 Fürst et al. (2000).

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Contingent Valuation Method (CVM) and Choice Modelling (CM). The latter elicit values by presenting respondents with a series of alternatives and then asking them which is the most preferred. They are often used in order to value specific attributes of a good, rather than the good as a whole. Reitbergen-McCraken and Abaza (2000) and Venkatachalam (2003) propose a compendium of techniques that integrates both internal and external environmental costs and benefits to value sustainable management of natural resources. In this collection, Zyl et al. (2000a) valued the time spent by farmers collecting water in Ikunda Town (Mombasa area, Kenya) to determine their choice for alternative water sources. Given their discrete choices, utility (satisfaction) functions for individual farmers were equated and their purchasing power was calculated for decision-making on new investments in water supply. Angeles et al. (2000)17 used a replacement-costs approach to evaluate the profitability of forest plantations in the Philippines. This method involved an estimate of the costs related to the effect of soil erosion on soil fertility removal; agricultural loss of earnings due to the impact of soil erosion on the siltation of a dam reservoir and the inefficacy of irrigation system. An opportunity cost was thus computed for constructing a large non-productive sediment pool to prevent the adverse effects of sedimentation. Fürst et al. (2000) computed the WTP for private water vendors’ services in urban Haiti utilizing a cost-savings approach. In the same vein, Zyl et al. (2000b) estimated the BCR of water supply and afforestation in Cameroon by predicting the cost of water shortage. The latter was said to be caused by deforestation and related deficiencies in farming water productivity and profitability. Finally, Bush et al. (2011) successfully measured the opportunity cost of forest conservation in Uganda and their implications on distributional impacts of forest management. It shall however be noted that many valuation methods for “extended” benefit/cost pay little attention to the economic efficiency and effectiveness of “non-market” projects such as GWS schemes. This study has filled that major gap by proposing a novel methodology on “hydro-economic cost-efficiency inventory” prior to conducting a CVM. Such a contribution shall be acknowledged in environmental economics’ literature.

17 Angeles et al. (2000).

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The following sub-section illustrates the newly improved CVM to elicit WTP and WTA bids. The findings are derived from a study conducted in Muooni catchment area of Machakos County, Kenya.

6.3

Applied Contingent Valuation Methods 6.3.1

Materials and Methods

The main findings of this study are drawn from a survey conducted in 2011 from 101 farmers living in Muooni catchment. The catchment is located in eastern Kenya, precisely in Kathiani Division of Machakos County. It belongs to the eastern highlands arc and is part of the Athi River Basin. Muooni is bound by latitudes 1o 14' 24'' S and 1o 16' 48'' S, and longitudes 37o 9' 36'' E and 37o 12' E. The catchment is haven of about 24,000 people distributed within 4,539 households, thus making an average population density of 960 persons/km2 . The catchment is well-known for its recurrent episodes of drought and famine reported since the nineteenth century.18 This catchment was purposely selected to build scenarios of vulnerability and capability to water disasters (floods and droughts) in the ASALs of Kenya. The study utilized econometric analysis to provide a consistent CVM, which relied on basic concepts known to farmers. Since all the farmers were employing agro-forestry, enumerators used expressions such as tree planting, erosion control, wetland conversion and catchment conservation, to illustrate “green water saving” in the catchment. This enabled farmers to elicit a revealed preference. The differences in cost measurements between the upper sub-catchment (for compensation bids) and the lower sub-catchment (for payment bids) seriously challenged the results of the study. However, WTA bids needed to be treated prior to modelling and further treatment after modelling to narrow down the gap between WTA and WTP bids. An ex-ante treatment used as “Provision Point Mechanism” (PPM) helped minimize the weight of unrealistic estimation of WTA bids during the final part of the econometric analysis.19 The expost treatment took into account the marginal WTP and WTA values to 18 Jaetzold et al. (2007), Tiffen and Mortimore (2002), and Tiffen et al. (1994). 19 Bush et al. (2011).

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adjust them accordingly. It used an equation suggested by Fujiwara and Campbell (2011) to close the gap between WTP and WTA. The following sub-sections present successive steps followed by the study to conduct the CVM. 6.3.2

Calibrating the WTP and WTA Bids

To be able to predict WTP and WTA bids, Cobb-Douglas utility functions were specified using data from downstream farmers (WTP) and upstream farmers (WTA). Durbin-Watson (D-W) model was used to test autocorrelation, and Vector Inflationary Factors (VIF) were employed for multicollinearity. A standard residual error model was finally tested for error correction. These tests enabled the validation of the WTP and WTA econometric models. Fürst et al. (2000) and Stathopoulos and Hess (2011) suggest a utility function for WTP that is influenced by among other factors: the farmers’ net annual income (y), age (a), education (e), sex (s ) and the family size ( f ). This study considered similar variables affecting farmer’s social status, two dummy variables and one more to complete the list of variables. The last variable included in the model was the cost of water (w) while dummy variables encompassed the Intention To Pay in semi-humid areas (I sh ) downstream Muooni, and the Intention To Pay in semi-arid areas (I sa ) upstream Muooni. The typical Cobb-Douglas model used to predict farmers’ WTP bid may be presented as Eq. (6.1): α7 α8 WTP = ʘ0 · y α1 · a α2 · eα3 · s α4 · f α5 · w α6 · Ish · Isa · expμ

(6.1)

where, ʘ0 is the intercept (or the constant term) α 1 to α 8 are estimated parameters representing WTP elasticity to the variation of a specific independent variable μ is the disturbance term reduced to a “white noise” (with mean = 0; variance = σ 2 ) Parameter estimates were obtained from Weighted Least Squares (WLS) regression with dummy variable Intention To Pay as the weighting factor. An income Marginal WTP (MWTP) was thereafter computed

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as the ratio of the farmers’ income coefficient (α 1 ) to his water cost coefficient (α 6 ). The Weighted Least Squares (WLS) regression also enabled predicting upstream farmers’ WTA bid for their GWS services using their Intention to accept compensation as weighting factor. A typical Cobb-Douglass model was used to that effect to present a WTA utility function that encompassed farmers’ income (y), age (a), education (e), sex (s ) family size ( f ), cost of water (w), Intention to accept compensation in semi-humid areas (A sh ) downstream Muooni, and Intention to accept compensation in semi-arid areas (A sa ) upstream Muonic (Eq. 6.2): β

β

WTA = Δ0 · y β1 · a β2 · eβ3 · f β4 · w β5 · Aha6 · Ash7 · Aβsa8 · expε

(6.2)

where, Δ0 the intercept (or the constant term) β 1 to β 8 the estimated parameters representing WTA elasticity to the variation of a specific independent variable ε is the disturbance term reduced to a “white noise” (with mean = 0; variance = σ 2 )

6.3.3

Treating the WTA Bids

The WTP and WTA bids obtained from the above modelling were hypothesized to be correlated with the costs and incomes of GWD schemes generated during an earlier Benefit-Cost Analysis (BCA). To establish the accuracy and reliability of these bids, Wilcoxon W test was used to test the difference in mean ranks between WTP and WTA. The acceptance of the null hypothesis gave insight on the validity and the reliability of the claims by upstream farmers vis-à-vis the wishes of their downstream counterparts. These elicited the fact that GWD schemes assessed were well-known by the community and/or were socially acceptable for implementation. Whereas, the null hypothesis was rejected, an experimental treatment known as “Provision Point Mechanism” (Ppm ) was considered to adjust WTA bids so that it could match the WTP.20

20 Zubrickas (2013).

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C. N. LUWESI ET AL.

In a Ppm design, the following three compensation hypotheses are generally tested21 : • H1 : Bj > PP: if the claim by individual farmer (Bj ) exceeded the average WTP representing the Provision Point (PP) or money available for him, no compensation payment was to be made and thus the bid was assigned a zero PP value (PP = 0). • H2 : Bj = PP: if the individual farmer’s claim (Bj ) was exactly equal to the PP, the compensation scheme was hypothesized to go ahead and the farmers’ bid was to receive a PP value exactly equal to one (PP = 1). • H3 : Bj < PP: if the bid by potential compensation claimant (Bj ) was less than the average WTP (the PP in this case), that individual farmer was supposed to receive his claim plus a share of the remaining portion of the total funds available that went unclaimed by him; his bid was herein to receive a PP value exactly equal to two (PP = 2). Such a treatment is explained by the fact that a WTA design generally uses the sum of money available from downstream farmers (WTP) to compensate all affected individuals in the catchment (i.e. upstream farmers) as the “Provision Point Mechanisms” (Ppm ), where a potential loss is in prospect. Respondents are asked to make a claim for compensation from that fund.22 This study was opted for an ex-post Ppm to validate the WTA based on the average predicted WTP bid. These WTA bids were only re-computed after inclusion of a Ppm in the model to distinguish WTA bids matching WTP (Ppm = 1) from those not matching WTP (Ppm = 0 and Ppm = 2). This means that another Cobb-Douglas function was utilized to re-predict upstream farmers’ WTA using data with Ppm . 6.3.4

Validating the WTP–WTA Bids

Besides the WLS estimates and parameters β, Wilcoxon W test was again used to test the difference in mean ranks between WTP and WTA with Ppm (PP ≥ 1). The acceptance of the null hypothesis informed on the 21 Bush et al. (2011). 22 Bush et al. (2011).

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quasi ubiquity of farmers’ bids both upstream and downstream. However, the validity and the reliability of farmers’ claims were subjected to a rigorous procedure suggested by Fujiwara and Campbell (2011) using the following Eqs. (6.3 and 6.4): [

WTP = e

] α ln( y¯ )−( α5 )−1 − y¯ 1

[

WTA = e

] β ln( y¯ )−( β5 )−1 − y¯ 1

(6.3) (6.4)

where, y the average income in the catchment α 1 and β 1 the income coefficients for WTP and WTA, respectively; α 5 and β 5 the water cost coefficients for WTP and WTA, respectively; −(α 5/ α 1 )−1 the income Marginal WTP (MWTP) −(β 5 /β 1 )−1 the income Marginal WTA (MWTA)

6.3.5

Aggregating Contingent Benefits

Based on the results of the CVM validation, the analysis looked back to the BCA to finalize the design of GWD schemes. A first estimate of the total valid WTP and WTA values for the whole catchment was done based on the total number of households using the Water Assessment and Development Planning (WADeP) model developed by Luwesi (2013) for horizons 2010 and 2030, respectively. Then ad hoc ratios for the CVM (that is WTP/GWD costs) and the CBA (that is GWS income/WTA) were obtained to allow comparison. This gave insight on the monthly and annual benefits (or deficits) expected from GWD schemes in the catchment. It enabled final conclusions on the economic viability of these schemes in the area after application of validated WTP and WTA bids or BCA costs and incomes. This analysis also provided a window for raising additional funds from the government and development partners to ensure that the financial and environmental sustainability of the GWD schemes, their good governance (mainly accountability) and management (that is resource optimization) are still in the course despite the threat of climate change.

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6.4

Results and Discussion 6.4.1

Introduction

Chapter 5 of this book has demonstrated that Green Water Development (GWD) schemes had some advantages in farming in terms of cost-efficiency and benefit-cost ratio compared to BWS projects under above normal rainfall regime (ANOR) as well as normal rainfall regime (NOR) and normal rainfall regime (BNOR). This chapter assessed the validity and reliability of such assumption from the farmers’ viewpoint using Contingent Valuation Method (CVM). The latter was recommended “to elicit the individuals’ preferences for the basic infrastructural projects such as water supply and sanitation” and Soil and Water Conservation (SWC) measures.23 The analysis was used econometric models to convert individual farmers’ preferences into bids for downstream farmers’ Willingness To Pay (WTP) and upstream farmers’ Willingness To Accept compensation (WTA). The following sub-section presents some specific characteristics of the model used to valuate downstream farmers’ WTP bids and upstream farmers’ WTA bids in Muooni area. These estimates are later on aggregated to give an idea of the total cost and total income of the Payments for Watershed Services (PWS) in Muooni. 6.4.2

Willingness To Pay for GWS Services by Muooni Farmers

Key variables of the Cobb-Douglas model for Muooni farmers’ WTP are presented and discussed below along with the potential performance of the model. Farmers’ Intention To Pay For equitable and fair management of their watershed resources, downstream farmers had to demonstrate their Intention to Pay (ITP) for their green water services. This was an indication of their willingness to support the implementation of GWS schemes in Muooni. Preliminary results indicate that an average commercial farmer aged 42 years old was willing to offer a monthly bid of US$21.82 (That is KES 1,745.46 with a standard deviation of KES 456.45), while his monthly farming income was estimated to US$80.95 (That is KES 6,475.92 with a standard deviation of

23 Venkatachalam (2003).

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KES 3,458.02). These figures were utilized for estimating downstream farmers’ WTP bids in Muooni. They indicated that the acceptance of GWS schemes in Muooni was somehow guaranteed by downstream farmers’ willingness to establish equity and fairness in the management of their natural resources. Model Estimation for Muooni Farmers’ WTP A Cobb-Douglas utility function predicted farmers’ WTP in semi-arid areas of Muooni with high precision. The predicted WTP bids averaged US$14.22 per month (that is KES 1,137.5) with minimum and maximum values of US$10 (that is KES 800) and US$19.11 (that is KES 1,537.5), respectively, along with a standard deviation of US$1.18 (that is KES 94.42) (Table 6.1). Farmers’ ITP was so consistent that it presented a WTP elasticity of 0.2% at 95% confidence interval (with MWTP = KES 0.14). All other factors also displayed statistically significant coefficients, except the farmer household size. This meant that the farmer sex, age, occupation (mainly subsistence cultivation) and education, total water cost, daily water use, cultivated area, on-farm and off-farm incomes, as well as awareness on climate change and GWD, former cash payments, food and clean water donated, contribution to WRUA and compliance to environmental laws of the country were among key determinants of downstream farmers’ WTP bids. It shall be noted that downstream farmers having lower off-farm incomes and higher on-farm incomes as well as those not engaged in subsistence cultivation (commercial farmers) were eager to pay for the GWD schemes compared to those with higher off-farm incomes. Finally, awareness created on GWD schemes and compliance to environmental laws recorded the highest WTP elasticities of 8.70% and 8.68%, respectively. Performance Evaluation of the WTP Cobb-Douglas Model Table 6.2 indicates that this model was strongly enough for viable predictions since it presented an adjusted R 2 > 0.50 and an F value statistically significant at 99% confidence interval. This meant that farmers’ WTP bids were normally distributed and could therefore not be obtained by chance. In most of the cases, the model did not show any multicollinearity problem, all the Vector Inflationary Factors (VIF) being below 5, and the tolerance above 68%, with exception of climate change awareness, food

0.02 0.02 0.02 0.02 0.02 0.03

1.98**

1.81**

1.93**

−1.12**

1.22**

35.33

0.057

4,198.7 0.03 0.03 0.05

Std. error

1.43**

−23.86

1.59**

543.42 2.54** 2.32** −2.18**

B3

Unstandardized coefficients

0.99

−1.00

1.00

1.00

1.00

1.00

−0.12

0.98

1.00 1.00 −1.00

Beta

Standardized coefficients

37.85

−48.65

91.83

89.53

87.92

59.51

−0.68

28.11

0.13 94.59 75.99 −46.58

t

0.00

0.00

0.00

0.00

0.00

0.00

0.50

0.00

0.90 0.00 0.00 0.00

Sig.

WTP utility function for Muooni downstream farmers

(Constant) Sex of farmer Age of farmer Subsistence cultivation Education of farmer Household size Total water cost Daily water use Cultivated area Farming income Off-farm income Climate change awareness

Variables

Table 6.1

17.35

0.01

−0.04

−23.21

2.91

−7.96

0.07

9.45

−4.23

−10.05

0.01

−0.01

0.54

−0.12

7.22

8,990.11 9.13 14.5 1.78

−7,903.27 −11.63 −9.25 −5.44

−94.94

Upper bound

Lower bound

95% confidence interval for B

0.35

0.79

0.87

0.84

0.74

0.82

0.69

0.84

0.85 0.70 0.83

Tolerance

0.89

1.47

1.15

1.20

1.35

1.23

1.46

1.19

1.18 1.43 1.21

VIF

Collinearity statistics

0.85

−0.78

1.35

1.27

1.38

1.00

−16.69

1.11

1.78 1.62 −1.52

MWTP

162 C. N. LUWESI ET AL.

7.34 0.10 0.20 0.80 0.21 0.08 7.12

0.20*

0.40*

3.25*

2.82**

1.79**

8.68**

Std. error

8.70**

B3

Unstandardized coefficients

0.61

0.99

0.98

0.92

0.27

0.30

0.53

Beta

Standardized coefficients

4.05

2.01

2.07

3.91

4.78

23.82

13.44

t

0.00

0.00

0.00

0.03

0.05

0.04

0.00

Sig.

1.00 7.24 8.08 7.22 4.71 29.45

−4.35 −6.84 −4.43 −0.03 −14.37

31.30

Upper bound

0.40

−15.01

Lower bound

95% confidence interval for B

Notes 1 Predicant: WTP_Totalvalue_KES/month_What kind of compensation are you willing to pay? 2 Model type: power (Cobb-Douglass) 3 Parameter value in natural logarithm (ln) *Parameter statistically significant at 95% confidence interval **Parameter statistically significant at 99% confidence interval

GWS awareness Intention To Pay Cash donations Food donations Clean water donations Contribution to WRUA Compliance to laws

Variables

0.69

0.72

0.62

0.46

0.95

0.85

0.91

Tolerance

1.45

1.40

1.61

2.17

1.17

1.18

1.10

VIF

Collinearity statistics

6.07

1.25

1.97

2.27

0.28

0.14

6.08

MWTP

6 A CONTINGENT VALUATION OF PAYMENTS …

163

28,773.10 1,420.05 30,193.15

Sum of Squares

0.584

18 39 57

df

0.573

1,598 .51 36.41

Mean Square

Adjusted R Square

Notes a The equation was estimated with a constant term b The independent variables are presented in Table 6.1

Regression Residual Total

ANOVA b

0.764

R

R Square 3,887.99

43.90

F

Std. Error of the Estimate

Performance of the WTP prediction model for Muooni downstream farmers

Model summary a,b

Table 6.2

0.00

Sig.

1.878

Durbin-Watson (D-W)

164 C. N. LUWESI ET AL.

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165

donated and clean water donated. Nonetheless, the analysis of residual values indicated a possible autocorrelation problem in the model (DurbinWatson = 1.88; k = 18 and n = 57). An adjustment of the model was hence needed to reduce the margin of errors due to the autocorrelation problem. The adjusted mean monthly WTP amounted to US$14.05 (that is KES 1,124.3) with a minimum of US$3.08 (that is KES 246.5), a maximum of US$19.42 (that is KES 1,553.2), and a standard deviation of US$2.24 (that is KES 179.3). The residual value being standardized with a mean of 0 and statistically significant at 1% (t = −2.58), the model was thence corrected and the error term removed (Table 6.3). These values were expected to match revenues and operational costs for GWD schemes computed much earlier under the BCA (Chapter 5), when multiplied with the number of farms available in Muooni. Table 6.3 Residual statistics for WTP bids in the lower Muooni Parameters Predicted Valuea Std. Predicted Value Standard Error of Predicted Value Adjusted Predicted Value Residual Std. Residual Stud. Residual Deleted Residual Stud. Deleted Residual Mahal. Distance Cook’s Distance Centered Leverage Value

Minimum 800 −2.68 41.05 246.54 −800.4 −2.58 −2.87 −987.69 −3.13 0 0 0

Maximum 1,528.8 3.1 244.28 1,553.2 1,621.2 5.23 6.01 2,135.5 12.30 33.8 1.14 0.60

Mean 1,137.5 0 89.03 1,124.3 0 0 0.017 13.18 0.12 4.99 0.04 0.09

Std. Deviation

N

94.4 0.75

57 57

48.40

57

179.25

57

212.49 0.69 1.05 380.01 1.79

57 57 57 57 57

6.11 0.17 0.11

57 57 57

a Dependent Variable: WTP_Total value_KES/month_What kind of compensation are you willing to

give?

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C. N. LUWESI ET AL.

Farmers’ Willingness To Accept Compensation for Their GWS Services

Despite mounting critics on the discrepancies between WTP and WTA bids, a “blue ribbon” NOAA panel of Nobel Laureates in economics recommended some restrictive assumptions to enhance CVM results validity for legal use by the US Federal Government.24 These included among others the ex-ante use of dichotomous questions, usually found in most referenda, or interrogating respondents to validate or invalidate one particular level of taxation. Besides using ex-ante dichotomous questions to elicit farmers’ Intention To Accept compensation (ITA) and Intention To Pay (ITP) for GWS services, this study also introduced an ex-post Provision Point Mechanism (Ppm ) to validate WTA estimates within the margins of the WTP derived from survey data. The following sub-sections present these results. Farmers’ Intention To Accept Compensation Upstream farmers’ Intention to Accept Compensation (ITA) for their green water services was an indicator of their availability to implement GWS schemes upstream Muooni. The analysis revealed that a male farmer averaging 42 years old would accept a monthly allowance of US$259.06 (that is KES 20,725 with a standard deviation of KES 6,942.47), while his average farming income was estimated to US$71 (that is KES 5,679.55 with a standard deviation of KES 2,891.67). These data served to estimate of the WTA bids in the upstream Muooni. Model Estimation for Muooni Farmers’ WTA As for the WTP, a Cobb-Douglas model was utilized to translate upstream farmers’ preferences for green water services into WTA bids. WLS regression procedure was first applied without a Provision Point Mechanism (Ppm ). Durbin-Watson procedure assisted in estimating the Cobb-Douglas utility function. The predicted mean monthly WTA bid amounted to US$259.06 (KES 20,725) with a minimum of US$208.77 (KES 16,701.97), a maximum of US$323.81 (KES 25,905.02) and a standard deviation of US$12.71 (KES 1,015.41) (Table 6.4).

24 Arrow, K., R. Solow, P.R. Portney, E.E. Leamer, R. Radner, and H. Schuman. 1993. Report of the NOAA panel on Contingent Valuation. Washington, DC: US Govt., Federal Register 58 (10): 4601–4614.

8,216.56 0.03 0.03 0.03 0.07 0.02 2.25 0.02 0.02 0.02 0.05 0.04

1.62**

2.01**

8.64**

1.97**

1.80**

1.92**

1.05**

1.26**

Std. Error

56.22 2.53** 2.31** 2.16**

B3

Unstandardized coefficients

0.99

0.99

1.00

1.00

1.00

0.56

1.00

0.97

1.00 1.00 1.00

Beta

Standardized coefficients

32.74

20.56

83.75

83.86

81.21

3.84

84.48

23.48

0.02 83.83 84.60 82.48

t

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.99 0.00 0.00 0.00

Sig.

89.05 10.62 47.03 19.67 12.36 10.01 7.07 6.86

−16.71 −10.03 −14.72 −12.63 −4.04 −6.25 −6.21

16,754.27 33.37 35.87 81.08

−16,641.8 −44.34 −11.88 −36.85 −28.9

Upper bound

Lower bound

95% confidence interval for B

WTA utility function predicted for upstream Muooni farmers

(Constant) Sex of farmer Age of farmer Subsistence cultivation Education of farmer Household size Total water cost Daily water use Cultivated area Farming income Off-farm income Climate change awareness

Predictor

Table 6.4

0.85

0.86

0.75

0.67

0.94

0.79

0.70

0.81

0.71 0.65 0.84

Tolerance

0.15

0.12

0.22

0.21

0.23

1.00

0.23

0.19

0.29 0.27 0.25

A CONTINGENT VALUATION OF PAYMENTS …

(continued)

0.93

1.65

1.31

1.80

1.85

1.27

1.42

1.25

1.41 1.55 1.20

VIF

Collinearity statistics MWTP

6

167

0.29 1.56 0.31

0.79 2.23

0.10

−0.67

−1.26**

8.77**

−8.76**

−0.63

0.88

−0.88

−0.19

0.32

−0.53

0.79

0.38

Beta

Standardized coefficients

−3.93

11.12

−4.11

−0.43

0.33

−0.88

4.20

2.33

t

0.00

0.00

0.01

0.69

0.80

0.47

0.00

0.03

Sig.

4.99

13.76

−27.94 −59.94

17.94

−10.08

28.18

25.14

−8.37 −7.22

14.79

25.77

−47.37 −17.86

12.81

Upper bound

−31.19

Lower bound

95% confidence interval for B

Notes 1 Predictand: WTA_Total value_KES/month_What kind of compensation are you willing to accept? 2 Model type: power (Cobb-Douglass) 3 Parameter value in natural logarithm (ln) * Parameter statistically significant at 95% confidence interval ** Parameter statistically significant at 99% confidence interval

0.70

2.09

8.78**

−0.61

3.70

Std. Error

8.63*

B3

Unstandardized coefficients

(continued)

GWS awareness Intention To Accept Cash received from others Food received from others Clean water received Contribution to WRUA/ WSP Compliance to laws Provision Point Mechanism

Predictor

Table 6.4

0.84

0.84

0.88

0.98

0. 54

0.77

0.91

0.69

Tolerance

1.20

1.76

1.67

2.05

2.63

1.84

1.86

1.38

VIF

−1.01

1.02

−0.15

−0.08

0.01

−0.07

1.02

1.00

Collinearity statistics MWTP

168 C. N. LUWESI ET AL.

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Farmers’ ITA was consistent with their WTA bids since it displayed a WTA elasticity of 8.78% with a MWTA of KES 1.02 (t = 4.2; sig. = 0.00). All the remaining parameters were also statistically significant, except for cash, food and clean water received from others. Therefore, farmer sex, age, education, occupation (i.e. subsistence cultivation), household size, total water cost, daily water use, cultivated area, on-farm and off-farm incomes, as well as awareness on climate change and green water development, contribution to WRUA and compliance to environmental laws of the country were among key determinants of upstream farmers’ WTA bids. It shall, however, be noted that the disparity between the mean WTA bid (US$259.74) and the mean WTP bid (US$14.05) aforementioned was so much beyond any expectation that the study needed to introduce an ex-post Provision Point Mechanism (Ppm ) to discard individual WTA bids above downstream farmers’ WTP. After introduction of the Ppm in the WTA Cobb-Douglas model, upstream farmers’ WTA bids dropped ten (10) times than before. The predicted mean monthly WTA bid was estimated to US$36.27 (KES 2,901.6), with a minimum of US$32.96 (KES 2,636.9), a maximum of US$39.55 (KES 3,164.2) and a standard deviation of US$0.71 (KES 57.1). Nonetheless, it comes out from the analysis that farmers who contributed the most in the GWS scheme were WRUA members and the WSPs as well as those with higher provision points. They were ready to undertake GWD services at a reasonable price compared to those who were not members of those institutions or received very low provision points. Performance Evaluation of the WTA Cobb-Douglas Model Table 6.4 does not indicate a multicollinearity problem in the WTA Cobb-Douglas model. Almost all the VIF are 65%, with exception of the farmer age, cultivated area and food received from others. Moreover, the WTA model was found to be strong enough for viable predictions. It presented an adjusted R 2 that was slightly around 0.40 and an F value statistically significant at 99% confidence interval (Table 6.5). This meant that farmers’ WTA bids were not obtained by chance rather than by a normal distribution. However, an autocorrelation problem needed to be corrected (D-W = 1.95; k = 18; n = 44; p = 95%). The model needed some adjustments to correct its residues. Table 6.6

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Table 6.5 Performance of the WTA prediction model for upstream Muooni farmers Model summary a,b R

R Square

0.701

0.491

Adjusted R Square 0.406

Std. Error of the Estimate 1,152.560

Durbin-Watson (D-W)

Sum of Squares

df

Mean Square

F

Sig.

5,833 1,728 7,561

19 25 44

307 69.12

4.442

0.006

1.945

ANOVA b

Regression Residual Total

Notes a The equation was estimated with a constant term b The independent variables are presented in Table 6.4

indicates that after reducing the residual error to a white noise (t = − 2.78 with mean = 0), the adjusted predicted mean monthly WTA bid amounted to US$36.19 (KES 2,894.97) with a standard deviation of US$3.01 (KES 240.8). Minimum and maximum bids were re-estimated to US$25.61 (KES 2,048.74) and US$42.63 (KES 3,410.4), respectively. Consequently, the gap between the mean WTP (US$14.05) and WTA (US$36.19) was narrowed down. These results indicate that upstream farmers operating in Muooni are willing to implement a GWD scheme for granted that equitable and fair compensation is assured to them by their downstream fellow members of the scheme. 6.4.4

Validation of the Contingent Benefits’ Valuation

Prior to introducing the Ppm , farmers’ WTA was statistically greater than their WTP. The gap was striking and highly variable across experiments. After the introduction of the Ppm , the observed WTP and WTA bids displayed slightly ubiquitous values across the two experiments. These results supported the hypothesis stating that downstream farmers’ WTP and upstream farmers’ WTA bids presented statistically insignificant gap when using the Ppm to elicit valuations of payments that farmers were

6

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171

Table 6.6 Residual statistics for upstream farmers’ WTA bids in Muooni Parameters Predicted Valuea Std. Predicted Value Standard Error of Predicted Value Adjusted Predicted Value Residual Std. Residual Stud. Residual Deleted Residual Stud. Deleted Residual Mahal. Distance Cook’s Distance Centered Leverage Value

Minimum

Maximum

Mean

Std. Deviation

N

2,636.92 −1.89

3,164.21 1.87

2,901.6 0.000

57.04 0.41

44 44

71.05

296.82

58.67

44

2,048.74 −1,310.68 −2.78 −3.31 −1857.19 −3.96 0 0.000 0

3,410.4 1835.8 3.9 4.9 2,951.26 9.15 16.1 1.5 0.4

96.33 2,895

240.8

44

0.000 0.000 0.005 6.628 0.077

170.43 0.36 1.1 637.88 1.66

44 44 44 44 44

1.483 0.062 0.035

3.61 0.24 0.08

44 44 44

a Dependent Variable: WTA_Total value_KES/month_What kind of compensation are you willing to

accept?

willing to pay and accept. In effect, results of the Wilcoxon rank sum test did not enable the rejection of the null hypothesis stating that the two independent samples were drawn from populations having identical distributions of mean WTA upstream Muooni (Z = 0.081; sig. = 0.037) and mean WTP downstream Muooni (Z = 0.104; sig. = 0.077). However, a median test resulted in a significant Pearson—two tailed test statistics of 0.097 (sig. = 0.0531) for both upstream and downstream Muooni farmers, respectively. Thus, the null hypothesis stating that the two independent samples were drawn from populations having similar medians in Muooni was validated. Nonetheless, these WTP/WTA bids obtained for each side of the catchment were later validated in accordance with Fujiwara and Campbell (2011) formulae derived from marginal bids (MWTP and MWTA values). Table 6.7 presents these re-computed WTP and WTA values.

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C. N. LUWESI ET AL.

Table 6.7 Monthly valid WTP and WTA bids for Muooni farmers

Farmers’ bid

Prior validation

After validation

14.05 259.74 36.19

57.67 62.87 62.87

WTP WTA without PPM WTA with PPM

6.4.5

Aggregation of Contingent Benefits Versus Conventional Benefits

The study looked back to the results of the BCA to finalize the planning and implementation of GWD schemes. The analysis first computed the total catchment’s WTP and WTA from validated bids. The total number of households was estimated to about 4,639 and 8,543 in horizons 2010 and 2030, respectively, with an average household size of 4.4. Then a comparison was done between these aggregated farmers’ WTP/WTA and GWS schemes’ expected income/costs (Table 6.8). The implementation of GWD schemes in Muooni would have cost increments of about US$5.2 per household, if validated CVM bids were Table 6.8 Monthly benefits expected from GWS schemes in Muooni Variable

Horizon 2010 Households (capita)

CBV WTP WTA Benefit CBA Revenue Cost Benefit GAP (%) WTP/ cost Revenue/ WTA

Horizon 2030 Unit amount (US$)

Total amount Households (US$) (capita)

267,531.13 8,543 291,653.93 8,543 −24,122.80 8,543

Unit Total amount amount (US$) (US$)

4,639 4,639 4,639

57.67 62.87 −5.20

4,639 4,639 4,639

56.29 97.66 −41.37

4,639

59.1%

59.1% 8,543

117.8%

117.8%

4,639

89.5%

89.5% 8,543

44.9%

44.9%

261,117 453,026.1 −191,909.1

8,543 8,543 8,543

57.67 62.87 −5.20

492,674.81 537,098.41 −44,423.60

28.21 241,002.6 48.94 418,128.6 −20.73 −177,126

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applied. However, the scheme would have incurred additional US$36.17 per household in 2010 (for a total deficit of US$41.37), and an increment of US$15.53 per household in 2030 (for a total deficit of US$20.73), owing to other administrative costs. Hence, if the cost of these schemes (as per the BCA) would be totally funded by downstream farmers’ WTP bids, GWD schemes would be expected to make profits of about 17.8% by the year 2030. But if to the cost of implementation of the schemes matches upstream stakeholders WTA and is solely funded by revenues from green water services (as per the BCA), additional 55.1% of the total cost should be raised from the government and development partners to fund the schemes. This resource optimization in Muooni coupled with good governance for accountability and best management practices, GWD schemes may sustain in the course of climate change.

6.5

Discussion on Contingent Benefits’ Valuation (CBV)

Water investments are necessary to boost agricultural production, food security and energy supply as well as the conservation of the environment. Hence, global debates c on water crisis have led to the reformation of Kenyan national policies on water and environment in 1999.25 The 1997 discussions focused on enhancing water storage viability for sustainable livelihood by building dams and underground tanks with piping systems, etc. This investment in dams was believed to be one of the best options for achieving poverty alleviation and environmental sustainability. Yet, building large dams could be too risky for smallholder farms, owing to multiple economic, social and environmental risks due to climate change impacts.26 Many dams and reservoirs in Kenya are silted up years before their design lifespan. The depleting volumetric storage capacity of most dams arose from both siltation and lack of investment in new infrastructure. Hence, Mumma et al. (2011) conclude that the quality and reliability of water resources are related to good catchment and aquifer management. In all the case, local stakeholders need effective strategies for longterm water resources management to address both water scarcity and 25 Scherr et al. (2011). 26 Ledec and Quintero (2003).

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rural poverty. This will require sober planning and serious management of all available resources. This would be scaled up from supply to demand sites, both downstream and upstream, to safeguard water resources in the catchment. There is also need for simultaneous actions for water conservation at source and investment on human and land resources through implementation of soil conservation measures, perennial cropping, tree planting and other related livelihoods.27 Yet, governmental budgets are generally inadequate to support effective implementation of water policies at small catchment units, especially through provision of huge infrastructure such as dams across the country. So, “the great challenge we face is to get to business not as usual”.28 Investment in green water harvesting and saving has been suggested to increase the one-tenth accessible blue water in streams, lakes and groundwater, in Kenya and elsewhere, by at least 50% to usher in a green revolution in ASALs. To be effective, GWD schemes shall introduce alternative financial mechanisms to supplement government and external partners’ budgets. All stakeholders, therefore, need to get involved in the search for innovative and sustainable ways of financing green water resources, their development and management in the catchment. One of the most feasible financial alternatives would be a fair Payment for Watershed Services (PWS) by “rich” local stakeholders to “poor” ones to enable them to deliver environmental services.29 To grant a fair Payment for Watershed Services (PWS) to those delivering these services, downstream farmers shall be willing to pay (WTP) upstream farmers for their services. Yet, the latter shall also be willing to accept (WTA) a fair compensation for their watershed services. If both WTP and WTA come to match, this would facilitate a fair PWS agreement and transactions between water resources developers and their users. This would enable the provision of watershed services at an affordable price in any catchment area. Charges constitute the cost factor in profit margin calculations that influences the choice of crop type, production method, increased efficiency, in

27 Luwesi and Badr (2013). 28 Berntell (2008). 29 UNEP (2011) and Porras et al. (2007).

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order to have a higher profit through ‘more crops per drop’. The understanding should be that fees are used in order to manage the water up to the end tap. This means that it will be managed rationally for the benefit of all users.30

Upstream stakeholders are to implement the schemes as per their WTA, which is solely to be funded by revenues from the sale of green water services. GWD schemes are to raise more than 50% of additional funding from the government and development partners to make the scheme function properly. Wherever these schemes are fully funded by downstream farmers’ WTP to meet the BCA cost of the schemes, profits of above 15% can be expected by the year 2030. So, there is need for a treatment of the WTA through a Provision Point Mechanism (Ppm ) to minimize that gap between WTP and WTA. The latter was strikingly minimized when Fujiwara and Campbell (2011) formulae were applied during the validation process. This meant that marginal contingent values (MWTA and MWTP) are to be incorporated in decision-making by local stakeholders, if GWD schemes are to succeed. It is necessary that the government intervenes in the design and implementation of GWS schemes. Tiffen et al. (1994) evidenced that high population increases in Machakos District leads to environmental recovery, rather than to the degradation of the catchment due to lifelong conservation programmes introduced by the colonial government. Waswa (2006), Shisanya et al. (2014) and Luwesi (2022) attributed this degradation to poverty issues, farmers being preoccupied with their survival engagements rather than raising funds for catchment conservation. Yet, the latter was vital and deserved more consideration for future blue water supplies. Hence, the role of the government is crucial to fill that gap by levying wealthier farmers within the lower sub-catchment with a higher amount to subsidize poorer ones, who would have not afforded to pay the WTP threshold. GWD schemes should, therefore, be allowed to receive subsidiary grants from development partners in order to minimize financial deficits in the management of green water services. These resources shall be coupled with good governance, mainly accountability and good management (for resource optimization, to ensure the sustainability of GWD schemes in the ASALs).

30 Förch et al. (2008).

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6.6

Conclusion and Recommendations

Compared to BWS projects, GWD schemes lack ability to ensure economic efficiency and cost recovery in time of drought. It is thus difficult for farmers to compensate the huge gap between their downstream fellow workers’ WTP and their upstream counterparts’ WTA for their green water services. This might be the reason why catchment managers and water users are not incentivized to recognize and reward PWS schemes. The following guidelines may help drive the water sector reforms towards enhancing investments on agricultural water development in Kenyan ASALs. First, farmers need innovative farming technologies to increase water productivity and its use efficiency in agriculture. GWS schemes to be not only innovative, needed and accepted by farmers, but also financially sustainable and economically feasible when associated with crop selection, the acquisition of water storage facilities (like “KrishakBandhu” buckets and quarter acre kits, tanks and dams) as well as automated technologies (i.e. Grundfos Lifelink’s pumps, Amiran farmers’ dripkits, etc.) to supplement substantial water to farms. The schemes save downstream farms from water logging, especially under flooding conditions (ANOR), to meet increased crop water requirements under normal (NOR) and below normal (BNOR) weather conditions. To improve both the Benefit-Cost Ratio (BCR) of farming water and its efficiency in use under fluctuating rainfall regimes, there is a need to design water allocation plans to save excess rainwater loss under the ANOR regime and supplement the available water resources in time of deficit to maintain actual crop water requirements under the BNOR rainfall regime. A fair pricing policy would be required to boost farming water profitability within the economic production possibility frontiers. Thus, farmers would be able to achieve an “economic order quantity” (EOQ) under a flooding scenario, a “Limit average cost” (LAC) under a normal scenario and a “minimum efficient scale” (MES) under a drought scenario. The new farming water policy should be perceived as a set of mechanisms that link agricultural decision-making to agricultural production and marketing, through pricing, regulatory and participatory mechanisms in management. These mechanisms shall be related to processes occurring in all the natural resources management sub-sectors, including water resources allocation, land use, and disaster planning and preparedness. F,

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Upstream and downstream farmers shall finally ensure to sign a consensual agreement to enable fair PWS prior to embarking on a robust GWD scheme. This Contingent Benefits ‘Valuation (CBV) shall be acknowledged as part of upstream-downstream stakeholders’ response for the implementation of GWD schemes in the ASALs. Though it is subject to severe criticism, especially with regard to the disparity between WTP and WTA, it assisted us validate rigorous socio-economic and environmental impact assessments as well as cost-efficiency and benefit-cost analyses performed earlier prior to supporting or rejecting new investments in the water sector. This CBV will certainly help watershed managers avoiding excessive external costs related to the implementation of BWS projects in the course of climate change. The CBV shall also be recognized as an integral part of the popularly used environmental valuation of non-market products and investments, including estimate use, non-use and passive values (avoidance costs of nuisance or loss) in a changing environment.31 This exercise was in line with participatory consultations initiated by the world Bank for the creation of the World Commission on Dams in the year 2000. Viable and sustainable new investments in dams were also recommended during discussions held in June 2001 by the World Bank and its partners for promoting Agricultural Water Development (AWD) in Sub-Saharan Africa.32

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CHAPTER 7

Innovative Water Financing in Africa: Lessons Learned from Kenya Floribert Ntungila Nkama, Cush Ngonzo Luwesi, Atakilte Beyene, Dzigbodi Adzo Doke, and Philip Wambua Peter

Abstract Financial sustainability is achieved through enhanced creditworthiness and snowball effect of borrowing. This chapter presents sample cases of applications of innovative water financing mechanisms in Kenya based on scale formation and adoption practices. These include the cases of Murang’a-, Nyeri- and Embu Water and Sanitation Companies

F. N. Nkama (B) · C. N. Luwesi University of Kinshasa, Kinshasa, Democratic Republic of the Congo e-mail: [email protected] A. Beyene Nordic Africa Institute, Uppsala, Sweden D. A. Doke Department of Environmental Science and Natural Resource Management, University for Development Studies, Tamale, Ghana P. W. Peter Kenyatta University, Nairobi, Kenya © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 C. N. Luwesi and A. Beyene (eds.), Innovative Water Finance in Africa, https://doi.org/10.1007/978-3-031-38234-5_7

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for enhanced creditworthiness, leadership and the use of Mobile Money and other technological innovations, as well as marketing and communication strategies to build Public-Private Partnerships (PPP) and raise capital and debt. Keywords Murang’a · Nyeri · Embu · Water and Sanitation Companies (WASCO) · PPPs · Kenya

Box 7.1: Lessons Learned • Financial sustainability can be achieved through enhanced creditworthiness and a snowball effect in borrowing backed by an exemplary leadership and marketing management as well as sustained by a close cooperation with the government for successful resource mobilization. Hence, sustainable financing of the firm shall be based on in-depth knowledge of the company’s present needs, and these shall be balanced with the future needs. • A situation analysis, technical assessments (pre-feasibility and feasibility studies), proper budgeting and human resources capacity building are key to borrowing and a prerequisite to materializing the intention to borrow and for ensuring successful completion of the project. • If support from development partners is expected, the project shall go beyond recurrent financial needs of the company to include infrastructure development and elements addressing sustainability in the water sector such as the SDGs, poverty eradication, global warming, renewable sources… • Taking into considerations hedges on the management team, the risk of interest and currency exchange rates during the loan negotiations, and adherence to the budget may allow the company to achieve its accountability and save time and money on the project implementation length and cost. • The company shall ensure capacity enhancement from the project implementation and proper tariff setting to nurture revenue growth and unit costs reduction, and so that enough grace period is granted to cater for the early idle period and learning costs. It is thus capital to establish a sinking fund if the loan repayment is periodical with a frequency longer than a month.

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185

Introduction

Public Services Providers (PSPs) and Water Services Providers (WSPs) shall embrace a societal marketing culture to apply communication strategies that create awareness on water scarcity and related financial needs, and promote “user pays” and “polluter pays” principles to enhance revenue collection and achieve a full cost recovery. WSP need effective leadership and management, marketing and communication skills to expose their strategies and seize opportunities for attracting funds to the water and sanitation sector. They shall be skilful in building partnerships with the banking sector, microfinance, NGOs and private companies as well as governmental agencies, bilateral and multilateral development partners.1 This Chapter presents success stories from four (4) Water and sanitation companies (WASCO) of Kenya. It aims at enabling the reader to draw lessons relevant to the financial sustainability of such businesses. These include enhanced creditworthiness through technological innovations, leadership and the use of marketing and communication strategies to build Public-Private Partnerships (PPP), raise capital and contract debts, like in the cases of Murang’a, Nyeri and Embu WASCOs of Kenya.

7.2 MUWASCO: Combining Leadership and Innovations for Creditworthiness 7.2.1

Case Study Rationale

Murang’a Water and sanitation companies (MUWASCO) is located in Murang’a County and provides a typical case of a Water and sanitation company of Central Kenyan region, which has combined leadership and technological innovations to achieve creditworthiness in a marginalized place. The management structures did neither foresee public relations and customer care nor Information and communications technologies (ICT) as key leverages for borrowing. The organizational structure almost comprised two major lines, one for operations management and another for maintenance management, besides the general administration and

1 AGRA (2022) and Luwesi and Beyene (2019).

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high management boards, comprising the Board of Managers and the Chief Executive Officer (CEO).2 The Board of Directors offered foresight leadership through mainly internal auditing and oversight. An audit committee established the soundness of utilization of resources and reliability of financial, administrative and technical management units of the company. However, the lower academic and professional qualifications of corporate board members might have been a hindrance for long toward achieving higher foresight of the management. A majority among the staff were plumbers, water and sewerage operators, holding either a certificate or a diploma (about 80%) and a minority had either higher levels of education (diplomas, bachelors and masters’ degrees) or lower professional credentials (such as driving BCE, KATC courses or no qualification at all). The company has formed a good rapport with both the national and county governments, external financial partners and private investors to enable it to obtain grants and borrowing from banks and international financial agencies, both bilateral and multilateral ones. This has helped the company to grow since its establishment in May 2006. However, it was not very clear whether the company had a regulation for competitions, especially for procurement and tendering of funded projects and community water projects, and how it implemented them. This is where tough measures for accountability were required to keep the management on the loop for its own performance.3 There was first a need for a leadership that could combine technological innovation with credit facilities and internally generated revenue. Happily, in 2013, the company got appointed a highly qualified, dynamic and young managing director with a few other senior managers. The quality of their supporting staff enabled a change in the way business would be soon conducted. The establishment of a customer care section and the expansion of office space to accommodate customer queries, complaints and deposits enabled an improvement of customer relations and revenue collection. Internal and external funding portfolios were to be boosted through combination of internally generated revenue and credit facilities from commercial banks, as well as funding from the

2 MUWASCO (2022). 3 MUWASCO (2022) and Luwesi and Wambua (2016).

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government and development partners, including CDF, County government, WSTF, AfDB, KfW, The World Bank, and other bilateral and multilateral organizations.4 7.2.2

Major Impactful Reforms Outcome

There was a high disparity between the roles of different genders in the utility. The new management encouraged young female applications through job offers, competitions and scholarships at high school, colleges and university levels. These efforts were later reflected in a fairly equitable partition between a male staffing of about 71% versus 29% female in 2015, thus slightly meeting the constitutional gender representation ratio of two-thirds (2/3) set by the Government of Kenya in 2010.5 There was also a great disparity between duty allocation and the staff education level. For instance, there were some officers in charge of others whose educational level did not match, thus insinuating that the appointed supervisors were not actually performing but delegating the roles under their docket. This distribution of staffers by their educational level was also reflected in the remuneration they earned. On average, a MUWASCO monthly wage was between Ksh. 15,000 (i.e., US$200) to 30,000 (i.e., US$400), to which one could add house allowances and other allowances rising up to Ksh. 15,000. This remuneration seemed to be fair for holders of certificates and diplomas living in rural areas but could not attract hardworking and highly qualified category of workers living in urban areas. Hence, MUWASCO management developed an effective and sustainable succession plan to release the old generation and absorb the new comers. Some positions held on permanent basis (91%) were released on short-term contract basis (9%) to minimize the heavy burden of pension. The management also recruited young university degree owners on a competitive basis. These competitions attracted the best brains of Murang’a county and other counties of Kenya.6 A detailed financial performance assessment of MUWASCO also revealed an improved growth of revenues from ksh. 88.4 million (in 2012) to ksh. 117.7 million (in 2015) (US$1 = 75,000). However, the 4 MUWASCO (2022) and Luwesi and Wambua (2016). 5 MUWASCO (2022) and WASREB (2015). 6 Luwesi and Wambua (2016).

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efficiency of the company was being challenged by the enormity of operating costs, high cost of inputs and inflation rate, despite the improvement in revenue collection and capital expenditure recorded over the last 3 years. Hence, the company needed to cut the cost of its operations and the heavy allowances accorded to the board of directors, as well as losses due to Non-revenue water (NRW) to remain on track. The management introduced a computerized administration to record all assets and keep track of all operations for the purpose of accounting and auditing. Also, a scheme for mobile phone bills was put in place to speed up the process of payment and revenue collection. Since then, MUWASCO enjoys consistent Earnings Before Interest, Taxes, Depreciation, and amortization (EBITD) with increasing rates of 3 to 7%.7 In addition, the utility received external funding to expand its water supply network to the underserved areas of its jurisdiction. The African Development Bank (AfDB) funded in total ksh. 689 million (i.e., close to US$920,000) for bulk water and Murang’a urban sewerage project (ksh. 175 million or about US$233,000), which were commissioned and completed. The Water Services Trust Fund (WSTF) funded the Kabuta water project for ksh. 20,000,000 (i.e., close to US$270,000) and two public sanitation facilities in Murang’a town for ksh. 9,000,000 (i.e., close to US$120,000). Through their partners and donors, the Tana Water Services Board (TWSB) funded the commissioning and completion of meter testing bench for Ksh. 3,000,000 (i.e., US$40,000). All these investments enabled the expansion of water networks as well as the construction of sanitation facilities. Another development partner granted MUWASCO an exhauster at a cost of ksh. 14,000,000 (i.e., close to US$190,000) still through the Tana Water Services Board (TWSB).8 These investments and the diversification of the funding sources enabled MUWASCO to sustain its water supply and sanitation services beyond Murang’a City.

7 MUWASCO (2022) and Luwesi and Wambua (2016). 8 Luwesi and Wambua (2016).

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Prospective Outcome of the Reforms

The utility is expanding its water supply network to Maragua town and other un-served areas such as Kiangage, Ndikwe and Muchungucha. This expansion program requires an estimated investment of over ksh. 1 billion (US$14 million). This calls for an aggressive resource mobilization, which is subject to a conducive operating environment, which will attract support from local stakeholders and funding from international development partners in the near future. Also, the company expects its bulk water sale project to relieve the huge operational costs due to the pumping of treated water. A final funding agreement will enable the rehabilitation and extension of the company’s water reticulation system through Public-private partnership (PPP). Plans are also underway to increase investments in sewerage projects to serve Maragua town, which is one of the key towns in development in Murang’a County.9

7.3 EWASCO: A Showcase of Strategic Leadership in Credit Finance and Grants 7.3.1

Case Study Rationale

Eng. Hamilton M. Karugendo, Managing Director of the Embu Water and Sanitation Company Limited (EWASCO) is a living example of leadership in strengthening a water company balance sheet by securing commercial financing in the Embu County based Wasco. In effect, when EWASCO was created by the Embu Municipal Council in the year 2004, the company could even not deliver 2000 m3 /day to satisfy the needs of half of the population of Embu town. The company operated without its own budget, being a department of the Embu Municipal Council until July 2005, when a new management was fully established, but without a formal handed-over. At the inception meeting held on 1 July 2005, the company capacity of producing water was estimated to 2,000 m3 / day against a total demand of 7,000 m3 /day. As a result of low water pressures, householders were rationed 3 hours every alternate day.10 Concerning technical and financial management, there were no formal plans for improving water supply and sewerage services. The operating 9 MUWASCO (2022). 10 EWASCO (2022).

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environment was Lukewarm if not hostile, with a staff morale and capacity to perform low, and a quasi-down discipline characterized by a sense of helplessness. This situation reflected the half-hearted support from the Tana Water Services Board (TWSB) and the company shareholders, the company being highly indebted to suppliers and its accounts empty at inception. Therefore, the customers expected much from the new management to immediately improve the company services.11 7.3.2

Leadership in Resource Mobilization and Innovations in Investments

In the kind of environment described above, the Managing Director (MD) was the man to hunt. Understanding his challenges, he had to put in place very practical strategies to improve the morale and discipline at work through increased innovative tasks, public relations and project funding applications. Yet, this was not easy since EWASCO could not afford consultancy services. Nonetheless, the MD, Eng., Hamilton M. Karugendo, with a small team of staffers, designed a pipeline from source to the treatment plant with an estimated engineering cost of Ksh. 50 million (i.e., close to US$670,000).12 A funding proposal was prepared to suit possible financiers targeted by the team, including the Government of Kenya (GoK) (through the Tana WSB), commercial banks, NGOs, donors and other international organizations (for grants). As per possible expectation, none of them could fund the project, except Co-operative Bank (CO-OP Bank). In fact, the GoK claimed through Tana WSB that no funds were available in the budget. All commercial banks argued that the financial situation of the company was insane, the lifespan of the company was short, and that there was lack of suitable collateral. Nonetheless, CO-OP Bank agreed based on the argument that EWASCO new management team would possibly provide good administration of the fund to secure reimbursement. Thus, the proposed project was declared financially feasible and sustainable.13 The German and Japanese international cooperation agencies (GTZ and JICA) accepted simultaneously to consider the applications for

11 Luwesi (2012). 12 EWASCO (2022). 13 EWASCO (2022) and Luwesi (2012).

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funding. They agreed to work together with EWASCO until GTZ withdraw from its agreement to avoid competition with JICA. The latter settled to work with the company. More struggles were yet to come for the implementation of the two agreements obtained (from CO-OP Bank and JICA). In October 2006, the Tana WSB refused to grant EWASCO permission to implement the project through CO-OP Bank loan. It gave no optional funding and decamped from Embu for one year. The high expectations from that loan vanished soon. Yet, the MD was undeterred, determined to find a credit financing, this time without Tana WSB approval. A small water supply project of 11,000 m3 /day capacity and 12 km pipeline was designed and ESLON PLASTICS, a private company, agreed to provide pipes and fittings worth Ksh. 30 million (close to US$400,000). It was agreed that this would be a credit payable over a 2-year period, after a down payment of Ksh. 9 million (close to US$120,000) and a grace period of 4 months. EWASCO raised funds for unskilled labor, building workmanship using skilled labor owned by the company. The construction was finished within 2 months, and the credit finance was repaid in 18 months.14 Using internally generated funds, EWASCO continued to finance treatment works at a cost of about Ksh. 80 million (above US$1.1 million). This provided a signal to JICA to hasten the implementation of its agreement. A total of Ksh. 2.2 billion (that is US$30 million) was assigned to this project by 2009 and the project was successfully implemented. EWASCO prepared the proposal for funding and financed initial undertakings for its pre-implementation. All the above enumerated strategic efforts have strengthened EWASCO operations with palpable outcomes on its balance sheet.15 Table 7.1 shows the strengthening of the operations, while Table 7.2 provides evidence for the balance sheet increased assets. 7.3.3

Prospective Outcome of the Reforms

JICA Grant Aid Scheme was a necessity for EWASCO and a development incentive for the Embu County, according to the request filed by the Ministry of Water and Irrigation to the Japan International Cooperation Agency (JICA). During one of the project monitoring meetings

14 EWASCO (2022). 15 Luwesi (2012).

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Table 7.1 Increased EWASCO assets (2005–2011) No

Asset

01 02 03 04 05

Permanent Functional Functional Functional Functional

staff computers vehicles motorcycles computer servers

July 2005

October 2011

19 2 0 0 0

81 37 4 19 3

Source EWASCO (2022) and Luwesi (2012)

Table 7.2 Strengthened EWASCO Operations (2005–2011) No

Variables

July 2005

October 2011

01

Max. water production (/ day) Mandated supply area Population within the area Water coverage Population served Number of water connections Number of sewer connections

2,000 m3 (Rationing)

13,000 m3 (24/24 supply) 900 Km2 150,000 people 460 Km2 97,000 people 12,000 (all functional) 2,300 sewages connected

02 03 04 05 06 07

80 Km2 54,000 people 24 Km2 24,000 people 3,800 (1800 meters functional) 1,500 sewages connected

Source EWASCO (2022) and Luwesi (2012)

with JICA, Eng. Hamilton M. Karugendo declared that financing his pipeline investment was not the only goal. The measure of success for EWASCO was not how much profit was made, but rather how many people have had access to water and sanitation services in Embu County. And since he started working with EWASCO in 2005, the company water production has grown from 2,000 m3 /day to 28,000 m3 /day: that is the most important performance achieved by Eng. Hamilton M. Karugendo as MD of EWASCO. The Tana Water Services Board (TWSB) and the Kenya Water Services Regulatory Board (WASREB) could not relent to rate EWASCO as the most innovative water company in the region in 2015.16

16 EWASCO (2022), WASREB (2015), and Luwesi (2012).

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In fact, the Embu Water and Sanitation Company (EWASCO) has been implementing this project with JICA since 2009 to improve the water supply system in Embu and the surrounding areas. The project had also to construct weather-proofed roads, to open up the area and ease transportation of farm produce and other goods. These achievements have enabled rice irrigated farming, hotels and other businesses to flourish in the community due to water availability, which in turn has increased their operational management efficiency and improved the value of land and other local assets. This innovative social financing approach and good management will go a long way to achieve the financial sustainability of the company, and improve the lives of 75,000 residents of the Embu community in Kenya. EWASCO Managing Director (MD) could one day satisfyingly declare: “My dream is that even the poor lady in the village will be able to access clean and sufficient water”. That is why, the MD could then move to addressing sanitation issues through an innovative financing deal, facilitated by Sustainable Water and Sanitation in Africa (SUWASA) project, a U.S. Agency for International Development (USAID) project.17 Initially intended for housing finance, the USAID project was adapted to fund water works and sanitation infrastructure. The water utility was granted funds to install 23 km of pipeline and provide water to more than 75,000 low-income residents in Embu County of Kenya. But Embu Water and Sanitation Company (EWASCO), under the leadership of Eng. Hamilton M. Karugendo, secured additional US$945,000 in commercial loan to finance housing finance for the work with a guarantee facility from the USAID Development Credit Authority, and the project was supported by an Aid on Delivery grant from the Kenyan Water Services Trust Fund (WSTF), funded by KfW, the German development bank.18 The commercial financing unlocked EWASCO capacity to expand services, and the Aid on Delivery subsidy from WSTF enabled the company to double its revenue and expand twice; this has never been possible before 2005. SUWASA also linked EWASCO to financing partners, helped accessing market demand and increase its visibility in the sector at large, with a BBB rating from the Water Services Regulatory Board (WSRB). Additionally, these projects were not just innovative for

17 EWASCO (2022) (personal communication). 18 EWASCO (2022).

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improving water and sanitation services, but also introduced supplierled financing in EWASCO and in the water sector at large, allowing the company to expand its services and increase its revenues. Finally, with support from the JICA grant, EWASCO was able to build a new water treatment facility. It also partnered with Kenya’s K-Rep Bank to construct household water connections in low-income areas. Sustainability has been achieved in the three perspectives of community welfare: social and human developmental welfare, economic and financial viability, and environmental and ecological resilience.19

7.4 NYEWASCO: When Endurance Is Needed to Capitalize Long-Term Benefits of a Loan 7.4.1

Case Study Rationale

Nyeri Water and Sanitation Company (NYEWASCO) is located about 160 km from Nairobi city, in Nyeri County of central region of Kenya. Geographically, Nyeri is bound by latitude 0.5° South and longitude 37° East, at a pick altitude of 1,880 m a.s.l. (5,500 feet). It has an approximate area of 200 km2 . Economic activities range from tourism to agriculture via industrial production. Tourism transit hotels also make the pride of the city, including “Out span”, “Tree Tops”, “Green Hills” and “The Ark (Aberdare Country)”, to name but a few. Few light industries are scattered in the town. The most visible ones are water bottling companies, namely “Mount Kenya Bottlers” designing Coca-Cola, New KCC, etc. among other products. The town is surrounded by diverse suburbs, which dictate its expansion to the rural areas. These encompass among others Sikuta, Ngagarithi, Nduta estate and Gatende estates. Cash crop farming is hence practiced by both small- and large- scale farmers such as the Catholic Dioceses of Nyeri. Plantations of tea, coffee, maize and beans, and dairy farms are therefore flourishing here and there. Some of these farms practice cattle zero grazing, poultry and pig farming, despite the fact that the latter is banned by the town administration. The rural setup remains more active in both subsistence cultivation and small-scale animal husbandry.20 All this development affects the volume and quality

19 Luwesi (2012) and WASREB (2015). 20 NYEWASCO (2022) and Luwesi (2012).

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of water provided to local stakeholders by the Nyeri Water and Sanitation Company (NYEWASCO). NYEWASCO history goes back to the 1980s, precisely in 1982, when the Nyeri Municipal Council took over the provision of water services from central government. The provision of water was undertaken through a small unit of municipal engineers. A water and sewerage department was created in July 1995. Nyeri Municipal Council resolved to incorporate NYEWASCO on 28 August 1997. A private company was incorporated within the provisions of the Companies Act Cap 486 on 23 September 1997. Hence, NYEWASCO commenced its operations on 1 July 1998. At its inception, the company had nine (9) directors (11 in 2012), including a management comprised of a Managing Director (MD), in charge of the overall administration; a Commercial Manager, in charge of finances, sales and human resources; and, a Technical Manager, in charge of logistics and other technical issues. NYEWASCO operated under an agency agreement with the Nyeri Municipal Council up to 5 October 2005, when it started leasing the council assets. It is nowadays operating as an agency of the Tana Water Services Board (TWSB), one of the eight (8) Water Services Boards (WSBs) of Kenya. This arrangement was made on requirement by KfW, the German Development Bank, for the extension of the Nyeri Water Supply. The latter was willing to fund 20.0 million Deutschmarks (1US$ = 2.1 DM) out of DM 21.0 million request of a loan. The perilous and long journey of this loan, which has transformed NYEWASCO into a very reputable and productive WSP, is worth of being recorded as a success story for future generations.21 7.4.2

Endurance in Resource Mobilization Calls for Sustained Governmental Support

KfW loan history starts in 1990, when the Nyeri Municipal Council wrote to the Ministry of Local Government requesting for funding for water system extension in the municipality. On 3 July 1991, Nyeri Municipal Council was requested to provide data related to water supply prior to the visit of a KfW mission led by Alexander Gibbs & Partners and the Kenya Ministry of Local Government. The draft Terms of Reference (ToR) for feasibility studies was prepared in February 1992, and on 2

21 Luwesi (2012).

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March 1992, a mission was constituted to discuss the proposed project. An agreement was concluded on 21 November 1994 for the Nyeri water supply feasibility study between the Kenya Ministry of Local Government and the consulting firm H.P. Gauff. Another meeting was held on 21 March 1995 to discuss the feasibility study. Three parties were represented to the meeting: the Local Government (led by Minister Muriuki), H.P. Gauff (led by Baker & Wangome) and NMC (led by Gikuhi Maina and Nguiguti). They decided to conduct the study in three stages, starting by a situation analysis, then a pre-feasibility study, and last, a feasibility study.22 The situation analysis was completed in three months and the report submitted on the 14 July 1995. On 7 March 1996, the pre-feasibility study was also completed and on the 25 April 1997 the consultant was given a let-go for the 3rd phase: the feasibility study. A draft report of the feasibility study was submitted by the Ministry of Local Governments on 27 November 1997, and a final one in October 1998. Thence, prequalification for detailed design, tender documentation and supervision of construction consultancy were advertised in December 1998. Draft documents of the Loan and Project Agreement (LPA) were forwarded to the Ministry of Finance and Planning in February 1999. The Signing of this agreement together with the Subsidiary Loan Agreement (SLA) was a precondition for the commencement of the detailed design to go ahead.23 On 23 November 2000, documents of a Revised Subsidiary Loan Agreement (RSLA) were forwarded to NYEWASCO by the Treasury for comments, which was done on 19 December 2000. A separate agreement signed on the 17 May 2001 was appended to the Loan and Project Agreement dated on 18 June 2001, the Subsidiary Loan Agreement being signed on 12 September 2001. Hence, preparations were made to invite proposals for the detailed design, contract preparation and project supervision. Invitations were sent to three firms, and NYEWASCO forwarded results of the technical assessment of proposals to KfW Nairobi on 11 January 2002. On 16 January 2002, approval was given to open financial bids, which assessment results were sent to KfW and approval granted to start contract Negotiations with M/S CES MIBP Consulting Engineers on 21 January 2002.24

22 NYEWASCO (2022) and Luwesi (2012). 23 NYEWASCO (2022). 24 WASREB (2015).

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At first, there was a conditionality to create a water department within the council with the intention of having a specialized approach to provision of water and sewerage services. The department was formed in 1995. Eventually, there was a need to form an autonomous organization to manage water and sewerage services. A limited liability company was registered in September 1997, starting its operations in July 1998. The council was the legal Water Undertaker while the loan was to be given to the company. This was resolved by the council signing an Agency Agreement with the company for management of water and Sewerage services. The council was the owner of assets valued at about Ksh. 560 million (about US$8 million). The council signed a Lease Agreement with the company for use of its assets, owing to the company incapacity to buy them.25 Finally, as a requirement of international development banks, KfW had to deal only with the Government of Kenya (GoK). The latter had to possess the loan from KfW through the Treasury and then lend it to NYEWASCO through Subsidiary Loan Agreement between the treasury and the company. The Treasury was to repay the Loan at 0.75% interest, while the company was requested to repay the Government at an interest rate of 6.5%. This was later on found not viable. After discussions, this was revised to 2.5%, and the currency of loan repayment to the Treasury was agreed to be the Kenya Shilling (Ksh) at the disbursement period exchange rate. A grace period of 5 years was given, owing to the idle time of construction. The company was initially supposed to repay the loan from 1 September 1996, after a grace period of five (5) Years. As the interest rate was reviewed, the grace period was extended by 3 more years to allow for growth on connections and revenue base. This was mainly due to construction works that were delayed by credit freeze put on Kenya by Donors in that year. Finally, the company management was put at hedge to avoid mismanagement and governance issues. For that reason, articles of the Memorandum of Association (MoA) were amended to give the Treasury one golden share with Vito powers on all financial matters.26

25 Luwesi (2012). 26 Luwesi (2012).

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7.4.3

Prospective Outcome of the Reforms

NYEWASCO has ever since improved its ties with the treasury and sustained its cooperation with the whole government to achieve further successful resource mobilization. The sustainable financing of the firm is based on an in-depth knowledge of the company’s present needs, which are balanced with its future needs. The company’s resources go beyond recurrent financial needs to include development partners support to infrastructure development and soft investments for addressing sustainability in the financing of water services, including support to the SDGs, poverty eradication, global warming and renewable sources… Hence, a situation analysis, technical studies (pre-feasibility and feasibility studies), proper budgeting and human resources capacity building are always part of NYEWASCO borrowing scheme and a prerequisite to materializing the intention to borrow and ensuring successful completion of its projects. This enhanced creditworthiness has had a snowball effect in borrowing, thus leading to increased resource mobilization. Taking into considerations hedges on the management team, the risk of interest and currency exchange rates during the loan negotiations, and adherence to the budget has allowed the company to save time and money on the project implementation length and cost. The company is then able to ensure capacity enhancement from the project implementation and proper tariff setting to nurture revenue growth and unit costs reduction, so that enough grace period is granted to cater for the learning costs of the early idle periods. For that reason, the company establishes a sinking fund to assure the refund of each loan, which repayment is periodical with a frequency longer than a month. No wonder that NYEWASCO has been rated ABA by the Kenyan Water Regulatory Board, as of 2014.27

7.5 Grundfos-Mpesa Integrated Technology for Financing Water Services 7.5.1

Grundfos-Mpesa Integration for Water Provision

The Rio and Dublin Conferences of 1992 recognized that water is an economic and social good and has to be paid for. Cost recovery from users should, however, be subject to affordability, with appropriate use of tariff

27 NYEWASCO (2022) and WASREB (2015).

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structures, targeted subsidies and cross-supports to reduce any hardship among vulnerable populations. It is in that context that Grundfos-Mpesa integrated technology (GMIT) has been developed as a socio-technical solution to abstract groundwater and avail it to farmers using MPesa mobile phone-based payment system for withdrawal.28 Figure 7.1 illustrates an elaborate application of the potential of MPesa as a means of mobilizing finance for water services development projects such as the GMIT technology. In the developing world, the national treasury cannot provide funds required for investing in such technologies, the water sector starving of financial needs. If countries like Kenya offer free or cheap water as a populist gesture that actually benefits the rich, it impoverishes water infrastructure and services, and makes their proper financing impossible. However, through Mpesa, Grundfos Lifelink, a Danish firm specialized in drilling and pumping groundwater, has proven that indeed, water does

Fig. 7.1 Schematic view of money transfer mechanism via MPESA payment platform (Source Nkpeebo et al. [2016]) 28 Luwesi and Beyene (2019).

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not have to be the neglected orphan of the financial world. MPesa is the secret conduit in this design. MPesa (M for “mobile”, Pesa for “money” in Swahili) is a mobile phone-based money transfer, financing and microfinancing service, launched in 2007 by Vodafone for Safaricom and Vodacom, the largest mobile network operators in Kenya and Tanzania. Since then, the service has expanded to Afghanistan, Ethiopia, South Africa, and India up to Eastern Europe in 2014. MPesa allows users to deposit, withdraw, transfer money and pay for goods and services (Lipa na MPesa) easily with a mobile device.29 In Kenya, GMIT technologies have been applied at Musingini in Machakos County, to improve drinking water using a solar pump activated by a mobile phone developed by Safaricom mobile operator (Fig. 7.2).

Fig. 7.2 Modeling integrated Grundfos/Bhungroo irrigation technologies with payment via MPESA (Source Luwesi et al. [2017])

29 Nkpeebo et al. (2016).

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The GMIT enables charging every drop that flows from the tap to the consumption site. Such an exemplary application of modern technologies for water provision and efficient use has also been made possible in irrigation through the same partnership between the Danish pumpmaking company (Grundfos Lifelink) and the Kenyan mobile operator (Safaricom). The combination of these sets of technologies effectively addresses the issue of efficiency in the withdrawal and charging of water, on one hand, and on the other, the issue of lifting groundwater at lowenergy cost so that it is available for farming within the plot. These technologies also enable farmers to achieve efficiency in the use of water in agriculture. Nonetheless, there is a limitation on the out scaling of the GMIT for irrigation technologies far beyond small-scale farms. Hence, researchers have been shifting toward locally best-fit technologies that can lift and avail water to local smallholder farmers through several innovations. 7.5.2

Bhungroo for Out Scaling Grundfos-Mpesa Technologies in Irrigation

Bhungroo irrigation technology (BIT) has been tested in Gujrat State of India and in Northern Region of Ghana to inject excess water from farm plots underground in the monsoon period with an objective of saving some standing crops. Bhungroo can also be erected in those places where subsoil strata allow the water storage. This feature makes the technology context specific and dependent on water storage that can be possible within: subsoil sand layer, subsoil partially sand and partially coarse granule zones (in this case design is changed partially), subsoil saline water table (in this case the design is changed), subsoil water table, stony areas provided fracture is possible (recovery, in this case, might be lesser), riverbed provided it is not saturated. Each Bhungroo can save 5 acres of land from waterlogging. This means, in optimum conditions, each unit of Bhungroo can store excess water from 5 acres of land. In case of total 90 days of rain in a year, it can be observed that Bhungroo sites get excess water in each 10 days and total 8–9 times water stands still on Bhungroo sites. It, therefore, plays critical role to save the land from submergence. Thus, each unit of Bhungroo takes in the excess water within 10 days period and subsequent splashes of water flow do not disturb the standing crop, while being got injected

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by Bhungroo. The general design of Bhungroo is based on the hydrogeological structure of candidate sites. The selection of appropriate sites for the project, therefore, influences the other design elements. This makes the technology very context dependent and implies significant variations in the performance of each installation. Put aside this hydrogeological technology, BIT uses Airtel transfer payment services, to allow subscribers to deposit money into an account stored on their cell phones, to send balances using PIN-secured SMS text messages to other users, including sellers of goods and services, and to redeem deposits for regular money. Users are charged a small fee for sending and withdrawing money using the service. The initial concepts of Airtel Money technologies, drawn from MPesa, had been to create a service which would allow microfinance borrowers to conveniently receive and repay loans using the network of Airtel/ Safaricom airtime resellers. This would enable microfinance institutions (MFIs) to offer more competitive loan rates to their users, as costs are lower than when dealing with cash. As illustrated above, the potential of this MPesa transfer payment service could be harnessed to unlock water service potential for arid and semi-arid lands. But more interestingly, it may just be the secret to unlocking not only water service potential, but also the potential of climate smart agriculture in Kenya, Ghana and elsewhere in Africa.30

References AGRA [Alliance for a Green Revolution in Africa]. 2022. Innovative financing initiative. Available at: http://www.agra-alliance.org/section/work/finance (Accessed on 31 January 2022). EWASCO. 2022. Embu Water and Sanitation Company. Website: www.ewasco. co.ke. Luwesi, C.N. 2012. Innovative ways in financing the water sector. SWAP/ bfz-WaterCap Workshop Report, 7–11 November 2011. Mombasa: BFZ [Bavarian Finance Center] and WaterCap [Capacity Development in Water Resources Management]. Luwesi, C.N., and A. Beyene. 2019. Innovative water finance in Africa—A guide for water managers, vol. 2. Uppsala, Sweden: Nordiska Afrikainstitutet.

30 Luwesi et al. (2017).

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Luwesi, C.N., and P.P. Wambua. 2016. Baseline Report Murang’a County Water Services Management Rationalization and Masterplan. Final Consultancy Report for the Consortium APEC-Be Associates, Nairobi, Kenya. Luwesi, C.N., A.Y. Nkpeebo, Y. Osei-Owusu, and P.K. Osei-Owusu. 2017. Towards integrated innovative technologies for sustainable provision and financing of agricultural groundwater in African Drylands. In Hydrology and best practices for managing water resources in arid and semi-arid lands, ed. C.M. Ondieki and J.U. Kitheka, 209–229. Pennsylvania, PA: IGI-Global Engineering Science Reference [2018]. MUWASCO. 2022. Embu Water and Sanitation Company. Website: www.muw asco.co.ke. Nkpeebo, Y. Amos, Luwesi C. Ngonzo, and Madyanga P. Juvenary. 2016. Probing adaptive farm-based decision-making: Assessing micro-catchment practices towards smart agricultural intensification within Muooni SubCatchment, Kenya. International Journal of Science and Research (IJSR) 5 (1): 1020–1024. NYEWASCO. 2022. Nyeri Water and Sanitation Company. Website: www.nye wasco.co.ke. WASREB [Water Services Regulatory Board]. 2015. Innovative water sector financing—Legal implications, risks and market constraints. Nairobi: WASREB Secretariat.

Index

A Accessible, Available and Affordable, 76 access to productive resources, 91 Adaptation Funds, 69 Africa, v, vii, ix, xvii, xviii, 5, 26, 27, 29, 31, 58, 64–67, 70, 71, 75, 84, 107, 114, 139, 177, 193, 200, 202 aggregated demands, 9 agricultural systems, 83 Agricultural Water Development, 114, 177 agriculture, vi, 3, 18, 81–85, 87, 89, 90, 92–94, 96–99, 102, 104, 106, 116, 139, 149, 176, 194, 201, 202 agriculture extension services, 82, 96, 107 ‘Alt-Finance’ , 43 Arbitration on water value, 7 available rainfall, 3 average cost, 8, 15, 72, 176 Average Cost of Water, 72

average product for water, 72 average product of the capital, 72 average total cost, 8 average variable cost, 8 Avoidance cost method, 2, 19

B behaviour, 6, 18, 152, 153 benefit , vi, 2, 12, 14, 16–18, 27, 71, 112, 113, 117, 118, 125, 128–131, 129, 152, 154, 160, 175, 177 Benefit-Cost Analysis, 115, 118, 157 Benefit-Cost Ratio, 115, 124, 152, 176 Benefits transfer method, 19 Bhungroo, 200, 201 boreholes, 6, 132, 140 bottled mineral water, 6 business not as usual , 112, 114, 148, 174

© The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 C. N. Luwesi and A. Beyene (eds.), Innovative Water Finance in Africa, https://doi.org/10.1007/978-3-031-38234-5

205

206

INDEX

C capital market , 63, 68 cash flow, 62 central government, 30, 195 Choice Modelling, 154 Clean Development Mechanisms, 69 Clean Technology Funds, 69 clearing banks , 43 climate-aligned bond, 68 climate change, v, ix, 5, 17, 26, 56–58, 68, 69, 73, 75, 82–84, 113, 117, 118, 121, 132, 138, 149, 159, 161, 169, 173, 177 Climate Impact, 126 Cobb-Douglas model, 116, 156, 160, 166, 169 Commercial Mortgages , 46 commodities, 7 Community Empowerment, Savings and Credit Associations, vi, 81, 82, 104, 105, 107 computerized administration, 188 Constant Elasticity of Substitution, 116 consumers and producers, 6 consumption, 2–4, 7, 11, 15, 65, 74, 93, 151, 153, 201 contingent valuation, 2, 18, 148 Contingent Valuation Method, 19, 153, 154, 160 Contracting out , 60 cost of saving, 12, 13 cost of transaction, 12, 123 costs of operations and maintenance, 12 costs of transaction, 12, 73, 74, 119 credit access, 87, 90, 91, 93, 94, 102, 104 Credit rationing, 85 crowdfunding , 43

D Data Envelopment Analysis, 117, 152 Deforestation and forest Degradation, 69 demand and supply, 6, 7, 12 demand curve, 7, 8 diminishing rate, 8 distance, 5, 12, 19 divestiture, 59–61 duopoly, 10 duopsony, 10 Durbin-Watson, 156 E Economic instruments , 6 Economic Order Quantity, 119, 137 economic principles, v, vi, 2, 6 economic value, 3, 14, 18, 152 ecotaxes , 73 Environmental Services, 150 Equity, 33, 34, 36, 40, 64 Equity participation, 33, 34 ex-ante, 149, 155, 166 exchange value of water, 9, 15 exclusion, 2, 3, 14, 26, 56, 58, 72, 75, 82, 104 F Financing of common-interest economic activities , 106 food, energy and water, 113 free commodity, 16 freshwater lakes, 6 freshwaters, 3 full costing , 16 full cost recovery, 2, 12, 26, 57, 58, 115, 185 future value, 17, 18, 120, 124 G Gearing , 46

INDEX

Global Environment Facility, 69 global freshwater reserve, 3 Green Bond Principles, 66, 68 green borrowing , 69, 70 Green Climate Fund, 69 Green investors, 66 green subsidies , 73 green taxes , 73 Green Water Saving, 112, 114, 120, 150, 151 group micro-credit , 74

H Hedonic price method, 18 high cost of energy, 6 high-energy intensive systems, 83 households, 5, 7, 65, 75, 86, 89, 155, 159, 172 human beings, 3, 118 Hydro-Economic Risk Analysis and Management, 119

I imperfect competition, 10 Implementation of social development activities , 106 incentives, 6, 37, 44, 67, 75 income-generation activities, 93 industries, 3, 19, 194 Information and communications technologies, 185 information asymmetry, 85, 86 Integrated Water Resources Management, vii, 139 interest rate, 8, 45, 74, 85, 91, 122, 124, 125, 134, 197 internal rates of returns, 126 International Financial System, 39 intrinsic and market values, 6 intrinsic value, 14

207

irrigation, xviii, 13, 26, 28, 44, 56, 58, 71, 75, 82–84, 87, 89–104, 106, 138, 149, 154, 200, 201 Irrigation farmers, 93

J Joint ventures , 61

L law of diminishing marginal product of the capital , 8 law of diminishing marginal utility, 7 law of diminishing returns , 8 law of increasing marginal cost , 8 Leasing , 60 legal and institutional frameworks, 30 Limit Average Cost, 119 livelihoods, 3, 15, 27, 84, 174 livestock, 3, 15, 71, 116 living biological systems, 3 Loan Stock, 44 local consumer taxes , 75 local stakeholders, 30, 37, 74, 129, 136, 137, 153, 173–175, 189, 195 low-energy extensive production, 83 luxury, 7, 16 luxury commodities, 7

M Marginal Cost of Water, 72 marginal product for water, 72 marginal product of capital, 8 marginal product of the capital, 72 marginal utility, 7, 15, 151 marginal value of product , 18 market demand, 7, 87, 193 market equilibrium price, 9, 10 market negotiations , 9, 11 merchant banks , 43

208

INDEX

microfinance institutions, 63, 75, 96, 202 Minimum Efficient Scale, 119, 137 Mitigation Funds, 69 Mobilization of internal and external resources , 105 modern types of concessions , 59, 60 monetary market , 63 monopoly, 10, 11 monopsony, 10 moral hazard, 70, 72, 74, 76 mutual revolving funds , 57, 74

N natural water resource, 3 net present values, 124–126 non-market value of water, 18 non-use value, 19, 153 northern Ghana, 84, 89, 90, 94, 95, 106 Not As Usual Business, 121, 132, 133

O oceans and lakes, 3 of irrigation infrastructure, 83 oligopoly, 10 oligopsony, 10 opportunity cost, 12, 13, 123, 125, 134, 154 Output-based Development Aid, 47, 75

P paradox of value, 7, 151 Payment for Environmental Services, 112, 114, 150 Payment service providers, 64 Payments for Environmental Services, 69 polluter-pays, 49

positive externalities, 67 present and future generations, 3 present value, 17, 18, 121 primary market , 63 private actors, 31 profit, 13, 17, 32, 34, 39, 56, 82, 85, 87, 89, 174, 192 profitability, v, ix, 12–14, 47, 59, 67, 72, 86, 112, 115, 137, 152, 154, 176 Provision Point Mechanism, 149, 155, 157, 166, 169, 175 public and private water service providers, 44 Public Limited Companies, 38 public-private partnerships, 26, 57–59 Public Service Reform Programme, 31 Public Services Providers, 185 purchasing water meters, 10 pure and perfect competition, 9, 116 Q quality water services, 19 quantity rationing, 85 R rainwater harvesting, 71, 139 rational choice of a product, 11 regulatory framework, 43 Residual imputation of shadow prices , 18, 153 risk rationing , 85 rivalry, 2–4, 14, 26, 56, 58, 72, 75, 82 S satisfaction, 7, 153, 154 search for water, 5 self-selection and transaction cost rationing , 85 Sensitivity analysis, 128, 136

INDEX

Sensitization and awareness creation of community members , 105 shadow prices, 2, 18 shortage cost, 12–14, 123, 127 short-run marginal cost, 8 smallholder irrigators, 83, 84, 90, 95, 97–103, 106, 107 social and environmental externalities, 6 Social Impact, 126 societal marketing strategies , 14 Soil and Water Conservation, 132, 150, 160 solidary /bound loans , 74 standard methods of pricing , 6 standpipes, 6, 65 start-up financing , 43 stated preference, 153 Stock Exchange Market , 41, 57, 63 supply curve, 8 surface runoff, 3, 73, 151 sustainability in water resource management, 114, 150, 151 sustainability of fresh water resources, 3 sustainable financing, 66, 72, 74, 184, 198 T table banking , 57, 74 Tana Water Services Board, 188, 190, 192, 195 total variable cost , 8 Traditional types of concessions , 60 Traditional water finance, 28 Transfers of repayment capacity, 62 travel cost method, 18, 19 U user-pays, 49

209

V value added, 2, 16, 17, 26, 56, 58, 75, 82 value added tax, 17 value in capital , 2, 16, 17 value in exchange, 14, 15 valuing water economically, 6 Vector Inflationary Factors, 156, 161 Venture capital funds , 43 vulnerability to natural disasters and poverty, 6

W walking long distances, 6 Water and sanitation companies, 185 water as an economic good, 3 water consumers, 10, 34 water for production, 3 Water harvesting techniques, 71 water poverty, 27, 149 water sector actors, 30 Water Services Providers, 10, 137, 185 Water Services Trust Fund, 188, 193 watershed development, 27 water supply and sanitation, 28, 160, 188 water use, 3, 66, 71, 73, 119, 121, 136, 138, 161, 169 Water valuation, 14 water vendors, 5, 16, 114, 137, 150, 154 Weighted Least Squares, 156, 157 wells, 6, 74 Willingness To Accept, 19, 148, 153, 160, 166 Willingness To Pay, 18, 19, 148, 153, 160 willing to pay, 14, 19, 163, 171, 174 women and children, 3