Source: World Bank
There has been a notable uptick in interest in the use of blended finance and other innovative financing mechanisms for the water and sanitation sector over the past year. Goal 6 (Clean Water & Sanitation) of the Sustainable Development Goals (SDGs) aims to ensure access to safe water sources and sanitation for all; but, the World Bank estimates that $114 billion per year would be needed to achieve this ambitious target.
The size of the estimated financing gap, along with several recent examples of blending for the sector (e.g., WaterCredit, Kigali Bulk Water Supply Project), has caught the attention of development practitioners in the space. The OECD and others have highlighted the urgent need – and the opportunities – to address the obstacles to mobilize commercial finance for water-related investments.
Yet, blended finance is not magic (and water and sanitation are seen to be public goods); so, is water and sanitation the next frontier for blended finance?
Benchmarking blending for water and sanitation
Our latest Data Brief analyzes the use of blended finance to mobilize additional sources of financing – including commercial finance – for water and sanitation projects in developing countries. To date, the water and sanitation sector lags behind other sectors in terms of harnessing alternative financing sources, including blended finance approaches to mobilize commercial capital.
According to the Convergence database, there have been 28 blended finance transactions for the water and sanitation sector, which represent an aggregate volume of $2.1 billion invested in full or part in the sector.
Blended finance for water and sanitation over time. Source: Convergence.
Here are some of our key findings on blended finance for the water and sanitation sector to date:
Water projects are more likely to mobilize finance than sanitation projects: The largest proportion of blended finance transactions for the water and sanitation sector have targeted water supply services (70%), while only 11% targeted sanitation and wastewater. Relative to water projects, financing sanitation projects can be particularly difficult because the infrastructure is often more challenging (fiscally, socially, and politically) to build, operators have more difficulty recovering costs via tariffs, and these projects tend to lag behind water supply service in terms of timeline and implementation.
In the short- to medium-term, there should be reasonable expectations about targeting low-income countries: Middle-income countries have been most frequently targeted by blended finance transactions in the water and sanitation sector, while only a quarter of blended finance transactions in the water and sanitation sector have targeted one or more low-income countries. Further, there have been challenges to date in attracting quasi-commercial (e.g., impact investors, DFIs) to this sector even in middle income countries, let alone low-income countries.
‘Public on public’ blending is key to building a solid track record of investment: While all of the transactions had mobilized some form of private sector investment, the lion’s share of commercial capital – by both frequency and value – was provided by development finance institutions like the Overseas Private Investment Corporation (OPIC) and the Development Bank of Southern Africa (DBSA), and multilateral development banks, like the International Finance Corporation (IFC). Building the market for private sector investment in water and sanitation will take time and it will require ongoing support from the public sector (i.e., concessional finance from development agencies and other development funders).
Mobilizing additional capital to water and sanitation projects may take more time, compared to other sectors: Leverage ratios for this sample of blended finance transactions varied from 1:1 (i.e., $1 of concessional capital mobilized $1 of commercial capital) to 1:9. Leverage ratios have been higher for blended finance funds than for other structures; but more notably, larger leverage ratios have been achieved for projects in later stages (e.g., expansion) and follow-on funds where the fund manager has a demonstrated track record.
Technical assistance and replication are paramount
Blended finance is not and cannot be the full solution to financing Goal 6 (Clean Water & Sanitation), especially given that water and sanitation services have public good elements. However, the water and sanitation sector faces significant barriers to attracting sufficient financing, including the local nature of projects and the considerable costs associated with operation and maintenance. It is important to consider where and how blended finance approaches can be used to attract additional commercial capital to viable projects, allowing traditional development aid to refocus on projects that should not attempt to or cannot attract private capital.
Concessional capital in the form of technical assistance is key. Overall, a gradual move towards mobilizing more commercial finance requires improving the financial performance of service providers through a mix of (i) improved technical and commercial efficiencies and (ii) governance and regulatory reforms. Technical assistance funds alongside commercial investments can be critical for increasing commercial viability, including building the operational efficiency of service providers / project developers and supporting the broader enabling environment. Technical assistance should be linked more closely with investments in infrastructure to ensure that such infrastructure can be operated and maintained sustainably over time.
Good practices and lessons learned are still nascent. Our Data Brief on blended finance in the water and sanitation sector seeks to contribute towards developing a common understanding of good practice and lessons learned in order to distil clear guidance on how to tailor blended finance instruments and mechanisms to different contexts and for different types of water investments. More replication is needed given the wide variety of projects (i.e., from large-scale water and water treatment projects to small-scale off-grid projects) and the small sample size of blended finance projects to date.
By Justice Johnston, former Manager at Convergence