Annex IV.pdf

LOCAL GOVERNANCE

PROJECT IN TAJIKISTAN

PUBLIC PRIVATE PARTNERSHIP – DRINKING WATER DELIVERY

SECOND STTA - Report with recommendations on ways to engage private sector and plan to proceed in FY17

NOVEMBER 2016

DRAFT

USAID LOCAL

GOVERNANCE PROJECT

IN TAJIKISTAN

Public Private Partnership – Drinking Water Delivery

Contract No. AID-176-C-12-00002-00

This document was prepared for the United States Agency for International Development Tajikistan (USAID) by Deloitte Consulting LLP on Contract No. AID-176-C-12-00002-00.

The contents are not the responsibility of USAID, and do not necessarily reflect the views of the United States Government.

Table of Contents

1. Executive Summary

2. STTA on Private Sector Participation to Water Service Delivery in Tajikistan Overview

3. Report Objectives ...................................................................................................... ii

4. Options for PPPs in Tajikistan ................................................................................... ii

5. Potential PPP Structures ......................................................................................... xii

6. Important Considerations for all Options .................................................................. vii

7. Financing Options ................................................................................................... viii

8. Implementation Challenge / Risks ............................................................................. ix

1. Executive Summary

During two field visits to Tajikistan for the water delivery pilot public private partnership (PPP), the short term technical advisor, in coordination with the local team, interviewed central and district government officials, entrepreneurs, and other water sector stakeholders. The purpose of these interviews was to understand the general legal requirements and procedural steps to implement a PPP in Tajikistan, as well as the feasibility of implementing a pilot drinking water PPP during LGP’s final project year.

Based on this analysis, the team identified potential pilot sites in Isfisor, Gafurov district. This report outlines the options for a PPP drinking water pilot in Tajikistan and the recommended path forward given the legal requirements in the country. We provide options for moving forward as well as recommendations for supplemental activities to support private sector investment in the drinking water sector in Tajikistan. Main options and decision points are below.

• Determine if PPP law or Lease law should be used to implement the pilot project in Isfisor.

• Select the village within Isfisor for the Pilot – earlier we believed that we had selected the specific village for the pilot site within Isfisor. However, the community does not want to use water meters and already has higher drinking water access rates, so we will be exploring other villages surveyed in Isfisor to select the pilot.

• Potentially extend the private sector engagement beyond the pilot site to support PPP education with government and private sector stakeholders.

Additionally, there is an opportunity to move forward with the PPP pilot in Isfisor under provisions of the Lease law directly with an already identified entrepreneur using some form of competitive tender. Under Tajik Lease law it is not required to conduct a competition for selection, while under the PPP Law it is. USAID policies on private sector participation and leading practice in PPP adoption recommend competition to support lower prices and better services. However, since it is not required under the Lease law and an entrepreneur is already identified, we seek USAID’s guidance on the need to implement a competitive tender for the pilot PPP.

Using the Lease law provisions for effectively outsourcing the delivery of water in a specific location would not follow the more extensive, and untested, procedures outlined in the separate PPP law. However, such an option would fit the small scale of the water project in question, as well as, the time available under LGP for completing the pilot implementation of the PPP. The LGP team has already begun to move this forward following the work plan to get the water system up and running with active customers before September 2017.

In addition to conducting the pilot, to support the operationalization of the PPP Law, we recommend holding a workshop with interested District Chairmen and private sector stakeholders in coordination with the PPP Center to review the required procedures and share insights into how using the PPP law, as well as the Lease law, can improve local service delivery.

2. STTA on Private Sector Participation to Water Service Delivery in Tajikistan Overview

Background

The Government of Tajikistan has recognized that improving Tajikistan’s water infrastructure, and achieving effective management and financial sustainability of water utilities can be facilitated by private sector investment. The Parliament of Tajikistan adopted a law on Public Private Partnerships (PPP) on December 13, 2012. When implemented, a PPP can be an effective tool for attracting private investment in the water sector. Currently, USAID supports the creation of a favorable environment for drinking water service delivery and improvement of water infrastructure at the local level through the attraction of credit/loans of banks and microfinance organizations, and reconstruction and extension of water supply systems. As such, USAID asked LGP to undertake the following tasks:

1. Identify a pilot site for a water infrastructure PPP

This is based on an analysis of key conditions that need to be met. (See the Pilot Selection Report Deliverable for more details on this analysis)

2. Help the identified entrepreneur/community group develop a business case After investigating the process for conducting a PPP in Tajikistan, this will be technical assistance that is provided to the district government that is the owner of the water system.

While the project information will be shared with the private sector through the process, LGP support will be focused on supporting the District government to meet its obligations under a PPP structure

3. Assist the District to apply to Antimonopoly Commission for an exemption This is a step that comes later in the process for establishing the PPP under all the options that we have laid out below. This will occur after the contract for the project is in place between the private sector and the district government and will be the responsibility of the operator (i.e. the private sector) to request Tariff Approval and/or exemption

4. Identify the procedure of the State Committee for Investment applicable to this particular project.

The procedure for implementing a water project under the PPP Law is outlined in the Options section of the report below.

5. Draw up necessary agreements / MOUs between parties Under the Lease law, signing MOUs may not be a requirement. However, there may be a benefit to putting one in place to establish the relationship between USAID and Garfurov District for the pilot project. Other agreements between the private sector partner and the District government will also need to be developed including the specific contract.

3. Report Objectives

The purpose of this report is to outline the options for a pilot PPP for drinking water in Tajikistan and recommend a path forward given the legal requirements in the country. In addition, the report presents leading practices in implementing drinking water PPPs and factors to be considered. It builds on the information provided to USAID during the outbriefing presentation on October 13, 2016, as well as, the report on Pilot Selection.

4. Options for PPPs in Tajikistan

According to an analysis conducted on possible sites for the PPP pilot, the team identified an opportunity in Isfisor, Gafurov district. To move forward with a pilot project in this Jamoat, there are a number of factors that must be considered. Below is a summary of the options for USAID to consider, keeping in mind the impending conclusion of LGP in September 2017, as well as actions to support private sector participation of public service delivery in Tajikistan in general.

A. Isfisor Pilot

1. Using the PPP Law

In Tajikistan, the PPP Law requires a specific process and approvals must be provided by the PPP Center and District Council. The full timeline and steps for this process are in the graphic in Appendix I. The minimum timeline is estimated to be 4 months to use the PPP Law process. However, thus far PPPs in Tajikistan that have resulted from this process have taken approximately 3 years.1

2. Using the Lease Law The Lease law in Tajikistan governs the leasing of state property to the private sector. This pilot would not be the first time that the District administration has used the Lease law to transfer public services and facilities to private companies. There have been previous instances in the health and irrigation sectors of using the Lease law to legally establish a PPP. In such cases, relevant departments of the District administration and its lawyers examine the documents and structure and pass to the District Chairman for approval. It is not clear how long it will take to implement the PPP under the Lease law, but it is estimated to be quicker than the alternative option of using the PPP Law procedures. It should be noted that when presented these two options, the Garfurov District Chairman supported using the Lease law.

Pros and Cons

Our current expectation is that the Lease law could be used to implement the pilot project;

however, further research by a lawyer may be needed. The below analysis compares the two options.

Options Pros Cons / Risks PPP Law • Provides example of how to implement PPP using the PPP Center process

• Supports capacity building of the PPP Center

• Entrepreneur provided stronger legal protection

• Time: 4 months minimum and could be up to 2 years

• High level government approvals required

• Uncertainty around the priority the pilot would receive from the PPP Center given its relative small size

Lease Law • Faster process

• Authority localized at district level

• District government has experience using the Lease Law

• Not an example of using the PPP Center

• Unclear how USAID could provide grant funding to the project through this structure

• Uncertainty around lease payment

• Uncertainty around lease legal protection when district government

1 This estimate is according to informal discussions with the PPP Center. We do not have a formal record of the timelines for the two PPPs: 1) Kindergarten in Dushanbe and 2) Transmission Line to Special Economic Zone changes. However, it has seemed to work in other service delivery

Steps to Move forward

The team has put together a detailed work plan to move the pilot project forward with either the procedure outlined in the PPP or Lease law. Below are some of the high level steps to be followed.

• Sign MOU with Garfurov district2

• Select site for the implementation of the project through competitive procurement to

Isfisor Mahalla Committees

• Develop the design and cost estimation documents. This includes:

a. Technical pre-feasibility study, and

b. Project proposal

• Entrepreneur formally applies to the District Chairman

• District Chairman adopts a relevant, formal decision

• Develop a business plan

• Sign Lease

• Construct water system

• Finalize lease contract

B. Expand Pilot Site Options

1. Investigate private sector contribution to Khisterorz LLC project

Khisterorz is one private entity currently delivering water as a private company in Tajikistan.

We did not conduct a survey of Khisterorz, but the LLC is mentioned in the pilot selection deliverable. The Khisterorz LLC does not currently realize a profit or operate like a for-profit corporation. Further investigation could be conducted to see if there is a potential to work with Khisterorz LLC in some capacity.

LLC does not currently have the financial resources to invest in drinking water infrastructure.

When asked if they could obtain a loan to expand the system, the Chairman indicated that they would not be able to meet the loan repayment terms given the low collection rates.

In addition, there is a need to understand the LLC contract with the government and asset rights. The ADB originally transferred the water system, but we were not able to obtain a copy of the contract.

Nonetheless, there are opportunities to work with the LLC. USAID could provide technical assistance to Khisterorz LLC to:

• Improve collections. Currently 20% of the population don’t pay for drinking water.

They have standing pipes every 50m and citizens claim that they do not use the water and then do not pay. If the system had in house water meters, the Chairman

2 This may no longer be required if using the lease law according to the District Chairman, however, USAID may want to put one in place. The Government of Tajikistan requires that all work with donors have clear documentation. And the district may be asked (though unlikely) for an MOU by the Oblast as well as Ministry of Security, Anti-Corruption Committee and if it concerns money, the Ministry of Finance. The MOU will lay out the requirements of both parties towards the pilot project including contributions.

believes citizens would pay. Adding meters is not an easy fix however, because the whole system was built for street pipes and does not have the pipe width for in-house installation. There is also a large population of people that do not pay because they are “privileged” people.

• Increase the tariff. Currently it is only 0.75 TJS/m3.

• Improve organizational operations to be run more like a for-profit business.

• Support private lending. Bring in MFIs or other lending institutions to support private customer lending to install in-house connections from the street pumps.

o More details on the populations income levels and willingness to take out loans would need to be investigated further o Given the technical specifications of the system, we are not sure that in-house connections are feasible. At best, if possible, the service would probably not improve.

Such support would be a considerable commitment of LGP resources, likely requiring a number of months of effort, including on-the-ground community outreach in support of the LLC.

2. Look into other sites for the PPP

From our surveys, we identified other areas that could be investigated further for the pilot site. These areas have: 1) Mahalla committee support, 2) District government support, and/or 3) Customer willingness to pay for drinking water. However, most of them did not identify private sector partners willing to be involved.

While we do not recommend expanding the scope for the pilot site due to the financial constraints of LGP and the amount of work to define the infrastructure projects in any of these new areas, there are potential ways for USAID to support private sector participation in these areas.

USAID/LGP could work with the district governments to:

• Build drinking water system upgrade project proposals / business plans

• Walk district governments through the tender process

• Share leading practices in tendering, criteria selection, oversight of the private sector on projects, etc.

Equipped with this information, the district governments could lead their own process to design projects and guide them through the PPP Center or Lease Law process.

3. Send out RFIs to find other PPPs beyond those surveyed Sending out an RFI into the districts in Tajikistan where there is district government support for PPPs is possible (Yovon, Rudaki, Khatlon). This should be kept broad and discuss the potential for future support or investment in water projects. Another option is to use an RFI to survey how the private sector would want to get involved in the water sector in Tajikistan. While this is something that could be done, it would depend on the typical responsiveness in Tajikistan to RFIs. It may make more sense to convene these stakeholders and seek their feedback in a roundtable discussion format, rather than obtaining input through a formal RFI.

C. Other Events to Engage Private Sector and Expand Support for PPPs

1. Round table or forum to discuss potential avenues for PPP in Tajikistan water sector Whether or not the Isfisor pilot site moves forward, there is an opportunity for USAID to share the lessons learned on PPPs in Tajikistan with drinking water stakeholders. A round table or discussion forum to bring together district governments and private sector could help to spur interest in using PPPs for drinking water delivery. At this event the below information and participants could be considered:

• PPP Center discusses PPP Law and process for PPP according to their methodology (from project inception to getting antimonopoly approval and maintaining antimonopoly approval each year)

• Lease law process and methodology for use

• Discuss water PPPs in other countries specifically highlighting the commonalities to the possible systems in Tajikistan

• Share with the private sector the need and desire for water projects to be executed with private sector involvement

• Discuss the potential PPP structures as outlined in the PPP law and how the Lease law fits into that

• Discuss the financial structures and the limitations and approximately the scale of investment that most of these projects would take from the private sector

2. Develop templates and process manuals for District Governments on the PPP process Executing the Isfisor PPP through the PPP Center or the Lease law provides opportunity to document that process and create a manual and template documents for executing future PPPs in Tajikistan. Process documents and a Road Map could be shared with other District governments. Training could accompany such manuals and templates so that the work completed in one district could be scaled to have a greater impact across the country.

Recommended Structure

Based on the asset ownership allowed under Tajik law, as well as the need for capital investment in the asset, a hybrid of the lease and concession structure is preferable. The main components of the agreement will be a lease with a structure that allows for the private sector to provide capital for asset refurbishment which is more similar to a concession structure. In addition, the specific terms of the contract and recommended time will need to be based on the calculations for the project cost.

Currently, we are recommending a pilot site in Garfurov district, Isfisor, Olimjon Yoqubov Street.

More detailed technical details will be provided in future deliverables, but at a high level the project will include:

- Refurbishing one well that is owned by the district government

- Relaying new pipe to the households

- Currently, they do not have access to consistent water

- Installing water meters

Below is a draft graphic of the lease/concession structure of the Isfisor water project to demonstrate the role that the each of the key stakeholders will play in the project.

• The water system is owned by the District government

• The private sector (the concessionaire) is conditionally granted asset ownership rights over existing and created assets for the term of the agreement and is responsible for providing, procuring and managing investment funds

• The private sector contributes 50% to the refurbishment of the system

• LGP as an implementing partner contributes 50% of the cost of the refurbishment through in kind contributions to the water project as advisors and support to the government

• If required, the local government can provide in kind donations if required to finance the project. However, ideally this is not required to separate the private sector operator and customer roles.

Figure 2. Draft Pilot Structure

5. Important Considerations for all Options

Follow the laws and legal business structures in Tajikistan. While there is potential to encourage private sector engagement in Tajikistan in the water sector, the laws and legal structures for companies and investment in public infrastructure must be followed. The country has limited experience with PPPs and thus the definition around how the country will operationalize the law may continue to change. Our recommendation is based on our understanding of the current PPP operations guidance.

Competitive procurement. Given USAID priorities and the opportunity for capacity building with local governments, competitive procurement should be conducted no matter which pilot site is selected. Our understanding is that the district governments (using the example of Garfurov district) have experience at soliciting bids for goods and services. Sharing these and other leading practices on tender documents and processes may be desirable. If for some reason competitive procurement is not required for implementation, USAID should work carefully to support competitive procurement as best it can and encourage the district government to seek competition wherever possible.

PPP contract should include performance standard requirements. Operational efficiency is perhaps the greatest advantage of PPPs for utility performance, resulting in the reduction of nonrevenue water delivery, improvement in bill collection, and better labor productivity.3 Given this fact, the contract with the private sector should lay out minimum performance requirements and associated penalties for not meeting these standards. Examples of performance standards might include number of households served, % of service disruptions, and water quality, among others.

Tariffs must be approved by the Antimonopoly Commission. After the tender is completed and the private partner is selected, the private sector partner, as the operator of the water system, will need to submit a formal application to the Antimonopoly Commission to receive approval to collect the rates. This will be based on a standard formula for the costs that can be charged. More details on the tariff to be charged for the drinking water pilot will be provided in future deliverables and is based on using the standard formula and the cost data collected in the technical prefeasibility study.

6. Financing Options

Currently, the options for financing the PPP pilot in Tajikistan are limited for the reasons below:

• Limited long term loans and high interest rates. Currently, typical loans are for three years with a minimum interest rate of 18%.4

• According to the Microfinance Association, government banks tend to have lower rates, but access is limited. Other interest rates in Tajikistan can be as high as 30-46% given the crisis in Russia.

• Collateral requirements that do not align with the government ownership structure. This limits the ability of an entrepreneur to take out a loan based on the collateral of the water system. The country requires 130% collateral for a loan. Collateral is usually vehicles, jewelry, other money; houses are hard to take in Tajikistan and banks do not like to use them as collateral. In addition, land cannot be used as collateral in Tajikistan because individuals do not own it o In the past different banks have worked with international donors to reduce this collateral requirement with guarantee facilities. For example there was a partnership by GIZ that reduced collateral requirement to 50% and the guarantee covered the other 80%.

• Utility based lending where a loan is provided based on the future cash flows of the water system does not exist in Tajikistan because of collateral requirements. There are some limited examples in the microfinance space, but those are for extremely small loans and even then collateral values are listed to houses and other property.

• Microfinance institutions tend to lend between $500 and $10,000 and are allowed to lend under law up to $50,000 but this is rare. Each financial institution sets up its own requirements and preferences for lending except that collateral requirements at 130% are a national requirement.

• Commercial banks can loan up to $200,000 without being approved by the board, but anything larger than that has to be approved by the board of directors of the bank

3 World Bank, African Water PPPs 4 Khomiljon, an entrepreneur in Isfisor, has access to other assets and cash flow to be able to get a loan from Astrada bank. This would be an eighteen percent, three year loan for up to $50,000. This loan is not based on the collateral of the drinking water system or the tariff cash flow, but other businesses or collateral that the entrepreneur has.

• Loans tend to be provided in USD and are cheaper when provided in USD. This could potentially become a challenge for the private sector that will be collecting tariffs in TJS and will have to also work to convert the money into USD to pay back the loans.

More detailed analysis on other financing options and alternative structures will be provided in future deliverables including discussion of the role that guarantees could play in this sector. For long term transformation of the private sector’s involvement in drinking water delivery, it will be important to work on addressing some of these financing constraints for transformational change to occur. Currently, the only private sector entities that can be targeted to be involved in a PPP are those that have collateral from other businesses or operations which is not a sustainable private sector financing strategy. This type of lending environment will tend to attract entities that have limited experience in delivering drinking water which may present technical skill limitations and make it more difficult to improve service delivery through private sector involvement.

7. Implementation Challenge / Risks

Given this is one of the first PPPs to be implemented in Tajikistan, there are a number of challenges or risks that will need to be tracked and mitigated moving forward.

• Need to follow Tajik law for implementation. As discussed above, there are two potential laws that we have identified could be used, but since few PPPs have been implemented, there is some unpredictability to how these laws will be operationalized.

• USAID may be required to sign an MOU with a district government to move forward with the pilot. This may delay the timeline for completion if there are items or terms that need to be agreed to.

• Need to quantify project impact o The strong government support, interested entrepreneur, and technical system in Isfisor make it a strong candidate for the pilot, however, the area is not one of the poorest areas, nor particularly remote. As a result, it will be important for USAID and the team to measure the impact of the project, the improved service and justify inviting the private sector into drinking water delivery

• If the project will be tendered out to multiple private sector entities, USAID and LGP need to be careful not to provide direct support to one candidate over others

• Other implementation risks will be laid out in the business plan, and include, but are not limited to:

o Government does not meet its contract requirements and takes back the property after a few years o Communities do not pay for water undermining private sector ability to maintain the system o Project does not meet service and water quality requirements discrediting private sector participation

Appendix A

Appendix B

The PPP implementation methodology lists a number of different PPP structures that can be used in Tajikistan. However, it does not lay out differentiated processes for using different structures. In addition, ‘Others’ is listed which may provide for the opportunity to

The list includes:

• Build, Operate, Transfer (BOT)

• Build, Rent, Transfer (BRT)

• Build, Use, Transfer (BUT)

• Build, Operate, Use (BOU)

• Build, Operate, Use, Transfer (BOUT)

• Build, Transfer, Use (BTU)

• Agreement on enhancement and use of the facility

• Rehabilitation, operate, and transfer (#8 ROT)

• This definition most closely matches the concession definition and would be ideally implemented to avoid the rent payment. However, as noted earlier in the report, the process to implement such a structure may take considerably longer

• Rehabilitation, rent, and transfer (#9 RAP)

• This is the structure that is similar to the leases that are provided for other industries such as land in Tajikistan.

• The rent payment amount will need to be determined and contractually set. This is important for the private sector to feel comfortable that it will not be changed during government turn over

• Provision of social services

• Others

Appendix C

Potential PPP Structures

Rationale for a Public Private Partnership In considering private sector participation in the management and refurbishment of the water systems in Tajikistan, the asset ownership will reside with the district government based on the requirements of the Laws in Tajikistan (PPP and Lease Laws). Lack of asset ownership is not normally a barrier to private sector participation in utility concessions in developing countries.

If asset ownership is therefore to remain with the GoT, operational control of the assets for the purpose of providing drinking water services will be given to the private sector where they will have responsibility for operations, establishing a cost recovery tariff, and payment collections.

While there are a number of different drinking water delivery systems spanning the full spectrum of public and private participation, this report is focused on the options for private sector models.

In this report and through the course of the LGP team’s work, we assume USAID wants to implement a drinking water PPP in Tajikistan to:

1) Attract capital/financial resources to refurbish already existing drinking water infrastructure. The district governments in Tajikistan own drinking water systems that are old and need to be refurbished. The government does not have the capital to refurbish the drinking water systems, and are seeking private sector involvement to refurbish / upgrade the current infrastructure.

2) Service delivery improvements. While some of the service delivery improvements will come from refurbished systems, the government is also looking to have the private sector improve operations beyond equipment maintenance.

A recent study (2009) conducted by the Public Private Infrastructure Advisory Facility (PPIAF) of the World Bank5 examined the question “Does Private Sector Participation Improve Performance in Electricity and Water Distribution?” The study examined the operating performance of 301 utilities with PSP and 926 State Owned Enterprises (SOEs) in 71 developing and transition economies primarily during the period 1992 to 2004. The study found that private sector participation in water utilities had the following outcomes when compared to SOE performance:

• 12% increase in residential connections for water utilities

• 54 % increase in residential connections per worker for water utilities

• 18% increase in water sold per worker (following the introduction of concession contracts)

• 41 percent increase in the number of hours of daily water service

There is a strong argument for involving the private sector in the drinking water system to attract capital and improve service.

5 Katharina Gassner, Alexander Popov, Nataliya Pushak

PPP Structures The LGP team reviewed the full spectrum of PPP structures to determine which options are legal, feasible and best aligned with drinking water delivery in Tajikistan. Looking at the available options for PPP structure, the district government, with USAID’s assistance, can look at a number of potential structures for Private Sector Participation (PSP) in the delivery of water services. Each option allocates risk differently between the private operator and the grantor.

Following industry leading practices, USAID should select the model that allocates risk to the party best able to manage or bear the risk.

Figure 1. PPP Structures

Technical Assistance The private sector is engaged to provide consulting services for a fee normally on a short term basis. In the longer term it may include embedding experts within the organization to act as advisors to improve operational efficiency through technical and managerial capacity building.

The contractor only assumes the risks inherent in a professional services contract although there may also be some incentives, or variable fees and penalties tied to performance indicators. These longer term contracts represent a limited engagement usually not exceeding a period of two to three years and generally utilized as a first attempt to build capacity in underperforming government owned enterprises.

Service Contract This type of contract is used for outsourcing specific operational areas such the commercial activities of billing, metering and collections or technical management such as generation operation and maintenance. The contractor’s remuneration may take different forms but is usually tied to performance and a combination of fixed and variable fees. The contractor only assumes risks within its control and penalties may apply for underperformance against agreed targets.

Management Contract In this case the contractor assumes responsibility for management of the utility, normally by placing its own employees in key positions within the organization and providing additional short term technical, administrative and training services. The contract will normally be performance based with fixed and variable fees and often penalties for under performance against targets.

The contractor’s risk exposure is restricted to matters within its control and measured against agreed targets. All assets remain the property of the grantor and the contractor is not required to take any investment risk. This type of contract is often used to improve the operational performance of the utility in advance of follow-on private sector involvement through affermage, concession or divestiture arrangements. The engagement is usually limited to a period of 3 to 5 years depending on the level of managerial competence in the utility and the objectives of the contract. This model has the main advantage of allocating the risk of operations, revenue, and collection to local private companies, while keeping the costs of service affordable with public funding for capital development.

This model has been used in many small town or rural piped water systems.6 However, management contracts use public funding for capital development. While the district governments may make financial contributions to the pilot project, the purpose of attracting capital for refurbishments do not exist in this model.

Lease / Affermage The contractor in this case takes over operational responsibility but the assets remain the property of the state. The state through a holding company may be paid a lease fee or affermage fee equivalent to a reasonable rate of return on the assets in order to allow it to reinvest in capital replacements or expansion activities. The contractor is not required to invest and receives its remuneration through improvements in operating efficiency in various areas such as billing, metering, collections, fuel efficiency, loss reduction and productivity. In cases where cash flow improvements are insufficient to pay the contractor due to inadequate cost recovery tariffs, the state will have to fill the tariff gap and/or defer lease fees. While there are many opportunities to quickly improve operating performance through the introduction of new processes, procedures and technology the pace of improvement is tied to the public entity’s ability to provide capital for investment in the longer term. Performance targets generally related to service quality standards will also form part of the arrangement. These contracts would normally run for a period of 8 to 15 years.

Lease contracts and affermage contracts share similarities but also maintain distinct differences.

Both can be used in cases where the public entity wants to engage the private sector by passing on commercial risk and performance incentives without requiring private capital. When procured competitively, both are often tendered on the basis of highest payment to the government (either in form of highest lease payment or lowest percentage of revenue retained).

The public entity remains responsible for investment in assets. In addition to performing operations and maintenance, the operator may be expected to oversee the capital investment program. Often, these contracts also include minimum replacement provisions toward the end of the contract. Both structures assume a greater amount of regulatory and revenue risk, as they are dependent on tariff levels to recover operational costs.

In a lease contract, the operator pays the public entity a fixed rental payment (lease fee) for the asset and assumes greater collection risk but keeps the excess revenue generated. In the case of affermage, the operator retains a portion of revenue generated and then pays the remainder to the public entity. Thus, as long as collections cover the fee, the operator’s revenue is secure and the public entity takes on a larger portion of the revenue risk. The operator pays the public entity the remainder of the revenue, which the public entity uses to pay expenses, sometimes

6 World Bank, African Water PPPs with a provisional portion of the remaining revenue contractually obligated towards additional investment.

Depending on the full legal analysis to determine what is legally possible in Tajikistan, it appears that a lease structure may the preferable option to move the PPP forward. We did not see any mention or past examples of affermage structures in Tajikistan and it is not listed as one of the PPP structures in the PPP law.

Concession In this case the concessionaire is conditionally granted asset ownership rights over existing and created assets for the term of the agreement and is responsible for providing, procuring and managing investment funds. Similar to a lease arrangement, the concessionaire’s remuneration is derived from improvements in operating efficiency in various areas such as billing, metering, collections, water sourcing efficiency, loss reduction and productivity. In cases where cash flow improvements are insufficient to pay the concessionaire a reasonable return on investment due to inadequate cost recovery tariffs, the state will have to fill the tariff gap through subsidization.

For the Tajikistan water project, the goal is to create a structure where this is not recovered and the tariff is cost reflective with an appropriate profitability built in. Normally investments are carried out according to schedules agreed in the concession agreement. In the case of the pilot water project, the refurbishment would occur at the beginning and scheduled upgrades would be at the discretion of the private sector. However, there would be performance requirements outlined in the contract that the private sector would need to meet.

Divestiture Partial or complete sale of the assets to the private sector or an autonomous electricity cooperative is precluded by the Tajikistan PPP law, which does not permit the transfer of ownership of state owned essential services infrastructure assets.

Build Operate Transfer (BOT) BOT and its variations (BOOT, BOO, BTO, etc) are PSP opportunities normally applicable to the creation of new assets in which the private sector finances, builds, operates and transfers the asset to the government after a contract term that allows for the agreed return on investment to be achieved. Normally the private sector’s risks are restricted to financing, construction, operations and payment risks. The operator will not assume market risks. The two PPPs to date in Tajikistan have been BOT contract structures and were for larger scale projects (Dushanbe kindergarten and transmission line for special economic zone). Thus the procedures in the country have been designed to accommodate significantly larger projects.

More details on how these structures fit into the list provided in the Tajikistan PPP Law implementation methodology can be found in Appendix B.

PSP Selection Given the legal structure, ownership rights and size of the project, the type of PSP for this pilot project will probably be decided between two structures: a lease arrangement or concession or a hybrid of either/both, for the reasons discussed below.

A management contract is designed for a short period to affect a turnaround of financial, technical and service quality performance of a utility before handing back to the state, or to prepare the utility for longer term private sector participation such as lease/affermage, concession or divestiture.

A BOT or similar arrangement is best utilized where the central purpose is to facilitate private sector investment and financing of a new asset or a relatively large investment in the rehabilitation of existing assets. In the Tajikistan drinking water case, the investment will come from USAID grant funding and the private sector. The small size of the pilot project makes it a poor fit for a BOT or similar arrangement.

The table below highlights the key characteristics and differences between Lease contracts and Concessions. The differences are not that significant and there is potential latitude to create a hybrid arrangement that best fits the situation of the PPP pilot.

Lease Contracts Concession

Description The public party delegates service provision to operator

The public party delegates service provision to operator who assumes ownership rights.

Scope of Operator

Operate and maintain the system (limited repair and renewal, takes operating and market risks.)

Operator agrees to operate, maintain and build/expand/rehabilitate the system

Ownership Public party Usually the public party, but with a buy back at end of the concession for assets on which the operator has not realized the full return.

Fee

Revenues used to pay Public Party Contractor retains % of revenue, public party splits remainder between fee and CAPEX requirements

No Fees. Operator receives a set return on investment and takes the operating risks but not market risks.

Revenue Source Tariffs Tariffs or public budget or a combination where subsidies are required.

Revenue Risk Operator Operator

Duration Medium to Long Term (10 – 15 Years) Long Term (20- 30 Years)

Investment Obligations Public party, which may include donors.

Operator often has significant investment obligations on a set schedule. Public and donors may also invest.

Bidding Parameter

Highest level of payment to public party:

Highest lease fee

Lowest tariff structure and investment schedule

Key Issues

Information asymmetry between bidders and public party on asset conditions.

Risk allocation for repairs and renewals.

Contractors depend on progress towards cost reflective tariffs to sustain program

Extensive operating, investment, and political/regulatory risks for operator