89153 Water Papers Water Papers April 2014 STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO From a Conceptual Framework to the Formulation of Pilot Initiatives Alessandra Campanaro and Diego J. Rodriguez Water Papers are published by the Water Unit, Transport, Water and ICT Department, Sustainable Development Vice Presidency. Water Papers are available online at www.worldbank.org/water. Comments should be e-mailed to the authors. Acknowledgements This project has been developed with the financial support of the Fondo Español para América Latina y el Caribe (SFLAC) and Water Partnership Progam (WPP), in cooperation with CONAGUA. Its content was developed during a technical assistance proj- ect for CONAGUA, which generated a dialogue over the course of two years of work. A number of workshops and seminars were held in 2011 and 2012 to discuss the different parts of this project and to further debate on the issue in Mexico. This report was prepared with the participation of Enrique Aguilar Amilpa (Consultant), Eduardo García-López Loaeza (Consultant), and Pilar Arronte (Consultant), under the supervision and guidance of Alessandra Campanaro (Senior Infrastructure Finance Specialist) and Diego Juan Rodríguez (Senior Economist) from the World Bank. Monica McDonough (Urban Analyst) and Alex Serrano (Environmental Analyst) from the World Bank supported the efforts to consolidate this version and incorporated comments from the client. Comments were also received from Javier Zuleta (Water Resources Management Senior Specialist), Cecilia Briceño Garmendia (Lead Economist), and Luis Ernesto Garcia (Senior Hydrology Specialist). Contact Information   This paper is available online at http://www.worldbank.org/water. Authors may also be contacted  through the Water Help Desk at whelpdesk@worldbank.org.    Disclaimer – World Bank  © 2014 The World Bank  1818 H Street NW  Washington DC 20433  Telephone: 202‐473‐1000  Internet: www.worldbank.org                                This work is a product of The World Bank with external contributions. The findings, interpretations, and  conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of  Executive Directors or the governments they represent.    The World Bank does not guarantee the accuracy of the data included in this work. The boundaries,  colors, denominations, and other information shown on any map in this work do not imply any  judgment on the part of The World Bank concerning the legal status of any territory or the endorsement  or acceptance of such boundaries.      Rights and Permissions  The material in this work is subject to copyright. Because The World Bank encourages dissemination of  its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as  full attribution to this work is given.  Any queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the  Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202‐522‐2422; e‐mail:  pubrights@worldbank.org. Table of Contents Acronyms and Abbreviations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiii Part 1: Background and Concepts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1.  Starting Point . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 1.1  Legal Foundations of the SFA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 1.2  Towards a Definition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 2.  Conceptualization of The SFA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 2.1. SFA Components . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 2.2. Projects and Programs Portfolio of the Water Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 2.3. Management, Performance, and Results Indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 2.4. Mechanisms to Guarantee the SFA’s Sustainability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 3.  Towards the Formalization of the SFA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 3.1. The SFA and CONAGUA’s Scope of Competence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 3.2. Formalization of the SFA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Part 2: Sectoral Initiatives Under The SFA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 4.  Hydro-Agricultural Sector Initiatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 4.1. Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 4.2 Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 4.3 Initiative 1: The Water Fund . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 4.4. Initiative 2: The PPP scheme . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 5.  Disaster Risk Management Initiatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 5.1. Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 5.2. Initiative 1: The Contingent Line for Priority Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 5.3. Initiative 2: The Climate Change Investment Fund . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 6.  Water Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 6.1. The Water Rights Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 6.2. Water Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: iv FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES 6.3. Directing the Income Generated by Water Use Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 6.4. Legal Reform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 7.  Water Supply and Sanitation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53 7.1. Program for Reimbursing Water Levies (PRODDER) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 7.2. Bulk Water . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 7.3. Water Supply and Sanitation Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 8.  Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 Figures Figure 1.  General SFA Scheme . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Figure 2.  SFA Conceptualization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Figure 3.  Finances of a Service Provider . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Figure 4.  Management Approach for the Ojo Caliente aquifer, Aguascalientes . . . . . . . . . . . . . . . . . . 18 Figure 5.  SFA and the Planning Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Figure 6.  National Water Planning System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Figure 7.  Diagram of the Water Fund Mechanism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Figure 8.  Volume of Transfer Applications and Demand for Water Rights . . . . . . . . . . . . . . . . . . . . . . 46 Figure 9.  Water Bonds According to Freig (2011) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49 Figure 10.  Composition of Levies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 Figure 11.  Financing Policy in Water and Sanitation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56 Tables Table 1.  Current Financing Mechanisms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Table 2.  Pros and Cons of the Water Fund . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Table 3.  Pros and Cons of the PPP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 Table 4.  Victims and Damages due to Disasters in Mexico (1980–99) . . . . . . . . . . . . . . . . . . . . . . . . . 39 Table 5.  Pros and cons of the Contingent Line for Priority Investments . . . . . . . . . . . . . . . . . . . . . . . 42 Table 6.  Pros and Cons of the Climate Change Investment Fund . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 Table 7.  Change in the Use of National Waters in 2008 (in Cubic Meters) . . . . . . . . . . . . . . . . . . . . . . . 47 Table 8.  Collection by Type of Use (in 2007 Millions of Pesos) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 Table 9.  Financial Challenges in Water and Sanitation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 Boxes Box 1.  Tariffs and Subsidies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 Acronyms and Abbreviations AFORE Administradora de Fondos para el Retiro APAZU Pension Funds Administration Programa de Agua Potable, Alcantarillado y Saneamiento en Zonas Urbanas Water Supply and Sanitation Program for Urban Areas Program APP Asociación Público Privada BOT Public-Private Partnership (PPP) Construir-Operar-Transferir Build-Operate-Transfer CENAPRED Centro Nacional de Prevención de Desastres CFE National Center for Disaster Prevention CONAGUA Comisión Federal de Electricidad Federal Electricity Commission Comisión Nacional del Agua National Water Commission COTAS Comité Técnico de Aguas Subterráneas Technical Committee for Groundwater CPPI Cartera de Programas y Proyectos de Inversión Investment Projects and Programs Portfolio FAIS Fondo de Aportaciones de Infraestructura Social Social Infrastructure Contribution Fund FFRES Fideicomiso Fondo Revolvente Sonora Sonora Revolving Trust Fund FINCA Fondo de Inversión y Contingencia FIRA Investment and Contingency Fund FMI Fideicomisos Instituidos en Relación con la Agricultura Agricultural Trust Funds Fondo Monetario Internacional International Monetary Fund (IMF) FONADIN Fondo Nacional de Inversión en Infraestructura National Fund for Infrastructure Investment FONAGA Fondo Nacional de Garantías de los Sectores Agropecuario, Forestal, Pesquero y Rural FONDEN National Guarantee Fund for the Agriculture, Forestry, Fishing, and Rural Sectors Fondo de Desastres Naturales National Disasters Fund STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: vi FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES FOPREDEN Fondo para la Prevención de Desastres Naturales Natural Disaster Prevention Fund GIRH Gestión Integrada de Recursos Hídricos Integrated Water Resources Management (IWRM) IMTA Instituto Mexicano de Tecnología del Agua LAN Mexican Institute for Water Technology Ley de Aguas Nacionales National Water Act LAPP Ley de Asociaciones Público Privadas LFD Public-Private Partnerships Act Ley Federal de Derechos Federal Levies Act MASAS Manejo Sustentable de Aguas Subterráneas Sustainable Management of Groundwater MDP Millones de Pesos O&M Millions of Pesos OBA Operación y Mantenimiento Operation and Maintenance Ayuda Basada en Resultados Results-Based Aid OCDE Organización para la Cooperación y el Desarrollo Económico Organisation for Economic Cooperation and Development (OECD) OO Organismos Operadores PADUA Water Utilities PAL Programa de Adecuación de Derechos de Uso de Agua Water Use Rights Adjustment Program Programa de Agua Limpia Clean Water Program PATME Programa de Asistencia Técnica para la Mejora de la Eficiencia del Sector de Agua Potable y Saneamiento Technical Assistance Program for the Improvement of Efficiency in the Water Supply and Sanitation Sector PEF Presupuesto de Egresos de la Federación Federal Expenditure Budget PIB Producto Interno Bruto PNH Gross Domestic Product PNI Programa Nacional Hídrico National Water Program Programa Nacional de Infraestructura National Infrastructure Program PREVDA Programa Regional para la Reducción de la Vulnerabilidad y Degradación Ambiental Regional Program for the Reduction of Vulnerability and Environmental Degradation PMTUR Programa de Modernización y Tecnificación de Unidades de Riego Program for Irrigation Unit Modernization and Technological Upgrading PRMDR Programa de Rehabilitación y Modernización de Distritos de Riego Irrigation Units Rehabilitation and Modernization Program Acronyms and Abbreviations   vii PRODDER Programa de Devolución de Derechos Program for the Reimbursement of Water Righs PRODEP Programa de Desarrollo Parcelario Parcel Development Program PROMAGUA Programa para la Modernización de Organismos Operadores de Agua PROME Program for the Modernization of Water Utilities Programa de Mejoramiento de Eficiencias de Organismos Operadores Water Utilities Efficiency Improvement Program PROSANEAR Programa Federal de Saneamiento de Aguas Residuales Federal Program for Wastewater Treatment PROSSAPYS Programa para la Construcción y Rehabilitación de Sistemas de Agua Potable y Saneamiento en Zonas Rurales Program for Construction and Rehabilitation of Water Supply and Sanitation Systems in Rural Areas PROTAR Programa de Tratamiento de Aguas Residuales Wastewater Treatment Program REPDA Registro Público de Derechos de Agua Public Registry of Water Rights SAGARPA Secretaría de Agricultura, Ganadería, Desarrollo Rural, Pesca y Alimentación SHCP Ministry of Agriculture, Livestock, Rural Development, Fishery, and Food Secretaría de Hacienda y Crédito Público Ministry of Finance and Public Credit SFA Sistema de Financiamiento del Agua Financial System for Water SMN Servicio Meteorológico Nacional National Meteorological Service SRL Sociedad de Responsabilidad Limitada TIT Limited Liability Company Tarifas, Impuestos y Transferencias Tariffs, Taxes, and Transfers (3Ts) Executive Summary T he main objective of this report is to contribute towards the formulation of a coordinated vision for Mexico’s Financial System for Water (Sistema de Financiamiento del Agua or SFA) by laying down definitions, a conceptual framework, and a set of concrete proposals and recommendations that will allow the SFA to operate effectively under the leadership of the National Water Com- mission (Comisión Nacional del Agua or CONAGUA) and with the support of the Ministry of Finance and Public Credit (Secretaría de Hacienda y Crédito Público or SHCP). The importance of addressing this issue from a medium- and long-term perspective stems from the need to understand the growing challenges faced by Mexico’s water sector as an engine of economic development and poverty alleviation. The water sector in Mexico faces many challenges and properly addressing them requires an analysis of the financing sources available for the sector and of their viability as a tool to reach the sector’s objectives. This analysis should be embedded in a model of integrated water management to ensure the rational use of water at local and regional levels. Against this backdrop, formalizing the SFA is seen as a means to integrated management of water resources rather than an end in itself. This report presents a proposal to formalize the concept of an SFA supported by the World Bank, providing CONAGUA with solid conceptual foundations, and offering suggestions to achieve the stra- tegic coordination of the flow of financial resources towards the water sector. The next step to this report would be to formalize the SFA, and then devise a financial strategy and implementation tools. The report examines the SFA through basic concepts and its current legal framework, and defines the SFA as follows: “A subsystem of the Mexican financial system composed of (public, private, and social) institutions that channel resources from different financing sources (public and private) to the various (public, private, and social) programs and investment projects aimed at the development and management of water resources and associated water systems; these financial resources are chan- neled through a range of instruments and mechanisms, in accordance with relevant legislation and regulations, and taking into account sustainability, economic efficiency, and equity criteria.” STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: x FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES Given the above definition, this report vided different sources of financing are tapped reviews the existing instruments and mecha- to reach the medium- and long-term objectives nisms that provide and could provide access of this sector. Given the variety and complexity of to various sources of financing. These include financial mechanisms for water, the formalization fiscal funds from the federal government and of the SFA is seen as an instrument of coordina- resources from state and municipal govern- tion and support that will increase the efficiency ments; federal contributions to state and munici- and effectiveness of the use of public resources; pal entities; special funds from federal programs it is also expected to increase the SFA’s multiplier (subsidies); revenues from tax collection; funds effect by leveraging other sources of financing. from FONDEN (the Fondo de Desastres Natura- This analysis elaborates on the elements les or Natural Disasters Fund) and FOPREDEN 1 that are necessary for the SFA’s formalization, (the Fondo para la Prevención de Desastres among others, the SFA and the responsibilities Naturales or Fund for the Prevention of Natural of CONAGUA; the portfolio of programs and Disasters); external credit; Public-Private Part- projects that is part of the national system for nerships (PPPs); funds from FAIS (the Fondo de 2 water planning; the role of CONAGUA in the Aportaciones de Infraestructura Social or Social operation of these financial mechanisms and Infrastructure Contribution Fund); from FFRES in the coordination with the competent authori- (the Fideicomiso Fondo Revolvente Sonora or ties (that is, the agricultural sector, institutions Sonora Revolving Trust Fund); and debt market responsible for urban development, and the funds (subnational bonds, regular bonds). It Federal Electricity Commission); the coordina- should be noted that an in-depth analysis of each tion with the SHCP; the catalogue of existing of these financial mechanisms lies outside the 3 and new financial mechanisms introduced by scope of the analyses undertaken; this report CONAGUA; the improvement of the existing therefore only discusses these mechanisms in operating rules; the strengthening of the project general terms and assesses their potential as an cycle; and the creation of indicators that will integral component of the SFA. allow for the monitoring and follow-up of the The transactions involving sources and SFA’s objectives. destinations of financial resources that are dis- The first part of this report focuses on cussed in this report relate mainly to programs processes and steps, such as the drafting of and projects aimed at increasing the supply of legal frameworks and establishment of work- water to meet the various end-user demands, ing groups that are required to implement the including those associated with preserving the SFA. The second part of the report, discusses quality of water and vital ecosystems. However, a number of initiatives on hydro-agricultural some transactions included in the SFA defini- infrastructure, disaster risk management, water tion—such as the implementation of economic incentives and initiatives to increase the effi- 1  For more information see http://www.proteccioncivil. ciency in the use of water are mechanisms to gob.mx/es/ProteccionCivil/Libro_FONDEN which is a FONDEN joint publication with the Ministry of Interior manage demand. (SEGOB) and the WB. The analysis of the water sector in Mexico 2  The widely used English acronym PPP rather than the Spanish acronym APP will be used throughout this sector shows that the financing needs of water report. programs and projects can in principle be met, 3  A financial mechanism, also known as a financing mechanism, is a method or source through which even when taking into account the additional funding is made available. Both terms will be used inter- challenges resulting from climate change, pro- changeably in this report. Executive Summary   xi and sanitation, and water rights. The issues of the SHCP. These schemes would ensure that the hydro-agricultural infrastructure and disaster project risks are duly distributed, risk mitigation risk management are highly relevant in the mechanisms exist, and that conditions facilitat- context of the proposal including in this report to ing the financing and implementation of projects create a special Water Fund. are promoted. Based on an analysis of the effectiveness In Mexico, disaster risk management is of the main existing financial instruments and increasingly demanding economic and technical market-support systems, a series of concrete resources. In 2010 alone, actions to mitigate the actions are proposed to support agricultural effects of the 40 main disasters, which affected producers. The proposals presented are moti- 18 states, accounted for nearly Mex$23 billion. vated by the results of the analyses conducted To meet this growing demand for resources, tools and the recognition that the agricultural sector must be available to respond efficiently to specific needs business models and long-term credits funding requests. For disaster risk management, that facilitate the effective financial participation the analysis suggests two possible instruments: of all parties involved, as well as interest rates (i) a contingent credit line for priority investments that are affordable for agricultural producers. and (ii) an investment component to specifically One potential action n is the creation of a special address climate change, to be created within the component within the Water Fund to provide Water Fund mentioned above. financial support to the agricultural sector; The contingent line for priority investments another option is the development of special would provide each state with a current account PPP schemes. The pros and cons of these two credit line, contracted with development banks. alternatives are reviewed in detail. Such a line of credit would enable the states to The creation of a component within the Water immediately meet their obligation vis-à-vis the Fund specifically dedicated to the modernization federal government to contribute counterpart and technological upgrading of irrigation sys- funds and cover the costs of operating the tems, along with other instruments and sources equipment to be provided by CONAGUA in case of public and private financing, would allow for of an emergency. It would also make it possible the structuring of different financing schemes for states to make the investments needed to involving recoverable funds (capital injections, respond to an emergency or mitigate the impact guarantees, and subordinated credits) as well of an imminent disaster. as non-recoverable funds (resources provided The component of the Water Fund ear- by the Water Fund). The second proposal envis- marked for investing in climate change and vari- ages the creation of PPPs for the upgrading of ability preparation—through measures aimed irrigation systems in the broader regulatory at prevention and long-term adaptation—would framework of the Public Private Partnerships Act comprise federal resources and a share of the (Ley de Asociaciones Público Privadas or LAPP), federal revenues that each state is entitled to. which came into force on January 18, 2012. In a This component would cover investments in PPP, a private investor assumes responsibility infrastructure, primarily to mitigate the impact for operating and maintaining a certain infra- of floods, and investments in climate change structure that meets pre-established quality adaptation projects in the context of disaster risk standards. In the case of irrigation systems, there management. is room for innovative PPP setups, to be devised The second part of the report assesses the in coordination with CONAGUA, SAGARPA, and financing options derived from the revenues STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: xii FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES generated by charging for the right to use water, incentives needed to progressively fine-tune the including the strengthening of the market for degree of cost recovery via tariffs and (ii) the water rights and the creation of so-called Water type and size of subsidies that will eventually Bonds. It is recommended that the Federal balance expenses and revenues. Levies Act (Ley Federal de Derechos or LFD) be The analysis of the existing SFA in Mexico reformed in order to guarantee the sustainability shows that major challenges remain. However, the of all activities related to water management and effective implementation of an SFA constitutes a facilitate the signing of agreements that would critical tool to ensure sustainable water manage- allow for the convergence of public and private ment and reduce the water demand-supply gaps financing schemes. In water and sanitation, a projected for the next 20 years. Mexico has to take priority for the medium and long term is how to concrete steps and set up pilot experiences to lay structure and implement a public policy of tariffs a sound foundation for an SFA that can respond and subsidies, including (i) the mechanisms and efficiently to the country’s needs. Introduction T he abundance of financial resources that characterized the second half of the 1970s and early 1980s, originating in the country’s rise as an oil power, and the relatively large supply of external credit, made it possible to sig- nificantly extend the country’s water infrastructure. Among other things, the total irrigated area was expanded and existing irrigation systems were rehabilitated; the development of the humid tropics was given a boost; and several bulk water sup- ply systems were built for urban centers and industrial ports. However, changes in the financial conditions, severely affected investments and operations and maintenance of water infrastructure. In the late 1980s, the overreliance on fiscal resources for the development of water programs further exacerbated its financial problems. Aside from funding provided by international development banks—by then already limited—no other funding sources were available. The sectors that benefited the most from the water works and associated services as well as the benefiting state and municipal governments were encouraged to shoulder a larger share of the burden, but with limited success. The declining revenue from service charges for water supply and sanitation services, the low service tariffs in relation to total costs (mainly covering the cost of operations and maintenance), and the cost of irrigation services in certain agricultural areas strained the federal government’s limited resources. In 1986, the LFD introduced a set of fiscal reforms that included charges for the exploitation, use, or usufruct4 of the nation´s water resources and their inherent public goods.5 However, the lack of clarity of the new regulations, along with the delay in updating the charges on water rights6, limited the financial resources collected in real terms. In 1990, the Contribution to Improvements in Public Water Infrastructure 4  Usufruct is the legal right to use and enjoy the fruits or profits of something belonging to another person or held in common ownership. 5  Article 27 of the Mexican Constitution states that all surface and groundwater, except water that flows through a single property or lies beneath one, belongs to the Nation. It also lists the “national waters,” which include territorial seas, lagoons, lakes, rivers and their tributaries, etc. The “inherent public goods” refer to so-called federal zones (land close to waters) and sand and gravel found in river beds. 6  While there is no universally agreed definition of a water right, it is usually understood to be a legal right to withdraw and use a quantity of water from a natural source such as a river, stream or aquifer. STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: xiv FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES Works Act (Ley de Contribución de Mejoras por “The National Water Commission is the Obras Públicas de Infraestructura Hidráulica) went instrument to comprehensively manage into effect, with the purpose of enhancing the cost the expenses, financing, and revenues, in recovery of federal investments. The enforcement order to efficiently organize the national of this legislation has run into major obstacles, efforts in the creation of water works mainly due to political factors and gaps and lack of and systems for the supply, distribution, precision in its formulation. use, and usufruct of water; it shall strike a Despite their initial limitations, the 1986 balance between the quantity and quality fiscal reforms laid down some fundamental of water, and shall address the different principles that today are part of the country’s uses of this resource at the watershed water policy. On one hand, the establishment in level with equity and consideration for the Mexico’s water law of an intrinsic economic value future.”9 of the resources and that all users, merely by This is how the idea of an SFA was born, virtue of being a user of water, must contribute to with the aim of providing financial sustainability its development and conservation. On the other and self-sufficiency for the development and hand, the economic value of water was linked management of water resources. Following to its availability—a greater economic value to the creation of CONAGUA, a water policy was reflect scarcity. Effluent discharge charges were drafted based on the following principles: also established to improve water quality. These measures results in a renewed water pricing ●● All members of society must contribute system based on the net water supply in the towards the cost of water works and ser- country’s various watersheds and the respec- vices; their contribution shall be directly tive quality. Revenues from the collection of proportional to the benefits they derive water-use charges have become a major source from these. of income for the federal government, which are ●● Users shall pay levies for the use or implicitly or explicitly reinvested in this sector.7 usufruct of water, based on their ability Against this background and the need to pay and the volume of water used, and to address the sector’s financial problems, relative scarcity. the 1989 reforms imparted a fundamental ●● Those responsible for wastewater dis- role to water-related finances. Along with the charges shall fully assume the costs of creation of CONAGUA,8 to bring together all preventing and, if relevant, eliminating responsibilities of the federal government the pollution they generate. related to national waters in a single authority, the fiscal policies on water management were updated. The latter was mainly done for two 7  As no clear policy existed to specifically allocate the revenues from the collection of water-use tariffs, the effi- reasons: (i) to strengthen the tools allowing ciency of this instrument was reduced. These revenues an economic value to be placed on water and should in the first place pay for managing the quantity and quality of the water resources; secondly, they should send a clear signal about the social and political support the development of water infrastructure in line will to make efficient and equitable use of the with government policies. This is precisely one of the areas where the SFA could make a contribution: spell out resource; and (ii) to clean the country’s rivers, the allocation of these resources so they can serve as a lakes, and other water bodies. On the occasion policy instrument. 8  By Federal Executive Decree published in the Official of the installation of CONAGUA, the president Gazette of the Federation on January 16, 1989. stated the following: 9  Installation ceremony of CONAGUA. Introduction   xv ●● Proceeds resulting from the application this is the current status in Mexico; it is an informal of the above principles shall be ear- system that has developed and strengthened over marked for the sustainable development time to meet the increasingly complex challenges of the country’s water resources, that is, faced by the water sector. However, the financing “unto water that which is water’s.” schemes potentially available are so diverse and complex that the institutionalization of the SFA Besides establishing a modern legal frame- will reap additional benefits. CONAGUA could work, the implementation of the above principles coordinate the flow of resources to the sector; also demanded the creation of a financial system draw on its experience for the benefit of subsec- that would allow for a comprehensive response tors other than water supply and sanitation; and to the water sector’s structural problems, under apply its expertise experience to the tasks associ- the premise that water is a resource with a quan- ated with the management and preservation of tifiable value and whose preservation in terms of national water bodies, all done ensuring the long quantity and quality constitutes a national priority. term financial sustainability and that resources Consequently, the financial strategies adopted by are adequately allocated. CONAGUA over the course of more than 25 years, The focus of this report is on those rules, have been developed along three lines: processes and instruments under the respon- sibility of CONAGUA. If the SFA is considered an ●● Strengthening the finances of the dif- instrument for the water sector as a whole, the ferent water users (mainly the water inventory of financial mechanisms should be utilities and the water user associations extended to cover topics beyond water supply of irrigation systems),10 based on a policy and sanitation. While CONAGUA currently plays of financial sustainability that seeks to no role in the financial operations of these other progressively phase out unnecessary topics, it does act as an agent of information and subsidies and redirect those that can be coordination. This is the case, for example, in justified. power generation, industry, and tourism. ●● Systematic strengthening of the fiscal This report seeks to contribute to building a water policy, based on the ongoing consensus on what the SFA’s profile and scope adjustment of the levies charged for should be, and the way in which it could operate water use and wastewater discharge, under CONAGUA’s leadership, with the support along with adequate levels of collection.11 and guidance of the SHCP. ●● The diversification of funding sources,12 in order to secure a broad range of financ- ing options for programs to develop and manage national water resources. Of particular importance is the fact that these financing options include mea- 10  The other water subsectors, such as energy and sures to ensure that the beneficiaries of industry, meet their water-related financial needs by such programs contribute and that the themselves. 11  In some years, the collection of these tariffs repre- private sector participation is increased. sented 80 percent or more of CONAGUA’s budget. 12  A mix of resources involving, among others, federal programs (subsidies), trust funds, private participation It is possible to discuss an SFA, even when it schemes, development and commercial bank credits, does not have a formal operational definition and asset management, and lease arrangements. Part 1: Background and Concepts M exico’s water sector is currently facing a severe crisis, despite the substan- tial increase in investment funds allocated to it. This crisis is character- ized, among other things, by an increase in the number of overexploited aquifers; the deterioration of the quality of water in rivers and other water bodies; the increase in the number of conflicts over water; the growth in the coverage of water supply and sanitation services, be it with services that are inefficient and of relatively low quality; and the hidden threat to dams and other important water infrastructure, in light of extreme hydro-meteorological events that are becoming more frequent and intense. The current crisis is very likely to escalate if corrective measures are not taken. In essence, it is necessary to tackle a series of weaknesses that afflict the entire sector, among others, the low efficiency and effectiveness of the numerous investment projects and programs that operate in an uncoordinated manner. This lack of coordination, in turn, has led to overlapping programs, inefficient use of public resources, and a lack of comprehensive policies. The Financial Challenge Analyses of possible future scenarios suggest that in order to successfully address the future chal- lenges in water, an annual investment of over Mex$50 billion will be necessary over the next 20 years.13 The most likely scenario corrected for the climate change impact would increase the gap between supply and demand of water by 58 percent, which would require additional annual invest- ments of Mex$12 billion a year. Other estimates (for example, Fernández, 2011) show that the above figures could be on the low side if the financial requirements to rehabilitate and/or replace the existing infrastructure, and the costs of addressing extreme events, in particular floods, are also taken into account. 13  CONAGUA. 2030 Water Agenda. STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 2 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES Given the financial limitations of the public sector, which even under the most optimistic scenarios would not be able to allocate substantially more resources to the water sector, it is evident that the investments required are considerable. Financing these investments will require resources from dif- ferent sources. At present, the financial resource mix appears to rely excessively and increasingly on taxpayers, something that is definitely not sustainable and should be corrected; the funding provided by users should be increased significantly. Chapter 1 Starting Point 1.1  Legal Foundations of the SFA The amendments and additions to the 1992 National Water Act (Ley de Aguas Nacionales or LAN), which took effect in 2004, include the Title Eight Bis (Título Octavo Bis), consisting of a single chapter entitled “The Financial System for Water”. Article 111 Bis of the LAN provides the legal basis for the creation of an SFA. In fact, the third paragraph of this article clearly establishes what is expected of the SFA. Article 112 of the LAN has been aligned with the provisions of the LFD regarding the payment obligations of the users of national waters, for the exploitation, use or usufruct of such waters and their inherent public goods—bodies of water that are used for the discharge of wastewater. Thus, by charging levies for water use, article 112 Bis to a large extent sustains the funding of actions and programs undertaken by the water sector to reach its medium- and long-term objectives.14 Even if the provisions of the LAN are confined to “the rates of the levies charged for the water use as well as other federal taxes and tariffs established for the use or usufruct of water, or for the provision of services related to water infrastructure works,”15 including the contributions to partially or totally recover the cost of federal investments in this area, the Act itself leaves open the pos- sibility of extending the SFA to achieve a coordinated funding mix that also includes other public and private resources (article 111 Bis, second paragraph), as is currently the case through different mechanisms. The challenge for the government is to make the provisions of the LAN operational and incorpo- rate them into the various programs and projects at the federal, state, and municipal level. As stated in the first paragraph of article 111 Bis, the federal executive shall define, create, and implement the SFA. The fastest legal path to attaining this would be the regulation of articles 111 Bis, 112, and 112 Bis.16 This would confer legal status on the SFA, thereby securing its long-term sustainability. 14  The provisions of article 112 Bis of the LAN in a way provide a solid legal argument to earmark the revenues resulting from the provisions of the LFD on the exploitation, use, and usufruct of national waters. 15  Article 112 Bis of the LAN. 16  It is not necessary to wait until all the articles of the LAN have been implemented. The federal executive may issue regulatory provisions regarding these three articles. STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 4 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES 1.2  Towards a Definition markets—which are continually engaged in com- plex interactions with each other, with the aim of Much of the literature reviewed mentions the mobilizing funds for investments—as well as the SFA. However, aside from what is stated in the 17 special facilities, including payment systems, for LAN, the literature focuses on explaining the the financing of all commercial activity.24 existing financing mechanisms for the various Banco Santander, defines a financial system programs and projects carried out in CONA- as one consisting of a set of mechanisms that GUA’s realm. Such programs and projects are allow specific operations to take place; these not coordinated and no mechanism is in place to operations ensure that the dispersed savings avoid overlaps among them. Most of these analy- of the economy are consolidated as resources, ses discuss mainly or exclusively public funding transferred, and made available at the place sources, barely considering private sources. 18 19 and time, in the amount, and in the timeframe Moreover, most of the national and international in which they are needed, thereby facilitating literature focuses on the subsector of water sup- investment projects and commercial transac- ply and sanitation;20 no major attention has yet tions; in short, the financial system contributes been given to other water subsectors, despite to the efficient functioning of the real sector.25 the fact that the financing of other subsectors is beginning to draw more interest.21 In view of the above, a pretty broad defini- 17  For example, Aguilar (2007), World Bank (2009), and CONAGUA (2005). tion was formulated as the starting point for this 18  Refers to the financial flows from the governments and report and for the dialogue with CONAGUA offi- contributing organizations through taxes and transfers. 19  Refers to the financial flows from service users, private cials as well as financial authorities (essentially service providers, and private financial agents such as the SHCP). This definition is based on a more banks, investors, and bondholders. 20  Anderson (2011), Castalia (2008), Chama (2008), general concept of a financial system and draws CONAGUA (2010), and Marín (2009). heavily on definitions used by other government 21  Baker (2002), CONAGUA-OECD-IMTA (2011), Depart- ment for the Economics, Assessment and Integration of entities, international organizations, and the Sustainable Development (2011), and PREVDA (2010). private sector. 22  http://www.banxico.org.mx/sistema-financiero/ index.html. For the Mexico Central Bank, the domestic 23  http://stats.oecd.org/glossary/detail.asp?ID=6189. financial system ensures the efficient allocation 24  The role of financial institutions within the system is primarily to mediate between those who provide the of resources among savers and parties in need of funds and those who need them. This generally involves credit. According to the Bank of Mexico, a healthy the transformation and management of risk. Especially financial system requires, among other things, for depository institutions, this risk derives from their role in the transformation of maturities, where liabilities are effective and solvent intermediaries, complete generally short-term (for example, demand deposits), and efficient markets, and a legal framework that while assets have a longer maturity and are often liquid (for example, loans). Financial markets provide a forum clearly establishes the rights and obligations of where financial assets can be negotiated according to all the parties involved. The Bank of Mexico over- certain rules of conduct and can facilitate the transfor- mation and management of risk. sees the activities of the institutions that make up 25  http://www.santander.com/csgs/Satellite/CFW- the financial system, encourages amendments CSancomQP01/es_ES/Santander-/Accionistas/ Mexico/Otra-informacion-de-interes/Glosario.html?pa to existing legislation, and issues regulations that gename=CFWCSancomQP01%2FGSAgrupAsset%2F fall within its sphere of competence.22 CFQP01_GSAgrupAssetInformacion_PT10&cidSel=12 78678993260&appID=santander.wc.CFWCSancomQP For the OECD/IMF,23 a financial system com- 01&canal=CSCORP&empr=CFWCSancomQP01&leng prises the institutional units and the financial =es_ES&cid=1278678851271. Part 1 Starting Point   5 In general, a country’s financial system is legislation and regulations, and taking made up of the institutions, markets, and instru- into account sustainability, economic ments, whose fundamental goal is to channel the efficiency, and equity criteria.” savings generated by lenders or spending units with a surplus towards the borrowers or spend- The above definition may be expanded to ing units with a deficit. In a market economy, the the different levels of government (state or local) financial system plays the key role of capturing and even to that of a private entity. For instance, the surplus finances of savers and channeling the concept of an SFA in the context of a state them towards public or private borrowers. could constitute a policy tool to duly arrange the With the feedback received through the dia- implementation of different instruments meant to logue with CONAGUA executives and specialists, ensure the water sector’s financial sustainability at as well as specialists from other government the state level, given the respective competences institutions and water sector stakeholders, the of the three levels of government. The LAN stipu- following consensus was reached on the essence lates that CONAGUA is responsible for the SFA’s of an SFA:26 operation (coordination/organization), under the supervision and with the support of the SHCP. “In the context of the financial system Taking the above definition as its starting in Mexico, the SFA may be considered a point, the next chapter elaborates a conceptual subsystem of the former and is made up model of the SFA and discusses how it could of (public, private or social) institutions function in practice. Chapter 3 presents some that channel resources from different concrete ideas about the way the SFA could be (public or private) financing sources to formalized under CONAGUA’s wing. the various (public, private or social) investment projects and programs aimed at the development and maintenance of the water resources and associated 26  During a workshop held at the facilities of CONAGUA systems; these financial resources are on July 27, 2011, a first draft definition of the SFA was discussed. The definition presented in this report incor- channeled through a range of means and porates the ideas and comments that surfaced during mechanisms, in accordance with relevant the discussions. Chapter 1 CHapter 2 Conceptualization of The SFA B ased on the definition proposed in the previous chapter, the SFA can be schematically conceptualized as an institutional arrangement that gives rise to the flow of resources shown in figure 1. Figure 1:  General SFA Schemea Political, Social, Economic and Global Environment Legal Framework CONAGUA/SHCP Sources Destinations Public Funds • Water and • Taxes sanitation • Water rights • Irrigation and • National debt Means/ drainage • Guarantees Transaction • Other subsectors • Transfers Mechanisms • Protection against “Ground Rules” floods and droughts Financial Financial Private Funds • Integrated Scheme Flow • Rates management of • Credits water resources • Issuances (quantity and • Guarantees quality) • Other instruments Public, Private & Social Institutions Refunds Source: World Bank elaboration. Notes: (1) The general tax concept includes the proceeds from the collection of the water use and wastewater discharge levies. (2) Water Resources Management includes all the actions necessary for the comprehensive management of the water resources (to control water quantity and quality), as well as those necessary to preserve vital ecosystems. (3) The resource flow derived from SFA is not static; it should be seen as a financial flow in a given timeframe. a As pointed out in figure 1, although the SFA is to a large extent linked to CONAGUA’s sphere of competence, it should also include the investment programs and projects related to other subsectors that use water such as the energy, industry, and tourism sectors. STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 8 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES As shown in the figure, the SFA operates in also establish the rules that must be followed by in a domestic environment marked by political, those searching for financial resources. social, and economic factors, which in turn are influenced by a series of global factors (for exam- ple, the financial, food prices, and energy crises,). 2.1  SFA Components All these factors affect both the demand for and supply of financial resources hence, affecting Conceptually, the financing demands of each their availability for different economic sectors. water subsector form the starting point for the The mode of operation and range of action of source-destination link, based on financial pro- the different actors active in water is determined jections regarding their assessed needs within a by of laws and regulations, which go beyond the given time frame. These projections give rise to LAN. These legal provisions, in turn, determine specific initiatives that require financing.28 These the nature and scope of the means and mecha- initiatives jointly make up a pipeline of projects nisms of transaction between the sources and and programs (see figure 2). Once in the pipeline, destinations of resources. they are classified by different eligibility, feasibil- Figure 1 also highlights the role of CONAGUA ity, and prioritization criteria, so they can be pre- (with the SHCP) as operator/coordinator of the sented to various public29 and private30 suppliers SFA and the fact that many parties intervene at of financial resources for their consideration. both ends of the financing flow. All these par- In the next stage, financial resources are ties interact with each other through different allocated in accordance with established rules; mechanisms or processes. Among these parties information flows from those responsible for are federal government agencies, state and local the allocation of resources (see figure 2). This governments, national financial institutions, and flow of information allows for the design and private investors, to name just a few. identification of indicators necessary to comply According to the LAN, the SFA aims to “sup- with the LAN provisions regarding monitoring of port all actions related with the integrated man- results and performance evaluation. In addition, agement of water resources in the country…” and these indicators provide sufficient information will also set “…spending and recovery criteria, to fine-tune or optimize existing transaction where relevant, for those financial resources, financial accountability and management indica- tors, as well as targets resulting from the use of 27  It should be pointed out that financing for the des- tinations as shown in figure 1 refers not only to water those resources and financial instruments.” Con- infrastructure projects (for expansion or rehabilitation sequently, another two components are added and replacement), but also to the investments needed to keep the country’s water systems in optimum condi- to the initial conceptualization of the SFA: the tion, in terms of quantity and quality. This implies that portfolio of programs and projects in the water investments aimed at strengthening the capacities of institutions involved in water management at any level of sector27 and the SFA’s system of indicators. government are also included. As shown in figure 2, parties offering 28  Research, projects, equipment, and non-structural actions. resources and parties demanding resources 29  For example, the initiatives included in PEF or those are linked through various transaction means or that are managed through the federal programs, the schemes established through BANOBRAS, and other mechanisms that are subject to specific ground special funds that involve fiscal resources. rules. These mechanisms set the feasibility and 30  In addition to the initiatives that are managed in the fee-setting process for the delivery of services, other eligibility criteria for accessing the different initiatives are brought under totally or partially private sources of funding (separately or combined) and capital financing schemes. Part 1 Conceptualization of The SFA   9 Figure 2:  SFA Conceptualization Legal Framework CONAGUA/SHCP Eligibility Initatives Viability Programs And Projects Portfolio From The Water Sources Sector Destinations Public Funds • Water and • Taxes Feedback sanitation • Water rights • Irrigation and • National debt drainage Means/ • Guarantees • Other subsectors Transaction • Transfers • Protection against Mechanisms “Ground Rules” floods and Financial Financial droughts Scheme Flow • Integrated Private Funds • Rates management of • Credits Feedback water resources • Issuances (quantity and Indicators quality) • Guarantees Management • Other instruments Information Performance Results Public, Private & Social Institutions Refunds Source: Author’s production. mechanisms or create new ones. In turn, these The World Bank (2009), CONAGUA (2005), changes inform the pipeline of projects and and Aguilar (2007), among others, have programs so that eligibility and feasibility criteria described the existing financial mechanisms in can be adjusted accordingly. The most important Mexico, as well as the eligibility criteria, operating aspects of each SFA component are discussed in rules, and other procedures governing access to more detail below. available funding sources for different types of investment programs and projects in in water.32 Sources of Financing Nowadays, investment programs and projects, It is widely recognized that the use and exploita- along with the cost of their associated services, tion of water resources for human and economic are financed through different transaction development bring important benefits. However, modalities and mechanisms. insufficient financial resources are currently allocated to manage water in many countries, Mexico being no exception. Closing the financ- ing gap requires that resources be mobilized 31  Tariffs, Taxes, and Transfers (commonly known as the “3Ts”), or “TIT” (Tarifas, Impuestos y Transferencias) in from various sources. These resources may Spanish). also derive from cost reductions (resulting from 32  These references represent some, but not all, of the financing mechanisms currently applied in Mexico. Gen- higher efficiency or less costly service options), erally speaking, the financing needs of the water sector an increase in basic financing sources,31 and the are covered by taxes that are channeled in different ways through public expenditures and surplus funds resulting mobilization of reimbursable funds provided by from the delivery of goods and services (for example, Chapter 2 the market or the public sector. water and sanitation services, and irrigation services). STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 10 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES Table 1: Current Financing Mechanisms Sources Transaction Mechanism Destinations Federal Government Fiscal •  Federal legislation • Programs and projects from Resources (particularly Areas •  PEF legislative Process the water sector incorporated 08, 16 and 20 of the PEF) • Rules established by the in different budget categories Investment Unit, SHCP Fiscal Resources from State and •  Federal and local legislation • Direct financing from local Local Governments (including projects and programs federal contributions of Area 33) •  PEF legislative process • Projects co-financed with federal resources Federal Contributions for Federal •  PEF allocations •  Issue of securities and Municipal Entities (Area 28) •  Local legislation • Debt service of bank loans •  SHCP obligations registry • Payment guarantee for •  Credit rating projects with private •  Master Trust participation Federalized Programs •  PEF allocations • APAZU, PROSSAPYS, PAL (Subsidies) subject to Operating • Rules established by the and Fund subject to bid, in the Rules: Investment Unit, SHCP water supply and sanitation • Rules of Operation and subsector Federal Resources + Own make-up of mix of resources • PRODEP, PRMDR, and Resources (Water utilities, user PMTUR in the agricultural associations) + State and local subsector resources Revenues from tax collections •  Criteria established by law •  PRODDER •  Rules of Operation •  PROSANEAR •  Specific agreements •  FIDEICOMISO 1928 FONDEN •  Regulations •  Emergencies •  Disaster prevention FOPREDEN External Credit • Contractual conditions for • PATME (credit is credit complemented with state, local, and internal generation resources of Operating Organisms, OO) • PROSSAPYS • SMN modernization (in progress) Private Public Participation • Specific requirements by •  PROMAGUA (FONADIN/BANOBRAS + risk project type •  Specific projects capital + private debt) • Public-Private Partnerships Act FAIS FFRES Debt market (subnational bonds, •  Credit rating • Financing of sector projects regular bond) • Authorizations from the by states and municipalities various Congresses • Contractual conditions and repayment bonds (continued on next page) Part 1 Conceptualization of The SFA   11 Table 1: Current Financing Mechanisms (continued) Sources Transaction Mechanism Destinations Capital market (e.g., AFORES, •  Federal and state legislation •  Projects of the sector bond issuance) •  Credit rating • Authorizations from the various Congresses • Contractual conditions and repayment bonds Source: Original production from bibliography. Service Providers services or products provided, from tax-related Figure 3 illustrates the case of a water utility or an resources, and through transfers such as irrigation system managed by user associations donations, grants from development agencies, (for the time being referred to as a “service pro- subsidized loans, etc. Such a situation is typical vider”) that cannot cover their financial needs of most, if not all, water utilities and user asso- in a given timeframe and must seek alternative ciations managing irrigation systems. Morever, funding sources. these service providers face today a gap between The service provider faces somewhat costs and revenues, resulting in a negative unpredictable future costs vis-à-vis a predictable financial gap. This financing has resulted in the flow of revenues—derived from the charges for inability to adequately maintain, rehabilitate and Figure 3:  Finances of a Service Provider Covers The Financial Gap Investment Expansion Financing Gap Rehabilitation Concessional Replacement Loans Maintenance Transfers Costs Commercial Loans Taxes Operation Bond Issuance Costs Rates Capital Costs Income Refunds Public Resources Grant Funding Available in the Private Resources Market Chapter 2 Source: Adapted from OECD (2009). STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 12 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES build water infrastructure systems. The funding revenue with respect to the total associ- gap can be closed by intervening both on the ated potential revenue.35 This explains demand and supply sides. the need for high subsidies for the water On the demand side, the service provider’s utilities and service providers, which, to a costs can be reduced by enhancing operational certain degree, have become “perverse efficiency (physical and commercial), which incentives,” by providing a political way raises net income (in addition to generating sav- out rather than substantially increasing ings in physical resources, particularly in areas the tariffs for these services. where water is scarce). Additionally, proper ●● Taxes. At present, the expansion of investment planning can generate substantial water and sanitation services and those savings and support the design of more realistic systems providing irrigation and drain- investment programs. Sometimes lower-cost age services in Mexico rely heavily on options, better suited for local conditions, are federal tax money. States provide some available; alternatively, more realistic (non- additional financing and municipalities standard) service levels that better reflect local contribute with limited amounts of conditions may be adopted (OECD, 2012). In any resources. Limited revenues from taxes, case, the key point in this context is to prioritize due to macro-economic factors, have those investments whose financing needs can imposed severe constrains in the flow of be duly covered, as well as to those that contain financial resources going to the sector. provisions to manage demand efficiently. Scenarios regarding future overall fund- On the supply side, additional resources ing needs show demand by far exceeding may be mobilized by raising the 3Ts or turning to the expected available fiscal resources, refundable sources—through a better allocation even under favorable conditions: of resources or the reduction of risks to attract ●● Since the early 1990s, federal funds have private investments. According to the OECD been raised by combining resources (2010), the costs of water-related services may from state governments, users, and the in principle be covered by three revenue sources private sector. As to the latter, rather] (the 3Ts, introduced earlier):33 than representing additional resources, the effect of private sector participation ●● Tariffs. The data available for Mexico is that the flows of revenues and expendi- show that, with very few exceptions, tures are balanced by devising schemes the tariffs charged are too low to cover that have a predetermined repayment the full cost of water-related services (management, operations, as well as maintenance and capital costs, including 33  The private sector’s participation in the water and sanitation subsector includes the direct investments infrastructure replacement) and often do from property developers or the industrial sector, which not cover basic operations and mainte- are amortized indirectly and represent a special case. 34  For example, to recover the costs of a production unit nance (O&M) costs. To some extent, the in a system with a 70 percent efficiency coefficient (that fact that these tariffs are too low is due is, 30 percent of the volume produced is lost to leaks), the user would have to be charged 1.43 times the cost of to relatively low physical and commercial each cubic meter produced. efficiencies: the former increases the 35  If, in the previous example, aside from the physical losses, only 80 percent of the volume delivered were production costs by m3 delivered to the charged, the price to the end consumer would be 1.78 end user34 while the latter reduces actual times the cost of every cubic meter produced. Part 1 Conceptualization of The SFA   13 time frame (between 10 and 30 years, assist to cover initial investment costs,39 leverage depending on the useful life of the assets additional sources of income, and, eventually, to be developed). reduce financing costs. However, these funds ●● According to the diagnostic report ultimately have to be repaid. prepared by the 2007–12 National As shown in figure 3 above, three alterna- Infrastructure Program (PNI, 2007), tives exist to close the financing gap, and they all the breakdown of total required imply an eventual repayment to be covered by investments is based on a most likely the various sources of basic revenue: baseline scenario in which the invest- ments in infrastructure represent 1. Repayable financing. This type of financing is 4 percent of GDP.36 Of the total invest- the most common in Mexico to finance infra- ments, only 8 percent are for water, structure projects with the participation of the even though another portion of the private sector (BOT agreements in wastewater investments in water infrastructure treatment plants and aqueducts, or service is incorporated in the investments of agreements and, more recently, PPP agree- the power subsector for hydroelectric ments), where a percentage of the investment projects. (risk capital and credit), as well as the O&M ●● Transfers from international donors or costs, are recovered through tariffs.40 private charities. According to the OECD 2. Market financing. This type of financing (2009), official development assistance refers to a subset of repayable financing (ODA) must be equated to taxes because that is implemented through the market by such aid is provided in the form of budget support, which implies that most of the 36  PNI believes that the figure for investments that are funds will be disbursed in the same way as financially feasible ranges from 2.5 to 5.5 percent of GDP, the federal budget.37 Although this source which means that if the share of total investments in the water sector is maintained, disregarding what could be of income is significant in less devel- destined for hydroelectric projects, this figure would oped countries, in Mexico this source is range from 0.2 to 0.5 percent of GDP. 37  This is the case, for instance, of the resources from relatively small; nonetheless, it can have a international development banks dedicated to technical major impact on the development of mar- assistance. ginal communities or in the formulation 38  Commercial banking, bond issuing, risk capital, and mixed funds. and implementation of public policies. 39  Water and sanitation service providers generally seek to mobilize repayable financing to fund the capital costs At the sector and service provider level, of the rehabilitation, renewal, or expansion of water sup- ply and sanitation systems, while they usually finance the the combination of tariffs, taxes, and transfers ordinary costs of O&M with a mixture of the 3Ts (OECD, determines who pays for the services (users, 2010). In developing countries, the water utilities use bank loans to finance capital investments, although gen- taxpayers, or donors). The composition of the erally these are soft loans from development institutions 3Ts also determines the solvency of water utili- (OECD, 2012). 40  At the end of 2009, the federal government introduced ties and service providers and, with that, their a series of structural reforms to increase private sector access to additional financing sources. participation and funding in the various investments that the country requires, including the water sector. These measures include a bill offering a modern and flexible Closing the Financing Gap framework to regulate PPPs, as well as legal reforms that will make it possible to implement or advance Other sources of financing (loans, bonds, or infrastructure works and facilitate initiatives to increase funds from public and private investors38) may investments in this sector. Chapter 2 STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 14 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES private participants. These sources of financ- that under the current rules and regulations, ing include: debt financing (commercial bank there is an incentive to work only with those loans, bonds issued through capital markets, providers that are in good financial health. and project financing) and capital financing The existing criteria do not provide any incen- (through the capital markets or private equity tives for financial entities to support those funds). The debt-financing mechanisms service providers that require assistance to have formed the backbone of infrastructure eventually become creditworthy. investments for developed countries (OECD, Two main types of subnational bonds are 2010); these mechanisms have taken the issued: (i) bonds that are secured by general form of bonds or loans, depending on the government revenue and taxes, and (ii) bonds development of the local bond markets and that are secured by a particular asset. The the debtor’s economic capacity. Access to latter type is used for investments in infra- these funding sources has been limited by the structure, which in turn generate enough current financial environment and the per- resources to cover operational and financing ceived risks associated with the politicization costs. Service providers have used this type in of water services, particularly regarding the very few cases; one conspicuous exception is criteria for setting the tariffs for the delivery Tlalnepantla, whose financial deal in 2003 was of those services and the robustness of pay- the first in the country’s water sector not to ment guarantees to be offered. 41 use government transfers as guarantees, but The commercial banks in Mexico have rather the revenues from the tariffs to cover had limited participation in water; the operat- financing costs. Other parts of the country ing conditions of most service providers do are looking at similar mechanisms and their not meet the requirements of the leading analysis can be considered of interest for the funding providers, who perceive the water development of the SFA. sector as one of “high risk and low return.” This In 2009, the state of Quintana Roo for- may seem somewhat counterintuitive, given malized a special initiative around a regular the sector’s economic fundamentals—assets with a long useful life, and a relatively stable 41  At present, measures are being implemented in the and almost recession-proof demand for agricultural sector to try and ensure that agricultural producers have access to different sources of financing. services. The sector’s weak institutional and 42  At the beginning of the last decade, CONAGUA legal frameworks, coupled with insufficient arranged a loan with the IDB aimed at reversing this situation; however, this effort failed, mainly due to the cash flow to cover costs, are at the root of the institutional weakness of local governments. Even at commercial banks’ reluctance to finance the present, CONAGUA remains committed to designing similar support programs. sector. Even though the country today has 43  This is the case of most Build-Operate-Transfer (BOT) over 2,000 water utilities, only a handful are and service contracts implemented in Mexico. 44  Mexico’s 31 states and 70 municipalities have a credit deemed creditworthy.42 Nevertheless, access rating (it is actually the second-largest market for credit to commercial banking is obtained indirectly, ratings outside the US and Canada). A law introduced in 2001 made it easier for local governments to expand through specific projects with private sector their debt-management capacity by requiring that states participation.43 and municipalities establish trusts for the repayment of bonds financed with federal contributions—taxes At the same time, bond issues have collected by the federal government and redistributed been a recurring source of financing for state to states and municipalities. These funds earmarked for debt repayment are separated from the general accounts governments, who in turn subsidize some of of local governments, thereby lowering transaction costs the water investments.44 It should be noted and interest rates. Part 1 Conceptualization of The SFA   15 bond, the first of its kind in Mexico, which proposed in a multi-temporary context, where the combines the issuance of bonds with state financial burden (repayments) is distributed over and some municipality support to finance time to balance the flow of revenues and expen- infrastructure projects in the state, including ditures. Herein lays the value of these resources. water projects. By creating a common fund, the participating municipalities were able to Water Resources Management achieve greater liquidity and thus paid lower The approach used to describe the provision interest rates than if they had issued bonds of services also applies to the financing of the on their own. The state of Campeche is pre- programs and actions associated with water paring an ambitious program to attract com- resources Management (or WRM), which in Mex- mercial financing for infrastructure, including ico is conducted by the executive branch through water infrastructure projects, through the CONAGUA. According to the OECD (2012), creation of a PPP Capital-Raising Vehicle for water resources management offers a range of the entire state (CONAGUA, 2011a); this will direct benefits to water users such as farmers, be a company with a specific purpose that will power-generation facilities and industrial plants, develop infrastructure and take out loans on as well as homes. For the various economic sec- the capital markets based on compensations tors, these direct benefits often take the form from the state government for this special- of higher economic production, but overall risk purpose company. The latter scheme gives reduction is also an important benefit. Another the state access to private funding without direct benefit is the conservation of biodiversity increasing its debt, though it still remains to and the ecosystems. be seen whether this will entail lower financ- As in the case of the service provider pre- ing costs than the alternative of issuing a sented in Figure 3, the tasks associated with the government-backed regular bond. management of national waters require financial 3. Concessional loans. Generally refers to resources for the following: loans provided at below-market interest rates by way of guarantee funds and/or govern- ●● Construction and O&M of infrastructure ment policies that support particular sectors, in order to optimize the use of water implemented through official banks (for resources in specific basins (regulation example, support to the agricultural sector reservoirs, flood control, restoration of through soft loans and/or guarantee funds). river beds, etc.). This category would include a good number ●● Equipment and O&M for measuring and of the credits granted by national and inter- monitoring networks for the different national development banks. It also includes components of the water cycle, in terms CONAGUA initiatives for the creation and of quantity and quality. implementation of guarantee mechanisms ●● Equipment and operation of the systems that facilitate access to credit for agricultural in place for conducting the different regu- producers. latory tasks (concessions, water alloca- tions and licenses, the Public Registry of It is important to point out that the sources Water Rights or REPDA) and command of financing highlighted above do not generate and control tasks, as well as financial any revenue additional to that derived from the incentives (collection of levies, water mar- Chapter 2 3T components. These sources of financing are kets, and water banks), all required for the STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 16 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES management of national waters under the conceptual framework. This analysis should be existing legal and regulatory frameworks. based on a forecast of the flow of fiscal resources to be allocated to a specific subsector (for Closing the financing gap that currently example, as a proportion of GDP), as well as on exist to manage the water resources entail and desirable but realistic scenarios for the evolution array of actions pertaining to both the costs of revenues deriving from service charges (evo- and the sources of financing. In fact, some of lution of the tariffs) and from improvements in the programs implemented by CONAGUA are technical and commercial efficiency. The result- specifically aimed at increasing and improving ing financing gap would be the starting point for the efficiency in the use of irrigation and water identifying realistic financial structures to bal- systems. Moreover, charging for the right to use ance and make viable revenue and expenditure water promotes a more judicious, frugal use. flows in a given subsector. When discussing activities associated with WRM, the revenues from the collection of levies Other Experiences for the use of water and for the discharge or dis- The experience to date in Mexico with financ- posal of wastewater are similar to tariffs charged ing programs and projects in water confirms for services provided by the country’s water the vast potential there is for various financial systems (to supply water, receive wastewaters, resources to be combined and thereby attain or support vital ecosystems), as well as for the the sector’s medium- and long-term objectives. construction of regulation and control infra- In the international realm (OECD 2009, 2010, structure for optimal use of the water resources and 2012), there is a wide range of financial in a basin or aquifer (public goods). mechanisms and structures to draw lessons Given that the management of the national from, both regarding options that work and water system is the responsibility of CONAGUA, options to avoid (Anderson, 2011; Department access to repayable financing is limited under for the Economics, Assessment and Integration current conditions . However, some financing 45 of Sustainable Development, 2011; Marín, 2009; schemes could be viable indirectly if private- OECD, 2010 and 2012). Some of these schemes participation mechanisms were considered could be adapted and applied in Mexico, particu- only for some aspects of this management. Two larly where meant for financing non-traditional examples of this are the structure that has been schemes (Baker, 2002; Ward, 2010; OECD, proposed for the expansion and O&M of the radar 2012), such as strengthening hydro meteorologi- network of the National Meteorology Service cal services (PREVDA, 2010). Other cases that (Servicio Meteorológico Nacional or SMN), and could be candidates for these schemes are the the outsourcing scheme to strengthen and main- outsourcing of measurement systems for the tain the national network for monitoring water different variables involved in the water cycle or quality. Furthermore, revenues from charging for for water-quality analysis; the insurance mecha- water use rights and wastewater discharge could nisms in high-risk flood areas; the creation of be channeled towards schemes that potentially PPPs to deliver bulk water in metropolitan areas; have access to repayable financing. Subsectors 45  Due to many factors including lack of incentives for The financial situation of the water subsec- banks and private sector to participate, high margins on interest rates and short maturities, requests of liquid tors may be analyzed using the same broad guarantees and collateral guarantees, and so on. Part 1 Conceptualization of The SFA   17 and the issuance of debt by water utilities. The actions were combined to ensure a balance World Bank has gained vast experience in this between the supply of and demand for water area, covering aspects ranging from the financ- (World Bank, 2007). ing of large infrastructure works (Head, 2006) to the financing of schemes to serve rural com- munities (World Bank, 2010 and 2011). Projects and Programs 2.2  Mexico has also considered new approaches. Portfolio of the Water A case that is relevant due to its potential as a Sector source of financing is related to the proceeds from the collection of levies for the use of water The programs and projects portfolio of the and the discharge of wastewater (Aguilar, 2010). SFA may be considered an expanded and It would be worthwhile analyzing the usefulness enhanced version of the Portfolio of Investment and viability of implementing securitization Programs and Projects (Cartera de Programas schemes, where a specific percentage of the y Proyectos de Inversión or CPPI),46 managed proceeds would support different programs by the Investments Unit of the SHCP. Doing so and projects. For instance, experiences like the ensures that all programs and projects identi- one of the French financing agencies, where fied in the water sector would be included,47 revenues from water-related levies are linked to regardless of their source of financing and the 5-year equipment plans, could be valuable for object benefiting from the financing. Moreover, Mexico. this would ensure mechanisms for appropri- A Mexican experience that illustrates the dif- ate follow-up of the stage of the project cycle ficulties to design innovative financing schemes that the various initiatives are at (research, for projects that generate primarily public goods evaluation, financial management, final design, is the case of Ojo Caliente basin in the state of procurement, execution, start of operations, Aguascalientes (CONAGUA, 2002), supported and monitoring). by the program for the Sustainable Management The Portfolio would be composed with of Groundwater (Manejo Sustentable de Aguas initiatives identified as part of the planning Subterráneas or MASAS). For the implementa- processes of CONAGUA at different levels (local, tion of the Ojo Caliente aquifer management state, regional, national) and for all water sec- plan, a special “Water Valuation Trust” was tors. This would allow for a more upstream and proposed, in which various kinds of resources programmatic identification and prioritization of would be brought together for the financing of programs and projects that contribute to meet- activities that are part of the management plan. ing the long-term financial needs of the sector, These kinds of financing schemes should be duly given certain medium- and long-term macro- incorporated in the SFA. economic variables, as well as various social and Figure 4 below summarizes the results of environmental priorities. studies conducted for the development of a management plan for the aquifer, which involves a comprehensive strategy for the different pro- 46  http://www.shcp.pob.mx/EGRESOS/ppi/Paginas/ Sistema_inversion.aspx. grams entrusted to CONAGUA, along with gov- 47  The portfolio would include investment projects as ernment and user initiatives. A similar approach well as non-structural programs and projects linked to the management of water resources and the administra- was used for the Lerma-Chapala watershed, tion of national waters. The investment projects would Chapter 2 where various structural and non-structural cover all subsectors of the water sector. STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 18 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES Figure 4:  Management Approach for the Ojo Caliente Aquifer, Aguascalientes Global Strategy for Integrated Water Implementation Management With Subsidiarity Core Objective Securing water resources necessary for socioeconomic development and quality Assessment of life, for present and future populations in the Aguascalientes Valley PMIR PROMMA PROMAGUA Users Alianza CFE—SHCP Other para el Institutional campo Programs Funding Three Action Implementation, Evaluation Three Instruments Program for Assessing, Coordination, One and Monitoring Implementation Support Unit Members: Water Valuation CNA SHCP CFE Create the Water Rating To manage SAGARPA Trust in Aguascalientes project resources, it is State necessary to establish Goverment a Water Rating State Fund COTAS Operating Rules SHCP – Trustee (NAFIN) Contract of the Technical Technical Committee Structure Committee of the Trust Operation: • Technical Committee Control & President: Governor of Evaluation Technical Criteria and Social Aguascalientes SECOOAM Communication • Technical Secretary: NAFIN The Fund will COTAS Elements • Members: CNA, SHCP, CFE, enable Comptroller SAGARPA, Inagua, COTAS... reconstruction State • SHCP 09 of the State’s Decision on • CFE Strategic Reserve actions to be funds • PHIR • State Gov’t. Action Fund ($) Programs • Federation Implementation, Evaluation Funding Source: CONAGUA (2002). Part 1 Conceptualization of The SFA   19 Management, Performance, 2.3  information found in the different government and Results Indicators units and entities at various levels (federal, state, and local) as well as in the private sector. First For the SFA to function effectively it is necessary and foremost, these indicators should improve and essential that management, performance, transparency and accountability. Data on tariffs and results indicators be identified early in the and subsidies should also be incorporated in the process. These indicators would allow for feed- SFA’s information component. These data could back into the system and make the SFA more serve as the basis for policy recommendations transparent, facilitating the adjustment of cri- aimed at strengthening the SFA. teria, the assessment of the different financing mechanisms, and the development of a monitor- ing and evaluation system. Some of the indicators Mechanisms to Guarantee 2.4  currently in use are based on the Operating Rules the SFA’s Sustainability governing the federal programs or on the indica- tors established for the evaluation of programs Medium—and long-term planning, in combina- and projects. The SFA in its final form should tion with the prospective analyses conducted take into account all the indicators applicable for by CONAGUA, constitute a solid foundation for each and every one of the proposed financing decision-making with regard to the allocation of mechanisms. The SFA must consolidate all the public funds and provides a stream of benefits: Figure 5:  SFA and the Planning Process Physical Framework Socioeconomic Framework Water and Soil Water Demands • National • National Resources Approach Approach • Diagnosis • Diagnosis • Prognosis • Prognosis • Objectives, • Objectives, Water Balances Targets and Targets and Identification of Constrains Policies Policies and Potentialities Alternative IWRM Scenarios Financing and Project Generation Implementation of Programs and National, Eligibility and Projects Regional and Local Viability Initiatives Criteria SFA Performance Indicators Impact Indicators Programs and Projects Portfolio from the Water Sector Process Indicators Source: Original production (adapted from PNH 1975). Chapter 2 STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 20 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES ●● Budgetary certainty. The sustainability of repayment, special funds, etc.), to aid in the SFA depends largely on the assump- its sustainability. This does not necessar- tion that, even in times of austerity, the ily mean that the recoverable investments legislative processes associated with would be collected in a special fund, given water sector-related budget approvals that the repayments would be destined command sufficient financial resources, for the original source of financing (banks, considering other national priorities, private investors, and bondholders, and are consistent with the medium- among others). Recoverable investments and long-term vision arising from the become an additional source of financing planning processes. It is particularly within the SFA to the extent that the credit important not to overlook the fact that commitments are met in time, the per- most programs, projects, and actions in ception of risk is reduced and, with it, the the water sector take more than one year willingness to make resources available in to implement and sometimes more than the market increases. one administration. ●● Specific fund. It is possible to consider the ●● The revenues from the collection of creation of a Water Fund linked to the SFA, tax contributions as established by funded with a share of the revenues from the Federal Levies Act could become the collections of levies for the use of water the permanent funding source for SFA and the charges for effluent discharges, operations, provided these revenues which would be destined to structure were explicitly earmarked for specific financing mechanisms for projects/pro- programs and projects. This earmark- grams specifically earmarked for water ing should include clearly defined resources management. This fund could objectives, especially for those projects also incorporate the financial resources and programs that are generate public allocated to federal programs and other benefits, such as in water management special funds currently managed by and regulation, flood control, hydro CONAGUA. The existence of such a fund meteorological systems, etc. would entail two large advantages: (i) pro- ●● Recoverable investment. Alternatively, vide greater realism and permanence the bottom part of figure 1 (at the begin- to the SFA, and (ii) lay the foundations ning of this chapter) assumes that for a system that would provide greater recoverable investments (repayments) consistency, transparency, and effective- would be reincorporated into the SFA ness to those resources provided by the via pre-established mechanisms (debt federal government. Part 1 Chapter 3 Towards the Formalization of the SFA P rograms, projects, and activities in water are currently implemented through different financing mechanisms, without having to resort to an SFA. However, the financing is channeled through a large number of federal programs with overlapping operating rules and eligibility criteria. Furthermore, the financing gap is increasing so a framework to coordinate and improve the efficiency in the public spending is required. The formalization of the SFA could contribute to improve the abovementioned and will also ensure the compliance of the LAN. Formalizing the SFA would facilitate the encoding of experiences and, thereby, the creation of a permanent system for reviewing, updating, and improving the different transac- tion mechanisms, aside from promoting the adoption of new and innovative forms of financing. The need to manage the financial arrangements for the sustainable development of water resources and its associated services has been highlighted in a recent report by the OECD (2012), which points out that there are several opportunities for Mexico to raise the efficiency of public spending in the water sector. In this context, one of the aims of formalizing the SFA would be to create an instrument that would make it easier to improve the efficiency and effectiveness, as well as the multiplier effect of the public resources applied to the programs implemented in this sector. 3.1  The SFA and CONAGUA’s Scope of Competence According to the conceptual framework presented in Figure 2, CONAGUA coordinates the relationship among the institutions providing financing and those demanding resources to finance their programs and projects,48 including CONAGUA itself as administrator of the national waters. As shown in the conceptual 48  Although initially the SFA would operate in the realm of programs that are under CONAGUA’s care (water supply and sanitation, agricultural irrigation and drainage, flood control, and IWRM), it would be possible and desirable to extend the concept to other sectors. STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 22 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES framework, in addition to its coordinating function, environmental, and economic feasibility. Once CONAGUA has three mechanisms/instruments to prioritized, these initiatives received financing carry out its task in relation to the SFA: (i) the pipe- from one of the existing federal programs. These line of programs and projects in water that enables financing is usually through grant resources for to organize and prioritize actions in accordance capital investments and, in some cases, the with short-, medium-, and long-term financial grants also include subsidies for operations and restrictions; (ii) the Operating Rules that include maintenance. eligibility criteria of different federal programs; It is proposed that CONAGUA’s current and (iii) an information system that includes a responsibilities be expanded under the SFA to series of indicators to monitor the performance of include not only those programs and projects the water supply and sanitation sector. being support by public resources, but rather all programs in the sector, regardless of their Programs and Projects Portfolio funding source. This approach will ensure that The programs and projects portfolio that CONA- CONAGUA has a strategic overview of the entire GUA is responsible for is part of the National financial needs of the sector and can establish a Water Planning System. In this context, the port- dialogue with financial institutions to encourage folio gathers all structural and non-structural their sustained participation in the financing of initiatives that arise from water programming at priority programs and projects. the national, regional, and local level. As depicted Article 9 of the LAN provides the legal basis in Figure 6, all these initiatives are assessed, for the incorporation of the programs and proj- ranked, and prioritized based on technical, social, ects portfolio of the water sector into the SFA: Figure 6:  National Water Planning System Development Water Policies Policies Prospective Technical Analysis Water Plans Water Programs Project Portfolio Structural Adjustments Execution Evaluation Source: CONAGUA (2011). Part 1 Towards the Formalization of the SFA   23 “V. Propose criteria and guidelines that to determine the mechanisms’ effectiveness and will ensure harmony and consistency of efficiency, as well as the measures required for the actions of the federal government improving them. Both the eligibility criteria and regarding national waters and their the ground rules should be updated periodically. inherent public goods, as well as ensure Bringing together the different mechanisms into and monitor the consistency among the one catalogue would allow CONAGUA to conduct various programs and the allocation of a comprehensive analysis with a view to harmo- resources for their implementation;” nizing these tools and, if necessary, set specific criteria to further improve the effectiveness of “VIII. Develop and implement technical these mechanisms. and administrative guidelines in order to prioritize investments in federal public Operating Rules works of water infrastructure and, at the Improvements in the Operating Rules governing request of states, the federal district, and federal programs (grants), such as FONADIN the municipalities, provide guidelines for and other programs that promote private sector prioritizing investments in this area;” participation, can lead to the implementation of projects that are socially and economically “XVIII. Establish national priorities viable, and meet the criteria of fairness, trans- regarding the administration and parency, and accountability. As part of this management of national waters and the effort, it is important to align these operating inherent national public goods referred to rules to ensure efficient and financially sustain- in this Act.” able targets and objectives. The revised rules can also promote policies that entail financial Financing Mechanisms co-responsibility on the part of the beneficiaries As explained in section 2.1, a whole range of of the infrastructure in question and the users of financing mechanisms and their corresponding the associated services. operating procedures exist at present for an array of different programs financial with federal Coordination with the SHCP resources. These mechanisms range from Modifying any of these operating regulations the simple allocation of resources through the requires consultation and coordination with the federal budget to complex financing packages in SHCP and other authorities. CONAGUA’s role which fiscal resources from states and munici- in this context should be one of leadership and palities are brought together alongside funding coordination to ensure that all proper stakehold- from users and the private sector. CONAGUA ers are involved and to implement any proposed currently plays an important operational role in recommendations. most of these mechanisms and in other cases it has a coordinating role. Project Cycle The ground rules governing the transaction In addition to modifications to existing operating mechanisms to access different funding sources rules, it is necessary to strengthen the portfolio of and, where necessary, the criteria for full or par- projects through the various steps of the project tial recovery of investments could be collected cycle. Clear procedures and methods have to be in a catalogue for distribution among interested formulated to ensure the strategic alignment of Chapter 3 parties. Moreover, this catalogue could be used projects and programs with national objectives STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 24 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES and their technical, financial, institutional, framework introduced earlier), to comply economic, environmental and social feasibility. with the provisions of article 111 Bis, 112, In this context, it is essential that the different and 112 Bis of the LAN. entities and agencies formulating programs and ●● Draft a bill based on the provisions of projects receive financial and technical support article 111 Bis through 112 Bis of the required to strengthen their capacity to access LAN to establish the SFA by Presidential funding and prepare viable projects. Decree.49 These provisions, together with the definition of the components referred Indicators to in the previous paragraph, would At present, the weakest point of the conceptual clarify CONAGUA’s and SHCP’s roles framework presented refers to the lack of and responsibilities; the coordination information to duly meet the SFA objectives, as mechanisms with the various institutions stated in the third paragraph of article 111 Bis that are part of the financial system; and of the LAN, in terms of establishing clear “[…] the potential recipients of funding. spending and recovery criteria, where relevant, ●● Prepare arguments—to be presented to for those financial resources, financial account- the competent fiscal and legal authori- ability and management indicators, as well as ties—in support of legal amendments targets derived from the use of those financial that will allow changes to the provisions resources and instruments.” of the LFD. The changes in the latter act CONAGUA has a basic set of data embedded should specify the destination of rev- in an array of different databases and systems enues from the collection of water levies that would allow it to design and implement an and tariffs charged for water consump- information system for the SFA in a relatively tion and associated services. This would short period of time. This system would system- support to the idea of a Water Fund (see atically gather information related to the tariffs Chapter 3). charged for services and to the subsidies that ●● Define the way in which the SFA’s func- affect the sector’s financial policies. The chal- tioning would be set up within CONAGUA, lenge lies in standardizing the various databases based on the responsibilities currently operated by CONAGUA so that a single informa- assigned to the major technical areas in tion system for the SFA may be created. order to, if necessary, lay out the transi- tion process from the current situation to one that would guarantee the SFA’s due 3.2  Formalization of the SFA functioning. The formalization of the SFA is not an easy task To work out the above steps in detail, it is and will comprise a series of necessary steps: suggested that a temporary working group be set up within CONAGUA, made up of repre- ●● Consider the creation of an advisory sentatives of all technical areas, if necessary board or similar figure composed by key stakeholders of the private and public 49  Although initially the SFA would operate in the realm of sectors. programs that are under CONAGUA’s care (water supply and sanitation, agricultural irrigation and drainage, flood ●● Specify the design of the different SFA control, and IWRM), it would be possible and desirable to components (based on the conceptual extend the concept to other sectors. Part 1 Towards the Formalization of the SFA   25 supported by a group of experts. This working federal and state water programs that group would carry out the activities outlined make up the pipeline of projects, among above to formalize the SFA. Other key parties other things. (financial authorities, bank representatives, and ●● Lay the groundwork for the design and private investors, among others) would gradually implementation of the information sys- be incorporated into the SFA. To this end, the tem of the SFA. working group would further proceed to: ●● Produce an operational manual for the SFA, which would include the role to ●● Take stock of the experiences with the be played by each functional area of financing of programs and projects in CONAGUA. water. ●● Identify the current public policies, the Identify initiatives that could be imple- corresponding financing mechanisms, mented in order to draw lessons and conclusions the system for the collection of levies, on innovative and financing mechanisms that general regulations, and the different could be scaled up. Chapter 3 Part 2: Sectoral Initiatives Under The SFA A s part of the work that led to this report and as a result of the dialogue with CONAGUA officials, a number of initiatives were analyzed that could be incorporated into the SFA. Four of these initiatives (technological upgrad- ing and modernization of irrigation and emergency services for floods) are further presented here and could be implemented as pilot projects. The report presents general considerations for potential initiatives on water and sanitation and on the development, management, and usufruct of national waters, as well as the use of public domain goods as wastewater-receiving bodies. Chapter 4 Hydro-Agricultural Sector Initiatives 4.1  Background Water for agriculture is channeled through irrigation districts and irrigation units,50 designed to trans- port large volumes of water to the fields under a shift-irrigation system. At present, producers who use irrigation systems still employ practices and technologies that were adequate at one time but nowadays are no longer acceptable due to their low efficiency, combined with the shortages of water and conflicts over this resource. However, farmers are reluctant to change their current irrigation practices. The reason for this is twofold: (i) the high cost of modernizing an irrigation system, which cannot be financed with easily accessible credit; and (ii) the fact that mandatory water-saving and efficiency actions have been undermined by policies that enable farmers to get their water and energy relatively cheaply. There are just not enough business mechanisms and innovative, long-term credit instruments that allow for a more effective financial participation of all the parties involved; moreover, the financial participation of farmers, particularly small, will require subsidize interest rates to make the credit affordable. A series of proposals and tools to optimize available resources and facilitate access to credit for investments in the upgrading of irrigation infrastructure and plot technological upgrading will be dis- cussed briefly. These tools, as well as the existing ones, would not be mutually exclusive: combinations involving different mechanisms, resources, and parties can be made to create the best fit for every specific situation or project. 4.2  Overview In rural areas, water management is usually characterized by practices that promote water to be wasted, as well as the overexploitation of aquifers. To reverse this situation, the federal government 50  The “irrigation districts” are areas of land linked to a principal project. The “irrigation units” are systems that receive irrigation from water sources (including wells and springs) that are somewhat dispersed. The main difference between the two lies in their origin. The infrastructure of the irrigation units was built primarily by the federal government and right at the start handed over to the users for its administration, and O&M. While the irrigation districts were also built by the federal government, their administration, and O&M were the responsibility of the federal government until being transferred to the users in the 1990s. STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 30 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES has promoted a series of policies aimed at also be informed of the means they have rationalizing the consumption of water in order at their disposal to reach these objectives. to cope with the effects of climate change and ●● A solid argumentation be developed and rising demand for food in the coming years. communicated to agricultural producers It is recommended that the SFA incorporate on the benefits of the use of certain tech- concrete actions in support of agricultural nologies that will be targeted to particular producers so that efficiency and the rational use contexts and needs. of water are enhanced. These programs should ●● CONAGUA rely on a financing mecha- involve subsidies and credits, while at the same nism that: (i) maximizes the use of public time entailing an improvement in the producers’ budgetary to ensure an increase in fund- net income. 51 ing for water infrastructure and improve The main existing financing policies and implementation; (ii) is clear, specific, and mechanisms for the modernization of irrigation easy to access, and that allows for the infrastructure, include the instruments currently participation of private investors, credit being implemented through FIRA, FONAGA, and institutions, and producers; (iii) may be FINCA. The issue to be addressed in principle is combined with other financial structures the balance between supply of and demand for in the market and is compatible with pub- water, particularly in those regions where irriga- lic policies; and (iv) fosters the efficient tion agriculture lays the greatest claim on water; use of water. further, the supply-demand gap is increasing ●● There be due supervision of the granting due to population growth, the inefficiency of of credits and the monitoring of portfo- agricultural systems, and climate change. lios; construction oversight of infrastruc- Closing the existing gap between water ture works is also required. supply and demand requires the modernization ●● There be a financial and technical and upgrading of irrigation systems. It is recom- mechanism to ensure infrastructure is mended that: maintained in the long term. ●● State and local governments be involved ●● The local and federal authorities (primar- in policy formulation as they have high ily CONAGUA and SAGARPA) determine political and economic stakes. Doing the regions in need for modernization so would create more possibilities for and technological upgrading, and pri- actions aimed at implementing comple- oritize them. Furthermore, it is important mentary water and agricultural policies, to identify and assess the technological and facilitate private sector participation. options available, their respective costs, and the parameters to be used in their This report substantiates the need to iden- evaluation. tify new instruments that complement and/ ●● Agricultural producers be persuaded or address the limitations of existing schemes, to adopt modern technology for their particularly to promote the participation of the irrigation systems (by pointing out the private sector in hydro-agricultural projects. The benefits) in order to increase agricultural productivity and personal incomes, as 51  The objectives of generating income, in the context of greater efficiency in the use of water, would be incor- well as raise the efficiency in the use of porated in the eligibility and feasibility procedures of the water. The agricultural producers should SFA. Part 2 Hydro-Agricultural Sector Initiatives   31 feasibility of the latter could be tested through ●● Operating Rules that clearly establish one or more pilot projects under one of the the terms and conditions for the use of proposed structures. This requires changing the resources, taking into account the char- prevalent short-term perspective to a medium- acteristics of each project and the need and long-term business plan. for its continuity, according to a financial plan. These rules will provide incentives for the financing of multi-year programs 4.3  Initiative 1: The Water Fund and projects. ●● A Technical Committee, composed pri- The size and implementation period of infrastruc- marily by representatives of CONAGUA ture works and other structural and non-structural and SAGARPA, established and with the measures for the modernization and technologi- capacity to authorize long-term invest- cal upgrading of irrigation, require that these pro- ment projects. cesses be institutionalized and financial resources ●● Funds would be disbursed through pri- made available over a multi-year period. vate administrative and payment trusts, In order to have a permanent instrument with to be created expressly for each project, sufficient resources, it is proposed that a special irrigation unit or district, to carry out fund be created; the Water Fund (see Figure 7). 52 specific investments. The investments One of the Fund components would aim to mod- would be financed through different ernize and technologically upgrade irrigation. 53 financing mechanisms and/or recover- This component should be complemented by able and non-recoverable contributions other public and private financing instruments (i.e., subsidies). and will have the following characteristics: ●● The use of resources would be arranged through financial support agreements, ●● Designed as a long-term institutional signed between the Water Fund and the instrument, with enough flexibility to projects’ trust funds. These agreements structure different financing mecha- would set out the terms and conditions nisms, involving a mix of public and for the management of federal resources private resources, subsidies and credits, destined for specific, authorized projects, as well as investment schemes and guar- in compliance with relevant legislation. antees and with the capacity to finance ●● The Fund’s resources would come from: multi-year activities. ●● Initially, from the existing budget- ●● Established through the transfer of pub- ary resources of CONAGUA and lic funds to a public trust fund that is not government-owned. 52  The creation of a Water Fund does not necessarily ●● Founded on an agreement with SHCP, imply substantial increases in the budget currently stipulating that a portion of the annual allocated to CONAGUA. Rather, it would imply a restruc- turing of the budget and an improvement in the rules for allocation of budgetary allocations to its exercise, so that the combination with other resources CONAGUA and SAGARPA be allotted to would add to the budget’s multiplier effect. 53  In this context, reference is made to a component the Water Fund. As a starting point, some because the scope of the Water Fund is not restricted of the resources currently allocated to to hydro-agricultural projects but extends to the entire water sector. In fact, the Water Fund’s creation would be federal programs could be transferred to associated with a new idea of the process for program- Chapter 4 the Water Fund. ming and allocating investments. STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 32 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES Figure 7:  Diagram of the Water Fund Mechanism Budgetary Other Resources Resources CONAGUA WATER FUND SAGARPA Project 1 Project 2 Project 3 Fiscal resources Producers Banks/Private • CONAGUA • Fees sector • SAGARPA • Contributions • Credits • FONADIN • Guarantees • Venture Capital • States • Partnering • Other • Other Water Fund Project 1 Project 2 Project 3 Source: Author’s production. SAGARPA, with previous approval ●● Development and/or commercial from SHCP. banks, with guaranteed repayment ●● In a second phase, financial resources sources. must become available from State ●● The Water Fund will have the capacity to and local governments for specific use an array of financial schemes: projects. These financial resources ●● Recoverable funds which are could come from or be guaranteed resources backed by one or more of with shares in federal revenues, the following recovery mechanisms: budgetary resources, levies for (i) capital contributions; (ii) guaran- water use, general taxes, and other tees; and (iii) subordinated credits contributions. and/or credits convertible to capital; ●● Private resources from (i) producer ●● Non-recoverable funds provided by associations; (ii) private companies the Fund for projects financed with a or companies benefiting from the mix of resources and with the partici- Fund; and (iii) investment funds. pation of the private sector. Part 2 Hydro-Agricultural Sector Initiatives   33 ●● The Fund’s contribution—in its various ●● Offer technical assistance for the evalua- forms—to specific projects shall never tion, structuring (of financing), financing, reach 100 percent. Various percentage and implementation of irrigation mod- contributions could be considered, based ernization and technological upgrading on particular purposes or objectives set projects. for in the Operating Rules. ●● Depending on the obligations whose fulfillment is guaranteed, the Fund may Prerogatives provide, among other things, the follow- The Fund will have a series of prerogatives: ing guarantees: ●● “Credit guarantees,” the guarantee ●● Promote the coordination among that a creditor will be paid a certain the entities involved in financing the percentage of the credit he extended, country’s irrigation modernization and in the event of default by the debtor. technological upgrading programs and Also, a certain amount may be guar- projects. anteed, corresponding to the flow of ●● Grant subordinated and/or convertible resources on account of one or more credits, guarantees, and contributions, to debt repayments in a given period, encourage private sector participation. where the aim would be to avoid the ●● Support, through guarantees, the partici- guaranteed credit is pre-paid. Such pation of construction companies and/ guarantees may be given for a specific or other suppliers of goods and services period of time, to boost longer-term (beneficiary companies) in the project lending. tenders. ●● “Performance guarantees,” the guar- ●● Mobilize private capital for project antee that a company participating in financing. the development of a project will com- ●● Assume risks that the market is unwilling ply with one or more of its particular to assume, in order to encourage private contractual obligations. sector participation, including user asso- ●● “Political risk guarantees,” the guaran- ciations and Limited Liability Companies tee that a creditor will be paid a certain (LLCs) of the irrigation districts, as well percentage of the credit he extended, as other associations legally established in the irrigation units.54 54  The initiative should maintain its capital structure ●● Promote the participation of banking and objectives as open as possible to ensure flexibility. This means, for example, that the fund capital could be and non-banking financial brokers in the strengthened with assets from other entities related to financing of projects for the modernization projects for modernizing irrigation infrastructure. If at any given time certain conditions warrant doing so, the and technological upgrading of irrigation. Water Fund should have the flexibility to access and ●● Grant non-recoverable contributions for manage assets requiring a specialized administration, in case the franchisee or service provider, for whatever the elaboration of master plans for public reason, is unable to do so. Similarly, in accordance with works. the corresponding legal status and relevant legislation, it should be entitled to obtain concession rights, licenses, ●● Provide recoverable and non-recoverable and powers granted to the Fund or its trustee. If neces- funding to promote the construction, sary, it has to be possible to have these transferred to enhance its assets and expand available resources to financing, and transfer of infrastructure finance infrastructure, as well as to build, manage, oper- Chapter 4 projects. ate, maintain, and exploit franchised goods. STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 34 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES in the event of non-compliance by a South Africa, Australia, Canada, and more company benefiting from the Water recently, in Mexico as well. Fund or participating in the develop- Several international organizations support ment of an infrastructure project PPPs in the hydro-agricultural sector in coun- that includes a beneficiary company, tries around the world. For example, the World provided the corresponding breach of Bank is supporting PPP experiences in Ethiopia, contract is the result of a legal regula- and Brazil, which are by now at an advanced tion issued by a competent authority. stage of development and implementation. In Mexico, the federal government promoted Pros and Cons a new type of PPP for project development, Table 2 summarizes the arguments in favor of the called the Service Provision Projects (SPPs). In creation of a Water Fund, and the obstacles that 2003, the SHCP established the correspond- would have to be overcome to ensure its viability. ing regulatory framework, which has allowed for the implementation of projects in health, transportation, and education. Since January Initiative 2: The Public 4.4  18, 2012, these contracts have been under the Private Partnership (PPP) framework of an expanded regulatory frame- Scheme work set by the LAPP. Scheme Background Through the PPPs, a private investor operates PPPs have been around globally since 1992. and maintains a certain infrastructure that The first schemes of this kind were introduced meets pre-established quality standards. The in the United Kingdom. At present, 25 countries investor designs, builds, finances, maintains, are using this kind of financing for investment and operates all the facilities needed to provide projects; the main projects are located in Europe, a defined service during a specified period of Table 2: Pros and Cons of the Water Fund Pros Cons • Maximizes budget resources for the water sector. • The Mexican parliament is reluctant • Allows for the development of projects in the to use trust funds because they feel it medium and long term. would imply the loss of direct control over • Facilitates the implementation of different financing resource allocation. mechanisms, recoverable and non-recoverable • The SHCP has to agree to earmark contributions, and risk capital. specific budget items for the Water Fund • Allows for the participation of new investors in the or to channel the funding reserved under industry and promotes commercial credits. specific budget items that currently • Allows for the development of a larger number of correspond to federal programs projects, of a wider scope. (subsidies) in support of modernization and technological upgrading of irrigation • Allows for the planning and joint coordination (both from CONAGUA and SAGARPA) to by CONAGUA and SAGARPA of the actions and the Water Fund. investments in the sector and the achievement of specific objectives and programs. • The operational regulations governing existing programs have to be modified so • Flexible Operating Rules to concentrate resources in that financing is more transparent and those areas where they are most needed. greater accountability is ensured. Part 2 Hydro-Agricultural Sector Initiatives   35 time or receives a periodic payment from the ●● The services to be provided by the pri- government as compensation, based on the vate investor will include water transport quality of the services provided. Payments to the and delivery; maintenance; insuring the investor are recorded as running expenditures facilities; and providing services. and can come from a mix of public and private ●● Depending on the characteristics of resources. Public participation must be autho- individual projects, other services such rized in the budget and, if financial resources are as technological upgrading; training; used for payments covering a period longer than agricultural extension; marketing sup- one year, they must have a multiannual budget port; and equipment can be provided. authorization. ●● The funds necessary for the implemen- In Mexico, PPPs already exist in the irriga- tation of PPP projects will be estab- tion districts; the water users associations lished separately for each project and (private) rely on the federal government and may come from public resources, the sometimes state governments, to rehabilitate, purchase of equipment and technical maintain, and preserve the systems. However, facilities on installment plans, capital new schemes that go beyond the current, short- contributed by producers, and private term conceptions need to be designed, to make investment. investment projects of a relatively wide scope (which demand large investments, and differ- Required Actions ent financing and repayment schemes) more In order to ensure the success of the PPPs efficient and effective. schemes, the following actions must be properly For the development of PPPs in the hydro- undertaken: agricultural sector, innovative schemes must be devised, in coordination with CONAGUA, ●● Clear definition of the Reference Project SAGARPA, and the SHCP. These PPPs will have (Project Definition Report or something the following characteristics: similar for irrigation units), based on the regulatory and legal framework. ●● The projects are carried out for the irriga- ●● Define the PPP in question, its payment tion districts and units. source(s), and project characteristics. ●● Private investors must design, build, To this end, and according to the LAPP, maintain, insure, and operate the infra- the objective of using the infrastructure structure and equipment in question for a provided by the private sector must be period of time as derived from the corre- to improve social well-being and increase sponding financial model, considering it investment levels. Moreover, in the case is a long- term investment (in accordance of the water sector, the sustainability of with article 2 of the LAPP). water resources must be ensured and ●● The infrastructure can be publicly or food production increased. privately owned, depending on the ●● Identify retained and transferable risks. specifics of the case. For example, the ●● Determine the guarantees, coverage, infrastructure for distribution in the and insurance to be contracted by the irrigation districts is public (similar to the provider. water supply network), while at the parcel ●● Determine the optimum term of the con- Chapter 4 level it is private. tract, taking into consideration the input STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 36 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES costs, the life cycle of the materials, the presented to the House of Representatives.56 maintenance periods, etc. Likewise, the projects must be authorized by the ●● Determine property and real estate Inter-secretarial Commission on Public Expendi- needs, as well as the fiscal requirements tures, and Financing, and Privatization.57 to be paid to develop the project. ●● Prepare a financial model to support a Pros and Cons comparative analysis. Table 3 summarizes the arguments in favor of ●● Conduct a comparative analysis of the implementing PPP projects, and the obstacles scheme versus the current situation. that would have to be overcome to ensure their ●● Conduct a legal analysis to determine the viability. project’s viability. It is proposed that a series of pilots be ●● Define the methods and formulae that will selected that could be implemented under a PPP be used to evaluate the providers’ perfor- scheme; this will demonstrate the conditions mance; defining the form and terms to under which such a scheme could be viable. be used in establishing, calculating, and implementing the applicable discounts. ●● Demonstrate the PPP scheme’s financial 55  Article 17 of the LAPP. advantage vis-à-vis other financing 56  LAPP, Article 14: “The Ministry of Finance and Public Credit, when presenting the draft Expenditure Budget options. of the Federation must include, under article 24 of this ●● Ensure that risks are properly distributed Act and article 41 of the Federal Budget and Finance Responsibility Act, an assessment of the impact of the between the government and the private PPP projects on public finance during their life cycle. investor (the principle of the best quali- Likewise, the SHCP shall report in its Quarterly Reports on the economic situation, public finance, and public fied agent). debt situation, in terms of the applicable provisions, the description of each authorized project, the amounts A cost-benefit analysis55 will justify a PPP disbursed and to be disbursed based on the relevant forecasts and estimates, the progress made in its imple- scheme if the project generates benefits (net, mentation, implementation schedule, as well as annual equal or greater than a traditional investment payments committed.” 57  LAPP, Article 21: “Based on the analyses mentioned project subsidy/public work). The assets may be in article 14 of this Act, the agency or entity shall decide owned by the private investor or the government, if the project is viable or not and, if considered viable, shall proceed with its implementation and develop- depending on the agreement under a long-term ment, following the analysis and authorization of the contract and in accordance with the applicable Inter-secretariat Commission on Public Expenditures Financing, and Privatization, for purposes of article 34 of legislation. The LAPP stipulates that the previous the Federal Act on Budget and Fiscal Accountability, and information must be posted on the Internet and article 24 of this Act. Part 2 Hydro-Agricultural Sector Initiatives   37 Table 3: Pros and Cons of the PPP Pros Cons • Allows for multiannual investments, thereby making • Once the running expenditure budget is the planning of larger-scale projects feasible. committed (substituting for the investment • Longer-term financing may be provided and are expenditures), there is a risk that the entity covered with running expensesa or through different may not be able to move on to other projects repayment schemes, structured differently for each because the expenditure has already been project. committed. On the other hand, this could • The investments’ source of payment is a avoid the politicization of the project. compensation included in later budgets, allowing   • It could have some political impact, the investment to be made by a private party and because it does not follow the to be covered during the period the service is traditional public work scheme. provided. However, it is already supported by the • Allows for the compensation to be used for the LAPP.c service provision, duly guaranteed as payment   • If the projects in question have a mixed source for the credits; this, in turn, makes the payment source (that is, involving projects “bankable,” reduces financing costs, and public and private funds), a cash enhances the quality of credits, thereby lowering payment source will be required from interest rates. the private component in the long term, • The applicable regime is the LAPP and, to ensure the project is bankable.d consequently, the PPP is not subject to the Public • A solid technical and financial capacity is Sector Procurement, Leasing, and Services Act or required in order to avoid guaranteeing the Public Works and Related Services Act.b high-risk projects. a  The fifth paragraph of article 24 of the LAPP points out: “In the draft decree of the Expenditure Budget for each year, the multiannual spending commitments deriving from PPPs shall be provided in a specific chapter and by sector, so that, where necessary, such commitments may be approved by the House of Representatives in order to proceed with the contracting and execution of the projects. In addition, a description of each project must be provided, including the amounts disbursed and to be disbursed based on the relevant forecasts and estimates, the progress made in its implementation, the implemen- tation schedule, as well as annual payments committed.” b  LAPP, article 105: “The construction, equipping, maintenance, conservation, and rehabilitation of the infrastructure of a PPP project shall be done according to the program, characteristics, and technical specifications agreed on in the relevant contract, as well as comply with regulations regarding environmental protection, preservation and conservation of the eco- logical balance, human settlements, urban development, and other applicable federal, state, and municipal regulations. The infrastructure works and services implemented by private parties to comply with their obligations in a PPP project shall not be subject to The Public Works and Related Services Act, or to the Public Sector Procurement, Leasing, and Services Act, or to provisions derived from these Acts.” c  Ibid. d  Under article 110 of the LAPP, the non-public goods related to the service provision may be used as a guarantee and, in case of foreclosure, the banking institutions are entitled to the revenues generated by the projects in question. Chapter 4 Chapter 5 Disaster Risk Management Initiatives 5.1  Background Mexico is exposed to different types of disasters. The geographic location of the country makes it particularly vulnerable to seismic and volcanic activity, while its location in the inter-tropical region makes it susceptible to tropical storms along the coasts of the Caribbean, the Pacific Ocean, and the Gulf of Mexico. These tropical storms periodically affect the populations by causing strong winds and significant amounts of rainfall, leading to severe damages and widespread flooding. CONAGUA plays a key role in the prevention of and response to disasters caused by these extreme hydro-meteorological events. According to the National Center for Disaster Prevention (Centro Nacional de Prevención de Desastres or CENAPRED), in the period 1980–99, Mexico suffered 75 disasters of a significant size, causing over 10,000 deaths (see table 4) and hundreds of thousands of victims suffered from dis- placement and the loss of valuable assets. The cost of direct damages in that period reached US$9.6 billion, giving a yearly average of approximately US$500 million. If indirect damages are also taken into account, that is, the interruption in the production flows of goods and services, at least another US$40 million a year would have to be added.58 Table 4 shows that the total number of fatalities caused by hydro-meteorological phenomena is 2,767 persons. Total direct damages for these weather-related disasters have been estimated at US$4.4 billion. Table 4:  Victims and Damages Due to Disasters in Mexico (1980–99) Direct Damages Indirect Damages Total Damages Type of Phenomenon Fatalities (US$ million) (US$ million) (US$ million) Hydro-meteorological 2,767 4,402.3 144.9 4,527.2 Geological 6,097 4,043.7 516.4 4,560.1 Chemical and 1,250 1,149.7 133.6 1,283.3 environmental Total 10,114 9,595.7 794.9 10,390.6 Source: CENAPRED. Overview of victims and damages caused by disasters in Mexico by type of event (in millions of US dollars; source: 58  CENAPRED). STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 40 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES Natural disasters require increasing amounts resources available from FONDEN, local govern- of public resources. According to the SHCP, the ments commit to provide resources should they average amount spent on national disasters be required to respond to the impacts of disas- has gone up from Mex$28 billion in 2001 to ters. It is important to emphasize that FONDEN Mex$11,937 billion between 2007 and 2009. In as well as other existing and/or new financing 2010 alone, the year with the highest number instruments, should begin promoting a culture of natural disasters ever registered in Mexico, that emphasizes prevention, which will be further the 40 main disasters, which affected 18 states, strengthened by the active participation of local cost around Mex$23 billion. It is expected that governments and civil society. the number of natural disasters in Mexico will The rising claims on public funds due to a increase in the coming years. Due to its geo- growing number of disasters calls for a permanent graphical location, Mexico is highly vulnerable to strategy to promote the design of legal and financial natural phenomena due to(i) its location in the instruments to address prevention and mitigation “Ring of Fire”, where 80 percent of all seismic and activities related to natural disasters. This applies volcanic activity takes place; (ii) its location in four to emergency and non-emergency situations, of the six cyclone- generating regions of the world; when investments are needed for adaptation and (iii) the consequences of global warming. measures and the strengthening of non-structural The Natural Disasters Fund (Fondo de actions that will contribute to mitigating the effects Desastres Naturales or FONDEN) is an inter-insti- of global warming. During emergencies, water tutional instrument and financial mechanism supply and sanitation services suffer from disrup- aimed at channeling resources to mitigate the tions and must be normalized rapidly in order to effects of natural disasters. The General Rules avoid adverse health impacts. While CONAGUA of the Natural Disasters Fund (henceforth “the does have emergency equipment, sometimes it Rules”) regulate access to the Fund, according does not have enough budgetary resources to to principles of complementarity, timeliness, duly operate them when emergencies strike. On and transparency. The FONDEN resources are many occasions, local water infrastructure is not limited, considering they are an instrument of adequately insured, so the costs of reconstruction national coverage. Therefore, it is recommended are not contemplated. As such, there is a need that new instruments be developed to comple- for public resources, both federal and local, for ment the resources available through FONDEN emergency response, which covers both invest- to respond to national disasters and invest in ment and operating costs. Timely and adequate disaster prevention and mitigation. In addition, financial contributions are usually hindered by local governments should contribute resources, budgetary and political considerations, primarily and savings should be pursued by harmonizing because the institutional and financial instru- policies and good practices. ments have yet not been designed. FONDEN has proved to be a fundamental instrument in responding to disasters and must remain a fund to respond to the impacts Initiative 1: The Contingent 5.2  of natural disasters and not be considered an Line for Priority instrument to merely have access to additional Investments federal resources, given the low investment capacity of local governments. For this reason, it The first initiative consists of the creation of a is important to ensure that, in addition to federal contingent line for each state with a development Part 2 Disaster Risk Management Initiatives   41 bank, which will allow it meet its immediate obli- of the drawdowns against the line. This would, gations as counterpart to the federal resources in turn, create a revolving credit line, ensuring and cover the operating costs of the emergency a long term sustainable instrument. The line equipment provided by CONAGUA, and the could also be used as a guarantee mechanism needs for investments in infrastructure. The or alternative payment source for other PPP or contingent line should be destined to: (i) cover financing projects. the operating costs of the equipment provided The contingent line could be implemented by CONAGUA when required; (ii) cover the local in the short term with those states that have a counterpart financing required for reconstruc- higher probability of being impacted by natural tion of infrastructure; and (iii) complement pub- disasters. However, the Agreement must be lic and private resources used for infrastructure negotiated separately between a development works aimed at mitigating the impact of future bank and each participating State. natural disasters. The contingent line should be set up along Pros and Cons the following criteria: Table 5 summarizes the arguments in favor of the creation of a Contingent Line for Priority ●● Amount of the contingent line: To be Investments, and the obstacles that would have determined on a case-by-case basis, to be overcome to ensure its viability. based on the incidence rate of natural disasters in each state, its population size, and debt capacity. Initiative 2: The Climate 5.3  ●● Payment sources: Budgetary resources Change Investment Fund from the fiscal year immediately following the year that the emergency occurred. In order to have a long-term instrument effi- ●● Guarantee: The share of the federal ciently addressing investments infrastructure income that the state and/or municipali- needs and to minimize the impact of climate ties are entitled to. change, it is suggested that a Climate Change ●● Drawdown: The state must arrange Investment Fund (CCIF) be established, as a with FONDEN the right of access to the component of the Water Fund (see section 4.1), contingent line, according to the terms funded by the federal income allocations to the and conditions of the Coordination States. The creation of a CCIF would provide a Agreement. new, long-term, institutional financing instru- ●● Interest Rate: 0-percent interest rate ment, with enough flexibility to implement during a maximum term of 12 months different financing schemes. Through this Fund, from the date of the first drawdown. the States could finance investments required to ●● Commissions: To be negotiated with the deal with the imminent effects of climate change. development bank in question. Characteristics It is suggested that the line of credit be ●● The Fund would be established as a guaranteed through the shares in federal income Management and Payment Source Trust that the state and/or municipalities are entitled Fund in a development bank. It would be to. This will ensure a bankable instrument as the constituted and financed with resources Chapter 5 creditor is given the guarantee of repayment corresponding to the participations in STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 42 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES Table 5: Pros and Cons of the Contingent Line for Priority Investments Pros Cons • The participation of the local governments is • Possible resistance on the part of the properly institutionalized. States to participate in the scheme. • Contribution of local resources in emergency • Resistance to indebtedness. response, normalization, and urgent works is • Lack of political support in some States. encouraged. • Resources are available for immediate use to cover the operating costs of emergency equipment. • There would be no delay in the contribution from the local counterpart for works undertaken during the normalization phase and urgent reconstruction works. • Greater commitment from the States. • More efficient management for the contracting of services and for ensuring the participation of the private sector. • Necessary and urgent works are completed. • Investment planning may be improved. • Contingent line may be used as guarantee or alternative payment source for PPP schemes. federal income that each State and sev- some municipalities. The percentage eral municipalities are entitled to, as well should vary according to the incidence of as federal budgetary resources. Addition- natural disasters in the entity in question ally, it would be convenient to have an and its development level. ad-hoc fund to finance the investments ●● The States, municipalities, and various required to address the effects of climate federal government agencies will define change (for instance, increasing the the type of projects that could funded by supply of water, increasing the efficiency the CCIF and plan their implementation, in the use of water, disaster prevention). giving priority to investments in higher- Alternatively, the fund could be created as risk and more vulnerable zones. a sub-account for Climate Change Invest- ●● Can receive participation from different ment within the National Infrastructure financing schemes to leverage funding. Investment Fund (Fondo Nacional de ●● It could be used as a payment source for Inversión en Infraestructura or FONADIN), PPP contracts. to be managed by FONADIN. This would require a modification of the Operating Pros and Cons Rules and other legal instruments. Table 6 summarizes the arguments in favor of ●● It would annually receive a percentage the creation of a CCIF, and the obstacles that of the participations from the States and would have to be overcome to ensure its viability. Part 2 Disaster Risk Management Initiatives   43 Table 6: Pros and Cons of the Climate Change Investment Fund Pros Cons • The CCIF represents a long-term, institutional • Negotiations with federal entities on the financing scheme that could be used to finance proposed scheme may prove difficult. investments in vulnerable conditions • Not all States and municipalities may be • The active and committed participation of States willing to participate, especially if they and municipalities would be institutionalized. perceive low vulnerability to natural • The CCIF is a financial instrument that would disasters. effectively and specifically address the investments • Some states and municipalities are at needed to deal with the effects of climate change. high risk for natural disasters, which could • Resources available for investments would be generate an imbalance in the allocation of maximized through collaborating with financing resources. schemes. • The proposed scheme may lack political • Private participation in investments would be support. encouraged by having a secure and permanent payment mechanism. • Investments could be implemented under a PPP arrangement. • The CCIF could be used as a guarantee or as an alternative source of payment to the PPP. Chapter 5 Chapter 6 Water Rights T he 1992 legal reform of the LAN incorporated a series of economic instru- ments to manage the water resources of the country in order to encourage a more efficient allocation and use of water. One of those instruments are water rights and by creating the possibility of transferring the rights associated with their respective concession titles, the LAN established a market for rights. This is a regulated market, since third parties and water quality are invariably affected—externalities that prevent the market from operating adequately when left alone. 6.1  The Water Rights Market The basic characteristics of the water rights market, established in 1992 and amended in 2004, are the following: ●● Article 25 of the LAN states that “The concession holder may totally or partially modify the use of the water licensed, as long as the consumptive use established in the corresponding title is not altered, provided the change is final and the concession holder provides timely notice to the Water Authority for the purpose of updating or modifying the respective discharge permit and, where needed, updating the REPDA.” Authorization will always be required when changes are made to the consumptive use stated in the corresponding title; the point of withdrawal;59 the discharge site; or the volume or quality or wastewaters.”60 ●● General provisions (articles 33 to 37 of the LAN) regulate the transfer of water rights outside the irrigation districts and units. ●● The possibility of “establishing final or temporary agencies to manage the regulated opera- tions of the transfer of water rights, called water banks, is defined. The Bank’s functions will be 59  The process of abstracting water from any source, either temporarily or permanently; most water is used for irriga- tion or treated to be safe for consumption. Water withdrawal is also known as water abstraction or water extraction. 60  This is an important restriction of the free transfer of water rights, meant to ensure that the rights of third parties are not affected nor is the quality of the water that down-stream users benefit from. It should be noted that what is set forth in this article concerning the regulation of water right transfers has not been put in practice. STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 46 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES determined in the respective regulations” of water rights transferred (see table 9). Infor- (article 37 Bis of the LAN). mally it has been reported that in some cases ●● A special regime for the transfer of water the recipient of the transferred rights does not rights for agricultural use (articles 49 and formally register the change of use (for example, 51 of the LAN), with specific modalities from agricultural use to public-urban use). for irrigation districts (article 70 of the Ninety three percent of the water right transfers LAN), as well as for irrigation units (article corresponded to groundwater and 7 percent to 58 of the LAN). surface water. The data on transfers registered in the The implementation of the water rights REPDA do not include the value of those trans- market, as envisaged by the LAN, is linked to actions nor those rights transferred to non- the REPDA, and the necessary administrative agricultural uses. Based on informal sources, the infrastructure for monitoring and controlling the value of the transactions range between Mex$20 existing titles and the transfers made. Despite to Mex$50 per cubic meter. some of the limitations that the national waters In accordance with a limited interpretation administration faces today, the volume of water of the LAN, CONAGUA has established Water right transfer applications and the demand for Banks with the responsibility to assist to assist water rights show an upward trend. and record the voluntary transactions of water Of all the applications for a transfer of water rights. The registration helps ensure that that rights received in the period 2002–09, a total of these transactions comply with the law and 73.73 percent were granted, 16.33 percent were that the stakeholders have legal certainty turned down, and 9.95 percent were reported regarding the validity of the acquired rights. pending (CONAGUA, 2010a). According to infor- Presently, the limitation of the Water Banks is mation provided by REPDA (CONAGUA, 2009), the lack of clear links with other processes to agricultural users show the highest volumes manage the regime of concessions that would Figure 8:  Volume of Transfer Applications and Demand for Water Rights 5,000 700 600 Volumes (in millions of m3) 4,000 Number of Applications 500 3,000 400 300 2,000 200 1,000 100 0 0 2002 2003 2004 2005 2006 2007 2008 2009 Volumes to assign Number of applications Source: CONAGUA (2010a). Note: Volumes in m3. Part 2 Table 7: Change in the Use of National Waters in 2008 (in Cubic Meters) Initial Agri- Agro- Aqua- Public Hydro- Total initial use cultural industrial Multiple Domestic Industrial Livestock culture Urban Services power use Agri- cultural 216,675,290 240,000 5,188,284 78,000 4,905,657 1,541,273 1,300,000 6,072,319 3,028,203 0 239,029,026 Agro- industrial 0 0 0 0 0 0 0 0 0 0 0 Multiple 2,839,558 0 30,653083 84,455 1,437,447 459,662 0 964,000 463,212 0 36,901,417 Domestic 1,040 0 1,531 23,418 0 319 0 0 0 0 26,308 Industrial 70,490 0 10,000 12,000 20,450,720 0 6,000 0 1,668,607 0 22,217,817 Livestock 203,280 0 14,873 0 41,610 3,301,122 0 0 7,200 0 3,568,085 Aqua- culture 0 0 100,000 0 0 0 1,203,760 0 0 0 1,303,760 Public- Urban 0 0 900,000 0 81,690 0 0 2,008,009 120,000 0 3,109,600 Services 4,074 0 2,553 10,000 231,826 0 0 150,000 10,909,345 0 11,307,798 Hydro- power 0 0 0 0 0 0 0 0 0 802,259,000 802,259,000 Total final use 219,793,733 240,000 36,870,323 207,873 27,148,949 5,302,376 2,509,760 9,194328 16,196,568 802,259,000 1,119,722,910 Source: CONAGUA (2009). Water Rights   47 5 Chapter 6 STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 48 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES allow detecting cases of undue accumulation the related water rights. The program was a suc- and speculation. cess because it increased the mean supply and To some extent, the amendments to the LAN reliability of delivery of water, making the system that went into effect in 2004 rather than improve overall less vulnerable. When implemented the functioning of the water markets actually led in agricultural production areas supplied by to a dispersion of provisions and more complica- underground water, PADUA is relatively effective tions in the administration of the concessions in enhancing the sustainability of the country’s regime. However, the amendments also offer overexploited aquifers primarily because the an opportunity to boost the regulated water Program withdraws concession titles from the market and strengthen the Water Banks through market, effectively lowering the total amount of the legal route. Beyond the legal aspects, the 61 water extracted. Monitoring though makes such proper functioning of the markets requires a programs very complex to fully implement, par- suitable database, fed by the REPDA and other ticularly in areas with a large number of under- computer systems operated by CONAGUA. ground wells that are owned by private agents. While significant amount of resources have been invested in the Program, the evaluation of 6.2  Water Bonds its effectiveness has been hindered by the lack of adequate indicators, lack of monitoring, and In several countries, different ideas have emerged slow registration process which impose high for the generation of Water Bonds, based on transaction costs. The existence of illegal wells water savings achieved either voluntarily or as a further limits the overall success of such Pro- result of public policies. These bonds are differ- grams. Even so, an assessment carried out by ent from those normally issued for the financing the UN Food and Agriculture Organization (FAO) of specific programs or projects (see the experi- in 2004 (FAO-SAGARPA, 2005) concluded that ences in OECD 2010 and 2012). For example, “… the implementation of PADUA in the irrigation in Chile, the Ministry of Planning has proposed districts which rely on surface water contributes the creation of a “Community Market of Water to reducing the degree of oversizing; guarantee- Bonds,” in which the fines charged for illegal ing the water supply for agricultural users; and withdrawals and other revenues associated with saving water to achieve the resource’s sustain- excessive consumption would be transformed ability.” More recently, other initiatives have been into Water Bonds for financing community proj- ects (not necessarily related to water In Mexico, a similar initiative was launched 61  For example, the Water Banks could become some sort of water rights “corridor.” Either through a voluntary through the Water Use Rights Adjustment Pro- waiver or through a bailout, the Water Banks could gram (Programa de Adecuación de Derechos temporarily collect these water rights and reassign them in conformity with the regulatory rules. The Water de Uso de Agua or PADUA). PADUA has the Banks would not be buying rights—in breach of the objective to preserve the productivity and Constitutional rules—but rather, these Banks would be managing the rights and reassign them in accordance competitiveness of irrigation districts through with efficiency, equity, and sustainability objectives. In the permanent buyback of water rights. PADUA this way, the Water Banks could play a valuable role in bringing closer together and coordinating the demand tries to match the demand with the availability and supply of water rights. The revenues derived from of water under different hydrologic conditions. these transactions could be channeled to a Water Fund set up to finance projects aimed at, for instance, reducing From 2004 to 2006 the program bought back the overexploitation of aquifers or promoting the efficient 130 million of m3 water. Additionally, it validated use and conservation of water. Part 2 Water Rights   49 proposed within CONAGUA. One of those seeks discharge. A secondary market has developed to incorporate a mechanism similar to the clean around these coupons. development mechanism but in the water sector In a second stage, the basic principle is to (Freig, 2011). reward the users who save water through a non- CONAGUA has recently started a new initia- monetary instrument that could be exchanged tive to promote water bonds (H20 Bonds). This for cash at a later stage. Through its River Basin instrument could be implemented once the nec- Organizations, CONAGUA would act as the essary conditions for institutionalizing a formal referee for similar Water Bond market transac- water market in Mexico have been created. The tions. Users would have the right to transfer their Bonds would promote water conservation and water savings to other users, provided their total encourage users to invest in the modernization consumption is below a specific water user effi- and technological upgrading of their parcels, ciency parameter; the latter would vary according so that optimum levels of exploitation may be to crop grown and the type of irrigation system reached. used. The standards to be developed would have The proposed scheme works is similar to to be recognized by all participants in the scheme. instruments being used in the United States In the final implementation stage, legal which involve tradable coupons entitling their amendments would be required to set deadlines owner to discharge effluents into water bodies to be met by each category of users for reach- under regulation of quantity and quality of the ing the maximum level of water consumption Figure 9:  Water Bonds According to Freig (2011) Replicating the CDM global system for a national water system, the roles and functions could be: User Use Authorized Third-Party CONAGUA Authorized Third-Party (Developer) (DOE) (JEMDL) CONAGUA Design Validation Report Verification • Water-Saving Project • Preliminary review • Focus on the • Periodic monitoring Design Document by an authorized who broader aspects of and verification (i.e., • In standard format is certified and the project each fiscal year) to • In compliance with previously accredited • Resolution by verify the continuity pre-approved • Thorough review to CONAGUA for. of the assumption methodologies ensure that the • The granting of the that gave rise project adheres to interruption for the (investment) to the Rationale for: the operating rules expiration of increasing efficiency • Baseline and methodology untapped volumes of water volume. • Additionality • Strict review of • The authorization to • Estimation of water supporting exchange water volume reduction documentation bonds • Monitoring plan The real and effective collaboration between users, experts and CONAGUA will be determinant to design a system and streamlined approval process that is adequate, equitable, meets the needs of both parties and provides effective solutions both in costs and approval times. Chapter 6 5 Source: From Freig (2011). STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 50 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES allowed. Failure to meet the deadline or exceed- derived from the collection of levies have sup- ing the consumption cap, would require the user ported contracting of external credits for a total to purchase H20 Bonds at a price dictated by amount of more than US$2 billion. CONAGUA. Private players could be encouraged The bulk of the levies collected for the use to invest in these special bonds if the latter could or usufruct of national waters comes from be used to pay for certain taxes and for buying industrial, commercial, and water service users water-saving equipment. (between 70 and 80 percent). The collection of The aforementioned initiatives have similar levies associated with hydro-power generation, characteristics. It is clear that the water rights which has decreased from 8 to 6 percent, strongly market needs to be strengthened as well as depends on annual precipitation conditions.62 CONAGUA’s authority to establish a proper certi- The collection associated with urban-public use fication system. Implementing these initiatives will has gradually increased, due to a series of incen- require modifications to existing legal frameworks tives to ensure that water utilities meet their fiscal and improvements in the monitoring systems obligations. Almost 58 percent of total collection used to estimate water consumption. The ideas comes from users in three water-administrative for strengthening the water market and creating regions: Río Bravo, Lerma-Santiago Pacífico, and Water Bonds are promising, and should be pro- Valley of Mexico. Effectively, there are significant moted as a medium-term initiative for the SFA. cross-subsidies to the irrigation and water supply and sanitation subsectors. Cross-subsidies also exist between different regions of the country. Directing the Income 6.3  Even though the collection of these water Generated by Water Use use fees has represented a large percentage of Rights the budgets allocated to CONAGUA, the current concept has strayed from its original concept in During CONAGUA’s first five institutional years several ways: (1989–94), it fiscal revenues from the payment of water use rights and other related levies 62  The smaller the rainfall, the smaller the volumes used increased to 90 percent of its budget. Resources to generate hydro-power. Figure 10:  Composition of Levies 12,000 100% Millions of Pesos in 2009 Prices 79.1 80.2 81.0 81.1 79.3 78.9 79.3 78.3 73.8 74.1 80% 8,000 60% 40% 4,000 19.8 19.4 16.6 16.2 16.1 14.1 14.7 13.6 14.5 14.4 20% 0 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: Estadísticas del Agua en México, 2011 edition. Use or usufruct of national waters Supply of bulk water Total Part 2 Water Rights   51 Table 8:  Collection by Type of Use (in 2007 Millions of Pesos) Use 2000 2001 2002 2003 2004 2005 2006 2007 General Use* 5,565.0 5,547.8 5,261.8 5,362.5 4,952.4 4,847.5 4,609.0 4,948.9 Urban-public 486.3 459.4 1,205.9 1,722.1 1,683.8 1,802.6 1,589.8 1,710.2 Power plants 558.3 451.1 415.0 349.6 386.7 388.4 453.6 435.2 Spas and 24.6 25.5 24.1 1.1 19.8 20.4 20.3 19.5 recreation centers Aquaculture 0.2 0.5 0.4 0.9 0.6 0.5 0.3 0.5 Total 6,634.4 6,434.3 6,907.2 7,436.2 7,043.3 7,059.4 6,673.0 7,114.3 Source: Estadísticas del Agua en México, 2009 edition. Note: Total may differ from the sum of the individual figures as a result of rounding. * Refers to any use other than those specified. ●● The budgetary allocation required to infrastructure, rehabilitation of existing one, ensure proper water resources manage- and operation and maintenance, are much ment (monitoring networks, manage- higher than the current federal resources ment of the concession regime, programs allocated to CONAGUA. But it is important to to restore the balance in aquifers and ensure that the national waters are managed to watersheds) is currently way below the ensure the long terms sustainability and to pro- needs. vide all the necessary services. The PEF does ●● The existing budgetary allocations are not consider the financial needs to manage destined for investment programs in and conserve the national waters. It is highly support of irrigation and water supply recommended that discussions be initiated and sanitation development programs with SHCP as well as Congress to highlight the and projects rather than on management consequences and long term impact of failing of the national waters. to cover those financial needs associated with ●● The LFD earmarks part of the water lev- the management of national waters (in terms ies collected for CONAFOR (Mex$300 of quality and quantity, surface and ground- million) and water supply and sanitation water). CONAGUA could propose the financial utilities63 but it should also earmark needs required to ensure long term water resources for the water management. management that would ensure that the main A back of the envelope analysis suggests objectives, as established by its National Water that earmarking 30 percent of the rev- enues stemming from water use rights 63  Through PRODDER, CONAGUA returns to the water would enable to strengthen and modern- utilities the amounts collected on account of water ize the water management systems. duties, under the premise that an amount equal to the amount refunded will be used by the water utilities to undertake actions aimed at raising efficiency. However, due to the lack of effective verification mechanisms, the utilities instead often use those resources for other pur- 6.4  Legal Reform poses. In a way, then, these refunds of levies somehow become perverse incentives for not raising the tariffs for their services. Something similar occurs with the It is acknowledged that the level of invest- resources obtained from the collection of wastewater Chapter 6 5 ments required for the development of new discharge levies. STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 52 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES Program (Programa Nacional Hídrico or PNH) the financing mechanisms that would allow to: are met. (i) secure support of the activities related to water An amendment to the LFD, as part of the management, and (ii) serve as an effective coun- medium-term initiatives of the SFA, would allow terpart for the implementation of schemes that turning the revenues collected by CONAGUA favor the mixing of public and private resources, into financial support for the introduction of directly or through their securitization. Part 2 Chapter 7 Water Supply and Sanitation There are multiple challenges in the financing of water supply and sanitation services: ●● Lack of financial viability of most water utilities. State laws proclaim the obligation to set tariffs that allow for full cost recovery. In practice, the tariffs, which must be approved by the local congresses, with some exceptions, do not fully cover real costs. Federal support, based on the current Operating Rules of federal supported programs, is lax when it comes to ensuring a proper tariff structure. The low efficiency of the water utilities substantially contribute to the financial deficit. ●● Budget Cycle of Federal Support. The existing one-year budgetary cycle imposes severe constraints in the design and implementation of infrastructure projects. ●● Competing Operating Rules of Federal Programs. The existing rules for the different federal programs in water supply and sanitation are not sufficiently linked to broader strategic objec- tives or results regarding financial efficiency and sustainability and the rules across programs are often with different types of requirements, some of them lax. ●● Lack of Solvency of the Majority of Water Utilities. The vast majority of the water utilities and municipalities in Mexico do not have a sufficiently high credit rating that will allow them to access non-public sources of funding. The last challenge is the result of a complex set of institutional interactions summarized in Table 9. For each challenge, the Table depicts, using Harvey Balls, the respective weight and responsibilities of the main players. On a scale from 0 (white or empty Harvey Ball) to 100 percent (grey or full Harvey Ball) the circles illustrate the relative influence that each player and framework has in making adjust- ments to address a particular problem. The table depicts that CONAGUA has enough space to act and improve in different areas, but other factors and players also come into play. A lack of willpower from utilities, the existing regulatory framework, and several political factors are additional external challenges that are not necessarily under the control of CONAGUA. The first salient point of this analysis is that the excessively low tariff levels are at the heart of the financial problems faced by utilities. This has made it necessary to increase the subsector’s revenues through taxation: either in the form of fiscal resources channeled directly through the PEF or the States’ expenditure budgets, or through other mixed financial programs such as PRODDER, APAZU, PROTAR, PROSANEAR, and PROMAGUA (PROME), or special funds like the 1928 Trust Fund (Valley of Mexico). The proliferation of financial mechanisms creates a perverse incentive for the water utilities (or the municipalities) not to raise because some of these programs provide capital and operation and STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 54 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES Table 9:  Financial Challenges in Water and Sanitation Main players Water CONA Development Business Regulatory Political Others Problem utilities Users GUA SHCP Bank Bank framework factors factors Insufficient rates Insufficient subsidies Limited private participation Poor control over results Source: Self compilation. Note: The relative weight each player and factor has in addressing a specific issue is depicted graphically by the surface area of the circle that is filled in blue. maintenance subsidies that are not contingent from CONAGUA. Adhering to PRODDER implied upon having a good financial standing nor on the cancellation of the debt and the imple- ensuring that tariffs cover costs. The existence mentation of an incentive mechanism known of numerous federal programs with different as “peso sobre peso” under which the levies overlapping and competing Operating Rules recovered by CONAGUA could be returned to undermines the efficiency in the allocation of the utility on the condition that these resources public funds. were invested in activities that would improve Most State laws stipulate that tariffs should efficiency. A similar incentive currently exists be set to ensure the recovery of capital costs related to the effluent discharge fees that could and operation and maintenance. However, it is be reimbursed if used by utilities to promote the same State Congress that enacts the law wastewater treatment. that breaches it by not enforcing municipalities’ The success of PRODDER is mixed; it has proper tariffs. In other cases, as in the State of promoted the increas e in revenues but its impact Mexico, Congress does set the tariffs, but each on improving the efficiency of water utilities is municipality can adjust them and they usually less evident. The following factors come into play: do so but downwards. The main challenge on this issue is on how to create an incentive that is ●● Most of the projects implemented under politically and socially feasible and that can be PRODDER have been formulated with properly enforced. the objective to cover the operational and rehabilitation needs of water sys- tems and, sometimes, the expansion Program for Reimbursing 7.1  of secondary networks. As such, these Water Levies (PRODDER) projects were not designed to improve efficiencies. PRODDER was a program established to ●● Investments are still designed under a address the low levels of payment of levies from yearly budget cycle. Efficiency improve- the water utilities and municipalities, and the ment programs can only be effective if lack of regulatory and enforcement capacity they are designed as long-term programs. Part 2 Water Supply and Sanitation   55 ●● The Program does not contain indica- by the Uspanapa-La Cangrejera aqueduct in tors that can monitor improvements in Veracruz and the Lázaro Cárdenas aqueduct in efficiencies. Michoacán. These two aqueducts operate under ●● The reimbursement of the fees from relatively healthy conditions; there are issues CONAGUA to the utilities is a very lengthy with the operation, maintenance, and expansion, process with high administrative costs. if necessary, of the Cutzamala System and the The administrative procedures are not well systems that make up the Immediate Action adequate. Plan (PAI). However, most utilities are not paying for the required costs of these bulk water and for An aspect to consider is whether PRODDER those who pay, the cost is below the real cost. is the proper mechanism to promote improve- Modifying this behavior and adjusting the costs ment in efficiencies of the water utilities. Lack of is coupled with political difficulties. payment from the utilities reflects the unsustain- In the case of the State of Mexico, there is able financial conditions that exist in the sector, a double payment scheme for bulk water: one primarily caused by very low tariff levels. Under collected by CONAGUA and one collected by the these circumstances, CONAGUA could condi- Water Commission of the State of Mexico (Comis- tion the reimbursement of the fees to the formu- ión de Agua del Estado de México or CAEM) from lation, by utilities, of a financial and institutional the municipal water utilities, who are in a precari- improvement long-term plan with activities and ous financial situation. In the case of the State of investments to ensure financial sustainability. Hidalgo, the lack of payment (or the non-collection) A series of indicators would be monitored and derives from sociopolitical considerations related will define the amount of the support based on to the fact that the state of Hidalgo has supply improvements. sources (wells) that serve the Metropolitan Area Two additional important considerations: of Mexico City. The non-collection is perceived (i) Redesigning PRODDER with a medium-term as compensation. Therefore, incentives will need vision based on the capacity to allocate a multi- to aim at improving the efficiency of the water annual flow of resources that will be disbursed utilities, as well as at programs for rationalizing against a series of performance indicators; and the consumption of the final users. (ii) the legal and political feasibility of presenting For those utilities that produce their own a draft amendment to the LFD. water, the incentive of programs that compen- Increasing the value of water use rights sate for efficiency improvement and water sav- under the premise that the levies charged would ings should be explored. still be reimbursed to the water utilities would not improve CONAGUA’s finances. Water use fees should be increased until they equal their Water Supply and 7.3  opportunity cost. Sanitation Services Several of CONAGUA’s programs focus on 7.2  Bulk Water improving efficiency. Among these PROME, and some measures included in PROMAGUA CONAGUA is responsible of providing bulk water and PRODDE. In this context, two additional only to the Metropolitan Area of the Valley of types of incentives are highlighted and pro- Chapter 6 5 7 Mexico and to the industrial areas serviced posed: (i) compensation programs based on STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 56 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES efficiency-improvement results; and (ii) micro- would be worth considering. PROSAPYS could metering and tariffs in line with consumption. It be strengthened and consolidated. is also recommended to assess the APAZU and PROSSAPYS programs, given their importance Wastewater Treatment for extending coverage of water supply and This matter has been strongly supported by sanitation systems. CONAGUA (PROTAR, PROSANEAR, FONADIN,) A first reflection would consider whether new but it would still be important to evaluate these incentives are needed in this area or whether the programs and assess their effectiveness. Given ones in place are just not working appropriately the lack of strong monitoring and evaluation with regard to coverage (who has access to these programs, a challenge will be to assess their programs) and effectiveness. PROMAGUA, and contribution towards reduction of pollution in possibly PROME as well, only apply to a limited surface and groundwater. number of water utilities, leaving the rest unat- tended. It would be worth considering further Water Efficiency Public Policy upon the way these programs combine different As part of a new water efficiency policy drafted funding sources; whether the private participa- by CONAGUA with the support of the World tion schemes that have been implemented or Bank, a section on tariffs and subsidies was are being implemented are appropriate; and formulated. This policy defines the mechanisms whether other schemes could lead to better and incentives to progressively fine-tune the results, in light of experiences in other countries. degree of cost recovery through tariffs, and the An important aspect to be considered is that of subsidies that would allow reaching balanced the provision of services in rural areas. In this revenue and expense flows. Subsidies would be context, many valuable experiences (community established in a focused way based on efficiency management, local and regional companies) and social criteria. Figure 11:  Financing Policy in Water and Sanitation T2 Current operation and maintenance Subsidy reduction cost Subsidy from the government Efficient operation T1 and maintenance Rate cost Increase in the rate T0 Current rate 0 1 2 3 4 5 Year Source: Author’s production. Part 2 Water Supply and Sanitation   57 Box 1.  Tariffs and Subsidies The tariff policy must take into account three basic aspects: (a) the efficient cost of the service provision; (b) the subsidy required for the low-income population; and (c) the financing mechanism of the subsidy. The tariff policy is directly linked to the financial policy. Costs that are not recovered through tariffs must be covered by the government through taxes and/or through the resources it receives from CONAGUA stemming from water use and effluent discharge fees. The amount to be paid by the government and CONAGUA to water utilities must be defined in advance, based on a multiannual plan that specifies the service goals, total costs, and the cost recovery through tariffs as well as the resources to be provided by the Government, which derive from taxes, duties, products, and water use. The tariff must reflect, as much as possible, the total cost of the provision of water and sanitation services. Sometimes this is not possible due to the socio-economic conditions of some users and the high cost of delivering these services, above all the result of obtaining new water supply and wastewater treatment sources. In these cases, the federal government must define a subsidy policy in order to help the low- income population, together with a financing mechanism that compensates for the subsidy payments, and a financing policy based on taxes, aimed at paying for the investments not covered by tariffs. The policy of subsidies implicit in the tariffs must be targeted exclusively at the lowest- income users. The identification of users who should benefit from the subsidy should be based on a detailed study of the socioeconomic conditions of the population. This study should include clearly defined objective and transparent criteria for the classification of the population, as well as reliable updating mechanisms. The consumptive uses of water that should receive a subsidy should coincide with the minimum level for subsistence and the corresponding tariff charged should be enough to at least cover operational costs and service maintenance. Some practical examples of identifying users who should benefit from a subsidy are: (i) Chile, where selection criteria are based primarily on the level of income and consumption; (ii) Colombia classifies users according to their housing situation and location. In both countries, the subsidy compensation mechanism is clearly established. In Chile subsidies are compensated with federal government tax resources, while in Colombia they are compensated through cross-subsidies and/or municipal government tax resources. The implementation of the tariff policy will not succeed if it does not go hand-in-hand with mechanisms that provide incentives for an efficient service provision and efficient commercial management together with high collection, invoicing, and measurement rates. Source: Extract from “Public Policy for the Improvement of Efficiencies of the Urban Drinking Water and Sanitation Systems in Mexico.” CONAGUA and The World Bank, 2012. Chapter 5 Chapter 8 CONCLUSIONS S ince its establishment in 1989, CONAGUA has promoted different policies to meet the financial challenges faced by the water sector given the rising demands resulting from a growing population and a higher rate of economic growth. CONAGUA has gained much experience in the design and implementation of financial instruments that would comply with the long-term vision objective in water to achieve the sustainable and equitable management of water. Based on the experience acquired and the current legal framework, a dialogue was started with a large number of interested parties to discuss how best to structure and implement the SFA.. As a result of this dialogue, a conceptual framework was developed for the various components of the SFA and CONAGUA’s legal role in this context as derived from the LAN, which would allow formalizing and institutionalizing the SFA in the short term. It was argued that CONAGUA has the technical and admin- istrative capacity to add value to the experience accumulated over more than 20 years by formalizing the SFA, through the joint efforts of its specialists and the financial and fiscal authorities. To this end, a series of steps and actions are suggested. The second part of our work consisted in identifying a series of initiatives that could be incorpo- rated into the SFA, alongside existing experiences. Two of these initiatives aim to provide additional mechanisms to promote additional activities for the modernization and technological upgrading of irrigation systems; two other initiatives aim to support programs in natural resources response and prevention. These initiatives undoubtedly require further analysis, in order to determine their feasibil- ity and a roadmap for their implementation, as well as a methodology to monitor and evaluate their potential results and impacts. One of the core issues that must be addressed is the provision of additional support for the modernization and technological upgrading of the irrigation districts and units, including the parcel level. Despite the efforts made to date, especially through the programs and mechanisms instituted by CONAGUA and SAGARPA, there are still inherent limitations associated with the lack and discontinuity of budget resources, and with access to financing and producers’ guarantees. The analysis has shown that FONAGA’s guarantee scheme, strengthened with additional resources provided by CONAGUA, makes financing more accessible and takes advantage of the management structure of the financial intermediaries (especially from outside the banking sector), thereby increasing the number of secured STRENGTHENING THE FINANCIAL SYSTEM FOR WATER IN MEXICO: 60 FROM A CONCEPTUAL FRAMEWORK TO THE FORMULATION OF PILOT INITIATIVES loans. However, FIRA only operates as a second- accelerate the modernization and technological tier bank and there are no limits to the net bro- upgrading of irrigation systems at the national kerage margin; as a result, the interest rates can level. It is important to mention that the recent be high, having a negative impact of the financial promulgation of the LAPP has given the afore- standing of farmers. mentioned schemes a stronger legal footing This study recommends the creation of the to facilitate their implementation. However, Water Fund, funded by a line item of the expen- certain requirements cannot be met right away. diture budget of CONAGUA and SAGARPA, It is recommended that CONAGUA selects which would direct its funds to long-term some potential pilot projects in which different projects through private trust funds to be set PPP schems could be developed and tested in up per project or per irrigation district or unit. order to assess the feasibility of scaling up the The report outlines the Water Fund’s structure approach. and functioning in order to conceptualize, plan, Because of its geographical location, every implement, finance, carry out, supervise, evalu- year Mexico is affected by the impact of extreme ate, and control the irrigation modernization and hydro-meteorological events, which seem to be technological upgrading projects. It also ana- intensifying due to climate change. In order to lyzes the positive impact the Water Fund would organize the Federal government’s response have on the availability of budget resources and to these events, and coordinate with States other financing instruments, and its possible and Municipalities, the National Civil Protection limitations; the latter mainly suggest the need System was established. For over a decade, to promote the Fund’s establishment with the the country has had the FONDEN which has support of the Treasury and key actors of the channeled resources to disaster-stricken areas legislative branch. throughout the country. However, in view of the A second option that has been explored is investments needed to duly address the effects the PPP, which, given its structure, can have of climate change, new financing instruments present-value resources that may be used should be devised so that future events can be to pay for services provided by an investor; avoided as much as possible and their impact the latter receives a compensation during mitigated. To this end, it is critical that State and the service period. The report describes the municipal governments participate more deci- general features of this type of scheme when sively in the financing of emergency works and applied to the modernization and technological response, taking into account their specific risk upgrading of irrigation districts and units, as and vulnerability conditions. well as the actions required for its implementa- This report proposes two instruments that tion. This option has been analyzed jointly with would strengthen the coordination of federal CONAGUA specialists and representatives and state-local authorities, through the perma- from user associations, who agreed it was nent and institutional allocation of resources worthwhile promoting and broadening this to address the effects of climate change. The type of scheme, given the positive experiences first one is the creation of a Contingent Line in other countries. for Priority Investments to cover short-term The combination of the two instruments investments and expenses, especially to meet proposed would enhance the effectiveness the financial needs of CONAGUA for emergency and efficiency of programs and projects response. The second instrument is a Climate funded through financing schemes in order to Change Investment Fund that would promote Part 2 CONCLUSIONS   61 medium- and long-term investments, necessary subsidies that will ensure revenue and expendi- to offer better protection to the most vulnerable ture flows are balanced. The subsidies would be settlements in case of extreme events related to clearly defined and be based on efficiency and climate change. social criteria. The implementation of the above two The prospective efforts that were analyzed financing schemes requires political will at all in the course of this study underline the existing levels (local, state and federal). This will not be financial challenge and the constraints in meet- easily secured. However, immediate actions are ing the long-term objectives in water. It must necessary to duly address the challenges of our be recognized that CONAGUA has developed times. In addition to FONDEN’s natural vocation various instruments to complement the federal to focus on emergency response, the proposed government’s efforts, resulting in growing financial instruments would be designed to fund participation of citizens—as users of water and larger-scope investments to rebuild the existing related services or as investors. The experience infrastructure to mitigate the impact of future accumulated over more than 20 years together events. They would also be used to fund larger with the evolution of the legal frameworks offer and better infrastructure as well as preventive a more optimistic view of what is attainable in actions to address the effects of climate change. terms of financing. The analyses also showed This is certainly possible: duly guaranteed that as a result of the complexity and diversity financial instruments and institutional funding of financing schemes for programs, projects, should help leverage investment funding and, and actions in water, there has been a lack of consequently, multiply the volume of resources coordination and a duplication of efforts. These, available to the water sector. in turn, reduce the efficiency in the allocation and At the end of part two, the report looked use of these scarce financial resources. at the revenue potential derived from the col- The current legislation lays out the founda- lection of water use and wastewater discharge tion to organize the myriad of financial instru- fees, without proposing specific initiatives. This ments currently available, and improve their revenue source is considered one of the SFA’s effectiveness and efficiency; this can be accom- strategic components, both to ensure continu- plished by formalizing the SFA. This requires the ity of the water infrastructure projects and development and implementation of a strategy programs and their associated services, and the for the SFA under the conceptual framework sustainability of the actions. presented in this document. Finally, the report also covered the financial The specific initiatives presented this challenges in water supply and sanitation and report have been discussed with specialists presented formulation and implementation from CONAGUA and with the users of irrigation of a public policy on subsidies and tariffs for districts and units. These discussions have led to the medium and long term in the framework of the recommendation that these initiatives be put the SFA. 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