3. Economic instruments for water risk management

Policy instruments of extremely varied design and practical application can be used to manage water risks such as water shortage, water pollution, flooding and the risk of undermining the resilience of freshwater systems. Based on the classification provided by the (OECD, 2008[1]), such instruments may be placed into seven categories: environmental taxes/charges and tradeable permit systems (pricing instruments), public financial support and payments for ecosystem services (financial support instruments), information measures and voluntary schemes. Discussing the effectiveness, cost -efficiency and feasibility of all of these instruments, and their combinations, is beyond the scope of this chapter.

Instead, the chapter discusses in depth two key instruments in water risk management in Peru, the payments for ecosystem services and the environmental charges, evaluating their implementation and proposing ways forward. The chapter also assesses the merits of mobilising public financial support to implement a river rehabilitation policy in Peru. Finally, the chapter underlines the need for these water policy instruments to be consistent with sectoral policies and environmental policies.

Various definitions of payments for ecosystem services (PES) exist, with no agreed single definition (Schomers and Matzdorf, 2016[2]). However, PES may be broadly defined as a voluntary transaction where ecosystem managers (e.g. landowners) are compensated through conditional payments by ecosystem beneficiaries (often governments, with the public being the general beneficiary), for the additional cost of maintaining ecosystem services above legally required levels. PES assessment involves criteria of effectiveness and cost efficiency. PES that are both effective and cost-efficient can be said to be cost-effective. Another criterion is the feasibility of PES implementation, which is obviously essential if a PES is actually to be introduced and function cost-effectively.1

To be effective, PES instruments employ the “beneficiary pays” principle. Beneficiaries (or buyers of ecosystem services) make conditional payments to ecosystem service managers (or sellers of ecosystem services – typically landowners) to maintain a level of ecosystem services that would otherwise not be in the private economic interest of (or regulatory obligation for) the ecosystem service manager to pursue. The payments to the landowner (which may be either cash or benefits in kind) (Asquith, Vargas and Wunder, 2008[3]) are intended to make forest conservation, the most common target of PES, particularly in developing countries (Engel, Pagiola and Wunder, 2008[4]), at least as economically attractive to the landowner as conversion to pasture. This maintains water and, with it, biodiversity and carbon sequestration services. The buyers may be either private or public sector actors, depending on the nature of the ecosystem service targeted (Figure 3.1). For instance, the buyer may be a private hydropower generator, paying upstream landowners to conserve water management-related ecosystem services (e.g. via forest conservation) for private economic benefit (a user-funded system). The buyer in this scenario may also be a government or other public sector organisations, paying to maintain forest-related ecosystem services that are public goods, such as biodiversity preservation (a government-funded system).

In order to provide sufficient incentive for sellers to accept PES, and therefore allow the instrument to operate, the minimum level of payment should be the differential between the private economic value gained from the presence of the ecosystem services (e.g. forest conservation) and the most profitable use of the land for the owner authorised by law (e.g. conversion to pasture), thus compensating for income loss. The maximum level of payment for cost-effective instrument operation is discussed in the cost efficiency section below.

The point of application should be impact-based and made directly on the basis of ecosystem services provided. However, measuring the provision of “additional units” of ecosystem services delivered against a pre-defined baseline requires a detailed understanding of causal pathways (recognising spatial extent and distribution) (Tomich, Thomas and Noordwijk, 2004[5]), that are often either not fully understood or are impractical to monitor. In such cases, proxies or indicators may be used, such as additional extent or density of forest cover, against which payments can be made. Monitoring such land use related proxies is common (Pagiola and Platais, 2007[6]).

Thus far, despite their growing use around the world, relatively few PES systems have been subject to rigorous ex post analysis in either high- or low-income countries (Engel, Pagiola and Wunder, 2008[4]; Pattanayak, Wunder and Ferraro, 2010[7]). However, Pattanayak, Wunder and Ferraro (2010[7]), using an available sample of such studies, found generally positive but limited effectiveness in producing additional ecosystem services. However, such analyses suffer from particular difficulties in determining counterfactual conditions (especially concerning “additionality”) and therefore induced change.

As with “polluter pays” instruments, PES systems retain the possibility of inducing the pollution haven effect, with the original ecosystem service-degenerating activity simply shifting (“leaking”) to another location. Wunder, Engel and Pagiola (2008[8]) conclude that although little is known about leakage from PES systems due to observation difficulties, some studies cite anecdotal evidence of local leakage (i.e. simply converting another plot of land nearby to substitute for another under a PES contract). Whilst the opportunity for leakage of localised ecosystem services decreases with the increasing scope of the instrument (e.g. proportion of coverage in a watershed for water-related services), the likelihood for the leaking of activities that degenerate global public goods services (e.g. deforestation and biodiversity preservation), the focus of government-funded systems, increases (Wunder, Engel and Pagiola, 2008[8]). Leakage may also occur across time, with an upcoming PES system creating a perverse incentive for landowners to further degenerate their ecosystem services to receive additional payments in future for restoring them (e.g. deforestation to allow future reforestation). This may be overcome by, for example, setting the baseline against historical circumstances.

As with other market-based instruments, PES instruments are cost-efficient when addressing the correct market failure. Additionally, the maximum payment should be either the marginal private benefit or social benefit received from the “additional units” of the ecosystem service in question (as also illustrated in Figure 3.1), depending on whether the instrument is user- or government-funded respectively. The use of reverse auctions may be useful in determining the most cost-effective price point within these parameters and across actors (OECD, 2010[9]).

Pagiola and Platais (2007[6]) argue that user-funded systems are theoretically likely to be the most cost-efficient and Wunder, Engel and Pagiola (2008[8]) find empirical evidence to support this view. Actors in user-financed systems (particularly buyers) are likely to have more information on the marginal benefit of the provision of an ecosystem service and therefore the maximum payment level, whereas calculating the marginal social benefit of public goods’ ecosystem services is an extremely difficult task. In addition, actors in user-financed systems have clearer incentives to ensure the instrument operates effectively, are able to more specifically target and observe directly whether the required service is being delivered, and have the ability to rapidly respond and renegotiate the terms of (or terminate) the agreement. Government-funded instruments that purchase public goods services generally suffer from a reduced ability to monitor whether additional services are being provided and a reduced incentive to ensure the instrument is working effectively. Other objectives in government-funded systems, such as poverty alleviation, may also impact cost efficiency in delivering the environmental objective (Pagiola and Platais, 2007[6]). Government-funded instruments may also constitute a subsidy to some actors in the private sector if not applied directly to a pure public good (i.e. non-excludable and non-rival in consumption), such as biodiversity preservation. Many water services are, for example, club goods (i.e. excludable) (Engel, Pagiola and Wunder, 2008[4]).

Can we pay the same land for different ecosystem services? Whilst a given PES system may target a single ecosystem service, separating such services is often not possible (as also illustrated in Figure 3.1). As such, PES may produce both positive and negative side effects (improving one ecosystem service may degenerate or reinforce another). For example, the provision of water management services may change the local habitat, reducing or increasing biodiversity services. Where synergies are identified, ecosystem services may be “bundled” together, allowing the potential for additional benefits and reduced transaction costs (OECD, 2010[9]).2

PES instruments may be applied to address a variety of ecosystem services provided by a range of environments managed by different types of entities. When an impact-based approach is infeasible – as is commonly the case with PES instruments, the use of proxies or indicators in an output-based approach may be tailored to the local environment (and other constraints). Conditionality requirements may also be tailored to account for events beyond the control of ecosystem managers (such as vegetation disease or forest fire). For example, as long as indicator thresholds are achieved every four in five years, full payments may still be received (Schwarz et al., 2008[10]).

For a PES instrument (particularly government-funded) to be effective, well-defined criteria for who is entitled to receive payments, along with agreed definitions for the baseline, “units” of additionality and performance metrics, must be clear. Whilst PES instruments do not necessarily require a specific legal framework beyond basic contract law, clear definition and attribution of property rights is a precondition for a feasible system (Greiber, 2009[11]). Construction of the instrument and potentially substantial monitoring and enforcement requirements may produce high transaction costs and require significant administrative capacity. Such issues may reduce the feasibility of PES instruments in low-income countries, particularly for government-funded systems. Further legal complications may also impact the feasibility of a PES instrument. For example, World Trade Organization (WTO) rules may prevent the use of government-funded PES (or other support) systems where private commercial actors (such as farmers) receive payments that effectively subsidise their output. For an instrument to fall within the WTO’s “Green Box”,3 payments to a production industry (e.g. agriculture) may only compensate for extra cost or loss of income from maintaining or increasing the provision of environmental services (FAO, 2007[12]).

As a financial support instrument, PES instruments are generally preferred by recipients to “polluter pays” instruments and are similarly subject to deadweight costs when actors are paid to provide services they would have provided anyway. Although the difficulties of monitoring PES systems have been discussed, it tends to be easier to secure co-operation from ecosystem service managers (e.g. landowners) when “offering them carrots than when threatening them with a stick” (Engel, Pagiola and Wunder, 2008[4]). In high-income countries, large agricultural producers have been able to steer the direction of policy towards financial support for environmental goods, rather than taxation on environmental bads. In low-income countries, the providers of environmental services are generally thought to be poorer than service users (or buyers), creating an equity preference for PES (Pagiola and Platais, 2007[6]). Although poverty alleviation is a common secondary (or parallel) objective of many government-financed PES systems (often introduced to increase public acceptability), there is little empirical verification surrounding distributional impacts (Engel, Pagiola and Wunder, 2008[4]).

The requirement for a continued funding stream with no direct economic return may substantially reduce the political feasibility of government-financed systems. Although government-funded systems are the only option when considering the protection of ecosystem services that are pure public goods (such as biodiversity preservation), national governments are disincentivised to implement such instruments unilaterally when they produce global public benefits. This is particularly likely to be the case in lower-income countries. In such cases, the provision of other incentives is likely to be required such as seeking biodiversity co-benefits for measures aimed at other environmental objectives, such as carbon sequestration.

Peru has introduced a legal framework for PES. In 2015, Peru’s Ministry of the Environment (Ministerio del Ambiente, MINAM) introduced an innovative PES mechanism, called Ecosystem Services Compensation Mechanism (Mecanismo de Retribución por Servicios Ecosistémicos, MERESE). The MERESE Act No. 30215 of 2014 and its regulation (Supreme Decree No. 009-2016-MINAM) aim to channel financial resources towards the conservation, recovery and sustainable use of sources of ecosystem services through agreements between parties. It encourages the involvement of the public and private sectors in conserving sources of ecosystem services and stipulates that the actions of those who retain these services can be remunerated. Implemented by MINAM, the law aims to ensure the permanence of the benefits generated by ecosystems.

Prior to that, the Sanitation Services Modernisation Act No. 30045 of 2013 already required each water and sanitation service company (Empresa Prestadora del Servicio de Saneamiento, EP) to establish environmental compensation and watershed management mechanisms in their Optimised Master Plan (Plan Maestro Optimizado, PMO). The PMO provides for investments (over the next 30 years) as well as tariff increases (for the next 5 years). It is subject to the approval of Peruvian water regulator SUNASS (Superintendencia Nacional de Servicios de Saneamiento). SUNASS approves the tariff structure of each EP (by resolution), including the share of tariff revenue allocated to MERESE. Many EPs have thus created specific MERESE funds financed by the water bill, representing up to 11% of their turnover. The funds will compensate communities that commit to providing hydrological services, such as protecting high mountain lake watersheds through reforestation (USD 44 million has been raised nationwide through 2020) (SUNASS, 2020[13]).

The MERESE Regulation of 2016 takes up the obligation for EPs to participate in MERESE. At the end of 2020, 40 of the 50 EPs had a resolution approved by SUNASS for the creation of a MERESE reserve fund according to their PMO. The MERESE Regulation also opens the possibility for board of users of the hydraulic sector (Junta de Usuarios del Sector Hidráulico, JUSH) to participate in the financing of MERESE, within the framework of their Operation, Maintenance and Development Plan of the Hydraulic Infrastructure (POMDIH), on a voluntary basis. The MERESE Regulation specifies that the JUSH and hydraulic infrastructure operators can sign MERESE agreements as long as they include actions for the conservation, enhancement and sustainable use of POMDIH water sources. Chief Resolution No. 230-2019-ANA provides guidance for the preparation and implementation of POMDIH by small operators of hydraulic infrastructure. In addition to being voluntary, the process of JUSH participation in MERESE (the decision to participate in the financing of water source conservation) is more complex than that of the EPs in that it must be approved by the assembly of irrigators, which implies a broad awareness-raising process to reach an agreement.

Table 3.1 details the share of EPS revenues allocated to the MERESE reserve fund at the end of 2018 (i.e. in 34 cities in 19 departments across Peru). During the five-year water tariff period, SUNASS can approve an increase in the amount of the reserve fund if the "viable" MERESE projects exceed the amount originally estimated in the PMO. This may lead to an increase in the water tariff subject to approval by SUNASS at the request of the EPs. A similar mechanism was put in place in 2011 to create funds for disaster risk management (Gestión de Riesgo de Desastres, GRD) and adaptation to climate change (Adaptación al Cambio Climático, ACC) in accordance with Law No. 29664 of 2011 establishing the National System of Disaster Risk Management (SINAGERD)4 (Table 3.1). In June 2015, SUNASS helped develop and approved the PMO of the Lima water company (Servicio de Agua Potable y Alcantarillado de Lima, SEDAPAL) which plans to allocate 1% of the company’s turnover to a MERESE fund and 3.8% to 3.5% to a disaster mitigation and adaptation to climate change (GRD/ACC) fund. For SEDAPAL, this represents, respectively, amounts of PEN 86 million (EUR 23 million) and PEN 315 million (EUR 85 million) over 5 years (2015-19). In September 2019, SEDAPAL raised PEN 60 million (EUR 16 million) for its MERESE fund.

The impact on the household budget is modest. Often, it is less than PEN 1 per month for the MERESE fund, which suggests that the criteria of affordability have been taken into account (Table 3.1). The other side of the coin, however, is that the amounts of reserve funds are often limited (except for Lima given the base of clients served by SEDAPAL). MERESE funds sometimes finance water supply and sanitation infrastructure in addition to the protection of ecosystems, as shown by the example of Cusco (Table 3.2). In Cusco, installing toilets for local communities was a prerequisite for the recovery of a lagoon contaminated by excreta. The PMO logic that underlies the financial functioning of MERESE funds may lead to an imbalance between resources devoted to water supply and sanitation services and those devoted to the ecosystem services for which the fund is normally intended. This is the case for the Cusco EP (Table 3.2).

The activities envisaged vary considerably from one EP to another. Legislative Decree No. 1280 of 2016 establishes three modalities for the use of MERESE funds: within the framework of the programming of public investments (national system of multi-year programming and management of investments); direct payments to PES suppliers; and subcontracting to specialised private entities created by law for the administration of environmental heritage funds. Resolution No. 039-2019-SUNASS-CD of 2019 added the possibility of using MERESE funds for the procurement of goods and services. However, this system of payments for ecosystem services (PES) under the water supply and sanitation policy (aimed at ensuring the protection of upstream water sources) shows its limits in the poor identification of activities providing hydrological services, a step that is essential to calibrate the reserve fund. Among the pricing studies developed by the end of 2018 (Ayacucho, Chachapoyas, Huancayo and Moyobamba, in 2015), only Moyobamba includes criteria to measure the impact (effectiveness) of payments. The participation of non-governmental organisations (NGOs) and academics in the fund’s management committee has certainly contributed to improving the quality of the Moyobamba price study. On the other hand, the Ayacucho and Huancayo price studies do not provide any details on the measures envisaged in their MERESE fund (Table 3.2).

Environmental charges are requited5 payments made by consumers to providers of environmental management services, including water resource management. In that they differ from environmental taxes, defined as “compulsory, unrequited6 payments to general government levied on tax bases deemed to be of particular environmental relevance” (OECD, 2001[15]).

Morley and Abdullah (2010[16]) evaluate the effectiveness of environmental taxes and charges, and find a significant relationship between their levels and a reduction in pollution. However, the effectiveness of an individual instrument depends heavily on the specific design of the instrument, the circumstances within which it operates (e.g. the availability of capital) and its primary objective (e.g. reducing water abstraction/pollution or simply revenue-raising) (Dias Soares, 2011[17]; Wakabayashi and Sugiyama, 2009[18]). These aspects also make ex ante estimations of the effectiveness of taxation and charging instruments in achieving its objective difficult.

The point of obligation for an environmental charge may be upstream of the point of water abstraction/wastewater discharge (e.g. on irrigated land or fertiliser inputs) at the point of abstraction/discharge itself (e.g. on abstraction volume or pollutant load) or on the “impact” of emissions (e.g. on ambient conditions, such as the minimum flow or pollutant concentration of the affected water bodies, with the tax paid by users/pollutant sources). Each point of obligation has different feasibility constraints and consequences for efficiency.

In a perfect market with perfect competition, the point of obligation does not matter, as the price signal and therefore the incentive for abatement across the system, in the long run, is equivalent. If the instrument is applied upstream, producers (farmers, industry) should pass through 100% of the cost of production (including the tax or charge) to consumers (as the long-run supply curve is flat),7 reducing demand for a given product or service in line with the elasticity of demand. If the instrument is applied at the point of abstraction/discharge, demand is directly influenced and upstream suppliers would be expected to react to this. However, regardless of the point of obligation, non-perfect markets, along with issues of specific design and feasibility constraints, also impact effectiveness and may act to prevent pricing instruments from achieving their full theoretical potential.

Pricing instruments are statically cost-efficient if the explicit or implicit price is applicable to and equalised across all water users/sources of pollution within the scope of the instrument. However, an equalised rate on a given user/pollutant does not consider marginal damages that may vary depending on the timing, location, medium, concentration and other characteristics of its abstraction/release, regardless of the point of application. This renders charges rather blunt instruments, unable to effectively address scarcity/pollutant “hotspots” (OECD, 2008[1]), with consequences for overall efficacy.

This is particularly the case for upstream charges. In addition, an upstream pricing instrument may also prevent the use of “end-of-pipe” abatement measures, which may produce abatement at a lower marginal cost than other options. In upstream pricing, downstream actors may only reduce costs through increasing input efficiency and product substitution, potentially reducing static cost efficiency at the outset. Applying pricing instruments at the point of abstraction/discharge may tackle these difficulties to some extent by allowing rate differentiation between different types of users/pollutant release in different locations (e.g. water abstraction/effluent released in areas of different ecological risk) and allowing the potential for abatement to be achieved where the cost is least. However, there are limits to the feasibility of each approach (see below).

The presence of environmentally harmful subsidies for scarcity/pollution generation (such as irrigation or fertiliser subsidies) may significantly inhibit the effectiveness of pricing instruments. For example, groundwater pumping that is subject to a reduced electricity tariff, producing an implicit water subsidy, counteracts the incentive for water use efficiency (e.g. to adopt modern irrigation technology) produced by abstraction charges.

Pricing instruments, by providing a liability that market actors constantly seek to minimise, theoretically stimulate innovation and adoption of new products, processes and practices, producing high dynamic cost efficiency. Whilst employing effective indicators to measure innovation and its attribution to a single factor is difficult, the empirical evidence suggests that environmental taxes and charges are effective in producing organisational and technical innovation (OECD, 2010[9]), although instrument design and operational context are considerable determinants (Kemp and Pontoglio, 2011[19]). In addition, policy certainty is an important driver for innovation, regardless of the type of instrument in question. A lack of certainty surrounding, for example, the level and scope of application of future charges, and therefore cost liabilities, may dissuade organisations from investing in research and development as the return on such investments becomes inherently riskier.

Generally, environmental charging instruments are highly administratively feasible: most countries have the required institutions and administrative systems already in place. Even so, there are various exceptions and nuances. An upstream charge, for example, is likely to be more administratively feasible than a charge at the point of abstraction/discharge, as the former targets far fewer actors than the latter, reducing transaction costs and increasing the potential for effective monitoring and enforcement, particularly in low-income countries lacking the administrative capacity required for implementing and enforcing instruments applied at the point of abstraction/discharge. Furthermore, by its nature, an upstream charge also reduces the potential for avoidance and evasion.

However, technical challenges remain both for the instruments targeted upstream and those applied at the point of abstraction/discharge. Whilst pollutants such as nitrates or pesticides depend largely on the nitrogen or chemicals content of the fertiliser/plant protection product, the amount of water diverted for irrigation depends largely on the location and technology employed, rendering an efficient upstream pricing instrument infeasible. Conversely, monitoring nitrogen pollution at the point of emission from small stationary sources (e.g. households) or from the multiple and diffuse pathways of non-point source pollution in the agriculture sector may be both technically and administratively infeasible. For such sources of pollution, a tax or charge on ambient conditions (e.g. pollutant concentration in a water body), for example, may be a practical solution. Similarly, although monitoring the use of water at the point of abstraction is theoretically simple, it requires a measuring device, rarely used in small irrigation schemes. For such water users, a charge on ambient conditions (for example, the minimum flow of a river) may also be a practical solution. However, such an approach may only be effective if individual actors believe that their water use/discharges substantially impact the aggregate, producing an incentive to reduce abstractions/discharges. This may be the case concerning water scarcity/pollution in a small watershed with few agricultural producers but not, for example, in an urban area with large numbers of inhabitants individually contributing very marginally to aggregate use/pollution levels (Karp, 2005[20]).

Opposition from industry and the public, which in turn influences political acceptability, often proves to be the most significant impediment to the introduction of environmental taxes and charges. Opposition to charges appears to stem from eight broad roots. The first is a misunderstanding, or a mistrust, of the rationale behind the introduction of such instruments. Both individuals and organisations tend to hold a view of charges as simple revenue-raising instruments, rather than in terms of incentives or welfare-maximisation. Second, even if the principles behind the charge are understood, it is often believed by the general public that they are ineffective in influencing behaviour, and third, the public may doubt that it is even required at all. This belief is influenced by the environmental attitudes of individuals, which are themselves associated with socio-economic circumstances and worldviews. This is linked to the fourth aspect of policy “labelling”. A policy labelled a charge is likely to be less popular than the same instrument with a less emotive label. The fifth aspect is the perception of coerciveness and impingement on individual and organisational freedoms resulting from environmental taxes and charges. Linked to this is the sixth aspect of fairness – environmental charges, particularly when associated with goods consumed across the socio-economic spectrum (such as water), may be regressive. Seventh, environmental charges may have or may be perceived to have negative impacts on industrial competitiveness. The eighth and final aspect concerns the use of revenue raised – pricing instruments are less popular when the revenue “disappears” into government budgets, rather than being hypothecated for a given purpose. This is often connected with a mistrust of government.

To reduce the possibility of excessive administrative burden, and distributional and competitiveness impacts, certain entities such as small organisations, households or industries that may otherwise be significantly impacted may be exempt from the provisions of pricing instruments, subject to reduced rates or receive compensation. Whilst this raises political feasibility, it acts to reduce environmental effectiveness and efficiency. Similarly, preferential treatment may be afforded to other users/sources of pollution for which costs would be prohibitive, such as ageing industrial installations. However, in order to prevent perverse incentives to maintain the operation of these installations, such provisions should be time-limited. An alternative option to exemptions and differentiated rates is the use of environmental taxation reform (ETR) principles, where taxes and charges on environmentally harmful activities are offset by reducing taxes on, and therefore stimulating, positive activities (such as labour). This may be combined with some element of revenue hypothecation; increasing transparency, for which empirical evidence suggests strong support, and to the extent to which it helps polluting industries reduce the net cost of pollution abatement, may help to prevent the migration of polluting activities to other jurisdictions (pollution haven effect), maintaining the overall effectiveness of the instrument. However, the ability of ETR principles to achieve revenue and cost neutrality may vary between high- and low-income countries. The latter tend to have a lower proportion of the population employed in the formal economy, for example, making compensation via a reduction in labour taxes less effective. In such instances, the provision of reduced (or no) cost services such as water use efficiency measures, healthcare or education may be a suitable mechanism for revenue recycling.

Environmental taxes and charges are relatively flexible instruments, as rates may be altered relatively easily. However, the hypothecation of revenue for a given purpose may lead to revenue dependency, which may impact the ability to adjust rates (particularly downwards) or alter the instrument in a more structural manner. This may be seen as a positive or negative attribute, depending on the attitude taken towards the instrument.

Since 2009, the National Water Authority (Autoridades Administrativas del Agua, ANA) has collected charges on water abstractions and sewage discharges from a range of stakeholders. By law (Article 95 of the 2009 Water Resources Act), charges must cover the costs of governance of integrated water management approved by ANA and rehabilitation of water resources subject to abstraction and discharge of wastewater. However, revenue raised by ANA is insufficient to cover its ordinary operating costs (USD 55 million in 2018 – see below).

Peru applies water abstraction charges (Retribuciónes Económicas por el Uso del Agua, REUA) according to the availability of water (and therefore the risk of shortage), thus applying the polluter pays principle. The Ministry of Agricultural Development and Irrigation (Ministerio de Desarrollo Agrario y Riego, MIDAGRI) is the competent body for setting the REUA rates, at the proposal of ANA (which belongs to MIDAGRI) and these rates are set annually through Supreme Decree. The revenues collected from REUAs are assigned to the ANA budget. In this way, the principle of “water pays for water” is applied, as Peru considers that ANA provides services (water management, monitoring, etc.) that users must pay.

In particular, ANA uses REUA revenues for the following actions (ANA, 2015[21]):

  • Formulation of water resource management plans per basin; management and administration of water resources in natural sources of water; integrated water management in less-favoured watersheds; and preservation of water resources in basin headwaters.

  • Control and monitoring measures to ensure the protection of water quality, an increase of water availability, conservation of sources of production and efficiency of water use.

Though the REUA revenues are allocated to the ANA budget, REUAs are collected by different actors, depending on the rights granted for the use of water (Head Resolution No. 083-2019-ANA):

  • Users of surface water for agricultural purposes that receive the water supply service pay their charges to the hydraulic infrastructure operators:

    • After water use, for the volume of water used.

    • Prior to the use of water, for the volume of water requested.

  • Users of surface water other than farmers, users of groundwater, users of seawater and users with their own supply system pay to ANA annually, according to the volume of water used during the previous year. In case of failure of reporting, the volume used to calculate the charge is equal to the volume granted in the right of use.

  • Users with authorisation to discharge treated wastewater pay to ANA annually and in advance depending on the volume of the authorised discharge.

  • Users with water use authorisations pay to ANA annually based on the volume of water used. In case of failure to submit the reports, the volume used will be equal to the volume granted in the right of use.

According to available OECD data,8 more than half of OECD countries have introduced similar abstraction charges but very few OECD countries take into account the risk of scarcity in the design of the instrument. In this sense, Peru is more advanced. What needs to be corrected is the differential rate of REUAs between sectors (Table 3.3), which must be eliminated because the impact of water withdrawal on the environment is the same regardless of the user.

In Peru, the REUA rate takes into account three factors: i) the volume used (in m3); ii) a coefficient of value (in PEN/m3) according to the use (for example, industrial, mining, population, agricultural); and iii) modulation of the value coefficient according to the demand/availability of water (in part, following ANA, (ANA, 2012[22])). The value coefficient takes into account economic criteria – which apply to the productive sectors (industry, mining) – and social criteria – for water use by the population and the agricultural sector. Thus, the value coefficients are higher for the productive sectors, leading to a cross-subsidisation of the productive sector to the population and agricultural sectors. The modulation of the value coefficient is based on environmental criteria, namely the availability of water per capita (m3/inhabitant/year) for each body of surface water. The modulation is between water bodies in equilibrium (high availability), water bodies in danger (the demand being close to the supply, priorities in use must be assigned and efficiency of use improved) and water bodies already overexploited (compromising all economic and social development). Similarly, Peru’s aquifers are classified into three categories: underexploited, in equilibrium and overexploited, depending on the demand/availability ratio of each aquifer. The modulation coefficient for groundwater is based on these three risk categories of scarcity. Such a setting is like trying to kill several birds with a stone. The formula mixes social, economic and environmental criteria. This is the best way to achieve no objective when there is a risk of water scarcity (the problem does not arise in case of high availability of water).

An REUA rate linked to the availability of water creates an incentive to turn to water bodies where the abstraction pressure (the risk of scarcity) is lower, which allows economic development and protection of the environment. But giving a preferential rate to the “social sectors” reduces incentives and can lead these sectors to turn to bodies of water where water is less abundant, increasing the risk of scarcity, compromising the environmental objective and, ultimately, the social goal (when scarcity is proven).

Moreover, In the case of the risk of scarcity, Peru already has an allocation regime that favours social sectors and an ecological flow. The preferential REUA rate is twofold with these direct regulatory instruments, which are sufficient on their own.

Different REUA rates apply to different sectors. More specifically, the REUA rate for the agricultural sector differs according to altitude, with a rate of almost half lower for farmers located in the upper basin (cuenca alta) compared to other farmers. This is a social measure that has no justification from the point of view of the protection of the environment (see further discussion below). The protection of the water resource (and natural ecosystems) in the headwaters area is indeed decisive for regulating the hydrology of the entire basin, which justifies the payments for ecosystem services through the MERESE fund. Halving the REUA rate in the upper part of the basin runs counter to the MERESE policy of water management at the watershed scale.

A number of boards of users of the hydraulic sector (JUSH) pay a fixed REUA rate, regardless of the availability of water resources. This is not justified from the point of view of the protection of the water resource, even if some of these JUSHs have to pay a higher rate than those subject to a variable REUA rate and located in an area where water resources are insufficient. A fixed REUA rate does not allow for taking into account the seasonality of water scarcity.

Similarly, the REUA rate in “special projects” is based on the water tariff (i.e. the tariff recovering the operations and maintenance (O&M) cost of the irrigation infrastructure serving an association of water users). Again, there is no reason not to keep the link with water availability, especially since “special projects” often refer to large-scale irrigation projects (e.g. the Special Project Olmos TinajoresProyecto Especial Olmos Tinajones, PEOT – in the department of Lambayeque) and are therefore major consumers of water.

The same differentiated REUA rates apply equally to surface water and groundwater. However, it is generally more difficult (expensive) to recharge an overexploited aquifer than to restore the flow or volume of a body of surface water. REUA rates should be higher for groundwater than for surface water, as is the case in most OECD countries for which (unpublished) information is available while maintaining the risk-based differentiation as is currently the case.

In order to ensure a regular minimum income for ANA, a first block of water withdrawal must be paid by water users, at the same implicit REUA rate as for volumes beyond the block (Table 3.4). For the population sector, the block for groundwater (and therefore the minimum fixed REUA) is half that for surface water, which encourages the use of groundwater rather than surface water. Communal water companies in rural areas enjoy preferential implicit REUA rates for 3 water withdrawal blocks, with a higher subsidy as the block grows (70% of implicit REUA rate for the first block, 93% for the second and 96% for the third). This decreasing block pricing structure discourages water savings.

Peru also applies charges on the discharge of treated wastewater (retribuciónes económicas por el vertimiento de aguas residuales tratadas, REVART) according to the type of use of the receiving water (and therefore the risk of pollution), thus applying the polluter pays principle. Peru is ahead of many OECD countries in this area. According to available OECD data, about a third of OECD countries have introduced similar pollution charges but very few OECD countries take into account the sensitivity of receiving waters in the design of the instrument. In this sense, Peru is more advanced.

Unlike the REUA, the method of calculating the REVART does not take into account economic and social factors but only environmental criteria. The REVART takes into account three factors: i) the volume of wastewater discharged (m3) – annual volumes discharged according to permit; ii) a coefficient of value (PEN/m3) that considers the persistence and toxicity of the substances contained in the effluent; and iii) modulation of the value coefficient based on the sensitivity of the receiving water body to contamination.

The value coefficient considers the dangerousness of the substances contained in the effluent to the environment, in particular the time necessary to return to a natural reference situation. Under these conditions, differentiated coefficients are obtained depending on the type of activity generating wastewater, whether it is domestic effluents (municipal) or industrial sectors (industry, fishing, mining, energy and agroindustry) (Table 3.5).

The modulation of the value coefficient reflects the classification of receiving water bodies in accordance with national environmental quality standards for water. Thus, the modulation differs according to whether it is a body of water used by the population, for coastal marine activities, for irrigation or for the conservation of the aquatic environment. The aim is to incentivise the reduction of the pollutant load of authorised wastewater discharges according to the sensitivity of the receiving water bodies to pollution.

As is the case with REUA, a first block must be paid for wastewater discharges, at the same implicit rate of REVART as for volumes beyond the block (Table 3.5). The block size (100 000 m3) is the same for all sectors. However, a preferential implicit REVART rate of 90% applies within the block to communal water companies in rural areas, although wastewater is generally less treated than in urban areas and therefore carries a higher pollutant load. Although the objective is not to hinder the necessary development of sanitation infrastructure in these areas, this preferential REVART rate discourages the search for advanced wastewater treatment. As a rule of thumb, any public financial support for sanitation infrastructure must be considered temporary, the tariffs having to, in the long term, recover all the investment, operation and maintenance costs of the infrastructure to ensure its proper management (see Cox and Borkey (2015[24]) for more discussion). In addition, the REVART rate should reflect the toxicity of pollutants in wastewater to health and the environment.

Revenues from the collection of water abstraction and sewage discharge charges have increased in constant terms (not adjusted for inflation) since their introduction some 10 years ago (Table 3.6 and Figure 3.2). Most of the revenue continues to come from abstraction charges outside agriculture (over 50% in recent years). Total charge income amounted to PEN 205 million (EUR 55 million) in 2018 (Table 3.6). According to ANA, the revenues are intended to cover ANA’s “integrated water management costs”, including: i) the development of water resources management plans by basin; iii) the daily administration of water resources (for example, issuing water licenses); and iii) monitoring and enforcement of water regulations (ANA, 2019[25]).

This section discusses how public financial support could be envisaged for the rehabilitation of watercourses, a policy that does not yet exist in Peru but which would greatly contribute to better management of water risks. River development (straightening and channelisation, disconnection of flood plains, land reclamation, dams, weirs, bank reinforcements) to facilitate agriculture, produce energy and protect against floods damages the morphology and hydrology of the water systems. Restoration of good hydromorphological conditions (river rehabilitation) and providing rivers with sufficient space enable them to fulfil their natural functions (connect ecosystems and provide the water needed for life, self-purification of waters and groundwater recharge) and guarantee natural protection against floods.

For all these reasons, public financial support may be granted for river rehabilitation (via environmental policy) and provision of space for waters (via agricultural policy), while electricity consumers (via a tax on electricity bills) may support the ecological improvement of installations related to hydropower use (see Energy Section below). These instruments must be combined with direct regulations on minimum flows and come in addition to any public financial support for flood control (i.e. using grey infrastructure).

The rehabilitation of rivers can benefit from public financial support as it contributes to the protection of aquatic and riverine biodiversity. For the same reason (preservation of biodiversity), the protection of alluvial forests can also benefit from public financial support within the framework of forest policy. Space for water can be cultivated but only as biodiversity protection areas, in which case agricultural land may benefit from public financial support. This is justified to the extent that farmers are paid to go beyond what agricultural policy requires them to do anyway. As long as it contributes to the improvement of agricultural production conditions by land consolidation, the rehabilitation of small rivers in agricultural areas may benefit from public financial support as part of the structural adjustment policy of agriculture. Direct regulation (delineation of risk zones in land use plans) and economic incentives (higher insurance premium in these risk zones) should be favoured to deal with the risk of flooding in populated areas.

Different forms of public financial support can enable landowners to rehabilitate their river in terms of nature protection, provide space for water, protect against floods and improve farmland. It is necessary to ensure synergies and coherence between these different objectives, especially when they are assigned to the same stretch of river. This means assessing the additionality (bundling) of ecosystem services (e.g. flood protection, nature protection, land improvement). In the case of overlapping objectives, no double funding should be allowed for the same service provided.

Beyond improving the design of economic instruments, such as PES and environmental charges, or introducing new ones, such as public financial support for river rehabilitation, it is important to ensure that sectoral policies do not offset their effects by encouraging excessive use or pollution of water. This may be the case for policies to stimulate agricultural production or the development of hydropower as renewable energy. Policy coherence also needs to be pursued with environmental policies that are not primarily aimed at managing water resources but can influence it, such as policies aimed at promoting carbon sequestration.

Because they encourage an increase in agricultural production, the forms of support most closely linked to agricultural production (market price support and payments based on output or input use) are often those that affect the most management of water resources (Henderson and Lankoski, 2019[26]).It can be expected that the effect on water resource management of payments by the number of animals (headage payments) or the area under cultivation (acreage payments) will be smaller and even less so for headage or acreage payments set on a historical basis, unrelated to the actual number of animals or area currently cultivated (decoupled payments).

Thus, the granting of public financial support to modern irrigation techniques would come under “input subsidies” (payment based on the use of inputs) having a distorting effect on agricultural production (and trade) and water use. In addition, this would counteract the incentive of abstraction charges (REUA) to use water more efficiently, in particular by adopting such modern irrigation techniques. In the case of board of users of the hydraulic sector (JUSH), the REUA is passed on to irrigation water tariffs. According to a 2010 survey, only 4.3% of Peruvian farmers had access to modern irrigation techniques (MINAGRI, 2019[27]).

The impact of agricultural support on water resources also varies depending on whether or not it results in a change in land use. For example, agri-environmental payments and agricultural PES can have unintended negative effects on water if they favour cropland over forest land or permanent grassland.

The size of the farm should not be an agricultural policy criterion in terms of water risk management. A small mountain farmer must be as conscientious in managing the water resource as a large irrigator on the coast. If this is not the case, in both cases, it would jeopardise good water management at the basin scale. However, it can be difficult for a low-income farmer to implement a water policy for lack of financial or technological means. The decision to put in place an explicit policy to support farmers’ incomes (decoupled from agricultural production) is a political decision. In Colombia, for example, rural development policies are seen as complementary to agricultural policies. Funded by the redistribution of revenues from the exploitation of non-renewable natural resources, they include social measures such as housing subsidies in rural areas.

Aquaculture in Peru requires a permit to use the aquatic space (sea, rivers or lakes) issued by the Directorate-General of Captaincy and Coast Guard in Peru (DICAPI), a water use permit issued by the ANA and a sanitary authorisation for the use of feedstuff and antibiotics issued by the National Fisheries Health Agency (SANIPES) of the Ministry of Production (PRODUCE). Fish farms must carry out periodic monitoring of their water quality (surface, average and bottom) and submit the results to the Environmental Inspection and Enforcement Agency (OEFA) of MINAM, which monitors compliance of water bodies with environmental quality standards (EQS).

Aquaculture in Peru is not subject to REUA because of non-consumptive use of the water resource. In general, aquaculture effluents do not require a discharge authorisation (Legislative Decree No. 1195, General Aquaculture Law of 2015). However, discharges of aquaculture effluents into a sensitive natural environment are subject to prior authorisation from ANA and payment of the REVART (Table 3.5). However, the use of antibiotics and fungicides, the excess feed used in fish farms as well as faeces pollute the water. The REVART rate is differentiated between sectors according to the persistence and toxicity of the substances contained in their effluents, on average, but with a single rate per sector and type of water use (see Table 3.5). Further differentiation of the REVART, within each sector, would create a better incentive to move towards substances that are less harmful to health and the environment.

An abstraction charge (REUA) applies in Peru to the (non-consumptive) use of surface water for hydroelectricity. It is justified by the environmental risks associated with hydropower generation: risk of hydropeaking, modification of sediment transport and eutrophication, obstacle to the migration of fish. On the other hand, the REUA is based on the price of electricity at the level of production, which creates a disincentive to produce such renewable and carbon-free energy. Many OECD countries have done the opposite by introducing feed-in-tariffs to promote electricity generated from hydropower. Neither of these two measures is to be recommended given the distortions they cause in the electricity market. Instead, the REUA for the hydropower sector should reflect the environmental risks associated with hydropower generation. In particular, the REUA rate should take into account the negative effects on water flow, sediment transport, pollutant dilution and fish migration, but also the positive role of dams in managing water scarcity and flooding risks. The decision must also take into account energy policy, in particular energy mix objectives. Unlike photovoltaic and wind (and nuclear) plants which generate electricity continuously, hydropower plants with storage dams can adapt the supply of electricity to demand, reducing dependence on fossil-fuelled thermal power plants during peak demand periods.

In accordance with the “polluter pays” principle, hydropower plant operators must cover the cost of upgrading old plants to new hydropeaking standards. This is because frequent fluctuations in flows and water levels downstream and upstream of plants (hydropeaking) hinder the proper management of water resources at the basin level. A tax on electricity bills could finance the costs of upgrading in case of acquired rights of operators guaranteeing them compensation for any limitation of the use of hydroelectric power.

Policy coherence must also be sought with environmental policies that are not primarily aimed at managing water resources. For example, a policy to foster carbon sequestration may help reduce the risks to water. In greenhouse gas emission (GHG) trading systems where GHG emitters may offset their emissions with carbon credits, as provided by the Clean Development Mechanism of the Kyoto Protocol to the United Nations (UN) Framework Convention on Climate Change, farmers who agree to sequester carbon can receive financial compensation if they commit to converting agricultural or pastoral land into forests, often reducing pressure on water resources.

MERESE funds set up in 2013 as part of Peru’s water supply and sanitation policy should continue to expand as the optimised master plans of water companies are updated. The turnover of EPs devoted to MERESE could be revised depending on the cost-effectiveness of the PES compared to investment spending in traditional grey infrastructure. Cost-effective use of MERESE funds requires identifying the appropriate projects to finance following a cost-benefit analysis. Local communities living in highlands in Peru have high expectations from the PES instrument, which also has social benefits (avoid migration of these populations to cities) and tourism benefits (preservation of cultural landscapes). There is an urgent need to estimate the needs and costs of protecting headwaters by assessing the risks of water scarcity and pollution in the watershed in the absence of such protection. The beneficiaries of PES payments (populations living in the headwaters) must fully adhere and commit to the proposed PES projects; the feasibility of PES projects depends on it. Equally important is the willingness to pay on the part of beneficiaries of ecosystem services, which implies that they are explicitly informed of the purpose of payments. MERESE fund-raising could extend to other beneficiaries of the protection of mountain ecosystems, namely farmers and industry. Finally, consistency must be sought in the use of MERESE funds and funds for disaster mitigation and adaptation to climate change (GRD/ACC) to avoid duplication and promote synergies in achieving objectives. Below, some options for an efficient effective and feasible design and use of the PES instrument are proposed.

Defining the MERESE fund envelope primarily based on affordability does not allow the identification of needs and the technical cost of protecting upstream water sources. Key sources of hydrological services among terrestrial ecosystems (including wetlands) must first be identified and their contribution to mitigating the risks of water scarcity and pollution of the watershed assessed. A cost-benefit analysis of the proposed MERESE projects can then be carried out. The "rapid diagnosis of water" proposed by SUNASS as part of the implementation of MERESE is a positive step in this direction.9 The diagnostic aims to facilitate the understanding of the hydrological processes in the basins in order to characterise the hydraulic ecosystem services and their benefits. Governing Council Resolution Resolución N° 039-2019-SUNASS-CD provides for the EPs to set priorities in the implementation of MERESE funds. However, it does not provide clear information on how to do it.

Pending a a better understanding of the hydrological services of ecosystems, prioritisation of the use of MERESE funds could seek synergies with biodiversity policy. Thus, the use of MERESE funds for terrestrial ecosystems could consider protected natural areas that lack public financial support. In the absence of analysis of terrestrial ecosystem services, the use of the MERESE fund will tend to focus on easily identifiable impacts. So far, priority has been given to the protection of lagoons. This is the case, for example, with the protection of the Piuray lagoon, which supplies the city of Cuzco with drinking water. There is greater difficulty in estimating water flow regulation services provided by terrestrial ecosystems (e.g. forests) than the risk of pollution or drying of a lagoon in the headwaters (Cuenca alta). Thus, the priority of use of MERESE funds for terrestrial ecosystems could be given to protected natural areas (Áreas Naturales Protegidas, ANPs, national and regional) in order to mobilise private finance for the protection of biodiversity. It is recommended to intervene as a priority in the ANPs also because they have a management plan and are placed under the supervision of MINAM via the National Service of Natural Areas Protected by the State (SERNANP). For example, the MERESE fund of the Chiclayo EP could prioritise the financing of measures to preserve 71 000 ha of ANPs in the district of Carmen de la Frontera located in its headwaters zone (Lambayeque Department). Payments could include helping communities living near the regional ANP to prevent illegal activities in the ANP (by creating a kind of buffer zone around the ANP).

Prioritisation of the use of MERESE funds could also seek synergies with river basin management policy. The MERESE fund could usefully contribute to the implementation of the Basin Water Resources Management Plan (Plan de Gestión de Recursos Hídricos, PGRHC) approved by the National Water Authority (ANA), and vice versa. On the one hand, the design of the MERESE fund (the percentage taken from EPs revenues) could aim for consistency with the PGRHC in addressing water risks. On the other hand, the PGRHCs could pay greater attention to ecosystem services and not only to inter-basin water transfers (trasvase, Box 3.1) and grey infrastructure (dams, reservoirs).

In sum, the following actions could be considered by MINAM, EPs, regional governments (GORE) and local communities to make cost-effective use of MERESE funds:

  • Develop a set of criteria (technical, social and economic) for the cost-effectiveness analysis (CEA) of hydrological services provided by ecosystems in upper parts of the basin and systematise the CEA of PES initiatives, current (ex post) and future (ex ante).

  • While waiting for a better understanding of the hydrological services provided by ecosystems in upper parts of the basin, continue to use MERESE funds primarily to protect the ecosystems surrounding the high mountain lagoons, given the essential role of these lagoons in the regulation of hydrology in Peru.

  • Consider protected natural areas (national and regional) as another priority in the use of MERESE funds, in particular those which lack public financial support.

  • Also prioritise the allocation of MERESE funds to the promotion of the traditional practice of storing and collecting runoff water (siembra y cosecha), for example through payments to build or strengthen terrace systems, as this practice has proven its effectiveness in improving the water supply to downstream water bodies.

  • Design the MERESE scheme in a more global approach to water risk management by basin;

  • Seek consistency of the use of MERESE funds with the river basin management plans, where they exist.

  • Match the use of MERESE funds to the water risks of the basin and undertake a cost-benefit analysis of the proposed MERESE projects.

  • New York City, United States, is an interesting example of a city that relies on watershed protection to protect its drinking water supply (Box 3.2).

Populations living in the upper parts of the basin need to fully adhere to proposed MERESE initiatives. In order to do this, the minimum payment should be at least as attractive to the landowner as the conversion to another legally permitted land use. In other words, the “consent to be paid” for PES activities of populations living in the upper parts of the basin (often farming communities) should be assessed to ensure their full adherence to the MERESE initiatives. It is only with this information that the percentage collected on EPs revenues can be defined. As such, cost estimates should be re-evaluated according to the economic principles of the PES, which entails a detailed socio-economic study of the populations concerned. The MERESE Act of 2014 could introduce the concept of minimum payment and maximum payment. The minimum payment must make ecosystem conservation at least as attractive to the landowner as conversion to another land use permitted by law. The maximum PES payment should represent the cost for downstream populations of reduced water services.

For reasons of cost effectiveness and transparency, the PES must be linked to individual water consumption. Making the individual contribution of PES beneficiaries explicit (for example, by linking urban households’ payments to their water consumption instead of taking a percentage of EPs revenues) increases the transparency and consistency of the PES mechanism and thus its sustainability. Progress has been made in this regard in Peru. SUNASS requires that the individual water bills mention the amount allocated to the MERESE fund. Ideally, this should be accompanied by an assessment of “willingness to pay” by city dwellers and other PES beneficiaries. Linking the PES payment to the individual water bill will lead to cost effectiveness (result-based payment) and transparency (the beneficiary knows why he/she is paying).

The MERESE scheme should be further developed in the irrigation sector and extended to the industry and hydropower sectors. The costs of PES payments (whether they are minimum or maximum payment levels as defined above) need to be passed on to the downstream beneficiaries of ecosystem services, including cities, but also farmers, industry and hydropower plants. The scheme is currently implemented by cities and, on a voluntary basis, some associations of irrigators. By participating in the scheme, industry would benefit from increased security of water supply and an increased brand reputation. The extension of the MERESE scheme to hydropower companies should also be considered, as hydropower generation also benefits from upstream source protection (e.g. reduced sedimentation in reservoirs); however, care should be taken not to discourage the production of such renewable energy (compared to fossil fuel-fired plants). If a design similar to the EPs were to be introduced (i.e. allocate part of the revenues of utilities), it could be passed on to the electricity bill of end users. Ex ante cost-effectiveness analysis can help select MERESE projects which do not penalise hydropower in the energy mix. As for board of users of the hydraulic sector (JUSH), they can finance MERESE projects as part of the maintenance of the hydraulic infrastructure for which they are responsible (major or minor), through POMDIH, on a voluntary basis. The resulting MERESE expenses should be passed on to the tariff collected from irrigators, as is the case for city dwellers connected to an EP. This mutualist approach considerably increases the feasibility and effectiveness of the MERESE programme, by increasing the sums available and the capacity to assess the ecosystem services provided (compared to the implementation of a PES by an isolated farmer or a city dweller). In the case of JUSH, it would not prejudge the voluntary nature of MERESE, each JUSH remaining free to participate in a MERESE initiative. Expanding the MERESE system beyond city water companies would strengthen actions to conserve, restore and monitor ecosystems in protected natural areas that regulate the water used by the various beneficiaries. This is the case, for example, with the Nor Yauyos Cochas Landscape Reserve, which supplies water to the El Platanal hydropower plant and the Cañete JUSH. Other examples are Huascarán National Park, which feeds the Chavimochic irrigation project, and Cerros de Amotape National Park, which feeds irrigation projects in Piura and Tumbes.

Consistency must be sought between the MERESE funds and the funds for disaster risk management (GRD) and adaptation to climate change (ACC) to avoid duplication, promote synergies and thus improve cost effectiveness in their use. The percentage from EPs revenue to fund the GRD/ACC funds is not set by the PMO; this gives EPs greater flexibility in deciding what measures to put in place and how much to allocate to the GRD/ACC funds than it does for the MERESE fund. The decision is often linked to the visible effects of climate change. For example, the drying up of a lagoon in Arequipa caused its eutrophication; the GRD/ACC funds were used to control eutrophication by activated carbon. More generally, the GRD fund is used more often than the ACC fund; disasters are easily visible while there is uncertainty about what to cover in terms of adaptation. Fostering coherence between the MERESE fund and the GRD/ACC funds would avoid duplication, promote synergies and thus improve cost effectiveness in their use.

Win-win approaches must be sought between payments for hydrological ecosystem services and payments for carbon sequestration, so that projects are mutually reinforcing (for example, sustainable forest management). PES for water regulation services in natural water sources can improve the carbon sequestration services of the ecosystems concerned (e.g. forests) and vice versa. Win-win approaches must be pursued by ensuring, however, that projects prioritise the purpose for which they were designed (water regulation services or carbon services). JUSH are also involved in MERESE interventions that use reforestation and the protection of natural ecosystems. The Quiroz-Chira Water Fund project (Piura Department) is a good example. This project has been very well designed and has the financial and technical support of an NGO (Table 3.8). Another example worth mentioning is the Regional Water Fund (FORASAN) which aims to improve the management of water resources in the Chira-Piura Basin by promoting the protection of ecosystems (e.g. páramos, cloud forests) and reforestation of degraded areas in the upper parts of the basin. FORASAN receives technical support from ANA and financial support from two JUSH (Chira and Middle and Lower Piura) and agribusiness (Central America Bottling Corporation, CBC). Sustainable forest management and reforestation do not need to be implemented by the state; the private sector can do that too. For example, the Public Works in Lieu of Taxes Act No. 29230 (Ley de Obras por Impuestos) facilitates the financing and execution by private companies of priority projects of public entities (for example, central, regional or local governments) by allowing the recovery of investments via concessions on the corporate tax. However, the National Forest and Wildlife Plan to implement the Forest and Wildlife Act should be published without delay in order to provide a global framework for forest management.

The traditional practice of storing and collecting runoff water (siembra y cosecha) is also to be considered, for example by payments to build or reinforce terrace systems, as it has proved its effectiveness in supplying water bodies downstream. The provision on the creation of MERESE funds of the Law No. 30045 of 2013 on the modernisation of sanitation services (repealed by Legislative Decree No. 1280 of 2016) has no equivalent in the field of agricultural and industry legislation. In other words, although addressed by the MERESE Regulation (Supreme Decree No. 009-2016-MINAM), there is no legal obligation to implement the MERESE mechanism in the agricultural sector as is the case for the sanitation sector. Nevertheless, payments for hydrological ecosystem services (PHES) have been put in place in the agricultural sector in accordance with the Operation, Maintenance and Development Plan of the Hydraulic Infrastructure (POMDIH), which water user associations (JUHS) are legally required to prepare for effective O&M of irrigation systems. One of the seven objectives of the POMDHI is indeed to preserve the upstream waters (cuenca alta). As a result, PHES developed voluntarily (without government intervention) between farmers and local communities. For example, an association of irrigators in the Cañete Basin devoted PEN 10/ha/year (EUR 2.7/ha/year) to protect water sources through reforestation in Yauyos District (a similar practice has developed in the Lurín Basin). The payment was recently suspended pending an evaluation of its effectiveness. Farmers in Valle Viejo (Olmos Basin, Lambayeque) donate part of their harvest to communities in the district of Carmen de la Frontera located in the area of their water sources. The principle is as follows. The water user associations (JUHS) located in the middle of a river basin (cuenca media) pay farmers located upstream (cuenca alta) to store rainwater through soil and water conservation practices. The water stored upstream (for example by terraces systems) infiltrates the soil (instead of running off) to supply surface water bodies and aquifers in the central part of the basin downstream. This age-old practice of storing and collecting rainwater (siembra y cosecha) can very well be considered as a type of green infrastructure and be given increasing attention in PHES policy. Peru’s agricultural policy encourages the re-evaluation of traditional practices in agriculture and, in July 2019, Law No. 30989 declared the implementation of the siembra y cosecha practice of national interest. In France, the mineral water company Vittel pays farmers to adopt more traditional farming practices to avoid contamination of aquifers by nitrates (see Perrot-Maitre (2006[29])).

Consistency with ANA groundwater monitoring is required to co-ordinate efforts and methodologies. A portion of the EPs revenues feeds into the groundwater monitoring fund. This fund is designed to help EPs monitor groundwater levels, which is essential to prevent the risk of groundwater shortage and to evaluate the effectiveness of measures taken under the other two funds, where applicable.

The MERESE system must be part of a more global approach to risk management by basin. Indeed, it would be pointless to protect the headwaters without also managing the risks associated with economic activities along the watershed, between the headwaters and the coastal waters (agriculture, industry, hydroelectric production, in particular). This involves dealing with policy coherence to manage risks of water shortage, water pollution, flooding and the risk of undermining the resilience of freshwater systems along watersheds (see below).

In sum, the following actions could be taken into account by MINAM, EPs, GORE, local communities, ANA and sectoral ministries (MIDAGRI, PRODUCE, Ministry of Energy and Mining [MINEM]) to ensure: i) that beneficiaries of PES payments fully adhere to proposed PES initiatives; ii) the willingness to pay on the part of beneficiaries of ecosystem services; and iii) consistency in the design of MERESE projects, projects for disaster risk management and adaptation to climate change (GRD/ACC funds) and other PES schemes:

  • Estimate the costs of PES projects in accordance with the economics of PES; in particular, the minimum payment must be at least as attractive to the landowner as converting his/her land to another legally permitted use.

  • Link the PES payment to the individual water bill for reasons of cost effectiveness (result-based payment) and transparency (the beneficiary knows why he is paying).

  • Extend the MERESE scheme to industry, which also benefits from increased security of water supply – MERESE is currently only funded by cities (EPs) and, on a voluntary basis, farmers’ associations (JUSH); this would increase funding for PES projects and the industry would benefit from a better brand reputation.

  • Consider extending the MERESE scheme to hydropower companies, since hydropower production also benefits from the protection of upstream water sources (for example, reduced sedimentation in reservoirs); however, it is important not to discourage hydroelectric production which is a renewable energy.

  • Clarify the scope of MERESE and GRD/ACC funds in the areas of flood risk management and climate change adaptation.

  • Seek win-win approaches between payments for hydrological services and payments for carbon sequestration so that the respective projects are mutually reinforcing (e.g. sustainable forest management)

  • MINAM could usefully keep a register of the various MERESE/PES projects and publish it (to contribute to synergy/avoid any duplication between these projects).

There is an urgent need to strengthen economic incentives based on water risks (scarcity, pollution) in order to sensitise stakeholders to the knowledge of the risks (to develop a “water culture”). Abstraction/pollution charge rates must be aligned between sectors (cities, farmers, industry) because the impact of water abstraction or wastewater discharges on the environment depends on the availability of the resource and the quality of the receiving water, regardless of the user/polluter. Estimating which charge rates, or which new charges, are necessary to fulfil the legal obligations to manage scarcity and pollution risks of water bodies is a prerequisite for creating incentives to reduce abstraction and discharges. It would also raise revenues, which could be redistributed in the form of financial aid to local communities, industry and farmers in accordance with the master plan for each basin. These options are discussed below.

According to the OECD Principles on Water Governance (2015[31]), water charges will only be viable: if responsible authorities are clearly in charge and endowed with the needed capacity; if they are designed, collected and disbursed at the right scale; if they are documented with robust information-based systems to guide decisions; if they are driven by solid, realistic and policy coherent planning; if they are properly regulated, with effective enforcement and compliance; if stakeholders are engaged well upstream to raise their awareness and secure their buy-in; if their design implementation is transparent; and if they are properly monitored and evaluated. Box 3.3 provides tailored guidance for water abstraction and pollution charges in Brazil (OECD, 2017[32]).

Agreeing on acceptable levels of risk for the community and each would give ANA an extremely powerful "entry point" to bring together stakeholders and inform on-the-ground discussion on water resource management. The freezing of major investments for the Peruvian economy (in the mining sector, for example) in the absence of a prior agreement on the risks to water could have been avoided if a risk-based approach had been followed. This approach would also reduce the need for legal proceedings (e.g. Water Conflict Resolution Court for the day-to-day management of water resources).

Setting a maximum level of water withdrawal or wastewater discharge that is acceptable to all stakeholders is at the heart of water risk management. The aim is to ensure a sustainable and cost-effective allocation of the resource among the different sectors while preserving the needs of ecosystems, cultural heritage and the resilience of water systems. Such a risk-based approach (see OECD (2013[33]) for further discussion) should take account of the water allocation regime that prevails in Peru and complement it by specifying how much each user will be able to benefit.

Developing incentives based on water risks (scarcity, pollution) would sensitise stakeholders to the knowledge of risks (to develop the “water culture”). This is why the differential REUA and REVART rates between sectors (cities, farmers, industry) should be eliminated. The impact of water withdrawals or wastewater discharges on the environment depends on the availability of the resource and the quality of the receiving water, regardless of the user/polluter. As such, the REVART rate should reflect the health and environmental toxicity of pollutants in wastewater. For example, a preferential rate applies for the REVART to communal water companies in rural areas. Although this encourages the necessary development of sanitation infrastructure in these areas, it reduces the incentive to build modern infrastructure (e.g. advanced wastewater treatment). The single REUA rate that applies to some boards of users of the hydraulic sector (JUSH) does not take into account the risk of water scarcity; it must be replaced by a differentiated rate according to the availability of water, as is the case for other users. For the same reason, the REUA rate applied to “special projects”, a percentage of the tariff to cover the cost of operation and maintenance of the irrigation infrastructure (tarifa por el servicio de agua), must be replaced by a differentiated REUA rate according to the availability of water.

Moreover, some options to be considered are:

  • Farmers: Eliminate the preferential electricity tariff for pumping groundwater in areas where it applies (e.g. Tacna), as it counteracts the incentive, through REUA, to use water more efficiently (for example, by adopting modern irrigation technology).

  • Hydropower plants: Set the REUA according to the environmental risks and benefits associated with hydropower generation – hydropeaking, modification of sediment transport and eutrophication, obstacles to fish migration, the positive role of dams in managing water scarcity and flooding risks – and not on the basis of the price of electricity ex-factory, as is currently the case.

  • ANA and EPs: Ensure that groundwater monitoring by ANA and the water companies (the latter financed by the water bill) complement each other and are consistent.

Extending ANA’s inspection fee coverage for water resource use would improve regulatory compliance and knowledge of water scarcity risks; the same recommendation applies to the Ministry of Health with respect to inspection fees for the discharge of wastewater. ANA and the Ministry of Health apply inspection fees. An extension of their coverage, both for the use of resources and for effluent discharges, would increase the number of inspections and, consequently, increase compliance with regulations and knowledge of the risks associated with water. There is an urgent need to improve knowledge of the water risks (scarcity, pollution) in Peru and to sensitise stakeholders (to develop a “water culture”).

The imposition of an REUA on seawater abstraction in Peru is surprising because there is no risk of depletion of the seawater resource. On the contrary, desalination increases the availability of freshwater. However, it can have negative effects on the marine environment in the form of brine discharges to the sea that can lead to a substantial increase in salinity and temperature, as well as the accumulation of metals, hydrocarbons and other toxic compounds in receiving waters (Roberts, Johnston and Knott, 2010[34]). The imposition of a REVART on the discharge of concentrated brine by marine outfalls of desalination plants, as is already the case in Peru, makes more sense from the point of view of the protection of the environment.

In sum, the following actions could be taken into account by ANA, MIDAGRI, MINAM, MINEM and EPs to strengthen economic incentives to develop a “water culture” based on the risks of water scarcity:

  • Farmers located in the upper basin (cuenca alta): Remove the preferential rate of abstraction charges (REUA) in areas at risk of water scarcity because this goes against any PES to protect headwaters.

  • Boards of users of the hydraulic sector (JUSH): Replace the single rate of REUA that applies to some JUSH by a differentiated rate according to the availability of water (i.e. the risk of water shortage), as is the case for other users.

  • "Special projects" under concession: Pass on the REUA paid by the water collector (concedente) to the irrigation water supply tariff (tarifa por el servicio), instead of applying a fixed rate of 2.61% of the tariff.

  • Farmers: Eliminate the preferential electricity tariff for pumping groundwater, as it thwarts the incentive of REUA to use water more efficiently (for example, by adopting modern irrigation technology).

  • Hydropower plants: Set the REUA according to the environmental risks and benefits associated with hydropower generation – hydropeaking, modification of sediment transport and eutrophication, obstacles to fish migration, the positive role of dams in managing water scarcity and flooding risks – and not on the basis of the price of electricity ex-factory, as is currently the case.

  • ANA: Broaden the base of ANA’s water resource use inspection fees to improve compliance with water legislation and awareness of water scarcity risks.

  • ANA and EPs: Ensure that groundwater monitoring by ANA and the water companies (the latter financed by the water bill) complement each other and are consistent.

The following actions could be taken into account by ANA, MIDAGRI, MINAM and the Ministry of Health (MINSA) to strengthen economic incentives to develop a “water culture” based on the risks of water pollution:

  • Communal sanitation organisations (rural areas): Replace the preferential rate of the charge on the discharge of treated wastewater (REVART) by a differentiated rate according to the quality of the receiving water, as is the case for other sectors.

  • All: Set the REVART rate according to the toxicity of the effluents for health and the environment.

  • MINSA: Broaden the base of MINSA wastewater discharge inspection fees to improve compliance with water legislation and raise awareness of water pollution risks.

In Peru, an explicit river rehabilitation policy is lacking. As such, it could usefully bring together different sources of financial support to restore the natural course of rivers (inter alia to avoid significant damage from floods). Restoring good hydromorphological conditions in rivers (river rehabilitation) can help improve water supply (self-purification of water and recharge of groundwater), ensure natural protection against floods and protect nature (providing sufficient space to rivers allows them to connect ecosystems). It is necessary to ensure synergies and coherence between these different objectives and policies to encourage them. To introduce such a river rehabilitation policy, Peru should estimate the river sections to be restored and the financial support to be mobilised. In particular:

  • Assess the ecosystem services provided by river rehabilitation (improvement of water resources, protection against floods, nature protection, land consolidation).

  • Consider river rehabilitation as part of MERESE payments for hydrological services.

  • Provide public financial support for river rehabilitation as it contributes to the protection of natural ecosystems and their services (such as floodplains).

  • Provide public financial support for the protection of alluvial forests.

  • Provide public financial support for the rehabilitation of small rivers located in agricultural areas to the extent that it contributes to the improvement of agricultural production conditions through land consolidation.

  • In case of overlapping policies for the same stretch of river, no double funding should be allowed for the same service provided.

In sum, the following actions could be taken into account by MIDAGRI and MINAM to bring together different sources of financial support to launch a policy of “river rehabilitation”:

  • Target agricultural policy support for flood risk management.

    • Provide agricultural policy support for the rehabilitation of flood plains and their natural habitats in agricultural areas as part of agri-environmental measures.

    • Provide agricultural policy support for the rehabilitation of small rivers in agricultural areas as part of land consolidation policies.

  • Target PES and public financial support to alluvial forests and natural riparian ecosystems.

    • Consider river rehabilitation as part of MERESE payments for hydrological services.

    • Provide environmental policy support for the protection of alluvial forests and natural riparian ecosystems.

An interesting example is provided by the Swiss river rehabilitation policy. In 2011, Switzerland embarked on a long-term effort to restore its rivers. The Swiss river rehabilitation policy was triggered by a popular initiative of fishermen to strengthen the biological functions of rivers through habitat creation and riparian zone management (Box 3.4).

Sectoral policies should not offset the effects of policies to pay for hydrological services and river rehabilitation, as well as charges on water abstraction and wastewater discharges, by encouraging overuse or water pollution. This may be the case for policies to encourage agricultural, aquaculture or hydroelectric production (Table 3.9). Coherence must also be sought with carbon sequestration policies.

For the purpose of strengthening policy coherence, the following actions could be considered:

  • Evaluate the impact of agricultural support, in its different forms, on water resources.

  • Evaluate the impact of hydropower development on fluctuations in flows and water levels downstream and upstream of plants (hydropeaking), sediment transport and eutrophication, and fish migration.

  • Manage the risk of water pollution by antibiotics, fungicides and feed used on fish farms.

  • Promote forest carbon credits for farmers who commit to converting their land to forests, thereby reducing pressure on water resources.

  • Within the framework of strengthening links for the management of water resources and water and sanitation services. It is suggested to articulate them with the Quality Control Plans of the sanitation services and the Health Adaptation Plan promoted by the Ministry of Health/ Directorate-General for Environmental Health and Food Safety (DIGESA).

Climate mitigation and water policies can help each other. In New Zealand, for example, in places where it has induced farmland conversion into forests, carbon emission trading has reduced nitrogen releases into water (Box 3.5).


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Additional references

Agence de l'eau Seine-Normandie (2019), “Les redevances de l’Agence de l'eau Seine-Normandie 2019-2024”, https://en.calameo.com/agence-de-l-eau-seine-normandie/read/004001913990170881f15.

Albán Contreras, L.E. (2017), “El Fondo del Agua Quiroz-Chira, Un mecanismo de gestión para los ecosistemas de montaña de Piura, Perú”, Programa Bosques Andinos de la Agencia Suiza para el Desarrollo y la Cooperación (COSUDE) and Naturaleza y Cultura Internacional, http://www.bosquesandinos.org/wp-content/uploads/2017/02/FAQCH-FINAL-WEB.pdf.


← 1. Görlach (2013[39]) identified five feasibility factors that may act to limit the ability to introduce instruments in the most theoretically desirable manner: administrative feasibility (e.g. transaction costs), side effects (e.g. distributional and competitiveness impacts), political and public acceptability, legal feasibility, (compatibility with existing legal frameworks) and flexibility (e.g. the ability to respond to new information).

← 2. See also discussion on “stacking” and “bundling” ecosystem services in https://www.forest-trends.org/wp-content/uploads/2018/11/Stacking-Bundling-Resource-Paper-01-11-18.pdf.

← 3. The WTO provides three “traffic light boxes” for subsidies, from Green (permitted), Amber (to be reduced) and Red (forbidden).

← 4. Decree-Law No.1280 of 2016 regulates the inclusion of GRD and ACC funds in the water tariff structure. Resolution No. 039-2019-SUNASS-CD of the Board of Directors of SUNASS of 20 November 2019 provides that GRD and ACC funds can be used to finance MERESE projects provided that the latter include measures of adaptation to climate change or disaster risk management.

← 5. Levied approximately in proportion to services provided.

← 6. Benefits provided by government to taxpayers are not normally in proportion to their payments.

← 7. Over time, the competitive price level will emerge, set at the marginal cost of production (zero profit), producing a flat supply curve.

← 8. For countries for which information is available (unpublished data from the OECD Database on Policy Instruments for the Environment).

← 9. Draft Resolution of the Board of Directors No. 027-2019-SUNASS-CD of 3 September 2019.

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