Chapter 1. The context of Moldova’s economic regulatory system for water supply and sanitation

Background

Economic regulation can be defined as all rules, procedures, practices, institutions, standards and norms, that set, monitor, enforce the economic aspects (tariffs, service standards) of water supply and sanitation (WSS) under given policy objectives (Castalia, 2005). As a natural monopoly sector, WSS requires economic regulation, either by contract (e.g. like in public-private partnership arrangements not yet in use in Moldova’s WSS), or by competent regulatory authority (i.e. a professional regulator).

The Republic of Moldova (hereafter “Moldova”) took important steps forward in the development of its economic regulatory system (ERS) for WSS with the adoption of Law 303 on Water Supply and Sanitation in 2013. This led to the nomination of the National Energy Regulatory Agency of the Republic of Moldova (ANRE) as the competent regulatory authority for WSS in 2014.

A sound ERS, however, includes much more than the establishment of a regulator. The 2000 Almaty Ministerial conference provided an idea of what one may expect from a sound ERS (OECD EAP Task Force, 2000[1]):

• economic efficiency i.e. ensuring the best possible use of resources for the most productive outcomes

• cost recovery i.e. providing revenues to meet the costs of operations, maintenance and administration

• fairness i.e. treating all customers equally and excluding any abuse of market power by the natural monopoly

• financial stability i.e. minimising revenue fluctuation

• resource conservation and resource use efficiency by providing environmental and economic incentives, respectively

• social orientation of water services, without making the water utility a social agency.

In the context of transition countries, it is possible to add (OECD EAP Task Force, 2000[1]):

• ruling out of unfunded mandates in the environmental, social and public obligation sphere

• simplicity and “understandability”.

To ensure the above outcomes, it is required to:

• provide the right governance of the regulatory agency

• ensure the proper integration, co-ordination and communication with the other constituents of the ERS.

Moldova’s ERS has to perform within two important contexts:

• “Policy”: the internal and external policy objectives of Moldova.

• “Capacity”: the characteristics of the WSS providers and their stakeholders, including in terms of number, production capacity, operations, physical condition and financial situation.

“Policy” sets the ambition. It provides direction on what must be achieved or accommodated by the ERS. Internationally, Moldova has committed to WSS-related objectives in the Association Agreement with the EU and the Sustainable Development Goals (SDGs), as well as the Paris Agreement on Climate. National strategy and policy documents also reflect commitments to WSS-related goals. Both international and domestic commitments are further described in section 1.2.

“Capacity” constrains the policy ambition. The WSS sector in Moldova faces challenges that will make it hard to absorb funds, regionalise, increase tariffs, co-finance, plan and manage projects required for compliance with the policy objectives.

As suggested in Figure 1.1, balance is needed between policy ambition and financial and human resources, planning, management and absorption capacity. A sound ERS would aim to achieve the balance and maintain it

Figure 1.1. Context within which Economic Regulatory System must perform

Source: Author's own elaboraion

Policy objectives

The policy framework for WSS in Moldova is explicit. Its targets are defined in:

• Moldova’s Association Agreement with the EU

• SDGs and Paris Agreement

• National policies and strategies (incl. WSS and adaptation to climate change) (UNDP, 2009[2])

Water supply and sanitation sector performance

Moldova’s ambitious policy agenda is to be realised in a developing institutional and regulatory environment and also in severe economic hardship. At purchasing power parity (PPP), gross domestic product (GDP) per capita in Moldova is just 55% of the average for countries in South Eastern Europe (SEE) that are non-EU members. This ranks Moldova as by far Europe’s poorest country. Figure 1.2 provides a snapshot of the capacity of the WSS sector in Moldova. Annex 1.A compares indicators of Moldova’s WSS sector with those of non-EU and Danube Region average values.

Figure 1.2. Moldova's WSS performance in comparative perspective

Sustainability Assessment

Source: author’s own elaboration based on data from the Water and Wastewater Services in the Danube Region project’s web-site: www.danube-water-program.org (accessed 13 June 2017).

The WSS sector in Moldova is well behind its Central and South East European peers with respect to:

• Access to WSS, which is around 65% for water and still significantly lower for sanitation.

• Wastewater treatment, at 24% of the population connected.

• Staff levels are two-three times above benchmark levels of three-five staff per thousand connections: water plus wastewater.

• Affordability of service, which for most of the population is above 5% of household expenditures, as illustrated by the recent affordability assessment (see Figure 2.5). Investment from utilities’ own resources in WSS per capita is on average 30% below other non-EU countries in SEE. It is 90% below the Danube average (i.e. including also new EU member states in the Danube basin).

While at least in line with the Central and South East European average, significant challenges remain in several other fields (Pienaru et al., 2014):

• non-revenue water (presently at 41%)

• customer satisfaction

• operating cost coverage (presently at 0.99 compared to a benchmark of 1.5) (see Table 1.3 and Figure 1.3 for more details).

Figure 1.3. IBNET country snapshot Moldova, based on 43 largest utilities

Source: Author’s own elaboration based on data from the IBNET database, www.IB-NET.org (accessed on 5 April 2017)

Demands on ERS for WSS in Moldova

Given the disparity between the limited capacity (human resources, financial, absorption) of the sector and the ambitious policy commitments, the demand on the ERS in Moldova is intense. There are nine demands on ERS that can be derived from the policy objectives:

1. Monitor and steer towards improved performance in WSS and on incentives for efficiency.

Rather than applying fixed standards, the ERS shall trigger developments leading to improved performance. Two key factors are increased transparency and negotiations with utilities on performance improvement trajectories, including for staff, non-revenue water, specific energy consumption, etc. This shall be done on the basis of business plans (or corporate development plan).

2. Focus regulatory efforts on large, regionalised entities.

Romania and Kosovo are seen as successful examples of regionalisation. Following their practice, the ERS in Moldova may consider leaving the economic regulation of small, non-regionalised entities completely to municipalities.

3. Facilitate the emergence of sustainable business models in WSS.

The traditional municipal water utility (Apacanal) model is not the standard solution or panacea for the sector’s challenges. Regionalisation of WSS services has been foreseen on paper, but is hardly functioning in practice. Apart from horizontal integration, a number of alternative solutions may be suitable in particular service areas. These include reconsidering and facilitating:

• the right degree of vertical integration

• the optimal combination of water production, distribution, sewerage and wastewater treatment may differ across regions and between rural and urban areas

• the use of private sector participation, including outsourcing services.

4. Allow for tariff increases to fund operation of WWTPs.

When WWTPs become operational, tariffs must be increased to cover the jump in operating costs. If tariffs do not rise, WWTPs won’t have enough cash flow to start operations.

5. Offer well-targeted mechanisms for protection of poor and vulnerable citizens.

Considering the necessary increases in tariffs and the human right to WSS, social safety nets are needed to ensure access for poor and vulnerable citizens.

6. Set the overall affordability constraint for the population within which tariffs may rise.

Unlike most SEE countries, the overall affordability constraint in Moldova is real. For some service areas, average expenditure on WSS is already above the commonly used threshold of 4% of household expenditure. A clearly defined affordability ceiling is needed. To meet affordability criteria, rural service areas may have to merge with richer, urban areas. A uniform tariff would be applied through the service area with the richer areas cross-subsidising the poorer ones.

7. Recognise the need to bridge the funding gap through (affordable) loans and other forms of market-based (repayable) external finance.

The foreseen peak in capital expenditure cannot be covered by tariffs, transfers and taxes (3Ts) alone. Such peaks require external, repayable finance, mostly through loans from international financial institutions (IFIs). This can bridge, but not close, the funding gap; only the 3Ts can close it, as illustrated in Figure 1.4. This requires an ERS that recognises the cash flow consequences of external financing. That ERS should allow tariffs to accommodate debt service obligations, if taxes and transfers have not been committed to do so.

Figure 1.4. Repayable external finance to bridge the funding gap

Source: (OECD, 2010[6]), Innovative Financing Mechanisms for the Water Sector

8. Allow for adequate and cost-effective ways to achieve SDG6 through revised design and construction norms for WSS and service quality standards, among others.

Given the challenge of meeting the SDGs, more flexible, appropriate approaches to WSS are needed, particularly in sanitation and in rural areas. This should be possible without breaking any construction or service norms or standards.

9. Apply dedicated economic instruments to co-finance investment, particularly in wastewater treatment (OECD, 2010[6]).

The WFD calls for water pricing in accordance with the full cost recovery and polluter pays principle. Full cost recovery implies charging not only the operating and capital costs of service, but also the environmental and resource costs. In Moldova, however, full cost recovery in WSS cannot be achieved through tariffs alone in the years up to 2030. The ERS will have to provide for other complementary economic instruments such as charges, taxes and market-based instruments. At the same time, these instruments can generate funds needed for co-financing WSS capital expenditure, particularly for wastewater treatment.

The demands are summarised in Annex 1.B. They were discussed among stakeholders and in an Expert Meeting on 16 November 2016. Furthermore, Annex 1.A.2 provides an overview of the relations, the necessary balance and the possible conflicts between these demands. From the overview, one can see that the demands on the system are compatible or can be reconciled.