Reforming economic instruments for water management in EECCA countries - Policy Perspectives 2016 by OECD

Reforming economic instruments for water management in EECCA countries policy perspectives 2016

policy Perspectives

Reforming economic instruments for water management in Eastern Europe, Caucasus and Central Asian (EECCA) countries KEY MESSAGES AND RECOMMENDATIONS Water is a key pillar to support transition to a green economy model. However, the water sector in Eastern Europe, the Caucasus and Central Asia (EECCA) countries faces significant challenges, including: •

Lack of water for some uses as water resources are often scarce or not efficiently allocated.

•

Low water quality in some water bodies.

•

Lack of monitoring of water resources (mostly due to insufficient financial resources).

•

Poor financial status of the water sector, resulting in low quality services provided by water infrastructure, and a lack of qualified staff in the water sector (due to low salaries).

•

High risk to the population from outbreaks of water-related diseases, and risks for human life, property and water infrastructure from waterrelated hazards (floods, droughts, mud-flows and landslides).

This Policy Perspective summarises key policy messages and recommendations on the role of economic instruments in addressing the aforesaid challenges and achieving key water policy objectives including relevant Sustainable Development Goals (SDGs). 1: Economic instruments have an important role to play in achieving water policy objectives including water-related SDGs. 2: The existing economic instruments in EECCA countries require improvement to deliver these objectives. The use of economic instruments for water management in the EECCA countries needs to improve in terms of their design, implementation and enforcement. Key recommendations to this end are: •

Recommendation 1: Close the gap between policy objectives and performance of economic instruments.

•

Recommendation 2: Develop and assess scenarios for reform of priority instruments, and develop an Action Plan (AP) for the implementation of preferred scenarios.

•

Recommendation 3: Ensure attention to the political economy of the reform of economic instruments. Critically important elements of the reform process are: sequencing proposed reforms appropriately and progressively implementing them; applying appropriate accompanying measures; and stakeholder consultation.

OECD : Reforming economic instruments for water management in eecca countries

Introduction

Since the early 1990s, the OECD has supported transition economies of Eastern Europe, the Caucasus and Central Asia (EECCA) to improve their environmental and water policies, integrate environmental considerations into the processes of economic, social and political reform and gradually shift to a green growth and sustainable development model. The OECD work has focused on the economic and financial dimensions of water resources management (WRM) and on reform of water supply and sanitation (WSS). This work has supported EECCA countries in the reform process, not least by integrating the IWRM principles1 and principles of the EU’s Water Framework Directive (WFD), including the polluterpays and the user-pays / beneficiary-pays principles, into national water policies, with the ultimate goal to help achieve water-related Millennium Development Goals (MDGs) till 2015, followed by the Sustainable Development Goals (SDGs) adopted in September 2015, and other water policy objectives as well as related socio-economic policy objectives set out in national development strategies and sectoral programmes. If properly designed and implemented, economic instruments (EIs) for water management can play a crucial role in achieving water policy objectives, and in particular: •

Provide incentives for conservation and more efficient use of water.

•

Mobilise additional financial resources for water management (by increasing revenues from economic instruments), thus enhancing the financial sustainability of the water sector.

1 There are five IWRM principles: manage water resources at the basin level and involve interested stakeholders; ensure inter-sectoral and vertical coordination of water management; ensure transparency and public participation in WRM; ensure sustainability of water resources use, including the protection of ecosystems; and ensure financial stability of water management and the use of economic instruments.

Also, by helping to reduce the risks and consequences of water-related hazards, economic instruments contribute to economic development and its sustainability. Since the 2011 “Environment for Europe” ministerial conference, the EAP Task Force has conducted extensive reviews of how economic instruments are applied in EECCA countries (focusing in particular on Armenia, Georgia, Kyrgyzstan and Russia, and on the Kura river basin) to address key water management challenges and meet water policy objectives. The key aim of the studies was to identify needs and opportunities for reform of the instruments. The work was implemented through policy dialogues on water conducted in respective countries and other forms of stakeholder consultation. This OECD Policy Perspective outlies key policy messages and recommendations from that work and a brief overview of the assessment methodology applied.

Common water management challenges and risks in EECCA countries

Despite geographic and climatic differences, EECCA countries face some common water management challenges and water risks that hinder sustainable economic development. In terms of water quantity, the EECCA region includes both water-scarce countries (e.g. Armenia) and waterrich countries (e.g. Kyrgyzstan, Tajikistan and the Russian Federation – the latter ranks second in the world after Brazil in the availability of renewable fresh water resources). Nevertheless, water quantity issues are reported even in water-rich Russia as water is unevenly distributed across its territory. In water-scarce regions, water is becoming a constraint for further economic development. Water infrastructure in EECCA countries is generally under-developed. Where infrastructure exists, it is often in poor condition due to chronically under-funded maintenance and repair and lack of rehabilitation. This particularly concerns flood protection infrastructure, urban storm water collector-drainage systems and WSS systems in rural areas. Poor financial status of the water sector is a common problem in all EECCA countries. It can contribute to local shortages and poor water-related services further worsening water quantity issues in water-scarce countries. In EECCA, in many cases water management challenges are linked by common fil rouge: the lack of sufficient funding for proper water management activities. Poor water policy often contributes to this by increasing future financial liabilities, demand for finance and ultimately the financing gap. Two examples are outdated design and construction standards that lead to building significantly over-sized WSS systems in rural areas, and the counter-productive incentive to build assets in water risk-prone areas for which the state acts as the “insurer of last resort ” (see OECD 2016b, forthcoming). Water losses are significant and there is room for improving water use efficiency in most sectors throughout EECCA. In Kyrgyzstan, for example, it was estimated that total water losses are 2.5 billion m3 per year – that is some 20-30% of the estimated total national water consumption of 8-9 billion m3 per year or 5% of the estimated total renewable fresh water resources in the country. In Russia, irrigated agriculture now consumes almost twice as much water per tonne of produce than it consumed in 1990.

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OECD : Reforming economic instruments for water management in eecca countries

In addition to water quantity issues, water is often not allocated to the uses where it could add most value. Competition for access to water resources is an issue in water-scarce regions, and it is growing even in basins with higher water availability. In many cases, planning and decision-making for water allocation remain purely administrative, and economic estimates of benefits of alternative water allocation options are often not considered. The economic dimension of water use is rarely assessed, as both quantitative and economic information on the different water uses is scarce (e.g. in the Caucasus region). In Armenia, for example, the economic analysis of water uses has not been integrated in river basin management plans. Issues of trans-boundary allocation of water resources also exist. The Kyrgyz Republic, for example, is facing significant challenges in achieving efficient and equitable allocation of water resources among competing uses within the country and with downstream countries. Under international agreements signed soon after the breakdown of the Soviet Union, the new states confirmed that they would continue to respect the water allocation quotas established during the Soviet era, so that Kyrgyzstan is allowed to use only a marginal share of the total annual water inflows (precipitation and melting glaciers) and must assign for downstream countries the majority of the country’s rivers run-off. • EECCA countries face significant water management challenges, including water quantity and quality issues, water allocation issues, lack of monitoring and water-related hazards. • There is a lack of incentives for improving water-use efficiency. • A lack of investment, maintenance and repairs is observed, resulting in the poor condition of existing water supply, wastewater collection and treatment infrastructure. • Many subsidies in the water sector are not costeffective, nor do they help achieve policy objectives and targets. • EECCA countries are characterised by a poor financial status of the water sector. Revenues generated by tariffs for water services typically are not sufficient to fully cover even operation and maintenance costs, which are often heavily subsidised. Investment costs are generally subsidised. Lack of financing is often a consequence of a poor water policy.

OECD : Reforming economic instruments for water management in eecca countries

Water quality issues are also common with a number of rivers and aquifers presenting high pollution levels which can lead to health concerns. In the case of surface water bodies, water pollution is mostly due to discharges of untreated wastewater and drainage water. Wastewater treatment facilities are insufficient and, where they exist, they are often in poor condition. In rural areas, very few treatment facilities have functional biological treatment. The poor condition of wastewater treatment systems are linked to the lack of financial resources to invest in new treatment facilities and to properly operate, maintain and repair existing ones. In the case of surface water bodies, quality issues are further worsened by discharges from industrial and other commercial enterprises directly to water bodies without prior local treatment by that enterprise to set treatment standards. Groundwater bodies, in turn, are affected by diffuse pollution from agriculture as well as point source pollution from domestic pit latrines and septic tanks – the coverage of wastewater collection and treatment systems in rural settlements is low and it often does not reach rural areas.

In order to identify, localise and address the problems described above relating to pollution of water resources, it is important to have an effective programme of water quality monitoring for surface and groundwater resources and drinking water supplies. However, in many EECCA countries a lack of monitoring of the status of rivers and aquifers is often observed, and this can also be largely attributed to the lack of sufficient funding. The main water-related risks in EECCA countries are associated with natural hazards, such as floods and droughts, as well as mudflows and landslides. These are further exacerbated by increased climate variability and climate change, which is projected to lead to major variability of river flows, faster melting of glaciers and snow accumulated over winter and a significant change in the profile of spring floods. However, in EECCA countries, often there are incentives to build assets in water risk-prone areas with land in such areas often being cheaper. These water management issues are often interlinked and have significant socio-economic impact.

Water policies implemented by EECCA countries share a number common objectives, for example: • • • • •

All EECCA countries aim to achieve water-related SDGs (SDG 6 and SDG 11.5). In terms of improving coverage by water services, rural WSS is a key focus. Most countries aim to improve water use efficiency foremost through innovation in irrigation and water-intensive industries. Most countries aim to achieve greater levels of water security, as well as food security and energy security, for which water is key. Some countries aim to increase capacity for strategic water storage (e.g. Kazakhstan, Kyrgyzstan and Tajikistan). Some countries plan to develop the resource base (e.g. through water re-use and recycling, development of ground water resources or use of salty water (desalination)).

For most countries, sustainable economic development is an over-arching socio-economic and environmental policy objective influencing sector policies including water policy. When comparing key water policy objectives between the EECCA countries on the global policy level, all EECCA countries aim to achieve water-related SDGs (MDGs, before 2016). This includes establishing national goals and targets (as well as indicators) on water resources management, water, food and energy security (based on SDGs 6, 2, 7 and 11.5 adopted by the UN Summit in September 2015), and integrating them into national policies, strategies and plans. In addition, all EECCA countries aim to combat the aforesaid challenges related to water scarcity, waterrelated risks, lack of financial resources and ineffective subsidies in the water sector. To reach these policy objectives and address the key challenges, EECCA countries need to apply various instruments, including carefully selected economic instruments.

policy Highlights

The role of economic instruments in achieving water policy objectives and SDGs

policy Perspectives

OECD : Reforming economic instruments for water management in eecca countries

affordability constraints, which is a serious concern in rural areas). These need to be supported by a wider use of lower-cost investment options and application of alternative sustainable business models for operating, maintaining, rehabilitating and financing rural WSS systems (including private sector participation) at appropriate scales. In several EECCA countries, a national financing strategy for urban and rural WSS has been developed with the ultimate objective to achieve the SDGs for WSS (for example, in Kyrgyzstan). To reduce diffuse pollution of water resources, EECCA countries could consider the use of product taxes (and equivalent custom duties) levied on products that contribute significantly to diffuse pollution (e.g. lubricants and toxic agro-chemicals). Achieving SDGs, in particular SDG 6.5, to implement integrated water resources management (IWRM) at all levels by 2030, has been reflected in all country reports, where the national objectives include the implementation of the IWRM principles and developing IWRM plans. Trans-boundary co-operation is another useful instrument currently promoted in the Kura

For example, to address the challenging situation with WSS in rural areas, EECCA countries need to use such economic instruments as sound tariffs (water pricing) and cost-effective state support to rural WSS (foremost for investment and for targeted social support to vulnerable groups to help address

OECD : Reforming economic instruments for water management in eecca countries

basin (agreement between Azerbaijan and Georgia), Dniester basin (Moldova and Ukraine), Chu and Talas basins (Kazakhstan and Kyrgyzstan), Aral Sea basin (all Central Asian states) and upper Amu-Darya (Tajikistan and Afghanistan). The country reviews showed that increased water scarcity is a major problem for several EECCA countries as pressures on water resources – from domestic, industrial and agricultural consumption – are growing. For example, the water exploitation index (WEI)2 reaches up to 45% in Armenia and 48% in Azerbaijan (OECD estimate) where countries with a WEI higher than 40% are considered to be under severe water stress. The challenge can be addressed through: (a) strengthening incentives for water conservation and improving water use efficiency; (b) innovation, including investment in water efficient technologies; and (c) development of the resource base and increased capacity for strategic storage of water resources. Respective economic instruments are (a) sound water pricing - for the former two measures; and (b) costeffective state support for implementation of the latter two measures. In many EECCA countries key problems associated with irrigation comprise a very inefficient water use, highly deteriorated irrigation systems, and acute

underfunding of development and rehabilitation of these systems, in addition to normal operation and maintenance. The financing gap leads to further degradation of irrigation systems (e.g. in Kazakhstan and Kyrgyzstan). Respective economic instruments for addressing the problems would be again (a) sound water pricing to create incentives for more efficient water use and mobilise funds sufficient for financing normal O&M (a related policy objective for irrigation water could be to gradually introduce charges for water supplied to agriculture reflecting at least full supply costs, see (OECD, 2010)); and (b) well-targeted and costeffective support to rehabilitation of irrigation systems. Finally, the problem of building excessive future financial liabilities of the state as the “insurer of last resort” could be addressed by introducing compulsory insurance of human life and economic assets located in areas where the risk of water-related hazards is especially high. Overall, country studies suggest that the common water management challenges and water risks presented in this document hinder sustainable economic development. Economic instruments have an important role to play with this regard as they can create right incentives and help mobilise finance for water priorities, or reduce demand for finance and future financial liabilities.

The water exploitation index (WEI), or withdrawal ratio, in a country is defined as the mean annual total abstraction of fresh water divided by the long-term average freshwater resources. It describes how the total water abstraction puts pressure on water resources. Another most commonly used measure of water scarcity is the ‘Falkenmark indicator’ or ‘water stress index’. This method defines water scarcity in terms of the total water resources that are available to the population of a region; measuring scarcity as the amount of renewable freshwater that is available for each person each year. If the amount of renewable water in a country is below 1,700 m3 per person per year, that country is said to be experiencing water stress; below 1,000 m3 it is said to be experiencing water scarcity; and below 500 m3, absolute water scarcity (see Falkenmark, M., J. Lundquist and C. Widstrand (1989), “Macro-scale Water Scarcity Requires Micro-scale Approaches: Aspects of Vulnerability in Semi-arid Development”, Natural Resources Forum, Vol. 13, No. 4, pp. 258–267.

Improving the existing economic instruments for water management in EECCA countries The current set of economic instruments for water management in the EECCA countries need to be improved in terms of their design, implementation and enforcement. The reviews conducted in Armenia, Kyrgyzstan and the Russian Federation revealed that current design, implementation and enforcement of economic instruments for WRM are ineffective in pursuing the aforesaid policy goals addressing water policy implementation challenges and issues. The existing design or state of implementation of the instruments neither create the right incentives for water conservation and pollution prevention, for the efficient use of water resources and for efficient operation and maintenance of water systems, nor do they generate sufficient revenues for the financial viability of the water sector. As a result, the water sector is often heavily subsidised with many subsidies not cost-effective, often counter-productive and they do not help achieve policy objectives and targets. In particular, two main shortcomings have emerged with respect to the design, implementation and enforcement of economic instruments: •

•

Economic instruments are often disconnected from key challenges and declared policy objectives; Their implementation can be improved, and innovative instruments introduced.

Table 1 summarises the issues reported for the main economic instruments currently in place for WRM in EECCA countries.

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OECD : Reforming economic instruments for water management in eecca countries

Table 1: Overview of the main shortcomings of existing economic instruments in selected EECCA countries Instruments Reviewed

Abstraction charges and water use fees

Pollution fees3 (both on discharges and as product taxes)

Water tariﬀs

Land taxes

Subsidies to the water sector

Overview of current situation In some countries (e.g. Armenia, Russia), existing charge levels are too low to provide an incentive for a more efficient water use. They do not reflect the environmental and resource costs. In other countries (e.g. Kyrgyzstan) surface water abstraction charges were not in place yet. In addition, some sectors have been exempted or partly exempted from paying the fees in EECCA (e.g. WSS, agriculture, and hydropower).

Current charge levels are too low to provide an incentive for reducing pollution (poor application of the polluter-pays principle). They do not reflect the environmental and resource cost of polluting water resources. In some cases (e.g. Armenia), the basis of charging is very complex, and difficult to apply in practice. Product taxes (e.g. on lubricants and on pesticides and other toxic agro-chemicals), potentially complemented by a deposit-refund system, could help to reduce diffuse pollution of water resources, especially in agriculture.

In EECCA, current water tariffs are often insufficient to cover even O&M costs of water provision, collection and treatment – with the exception of Armenia and Russia, where the recovery of O&M costs has now reached 90-95%. In Georgia and Azerbaijan, cost-recovery of domestic water services is 75% and 73% of O&M costs only. In all reviewed countries, investment costs are never covered by existing water tariffs. Water tariffs should be increased and restructured, introducing for example two-part tariffs with a fixed component (to cover the fixed costs of water provision) and a volumetric component (to charge users based on actual (metered) consumption).

Land-tax rates could be increased and better differentiated to capture a proportion of the rent related to the high value of land: (a) connected to WSS infrastructure, storm water collector-drainage system and protected from water-related disasters; and (b) located in areas close to valuable water bodies of high recreational and environmental value (e.g. Lake Baikal in Russia, Lake Issyk-Kul area in Kyrgyzstan, Lake Sevan in Armenia).

Existing subsidies to the water sector include: (i) Direct budget support; (ii) Revenue foregone due to various exemptions and a vast use of privileged (discounted) rates of charges, taxes and tariffs, as well as poor collection efficiency; and (iii) Transfer of risk to the State. Case-studies revealed that many subsidies impacting the water sector – be they in agriculture, the energy or the water sector - are counterproductive (undermine fiscal revenues while being not cost-effective) and should be phased-out. While cost-effective subsidies, such as capital subsides to developing rural WSS and introducing more efficient irrigation technologies, should be strengthened.

3 Note a difference in terminology: in OECD countries, they are called taxes, not fees or charges as in EECCA.

Source: OECD (2013a, 2014a, b).

OECD : Reforming economic instruments for water management in eecca countries

Overall, improved design, implementation and enforcement of economic instruments will result in more efficient water resource management. In turn, this is expected to lead to green economic growth (e.g. higher economic growth with enhanced water resource efficiency, tourism development, and export-led agriculture).

In those EECCA countries in which reviews were carried out: â&#x20AC;˘

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Existing economic instruments are unable to influence end-users behaviour towards sustainable and efficient use of water resources or to raise sufficient revenues for water management activities. Economic instruments are often disconnected from key challenges and declared policy objectives The design and actual implementation and enforcement of existing economic instruments for water resource management are often poor and could be substantially improved.

Closing the gap between objectives and performance of economic instruments Selection of appropriate instruments in each EECCA country follows ultimate policy objectives. For example, in Kyrgyzstan, by strengthening incentives for improving water use efficiency, economic instruments could help to better balance growing demand for water (not least due to demand from export-led agriculture and tourism as key drivers of economic growth in Kyrgyzstan) with the available fresh water resources (the annual run-off will likely drop after 2050, according to the Second National Communication to the UN FCCC, due to negative impact of climate change) thus ensuring greater levels of security of water supply (presently, many farmers experience water shortages over the growth period). Possible reform options are defined after a review of existing instruments and careful evaluation of their performance and shortcomings. The options typically presented three levels of possible development, mainly in terms of revenue-generating capacity. Though in the first place, the economic instruments were expected to create strong incentives to reduce water pollution and improve water-use efficiency. The reviews and assessments of existing economic instruments, conducted in Armenia, Kyrgyzstan and the Russian Federation, highlighted that to close the gap between key stated policy objectives and performance of economic instruments, the reform should focus on all features of the design and implementation of economic instruments. The design of a reform proposal might in fact involve one or more features of the economic instruments at stake, and in particular:

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OECD : Reforming economic instruments for water management in eecca countries

1. Level of tariffs, charges, rates (which are normally increased by the reform). 2. Tariff structure: in the case of water tariffs, for example, the reform might imply the shift from a fixed or volumetric tariff to a two-part tariff, including a fixed and a volumetric charge. 3. Tariff-setting process: it is an iterative process that may involve revisions of sector development targets, investment and operational programmes of WSS utilities, as well as the development of financial plans and sources of finance and state support to the sector from the public budget. 4. Basis for charging: in Armenia, for example, pollution fees are based on actual pollutant discharges; however, actual discharges require regular measuring, so this charging system requires a high administrative capacity and entails high transaction costs. In this case, it was proposed, among other things, to calculate pollution charges to be paid by each user on the basis of permitted discharges (this of course would require good policies in place to enforce the discharge limits). 5. Charge/fee collection systems, to improve collection efficiency. Figure 1 illustrates how specific features of the design and implementation of economic instruments can help improve three objectives of each economic instrument: i.e. to create right incentives, to raise revenues while fairly treating those affected by the instruments.

The priorities for the reform of economic instruments for water resource management in EECCA countries stem directly from the shortcomings of existing instruments. To ensure that all key policy objectives and challenges are cost-effectively addressed, the reform of economic instruments should focus on all features of the instruments at stake: their design, structure and implementation. For example, increasing volumetric water tariffs can be effective in providing an incentive for a more efficient water use, but the increase can also be combined with a revision of the tariff structure â&#x20AC;&#x201C; by also introducing a fixed component aimed at ensuring better recovery of at least the fixed part of O&M costs of water provision.

OECD : Reforming economic instruments for water management in eecca countries

Figure 1: Achieving key objectives of an economic instrument by improving specific features of its design and implementation

Fairness: application of the polluter pays and user pays principle

- Charge structure. - Basis for charging.

- Levels of tariffs, charges, rates. - Charge structure. - Basis for charging.

- Levels of tariffs, charges, rates. - Charge structure. - Tariff-setting process. - Charge/fee collection system.

Source: Adapted from OECD (2014b).

Incentives for a more efficient water use

Revenue generation

Develop scenarios for reform of priority instruments and an Action Plan (AP) for implementation For each reform option expected environmental, social, economic and fiscal impacts are assessed and a synthesis of its policy implications presented, while recommendations are formulated in the form of a draft Action Plan. For each instrument, the scenarios are not just presented as alternatives; rather, they should be seen as a continuum, i.e. a gradual development that can be the basis of the Action Plan for the short (1-3 years) and medium term (up to five-seven years), in line with the timeframe of the National Strategy for Sustainable Development; and as options that (a) can be implemented in sequence and (b) can be combined (where appropriate).

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OECD : Reforming economic instruments for water management in eecca countries

For example, in Kyrgyzstan, the draft Action Plan resulted in follow-up implementation of some measures such as the development of methodologies needed for introducing two key missing instruments: •

Surface water abstraction charges.

•

Monetary evaluation and compensation of damage to surface water resources.

Boxes 1 and 2 provide examples of the proposed reform scenarios designed in Armenia and Kyrgyzstan.

Box 1: Reform of abstraction charges in Armenia

In the case of water abstraction fees, some water use sectors are exempted or partly exempted from paying the fees, for example the hydropower sector. The agricultural sector typically pays very low fees compared to other sectors. In general, very low charge levels, as well as the unfair distribution of charges among users groups, reveal a poor application of the Beneficiary-Pays and Polluter-Pays Principles. In addition, as abstraction charges are based on actual water use, managing the system requires a high administrative capacity and entails high transaction costs. An alternative solution was recommended for consideration – to charge on the basis of permitted quantity. Compared to the present system, the proposed alternative approach: • •

Is associated with much less administrative and transaction costs. Would create incentives for a better planning of required volumes of water by users, freeing some water for alternative uses not possible presently in water-stressed Armenia.

Source: OECD (2014b).

OECD : Reforming economic instruments for water management in eecca countries

Box 2: Reform of irrigation tariffs and introduction of abstraction charges in Kyrgyzstan

Proposed reform of irrigation tariffs Background: In recent years, the tariffs paid by farmers for irrigation services only represent 10% of the funds required to cover O&M costs; the state effectively subsidises 90% of the financial costs of operating and maintaining the state irrigation system. Evidence regarding the deterioration of irrigation services suggests the combined current funds from the state budget and user charges are insufficient. A simple volumetric tariff is applied, which only covers variable costs, thereby generating a financial deficit in the operation of the network. Most costs of operating the state irrigation network are fixed (e.g. staff, maintenance of infrastructure, buildings), which remain the same irrespective of the volume of water supply. Scenarios for reform: A two-part tariff system would more adequately address the need to cover both fixed and variable costs of the state irrigation service. The first part of the irrigation tariff could be set to contribute to the fixed costs of providing irrigation services. It would be based on the area of irrigated land (per hectare) serviced by the irrigation network – even if farmers are not using that land. In practice, this would be charged in addition to land tax. The system of land tax collection is already well established in KR; it could be adapted to add the fixed cost of irrigation services to the appropriate tax rates for irrigated land in each oblast and rayon of Kyrgyzstan. The second part of the irrigation tariff would cover the variable cost of providing irrigation services, such as the costs of electricity in areas where water is pumped. These costs vary according to the volume of water supplied to farmers; therefore, a variable charge (per m3 of water) would be levied. Overall, four scenarios for reform are proposed, which could be implemented progressively. Action towards introduction of surface water abstraction charges In the medium term: • • • • •

Prepare a draft regulation on surface water abstraction charges and submit it for approval to the government (the regulation should set rules, procedures and accountability for calculating and paying the charges, as well as establish sanctions for violations). Prepare and submit to Parliament a draft law on amendments to the Water Code and other water-related legislation (e.g. on WSS). Through information and public awareness campaigns, better inform general public about the “true” costs of water management so that better- informed citizens can contribute to it. Reinstate surface water use permits by amending existing legislation. Launch a diagnostic of industry needs for improving resource-use efficiency and pollution control (this should not be limited to water resources, but also to energy efficiency and other key resource inputs).

In the long term: •

Provide a targeted support programme (including financing and guidance) for improvement of production processes to support innovation in resource intensity reduction (e.g. by introducing “best available techniques”) and pollution abatement and control (better treatment).

Source: OECD (2014a).

Ensure attention to the political economy of the reform of economic instruments

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This recommendation highlights three key elements of the political economy of the reform: •

Appropriate sequencing and progressive implementation of the proposed reforms.

•

Application of required accompanying measures.

•

Strengthening the role of National Policy Dialogue and other forms of stakeholder consultations in the reform process.

These three elements are presented below:

Step 1: Sequence proposed reforms and progressively implement them The reviews and assessments conducted in Armenia and Kyrgyzstan highlighted that appropriate sequencing and gradual implementation of the reform process is key to successful implementation of proposed policy options. This approach will allow for mitigating potential negative impacts of the reform (e.g. on affordability and vulnerable groups); however, even where the negative impacts of the proposed reform are not expected to be significant, an appropriate sequencing will bring positive environmental, fiscal and social benefits, as well as help mitigate eventual political resistance to the proposed reform.

Ambitious water policy objectives can be progressively achieved through appropriate sequencing and progressive implementation of the proposed reforms. A well-structured staged approach to reforms will also help mitigate or reduce eventual political resistance to the proposed options. Both the options for reform and the action plan toward their implementation should be supported by a thorough assessment of the pre-requisites for implementation, to ensure that the proposed reforms are actually feasible in the national institutional and administrative context.

Overall, the reform or introduction of “traditional” economic instruments seems more feasible in the short term. On the longer term, however, the possibility of introducing innovative economic instruments (e.g. payment for ecosystem services) should be further explored. In addition, the design of options for reform, as well as the action plan for their implementation, should also be accompanied by a thorough assessment of the prerequisites for implementation. The following should be investigated: •

Administrative and transaction costs: to be feasible, the proposed reform should not entail additional significant administrative or transaction costs. In some cases, additional transaction costs might not hamper the feasibility of the reform, provided that these additional costs are largely outweighed by sufficiently large benefits coming out of the reform.

•

Changes in current administrative structures: options for reform are unlikely to be feasible if they are not tailored for the administrative and governance structures.

•

Compliance assurance systems (i.e. checking users’ compliance) must be adapted to the actual administrative capacity of the country.

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Step 2: Apply appropriate accompanying measures The impact assessment of the proposed options for reform, as well as the assessment of the pre-requisites for implementation, might highlight challenges with potential to undermine the feasibility of the reform, for example: •

Expected negative impacts (especially on affordability and/or vulnerable groups).

•

High expected administrative costs, or transaction costs.

In these cases, the implementation of accompanying measures together with the proposed options for reform can counteract these negative impacts or overcome administrative challenges. Box 3 illustrates proposals from Armenia with respect to the reform of abstraction and pollution fees.

In many cases, the reform or introduction of economic instruments should be coupled with appropriate accompanying measures. These measures are meant to tackle possible negative impacts of the reform (e.g. affordability concerns in case of increased water tariffs) or to overcome some institutional or administrative challenges. Designing and implementing appropriate accompanying measures, which are applicable to the national context, requires a thorough feasibility and costs assessment.

Box 3: Accompanying measures for ensuring access to affordable water and sanitation services for low-income groups

The proposed reform of abstraction and pollution fees in Armenia is likely to entail affordability issues for low-income groups. Whereas the projected increase of abstraction tariffs alone would imply a negligible increase of final domestic water prices, the projected increase of pollution fees would have a strong impact on WSS tariffs. A straightforward solution would be to limit the increase of pollution fees for water utilities. However, this would imply a distorted application of the polluter-pays principle: domestic wastewater discharges are in fact a major cause of pollution of surface water bodies in Armenia, and therefore the sector should pay accordingly. This solution was therefore deemed to be inappropriate. It was therefore suggested to implement an appropriate accompanying measure which could address affordability issues for vulnerable groups. By doing this, the overall scope of the reform was not hampered, and vulnerable groups were protected at the same time. International experience suggests that several accompanying measures could be applied to ensure the affordability of water and sanitation services to low income groups. For example, common measures adopted by EU countries include: • • • •

Progressive tariffs: water and sanitation tariffs are modulated according to consumption blocks, so that households consuming less water are paying lower unitary rates as compared to households consuming more. Separate social policies: subsidies and grants aimed at supporting the access of low-income families to basic services, including water supply and sanitation. Social tariffs: low-income groups are charged lower (discounted) water and sanitation tariffs. This reduction is cross-subsidised by the other customers, who pay a slightly higher tariff. Social Fund for Water: water and sanitation tariffs for all customers include a special additional charge (0.0125 €/m3) which feed the Social Funds. The charge is sufficiently low to have no significant impact on household water expenditures. The Social Fund is used to help pay the bills of those households which are not able to pay; a very small share of the Fund is also used to cover the costs of running the Fund itself.

Source: OECD (2014 b).

Supporting and accompanying measures should target all main groups of water users and be prepared for both

the medium and long term. For example, in Kyrgyzstan, accompanying measures cover domestic users, farmers and industrial users (see Box 4).

policy Perspectives

OECD : Reforming economic instruments for water management in eecca countries

Box 4: Accompanying measures in Kyrgyzstan - medium and long term

In Kyrgyzstan, a main economic impact on households and other stakeholders would come from the proposed introduction of surface water abstraction (and water-use) charges to be paid by hydropower plants since they will pass respective costs onto electricity consumers. Accompanying measures, such as strengthening of targeted social support to vulnerable households by fully compensating them for the additional expenses for electricity, can help mitigate potentially negative social impacts. This could be financed through the additional budget revenue generated under the proposed reform scenarios.

Source: OECD (2014 a).

The applicability of accompanying measures to the national context should also be carefully assessed; in particular, the following aspects should be taken into consideration:

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This last consideration leads to another basic question: which entity should manage the accompanying measures (e.g. water supply companies, the Water Agency or the Social Fund)?

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Which administrative and transaction costs would be involved in each of the available options?

Which accompanying measure could best fit into the current administrative setup? In the example above, the Social Fund might look like an attractive option. The application of a special additional charge would not significantly impact WSS tariffs, and would make piped water available for lowincome groups. However, this implies the use of an allocation mechanism which, at present, might be very difficult to put in place in some EECCA countries.

Therefore, setting up an appropriate accompanying measure is a complex task which needs a specific assessment.

OECD : Reforming economic instruments for water management in eecca countries

Step 3: Strengthen the role of National Policy Dialogue and other forms of stakeholder consultation in the reform process

The reviews and assessments in Armenia and Kyrgyzstan were conducted through the on-going National Policy Dialogues (NPDs) in each country, while in the Russian Federation it was done through a dialogue process in the Republic of Buryatia (i.e. at the province / subject of federation level). Policy dialogues bring together policy makers from different policy areas (e.g. Ministry of Environment, Ministry of Agriculture, Ministries of Economy and Finance), as well as expert community NGOs and international partners (international and donor organisations), and thus provide a platform which facilitates and stimulates policy discussion and helps to build consensus and ownership. In particular, discussions within NPDs highlighted water management challenges and the need for reforming existing economic instruments as one of the tools to address these challenges and meet water policy objectives – and this created the need for conducting a review and assessment of existing economic instruments, with the aim of developing options for reform. Priorities for reform of economic instruments were identified and discussed during NPD meetings, as well as during bilateral meetings with relevant NPD participants. Later on in the process, preliminary results of the studies were discussed and agreed upon during NPD meetings, as well as proposed action plans and steps towards the reform.

In the process of reforming economic instruments for water management in EECCA, National Policy Dialogues played a key role in defining national priorities and identifying the way forward. The NPD is a good platform for stakeholder consultation as it brings together policy makers from different policy areas which are all involved in the reform of economic instruments, thus facilitating exchanges and discussions on all aspects of the reform and helping to build consensus and ownership. In addition, NGOs and international organisations also participate in the process, bringing to the table different perspectives and expertise on water management issues and reform challenges.

The studies referred to in this document, were an integral part of NPD processes in these countries, and in particular: •

The studies responded to a specific demand for reform emerging from NPD discussions.

•

In turn, the studies stimulated further discussion on key challenges, policy objectives and options for reform.

•

The studies provided the necessary information base to advance with the reform.

The NPDs provide the policy platform to initiate and stimulate reform in the field of water management. The NPDs also play an important role in stakeholder engagement, local capacity development, awareness raising, consensus building and removing eventual political resistance to reform. It is therefore recommended to strengthen the instrument and apply it more widely.

Overall approach to assessment of the use of economic instruments: frameworks and methodology Key water policy objectives and implementation challenges were identified, assessed and prioritised through policy dialogue using a staged approach as outlined below:

4. Options for reforming existing economic instruments, or introducing new ones, were developed. For each option, different scenarios for reform were designed.

1. Policy objectives and implementation challenges were identified through discussions during NPD meetings, interviews with policy makers, data collection and literature review.

5. The economic, social and environmental impacts of the proposed scenarios for reform were assessed.

2. Existing economic instruments were reviewed and their performance (implementation) assessed and shortcomings of existing economic instruments identified. 3. The minimal sufficient budgets for specific water management objectives and for performance of relevant regulatory bodies were estimated, to set a target for revenue collection after reform.

policy Perspectives

OECD : The evolving landscape of climate finance for eecca countries

6. Preferred reform options or scenarios (or sequence of most preferable options/scenarios) were identified. 7. A draft action plan outlining practical steps needed to implement the proposed reform was developed and presented to stakeholders for eventual endorsement.

Analytical frameworks applied Several dedicated frameworks were developed for, and applied in, this work, in particular, frameworks for: (i) assessment of individual economic instruments; (ii) assessment of subsidies impacting the water sector; and (iii) assessment of reform options and scenarios. The analysis of existing individual economic instruments is the first and basic step to be conducted when assessing how economic instruments can support making and implementing a sound water policy. In all EECCA countries, economic instruments for WRM do exist and are used: these instruments include pricing instruments (water abstraction and water use fees; tariffs for irrigation water and for WSS services), tax instruments (including pollution charges), subsidies (state support to the water sector) and insurance (to a limited extent). A number of instruments from outside the water domain also influence the water sector for example, some subsidies in agriculture, land taxes and product taxes levied on products contributing a lot to diffuse pollution of water resources.

Criteria for assessing individual economic instruments applied in the country studies are presented in the Annex to this policy perspective. In addition to economic instruments applied specifically for WRM, the EAP Task Force’s work in several EECCA countries (e.g. Kyrgyzstan and Russia) also targeted various subsidies impacting the water sector – be they in the water sector or in other sectors, for example free irrigation water and tax free pesticides in agriculture. The assessment of subsidies required a dedicated framework which was developed for, and pilot tested through, respective country case studies. According to this framework, three subsidy categories were distinguished: (i) Direct budget support; (ii) Revenue foregone due to numerous exemptions from, or application of “privileged” (discounted) rates of, charges, taxes and tariffs, as well as poor collection efficiency; and (iii) Transfer of risk to the State. Each subsidy was assessed by weighing its financial, social and environmental costs (see Table 2).

Instruments such as trading in quotas for water abstraction (tradable water rights) or for pollution of specific pollutants are yet to be pilot tested in EECCA.

OECD : Reforming economic instruments for water management in eecca countries

The analysis of existing economic instruments typically led to the development of options for reform of existing instruments or for introduction of new ones. The objective was to offer a better set of instruments for achieving water policy objectives, by creating stronger incentives for more efficient use, conservation and protection of water resources and by improving the financial capacity of responsible public and basin administrations and water services’ providers to develop, operate and maintain needed water systems. Regarding the incentives versus revenue generation capacity dilemma, the approach has been as follows: •

for pollution charges and other instruments used to internalised negative externalities, right incentives to be created by respective instrument was the key focus.

•

for tariffs for water services, the objective was to gradually achieve the level of full coverage of at least O&M costs while capital costs could be financed from an appropriate mix of the ultimate sources of finance – taxes, tariffs and transfers (the 3Ts).

•

economic rents associated with water and land resources should be taxed (appropriated to the extent possible) and tax revenues should go to respective public budget(s) (local, national) so that to improve their capacity to fund, among other priorities, also priority measures in the water sector (e.g. monitoring system and development of water infrastructure).

For each reform option, different scenarios for reform were developed: the scenarios were different, for example, in terms of tariff/charge levels (e.g. from a lower increase to a higher increase of existing tariffs) or other aspects of the design and delivery mechanisms (e.g. different basis for charging), or in terms of the speed of reform. For each scenario, the potential economic, fiscal, social and environmental impacts were assessed ex-ante, by adapting and applying the policy impact assessment framework developed by the European Commission (EC, 2009). Table 3 illustrates the impact categories that were assessed with respect to the reform of abstraction and pollution charges in Armenia.

National Policy Dialogues Support to the improvement of water policy in EECCA countries has been provided through National Policy Dialogues (NPDs) on water conducted in cooperation with the European Union Water Initiative (EUWI)4, facilitated by the OECD and UNECE and cosponsored by a number of international organisations, development banks and bilateral donors, including the EU and UNDP, ADB, EBRD and the World Bank, Austria, Finland, Germany, Norway, Switzerland and many others (for more details see OECD and UNECE (2014)). In brief, NPD is an iterative and participatory policy process substantiated by robust data, information

and analysis, which helps to design and implement a sound water policy and aims to make reform happen. The dialogue process is usually conducted under the leadership of a high-level Government representative, such as the Minister/Deputy Minister of the Environment or the Chairman of the State Water Committee, chairing national Coordination Councils (Steering Committees) established to guide and steer the NPD process. They include representatives of relevant ministries and agencies, parliamentary bodies, expert community, NGOs and international partners, as well as other local and international stakeholders. The country reviews of economic instruments for WRM summarised in this document were conducted through the policy dialogue process.

“Over the last few years, National Policy Dialogues have been providing outstanding opportunities for EECCA countries to develop sustainable water policies and reach the Millennium Development Goals as well as address some of the most pressing water challenges faced by the region. It was an honour for me to cooperate with the implementing agencies and with our colleagues and partners throughout the region and to share the EU experience in water management to the benefit of EECCA countries and people. We are proud of the EUWI-EECCA achievements so far and look forward to continuing the effective implementation of water policies designed through the NPDs.”

EUWI EU WATER INITIATIVE

EECCA

Gheorghe Constantin, Chair of the EUWI EECCA component, Director of Water Resources Management, Ministry of Environment and Climate Change, Romania.

National Policy Dialogues on water have been the main operational instrument of the European Union Water Initiative (EUWI) component for EECCA countries. Until mid-2016, the ultimate goal of the EUWI has been to support the implementation of the water-related Millennium Development Goals (MDGs). The NPDs also facilitated transition to a Green Economy model, implementation of international agreements on water and convergence of EECCA regulation with the EU Environmental legislation, including implementation of principles of the Water Framework Directive.

Analytical framework applied Framework for analysis of individual economic instruments

policy Perspectives

OECD : The evolving landscape of climate finance for eecca countries

5. Consistency with institutional framework: is the instrument consistent with the polluterpays principle, the user-pays principle, the precautionary principles and other policies and effective laws.?

The OECD (1997) developed a set of assessment criteria, which were applied in the country studies. Note that analysing economic instruments against this set of criteria requires that both a qualitative and quantitative assessment is carried out. The OECD criteria include:

6. Impact on competition: will the instrument distort competition within or between industries?

1. Environmental effectiveness: how well does the instrument work in terms of achieving WRM objectives?

7. Impact on income distribution and equity: does the instrument affect income distribution? Does it hit a particular social group hardest and could revenues be used to mitigate these effects?

2. Cost-efficiency: how economically efficient is the instrument? 3. Dynamic efficiency: what is the impact of the instrument on long-term economic efficiency? Are there incentives for the long-term development of new technologies and practices?

8. Ease of administration: how easy would it be to implement, ensure compliance and monitor the instrument? 9. Political and social acceptability: what are the possible barriers to political and social acceptance of the instrument? What actions can be taken to improve acceptability? How transparent is the implementation and operation of the instrument?

4. Revenue-generating capacity: how much revenue is raised? How might this revenue be used to help meet WRM objectives or replace more distorting taxes?

Framework for assessing subsidies impacting the water sector Table 2 below provides an example of the assessment of government funding for capital investment.

Each subsidy was assessed by evaluating its financial, social and environmental costs and benefits.

Table 2: Example of assessment of financial, social and environmental costs and benefits of a subsidy in Kyrgyzstan the case of tax revenue foregone related to the use of duty free imported toxic agricultural chemicals Benefits of the subsidy Transfer mechanism

Tax revenue foregone

Subsidy Lack of taxation for potential diffuse pollutants (e.g. product tax & custom duty for toxic agricultural chemicals)

Financial and economic

Social

Low costs for economic agents causing pollution (e.g. farmers) and their customers.

Social benefits of lower food prices.

Shortcomings and costs of the subsidy

Environmental Financial and economic Foregone public revenues (which could contribute to environmental monitoring and protection systems, and to targeted support to poor households suffering from malnutrition etc.)

Social

Environmental

Health impacts as clean water may not be available while polluted water may be hazardous for use.

No disincentive for reducing diffuse pollution. Environmental impacts not internalised.

Source: OECD (2013 a).

OECD : Reforming economic instruments for water management in eecca countries

An example of assessing reform options Table 3: Adaptation of the impact assessment framework developed by the European Commission (EC, 2009) to the assessment of the potential impact of the reform of abstraction and pollution charges in Armenia.

Economic Impacts

Scenario... Impacts on... Business

Key questions - Will the instrument impose additional adjustments, compliance or transaction costs on business?

Innovation and research

- Will higher revenues for the sector correspond to higher investments in innovation and research? - Does it promote greater productivity resource eﬃciency?

Consumers and households

- Does the instrument aﬀect the prices consumers pay?

Speciﬁc regions or sectors

- Does the instrument have signiﬁcant eﬀects on certain sectors? - Will it have a stronger impact on certain regions?

Social Impacts

Scenario... Impacts on...

Key questions

Vulnerable goups

- Is the instrument aﬀordable on average? - Is the instrument aﬀordable for low-income groups?

Paricipation

- Does the instrument aﬀect the prices consumers pay?

Public health and safety

- Does the instrument increase or decrease the likelihood of health risks due to substances harmful to the natural environment?

Environmental Impacts

Scenario... Impacts on... Climate

- Does the instrument aﬀect our ability to adapt to climate change?

Water quantity

- Will increased abstraction rates reduce water consumption? - Will application of abstraction fees at permit level reduce or increase water consumption? - Which will be the cumulative eﬀect on water ﬂows?

Water quality Water resources

Source: OECD (2014 b).

Key questions

- Will increased pollution charges decrease pollutant discharges in water bodies?

- Does it aﬀect drinking water resources?