Report No: AUS8335 .
Republic of Kazakhstan JERP - Modernization of Housing and Utilities Sector
. September 9, 2014
. GSURR EUROPE AND CENTRAL ASIA .
Document of the World Bank
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Joint Economic Research Program (JERP)
KAZAKHSTAN Modernization of Housing and Communal Services
Final Report Prepared by: The World Bank September 9, 2014
Contents Executive Summary ....................................................................................................................... 7 I.
INTRODUCTION ............................................................................................................ 13
II.
SITUATION ANALYSIS ................................................................................................. 15 (i) Institutional Context ........................................................................................................... 15 (ii) Housing Sector ................................................................................................................... 21 (iii) Water Sector ....................................................................................................................... 30
III.
CHALLENGES AND ITEMS FOR CONSIDERATION .................................................... 31 (i)
HCS Modernization Program financing: Mismatch in demand and supply ....................... 31
(ii) Bureaucratic bottlenecks .................................................................................................... 31 (iii) Housing Allowance for the poor: Possibly a costly affair .................................................. 32 (iv) Lack of HOAs and building management companies ........................................................ 32 (v) Utility meters: A key component of “modernization”........................................................ 33 (vi) Absence of a centralized sector information and monitoring system ................................. 34 (vii) Conflict between HCS Fund and current channels of “free” budgetary financing ............. 34 (viii) Zero percent loans for housing; grants for utilities............................................................. 35 (iv) Tariff setting and asset depreciation ................................................................................... 35 (v) Private sector participation ................................................................................................. 36 IV.
INTERNATIONAL EXPERIENCE .................................................................................. 38 (i)
Municipal Development Funds (MDF) .............................................................................. 38
(ii) Housing Renovations.......................................................................................................... 41 (iii) Municipal Water Sector - Comparison with International Practice.................................... 42 V.
RECOMMENDATIONS FOR OPERATIONALIZING THE HCS FUND ........................... 47 (i)
Entry of new financial contributors over time .................................................................... 48
(ii) Expanding the beneficiary pool .......................................................................................... 50 (iii) Revenue generating projects............................................................................................... 51 (iv) Financing criteria ................................................................................................................ 53 (v) Moving from grant to credit-based systems ....................................................................... 54 (vi) Roles and responsibilities ................................................................................................... 56 (vii) “Road-map” for the Start-up of the HCS Fund .................................................................. 59 Annex A. Government Programs ............................................................................................... 63 Annex B. International Experiences ........................................................................................... 71 Annex C. Financial Projections and Considerations .................................................................. 99
Note: A draft Operations Manual is provided as a second document attached to this report.
Acronyms
AREM – Agency for Regulation of Natural Monopolies BMC – Building Management Company ESCO – Energy Savings Company GC – General Contractor HCS – Housing and Communal Services HCSF – Housing and Communal Services Fund HH – Household HOA – Homeowners Association JSC – Joint Stock Company KSK – Cooperative of Apartment Owners KZT – Kazakhstan Tenge MDF – Municipal Development Fund MFB – Multifamily Building MOF – Ministry of Finance MoRD – Ministry of Regional Development OM – Operations Manual PUC– Public Utility Company SAO – Specialized Authorized Organization SCE – State Communal Enterprise SEC – Social Entrepreneurship Corporation
6
Executive Summary Kazakhstan has undertaken several reforms in the housing and communal services sector since 1996 including mass privatization of the housing stock, de-monopolization of the utility sector, and a transition to differentiated tariffs of public communal services. However, the sector is still characterized by deteriorating assets, a backlog of investment and maintenance needs, unaccounted for energy, water and other resources, and limited technical capacity of sector agencies/utilities. The management and financing of housing maintenance has become a serious issue, and the communal services sector is underfunded. Since 2011, the Ministry of Regional Development (MoRD) has been administering a Housing and Communal Services (HCS) Modernization Program and – following recommendation of a Joint Economic Research Program (JERP)1 by the World Bank the same year – established the HCS Development Fund (HCS Fund) in 2012 to support rehabilitation and modernization of the multifamily housing and communal services infrastructure. This report is the result of a follow-on JERP with MoRD, carried out in 2014 with the objective to review the current policies, practices and situations surrounding the country’s HCS sector, and help operationalize the HCS Fund. The report includes a situation analysis and a summary of key sector challenges in Kazakhstan, lessons learned from international experiences, and recommendations for the operationalization of the HCS Fund, including a “road-map” for the start-up of the Fund, roles and responsibilities, investment process flows, and a draft Operations Manual (as separate document) with proposed organization, lending policies, etc. The HCS Fund is a vehicle for the government to: (a) respond to demand from private homeowners (and their representatives) for housing renovation funds; and (b) channel budget funds on primarily credit basis for capital investments in municipal public utility companies. In the short and medium term, it is expected that state funding to the HCS Fund will continue - until its financing needs can be fully met by private funding sources and entities (e.g. domestic banks; infrastructure management firms; etc.). Regarding (b), the report provides most details related to the water sector, although this will not be the only communal services sector that the Fund will support in the future. Main recommendations are:
The HCS program design and the related HCS Fund should facilitate entry of new financial contributors over time, in the housing renovation sector as well as in the communal services sector.
The pool of beneficiaries of the HCS Fund should grow over time, i.e. additional communal services sectors.
Initial investments in utility projects should be revenue-earning. Housing projects investments should be based on owner preferences, affordability, and guided by government policy (e.g. preference for energy efficiency related investments).
Kazakhstan Joint Economic Research Program (JERP): “Establishing Financial Mechanism to Support Housing and Utilities Sector Based on International Experience”, 2011, World Bank. 1
7
Projects should be reviewed against viability criteria and approved on a “first comefirst served” basis. In the community services sector, the size of loans should also be dependent on utilities’ operational and financial performance.
A well-managed transition from grant-based to loan-based government funding will be needed in the communal services sector.
Proposed Evolution of the HCS Fund Housing Renovation Short-term, 100% funding of housing renovations with government budget funds through zero-interest loans (or low interest loans plus a grant component), is expected to be required for a while in order to generate a reasonable early volume of renovations in major cities. Homeowners should be encouraged to collect monthly savings, e.g. in a condo/ homeowners’ association (HOA) account, to be used as partial payment for renovation costs. Although “First come-first served” should be the prime criteria for which buildings get access to budget funds, accumulated savings by the residents for renovation purpose could be given some level of priority. Acceleration of housing inspections by akimats is a critical short-term measure to respond to the increasing housing renovation demand. Promoting of HOAs and housing renovation should continue. To prepare for the future, government should actively facilitate the growth of the private building management company (BMC) and energy savings company (ESCO) sectors. Medium term, the funding sources should be widened progressively, for example, with 510% upfront contribution by the residents and low interest loans, e.g. starting at 4%, and increasing over time to at least half the market rate for long term loans in the country (or a combined loan/grant program); mobilization of funds by ESCOs; lending by domestic banks to well established and financially strong BMCs (for on-lending of the funds to HOAs; likely at different rates than by the government funds though); some co-financing by Oblast and City Akimats; and, as appropriate, consider long term loans from international financial institutions (IFIs) to provide low cost external funds for the program, if necessary. Energy efficiency targets could also be introduced in the medium term as condition for receiving funding from the HCF Fund. It is important for the government and the HCS Fund to clearly inform the public what the anticipated medium term scenario is, in order to: (a) create incentives for early action by residents; and (b) prevent future complaints if the changes to less favorable terms would come as a surprise to them. Longer term, the HCS Fund could: (a) provide government funds to participating domestic banks, for them to manage the on-lending together with their own funds, and over time assume more credit risk; or (b) provide a partial credit risk guarantee (supported by a “guarantee fund” established by the government), declining over time, with the participating banks lending with their own funds only. Alternatively, domestic bank funds could be provided to the HCS Fund at market rates (partly collateralized by a “guarantee fund” established by the government), with on-lending by the HCS Fund to HOAs - directly or through Specialized Authorized Organizations (SAOs) or BMCs - at below market rates, and risk sharing of the on-lending with the participating banks. The long term aim should be to phase out the government program, as commercial banks and other entities respond to the financing needs, and homeowners also have access to private BMCs and ESCOs. Continued assistance to low-income households on a targeted income basis will continue to be essential. 8
Water Sector (as example of communal services sector) Short- to medium term, the akimats of the 25 or so larger cities (the anticipated early focus of the HCS Fund), and their Vodokanals (operating companies), will likely depend on government budget funds, due to the current low tariffs, incomplete water metering, high investment needs, and limited autonomy of the publicly owned utilities – all of which are likely to deter potential private sector partners. Low interest loans can be provided by the HCS Fund in parallel with continued tariff reforms towards full cost recovery in the medium to longer term, including full implementation of differentiated/block tariffs, and improved efficiency of operations and maintenance (O&M) of service provision for sustainability. Longer term. Once a municipal utility is not only corporatized (as most are already today in the country), but also reasonably institutionally (organizationally) and financially independent (although still owned by the city akimat), and operating with full cost recovery, it may pursue one or both of the following paths: (i) seek long term loans from the domestic capital markets; and/or (ii) seek interest and engagement by domestic or foreign infrastructure management firms; for example, for management contracts, concessions, etc.2 For both the housing renovation and the utility sectors, the participation of some domestic banks may transition from involvement on a fee-for-service basis, through limited credit risk being taken by the banks, to lending by them with own funds on market terms. In order to accelerate the operations of the HCS Fund, and thereby the housing renovation programs and priority communal services sector investments, with related institutional and managerial development, the Government may, depending on overall country priorities, seek loans from multi-lateral development banks. With such loans usually comes exposure to good international references and assistance with the development of policies, practices and capacity for the sectors. Growth of beneficiaries under the HCS Fund Short-term. Heat metering program and housing renovations. The HCS Fund is expected to get capitalized and start its activities by channeling government funds and oversee a program for heating meter installations in larger urban areas. In parallel, the study recommends that the HCS Fund gets a mandate to manage the allocation of the government funds for housing renovations going forward, to be on-lent by them to either SAOs, private building management companies (BMC), or to well organized HOAs directly. Medium term. Water and heating utility programs, and continued housing renovation activity. The logical progression for the Fund would be to continue to support priority investments in the heating sector with credits. The utility arm of the Fund should, however, as soon as possible also start channeling government funding in the urban water/wastewater sector (Ak Bulak funds and any other budget funds for the sector) to the akimats (and in due course to their Vodokanals directly). The study suggests that the Fund be assigned the responsibility to oversee all government funding to this sector in order to ensure coherent and consistent assessments and rules. This should include both credit for financially “viable” projects, and 2
According to the PPP Center in Astana, the first tender for private participation in the water sector (by the city of Atyrau) is not expected to be issued until 2016. While a more attractive, enabling environment emerges, after efficiency improvements, revenue enhancements, etc. some opportunities may exist for involvement of domestic private partners though. 9
grant funding (or combination of grant and credit) in situations of particularly weak water utilities. This distinction would need to be made in a way which does not create a disincentive for akimats/ utility companies to become “creditworthy” from the perspective of the Government. There should be a rather strong incentive for an akimat and their utility company to qualify for a loan. For example, that: (i) significantly more funding being available under the credit program than the grant program; (ii) in the grant program, projects may be selected with some element of “competition” based on performance indicators; and (iii) the credit program should be applied on a “first come-first served” basis only (subject to eligibility and availability of funds). The Fund should manage both the loan and grant funding to ensure a coherent set of allocation criteria and technical support aimed at an effective overall program with the government funds. The housing renovation arm of the Fund would expect to expand in line with the development of a private building management sector. Longer term: Priority infrastructure (and continued housing renovation activity). Once the Fund has proved itself as an effective mechanism, its scope should be expanded to include funding of any infrastructure development that local governments are responsible for. At such stage, the Fund should only respond to requests for credits based on a comprehensive prioritized investment plan by a city. Based on such a plan, the Fund could in due course offer funding for non-revenue-earning investments as well, such as improvement of local roads, street lighting, and public spaces. The borrower (beneficiary) would still be the city akimat, or any majority owned municipal service company. While beneficiaries under the housing renovation arm of the Fund will remain the same, in the longer term the SAOs are expected to have fulfilled their important public sector role of having facilitated the creation of a vibrant housing renovation market, with more licensed BMCs providing similar support to HOAs as the SAOs. Projects Eligibility under the HCS Fund Short- and Medium-term. Taking into consideration the large investment needs in the utility sectors, and the limited financial capacity of the City Akimats and their service/operating companies, eligible projects for the limited government funds should for some time all be revenue-earning public utility projects. That is, the capital costs of the investments should be possible to recover over time through user charges in order to ensure long term sustainability of the services. Within the revenue-earning sector, project funding should be subject to a set of eligibility criteria. For example, the project should be: (i) prioritized in the city’s overall development plan; (ii) consistent with regional (Oblast) plans; (iii) supported by a comprehensive feasibility study; (iv) represent well justified investment needs (e.g. replacing leaking pipes, extension of networks, improvements to meet government standards, and reducing energy consumption); and (v) supported by final beneficiaries (in most cases residents). Local institutional capacity development, including training of staff, which is directly related to the capital investments, should be eligible components of a project funded by the Fund. The allocation and level of funding among applicants should to some extent also depend on: (i) past project implementation performance; (ii) annual improvement in akimat and sector financials in the city (reflecting fiscal discipline); (iii) preparedness (e.g. institutional capacity 10
to undertake the investments effectively); and (iv) level of counterpart funding provided by the borrower. The housing renovation projects should be based on the priorities of the residents, supported by affordability analyses and feasibility studies. However, government could require that a minimum portion (e.g. 50% to 80%) of the investment has an energy saving effect (guided by an “energy audit”) and thereby help the affordability for the residents through lower heating bills, allow larger renovations than otherwise would be the case, and support broader national energy efficiency objectives. Longer term. Regarding utility investments, the Fund should only respond to requests for credits based on a comprehensive prioritized investment plan by an akimat, which could include non-revenue earning investments. With the agreement of the respective responsible Ministry, the HCS Fund may also expand its operations and financing to other public sectors, such as energy efficiency in public buildings (particularly education and health facilities) and in state-owned industrial enterprises. Financing criteria for the HCS Fund As long as the known investment needs across the country are very large and urgent - in both utilities and multi-family buildings - projects should be reviewed against viability criteria and approved on a “first come- first served” basis. In case the demand is expected to substantially exceed the availability of funds for a particular year, the Fund may pre-define a maximum credit amount (ceiling) per akimat and homeowner respectively, in order to ensure that the available funds come to a reasonably broad use, and are not allocated to a limited number of large borrowers only. Those akimats/ utility companies which demonstrate significant improvements in their operations and maintenance management (e.g. lower energy costs, rationalized staffing, improved ratios compared to benchmarks, etc.), should be given access to higher credit amounts or given a preference in support from the Fund in other ways. To be meaningful, this incentive will need to be significant enough to influence the activities across the country, and must be communicated clearly for potential borrowers.
11
The figure below illustrates the proposed phased expansion of the HCS Fund and its product offerings over time. The numbers 1, 2, and 3 indicate phases. Proposed Structure and Evolution of the HCS Fund
State Budget MoRD: HCS Modernization Program HCS FUND
In the future, as the utilities become more efficient, they may be able to access commercial loans. The Fund can accelerate this by offering partial loan guarantees or credit enhancement facilities.
C
service
LOAN (with Akimat guarantee)
1
UTILITIES
SAO
C
Subcontractor
Contractor
SC
service
CONSUMERS
CONSUMERS
HOMEOWNERS
Initiate lending to creditworthy Akimats/ utility companies, and over the course of the next 3-5 years as more utilities become creditworthy, increase the loan financing.
Continue the grant mechanism currently provided to Akimats/ utility companies through state transfers, to non-creditworthy Akimats/ utility companies, as required.
Re-channel all funding currently going to Akimats/ SAOs through the Fund.
12
LOAN (collateralized by future cash flow)
Condo Assoc. / KSK, Mgmt. Companies
service
Channel all such state funds through the Fund (not directly to Akimats as is currently the case). Reduce the grant funding over time as utilities strengthen their operations and qualify for loans, responding to related incentives.
2
SAOs will continue to function as General Contractors for building improvements funded by these loans. SAOs will repay their loans to the Fund, i.e. the revolving element of the funds will be managed centrally, facilitating meeting demand across the country.
Subcontractor
SC
service
HOMEOWNERS Promote the establishment of licensed Building Management Companies. Support and facilitate the formation of homeowners/condomi nium associations (including their technical capacity to manage their buildings). As more HOAs and licensed management companies get established, promote lending directly to them from the Fund, secured by their future cash flow.
Loan Repayment
Contractor
GRANT
Loan Repayment
1
(with Akimat guarantee)
UTILITIES User fees
UTILITIES
LOAN
Loan Repayment
commercial loans)
2
Housing Loan Repayment
LOAN GUARANTEE (for
User fees
3
Loan Repayment
Utilities/Communal Services
I.
INTRODUCTION
Kazakhstan has undertaken several reforms in the housing and communal services sector since 1996 including mass privatization of the housing stock, de-monopolization of the utility sector, and a phased transition to differentiated tariffs of public communal services. However, the sector is still characterized by deteriorating housing and utilities assets, a huge backlog of investment and maintenance needs, large amounts of unaccounted for energy, water and other resources, and limited technical capacity of sector agencies/utilities. Housing is recognized as a priority sector in the Kazakhstan 2030 Development Strategy, and among the most essential tasks to be addressed at the national level. Soon after its independence, Kazakhstan privatized most of its public multi-family apartment housing stock. Since then, these apartment buildings have been deteriorating, and the management and financing of their maintenance has become a serious issue. The status of the communal services sector in Kazakhstan belies the prosperity and growing income status of the country. The sector is underfunded, with regulated tariffs which are among the lowest in the region. In 2011, the Government announced the KZT 1,274 billion Ak Bulak program to upgrade and modernize water supply infrastructure and institutions by 2020. Ak Bulak was developed with a vision of tariff reform to restore the financial sustainability of service provision and to attract private operators and capital into the sector. (See Annex A for more details on these programs, and their current status.) In 2011, the Government also announced a KZT 877,170 million3 Housing and Communal Services (HCS) Modernization Program to be administered by the Ministry of Regional Development (MoRD). Following a JERP study4 by the World Bank, the HCS Development Fund (hereinafter, the Fund, or HCSF) was established under MoRD in 2012, aiming mainly to help rehabilitate and modernize the deteriorating housing and communal services infrastructure. The Fund, however, has not become fully operational yet, and the Government has sought the Bank’s technical assistance to get this done. Objectives. The main objectives of this JERP task are to contribute to the modernization of the housing and communal services infrastructure by reviewing the current policies, practices and situations surrounding the country’s HCS sector, and help operationalize the recently established HCS Development Fund. Scope. The analysis in this report covers housing and communal services sector to the extent that it is relevant to the operationalization of the HCS Fund. Accordingly, it focuses on the old Soviet-style multifamily multistory apartment blocks in Kazakhstan, and not on the new housing stock. Regarding communal services, it focuses primarily on the water sector. This document attempts not to duplicate material in the 2011 JERP report, but rather report on the progress of the HCS sector to date and to provide recommendations to help operationalize the Fund.
3
This includes KZT 304,478 million funded from the national budget, KZT 44,476 million from local budgets, KZT 452,406 million from utility companies, and KZT 75,810 million by citizens. 4 Kazakhstan Joint Economic Research Program (JERP): “Establishing Financial Mechanism to Support Housing and Utilities Sector Based on International Experience”, 2011, World Bank. 13
Structure of the report. The report starts by presenting the context/ situation analysis in Section II, followed by some of the key challenges in the sector in Section III, and lessons learned from international experiences in Section IV. Recommendations to support the operationalization of the HCS Fund are presented in Section V. A draft Operations Manual is attached to this report (as a separate document).
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II.
SITUATION ANALYSIS
Today, most urban residents of Kazakhstan (98%) are the owners of their individual apartments and own shares in the common areas of their apartment buildings. There are some 169,000 multifamily buildings (MFBs) in Kazakhstan, which account for 79% of the country’s housing stock. According to the latest estimate by the government, 28% of these apartment buildings are in urgent need of capital repair and 2% are failing buildings or subject to demolition as they are unsuitable for habitation. Both national- and local-level officials confirm the prevalence of leaky roofs, mal-functioning elevators, and dangerous wiring in MFBs; the need for financing these capital repairs is dire. Energy losses in buildings are estimated to range from 30 to 50 percent. To date, Government funding has been inadequate to meet the need, and private capital is yet to flow into the sector. With few exceptions, Kazakh utilities still manage degraded and inefficient systems, with marginal service quality and low level of cost-recovery through user charges. Infrastructure and service deficiencies are striking in both urban and rural areas – for example, access to piped water service is 86% in urban areas and 45% in rural areas. 5 According to 2010 figures, only 36% of water supply networks are in full working condition, and about 70% of the networks are in need of overhaul, repair or complete replacement. Similarly, wastewater connections service about 73% of the municipal population, but 70% of sewerage networks in Kazakh cities were in need of repair in 2010. Losses in water supply and sanitation (WSS) networks amounted to 40%, which is 11% more than in 2004. (i)
Institutional Context
Legislation and regulations in the water sector The main document governing the water supply and sanitation (WSS) sector in Kazakhstan is the new Water Code adopted in July 2003. The previous Water Code was in effect from 1993 to 2003. According to the Water Code of 2003, water reserves belong exclusively to the state, and the government exercises the rights of ownership, use, and allocation of water resources. The Water Code establishes the legal framework for the use and protection of water resources by defining responsibilities of the Water Resource Committee, local executive bodies or akimats6, environmental protection agency, and sanitation inspection, among others. In order to operate, water and sanitation utilities must obtain special water use and discharge permits at the regional or Oblast level. In addition to the Water Code, there are a number of other laws, decrees, and rules that together constitute the legal framework governing the water service provision in Kazakhstan. Technical standards and norms. Developing construction and other technical norms and standards pertaining to the water supply and sanitation sector is the responsibility of the Committee on Construction and Housing and Communal Services under MoRD. According to the Ministry, the Committee’s vision is to adopt European standards in Kazakhstan as well as to harmonize them among the countries in the customs union with Belarus and Russia.
5
MoRD, 2014. Akimat is the local executive body or municipality equivalent. Oblast is the administration at the regional level. Akimats exist at both the Oblast and the City level in KZ. For ease of discussion in this report, the Oblast Akimat is referred to as “Oblast”, and the City Akimat is referred to as “Akimat”. 6
15
Sector strategy. While the government has identified its policy priorities in the water supply and sanitation sector, they have not been specifically assembled in a national strategy document. These policy priorities include: (i) Full water supply and sanitation service coverage in urban areas; (ii) Financial sustainability; (iii) Private sector participation in the sector; and (iv) Improved operational efficiency in terms of reduction of water losses and increased energy efficiency. These policy priorities were reflected in the Ak Bulak program (2011-2020), which established targets for such performance indicators as coverage, metering level, and water losses (see Annex A for more details on Ak Bulak and other government programs relevant to the HCS sector). The program reflects the government’s determination to modernize the sector and improve service provision. Sector stakeholders. MoRD is the sector line ministry, coordinating the management of water supply and sanitation at the national level. Other key stakeholders include: (i) the Ministry of Environment and Water Resources (MEWR), responsible for coordinating water sector globally (e.g. water basins, transboundary waters etc.); (ii) the Water Resource Committee under MEWR, which mainly deals with water allocation and irrigation facilities management, as well as construction of water pipes for rural settlements; (iii) Ministry of Agriculture responsible for coordinating water allocation for irrigation needs; (iv) Agency for Regulation of Natural Monopolies (AREM), an anti-monopoly authority tasked with approving business plans and water and wastewater tariffs. Kazakhstan also has a very active National Association of Water Utilities, whose mission is to represent interests of its members at the national level. Sector organization. Kazakhstan has a total of about 150 water and sanitation service providers. The four largest water companies in Astana, Almaty, Karaganda, and Shymkent together serve 3.5 million inhabitants, which is more than a fifth of the total population of Kazakhstan. In addition, there are 16 large water companies that each serve more than 100,000 inhabitants. The rest serve smaller towns with less than 100,000 inhabitants. Most utility companies provide both water and sanitation services, with only a few that provide exclusively water supply. Since the early 1990s, water supply and sanitation service provision has been decentralized to the municipal level, with akimats being the owners of water companies. Today, most water companies – about 140 out of 150 – are municipally-owned and considered “state communal enterprises” (SCE)7. There are a handful of companies that are under mixed ownership (municipal and private) and one or two that are fully private. There are no national or regional water companies in Kazakhstan; although recently there was a proposal in the government to create a single national operator for rural water supply. - Policy formulation The water supply and sanitation sector policy is defined at the presidential level. The central government formulates sector policies pertaining to service standards, institutional arrangements, financing, and cost recovery mechanisms. The presidential administration defines the sector policy priorities and their implementation lies primarily with MoRD, as well as the Ministry of Agriculture and the Ministry of Environment.
7
A more detailed explanation of SCEs and other similar entities is provided later in Box 1. 16
- Asset ownership and infrastructure planning Water and wastewater infrastructure is considered “communal property” and owned by city or oblast akimats. Although new and existing assets are transferred to utilities for operation and maintenance, the ownership remains with akimats in the sense that these assets cannot be leased, sold, or used as collateral without akimats’ consent. Furthermore, at any point, an akimat may decide to restructure or liquidate a utility and dispose of its assets. Akimats also review and approve investment proposals prepared by water utility companies. Once city or district akimats endorse the proposal, they send it to the oblast akimat for selection. Smaller investment projects of less than 80-100 million tenge normally get approved at the oblast level, whereas those above that amount are submitted to MoRD for another round of review. The Ministry considers the project after an in-depth technical assessment, also known as the “state expertise.” Once the project is accepted by MoRD, a budget request is sent to the Ministry of Economy and Budget Planning for approval and financing. The criteria used for evaluating investment projects normally include the population size served by the utility, number of accidents in the network, and technical viability of the proposed investment. - Service provision With the exception of few mixed ownership and private utility companies mentioned above, services are operated by SCEs accountable to city and oblast akimats, who are ultimately responsible for the provision of water supply and sanitation services. The relationship between akimats and water companies is typically described in a charter (articles of association). The charter is a standard legal document which outlines roles and responsibilities of both parties: the akimat, or the founder, and the communal enterprise providing water and wastewater services. - Sector financing Since the aforementioned institutional reform in 1993 transferred ownership of water utilities and the underlying assets from the central government to municipalities, individual utilities cannot obtain direct financing for new investments or rehabilitation from the national budget. Instead, municipalities receive earmarked transfers under various government programs – currently it is Ak Bulak – from the national budget, contract construction or rehabilitation works, and then transfer new or rehabilitated assets to the balance sheets of the utility companies. As a result, often utility managers are not even aware from which “pot” the works are financed – either the national budget or akimat’s own budget. - Regulation The Agency for Regulation of Natural Monopolies (AREM) is Kazakhstan’s multi-sector tariff regulator. AREM was established in 1999 and is financed from the national budget. The agency together with its oblast departments play an important role in controlling the prices charged by water utilities. AREM reviews tariff applications using non-discriminatory methods for calculation of tariffs, ensures that only eligible costs are included in the financial analysis, and determines a reasonable level of water consumption by non-metered consumers.
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The agency also maintains a registry of subjects of natural monopolies, including water supply and sanitation utility companies.8 Reportedly, utility operations are supervised by oblast akimats on at least annual basis. Financing mechanisms under the HCS Modernization Program There have been several mechanisms for financing under the HCS Program to date. For ease of understanding, these are illustrated in Figure 1 and 2 respectively. Figure 1 is a self-explanatory illustration of the financing mechanism used in the past (20112013) for HCS financing from the government. Prior to 2014, SCEs and socialentrepreneurship corporations (SECs) at the akimat or oblast level served as financial operators/ intermediaries for MFB renovation programs. However, these entities had little experience in building renovation works, and this type of activity was not consistent with their main function. It was, therefore, decided by the government that they will not be engaged in renovation activities starting from 2014, and instead replaced with special authorized organizations (SAOs), which will constitute specialists in the housing sector, and serve as General Contractors (GC) for works (see Box 1). Box 1. Definitions SEC - Social Entrepreneurship Corporation [Russian transcription SPK-СПК or Социальная Предпринимательская Корпорация]. Established in each region of the country within National Fund Samruk in order to facilitate regional development. Under the first mechanism of financing of the HCS Modernization Program (in 2011-2012), SECs served as financial operators (intermediaries). SCE - State Communal Enterprise [not to be confused with public utility company] is a company which is owned by the state and operates in services that are rarely run by private businesses. A large share of the General Contractors under the HCS Modernization Program in 2011-12 was SCE-type companies. PUC - Public Utility Company is a communal services provider (water, heating, electricity, gas). In Kazakhstan, most PUCs are a form of state communal enterprises (SCEs). SAO - Special Authorized Organization Starting from 2014, the SECs and SCEs are being substituted by SAOs, under Akimats (one per participating Akimat). The various SCE-type contractors will cease to function, and the SAOs, with staff specialized in housing-related fields, will be the General Contractor for housing renovation works.
8
This study was unable to determine what type of utility information is collected in the registry. It is also not clear whether AREM monitors operational performance of individual utilities or provide any feedback on ways to improve their performance. 18
Figure 1: Financing Mechanism for housing and communal services under the HCS Program 2011-2013
State Budget MoRD: HCS Modernization Program Capitalization (300M KZT)
Annual Transfer
Repayment
Pilot Housing Modernization Project
OBLAST
AKIMAT
Contractors (e.g. JSC Astana-Kyzmet)
C
service
HOMEOWNERS
Pilot project: In 2012, the Agency for HCS supported JSC Astana Kyzmet, a management company, to carry out improvements in one pilot multi-family building. The project was very successful, but government financing for the work on housing was halted temporarily in 2013 after completion of this pilot.
Repayment
Contractor
(Financial Operator)
Contractor service
C
0% interest loan
SEC/ SCE
HOMEOWNERS
State budget transfers under the HCS Program were made to Oblast/ Akimat, which transferred these funds to SECs/SCEs. They served as financial operators, signing agreements with homeowners and contracting private companies to undertake building improvements on behalf of the homeowners.
Transfer of capital investment/ new asset
UTILITY COMPANY service
CONSUMERS
User fees
MGMT COMPANY
Repayment
0% interest loan (Tripartite Agreement (HOA, Kyzmet, Agency)
Agency for HCS*
State budget transfers under the HCS Program were made to Oblast/ Akimat. The akimat arranged capital improvements and transferred the new assets to the operator/utility company.
* The Agency for Housing and Communal Services has since ceased to exist as an independent institution, and is now a “Committee” for HCS under MoRD.
19
Figure 2 presents the financing mechanisms envisaged by the Government in 2014 and onwards. As illustrated, funding for housing improvements under the HCS Program will be channeled from MoRD through the Oblast to the city akimat to the SAO. The SAO will act as the GC, and based on agreement with the home owners, be responsible for hiring subcontractors to carry out the works. The SAO will collect loan repayments from the home owners, and use these payments on a revolving basis to finance more buildings. Figure 2: Financing Mechanism for housing and communal services under the HCS Program (planned, 2014 onwards)
State Budget MoRD: HCS Modernization Program Annual Transfer
HCS FUND Repayment
Heating Meter Project (Forthcoming: 2014)
OBLAST AKIMAT
Contractors
service
Sub-contractor
service
HOMEOWNERS
HOMEOWNERS
Pilot project: HCS Fund is starting a pilot program in 2014 to finance heating meters. Financing of KZT 8 billion is being obtained from MoRD (authorized capitalization), which will be used to provide loans to district heating companies to install heating meters in MFBs in Kazakhstan’s largest cities. The utilities will recover this money through user charges from the consumers and repay the fund over two years. Based on the experience of this undertaking, the Fund envisages providing loan financing to other ‘financially viable’ projects in the utilities sector in the future.
SC
0% interest loan
C
Repayment
Contractor
SAO (General Contractor)
State transfers to the Akimats are to be channeled to SAOs who are to function as the GC for renovation works of MFBs for which owners seek government financing/ loans. The SAO pays the subcontractors for the works, and the individual homeowners – not HOAs or condominium associations – make loan repayments based on individual loan contracts with the SAO. These are 0% interest loans for 10-15 years, without any grant subsidy element.
20
Transfer of capital investment/ new asset
UTILITY COMPANY service
CONSUMERS
User fees
UTILITY COMPANIES (Heat Distribution) User FEES
4% interest loan (2 year term)
Capitalization (8B KZT)
State budget transfers to city Akimat will be used to make capital improvements or acquire new assets for the utilities (same as before 2014). The akimat will then transfer the new assets to the operator/ utility company.
(ii)
Housing Sector
Management of common areas of multifamily buildings The Law on Housing Relations provides a legal basis for condominium associations or home owners’ associations (HOAs)9 to open a savings account at a bank in order to manage funds for needed improvements in common areas. The passage of Amendments to the Law on Housing Relations in 2012 put the burden and responsibility of maintenance of a building on the homeowners. According to Article 42 in the Amendment, “No later than a month after the registration of the condominium object, the premises owners shall decide on the form of management for the condominium object. Before such decision, the owners assume joint and severe responsibility in relation to the condominium object as a single complex and the centralized provision of utilities services for the residential building. Only one form of joint management of the condominium object applies to the apartment block (or its part) that has a single system of engineering and utilities services.”
There are also provisions in the above law for HOAs to take measures in case individual apartment owners fail to pay maintenance and utility fees. The law provides for the HOA to take apartment owners to court to enforce payment. Some HOAs have resorted to posting the names of non-payers in public places in the building so as to exert peer pressure. The amendment to the Law on Housing Relations simplifies the process of judicial review by the courts of such claims – through the form of a court order, which is supposed to be dealt with within 2-3 weeks. However, there does not appear to be a provision in the law for HOAs to take an intermediate step used in some countries to force payment, namely the imposition of a lien on the property.10 In 2010, more than KZT 350 million were recovered through such a process. However, the court procedures in relation to these debtors were cumbersome and took six months or more. According to the Law on Housing Relations, “The management form for the condominium object is defined by the agreement of its participants. Such forms may include: - direct joint management by all owners if their number is less than twenty; - cooperative of the owners of premises (apartments); - management of the condominium object by third parties: elected or hired persons – managers of residential buildings or legal entities; - other forms not contradicting the legislation of the Republic of Kazakhstan.”
By 2011, the number of registered condominium buildings was 14,678, or 8.5% of total MFBs. A 1-2% increase in MFB and HOA registrations is expected in 2014, attributed to capital repair activities being supported by the government. 11 With respect to establishing HOAs, most apartment owners in Kazakhstan organize themselves into ‘loose’ or informal HOAs, represented by the more active members of the building – for example, with one representative or leader per entrance of the building, representing about 10-20 dwelling units.
The terms Condominium Association and Home Owners’ Association are used interchangeably in Kazakhstan’s context, and accordingly in this report. 10 A lien is a security interest granted to the HOA over an individual apartment in order to secure the payment of a debt. 11 Source: HCS Center. 9
21
Each owner pays a fee (roughly KZT12 15-20 per m2 of the dwelling per month), which is used for basic maintenance of the common areas13. “KSKs” are the established entities in the sector to manage and maintain the common areas. According to the Law on Housing Relations, a KSK (Cooperative of flat owners) is one of possible form of condominium management. To establish a KSK, flat owners within a registered condominium make such decision (commonly) and register the KSK in the Department of Justice. In this way, a KSK is similar to an HOA. However, there is no restriction on how many condominiums can enter one KSK; a KSK could thus manage the MFBs of multiple HOAs. According to official information from the Statistics Agency of Kazakhstan, 4,551 KSKs have been registered, and of them, 2,064 are currently in service. Over 70% of all KSKs were established prior to 2000; the “activity peak” was accounted for 1996. KSKs were created when the former state housing management agencies (or “zheks”) were eliminated. KSKs typically manage multiple buildings, ranging from 2-3 to upto 30 and more (see Box 2). Box 2. Multifamily housing in Astana managed by a KSK The photos below show a KSK in Astana that manages 16 buildings, with some 1,500 dwelling units. They charge a monthly management fee of KZT 20 per square meter of dwelling space, and provide the basic maintenance services. To undertake any improvements that affect a specific building, the residents of that building need to agree to contribute additional funds to cover the costs.
This KSK participated in the HCS program to undertake the improvement of two apartment blocks that were in very poor conditions. A complete overhaul of the two buildings was carried out (basement, plumbing, electrical, toilets, front door, painting, etc.). Since most of the people in these two buildings had very low incomes, over 90% of the cost of the renovation was borne by the government (through housing allowances). The KSK Chairperson reported that “after all this investment and time spent to improve the premises, the residents are not taking care of the property, and that the condition is likely to deteriorate again ….”
12 13
1USD = KZT180 (conversion rate as of April 2014) Common areas include, for example, exterior walls, roof, stairwell/ hallway/ entrance, outdoor spaces etc. 22
Smaller KSKs managing 1-5 buildings appear to be ‘closer’ to the homeowners, and more responsive to their demands. Some KSKs are more proactive, and have facilitated access to financing for building improvements under the HCS Program (see Box 3). Box 3. Building improvement organized by KSKs under the HCS Program in Karaganda A KSK in Karaganga participated in the HCS Program to renovate a building in very poor condition – as evident from the ‘before’ and ‘after’ pictures below. Of the 128 apartments, only 15 had household incomes of more than KZT 350,000/month (about $2000); all the others qualified for the housing allowance. Ninety percent of the cost of building renovation of KZT 150 million was covered by state-funded housing allowances. Façade
Stairwell
Meters
BEFORE
AFTER
Since the improvement, the value of the property has appreciated substantially – nearly doubled. Commercial space on the ground level is used to generate income for the KSK, which helps pay the cost of maintenance and common services. This KSK has also prepared applications to improve two other buildings under its management, of which one has been approved and will be implemented in 2015.
About 50-60% of KSKs funds go to management staff, 20% towards mandatory fees paid to the state budget, and only the remaining 20% are used for building maintenance. Not only are these funds not enough – in addition, the collection of monthly dues from homeowners stands at about 70-80%, with 20% home owners not paying at all. In other words, KSKs do not have the capacity or the financing ability to undertake major capital repairs needed in many of these old buildings. Another problem with KSKs is that they have so far been considered licensed contractors to carry out work on the buildings, i.e. the KSK both governs and implements – deciding what is to be done in the buildings and paying itself to do it. This conflict of interest, together with 23
often poor delivery of required services by the KSKs, has led to an increased distrust of KSKs by homeowners, particularly in cases where KSKs are managing a large number of buildings (say, more than 8-10). Building Management Companies. All contractors or companies involved in the capital repairs and construction services must be licensed by the relevant Akimat Construction Department. As illustrated by Astana Kyzmet, a JSC management company, there is now an on-going shift in mindset to encourage the establishment of professional management companies14 (see Boxes 4 and 5). Under the current system, however, private companies (KSKs, management companies etc.) can only access government funds under the HCS Program through public sector financial intermediaries (illustrated earlier in Figure 2). To qualify for modernization under this government program, agreement must be obtained from at least two-thirds15 of the homeowners to proceed with the application requesting a loan under the HCS Modernization Program. The process of getting agreement of the residents is time-consuming, often taking 6-12 months. This engagement is not only a requirement, but critical for the success of a project. Box 4 illustrates the steps required to participate in the HCS Modernization program. Box 4. JSC Astana Kyzmet Step 1: Community Organization Get consent of homeowners for carrying out capital repairs and modernization (two thirds is a minimum) Step 2: Technical Inspection and Energy Audit Prepare and agree on the list of defects; obtain the energy passport on housing Step 3: Prepare Technical Design and Cost Estimates Prepare design and cost estimates; obtain state expert review conclusion, and clear with Housing Inspectorate. Step 4: Approve Design and Cost Estimates Approve design and cost estimates Step 5: Request Funding Applications for Housing Allowance by homeowners; Application for Budget funds (7 to 20 year loans) Step 6: Implementation of Capital Repairs Carry out capital repair
14 15
The number of building management companies currently operating in Kazakhstan is unknown. There is currently a proposal to increase this to three-fourths, i.e. getting agreement by 75% of the owners. 24
The Management Company (MC) Astana-Kyzmet LLP was established in Astana in December 2011 as Joint Stock Company (JSC) or public-private partnership (51% private and 49% public), with a loan from the government under the HCS Modernization Program. The main aim in establishing Astana-Kyzmet was to demonstrate a systematic approach in the relationship between homeowners, management bodies of condominiums, service companies and contractors with regard to management, maintenance, operation and repair of MFBs. It has a customer-oriented approach tailored to each HOA/. Astana-Kyzmet, under its
25
pilot project for the HCS Modernization Program (capital repair of Building 37, Kuyshi Dina Street, Astana, costing KZT 73 million) also undertook the function of carrying out capital repairs on behalf of the HOA. This was a 23-year old building with 95 apartments averaging about 68m2 in size, with an average investment of about KZT 768,000 per apartment (see Box 5). Box 5. JSC Astana Kyzmet pilot housing project Under the Astana Kyzmet pilot project, the building to be renovated was registered as a condominium; there was no condominium association (HOA), but an informal ‘Council of Homeowners’ comprising two representatives per building entrance (there are 8 entrances so the Council constitutes 16 people). The capital repair works in the Astana-Kyzmet pilot project was financed through a loan by the HCS Center to the home owners (zero percent interest, 15 years). A three-party agreement was signed between the HCS Center, Astana Kyzmet (as this building’s management company), and each Apartment Owner. The repairs included: roofing replacement, basement repair with heating infrastructure replacement (including installation of new heat meters and automatic regulator for the building), thermo-insulation of facade, and insulation of window/door at each entrance of the building. Astana Kyzmet involved engineering staff and provided help to homeowners in selection of technical solutions (choice of equipment, roofing technologies, etc). The Akimat was not involved in this project. A company Astana Kurylys Services LLC did the building assessment/ inspection for a fee, and some 7-8 contractors were used for the construction works. The construction was monitored regularly by Astana Kyzmet jointly with the Homeowners Council. Of the 95 dwelling units in the building, 54 households (57% of total) obtained housing allowances that covered a major part of loan repayment. Those with the housing allowance have, on average, a loan of KZT 15,400; those without have an average loan size of KZT 74,800. This appears to be quite affordable – and even more so in light of the fact that the heating bills since the renovations are 50% lower, and the value of the property has appreciated significantly. Loan repayments are now on-going. A few (8) residents did not sign the tripartite agreement and do not pay yet (some of them operate businesses on the ground floor); Astana Kyzmet plans to take them to court. In addition to the loan repayments, all homeowners pay KZT 25/m2/month (of the living space) to Astana Kyzmet for cleaning and basic maintenance of the common areas.
At the top-left is the photo of another building in the neighborhood that resembles pilot building ‘before’ the project. The others are photos of the pilot after the works were completed: Top right: thermo-insulation of facade; bottom left: new heat substation in the basement; bottom-middle: motion sensor light in the hallways/ staircase; bottom right: the Chairperson of the HOA showing the electricity meters for each apartment unit.
26
Homeowners’ financing sources for housing and infrastructure improvements Financing is a major hurdle faced by many homeowners to undertake major capital repairs. The maintenance fees or condominium account reserves are simply not enough to meet the cost of major capital repairs. Even if the residents were to contribute money – or save over a period of say 3-4 years – to do the repairs, the scale of the work involved (for example, roof repair, thermo-insulation of façade, upgrade of heating system, etc.) would usually require additional funds. Commercial banks, for most part, at present, do not lend to homeowners for common areas, since a HOA is a new type of organization in Kazakhstan, and still not very common. Notwithstanding, even if they were willing to offer loans, the cost of these loans would be prohibitive. Besides, the homeowners, on their part, are typically hesitant to enter into loan obligations with commercial banks, pledging their apartments as security, as they fear the risk of losing their home (see Box 6). Since the Astana Kyzmet pilot, and the commencement of the HCS Modernization Program across the country, many homeowners have expressed interest in undertaking improvements in their homes. However, as reported by several akimats, the demand for improvements far exceeds the supply of financing in most cities,16 resulting in delays or postponement of improvement plans. In addition to loan funds for capital repairs under the HCS Program, eligible homeowners may get a Housing Allowance to cover part of their cost of the repairs. Eligibility requirements include: (i) the applicant should be the owner of the apartment in which he/she resides; (ii) all adult members should be employed, or formally registered as unemployed 17, with the exception of new mothers (with children less than 3 years of age), handicapped persons, or students; (iii) the applicant is single parent family, handicapped person, or sole surviving pensioner; (iv) household income is insufficient to cover housing expenditures including utility bills and rent (if the total housing expense exceeds a certain percentage of income - see Box 7); (v) the applicant does not own another residence, and so on. While the exact amount of the allowance varies by Oblast/ Akimat, the general rule is that qualifying beneficiaries can receive an allowance to cover any housing costs (housing+ utilities; including housing improvements) that goes above and beyond 8-10% of the household income, based on the minimum standard of 18 m2 per person of living space. In other words, a 3-member household can get a Housing Allowance subsidy for a maximum of 54m2 of dwelling space. In the case of capital or other improvements under the HCS Program, this Allowance is transferred directly from the akimat (rayon level Employment and Social Programs Department) to the General Contractor for the construction works.
16
In some cases, the situation is opposite: for example, as reported in Karaganda, the low uptake for HCS Program is attributed to the fact that people are not interested in upgrading their heating systems or installing water meters due to a perception that they will pay higher bills with these modernized systems/ equipment. 17 Unemployed persons need to have documents confirming their status as “registered unemployed”. Categories of people exempt from the employment requirement include: handicapped persons, persons who have been hospitalized (for over a month), full-time students, people taking care of Category 1 and 2 disabled people, disabled children under 16 years of age, people over 80 years of age, children under the age of 7 years (Source: “Model on interaction between HCS subjects”, HCS Centre of Construction and HCS Agency, 2012). 27
Box 6. A multifamily building in dire need of repairs The photos below illustrate an MFB in Astana with residents who are largely low and middle income earners – say, with a monthly household income between KZT 3,600-14,400 (US$200-800). The interiors of most dwellings are well finished but the building is currently in very poor condition. The roof is leaking, the bricks on the walls are crumbling, and there are several cracks in the structure. [Notably, however, the extremely high cost of housing in Astana is evident from the fact that an apartment even in this building in such poor condition can fetch anywhere between KZT 270,000-360,000 ($1500-2000) per m2.] The residents want to get these problems fixed before the building gets characterized as ‘condemned’, after which it will be impossible to make any improvements. They have considered pooling money and hiring a contractor to do the repairs, but they cite two problems: one, the cost of the repairs is too high for them to afford (or have all owners contribute willingly), and two, even if they were able to collect the money, the scale of works is “too complicated for a petty contractor, and too small for a large contractor.” This highlights the importance of the HCS Modernization Program. The building was previously managed by a KSK, but the homeowners ended their engagement with the KSK and hired Astana Kyzmet as their management company. They pay a fee for maintenance, which is used to carry out some basic maintenance activities, such as cleaning the yard, stairwells, and basic repair work with plumbing/ electricity. Most residents pay their dues in a timely manner, except for a few owners who are absentee landlords (their apartments are rented out). The residents, through Astana Kyzmet, also requested funds for building improvement under the HCS Modernization program in 2012. An inspection was completed, together with an energy audit in 2012, and full cost estimates (~KZT 50M). But they have now been informed that there is no funding available for this year (2014).
Left: Top: Structural damage on the building – a major crack and falling bricks; Bottom: Water damage on the ceiling of the top floor unit due to a leaking roof Middle: Efforts by the homeowners (through Astana Kyzmet as management company) organize the trash (top), and clean and light up hallways (bottom). Right: Clean and well-kept interiors of the houses (top and bottom)
28
Box 7. Housing Allowance Program An enhancement to the Housing Allowance program started in 2011 to assist residents on an income-targeted basis with the cost of capital repairs in common areas of multifamily residential buildings. The allowance covers the expenditures beyond 10% to 30% of the total household income, depending on region, as determined by the local representative bodies. Eligibility criteria and application rules vary by local legislatures (maslikhats). In principle, this is a good program for the support of housing renovations; however, data to determine its effectiveness are unavailable. Illustrative example At a general meeting of a HOA, the required 2/3 of the homeowners decides to make certain repairs of common areas in their building where 500 households reside. The cost of work is KZT 10 million. Accordingly, the contribution from each of the 500 apartments will be KZT 20,000 (assuming all apartments are of equal size). A household with a total income of KZT 50,000 - in a region of Kazakhstan where the threshold for co-payment by a household is 10% of total family income should contribute KZT 5,000 (for housing plus all utilities), and the difference KZT 15,000 is paid by the Government as housing assistance to that household. In a region with 30% limit, such a household would pay KZT 15,000 with the remaining KZT 5,000 paid by the Government.
Identification and prioritization of modernization projects With respect to housing modernization, the Housing Inspectorates under the akimats were established after the commencement of the HCS Program, to perform a supervisory function for implementation of modernization projects. The Housing Inspectorates are responsible for carrying out inspections (issuing “building passports”) and assessments (including energy audits) of buildings in their jurisdictions, and making recommendations for repairs and improvements to the homeowners. Apart from implementing their own plan to carry out citywide inspections, they also respond to request from HOAs to carry out inspections in their buildings, particularly when they might qualify for financing under the HCS Modernization Program. Interviews with the Housing Inspectorates, however, seem to suggest that building inspections and energy audits to date have been completed in only a small fraction (less than 10%) of the total buildings that may require repairs. Based on the assessment/ audit, the home owners are expected to get a cost estimate, and get agreement from at least two-thirds of the owners to undertake the repairs. They can then submit an application to the SAO for financing under the HCS Program. The application is reviewed, and if approved, passed on to the akimat. The applications are then reviewed and prioritized by the akimat, submitted to the Oblast administration (by March 15 of every year), which forwards them to MoRD requesting financing allocation under the HCS Program for the coming year. The Inspectorate also keeps track of the performance quality of service providers, and maintains a blacklist of the ones with bad performance. Housing renovation volume to date As a precursor to the establishment of the HCS Fund, the HCS Center tested the implementation of a housing improvement project facilitated by Astana Kyzmet, as described earlier. In parallel, during 2011-2012, SECs/ SCEs channeled KZT 17.8 billion of funding for renovations in 1,357 buildings across the country. This corresponds to about KZT 13 million per building on average. However, only minor renovations were made in almost two-thirds of the buildings, with only a third making the more significant improvements. This represents an important start for the sector though since homeowners tend to trust experience from works done by others more than general information and estimates.
29
In 2013, no funding was available under the HCS Program, which has created some level of uncertainty among potential beneficiaries of the government financing, and effectively brought the effort to a standstill. Funding has since been resumed in 2014, with the SAOs replacing SECs and SCEs for housing renovations. (iii)
Water Sector
Ak Bulak implementation At the time of adoption of the Ak Bulak program in 2011, 82% of Kazakh urban population had access to centralized water supply and about 73% had a connection to sewerage. These coverage rates are comparable to or slightly higher than those in other former USSR countries, yet lower than European country averages. Wastewater treatment is at an even lower level: of the wastewater collected, only 64% is treated to a normative level, while the remaining 36% goes untreated. Thirty-nine cities and towns lack wastewater treatment facilities altogether.18 One of the main goals of Ak Bulak is to increase water supply, wastewater collection and treatment coverage rates to 100% by 2020. In 2013, almost half-way into the Ak Bulak program implementation, urban water supply and sanitation coverage rates had reportedly reached 86% and 78% respectively. Hence, in terms of reaching its results indicators for water and sanitation coverage, the program appears to be on track. In 2013, 137 projects amounting to KZT 48.7 billion were funded under the program, resulting in 680 km of newly constructed or rehabilitated water pipes and 290 km of newly constructed or rehabilitated sewerage network. The table below presents self-reported data on the performance of 30 utilities from 2006-2010 (See Annex A for more details on Ak Bulak and other government programs relevant to the HCS sector.). Indicator Water coverage (%)
2006
2007
2008
2009
2010
85
86
81
79
81
Sewerage coverage (%)
64
65
61
62
63
Total water consumption (liters/person/day)
286
295
318
304
286
Residential consumption (liters/person/day)
121
121
130
132
129
Non-revenue water (%)
33
32
34
35
31
Non-revenue water (m /km/day)
61.8
59.5
82
78
59
% water sold that is metered (%)
55
55
42
46
47
Operational cost W&WW (US$/m water sold)
0.24
0.27
0.25
0.28
0.33
Water Staff /1000 pop served (W/1000 pop served)
1.4
1.4
1.4
1.5
1.5
3
3
3
Average Revenue W&WW (US$/m water sold)
0.22
0.23
0.2
0.27
0.34
Collection Period (Days)
83
88
66
130
163
Collection Ratio (%)
95
96
101
85
92
0.91
0.86
0.8
0.97
1.02
Operating Cost Coverage (ratio)
Note: Indicators are based on self-reported data of about 30 utilities in the International Benchmarking Network for Water and Sanitation Utilities (IBNET), www.ib-net.org. IBNET allows water and sanitation utilities to measure their performance both against their own past performance and against the performance of similar utilities at the national, regional, and global levels.
18
“Ak Bulak” Program 2011-2020 30
III.
CHALLENGES AND ITEMS FOR CONSIDERATION
(i) HCS Modernization Program financing: Mismatch in demand and supply Under the current system, the akimat/ SAO relies on the national government annual transfers under the HCS Program to undertake any building renovations. Interviews with city officials in some of the cities seem to suggest that the effective demand for financing (i.e. homeowners able and willing to take a loan) far exceeds the supply of funds. However, there is no comprehensive analysis of this demand or cost of building improvements disaggregated at the akimat level to date. As a result, allocations are made on an ad hoc case-by-case basis, determined largely on a “fist come – first served” basis for which building inspections have already been carried out and, to some extent, the urgency of the underlying repairs. A critical factor driving the success of any renovation program is the level of demand and the willingness of apartment owners to participate – and pay – for improvements. This means they must be willing to organize themselves, co-finance from their own funds, and possibly borrow to undertake capital improvements in the common areas of the buildings. At the micro level, this raises the question whether residents will perceive and actually realize the benefit of capital improvements or savings from energy efficiency improvements in common areas. At the macro level lies an even more important question: how large is the effective demand, what type of financing (government share, private share, government subsidy in the form of Housing Allowances and low interest loans/ upfront subsidy etc.) will this require, and over what period of time, and how will this be phased. To date, no systematic studies of the ability and willingness to pay among residents have been carried out in Kazakhstan. (ii) Bureaucratic bottlenecks Repairs to buildings under the HCS Program in the past reportedly comprised ‘cosmetic’ repairs to a large extent versus the much-needed capital repairs. It is reported that decisions for such repairs were sometimes made by the akimats/ SECs/ SCEs, without adequate consultation with the home owners. While the SAOs may be more technically competent than the SECs or the SCEs, there may be concerns that this will result in a disproportionate concentration of power with the SAOs, and hence, indirectly with the akimat – from initial inspection stage after which residents are advised to do the required renovations, to the final implementation when the SAO approves the sub-contractors and completed work. Also, how quickly and efficiently improvements in the HCS sector are made depends on numerous factors, not least of all, the capacity of local akimats and SAOs to undertake housing inspections and energy audits expediently, identify the need for capital repairs in MFBs, get agreement from the owners to undertake this work, and in parallel, channel loan financing (through SAO, the General Contractor) to implement the work in buildings where agreements exist. As discussed in the previous section, only a small fraction of buildings have been inspected to date by the Housing Inspectorates. A more speedy process needs to be put in place to ensure that these inspections are scaled up, i.e. carried out for a much larger number of buildings. With the establishment of the Fund and alternative channels for financing (e.g. lending to private licensed building management companies, and registered condominium associations/ HOAs borrowing directly from the Fund), it is expected that homeowners will have more choice. However, acceleration of housing inspections will still be critical. These inspections 31
are currently mainly dependent on resource allocation from the central government to the akimats. (iii) Housing Allowance for the poor: Possibly a costly affair As mentioned earlier, any expense on housing and utilities beyond a certain percentage of the household income (10-30%, depending on the akimat) can be covered by a state-funded Housing Allowance program for eligible households. This provision is very good in terms of ensuring that the cost of renovation does not pose a disproportionately heavy burden on low income households (and hence their denial to participate). However, it also has some possibly challenging implications: -
-
-
One, if the building largely has low income people, it may be easier to get the residents to agree to undertake the improvements, since much of the cost burden falls on the government. In the example presented in Box 3 (Karaganda), almost all of the residents in that building qualified for the Housing Allowance, which covered all or part of their share of the capital improvement cost. As a result, about 90 percent of the total cost of renovation was covered through state-funded Housing Allowances. Apart from putting a high cost burden on the government, this also raises the issue of perverse incentives, whereby it would not be in the interest of the owners to try to keep the costs down (for example, by doing the improvements in phases, with the priority items being covered first) – since the government is covering it in full. Two, if a building largely has residents who do not qualify for the Allowance for one reason or another, it may be harder to convince the owners because they would, in effect, have to bear all or a large part of the cost themselves. In other words, it may be harder to get agreement for improvements in buildings with “better-off” residents.19 An incentive grant that is not dependent on income levels may be needed in such cases for energy efficiency improvements. Three, more than 40% of the households in Kazakhstan qualify for the Housing Allowance. As a result, a significant percentage of state funds are associated with the Housing Allowance. Thus housing modernization activities may become rather costly for the public budget once the program expands, considering that the allocations from the state budget for loans under the HCS Program, to a great extent will be repaid through allocations from the Social Program in the form of Housing Allowances.
(iv) Lack of HOAs and building management companies An efficient multifamily housing sector is one in which residents through their HOAs take full responsibility for their buildings. The current limited number of registered HOAs implies that, rather than dealing with a single entity, the Fund or the SAO needs to sign loan contracts with each individual borrowing household. This is time consuming. At the initial stage, while the scale of such loans is small, this may be manageable. However, as the number of such loans grows, as is envisaged with the operationalization of the Fund, it is important that more condominium/ homeowner associations get established, so that they can sign contracts and loan obligations on behalf of the residents, with an SAO or directly with the Fund. The Law on Housing Relations has taken positive steps in this direction. The government and the HCS Fund need to take further proactive measures though to encourage residents of apartment buildings to organize into formal, registered HOAs, preferably one HOA per building. International experience shows that homeowners need considerable assistance in 19
The wealthy residents are not relevant here since, one, they are a minority, and two, the assumption is that they can afford to pay for these improvements. 32
forming and operating their HOAs. Even though a HOA may hire professional managers, the apartment owners need to know the basics of how HOAs work, and their rights and responsibilities as members of an association. Mechanism to stimulate savings by residents for housing renovations should also be established. One HOA per building helps connect resident payments to services. A legacy of Soviet times is that older buildings tend to have a mix of occupants of different income levels, corresponding to different willingness and ability to pay for capital repairs of their common areas. Since two-thirds of the residents are required to vote in favor of major capital improvements, an HOA for each building is more likely to reach such agreement. It is, however, worth noting here again that there is a proposal currently on the table to increase this voting requirement from two-thirds majority to three-fourths. The reason behind this proposal is unclear, but it should be noted that this will make it more difficult to get agreement to proceed. The more commonly used norm internationally is the simple majority, i.e. at least 51% of the vote is required. Homeowners need to have a choice on who to engage for their renovation projects. Their main options would be to get things done: (a) by themselves through their HOA; (b) through a public sector SAO; or (c) through a private building management company. SAOs will have a very important role to play in the sector for quite some time, as the main intermediary for homeowners for advice, project preparation, and access to loans. As the private building management sector grows, the local government’s engagement in the sector should decline. Government and the HCS Fund should actively support both start-ups and established firms in the sector to develop, creating a vibrant competitive building management market over time. Measures could range from enhancement of vocational training and licensing, to facilitating finance for general operations. The HCS Fund should lend to well-established building management companies on the same terms as the lending to SAOs, albeit with different loan security arrangements (assuming that akimats will provide a guarantee for loan repayments of their SAOs). The legal right to collect monthly fees from the residents can serve as the primary collateral. A common lending practice in a number of other countries is lenders’ legal right to collect monthly fees or special assessments from individual homeowners, with the right to collect being the primary collateral. This practice makes it possible to lend to building management companies or directly to condominium associations and HOAs. A management company may also pledge some of its assets and additional cash flow, as required. Holding the HOA’s right to assess monthly fees as collateral, lenders (e.g. a management company, the HCS Fund itself, or in the future a commercial bank) can put in place a mechanism to collect the monthly condo fees to pay back a loan in case a HOA would default. While individual apartment owners may fail to meet their obligations, the HOA would as a legal entity, and the borrower, still be responsible for the total loan repayment though. (v) Utility meters: A key component of “modernization” One of the targets under the Ak Bulak program is 100% installation of water meters in urban areas by 2014. This intermediate target indicator has not been reached.20 At the time of
Interviews with stakeholders, including the Center for Modernization of HCS, Association “Su Arnasy,” and water utilities in Astana and Karaganda 20
33
adoption of the Ak Bulak program in 2011, the reported metering level in urban areas of Kazakhstan was 76%.21 Interviews with utility managers suggested that bridging the gap to reach the goal of 100% metered household consumption will require a change in legislation. According to the current law, Kazakh citizens have two options of paying for water: (1) based on the actual consumption measured by a meter; or (2) based on an assumed consumption of 3m3/ person/ month, each, for hot and cold water, i.e. 6m3/ person/ month.22 The latter is three times the old norm (1+1=2m3/ person/ month, for hot and cold water), and was put in place to serve as an incentive for people to install water meters. However, some akimats and utility companies23 reported that, in some cases, homeowners are still not interested in installing water meters because they will end up paying more for the water under a metered system. This may, however, be more prevalent in cases where people use water for gardening as well, and drinking water and ‘technical’ water are not distinguished, and less likely to be the case in multifamily dwellings. Regardless, it shows that at least for some customers, the current estimate of water consumption (3m3+3m3) is still too low to serve as disincentive to switch to the metered payment system. Therefore, any change in the law will either need to increase the estimate or eliminate the non-metered option altogether. In the case of heating, however, which is considered quite expensive, this differentiated tariff24 creates a strong incentive for homeowners to get meters. Thus, this issue may be more one of ‘perception’ than facts, and could be addressed through information dissemination to the public. (vi) Absence of a centralized sector information and monitoring system At the moment, there is no system in place or institution responsible for collecting utility performance information nation-wide. The national utility association “Su Arnasy” collects some performance data for around 30 utilities that together provide services to more than 50% of population. However, the latest available information collected by the association is from 2010. The lack of an adequate sector information and monitoring system not only makes it difficult to assess the state and performance of the water supply and sanitation sector, it also makes it difficult to measure the effect on the sector of any governmentsponsored programs. Ak Bulak calls for the creation of a water supply and sanitation sector monitoring system that would collect and analyze performance data. However, during stakeholder consultations in preparation of this report, neither the government nor utilities attested to the existence of such a system. (vii)
Conflict between HCS Fund and current channels of “free” budgetary financing Currently all transfers to akimat for water investments are budget transfers under the HCS Program. The HCS Fund, on the other hand, is expected to mainly provide loans – and only to ‘financially viable’ projects. This raises two concerns in the short term: on one hand, it may serve as a disincentive for a water utility/ vodokanal to design projects that are “Ak Bulak” Program 2011-2020 For reference, the water consumption per person in the United Kingdom today, for example, is 4.5m3/person/month. The UN standard for consumption is 120 liters per person per day (~3.6m3/person/ month). 23 Interviews with Housing and Communal Services Departments and Housing Inspectorates of Astana and Karaganda in April 2014. 24 Differentiated tariff: Tariff for unmetered connection may be as much as 3-4 times higher than a metered connection. 21 22
34
financially viable just so that they can secure grants instead of loans, and hence underutilizing the Fund’s potential with a competing (and not necessarily complementary) channel of ‘free’ financing. There need to be some measures to address this distortion in the short term – one option could be to channel the budgetary allocations under the current system (currently flowing through the akimats) through the HCS Fund, as ‘grants’ for those utilities that do not have the capacity to borrow. Limits/ restrictions may be imposed on the number and amount of ‘grants’ that can be accessed by a particular utility, or on the types of projects. In parallel, loans could be given to more creditworthy utilities for “viable” projects.25 As utilities improve their performance and become creditworthy, they may be ‘graduated’ to the loan category for future financing. Accordingly, the grant mechanism can slowly be phased out, and eventually all financing from the Fund can take the form of loans. A similar approach would apply to financing in the housing sector. The current government financing through the SAOs can be rechanneled through the Fund to the SAOs, under the same terms and conditions to homeowners as at present (either zero interest loans, or better still, below-market interest loans with an upfront subsidy, as suggested below). Over time, as demand increases and the Fund’s capacity to handle this market improves, (secured) lending may be envisaged also to non-SAO borrowers, i.e. registered HOAs or condominium associations and licensed building management companies. Rechanneling budgetary funds through the HCS Fund will: (i) streamline the financing support to homeowners and utilities through one single channel rather than through multiple agencies, and (ii) allow single oversight of the financing and its most effective allocation among municipalities. (viii) Zero percent loans for housing; grants for utilities The use of zero interest loans raises some cause for concern. Such low rates may serve as a disincentive and delay the participation of banks and other private entities in the HCS Modernization Program. Instead of zero percent interest loans that have been applied to date, it might be prudent to consider the option to provide an upfront one-time subsidy (partial payment of the renovations) and charge market (or slightly below market) interest on the loans. This will also help transition into a borrowing ‘culture’ that will be necessary for scaled-up capital improvements in the longer term. Similarly, the transition from all grants to all loans for an akimat or a utility company may go through a few stages of part grant-part loan. Financial projections are included in Annex C to illustrate how many years money would remain in a Fund on a revolving basis for continued lending for housing and utilities respectively, using various assumptions on interest rates and levels of grants. (iv) Tariff setting and asset depreciation Full cost recovery by a utility company through tariff revenues means that these revenues are sufficient to not only cover the ongoing expenditures for operations and maintenance, but also annual depreciations of all assets used to provide the service, and any annual debt service 25
A fully viable project will require that the utility company is operating without a deficit, and that its future revenues from tariffs will be able to cover the operations and maintenance, and the annual depreciation of the new assets created by the project. 35
(payment of principal and interest) related to the same. At present, in most municipalities in Kazakhstan, the akimats takes responsibility for managing the construction of major new assets, and upon their completion (and acceptance), hands over the new assets to the utility company (e.g. a Vodokanal) for operations and maintenance. Thereon, the assets are on the balance sheet of the utility company with annual depreciations being applied. It appears that in some akimats, however, new assets are only formally transferred to the utility company over a number of years, and depreciations not being applied fully on the financial statements of the utility company. This may distort the process of tariff setting. With the introduction of government funds being provided to akimats as loans instead of grants through the HCS Fund, the loan obligations may for some time be assumed by the akimat itself. Over time, however, the debt service will need to be reflected in the financial statement of the utility company, to reflect all costs of the service provision. During the period that tariff revenues are progressively increased over time, the akimat could provide an annual budget contribution to the utility company. (v) Private sector participation The status of private sector participation in the water supply and sanitation sector in Kazakhstan presents a mixed picture. On one hand, there seems to be strong government encouragement for greater private sector involvement in the sector operations. The Ak Bulak program is a prime example of the government’s commitment to promotion of public-private partnership (PPP) and private sector participation (PSP) schemes in provision of water and sanitation services. On the other hand, the government’s enthusiasm is not matched by the same on the part of utilities management. Box 8 presents Kazakhstan’s mixed PPP/PSP track record to date.
36
. Box 8. PPP/PSP Experience in Kazakhstan The experience of the Water Resources-Marketing LLP, which has been in operation Shymkent for nearly 15 years, presents some positive experiences. The company was established as a municipal water supply company. Its first task was to implement a program to improve efficiency involving the installation of meters both in the housing sector and in organizations and enterprises. As a result, registered metered water consumption was reduced by some 75%. Water supply pipes were repaired, leaks were identified and fixed, the production of polyethylene pipes started—they are widely used nowadays for construction of new pipelines and replacement of old ones. The computer control system for water supply to the city and automatic pressure monitoring were introduced. The water company pays special attention to communication with consumers: meetings with condominiums, incentives to on-time paying consumers, provision of benefits for veterans, sponsor aid, and information about the company operations became customary for residents. “Water Resources—Marketing” LLP is now considering opportunities of securing a long-term loan to implement its investment program. In December 1999, Vivendi Water (now Veolia Water) of France signed a letter of intent with the Almaty city government for a 30-year drinking water provision and water purification contract. Investment was expected to reach USD 100 million over the life of the project. Almaty Sui, Vivendi Water’s first project in Kazakhstan, was aimed at improving water supply and sanitation services to the city of Almaty and was the first outsourcing project in the Commonwealth of Independent States (CIS). It was expected that the project would provide for a major reconstruction program financed through low-cost loans, and a transfer of Vivendi Water’s technologies and know-how to the Almaty water company. Vivendi (Veolia) Water also had a cooperation agreement with KazTransOil, which was aimed at improving the quality and reliability and increasing the operational, financial and economic efficiency of the water supply infrastructure in the Caspian Sea area. At about the same time, Vivendi and its sister company SOGEA were also contracted to provide drinking water infrastructure in Astana. In April 2002, Foreign Direct Investment magazine reported, “Vivendi […] will be cutting its staff of five expatriates as prospects for a contract dim.” Since 2003, there has been no news on the progress of the case, or on any other Vivendi (Veolia) contracts in the country. The transfer of the water supply company in Ust-Kamenogorsk for trust management illustrates some further difficulties associated with public-private partnerships. In 2004, the public enterprise “Oskemen-Vodokanal” was transferred to trust management for 25 years to Almaty company IR-Group LLP. During the tendering process, the rules of transfer of water supply facilities for lease and trust management were violated. Government expectations about enhanced efficiency and reliability of Ust-Kamenogorsk water supply and sewerage networks were not met. In 2007, the regional administration terminated the contract with IR-Group LLP and “Oskemen-Vodokanal” was returned to public management. KZT 10 million (EUR 26,000) were allocated from the budget to repay the company’s debt for electric power that amounted to KZT 28 million (EUR 129,000). In addition to the debt, the company had almost 100% depreciation of the main assets, high personnel turnover and understaffing, and low salaries. Sources: - OECD/EAP Task Force (2010c), “Private Sector Participation in Water Supply and Sanitation in Eastern Europe, Caucasus, and Central Asia,” Status Paper, OECD, Almaty, October 2010. - Water Market Europe: Opportunities in EU Accession, the Framework Directive & the CIS. August 2005: 371
37
IV.
INTERNATIONAL EXPERIENCE
Annex B provides international experience in lending to municipalities and municipal utility companies, in particular when done through the use of a Municipal Development Fund (MDF). It also describes financing approaches to HOAs or their representatives for renovations of common areas of multifamily buildings, particularly in Eastern European countries. Some lessons learned of particular relevance to Kazakhstan are outlined below. (i) Municipal Development Funds (MDF) The lessons described below from MDFs in various countries are primarily drawn from studies carried out by or on behalf of the World Bank (WB).26 Some of the studies focused on such WB-financed programs, while some reviewed Funds with either domestic or international funding. These tend mostly to be Funds that lend to local governments themselves, but the same principles and lessons would apply to direct lending to municipal utility companies. This section include lessons which may apply to Kazakhstan both immediately, as well as medium and longer term after further advances in the sector, in order to facilitate an understanding of the various aspects involved as the HCS program evolves over time. MDFs are parastatal institutions that usually start as an intergovernmental approach to municipal credit supply, but then evolve to become financial intermediaries with other sources of funds as well. They provide credit to local governments and to other institutions investing in local infrastructure, and are typically envisioned as transitional instruments, intended to prepare the way for self-sustaining municipal credit systems that can tap domestic and international capital markets for financing. Many MDFs allocate loan capital to local government investment projects following procedures very similar to those that the World Bank and regional development banks employ in international lending, reaching far more local authorities and smaller investment projects than it would be efficient for international institutions to try to finance directly. One type of MDF, currently common in the developing world, operates primarily as a substitute for government capital grants to local authorities. These programs supply capital through MDFs at below-market rates, often combining subsidized loans with grants. Typically MDFs of this type have a monopoly in lending to the municipal sector, impose standards of project preparation on localities, and incorporate central or regional government investment priorities in project selection. This kind of MDFs have normally been introduced in environments where there is virtually no private lending to local governments and where public authorities believe that private credit markets cannot be developed in the short and medium term. Credit Local de France and several other MDFs in Western Europe have evolved from such lending institutions to currently competing with private sector lenders. Another type of MDF is intended to serve as a bridge to the private credit market. They help prepare the municipal and financial sectors for private lending to municipalities. MDFs of this type lend at market interest rates, do not lend directly to municipalities but allocate capital through commercial banks, require that the private lenders assume the credit risk of the municipal loans, and help establish a track record of municipal creditworthiness. One such market-oriented MDF was developed in the Czech Republic. It borrows funds from 26
“Improving Municipal Management for Cities to Succeed - An IEG Special Study”, The World Bank, 2009. 38
abroad with a national government guarantee, and on-lends the funds to domestic commercial banks, which in turn lends to municipalities. The municipalities do all project selection and preparation. The commercial banks perform all credit analysis and retain all repayment (credit) risk. The MDF merely confirms the creditworthiness of the various commercial banks to which it lends. The first type of MDF may evolve to the second type rather than end up competing with commercial banks. This may be a more appropriate evolution in Kazakhstan. In summary, some of the key lessons learned from MDFs include: - Funds serving many municipalities – both large and small – have had better outcomes than infrastructure projects without support of a Fund serving just a few municipalities; - Many Funds have had strong impact on its municipal clients, helping them improve their own-source revenues (through tariff justification, improved collection, etc.), financial management, information systems, and procurement; - Weaker results have been common in monitoring and evaluation (M&E) systems, operations and maintenance (O&M), and attracting private finance for the services; - M&E tends to work well as part of day-to-day management of project implementation, and when focus is on the project results (outcomes) as opposed to administrative matters; and - Many municipalities have lacked sufficient experience in contract management. The following factors have contributed to good performance of MDFs: - A share of project funds (for all borrowers) should be allocated to technical assistance (TA) and institutional development - Municipalities/utility companies that fail to meet the Fund’s performance criteria or agreed targets (e.g. for collection of user fees) should not be entitled to project support; - Municipalities that do not qualify can become eligible for funding later if their performance improve; e.g. after technical assistance (TA) arranged by the Fund; and - Strong procurement management and attention to O&M is critical. The access to investment funds by municipalities often need to be complemented by fiscal reform and decentralization. It is, for example, important to ensure a sound intergovernmental finance system with appropriate incentives for municipalities. Technical support, either through national government specialists or through consultants, is important for program effectiveness - for example, to assist the utilities in investment planning, cost-benefit or cost-effectiveness analysis to select the best investments (and the best technical options), cost recovery mechanisms, and enforcement capacity for collection of user charges. Full cost recovery of local public services is often difficult to achieve sometimes due to a lack of political commitment - but can be achieved through stages and combined with targeted support for low-income users. An enabling environment for lending by commercial banks for municipal infrastructure needs to be created over time. For private-sector banks to be willing to lend to the municipal/utility sector at their own risk, and with own funds, several basic pre-conditions need to be met. For example: 39
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Municipalities/utilities must have stable sources of revenue. Lenders have to be able to make their own credit decisions, based upon their analysis of risks and returns, without government interference. Inflation must have moderated to make at least medium-term lending possible.
Non-payment of debt service to a MDF by a borrower has to carry significant penalty. If it does not, this makes it more difficult for market-based lending to emerge. The creditworthiness of municipalities can however be enhanced, preventing or reducing poor repayment records. Many countries have guidelines for borrowing ceilings, based on a municipality’s/utility’s capacity to service debt. For example, limit total debt service to 15 percent of a municipality’s or a utility company’s revenues (usually defined to exclude onetime or discretionary grants from higher level governments). In France, the credit assessment procedure is instead to project a municipality’s/utility’s budget surplus from existing operations (“management surplus”) and limit new debt to what can be serviced by this surplus.27 An effective form of municipal loan guarantee has been the intercept provision. This gives the lender first claim on intergovernmental transfers otherwise due to the municipality/utility company.28 In countries where this is allowed, arrear rates have been very low. Many Funds have incorporated intercept requirements in their loan authorization procedures. (Note: A legal/regulatory change may be required for this to be applied in Kazakhstan.) In Central and Eastern Europe, it has been common to collateralize municipal/utility company loans with real property owned by the municipal government or the municipal utility company. Another approach to help reduce the credit risk of a Fund is to sign a performance contract with each borrower. This emphasizes the commitment by the borrower and further formalizes the relationship between the lender and the borrower. Such contract would include specific time-bound development targets (performance criteria) for a utility company to achieve, such as for example: (i) reduced system losses (in water and heating systems); (ii) revenue increase through tariff restructuring; and (iii) improved collection rates. For a MDF itself to be creditworthy, and be able to access non-government funds, the underlying income stream of the Fund has to be strong, i.e. a stable, predictable income stream as collateral for their borrowing. Otherwise a government guarantee will be needed to make a Fund creditworthy. In designing a municipal/utility credit system and a Fund, it must be kept in mind that the objective is overall growth of the credit supply and overall improvement in local investment efficiency. The process of introducing the domestic commercial banking sector to the utilities 27
i.e. projecting the current revenues from transfers, taxes/ fees, and then subtracting the projected expenditures for recurrent operations, service on existing debt, and capital investments financed from recurrent revenues. The difference is the “management surplus”. Borrowing is usually permitted up to at least 75% of this amount. 28 Intercepts of this kind are found in a number of Western countries. The majority of states in the United States have intercept laws, which allow distressed city governments or utilities to assign to lenders first claim on state aid to the borrower, if the municipality or utility company would not be current in its debt payments. 40
as clients may start by one or more banks simply handling the disbursement and payment collection for a service fee on behalf of the MDF, and later be contracted to do the credit analysis for a fee. A Fund should always be judged by its impact on the development of the aggregate municipal credit system. Two advanced examples of MDFs are FINDETER in Colombia, and the Tamil Nadu Urban Development Fund (TNUDF) in India. These are described in Annex B. (ii) Housing Renovations In most countries, HOAs are empowered to make important decisions regarding the capital improvements of their buildings. Membership in a building’s HOA should be mandatory for all apartment owners and the HOAs should ideally be formed on a building-by-building basis. A joint association by a few buildings may make sense though, particularly in case of smaller buildings (e.g. 20 apartments or less), in order to achieve some economies of scale in their building administration and/or attract private maintenance and management companies. Assistance to homeowners required. International experience suggests that it is unrealistic to assume that groups of homeowners with little or no prior experience can immediately get the HOA up and running on their own. Some will undoubtedly be able; others may require advice, training, and basic information about running an association.29 SAOs and building management companies in Kazakhstan will have an important role in this regard. Individual apartment owners need to know the basics of how a HOA works, particularly their rights and responsibilities as members of such an association. Apartment owners have the right to fair and honest treatment by their elected representatives, prudent use of their monthly fees and assessments, and full access to budget information and records of expenditures. They have the responsibility to vote and participate in elections and decisions regarding maintenance and renovation of the buildings, and a responsibility to pay monthly fees and assessments on time. Collateral for loans. The ability to attract financing ultimately depends upon how well the affairs of a building are managed, and the power to enforce the collection of monthly fees from the individual apartment owners. The ability to collect a future stream of payments is the most important form of collateral that can be offered to a lender. HOAs should be allowed to do renovations in stages if they wish to ensure that they can afford to pay for the renovations. For example, first install heat regulator and balancing, energy efficient lighting, repair/improve front doors and windows,30 and possibly later undertake larger investments once they consider that their financial situation allow. 29
Much information material has already been produced in Kazakhstan and distributed by Akimats to homeowners and HOAs/KSKs. Based on experience from Eastern Europe, the following needs to be included in basic orientation for homeowners: (i) how to form and register an HOA (if not already done); (ii) selfmanagement vs. professional management; (iii) basic condominium documents – charter, by-laws, rules and regulations, amendments; (iv) rights and responsibilities of owners – rules of order, quorums, voting at meetings; (v) relations with management company, commercial tenants, and municipality; (vi) meetings, notices, proxies, minutes, communication of decisions; (vii) contracts – for management, maintenance, other services; (viii) communal services – pricing, metering, controls and conservation; and (ix) budgeting, financials controls, risk management. 30 Windows in apartments are in most countries considered part of the apartment, and not part of a building’s common area. Since repair or replacement of windows often is a prime candidate as energy efficiency improvement, they can still be defined as eligible for funding through a Fund; for example, with the condition that all windows in the building will be repaired or replaced (unless already done by some apartment owners themselves). 41
Lower heating bills – A key incentive for renovations. Energy efficiency and savings can be a catalyst for forming HOAs and undertake building renovations – if the incentives are right. It is critical that residents can realize financial benefits of reduced consumption by renovating their buildings, i.e. get lower heating bills (than they otherwise would have paid). As Kazakhstan continues to move away from a system of flat tariffs to a system of differentiated tariffs that would reflect the actual volume of consumption of the respective communal service (water, heating, etc.),31 there will be greater financial incentive for building renovations. Building Management Companies (BMC). It is also hard to conceive of long-term success in the sector without development of an industry of private building management and maintenance companies, providing homeowners with a choice of who they wish to engage for their housing management and renovations. Energy Savings Companies (ESCO). ESCOs have been used in many countries as retrofit contractors: ESCOs provide the benefit of energy savings guarantees for projects. The advantage of ESCOs is that no upfront money is required from the HOA. The ESCO is paid out of energy savings (lower heating bills), and once the ESCOs are paid, the HOA gets the benefits of the savings. Ideally, as is the case in Poland, Hungary and elsewhere, a small industry of ESCOs would emerge from which HOAs can select. The ESCO organizes the process and cooperates with HOAs, authorities, and contractors, including helping low income residents obtain assistance. The HCS Fund should make every effort to promote the development of an industry of small ESCO enterprises, including provide financing if permitted by Kazakhstan law. Eventually, as Kazakhstan follows the path of countries in Eastern Europe, such financing will come from banks. (iii) Municipal Water Sector - Comparison with International Practice This section summarizes international practices of particular relevance to the municipal water sector in Kazakhstan. International application of municipal development funds (MDF), for this and other sectors, is included in Annex 2. Standards and Regulations. Most countries have a central government agency responsible for setting sector policies and water quality standards, and maintaining a national-level monitoring and evaluation (M&E) system which is updated periodically (at least annually). While MoRD is the ministry overseeing the water sector at present in Kazakhstan, most monitoring data appears to be collected by the Association of Water Utilities. Since water supply and wastewater management are natural monopolies, the government, on the one hand, needs to regulate decisions on tariffs (user charges) and, on the other, the water utility companies need a reasonably predictable framework based on which to do thier financial planning and carry out their business. Many countries have found it advantageous to have a fully independent regulator to address requests for tariff increases from water utility companies based purely on technical and financial merits. Predefined criteria, financial ratios, and performance achievements should drive tariff revisions rather than being influenced by short-term political considerations that can end up making utilities financially unstable. The
31
Modernization of Housing and Communal Services Program 2011-2020 42
current Kazakh arrangements with the National Agency for Natural Monopolies (AREM) being focused on tariff questions is a step in this direction. Regarding service quality, basic standards applied internationally are commonly the provision of 24/7service, and 100% water metering. The aim is often to achieve water losses of less than 20%,32 and wastewater clogs of a maximum of 2-3 per km of network. Management of Municipal Services. The water companies (Vodokanals) in the 20 largest cities in Kazakhstan operate as municipal corporations; 100% are owned by the respective city akimat, with two exceptions33. They are “operating companies”, with the akimats taking responsibility for managing the planning and construction of major new assets, assuming some of the related debt, and upon construction completion (and acceptance) hands over the new assets to the Vodokanal.34 With the current tariffs the own investment programs by Vodokanals are very limited or non-existent. Internationally, a fully established public sector water utility company is characterized by the following:35 - It is responsible for managing all aspects of the service provision (except deciding on tariffs); it can still contract out some functions, for example the collection of user charges. - It is managerially and financially autonomous. This means: o All management decisions are taken by its Board of Directors. The municipality (the owner) exerts its influence through its representatives on the Board. o Financially, its revenues (mostly from user charges) are sufficient to cover all its expenditures, including depreciation of its assets and debt service on any loans taken for capital investments in the sector (and possible short-term loans as working capital), i.e. full cost recovery of the service provision.36 - Periodically it undertakes detailed demand studies to guide its planning and adjustment of services. - It submits requests for tariff adjustments to an independent regulator, as required, with supporting justification (e.g. based on operational efficiency improvements to date, demand projections, inflation projections and general corporate financial projections). A first target for a Vodokanal would be to cover the operating and maintenance (O&M) costs through efficiency improvements and tariff increases. Financing of new investments would likely need to come from government funds, as grants (transfers) or loans, for the foreseeable future.
32
Defined as the difference between the water leaving a water plant and the volume reaching consumers (and thereby being billable). 33 The water company in Shymkent has majority private ownership, and 49% of the Vodokanal in Karaganda is owned by a private firm. 34 At present, there is no financial mechanism that may channel national budget funds directly to the Vodokanals, only through the Akimat. Investment planning, and all contracting and works under these transfers - called Earmarked Transfers for Water and Wastewater - are conducted by Akimat with limited involvement of the water companies. The new or rehabilitated assets are then transferred onto the books of the Vodokanal. 35 Changing some of these practices may require some legal and regulatory change in Kazakhstan. 36 Wastewater management tends to have significant externalities, i.e. the beneficiaries are not only the people with sewerage collection, but the community at large through environmental improvement. Therefore, a government subsidy element for the wastewater management may be justified for a much longer period of time. 43
Although achieving full cost recovery of the water services in Kazakhstan will take some time (due to affordability, significant investment needs, etc.), it is still possible for the municipalities to reflect all costs for the sector on the financial statements of their Vodokanal, and provide an annual budget contribution to the company to cover its deficits. This would not only facilitate monitoring of the full costs of the service provision, but also facilitate attracting private sector interest in the future. These transfer decisions are made as part of the annual budget cycle, complicating investment planning and contracting; larger investments may need more than one construction season to implement. Another “bottleneck” appears to be the capacity to prepare projects ready for implementation and financing, with full feasibility studies, implementation preparation (e.g. initial tender documents). Investment Attractiveness. Increasing the investment attractiveness in the municipal water sector and stimulating innovative technologies relates closely to the institutional, financial and regulatory matters mentioned above. For a private investor, the predictability of the revenue stream expected by the utility company is critical. Therefore, an independent regulator, applying transparent rules for tariff decisions, significantly reduces the uncertainty for an investor. Private partners should primarily be attracted for three reasons, in the following order of priority: (i) To get particularly experienced water sector management expertise; (ii) To get access to modern technology, and related experience; and (iii) To get additional funding for the needed capital investments. If the main purpose for seeking private sector engagement is the provision of funding for capital investments, loans from the domestic banking sector should be sought first. If a water utility is in a position to seriously attract particularly foreign infrastructure management firms, the utility will likely also be able to obtain long term loans from the banking sector (albeit possibly with some credit enhancements in the form of guarantees).37 Private sector participation may take the contractual form of a Service Contract, a Management Contract, a Lease, a Concession (or transfer-operate-transfer contract), or full Privatization of the company and its assets. In each case, the contract needs to include the duration of the contract and specification of the responsibility for asset ownership, capital investment, O&M, tariff collection, and the commercial risk. Requirements for the private company to finance new capital investments usually apply only to a Concession or full Privatization. Even in the case of full privatization, the government retains the right to agree on the tariffs due to the monopoly character of the service. Measures of State Support. As mentioned above, as long as a Vodokanal is running annual deficits, akimat will need to provide budget support, and arrange financing for new investments through government budget funds.38 Some countries allocate such funds as grant 37
If an infrastructure management firm will provide financing for significant capital investments, they will likely need to do this by borrowing themselves (from a domestic or international bank). 38 At present, transfer decisions are made as part of the annual budget cycle, complicating investment planning and contracting for the Akimats; larger investments may need more than one construction season to implement. A “bottleneck” at the local level appears to be the capacity to prepare projects ready for implementation and financing, with full feasibility studies, and implementation preparations (e.g. initial tender documents). 44
or long-term preferential loans depending on the development stage and financial strength of the region, the geographical area (applied in China). Alternatively, this can be done city-bycity. Important is that this is part of a broader program of incentives and support to get a city and utility company to over time qualify for a loan from the government (see IV(ii) above). The state support in this regard can be through grants for training programs and technical assistance for project feasibility studies, advisory service for project design, investment and financial planning, etc.; either upon request or as condition for the investment funding (both approaches are common in MDFs internationally). Allocation of capital investment funding among local governments is in some countries made dependent on: (i) the performance on sector reforms that are promoted by the government; (ii) the financial improvements by the city or utility company; and/or (iii) the proportion of local funds provided for an investment. Sometimes, this takes the form of a Performance Contract with specific time-bound targets. In the water sector, performance criteria may include: (i) reduced system losses (non-accounted for water); (ii) revenue increase through tariff increase or restructuring; and (iii) improved collection rates. Some countries provide incentives to local governments and their utility companies for particular types of local investments, for example energy efficiency improvements, supporting broader national objectives (common in Europe). To encourage metropolitan-scale planning and development, a national government may define as a pre-requisite for government budget funding, that the local governments in the agglomeration presents a regional plan for its water supply and wastewater management (applied in the United States). Borrowing by a local government or its utility company from domestic banks can be supported, as required, by the national government as follows. Such support to a particular local government usually depends on its financial situation at the time though (its credit rating and borrowing capacity) and related prospects,39 and may include the following: - Provision of a partial credit risk guarantee from the government - A Guarantee Fund can be established to support local borrowing - Allow a local government to pledge its future transfer revenues as guarantee for a loan (interception of the transfers by the lender) - Support through capitalization of an MDF (See Annex B) One version of the MDF concept is for government to allocate a portion of the tax revenues from local governments to a fund for redistribution among investment projects (applied in Turkey with a commercial bank as fund manager). In the EU, the European Regional Development Fund (ERDF) has for many years provided grant-funding of upto 85% of eligible expenditure of major water and wastewater projects. The level of funding depends on forecasted revenues generated by a project. In the United States, the Federal government moved in the 1990s from a municipal grant program for water supply and pollution control, to a “capitalization grant program”, granting funds to the states to make loans to municipalities, with a condition that this would be managed in a sustainable way. Several states created a legal structure to leverage the Federal capitalization grant with own funds and loans from commercial banks. These State Revolving 39
Most of the Vodokanals in Kazakhstan have already accumulated significant debt. 45
Funds (SRF) use federal capitalization grants and the state contributions as security for borrowing from banks. The SRF makes loans to water companies, with their repayment obligations secured by the user fees and/or a municipal guarantee (supported by the municipal bond issues, pledge of tax revenues, or other security). This credit support mechanism has made it possible for these SRFs to borrow at favorable rates, to subsidize the interest rate available to water projects, to make interest free loans to those deemed worthy of such support, and still create a sustainable fund for future projects.
46
V.
RECOMMENDATIONS FOR OPERATIONALIZING THE HCS FUND
The HCS Fund is a vehicle for the government: (a) to respond to demand from private homeowners (and their representatives) for housing renovation funds; and (b) to channel budget funds on primarily credit basis for capital investments in municipal public utility companies. Thus, in the short and medium term, it is expected that state funding to the HCS Fund will continue - until its financing needs can be fully met by private funding sources and entities (e.g. domestic banks; infrastructure management firms; etc.). Regarding (b), this report provides most details related to the water sector, although this will not be the only utility sector that the Fund will support in the future. Figure 3 is a simplified illustration of the HCS Fund reflecting a proposed phased expansion of its product offerings over time. The numbers 1, 2, and 3 indicate the phases over time. Figure 3: Proposed Structure for the HCS Fund
State Budget MoRD: HCS Modernization Program HCS FUND
In the future, as the utilities become more efficient, they may be able to access commercial loans. The Fund can accelerate this by offering partial loan guarantees or credit enhancement facilities.
C
service
LOAN (with Akimat guarantee)
1
UTILITIES
SAO
C
Subcontractor
Contractor
SC
service
CONSUMERS
CONSUMERS
HOMEOWNERS
Initiate lending to creditworthy Akimats/ utility companies, and over the course of the next 3-5 years as more utilities become creditworthy, increase the loan financing.
Continue the grant mechanism currently provided to Akimats/ utility companies through state transfers, to non-creditworthy Akimats/ utility companies, as required.
Re-channel all funding currently going to Akimats/ SAOs through the Fund.
47
LOAN (collateralized by future cash flow)
Condo Assoc. / KSK, Mgmt. Companies
service
Channel all such state funds through the Fund (not directly to Akimats as is currently the case). Reduce the grant funding over time as utilities strengthen their operations and qualify for loans, responding to related incentives.
2
SAOs will continue to function as General Contractors for building improvements funded by these loans. SAOs will repay their loans to the Fund, i.e. the revolving element of the funds will be managed centrally, facilitating meeting demand across the country.
Subcontractor
SC
service
HOMEOWNERS Promote the establishment of licensed Building Management Companies. Support and facilitate the formation of homeowners/condomi nium associations (including their technical capacity to manage their buildings). As more HOAs and licensed management companies get established, promote lending directly to them from the Fund , secured by their future cash flow.
Loan Repayment
Contractor
GRANT
Loan Repayment
1
(with Akimat guarantee)
UTILITIES User fees
UTILITIES
LOAN
Loan Repayment
commercial loans)
2
Housing Loan Repayment
LOAN GUARANTEE (for
User fees
3
Loan Repayment
Utilities/Communal Services
Recommendations for the evolution of the Fund are presented below. (i) Entry of new financial contributors over time The HCS Program design and the related HCS Fund need to facilitate entry of new financial contributors over time, in the housing renovation sector as well as in the water sector. HOUSING Short-term. For the immediate future, 100% funding of housing renovations with government budget funds through zero-interest loans (or low interest loans plus a grant component), is expected to be required in order to generate a reasonable early volume of renovations in at least each major city. Reaching such volume is important, since residents tend to trust experience and “word-of-mouth” opinions from completed projects more than general government information and plans. Since short-term government budget allocations will not be sufficient to meet the existing demand, homeowners should be encouraged to, in the meantime, collect monthly savings, e.g. in a condo/ HOA account, to be used as partial payment for renovation costs once their loan-based project starts. While “first come-first served” should continue to be the prime criteria for which buildings get access to the budget funds, the existence of accumulated savings by the residents for renovation purpose could be given some level of priority. Medium term. Over time though, the funding sources should be widened progressively, for example, as follows: - Some (e.g. 5-10%) up-front contribution by the residents to the renovation costs.40 - Low interest (subsidized) loans, e.g. starting at 4%, and increasing over time to at least half (currently about 8%) of the market rate for long term loans in the domestic banking system (currently about 16%). - Promote Energy Services Companies (ESCO), who may mobilize funds through their own sources (e.g. local bank loans) for renovation costs, which they would recover by intercepting the reductions on the heating bills of the residents over some years. - Lending by domestic banks to particularly well established and financially strong Building Management Companies (BMC) for on-lending of the funds to HOAs (likely at different rates than by the government funds though). - Oblast and City Akimats may wish to co-finance some housing and utility sector improvements with their budget funds. - Consider requesting long term loans from bilateral or multi-lateral international financial institutions (IFI) to provide low cost external funds for the program (Note: with currency risk though.) The first two measures would make the initial budget allocations available for more buildings and last longer through the revolving element of the housing renovation program. It will be important for the government and the HCS Fund to clearly inform the public what such 40
This includes preparatory expenses such as condominium registration, technical audit and needs assessments, project design and associated expertise, which amounted to about 3% of total cost of the investments in 2013, and is estimated to be 5% in 2014, and about 7% in 2015. (Source: "Model on interaction between HCS subjects", HCS Centre of Construction and HCS Agency, 2012) 48
anticipated medium term scenario will be, in order to: (a) create incentives for early action by residents; and (b) prevent future complaints if the changes to less favorable terms would come as surprises to them. Longer term. - The HCS Fund could: (a) provide government funds to the participating banks, for them to manage the on-lending together with their own funds, and over time assume more credit risk as above; or (b) provide a partial credit risk guarantee (supported by a “guarantee fund” established by the government), declining over time, with the participating banks lending with their own funds only. - Alternatively, domestic bank funds provided to the HCS Fund at market rates (partly collateralized by a “guarantee fund” established by the government), with on-lending by the HCS Fund to HOAs (directly or through SAOs or BMCs) at below market rates, and risk sharing of the on-lending with the participating banks. For example, initially without any credit risk taken by the banks (the banks would only provide a loan to the HCS Fund). Later, for example, progressively on-lending by risk sharing 20-80, 50-50, and 8020. - Lending by domestic banks to BMCs for on-lending to HOAs (this could also be supported by the HCS Fund as per (a) or (b) above for some time). - Eventually, lending by domestic banks to HOAs directly as well without involvement of the HCS Fund or the government. - Continue promoting development of the BMC and Energy Services Company (ESCO) sectors. WATER Short- and Medium term. The akimats of the 25 or so larger cities (the anticipated early focus of the HCS Fund), and their Vodokanals (operating companies), will likely depend on government budget funds for quite some time, due to the current low tariffs, incomplete water metering, high investment needs, and limited autonomy of the publicly owned utilities – all of which are likely to deter potential private sector partners. According to the PPP Center in Astana, the first tender for private participation in the water sector by the city of Atyrau is not expected to be issued until 2016; the cities of Aktau and Semey may be in the same position shortly afterwards. While a more attractive, enabling environment emerges, after efficiency improvements, revenue enhancements, etc. some opportunities may exist though for involvement of domestic private partners.41 In order to accelerate both priority investments and institutional and managerial development, the Government may, depending on overall country priorities, seek loans from multi-lateral development banks. With such loans usually comes exposure to good international references and assistance with the development of policies, practices and capacity for the sector. Longer term. Once a municipal water utility is not only corporatized (as most are already today in the country), but also reasonably institutionally (organizationally) and financially 41
As example, the Karaganda Vodokanal is 49% owned by a local private firm. For a utility company in Kazakhstan to receive state budget funds, the public sector must have majority ownership of the company. The Karaganda water company has been able to make significant improvements in recent years: within the10 year period 2003-2013 the utility replaced 25% of its water pipes, and during 2013-2015 an additional 25% is expected to be replaced. 49
independent, although still owned by the akimat, it may pursue one or both of the following paths: - Seek long term loans from the domestic capital markets - Seek interest and engagement by domestic or foreign infrastructure management firms; for example, for management contracts, concessions, etc. (ii) Expanding the beneficiary pool The pool of beneficiaries of the HCS Fund should grow over time. Short-term. Heating meter program, and initial housing renovation activity. The HCS Fund is expected to get capitalized and start its activities by channeling government funds and oversee a program for heating meter installations in larger urban areas. The Fund will on-lend budget funds to municipal district heating companies under terms and conditions approved by the Government. Repayments will form a revolving fund for the same purpose, until the funds eventually “run out” (since the lending is at a rate below the inflation rate in the country). In parallel, the recommendation here is that the Fund gets mandated to manage the allocation of the government funds for housing renovations going forward, to be on-lent by them to either SAOs, private building management companies, or to Condominium Associations (HOAs) directly, based on the respective demand for loans from each of these channels. It is important to get the Fund engaged in housing renovation, in a limited way, to start gaining experience from the sector, and more importantly, offer alternative channels for homeowners to the main SAO-based mechanism. Although the vast majority of homeowners will probably wish to go through the akimat-owned SAO(s) for quite some time, in the near future: (a) there should not be a requirement for a private, licensed building management company (e.g. such as the Astana Kyzmet) to go through a SAO in order to support a HOA, and get access to government funding on their behalf for renovations; or (b) in case a HOA is well organized and competent in managing its own renovations, they should be able to apply for and get a loan directly from the Fund, without any intermediary entity. Medium term. Water and heating utility programs, and continued housing renovation activity. The logical progression for the Fund would be to continue to support priority investments in the heating sector with credits (i.e. through akimats or their District Heating Companies directly) building on established relationships from the mentioned heating meter program. The utility arm of the Fund should, however, as soon as possible also start channeling government funding in the urban water/wastewater sector (Ak Bulak funds and any other budget funds for the sector) to the akimats (or to their Vodokanals directly if there are cases in the country where these companies are in charge of all new investments in the sector, not only smaller investments funded by their own (mostly tariff) revenues). As already mentioned above, this should include both credit for financially “viable” projects, and grant funding (or combination of grant and credit) in situations of particularly weak water utilities in a city. This distinction would need to be made through pre-defined criteria, and in a way which does not create a dis-incentive for akimats/ utility companies to become “creditworthy” from the perspective of the Government. There should rather be a strong incentive for an akimat and their utility company to qualify for a loan. Such incentives could, for example, be a combination of: 50
-
-
Significantly more funding being available under the credit program than the grant program; In the grant program, projects could be selected with some elements of “competition” based on: (i) a project’s financial strength; (ii) the commitment by the recipient akimat/Vodokanal to undertake certain sector reforms; and (iii) their performance in recent years on such reforms (e.g. related to tariffs, leakage, metering, utility management, etc.); and The credit program being applied on a “first come-first served” basis only (subject to eligibility and availability of funds).
The rationale for the Fund managing both loan and grant funding is that a coherent set of criteria need to exist for allocation of grants/credit, and that efforts need to be taken to support particularly weak grant-recipient City Akimats and Vodokanals to become “creditworthy” from the perspective of the Government. One of the functions of the Fund would be to arrange and pay for such technical support, aimed at an effective overall development program with the government funds. The beneficiaries under the housing renovation arm of the Fund would remain the same. It would be assumed though that the activities would expand in line with the development of a private building management sector in the country; not only encouraged by the Fund, but actively supported through information dissemination, etc., to the extent possible. Longer term: Priority municipal infrastructure (and continued housing renovation activity). Once the Fund has proved itself to be an effective mechanism for the government in these sectors, its scope should be expanded, possibly to include funding of any infrastructure development that local governments (City Akimat) are responsible for. The logical progression beyond the heating and water sectors would first be to support gas distribution and solid waste management. At such stage, the Fund should only respond to requests for credits based on a comprehensive prioritized investment plan by the City. Based on such plan, the Fund could in due course offer funding for non-revenue earning investments as well, such as local roads, street lighting, and public space (e.g. riverside development, parks). The borrower (the beneficiary) would still be the akimat, or any majority owned municipal service company. The beneficiaries under the housing renovation arm of the Fund will remain the same, with all government funding for housing renovations being channeled through the Fund. The SAOs will have fulfilled their important public sector role of having facilitated the creation a vibrant housing renovation market, with more licensed BMCs providing similar support to HOAs as the SAOs. This leads to the next consideration, about what projects would (would not) be eligible. (iii) Revenue generating projects Initial communal projects should be revenue-earning. Housing projects should be based on owner preference, affordability, and guided by government policy. Short- and Medium-term. Taking into consideration the large investment needs in basic infrastructure and the related public services, and the limited financial capacity of the City Akimats and their service/operating companies, eligible projects for the limited government 51
funds should for some time all be revenue-earning public utility projects. I.e. the capital costs of the investments should be possible to recover over time through user charges in order to ensure long term sustainability of the services. It is important to recognize, however, that full cost recovery cannot be expected short-term in any of the mentioned services, but through efficiency improvements in the service provision, coupled with tariff reforms over time, and related social safety provisions, financially independent and sustainable utility services represent the prime long term development objective to which the Fund aim to contribute. This may be achieved faster in some sectors than other. For example, wastewater management tends to have significant externalities, i.e. be beneficial to not only the people directly beneficial of improved sewerage collection, but by the community at large. In such case, a government subsidy element may be justified for a much longer period of time, than for example for drinking water, heating or gas supply, for which the benefit can be directly attributed to the user (consumer) of the service. Within the respective revenue-earning sector, project funding should be subject to a set of eligibility criteria. For example, a project needs to be: (i) prioritized in the city’s overall development plan; (ii) consistent with regional (Oblast) plans; (iii) supported by a comprehensive feasibility study; (iv) represent well justified investment needs (e.g. replacing leaking pipes, extension of networks, improvements to meet government standards, and reducing energy consumption (often the highest cost in water and wastewater operations due to treatment processes and pumping needs); and (v) supported by final beneficiaries (in most cases residents), demonstrated through, for example, public consultations and/or willingness to pay surveys. The feasibility study should include technical and financial feasibility, as well as address social (e.g. land acquisition and resettlement), environmental, and project managerial matters. Local institutional capacity development, including training of staff, is directly related to the capital investments and should be an eligible component of projects funded by the Fund. The allocation and level of funding among applicants (akimats or their service or operating companies) should to some extent also depend on: (i) past project implementation performance; (ii) annual improvement in akimat and sector financials in the city (reflecting fiscal discipline); (iii) preparedness (e.g. institutional capacity to undertake the investments effectively); and (iv) level of counterpart funding provided by the borrower.. The housing renovation projects should be based on what the priorities of the residents are for their building, supported by affordability analysis. However, government could require that a minimum portion (e.g. 50% to 80%) of the investment has an energy saving effect and thereby help the affordability for the residents through lower heating bills, allow larger renovations than otherwise would be the case, and support broader national energy efficiency objectives. Such requirement would be an added justification for the use of government funds. Such renovations should be guided by an “energy audit”, indicating (although not guaranteeing) the expected impact on the heating bill of different measures. The residents may still not choose the renovations with the highest impact though as their first priority (since those may also be subject to the highest investment amount), but rather choose those with the lowest payback periods42, taking both investment amount and the loan terms into
42
Defined as the number of years it will take for a household to pay back a loan with interest by the savings on their heating bill. 52
account. An energy audit should include a ranking of measures in this regard to guide the decisions by the residents. Longer term. Regarding utility investments, as mentioned earlier, longer term the Fund should only respond to requests for credits based on a comprehensive prioritized investment plan by an akimat. i.e. this could also include non-revenue earning investments such as local roads, street lighting, and public space. In addition, with the agreement of the respective responsible Ministry, the HCS Fund may also expand its operations and financing to other public sectors, such as energy efficiency in public buildings (particularly education and health facilities) and in state-owned industrial enterprises. Also, in the short-term, the government may require that a high portion (e.g. 80%) of the investment must have an energy saving effect, this requirement could be lowered over time, allowing people to use more of the government funds for investments such as elevator replacement, renovation of basement, and painting of the building. (iv) Financing criteria Projects should be reviewed against viability criteria and approved on a “first come- first served” basis… The assumption here is that the government will appropriate a certain budget amount to the HCS Fund annually for some time, for the utilities and the housing renovation program respectively. These amounts together with loan repayments to the Fund, will still represent limited government funds to meet increasing demand. This should be communicated to the potential borrowers, creating an incentive for applicants to not delay their credit applications. In case the known demand will substantially exceed the availability of funds for a particular year, the Fund may pre-define a maximum credit amount (ceiling) per akimat and homeowner respectively, in order to ensure that the available funds come to a reasonably broad use, and not allocated to a limited number of large borrowers only. Akimats should publish this as well locally. As long as the known investment needs across the country are very large and urgent - in both utilities and multi-family buildings, it would be appropriate to introduce any other competitive elements in the process; e.g. have a deadline for submission of applications and then select “the best” projects based on, for example, estimated returns on investments. Such approach should only be considered longer term when program funding might be reduced, particularly urgent investments have already been made, etc. UTILITIES For investment in public utilities, the Fund should address credit applications in the order they are received from akimats (or directly from their utility companies). However, some applications may need iterations of adjustments before they can be approved, and may thereby take longer to process than others. The proposed process is included as a table under (vi) below. The Fund need to have some constraining criteria regarding the size of a credit though, based on the financial situation of the respective akimat/ utility company, and their repayment capacity. Sufficient information in this regard will need to be included in the feasibility study accompanying the credit application. The application will also need to demonstrate that: (a) the intended investments represent the highest priority to improve the quality of a particular service (e.g. drinking water supply); and (b) that the technical solution represents the least53
cost solution (and that options has been analyzed, including the implications of “do nothing”). A cost-benefit analysis will in most cases be required. Further details are included in the Operations Manual (OM) attached to this report. HOUSING For housing renovation, the Fund should also address credit applications in the order they are received, from an SAO, a BMC, or directly from a HOA. It is expected that the same “first come – first served” approach will be applied by the SAOs and private BMC, although this is beyond the control of the Fund. The maximum scope of renovations in each case, and thereby the loan amount, will be determined by pre-defined affordability (repayment capacity) criteria. For example, the loan repayment per household should not exceed a certain percentage of household income (e.g. 3%, except for households qualifying for housing allowance). It is anticipated that homeowners in most cases would limit their renovations of their common areas to a lesser amount anyway. As mentioned above, the Fund may also require that a certain minimum portion of renovations will need to relate to energy savings. … but for the utility sector, the size of credits should also be dependent on performance. Those akimats/ utility companies which would demonstrate significant improvements in their operations and maintenance management; e.g. through operational savings shown as lower energy costs43, rationalized staffing, improved ratios compared to benchmarks, etc., should be given access to higher credit amounts or given a preference in the support from the Fund in other ways. To be meaningful, this incentive will need to be significant enough to influence the activities across the country, and must be communicated clearly to the potential borrowers. It would encourage akimats/ utility companies to deliberately move towards becoming creditworthy not only in the eyes of the government, but in the eyes of the domestic capital markets. (v) Moving from grant to credit-based systems A well-managed transition from grant-based to credit-based government funding will be needed. Short-term. The akimats of the 25 or so larger cities (the anticipated early focus of the Fund), and their Vodokanals (operating companies) will continue to receive government budget funds as grants through the Ak Bulak program in the immediate future, while the Fund is soon expected to start a credit program to akimats/ district heating companies for installation of heat metering equipment in these cities. This will allow the Fund to become operationalized in terms of organization and staffing, in preparation for taking on activities beyond the heat metering program, for example initially also the water and sanitation (wastewater) sector as suggested above. Medium term. Once the Fund is requested to engage with the water sector, it is suggested that they be assigned the responsibility to oversee all government funding to this sector in order to ensure coherent and consistent assessments and rules for the sector. The evolution of the activities may take the following form:
43
For example, electricity normally constitutes about 30% of the costs of water supply. 54
-
-
Initially the Fund takes stock of the current situation in the water sector and the ongoing projects funded through Ak Bulak Management of the Ak Bulak at the central government level is taken over by the Fund (i.e. overseeing the use of transferred grants) The Fund initiates its water sector program: Receives applications for water sector investment projects; evaluates them based on a set of pre-defined criteria; determines which projects are considered financially “viable” and which are not; allocates loan funds for the former, and continues (limited) grant funding and technical assistance support for the latter. The Fund submits reports to the relevant ministries regarding ongoing program funding in the water sector, submits requests for future funding to the relevant ministries, and engages with the prospective borrowers (akimats/ Vodokanals) on their ongoing activities Ak Bulakas well as on their investment plans and anticipated project applications.
An option for the government would be to use the HCS Center (or other) resources to evaluate the proposed water sector investments in terms of financial “viability” or not, and charge the Fund with arranging loans to akimats/Vodokanals for the “viable” projects, while continue distributing grant funding to the other akimats/ Vodokanals through the current Ak Bulak management. However, in order for the government to provide technical assistance and other institutional development support to the latter group of akimats, to over time qualify for the credit program, it would be a significant advantage to have both the grant and credit programs overseen by the same entity, i.e. the Fund. It will be extremely important to design rules and conditions for the two programs which provide strong incentives for an akimat/ Vodokanal to qualify for borrowing from the Fund. Examples of such incentives have already been mentioned under (ii) above. The Fund would also be in the best position to determine most appropriate mix of grant and credit, as appropriate according to pre-defined rules. A possible progression for Kazakhstan is outlined in the table below (H = Housing sector U= Utility sector): Program Funding
Reforms
Short-term H: Low-interest loans, possibly complemented by grants and some resident contributions U: Low-interest loans to the larger akimats or utility companies in the country
Medium-term H: Loan/grant program with some financial contribution from the homeowners U: Loan program to urban akimats or utility companies across the country
Long-term H: Government programs phased out as commercial banks and other entities respond to needs. Continued assistance to low-income households on a targeted income basis. U: Commercial banks respond to the funding needs
H: Acceleration of housing inspections. Promotion of HOAs and housing renovation. Support of private BMC and ESCO sectors. U: Continued tariff reforms towards full cost recovery medium/longer term, including full
H: Energy efficiency targets in the housing sector. U: Improvements of the efficiency of operations and maintenance (O&M)
H: Homeowners have access to broad market of private BMCs and ESCOs. U: Heating and water sectors operate with full cost recovery (with financially and managerially independent utility companies)
55
Participation of local banks
(vi)
Short-term implementation of differentiated/block tariffs. H&U: On a fee-forservice basis
Medium-term
H&U: Limited credit risk by participating banks
Long-term
H&U: Lending with own funds on market terms
Roles and responsibilities
The following tables summarize the main roles and responsibilities of the organizations and HCS Fund units involved in the lending process, from project preparation and loan application through post-implementation evaluation. Different tables are shown for lending to the utilities sector and for housing renovations. Regarding housing, some responsibilities are also different depending on if an SAO or a BMC is the borrower, and is used by the homeowners as an intermediary; or if a HOA is the borrower (and no financial intermediary is used). Utility Sector: Process for Investments Stage Involved entity Board of Directors
Credit Committee (CC)
Managing Director
Technical Assistance Dept. Project Analysis & Appraisal Dept. Implementa tion Oversight Dept.
Legal
Loan Screening Project Appraisal/ Implementation PostApplicaPreparation Approval Support / Evaluati tion Supervision on Approve Operations Manual (OM), annual work program, and budget. Submit annual report and audit report to the Annual Meeting. Ratify loans Engage above third predefined party threshold evaluator . Approve Review and Periodic review of concepts in approve all portfolio status principle. applications reports . Inform borrower Organize and manage the Fund’s staff and activities Conclude agreements on behalf of the Fund Report to the Board on all matters which require their attention and provide information to facilitate its decision making Coordinate with relevant Ministries, Agencies and Local Authorities, as required Provide ongoing support to prospective and actual borrowers, upon request, during preparation as well as implementation. Provide advice to other departments of the Fund based on knowledge about prospective and approved cases. Review Reject, Review request project docs. more data, Request data or /recommend recommend approval . Periodic oversight, review and support, as required . Inform CC about need for significant project/loan change Prepare loan Make changes to 56
Stage Involved entity Department
Accounting Dept. Portfolio … * Internal Audit Regional Offices of the Fund (once justified) City Akimat or Utility Company (The Borrower)
Loan Application
Screening
Project Preparation
Appraisal/ Approval
Implementation Support / Supervision documents, as required
PostEvaluati on
documents and management contracts for signing Financial and management reporting monthly/quarterly/annually. Financial planning and budgeting Portfolio and risk analysis, portfolio monitoring, and strategic planning Internal control systems and periodic audit reports . Review /support /comment . Forward to HQ . Prioritize investment needs (e.g. as per municipal development plan) . Prepare and submit loan application
. Review /support /comment . Forward to HQ . Organize project preparation . Submit project document incl. full feasibility study(ies)
Periodic oversight and support, as required
. Respond to questions . Mobilize implementation resources
Project management . Issue tenders . Sign contracts . Pay contractors . Arrange supervision of works . Submit progress reports . Prepare for periodic loan repayments (after grace period) . Prepare for O&M * Portfolio & Risk Analysis, Monitoring, Strategy & Budget Planning Department
Provide data to evaluator
Housing Renovation Process: SAO and BMC as financial intermediaries Stage
Involved entity Board of Directors
Credit Committee (CC)
Technical Assistance Dept Project Analysis & Appraisal Dept Implementatio n Oversight
Loan Agreement with SAO or BMC Ratify loan agreement
Preparation of Renovation Projects
Approval of Renovation Projects Ratify (only for exceptional cases)
Implementation Support/ Supervision
PostEval. (selective ly) Engage third party evaluator s
Approve Approve Periodic review of loan application (or portfolio status reports agreement package of with SOA or applications) BMC Provide support to SAO/BMC, upon request, during preparation/implementation. Provide advice to other departments of the Fund based on knowledge about prospective and approved cases. Review, request data, or recommend approval . Periodic oversight, review and support, as 57
Stage
Involved entity Dept.
Loan Agreement with SAO or BMC
Preparation of Renovation Projects
Approval of Renovation Projects
Implementation Support/ Supervision
required . Inform CC about need for significant loan changes Make changes to loan documents, as required Ongoing program oversight and support, as required
Legal Department Regional Offices of the Fund (once justified)
Prepare loan documents
City Akimat
Provide guarantee for SAO in their capacity of owner. (Regarding BMC no direct involvement in the lending process.) Annually: . Facilitate Submit Project management . Assess the process for HOs application (or . Sign contracts effective to decide project package of . Pay contractors demand for scope applications) to . Arrange supervision the coming . Assess the Fund for of works year cost/benefits of approval . Inform HOs of . Submit investment progress proposal to options (including . Arrange acceptance the Fund for through energy inspection and related a loan audit); review process envelope with HOs . Prepare for collection (“line of . Obtain from homeowners credit”) quotations (or full . Pay the HCS Fund bids depending on periodically as per the project scope) financing agreement . Select contractor together with HOs . Sign financing (payment) agreement with HOs Express . Decide on what . Liaise with SAO/ interest to investments to BMC SAO or make . Participate in BMC . Sign financing acceptance process of to start (payment) works process agreement with SAO or BMC
SAO or Building Management Company (BMC) (the Borrower)
Homeowners
Provide advice to SAO/BMC/HO upon request (e.g. eligibility, and other requirements)
. Review/ support / comment on application(s) . Forward to HQ
PostEval. (selective ly)
Provide data to evaluator
Provide data to evaluator
* Portfolio & Risk Analysis, Monitoring, Strategy & Budget Planning Department
Housing Renovation Process: Initial process with HOA as Borrower, i.e. no financial intermediary The HCS Fund Departments City Akimat Condominium Association /HOA (the Borrower)
Review and approve application, as per above. (No direct involvement.) . Inform and consult with HOs regarding renovation program . Assess cost/benefits of investment options (including through energy audit); review with HOs . Decide at a meeting with the homeowners on the 58
Project management . Sign contracts . Pay contractors . Arrange supervision of works
Provide data to evaluator
project scope (what investments to make) and the repayment approach . Obtain quotations (or full bids depending on project scope) . Submit loan application to the HCS Fund
Homeowners
After loan application is approved: . Sign financing (payment) agreement with HCSF . Select contractor(s) . Receive information from HOA . Participate in meetings to discuss and decide on renovations (or not)
. Inform HOs of progress . Arrange acceptance inspection/process . Prepare for collection from homeowners . Pay the HCS Fund as per the financing agreement . Liaise with HOA . Pay HOA as per loan repayment agreement
Provide data to HOA, as required
The operations of the Fund will be governed by an Operations Manual (OM). Key contents of an Operational Manual (OM) for the Fund are included as an attachment to this report. It includes a suggested organization of the Fund, and related roles and responsibilities of each department and body of the Fund. It outlines it’s the business processes of the Fund, including procurement and financial management procedures, and frameworks to safeguard potential environmental and social (land acquisition and resettlement) matters. (vii)
“Road-map” for the Start-up of the HCS Fund
Although the HCS Fund during 2011-2012 had 5-10 staff, at present its staffing is only one person. It is closely linked to the HCS Center, which has some 15 professionals, undertaking studies for MoRD and others. Outlined below is a proposed sequence of events to get the Fund to an early stage of operations, for the communal services (utilities) as well as for the housing renovations sector. Items 1 and 2 are based on information from the HCS Center and the Fund. The subsequent items are the actions proposed by the authors of this report. 1. Approval of Feasibility Study on Lending for Heat Meter Installations As mentioned earlier, the first activity by the Fund is intended to be lending to district heating companies for installation of building-level heat meters, based on an allocation of budget funds of KZT 8 billion (US$ 44 million).44 This is subject to approval of the corresponding feasibility study by the Ministry of Economy, which is expected before the end of June 2014. 2. Capitalization of the HCS Fund Two option are being considered for the ownership of the Fund: (a) the Fund being 100% owned by the HCS Center; KZT 8 billion being allocated by the government to the HCS Center which will pass it on to the Fund as its equity; or (b) the Fund being owned 99.99% by the MoRD, and 0.01% by the HCS Center. The decision is expected to be taken by the government before the end of June 2014. 3. Establish Initial Organization, Policies and Procedures This should start with the Board of Directors, unless already established. As proposed in the attached draft Operations Manual (OM), it is suggested that the Board be chaired by a high level representative of MoRD or by the Deputy Prime Minister. It should have at least 5 44
The loans will have a maturity of 2 years, and carry an interest rate of 4%. The HCS Fund will repay the government KZT 1 billion and use the remaining (about KZT 7.3 billion) loan repayments as a revolving fund for continued lending in the communal and housing sectors. 59
members, for example representatives of MOF, MOE, Ministry of Industry and New Technology, and two organizations representing the interests of akimats/utility companies and homeowners respectively. The Board should appoint a Management Director (MD) for the HCS Fund, establish human resource policies, define a budget for 2014 (and a tentative one for 2015), and instruct the MD to carry out recruitment of initial staff. Assuming that the heat meter program will be the only operational activities for the Fund in 2014, the following skills will be needed as soon as possible (as full time staff or as contracted resources), once the MoRD gives the go-ahead for the Fund for this program (following 1. above).45 Technical resources required - Project Analysis & Appraisal. Main functions are to review loan applications from district heating companies, appraise their supporting documentation (feasibility studies with number of heat meters to be installed, cost estimates, etc.), and recommend course of action (normally approval) to the Board (or credit committee if established). - Implementation Oversight. Oversee implementation of projects by the borrowers, based on reports received and/or through site visits. Particularly review that procurement and accounting has been carried out properly for the respective project. This technical staff should also support implementation of the projects by sharing useful information from ongoing projects among the borrowers. He/she may use the Fund’s support staff, as required (e.g. for accounting reviews). Administrative resources required - Accounting / Financial Management and Reporting. An adequate financial management system, with a Loan Accounting System, needs to be established, and able to reflect the operational and financial position of the Fund, including loan and repayment accounting. - Legal skills for preparing loan agreements, and address recourse in case of nonrepayments. The following two functions may initially be carried out by the MD him/herself: - Communications functions include representing the Fund vis-à-vis the media, borrowers, and beneficiaries. - Human Resources functions include recruitment, and staff compensation and benefits (in case staff will not be civil servants). 4. Adopt an Operations Manual. The Board should adopt an Operations Manual as soon as possible (draft is attached). This can, however, initially be limited to the heating meter installation program (expected to commence in 2014), and other activities that the Fund will be mandated to undertake initially (including those starting in 2015). This shall, for example, initially include lending policies, and procurement, disbursement, accounting and reporting requirements. It should be enhanced over time as activities expand. 5. Start Lending to District Heating Companies. 45
While a Credit Committee should be appointed by the Board in due course (see OM), this will not be needed for the limited heat meter program. 60
The Fund will need to receive loan applications from the respective heating company (or akimat), appraise the projects, and sign loan agreements with each borrower. 46 It will be important that the Fund applies any restrictions or conditions stipulated by MoRD, MOE or MOF for the program. 6. Business Planning. During 2014, and in parallel with the start-up of lending to district heating companies, the Fund should create a realistic business plan for the coming 3 to 5 years, based on: (a) the aspirations of MoRD and the Board; and (b) how quickly the Fund can mobilize capacity to expand its operations. The plan shall include financial projections and a proposed budget for 2015; and all of this should be approved by the Board before the end of 2014. 7. Prepare for 2015 Activities and Beyond The organization of the Fund needs to evolve according to the volume of activities and related staffing needs. It will likely initially be composed of a small group of resources as indicated above, but need to quickly expand when it will be requested to lend for housing renovation and/or some communal services (e.g. the heating and water sectors). While at some point, all project appraisals and loan approvals should be made by the Fund (its Credit Committee and its Board), for lending to the utilities sector, it is envisaged that projects may for some time also need to be reviewed within MoRD and MOE until the Fund organization has been fully established and has proved itself. Housing and Communal Services (Utilities) matters should be managed separately (eventually as separate departments) due to their very different characteristics and procedures. However, the administrative support functions mentioned above (legal, accounting, etc.) should be common, and a common Credit Committee can be used for approval of credits. Once the volume of activities can justify it, the Fund could create “subdepartments” within the Utilities and the Housing Sector Departments respectively, for Technical Assistance, Project Analysis & Appraisal, and Implementation Oversight. See the draft OM for further details, including proposed short-term and longer-term organizational charts. -
Lending for Housing Renovation. Initial lending would be to SAOs for their housing clients, with repayments to the Fund to facilitate most effective allocation of funds across the country over time. (At present, the funds are transferred to SAOs or similar organizations, and remain as revolving funds at the local level.) The Fund would, in parallel, promote private building management companies to take an interest in the HCS program, and in due course submit loan applications to the Fund, similarly to an SAO, for services to homeowners. Eventually, it is envisaged that that the Fund may also lend directly to an HOA or management company, as required. Recommended policies and lending terms are provided in the draft OM.
-
Lending to Utility Sector. Following the initial lending for the heat meter program, it is anticipated that the government will request the Fund to channel government funds to local governments and their utility companies – for example starting with the heating and/or the water sectors – as long term preferential loans or conditional grants, depending
46
The assumption here is that the heating companies or Akimats will carry out all procurement without involvement by the Fund 61
on project circumstances. As mentioned above, once the Fund would be requested to handle funds in a particular sector, it is recommended that it be charged with channeling all government budget funds for that sector. Therefore, it would be prudent to start with one sector only to build experience. Recommended policies and lending terms are provided in the draft OM. 8. Monitoring and Reporting. Due to the HCS Fund being in a start-up mode for quite some time, close monitoring and evaluation of its activities will be particularly important. The Fund should report to MoRD frequently (at least quarterly) on its activities, but also periodically communicate suggestions for refinement to policies, regulations or laws, based on insights gained from its operational activities in the respective sector.
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Annex A. Government Programs
Annex B. International Experiences
Annex C. Financial Projections and Considerations
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Annex A. Relevant Government Programs HOUSING AND COMMUNAL SERVICES MODERNIZATION PROGRAM 20112020 Background. The Housing and Communal Services (HCS) Modernization Program was adopted on April 30, 2011 for a ten-year period from 2011 to 2020. The main objective of the program is twofold: (1) Ensuring maintenance of the housing stock; and (2) Modernization of communal infrastructure. The overall volume of financing required for implementation of the program was estimated at KZT 877,170 million, including KZT 304,478 million funded from the national budget, KZT 44,476 million from local budgets, KZT 452,406 million from utility companies, and KZT 75,810 million by citizens (see Figure (i)).
Figure (i). Sources of financing for HCS Modernization Program implementation (2011-2020) Private [citizens] funds 9%
[Utility] company funds 51%
National budget 35%
Local budget 5%
Key results indicators. The HCS Modernization Program sets the following results indicators to be achieved at the end of the first implementation phase in 2015, and at the end of the second implementation phase in 2020: - Share of condominiums in need of capital repair to decrease from 32% to 22% by 2015 (see Figure (ii)). - The length of modernized networks to exceed 31 thousand kilometers by 2015 (24,400 km as a result of the HCS Program and 6,700 km as a result of the Ak Bulak Program implementation). - At least 50% of users satisfied with quality of communal services by 2015, and 70% by 2020.
64
Figure (ii). Results indicators under the housing component
100 80 60 40 20 0 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 % of condominiums in need of capital repair % of condominiums independently maintaining…
Targets for heating, electricity and gas supply under the HCS Program are as follows: Infrastructure requiring modernization, % of total
2011
2012
2013
2014
2015
2020
Heating supply
63
61
58
55
52
40
Electricity supply
73
71
70
66
63
53
Gas supply
54
53
52
50
48
38
Financing mechanism. In 2011-2012 there were two mechanisms for financing current and capital repairs of condominiums. Under the first mechanism, aimed primarily at financing capital repairs, targeted transfers were allocated from the national budget to local executive bodies (Akimats) for capitalization of specialized regional organizations, known as socioentrepreneurial corporations (SECs). In turn, SECs pay for capital repairs and collect repayments from apartment owners. Under the second mechanism, aimed primarily at financing current repairs, targeted transfers were allocated from the national budget to Akimats for capitalization of Akimat-owned specialized authorized organizations (SAOs) that act as a financial intermediary and the general contractor. The governance structure of SAOs may take a form of a state communal enterprise (SCE) or limited liability partnership (LLP). Starting in 2013, the first financing mechanism has ceased to exist and only the second mechanism remains. However, since no funding was allocated for the HCS Modernization Program from the national budget in 2013, there were no current or capital repairs financed through SAOs before 2014. Currently, the number of SAOs is limited to one per region. Implementation status. In 2011, 564 apartment buildings were selected for projects for maintaining multi-family housing stock using contracted service companies. In 2011-2012, KZT 17.8 billion were allocated for overhaul works of 1,350 multi-family buildings. Out of them, 422 buildings (KZT 6.8 billion) were renovated using the first mechanism and 928 buildings (KZT 11 billion)—using the second mechanism. The 2011-2012 repayment volume was 10% (KZT 1,780 million) of the funds allocated. In 2012, with the repayments of 2011 (KZT 285 million), capital repair works were initiated for 212 multifamily buildings; in 2013, modernization of 79 multifamily buildings was completed with repayments of 863 million KZT. As mentioned above, no funds were allocated from the national budget in 2013. In 2014 the funds envisaged for modernization of 721 multifamily buildings is KZT 12 billion. 65
According to the 2013 results, the share of the total housing stock requiring modernization and upgrading is 28%. Challenges in implementation - Some regions experienced delays in disbursement of program funds due to a slow pace of condominium (building) registrations, opening of condominium bank accounts, and repayment of invested funds; - The process of ensuring apartment owners’ active participation and agreement takes a long time. However, in those cases where the consultation process was circumvented, the quality of the completed works was not up to the home owners’ satisfaction.
AK BULAK PROGRAM 2011-2020 Background. In 2002-2010, massive state support of KZT 205 billion was provided to rehabilitate 13,000 kilometers of pipes and improve access to drinking water in rural areas covering 3.5 million people through the Drinking Water Program. Despite some positive results, the Program has only halfway met its goal of increasing access to centralized water supply by 20-25%. The lack of a systematic and transparent approach, together with an inadequate communication across authorities (akimats) at different levels, resulted in ineffective use of resources, namely poor construction quality, poor quality of water supplied, and inability to prioritize projects. The Ak Bulak Program was launched by the Government of Kazakhstan to continue implementation of policies and activities aimed at providing full access for all to safe and efficient water supply and sewerage system across the country. Rural water supply is still on the agenda of the Ak Bulak Program along with improved urban water supply and sewerage, wastewater treatment, and financial and operational efficiency. Objective. The main objective of the Ak Bulak Program is to provide good quality drinking water and wastewater services to the public. The overall volume of financing required for implementation of the program was estimated at KZT 1,273,859 million, including KZT 1,164,142 million funded from the national budget and KZT 109,717 million from local budgets. Key results indicators. In order to track the progress toward achieving the objective of the Program, Ak Bulak includes a number of specific results indicators: - Increased access to centralized water supply: 80% in rural areas and 100% in urban areas; - Increased access to centralized sewerage: 20% in rural areas and 100% in urban areas; - Urban wastewater treatment coverage of 100%; - Increased water metering level: 80% in rural areas and 100% in urban areas; - Increased number of water and wastewater utilities operating on the basis of private sector participation (PSP) to 20; among others. The Program also aims to: - Improve legislative and regulatory framework of the water supply and sanitation sector; - Ensure effective and efficient management of water supply and sanitation systems; - Build capacity of sector technical staff in project design, preparation, new technologies and research; - Adopt tariff regulation that ensure medium- and long-term full cost recovery, including depreciation, and thereby sufficient to finance future investments.
66
Financing Mechanism. Projects are selected after a detailed evaluation of applications submitted by local authorities to receive financing from the state budget. Currently, the mechanism applied to get state financing is the following: regional level authority (oblast akimat) collects applications from water utilities including those at a lower level (rayons). The projects are differentiated by cost and prioritized based on certain criteria (e.g. population coverage, level of urgency, and the viability of the proposed technical solution). Projects that are less than KZT 80-100 million are approved at the oblast level; those larger than KZT 80-100 million are sent for approval to the MoRD. Once approved, the state allocates up to 80% of necessary funds and the local akimat provides co-financing. Annually each oblast receives about KZT 7-8 billion from the state budget. Implementation Status. In 2013, 137 projects received funding, at a cost of KZT 48.7 billion. Some 680 km of water pipes and 290 km of sewerage pipes were constructed or repaired. The Program’s performance indicators for 2013 were achieved: in-house piped access to water in urban areas reached 86% as planned (from a baseline of 82%); sewage collection reached 78% as planned (from a baseline of 73%).
According to 2011 data, some 60-80% of pipes are in poor condition and need rehabilitation or repair or replacement. Based on these estimates, rehabilitation of pipes in 86 cities (26 big cities and 60 towns) will require KZT 517 billion. This amount by far exceeds the KZT 25 billion contributed annually by the state for water system infrastructure improvements. The aim therefore is to attract private investments into the sector under the Ak Bulak program to supplement state financing. Currently, MoRD is working on PPP pilot projects for the water utilities of the cities of Atyrau and Semey. Implementation challenges and lessons learned. Lack of technical capacity. One of the challenges faced by water supply and other public utilities is lack of professional engineering and operational staff for utilities management. So far, there is no strategy to improve systems for higher learning in the public utilities sector. The current challenge of poor quality project design, as observed during implementation of programs prior to Ak Bulak, thus continues. Monitoring and evaluation. There is currently no system in place and no institution responsible for collecting nation-wide information on utility performance. The water supply sector was seen as pioneer in terms of introducing systematized approach to sector management through an electronic project database. However, the activity launched more than ten years ago is still far from being a practical analytical tool. Ak Bulak calls for the creation of a water supply and sanitation sector monitoring system that would collect and analyze performance data; however, no such system has been established yet. The lack of an adequate sector information and monitoring system not only makes it difficult to assess the state and performance of the water supply and sanitation sector, it also makes it difficult to measure the effect on the sector of any government-sponsored programs. Research and development. Development of Kazakh suppliers (technology and equipment) and resource efficiency research during project implementation is one of the program objectives of the Ak Bulak program. However, no strategic link has been established between industry and communal services upgrade. Much work remains to be done in terms of establishing and refining standards and regulatory frameworks for R&D. Environmental Sustainability. The biggest challenge from underground water sources exploration and substantial extraction, as announced under Ak Bulak Program, is to ensure 67
environmental sustainability. A strict regulation must be put in place to ensure the underground water use efficiency is justifiable. Again it is crucial that surface water sources are adequately protected and wastewater treatment (industry, agriculture, population water supply) is done adequately to limit the need for extraction of underground waters. Underground water should be viewed as a strategic and vulnerable reserve to be secured for long term. PPP/PSP implementation. While the main objective of the Ak Bulak program is to ensure provision of high-quality drinking water and sanitation services to the public, the program has a number of other goals that are not directly linked with expanding service coverage. For instance, the program makes an explicit goal of increasing the number of water supply and sanitation utilities with private sector participation to 4 by 2012, and an additional 16 utilities by 2015. The first intermediate target indicator of 4 pilot utilities (Taraz, Atyrau, Semey, and Uralsk) was not met due to several reasons. The main reason is that Kazakhstan’s legislative framework – namely the Water Code – did not allow the transfer of water supply and sanitation facilities under private management until July 2013. Until that date, water supply and sanitation facilities were considered of “strategic importance” and thus kept under public management. Although the restriction in the Water Code has been lifted, a number of secondary legislative acts and decrees have not yet been amended to ensure consistency in legislation. Until all relevant legislation is consistent on the subject of private sector participation in the water supply and sanitation sector, no concession, management or other forms of private sector participation contracts can be implemented. Furthermore, during preparation of this JERP, it was not apparent that there is a strong interest or demand on the part of utility companies to introduce any private sector participation schemes in management of their utilities. Any successful public-private partnership (PPP) or private sector participation (PSP) arrangement requires strong commitment and openness to change from utility management. It is not clear whether the provisions on PPP/PSP were introduced into Ak Bulak after consultation with individual utilities that would potentially be affected by these provisions. AFFORDABLE HOUSING 2020 PROGRAM The Affordable Housing Program, launched in 2011, links back to a set of state initiatives on housing development started in 2005. According to an affordability analysis preceding the Affordable Housing Program, more than 6 million out of 8.4 million of the economically active population were not able to purchase housing from the market. Creating conditions that make it possible for this population group to access housing was thus the main task of the program in the short term. The 2020 target is 4 million additional square meters to the existing 6 million (2011 baseline), reaching 10 million m2. This volume is to be achieved using innovative industrial approaches: large-panel housing construction, and prefabricated technology. These technologies and materials are to be produced locally to reduce construction cost and time, and improve quality. The Affordable Housing Program aims to: - create a balanced housing market; - provide housing to the population eligible under the Law on Housing Relations, including young families, using relevant financial mechanisms and instruments (e.g. housing savings system under Housing Construction Bank and the Kazakh Mortgage Company); 68
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construct low cost ("economy" class) housing at a mass scale under specified parameters; create investment opportunities and public private partnerships in the sector; develop housing-related infrastructure, including delivery of serviced land; demolish housing that is unfit for habitation ("emergency" housing); provide support to non-commercial construction cooperatives; support the construction industry with innovative energy efficient and environmentally friendly technologies, with the state providing favorable conditions and materials being produced locally.
Housing affordability is to be achieved through several means: - Establishing a housing queue of people in need - Housing finance: savings system (Housing Construction Bank), mortgages (Kazakh Mortgage Company) - Capital repairs under Housing and Communal Services Modernization program - Housing construction under pilot projects to replace emergency housing - Individual housing construction - Housing infrastructure construction - Housing construction under the Employment 2020 Program - Housing construction within projects of the Samruk Kazyna Fund. REGIONAL DEVELOPMENT PROGRAM - 2020 The Regional Development Program was elaborated within the implementation of the territorial and spatial development program - 2020, referred to as the Scheme. The Scheme provides a conceptual basis for the regional policy on the new territorial structure, including growth of agglomerations. Close to one-third of the population of Kazakhstan is concentrated in emerging agglomerations. The most intensive agglomerations are formed around Almaty city and Shymkent city. The prospective agglomeration of Astana city is linked to the expanding role of the capital city. Even Karaganda city and its surrounding towns and settlements are seen as gravitating to the Astana agglomeration in the future. Prospective agglomerations in the west are the city of Aktobe and/or the city of Aktau. The new regional strategy aims to concentrate available resources in areas with high growth potential, and in particular, address the spatial and economic inequalities associated with the concentrations of the economically active population. Along with the emerging agglomerations, the new regional policy will also address socio-economic problems in the monotowns (industrial zones of the former Soviet planned economy), and rural settlements.47 MONOTOWNS (MONOGOROD) PROGRAM The Monotowns (Monogorod) Program represents a combination of industrial and sub-regional socioeconomic development objectives of the main state development policies (Socio-economic Modernization, Projected Scheme of Spatial Development by 2020, Regional Development, Business Development Road Map 2020, and Employment Program 2020).
Monotown is defined as a town, where the main share (20 per cent and above) of production and labour is concentrated in a single or several 'town forming' enterprises, of single 47
To address social issues (including migration, unemployment, and social marginalization) and infrastructure degradation, the state provides additional financing under the Monotowns Program, and the Business Development Map 2020 operated by DAMU Fund. 69
specialization. Most of these towns are characterized by a declining population, and suffer from a range of other socio-economic problems. There are 27 monotowns in Kazakhstan, with a total population of 1.53 million people (16.8% of national population). Four monotowns have a population of more than 100,000. The specialization distribution is as follows: - Mining (21 towns); - Processing industries (6 towns): Chemical industry (1 town); Machinery and metallurgy (1 town); Metallurgy (3 towns); Scientific-industrial centre (1 town). The Monotowns Program aims at: - Optimization production capacity of the more stable working enterprises; - Economic diversification and development of small and medium size businesses to achieve optimal employment structure; - Improvement in labour mobility by stimulating transfer/ emigration to areas of high socio-economic potential and growth; and - Development of social and engineering infrastructure optimized according to the size of the population. Financing. Financing for the pilot year (2012) was 40 million USD. In 2013, financing was 19 billion KZT, and included KZT 1.75 billion for small and medium business development. Mechanisms for financing include: - Investment instruments package from the State budget, including loan subsidies, loan guarantees, infrastructure investments, start-up support, and service support for accounting, tax reporting, IT, legal issues, custom procedures, and quality management systems; - 'Anchor' investment projects, such as a medium or large investment project in a non-raw material sector, aimed at the diversification of a Monotown's economy. These projects will be supported within existing state programs (Business Road Map 2020, Performance 2020, and others). - Small and medium size business development stimulation measures: Subsidies, development of enabling infrastructure; grants for new production excluding mining, metallurgy sectors and national companies; partnership programs with 'town forming' enterprises, business incubators (start-up, micro loans), which has experience with similar activities within 'small towns' and 'regions' programs The target indicators for the Monotowns Program during 2013-2020 include the following: - multiply small businesses by 4 times; - reduce poverty (the population earning minimum living wage or below) by 6%; and - reduce unemployment by 5%.
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Annex B. International Experiences This annex summarizes international experience from lending to municipalities and municipal utility companies, in particular when done through the use of a Municipal Development Fund (MDF). It also describes financing approached to HOAs or their representatives for renovations of common areas of multifamily buildings, particularly in Eastern European countries. MDFs and similar forms of parastatal institutions are financial intermediaries that provide credit to local governments, local utility companies, and to other institutions investing in local infrastructure. Around the world, more than 60 countries have established financial intermediaries of this kind. In larger, federal nations such as Brazil and India, individual states often have established their own municipal development funds. The goals of the Funds tend to extend beyond the provision of credit, to helping increase the efficiency of local investments, promote development of service pricing and cost recovery, upgrade the local financial management systems, and ensure that critical investment projects get funded even in situations when full financial cost recovery is not feasible. Funds are typically transitional instruments, intended to prepare the way for self-sustaining municipal credit systems that can tap domestic and international capital markets for financing in the long term. The Funds sometimes start as an intergovernmental approach to municipal credit supply, but evolve to become financial intermediaries focusing on municipal credit. They allocate loan capital for local government investment projects following procedures similar to those that International Financial Institutions (IFIs) apply, while reaching far more local authorities and smaller investment projects than it would be efficient for IFIs to try to finance directly. MDFs are usually focused on lending and technical assistance to municipalities and municipal utility companies only. Nothing prevents the same Fund organization though to also manage financing of housing renovations on behalf of the government.48 However, this needs to be managed as a separate program with different rules, terms, procedures, etc. due to the different characteristics of lending to public utility service providers versus lending to private homeowners associations (HOAs) or management companies borrowing on behalf of HOAs. International experience does not point to a single model as to how municipal/utility development funds "ought" to be designed. The lessons noted below, however, help identify critical choices that must be made in designing a Fund, and emphasize implications of these choices for the longer term objectives of the government. This Annex is divided in the following three sections: A. Evolution of a Country’s Local Government Infrastructure Finance System B. Global Experience of Municipal Development Funds (MDFs) C. Supporting Housing Renovation in Multi-family Buildings
48
Lithuania is an example where this has been the case. 71
A. Evolution of a Country’s Local Government Infrastructure Finance System Internationally, local urban infrastructure has traditionally been financed from three sources: (i) operating savings of local governments; (ii) grants from higher level government; and (iii) borrowing. In some countries, capital investments by the private sector, or public-private partnerships (PPPs), have played an important role. The evolution of infrastructure finance – particularly in countries with traditionally weak capital markets – has typically moved along the following trajectory: (i) (ii) (iii) (iv) (v)
a government run grant facility for earmarked types of investments; a subsidized, directed government credit facility; an on-lending institution intended to evolve into a market-oriented intermediary; privatization (or phase-out) of this institution; and finally evolution to a competitive private municipal credit market, with commercial banks drawing on own funding sources and competing for local government (LG) business.
Such evolution has usually been accompanied with a strengthened decentralization process, improved LG finances, and development of the financial sector in the country. Systems design needs to be in tune with these conditions, and adapt to the reality at each stage of a country’s development. Experience across the world has shown that rather than building a LG infrastructure lending system around expectations of a dramatic strengthening of the LG finances in a short period of time (which are usually unrealistic), it is more effective to develop an enabling environment to ensure the success of progressively more ambitious approaches.49 Where a particular country is positioned depends to a great extent on the creditworthiness and financial strength of its LGs. Various financial intermediation models have been applied internationally - for example, Municipal Development Funds (MDFs), Special Purpose Vehicles (SPVs), Social Funds, etc.50 - to provide funding to local governments in the form of loans and/or grants, or channeling credit funds through the local banking system. Many countries are today characterized by: (i) basic urban infrastructure mainly being the responsibility of the LGs; (ii) weak LG finances; (iii) under-developed capital markets (e.g. no long-term loans); and (iv) the national government providing grant funding for the provision of basic services through an inter-governmental fiscal transfer system (IGFTS), with funds channeled directly from the Ministry of Finance to the LGs or via sector/ line ministries. The LG spending may be heavily earmarked, based on the rules of the IGFTS. Limited LG borrowing is sometimes allowed, but often not feasible due to low creditworthiness. The following section describes an incremental evolution of a country’s infrastructure finance system in six(6) stages, from a government funded grant-based system, towards options of financial intermediation, and finally to a system with strong market orientation (see Table 1). 49
Innovative approaches and successful evolutions have been applied in Colombia (FINDETER), India (TNUDF), and in Czech Republic (explained below). Experience of more advanced infrastructure finance intermediation also exists in Morocco, Tunisia, and South Africa (DBSA and INCA). 50 Financial intermediation focuses on strengthening the municipal finances and builds a sustainable credit market for LGs for larger infrastructure needs. Social Funds tend to focus on creating community capacity to achieve small scale investments quickly through grants and to build “social capital”, rather than evolve into a permanent, sustainable system. 72
Although this progression typically takes a long time (say, 10-20 years) with an improved business and governance environment it could happen faster. The goal in many countries would be to move from a local government grant dependency to capital markets that the LGs can rely on for their infrastructure finance needs. A challenge in many countries is, however, to expand the public sector financial resources for LG investment needs without compromising the country’s fiscal discipline, until such time that the system can be based on tapping private savings through the capital markets. Grant-based Systems (Stages 1-2) Stage 1 in the Table below reflects a system where the current - and often limited - LG infrastructure investments are financed mainly through the existing transfer system as earmarked grants. In some countries, the funding may be dependent on loans from IFIs, earmarked for the grant system. An initial development step would be to separate the funding for infrastructure investments, either as (i) a separate part of the IGFTS (as conditional or unconditional grants), or (ii) a separately managed “window” (or Fund) with project proposals submitted by LGs and reviewed and prioritized based on pre-defined eligibility criteria (Stage 2). Such a “window” would over time move to a system of a blend of grants and loans to the LGs, with loan repayments entering a revolving fund. By moving from grant to loan funding, the need for diligence on project financials increases significantly (project viability, cost recovery, etc.). A frequent evolutionary step is also to apply a formula-based allocation of funds to the LGs, but with the LGs deciding the investments themselves (rather than the national government). Instruments which can be applied to enhance the LG performance are: (i) performance grants (i.e. grants being conditional on achievement of certain performance indicators); (ii) “municipal contracts” (agreements between the national and each local government for institutional and financial improvements); and (iii) pre-defined eligibility criteria for loans. Providing funding based on performance only, however, may in a competitive environment prevent weaker LGs to access any funds. The system may therefore also need to include a (well-designed, well-targeted) subsidy element from public funds for such LGs. Financial Intermediation Approaches (Stages 3-5) A financial intermediary tends to be: (a) a dedicated and specialized entity for providing grants and/or loans to local governments; or (b) an entity to facilitate lending (or on-lending) from local banks to local governments. An effective design will reflect the state of both the financial sector and the fiscal and management capacities of the LGs (e.g. for investment planning and selection). Such an intermediary entity may evolve from a central government agency or Fund, into a more independent organization, and eventually into a for-profit financial institution. While intermediation needs to be well aligned with the intergovernmental relations and fiscal transfer system, many successful intermediation initiatives have not been part of the intergovernmental fiscal system itself, and focused on investments rather than broader reforms.51 Three varieties of financial intermediation are described in the Table under Stages 3 to 5.
Table 1. Evolution of a Local Government Infrastructure Finance System (Some progression may also occur within each Stage, from basic to more advanced) 51
E.g. see Annez, Huet, and Peterson: “Lessons for the Urban Century”, The World Bank, 2008. 73
STAGE
Stage 1 Transfers
Stage 2 Governmen t Fund
Stage 3 “Independe nt” Fund
Stage 4 Municipal Bank
Type of Intermedi ary
N/A Direct transfers from national Governmen t to local government s (LGs)
National government (incl. developmen t partner / IFI contribution s) Grants
Dedicated entity/Fund with both Government , institutional (e.g. pension funds), and private equity (ownership) Same but enhanced with private funds and/or through own bond issues, or nat. govt. bond issues Grants and loans LGs or utility companies Intergovernmental or other financial flow intercepts LG projects based on eligibility criteria and subject to entity/Fund appraisal.
Specialized Private LG Finance Institution(s ) (Could be through privatizatio n of Stage 3.)
Source of Funds
Dedicated Government owned entity/Fund (e.g. revolving fund). (Could be part of IGFTS52 if grants only.) Same
FACTOR
Instrumen t Borrower
N/A
Grants and loans LGs
Security
N/A
If loans, intergovernment al transfer flow intercepts
Investmen t Selection
By nat. govt. e.g. for priority sectors or geographic areas, etc.
LG prioritized projects based on broad eligibility criteria
Stage 5 Stage 6 Second Tier Banking Municipal Sector (*) Finance Inst. Second-tier Private financing financial institution, institutions lending to commercial banks for on-lending to LGs
E.g. through own bond issues, or pooled institutional funds
E.g. through own bond issues, or pooled institutional funds
Own funds (private savings, etc.)
Loans
Loans
Loans
LGs or utility companies Intergovernmental or other financial flow intercepts Proposed projects by LG, appraised by bank
LGs or utility companies LG or utility assets and finances
LGs or utility companies LG or utility assets and finances
Proposed projects by LG, appraised by 2nd tier institution and bank
Proposed projects by LG, appraised by bank
(*) At a later stage of the above evolution, a municipal bond market may also become feasible if it is more cost-effective for the LGs than traditional bank borrowing. However, a small or medium-sized LG will likely have difficulty accessing financing - particularly bond financing - on a stand-alone basis, in which case a pooled approach among various LGs might be a possible approach.
52
Inter-governmental fiscal transfer system (IGFTS) 74
Stage 3 “Independent” Fund. The logical progression from facility fully financed through the government budget and IFI funds, is to mobilize some non-governmental funds, e.g. from private financial institutions, pension funds, etc. This tends to require that the intermediary (e.g. a Fund) is legally, financially, and managerially independent, and focused on the function of providing grants and long-term credit to LGs or their utility companies. Stage 4 Municipal Bank. In some industrialized countries specialized municipal banks have been established, sometimes based on a cooperative model with member LGs as shareholders (as in the Nordic countries), or as privatized government controlled intermediaries (such as the evolution of Credit Local de France to the current firm Dexia in Europe). In some cases, they have been allowed and able to issue bonds to raise funds (e.g. the private sector entity INCA in South Africa). To facilitate loan recovery from the LGs, some countries have allowed interception of intergovernmental transfer or other financial flow as collateral for the financial intermediary, significantly reducing credit risk (for example, successfully applied in Brazil). Stage 5 Second Tier Municipal Financial Institution. When the financial sector is ready to engage in lending to the LGs, they may lack sources of long-term funds. A separate secondtier financing institution could fill that gap by lending to commercial banks for on-lending to LGs. This usually requires strong government support and involvement in the beginning, and over time possibly becomes a fully private sector entity. The long-term funds could come from government contributions - for example, initially from the general budget and later via sovereign bond issues - and from institutional investors such as pension funds and insurance companies. The independence, risk management skills, and credibility of such a second-tier entity are critical. Depending on allocation of responsibilities and risks, this entity would focus on appraising participating on-lending banks, LGs, and/or individual investment projects (depending on the specific design).53 Once a country has reached a situation where the capital markets show interest in lending to LGs, any government-dominated system should be adapted to make it easy for banks to enter with additional financing (i.e. avoid crowding out lending by providing subsidized loans to LGs within the public sector), and eventually ideally cease to exist, having reached its longterm goal. Market-based Systems (Stage 6) For an effective market-oriented system, there must be lenders who are willing to lend, and LGs who are willing and capable (credit-worthy) to borrow. Some common bottlenecks are: (i) available credit tenures are too short to be effective for long-term infrastructure investments; (ii) creditworthiness criteria for LGs only qualify the very strongest; (iii) subnational credit risk, foreign exchange risk, and political risk are “moving targets”, sometimes changing the banks’ willingness to lend; and (iv) effective demand for credit is sometimes reduced if the LGs have (or have expectation of) access to grant funds, or credit on concessional terms from the government.
An advanced system of financial intermediation requires - in addition to a certain level of government decentralization – the existence of well-developed capital markets, credible risk assessment abilities, and an enforceable contract law of the country. The financial strength of a LG or local utility company would be assessed based on its solvency, liquidity, turnover, current revenue, and cash-flow. A bank would also look at the diversity of revenue sources, growth indicators, the institutional capacity, and local policies and practices. 75 53
A market-based system relies on assessment of creditworthiness and project risk. In a sustainable LG credit market, LGs would be able to satisfy their borrowing needs at market rates and with loans of sufficiently long tenure (e.g. 20 to 30 years). Borrowing from private lenders forces long-term fiscal planning at the LG level. Borrowing capacity will likely still be limited for some time though, restricted by a LG’s overall revenue volume. 54 A fully functioning market system would provide a sustainable window for LGs to access domestic savings in the banking system, reducing the need to finance infrastructure through fiscal transfers.55 However, as long as a local banking system does not have access to long term savings (or other funds), it will be unable to offer sufficient long-term credit needed for the LG infrastructure. Revenue Generating vs. Non-revenue Generating Projects. To make local infrastructure projects commercially viable, a revenue stream is needed (e.g. through user charges). Credit enhancement mechanisms such as guarantees, maturity extensions, etc. are sometimes needed to make the financing attractive. A market oriented system will likely emerge sooner for projects with strong revenue earning capacity and predictability, e.g. water supply, while local roads, drainage, and sanitation may remain grant-funded investments for much longer. Public-private partnerships (PPPs). Over time PPPs may also become feasible for a country’s local utility services. Such arrangements are characterized by an appropriate balance of risk-taking between a LG or utility company and a private partner. It tends to require: (i) corporatization of the utility service; (ii) a predictable revenue stream (cash flow); (iii) strong corporate governance; (iv) a contract enforcement framework; and (v) financial transparency. The general investment climate would also influence such development. “Infrastructure Investment Trusts” could eventually emerge as investors based on institutional resources, e.g. from pension funds. Such trusts increase liquidity and tend to provide attractive entry and exit flexibility for the private investors. Land-based Financing. This has become an important source of urban infrastructure finance in some developing countries. In addition to property taxation, it can include: (i) betterment levies; 56 (ii) impact fees and developer contributions; (iii) direct sale of land; and (iv) borrowing backed by land as collateral. In developing countries, where it is usually difficult to obtain long-term credit, the up-front revenue generated by land financing is attractive. Such financing has the biggest potential with rapid urban growth and appreciation of land value. These instruments may also support efficient operation of the urban land market. Land sale/lease and borrowing against land by LGs is however not very applicable where most urban land is privately or communally owned. Financing of Operations and Maintenance (O&M). Local infrastructure O&M is usually financed through the general budget of the LGs, which in many countries is largely from transfers. With certain rules in the fiscal transfer system, the sustainability (maintenance) of investments may be improved by making grants or loans conditional on local maintenance plans and matching funds. For example, in order to ensure adequate road maintenance, some
54
Common borrowing restrictions are: debt 0.90% Over the latest three years, overdue accounts payable showed: (i) decline each year in nominal terms; and (ii) a total of at least 30% reduction by end of the three years. Such indicators should relate to an agreed project implementation schedule and ideally have benchmarking data as reference. Issue #3: MDF Lending - Intermediation and Development Bank Functions. MDFs are either literally development banks or are institutions charged with similar functions. Their goals extend beyond credit supply to increasing the efficiency of local investment, promoting the development of service pricing and cost recovery in local investment projects, upgrading municipal financial management generally, and ensuring that critical investment projects get 82
built even when full financial cost recovery is not feasible. MDFs for the most part have addressed this range of goals by trying to bring a host of different developmental functions under their own roofs. Table 3 shows that the typical MDF, in addition to lending funds to local authorities (directly or via commercial bank), sometimes performs project appraisal from both a financial and economic perspective, blends loan funds with capital grants or subsidies for high-priority projects, oversees local project preparation and construction, provides technical assistance in financial management, and collects loan repayments, among many other responsibilities. This allows an MDF to coordinate all of the activities critical to the success of an investment project. Without coordination, local authorities may never make use of loan funds because they are hoping to become eligible for a capital grant instead, or a project may get financed but never be completed because of inadequate local implementation capacity or poor technical design. As the pre-eminent institution dealing with local government investment, an MDF can assemble the critical mass of technical expertise necessary both to improve local investment practices and serve as a comprehensive counterpart for international funding. Table 3. Functions Performed by MDFs Economic & Financial
Financial
Appraisal Construction Technical of MDF Projects Oversight Assistance No, for Little Yes Brazil small PrAM/PIMES projects Country and
Capital
Credit Assessment &
Allocation Yes
Collections Yes
PostProject Monitoring No
No
No
No
No
Subsidy
Payment
Colombia FINDETER
Yes
Yes
Yes
Czech Republic MUFIS Ecuador BEDE Honduras BANMA Indonesia RDA Jordan CVDB Kenya LGLA Morocco FEC Philippines MDF
No
No
No
None currently Yes, in past No
Yes
Yes
Yes
Yes
Yes
No
Yes
Yes
Some
Yes
No
Yes
No
Yes
Loan Forgiveness Some
Yes
No
Yes
Yes
Yes
Yes
Yes
No
Yes
Yes
Yes
Yes
Yes
No
Yes
Yes
Yes
Yes
Yes
No
Yes
Yes
Yes
Yes
Yes
No
Nonetheless, there are dangers in internalizing all of the functions associated with local government investment financing in a single institution. One danger is bureaucratic delay. In 83
performing the various roles assigned to it, an MDF may become a cumbersome bottleneck that slows down the investment process. A second danger is that a development bank empowered to perform the full range of functions illustrated in Table 3 will act as a monopolist, squeezing out competition and hampering development of a private credit market and/or local government capacity to plan and execute projects on their own. If the municipal development bank, for example, has the ability to blend subsidy funds with its loans, it will tend to underprice pure commercial lenders, forcing them to stay out of the market. If municipal authorities must utilize MDF loans in order to gain access to technical assistance, other institutions will find it difficult to compete for loan business. A strong MDF can likewise stand in the way of decentralization initiatives. MDFs often have proved reluctant to let local governments prepare investment projects on their own or set their own priorities for capital spending. The development functions that an MDF performs are critical though to improve the quality and cost efficiency of local investments. Whether these functions should be centralized in a single institution, however, is an open question. An alternative path is to unbundle the functions, so that some of them can be assumed by the private sector, once it becomes equipped to do so, and others can be performed by municipalities themselves. This strategy introduces competition into local investment design and financing, while keeping the MDF in a pivotal coordinating role. Example #1 of Unbundling: Assigning responsibility for credit analysis, credit risk, disbursements, and payment collections to commercial banks or other specialized privatesector firms. Commercial banks and other commercial lending institutions routinely conduct credit analysis and perform loan operations, i.e. disbursement and collection. In countries where private-sector banks already are functioning, such responsibilities may be more efficiently carried out by commercial banks (for a service fee) than by the MDF itself. Not only is commercial bank participation likely to boost municipal loan repayment rates and reduce MDF risk exposure (as in the Czech Republic and Colombia), but commercial banks’ participation in municipal lending as an MDF partner can hasten their independent entry into the market and clear the way for other private-sector institutions to lend to the municipal sector. Commercial lenders will be willing to assume municipal credit risk only if the risks can be well defined and limited. The same array of guarantees that have been effective in reducing MDF payment problems should be available to the commercial sector. Intercept provisions often are available only to state lending institutions though. In Brazil, the Philippines and some other countries, the law does not permit private lenders to intercept state tax-sharing payments, even if a borrowing municipality voluntarily seeks to enter into such an agreement. Limitations of this kind impede the spread of municipal lending beyond a state-sponsored MDF. One of the principal reasons for the success of FINDETER in Colombia in spreading its municipal lending model to the commercial sector has been the ability of banks and municipalities to enter into exactly the same type of voluntary intercept agreements that were included in earlier FINDETER loan contracts. In a number of countries with active capital markets, including India, independent credit rating firms also exist. These firms can be introduced to the municipal credit market by MDFs. Experience reveals that credit assessment is a function that MDFs generally perform poorly. They tend not to have highly trained such technical staff and often are restricted by political factors in awarding loans. MDF reliance on independent credit rating of municipal loan risk can both improve repayment experience and introduce to the municipal credit 84
market firms that will play a crucial role in allocating credit in a fully developed, private market. Example #2 of Unbundling: Separating subsidies from loans. Linking state capital subsidies exclusively to MDF loans would deter expansion of the credit market. Unbundling these functions need not reduce the magnitude of subsidies. Rather, the subsidy decision can be made by a different government agency or agencies, based on the characteristics of the project (e.g. its external benefits or importance to national priorities) or the characteristics of the local government seeking financial assistance (e.g. its revenue-raising capacity). In an unbundled system, the subsidy decision would be made independent of how a municipality chooses to finance the unsubsidized portion of project costs. In other words, subsidies would not be tied exclusively to MDF loans, and the municipality may raise investment finance outside of government channels. A contrast between Poland and the Czech Republic in the financing of local environmental projects is instructive in this regard. In Poland, most municipal environmental projects have been financed in their entirety through the Environmental Bank at highly subsidized interest rates. This policy delayed the introduction of a commercial credit market. Municipalities preferred to queue for subsidized loans from the Environmental Bank, rather than borrow at market rates from private lenders. In the Czech Republic, municipal environmental investments also have been heavily subsidized, initially through grants and later through zero-cost loans. However, the subsidized funding covered only part of a project’s costs. Local authorities were obligated to finance the rest of a project’s costs through own-source savings or by borrowing on the commercial market. A large number of municipal environmental projects have been co-financed by the Czech Environmental Fund and commercial banks, leading to very rapid growth in the private municipal credit market, as banks became quickly exposed to the special characteristics of municipal lending. In most countries, the share of subsidy funds in overall MDF financing has fallen over time. However, MDFs’ exclusive ability to match capital subsidies with MDF loans continues to impair market entry by other lenders.62 Example #3 of Unbundling: Decentralizing responsibility for small-scale project preparation. Small-scale projects can be a testing ground for decentralized project preparation by local governments. The technical benefits gained by having MDF staff review and approve small-scale individual projects are likely to be outweighed by the time savings gained from allowing local authorities to move ahead on their own. The experience of taking full responsibility for project preparation is an important ingredient of local capacity building. It also furthers the conditions for a competitive credit market. Municipalities that have prepared their own project specifications can “shop around” for the best financing terms. If all project designs must be prepared, or reviewed and approved, by a professional team associated with the MDF, it becomes difficult to seek financing from any source but the MDF, reinforcing its monopoly role in the field. However, central review becomes critical until local authorities have a track record of efficient project preparation.
62
In Western Europe and the United States there is experience both with unbundled subsidies and with bundled systems that tie together subsidies and loan financing. Many of the Western European MDFs, until the 1980s, raised capital noncompetitively and supplied it at below-market rates to municipalities. The Environmental Revolving Loan Funds operated by states in the United States blend market-rate capital with subsidies to on-lend at below-market interest rates. These funds generally do not have the other developmental responsibility though. 85
Even if some of the developmental functions are unbundled and performed by others, the MDF will remain responsible for a wide range of activities. However, one of the critical banking roles of monitoring outstanding loans has often been neglected. Few MDFs perform post-construction monitoring to determine if, for example, agreed tariff covenants are being implemented, or even assess the ongoing capacity (and willingness) of the municipality to service its debt obligations. World Bank follow-up studies have found that local water distribution projects, for example, rarely generate the revenues forecasted at the time of project appraisal. Although this situation jeopardizes loan repayment capacity, it is rarely monitored by the MDF financing the project. Other post-construction conditions that would provide early warning signals of a municipality's difficulty in repaying debt have also often been ignored. Issue #4: Raising Capital. MDF experience in tapping the overall capital market in developing countries is quite limited. This contrasts with the experience of MDFs in Western Europe and of Environmental Revolving Loan Funds in the United States, both of which have become efficient vehicles for mobilizing funds from the private capital market for environmental investments. All developing-country MDFs reviewed received funds from government budgets and/or from multi-lateral development bank loans. Some such MDFs also function as a type of municipal credit union, usually with banking license. Municipalities maintain deposits at the MDF at below-market interest rates; these deposits are then used to finance below-market loans to other municipalities. Such arrangements, however, are generally successful only in financing short-term loans, and are subject to the same kind of pressures as other credit unions. Better-off municipalities may prefer to invest their savings elsewhere, rather than subsidize the borrowing costs of poorer municipalities. To restrain the withdrawal of richer municipalities from the system, the law may make it mandatory for municipalities to maintain all of their savings in the MDF. This type of financing can survive as part of a regulated capital market, but once savings deposits are opened to competition, it may be difficult to sustain. Developing-country MDFs' efforts to tap the broader capital market have often involved public savings or savings subject to public regulation. BANOBRAS, the local public works financing institution of Mexico, sold its bonds to state banks, which purchased them only at government instruction. In Colombia, the MDF sold a special class of bonds to banks (largely public banks) that participated in its municipal on-lending program; the bonds were preferentially treated by the Central Bank, which allowed the banks to count them against reserve requirements. However, experience with this kind of resource mobilization has been mixed, and includes some prominent failures. The National Housing Fund of Brazil, which at one point financed a large part of the infrastructure investment associated with housing construction in Brazil, borrowed heavily from the state pension fund, but went bankrupt when it was unable to collect on its loans. At the time, this was the largest bankruptcy of a public financial institution in the developing world. BANMA of Honduras sold bonds to the national teachers’ public pension fund, which purchased them at government instruction. It became delinquent in repayment. These precedents involve government steering funds into municipal credit intermediaries. Of the institutions examined in the referred report, few have sought to raise funds in the competitive capital market, and then only under special conditions. FINDETER attempted to sell $50 million of bonds in the competitive market--a very small share of its loan funds. However, it succeeded in placing only 20 percent of the issue. The commercial banks to which the bonds were marketed saw FINDETER as a competitor in the municipal credit 86
market, and preferred to lend directly to local governments rather than finance a parastatal intermediary. Why has it proved difficult for MDFs to mobilize private sector funds? Where municipal repayment history is poor, the underlying income stream is too weak to allow MDFs to raise capital on their own. They lack a stable, predictable income stream to collateralize their borrowing. A government guarantee would be needed to make MDF borrowing creditworthy. Governments willing to provide such guarantees on behalf of an MDF have found it more convenient to borrow from the multi-lateral or bilateral development banks than to go directly to the capital market. Even where the municipal repayment record is stronger, the MDFs are often thinly capitalized and not designed structurally to attract outside financing. MDFs should be designed with access to the private capital market in mind. However, they rarely have more than nominal reserve funds, and little more than ad hoc guarantees from government. Financial intermediaries that are able to raise private-sector funds for municipal on-lending normally combine three characteristics: -
-
-
They have significant equity (in the form of a government capital contribution, for example) which can be used to augment municipal loan repayments, if necessary, to ensure that the MDF's external debt servicing obligations are met. They have a Debt Service Reserve Fund, or its equivalent, whose size is dictated by the anticipated payments for future debt service. In the United States, a Debt Service Reserve Fund equal to two years' debt service obligations is the norm. There is a moral obligations pledge on the part of the state to replenish the Debt Service Reserve Fund from its own revenues if the Fund is drawn down. This pledge can take a variety of legal forms, but its purpose is to assure the market that the state will use its budget as a last layer of security in meeting the MDF’s debt obligations.
Funds structured in this way tend to enjoy good access to domestic and international credit markets. Credit Local de France and the Municipal Bank of the Netherlands, for example, enjoy AAA bond ratings and are among the most active issuers of bonds on worldwide capital markets. Most states in the United States sponsor bond banks or Environmental Revolving Loan Funds, or both, which operate on similar principles and are active borrowers in the U.S. capital market. Furthermore, domestic private capital markets in many countries are dominated by commercial banks. MDF bonds, if sold on the private market, would have to be sold largely to banks. However, once municipal debt repayments become a sufficiently predictable and low-risk income stream to collateralize MDF bond issues, commercial banks are likely to want to lend directly to municipalities (as in the Colombia case mentioned above). Raising funds for MDF on-lending is only one (indirect) way to mobilize capital for local infrastructure investment. Commercial banks, pension funds and insurance companies can lend funds directly to local governments, or can lend to private firms that invest in basic urban facilities like water or heating distribution systems subject to municipal regulation. Capital mobilization over time is likely to be easier and more efficient in such a competitive environment, rather than in one where a single MDF enjoys quasi-monopolistic control over lending to a sector. Transition to a Market Based System of Municipal Credit 87
Two types of models have been pursued in expanding a Fund into a self-sustaining, marketbased system of credit to municipalities/utilities. -
In one model, the Fund gradually sheds its government-protected status, and instead gathers capital competitively on the open market and continues to on-lend to local entities. This model has been followed in most of Western Europe. Specialized municipal credit institutions have lost their historical monopolies, but have built on their close relations with local governments to continue to be the dominant suppliers of municipal/utility credit, but now within a competitive environment.
-
In the second model, most of the growth in the local credit supply occurs outside the Fund, through the entry of private sector institutions into the municipal/utility credit market. In this case, a Fund may: (a) be designed to phase out as the private sector gains capacity to service the credit needs; or (b) continue to play an important but limited role, by meeting the credit needs of smaller or less creditworthy municipalities/utilities.
The process of transition to competitive municipal credit supply is illustrated below with five lessons from global experience. (1) The loss of monopoly status need not shrink the scale of the MDF financing activity. In Western Europe, some municipal credit intermediaries have grown faster in a competitive environment than they did as monopolists. State budget reforms have reduced the volume of capital grants for local investment, driving up municipalities’ overall demand for credit. MDFs that have compiled strong records of municipal loan repayment have had no difficulty in accessing worldwide capital markets for funds to on-lend to local governments (2) No municipal development fund can be expected to voluntarily surrender its monopoly status or to surrender the preferential treatment it initially receives from government. Even those systems that have made the transition to open competitive municipal credit markets have had to overcome the resistance of traditional intermediaries which sought to preserve their preferential role. Rules need to be defined that gradually wean parastatal MDFs from their dependence on government capital and their exclusive ability to blend state subsidies with loan funds. (3) The experience of MDFs suggests a gradual strategy for accessing the private capital market for municipal lending. The first step beyond direct government provision of capital or IFI financing involves government assistance to MDFs in tapping the private savings market. This assistance may take the form of having government partially guarantee MDF bond issues. Alternatively, in systems which still have regulated savings and capital markets, certain sources of private savings may be steered into the municipal credit market. If this transition period is used to build up a record of reliable municipal debt repayment, graduation to the competitive capital market has proved to be relatively easy. (4) It is important to introduce the principles of collaboration between MDFs and private credit suppliers at an early stage of municipal credit market development. Early on, there may be very little interest on the part of commercial banks or other private-sector entities to enter the municipal credit market. An MDF serving as a specialized lender to the sector may provide the best opportunity to establish a standard municipal loan system. Nonetheless, even at such an early stage, MDFs can cooperate with commercial banks and other private 88
financing institutions. Both FINDETER in Colombia and MUFIS in the Czech Republic used commercial banks early on to perform credit analyses, assume credit risk, and collect loan repayments. This experience introduced banks to the municipal credit market and accelerated their independent entry into it. The process may start by one or more banks simply handling the disbursement and payment collection for a service fee on behalf of the MDF. (5) In designing municipal credit systems and the MDF structures that support them, it must be borne in mind that the objective is overall growth of municipal credit supply and overall improvement in local investment efficiency. A risk exists that a parastatal MDF may expand its activities by squeezing out private sector competition, by for example using increasingly stronger doses of government funds to subsidize its lending. An MDF that is stable in size or losing market share may be fully serving its purpose, as long as it is operating side by side with a private sector credit market that is over time becoming capable of meeting a larger proportion of local credit needs on its own. An MDF should always be judged by its impact on development of the aggregate municipal credit system. Potential Lessons for Kazakhstan International experience does not point to a single model as to how municipal development funds "ought" to be designed. It does, however, help identify critical choices that must be made in designing a Fund and the implications of these choices based on the longer term objectives of the government. For example: Is the Fund Intended to Support Decentralization or to Retain State Control of Local Investment while Reducing State Budget Costs? Many Funds maintain or even strengthen state control of local investment by establishing a powerful technical and financing authority. The loan function serves to perpetuate the institution by creating a long-term reflow of loan payments, and may reduce the cost of local investment to the state by partially substituting loans for grants. A Fund which coordinates all local investment financing inevitably exerts great control over the local investment choices, unless very clear pre-defined eligibility and selection criteria are in place. If a political choice is in favor of further decentralization, the task is to design a Fund which supports decentralization of investment responsibilities to local authorities, while recognizing possible lack of technical skills and financing capacity on the part of many local governments. Such a Fund would: -
Establish clear criteria for when a local government can “graduate” from project review by a Fund. Often a number of larger cities and metropolitan areas already have adequate capital planning and priority-setting procedures. Other cities are building that capacity. Once a satisfactory standard is reached, the Fund would relinquish responsibility to control local project selection. Local governments that graduate to this level would be responsible for their own investment choices and use the Fund only to obtain financing.
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Not rely on automatic state intercepts as the principal form of municipal loan security. Instead, local governments would be encouraged to set up reserve accounts or voluntary intercept agreements as ways of demonstrating creditworthiness. The modestly higher financial risks to the Fund would be justified by the benefits of having local governments face directly the costs of their borrowing decisions. 89
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Take financial discipline seriously, by not lending new funds to municipalities that are in arrears on past debt payments and by not awarding political bail-outs to local borrowers. Not all local governments are in a position to finance their capital investment through borrowing. Grants and state subsidies should continue to be targeted to localities that require them. Loans should not be made unless it is reasonable to expect local authorities to repay them. Assessing local creditworthiness is the key task of credit analysis. Once a loan is made, however, repayment has to be demanded. It only perpetuates dependence if higher authorities continually apply special arrangements for local governments that profess to be unable to meet their debt obligations.
Is the Fund Intended to Pave the Way for a Self-Sustaining Municipal Credit Market? If the objective is to develop a self-sustaining municipal credit market in the future, certain basic characteristics need to be incorporated into the Fund design. These measures would be intended to accelerate private sector entry into the municipal credit market. A measure of Fund success will be that its presence in the market place is limited. It will not be the sole, or necessarily the principal, source of local capital financing in the future. Rather, standardized financing for creditworthy borrowers would be turned over to the private sector, with the Fund serving only specialized segments of the municipal sector not reached by private lenders. Specific steps that can facilitate private-sector entry into the municipal credit market alongside a Fund include the following: -
Ensure that features of lending by the Fund that successfully reduce credit risk are equally available to all lenders, not only to the Fund (e.g. voluntary intercept mechanisms);
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Unbundle government grants and other subsidies for infrastructure investment from Fund loans; in this way, the credit market becomes open to market-based competition;
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Unbundle other Fund responsibilities to encourage market competition, for example municipal credit analysis. This is a pronounced weakness of most Funds worldwide. Kazakhstan may build on the experience of private-sector credit rating firms in other sectors of the economy to both strengthen the technical quality of credit rating and reduce political pressures on lending decisions;
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Require that loans from the Fund over time be made at market rates of interest, or with a positive spread over the institution's market cost of capital, so as to permit entry by costefficient competitors. Subsidies should ideally be delivered in the form of matching grants, rather than hidden as interest-rate subsidies tied to loans from a Fund;
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Tolerate, even encourage, competition in municipal credit supply. For example, private commercial bank lending and municipal bond issuance should be encouraged in due course. The government should not limit borrowing methods by regulation;
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Extend credit financing to private firms building local infrastructure projects under local government contracts on the same terms that credit is available to municipalities. Credit access should not drive the choice between public and private investment; 90
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Require that the Fund raises part of its capital in the private market as soon as possible. Initial efforts may not succeed, or succeed only in part. However, the attempt to raise market financing will help both the Fund and potential private sector competitors assess the strengths and weaknesses of municipal lending, and make clear the issues that need to be addressed in order to attract private capital. A periodic "report card" on the state of the municipal credit market is essential in moving toward a self-sustaining municipal credit system. Without injections over time of private capital, attracted on market terms, the Fund is likely to remain a sheltered, parastatal financing institution that operates outside the rest of the financial sector for a long time
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C. Supporting Housing Renovation in Multi-family Buildings This section presents a variety of international examples of financing to HOAs or their representatives for renovations of common areas of multifamily buildings. It describes cases that show how countries at different stages in the development of the housing sector have dealt with the issue. It reflect a continuum from heavy state funding in Georgia to limited bank involvement in Lithuania, to greater risk on the part of banks in Hungary and Slovakia, to largely private sector funding in the USA.63 Georgia Even in developed market economies, the financing of residential capital improvements for HOAs is complex. In Georgia, there are many obstacles concerning registration, collateral, and credit risk that stand in the way of private financing for the renovation of common areas of buildings. Government decided to experiment with a program in which large subsidies were offered for building renovations and energy efficiency improvements. In exchange, residents had to take permanent control of the building for the future. In Tbilisi, a dedicated unit in the municipal government, Tbilisi Corps, was formed specifically to assist residents through the process of becoming an HOA and applying for funding. Once formed and in operation, the HOAs could submit proposals for renovation of their common areas. The municipality provided 85 to 90 percent of the funding through a (one-time) grant, while residents paid the remaining 10 to 15 percent. One notable feature of the project is that residents are required to form an HOA in order to be eligible for the program. Another is that the application form for HOAs to submit to the municipal government is very simple. Only three pages long, the application requires only the following items: - Date, title, address of HOA - HOA chairman’s name and contact information - Description of existing problem or condition - Scope of work – based on energy audit - Timeframe - Cost sharing and plan for low-income residents - Evidence of minimum three bids from contractors - Proposed contractor – contact information, bank information - Signatures of HOA members Through the HOA, the residents manage the renovation process, including choosing the contractor themselves on a competitive basis. Indications so far are that because of the direct involvement of the HOAs in monitoring, the quality of the work is quite good. 64 One study showed that the cost of a standard elevator repair decreased to about half of what it was when the work was performed by the state maintenance company (Zhek). Surveys showed increased public satisfaction with the quality of renovations. Importantly, participation in the program made residents aware of the cost of renovations and overwhelmingly (over 90 percent) said they thought the program eliminated the possibility of corruption as compared to the old system. Additional international cases are described in Task 2 Report “Reform of the Housing and Utility Sector in the Republic of Kazakhstan – Recommendations and Action Plan” by Institute for Urban Economics, Moscow, 2010. 64 New Funding Arrangements for Repair of Multi-Story Housing Stock in Tbilisi,” Maryam Sekhniashvili and Tamara Sulukia, in Addressing Corruption in Infrastructure Services in Georgia, Loughborough University, Leicestershire, UK 2007. 92 63
Lessons from Georgia -
Simplified procedures as well as subsidies (often large) may be required as an incentive for residents to form HOAs and undertake renovations. Real savings and improved quality are the result when residents are directly involved in the selection of contractors and in monitoring the work. Large grants can be viewed by the government as an “investment” in getting out of the building maintenance business and passing on future responsibility for the buildings to residents.
Lithuania The long term vision for the Government of Lithuania was to have a system that does not depend on budgetary resources for housing. A housing modernization program was initiated some 15 years ago. Early on in the program, a coordinating entity was put in place to administer the program called the Housing Credit Foundation (HCF). At the time, the Government of Denmark paid all costs of Housing Advisory Centers in five cities providing technical assistance to HOAs, information campaigns, and a full time advisor to HCF. The name of the Housing Credit Foundation (HCF) changed to Housing and Urban Development Agency (HUDA) when HCF in the late 1990s also became the implementing agency for a Municipal Development Fund (MDF) in Lithuania for lending to municipal utility companies. They continue to provide technical assistance to HOAs, both directly, including procurement support, and through the now independent Advisory Centers. During the last ten years the HCF/HUDA has expanded to an Agency which now has 200 employees, with a very large and diverse program/project portfolio, mainly funded by EU grants. The Agency has defined standardized renovation packages for multi-apartment and public buildings, with example calculations of heating cost savings posted on their web-site (www.cpo.ltas). The Agency also provides centralized procurement services to government entities with an e-catalogue system developed in-house. The program has undergone various modifications since its commencement, and while the progress has been slow, some notable achievements have been accomplished to date: (i) about 1,000 buildings were renovated by their HOAs, and the implemented measures achieved up to 30% heating cost savings for the homeowners; (ii) HOAs that participated were highly satisfied; (iii) once a grant component was introduced, larger and more varied investments were undertaken; (iv) behavioral changes of residents with regard to building maintenance occurred over time; (v) an industry of energy consultants emerged; and (vi) some municipalities privatized their municipal maintenance companies (usually taken over by the company managers). The increase in the grant component in 2005 from 30% to 50% of the investment resulted in a strong increase in demand from HOAs.65 Total investments have been about US$30 million. The most common renovations included refurbished heating systems (sub-stations with heat regulation and balancing) and replacement of exterior doors and windows. (Note: the program considers windows in 65
However, with the global financial crisis that followed, it was not possible for the Government to offer a 50% grant component any longer. Currently, there is a program funded by EU Structural Funds with a holding fund managed by European Investment Bank (EIB). The program offers 15 year loans through commercial banks with a fixed interest rate of 3% to HOAs, and with a government grant of 15% of the investments. The demand for this new program has, however, been low. 93
individual apartments as part of the common area.) In relatively few cases, HOAs have elected to undertake the insulation of roofs and exterior walls. Generally, these measures achieved up to 30% cost savings on the heating bills for the homeowners. A “full package” of measures, including installation of a heating substation and balancing the heat distribution, replacement of windows and external doors, and insulating external surfaces (roofs and walls), reduced the energy consumption by around 50%, although only few HOAs opted for the full package. However, some problems persist: (i) commercial banks are still reluctant to lend to HOAs, although some progress has been made;66 (ii) people in HOAs have difficulty agreeing to renovations, i.e. to achieve 50%+1 vote for decisions; and (iii) the large scale renovation volumes which were initially hoped for have not fully materialized. Lessons from Lithuania -
It is important to test the demand for financing – including various combinations of grants/loans – in the early stages of a program. Strong advisory entities – well-staffed and with relevant expertise – are key to creating ‘effective’ demand and assisting HOAs through the application process. Initial involvement by a bank on a fee basis can gradually lead to greater involvement by banks later in the program.
Hungary In Hungary, a large portion of multifamily buildings (more than 20 percent of the total housing stock) was constructed in the 1970s and 80s using panel technologies that now outdated and need renovation. Inefficient energy use in an environment of escalating energy prices places a huge burden on the population in these buildings. Raiffeisen Bank together with the International Finance Corporation (IFC) has spent a considerable amount of time and effort developing a viable business model to address the needs of these buildings. A case study of the project noted that the most important lesson learned is that multi-family buildings are ‘different’ when it comes to lending; a special approach is required. 67 The challenge for a private bank in lending for multifamily housing improvements is that the HOAs that run the housing blocks have no profits, no savings, no bank account, and no real financial records. In Hungary, residents are required to form HOAs for the management of the commonly owned assets of the building. They are also obligated by law to contribute financially on a monthly basis ("common cost payments") as co-owners of the building. The association determines the minimal level of these contributions. Moreover, as the IFC report noted, “housing associations have a powerful tool in their hands to enforce payments: they have the right to originate a mortgage on the property of nonpayers.” Loans to housing associations are non-recourse in Hungary, i.e. if an HOA defaults under a loan agreement, the bank does not have the right to go after the residents. They can only go after the HOA, and it is the HOA's responsibility to collect dues from tenants. According to the bank representatives, there were relatively few instances where residents were behind on their monthly payments to the HOA, and these arrears amounted to just a small fraction of the value of the apartments. A HOA’s ability to ensure payment imposes a strong payment discipline. 66
Four commercial banks have participated to date. One other bank has agreed to take 20% credit risk on loans to HOAs. “Lending to a ‘Different Animal’: Energy Efficiency Renovation of Multifamily Housing Buildings in Hungary,” by Tibor Kludovacz, Smart Lessons, International Finance Corporation, May 2008. 94 67
Raiffeisen Bank determined that cash-flow lending would be feasible as long as: (1) the Bank had access to the cash flow of monthly resident payments to the association, and (2) the cash flow was big enough to amortize the loan. Under the program, residents agreed to increase the monthly rate for the upkeep of the common areas of the buildings, high enough to service the loan. The association made the payments to the Bank on behalf of the residents. It was left up to the association how to distribute and collect costs among residents. The Bank evaluated applications on the basis of past history of paying utility bills, tax obligations, etc. They also required documentation of a valid vote to accept the loan on the part of members of the HOA. Raiffeisen required HOAs to attach to their applications an energy audit performed by a qualified energy or building engineer listed in a regional Chamber of Commerce directory. In addition, IFC guarantees were put in place. The product offered was a portfolio level 50/50 risk-sharing between the bank and IFC. A special incentive of a small first loss account (up to 2 percent) was funded by the Global Environment Facility (GEF), a multi-donor trust fund, and provided to the bank to cover subordinated risk obligations. This first loss incentive gradually decreased to zero as the bank gained experience with the market. Apart from the IFC guarantee, the only collateral the bank has is a drawing right on the account(s) of the building. The bank offered 100% debt financing without any contribution from the HOAs. Some state money was available to supplement loan funds. The use of these funds was optional. They included: (1) a nonrefundable state grant up to two-thirds of the total investment amount for qualifying residents; (2) an interest subsidy program whereby the state covered a certain percentage of the interest charged by the bank; and (3) a state grant program complementing the savings of tenants if channeled through Building Savings Fund institutions. One of the key drivers of the market for renovation loans from Raiffeisen Bank turned out to be the poor condition of the buildings which generated strong demand from residents. The rising cost of energy also drew attention to the lack of energy efficiency in the nearly halfcentury old buildings. It became clear to residents that energy savings are maximized if residents act jointly to address the whole building envelope. By renovating their building, not only did the residents benefit from better insulation and more cost-efficient energy use, but the value of their property increased and the quality of their living environment improved. Also, the domestic market benefitted from a wide range of relatively cheap and simple locally available technology to carry out energy efficiency improvements. These typically included building insulation upgrades (including window replacement), renovation of the heat distribution network (heat exchangers, pipes, radiators, etc.) and installation of heat regulation and metering devices to allow tenants to manage their consumption. There were well-supplied and qualified local contractors. Finally, an important component of the project was strong marketing on the part of Raiffeisen. In addition to workshops, seminars, road shows, and client events, the Bank’s extensive network of agents was successful in introducing the program to residents door-todoor. Program directors also credited word-of-mouth information about renovated buildings towards helping the program.
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Lessons from Hungary -
Private bank capital, third-party guarantees, and state subsidies can be tailored in various combinations to address the renovation needs and income-levels of multi-family buildings. A strong private-sector industry of energy auditors, building engineers and private contractors is essential to implement energy efficiency measures. Banks can be active in marketing a program to prospective HOA clients.
Slovakia68 The Slovak Republic’s policies and financing programs have enabled and encouraged residents to form housing associations (HAs) and invest in energy efficiency. Notable policy measures included an increase in energy and water tariffs and a law to establish housing associations. These HAs have played an integral role in the implementation of energyefficiency projects. The policies have been accompanied by state-sponsored programs to help residents finance renovation of their homes by offering grants, low-interest loans and/or loan guarantees for energy efficiency improvements. Government assistance to finance rehabilitation of existing housing comes in three forms. One is a Construction Savings Scheme, which offers low-interest loans to upgrade existing dwellings. The scheme is run by three banks offering different products geared to different situations and income levels, including intermediate loans to clients who are unable make a down payment. Interest rates vary depending on the tenure of a loan (up to 15 years). Another is the Programme of State Support of Housing Stock Rehabilitation through which loan guarantees are provided by the state-owned Záručná a rozvojová banka (Guarantees and Development Bank). The program was launched to revitalize rehabilitation of the housing stock, including reduction of energy use, and to involve resources of banking institutions in housing development. Eligible beneficiaries are those with sufficient collateral, including condominium associations and managers engaged by apartment owners who do not want to do their own building management. Bank guarantees for maximum 10 years can be provided for up to 100% of the loan principal, up to a certain amount per apartment. Eligible projects include those to reduce the energy use in apartment buildings by at least 20 percent. Finally, the State Fund of Housing Development (ŠFRB) provides long term loans, and to a smaller extent, grants for rehabilitation that eliminate construction and design defects in old prefabricated buildings. The Fund awards financial support based on a prioritized order of submitted applications until the amount allocated to the Fund for a given year is exhausted. Some municipalities provide subsidies to reduce the interest rate on loans granted for the purpose of rehabilitation and modernization of buildings in historic neighborhoods. The subsidy, if granted, generally amounts to about 50% of the cost, subject to a per apartment maximum.
“Addressing Affordability of Utility Services in Urban Housing: Energy Efficiency Solutions,” Alliance to Save Energy Report to USAID, October 2007. 96 68
Lessons from Slovakia -
State guarantees can provide a powerful incentive for private banks to enter the multifamily renovation and energy efficiency market. Once banks are involved, a variety of loan products geared to different segments of the market will develop Private capital does not eliminate the need for state subsidies to deal with buildings in particularly bad condition.
USA In the USA, a loan is not always an HOA’s first choice for funding renovations. HOAs often designate a portion of the fee residents pay each month for upkeep and maintenance of the common property as “reserves” for capital improvements in the future. Such improvements might include roof replacement, new heating and plumbing, air conditioners, boilers, or new windows. In general, HOAs try to finance the cost of capital repairs with their reserve fund, i.e. their savings. However, sometimes the capital outlay for repairs and improvements drain these reserves. In this case, the HOA may decide a “special assessment”, i.e. an extra monthly payment by the residents for specific projects or to rebuild the reserve fund. While this may make economic sense, large special assessments/ payments may impose financial hardship and may not get approved by or collected from a majority of residents. If so, residents can instead decide to borrow the funds through their HOA from a commercial bank, securing the loan with the HOA’s future cash flow of monthly fees. The primary collateral a condominium association/ HOA have is the legal right to collect monthly condominium fees or special assessments from residents. The commercial lender typically requires that a HOA’s budget has a line item equal to the debt service of the loan and have it pledged for loan repayment. Holding the HOA’s right to assess monthly fees as the collateral, lenders can put in place a mechanism to collect monthly condominium assessments or fees from the residents to pay back the HOA loans in case the HOA were to default. Because of this risk, the HOA’s interest rates on a loan tend to be slightly higher than mortgage loans to individuals homeowners. Many lenders also require HOAs to conduct all their banking with the lender during the term of the loan, and so obtain a security interest in the HOA’s bank accounts. The question arises: if the HOA defaults on its loan payments, would a lien be placed against the property of all apartment owners, or just the apartment owners that did not pay? The lender will rely on the HOA to follow its usual policy to collect past due monthly fees from residents. While the HOA may place liens on the apartments of owners that do not meet their obligations, the HOA as a corporate entity is still responsible for the total loan repayment. This may require the HOA to pass an additional assessment (payment) against all of the apartment owners to make up any uncollected fees. In this sense, the HOA’s loan repayment is conceptually not different from any other financial obligation that is not being met by the ongoing cash flow of the HOA. Although less common, financing capital improvements that involve large investments in equipment, such as the replacement of a heating and air conditioning system, may provide the lender with security in the equipment as collateral. Lenders also protect themselves through criteria they use. Typically, no one owner or entity may be in voting control of the HOA Board and may not have ownership of more than 10% of the annual HOA budget. Residents 97
must have a strong record paying their current monthly fees on time (for example, not more than 7% of the total number of apartment owners can be more than 60 days past due on their fees). The number of apartments per HOA property should be at least 25 in order for the bank to distribute its risk. Banks also prefer that a large percentage of apartment owners (often 60% or more) to actually live in the units. That is, they do not want to see large numbers of owners who rent out their apartments rather than occupy them themselves. Since the loan is made to the HOA as a legal entity, and not its individual members, the Board of the HOA can allow each apartment owners to choose how they wish to pay their share of the loan (e.g. monthly or lump sum repayment). An important feature of a loan to a HOA is that since the apartment owner is not directly obligated for the HOA's loan, apartments can be bought and sold regardless of whether there is a HOA loan in place. Repayment obligations follows the apartment to a new owner as part of the agreement to pay fees to the HOA as a member. Lessons from the USA -
The primary form of collateral that a HOA has to offer is its ability to collect monthly fees and assessments from its members (the residents). The HOA may take legal action against individual owners who do not pay their share of loan repayment; however the HOA is still responsible for repayment. Individual apartments can be bought and sold. The obligation to repay the loan stays with the unit and is assumed by a new owner.
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Annex C. Financial Projections and Considerations Attached Excel sheets illustrate the following for considerations by the Fund when it will decide on its lending policies. Note: The projections (Excel Sheet 1 for both housing and utilities) are for illustrative purposes only, since they are based on certain assumptions and that particularly the inflation adjustments are approximate only, and administrative costs are not deducted. HOUSING (Click on the worksheet below to launch the Excel spreadsheet) Excel Sheet 1 Purpose: To illustrate how many years money would remain in a Fund on a revolving basis for continued lending to SAO/BMC/HOAs, using the following assumptions: Option 1: 40% grant, 50% loan (10years) at 10% Outcome: The money runs out year 18 Option 2a: 0% grant, 85% loan (10 years) at 0% Outcome: Beyond 30 years. Option 2a: 0% grant, 85% loan (15 years) at 0% Outcome: Beyond 30 years. Option 3: 80% grant, no loan Outcome: The money runs out year 10 Excel Sheet 2 Purpose: To determine the monthly payment for a homeowner based on different Grant percentages and Interest Rates; in particular to show that: (a) a 0% loan with no Grant, creates the same monthly payment as (b) a loan at 10% or 15%, with certain Grant percentages.
UTILITIZATION OF FUNDS FOR RENOVATION OF PRIVATELY OWNED BUILDINGS ASSUMPTIONS: Fund capital for grants / loans KZT billion 30 i.e. $207 million Deployment of the funds each year (%) 10 i.e. with 50% loan, about $10 million per year d Deployment by year in KZT billion 3 i.e. assumed flat here; in reality there would b NOTE: Average investment per building KZT 10 million (about $70,000) at 2011 level cost of works (i.e. the allocation to the Fund is depleted by inflation, unless they get it all up fron No of buildings renovated per year, Option 1: 333 buildings (assumes very high demand for the loan option) No of buildings renovated per year, Option 2: 375 buildings (assumes most HOAs can pay 20% of the cost) No of buildings renovated per year, Option 3: 353 buildings (assumes very high demand; HOAs can pay 15%) Annual increase in cost of works, i.e. inflation (%) OPTION 1: % contribution from HOAs % grant from the Fund % loan Maturity (length) of loan in years
4 10 40 50 10
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UTILITIES (Click on the worksheet below to launch the Excel spreadsheet) Excel Sheet 1 Purpose: To illustrate how many years money would remain in a Fund on a revolving basis for continued lending to Utilities, using the following assumptions: Option 1: 20% borrower contribution, no grant, 80% loan (15 years) at 15% Outcome: The money does not run out within 25 years Option 2: Outcome:
20% borrower contribution, 30% grant, and 50% loan (15 years) at 15% The money does not run out within 25 years
Option 3: Outcome:
20% borrower contribution, no grant, 80% loan (15 years) at 5% The money runs out year 16
Excel Sheet 2 Purpose: To determine the monthly payment for a Utility Company based on different Grant percentages and Interest Rates; in particular to show that: (a) a 0% loan, with no Grant, creates the same monthly payment as (b) a loan at 15%, with a 48.2% Grant, or (c) a loan at 5%, with a 23.8% Grant and that: (d) a 5% loan, with no Grant, creates the same monthly payment as (e) a loan at 15%, with a 34.8% Grant,
UTILITIZATION OF FUNDS FOR UTILITIES ASSUMPTIONS: Fund capital for grants / loans KZT billion 1,000 i.e. approximately $ 7 billion Deployment of the funds each year (%) 10 i.e. with 80% loan about $550 million per ye Deployment by year in KZT billion 100 i.e. assumed flat here; in reality probably l NOTE: Average investment per Utility Company KZT 5 billion (about $ 35 million) at 2011 level cost of works (i.e. the allocation to the Fund is depleted by inflation, unless they get it all up No of participating utilities per year, in Option 1: 16 Total # Utilities: (lending possible beyo No of participating utilities per year, in Option 2: 16 Total # Utilities: (lending possible beyo No of participating utilities per year, in Option 3: 16 Total # Utilities: 256 Annual increase in cost of works, i.e. inflation (%) OPITON 1: % contribution from Utility % grant from the Fund % loan
4 20 0 80
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