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China’sIMPROVING THE PERFORMANCE OF

URBAN WATER UTILITIES

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Greg J. Browder

with

Shiqing Xie, Yoonhee Kim, Lixin Gu, Mingyuan Fan, and David Ehrhardt

©2007 The International Bank for Reconstruction and Development / The World Bank1818 H Street NWWashington DC 20433Telephone: 202-473-1000Internet: www.worldbank.orgE-mail: [email protected]

All rights reserved

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This volume is a product of the staff of the International Bank for Reconstruction and Development / TheWorld Bank. The findings, interpretations, and conclusions expressed in this volume do not necessarilyreflect the views of the Executive Directors of The World Bank or the governments they represent.

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ISBN: 978-0-8213-7331-6eISBN: 978-0-8213-7332-3DOI: 10.1596/978-0-8213-7331-6

Library of Congress Cataloging-in-Publication Data

Browder, Greg, 1961-Improving the performance of ChinaÕ s urban water utilities / authored by Greg Browder.

p. cm.Includes bibliographical references and index.ISBN 978-0-8213-7331-6 — ISBN 978-0-8213-7332-3 (electronic) 1. Water utilities—

China. 2. Urban policy—China. I. Title.HD4465.C5B76 2007363.6'10951—dc22

2007034616

Photographs courtesy of Michael Page and Mei Xie

Foreword xi

Acknowledgments xiii

List of Acronyms xv

Executive Summary xvii

Introduction: Objectives and Scope 1Conceptual Framework 2Key Policy Themes and Strategic Directions 4Urban Water Market Segments 7Report Organization 8Data Sources 9

Sector Achievement and Performance 11Sector Achievements 11Water Supply Utility Performance 16Wastewater Utility Performance 19Chapter Summary 22

Sector Challenges 25Responding to Rapid Urbanization 26Dealing with Urban Diversity 29Confronting Water Scarcity and Degradation 31Meeting Infrastructure Investment Needs 33Improving Utility Financial Sustainability 34Chapter Summary 36

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Contents

2020 Sector Vision and Path Forward 37Sector Vision in 2020 37Benefits of Achieving the Sector Vision 40Strategic Directions and the Way Forward 42

Goal Based Sector Governance 45Overview of Sector Governance Structure 46Improving National Policy Coordination 50Shifting from Physical Targets to Policy Goals 52Strengthening Provincial Government Oversight 53Setting Appropriate Water and Wastewater Standards 58Summary of Strategic Directions 65

Improving Municipal Utility Governance and Structure 69Overview of Municipal Sector Structure 70Facilitating Cost Recovery 73Fostering Efficient Urban Water Utilities 80Managing Wastewater as a Network Utility Business 83Exploiting Opportunities for Service Aggregation 88Summary of Strategic Directions 90

Moving Up the Utility Financial Sustainability Ladder 93Achieving Utility Cost Recovery 94Accessing Domestic Credit Markets 104Improving Concessionary Finance Programs 110Summary of Strategic Directions 115

Using the Private Sector to Help Improve Municipal Utility Performance 117Private Participation Trends in China 117Engaging with the Private Sector as Part of the Reform Process 123BOT Treatment Plants as Part of a Network Business 124Utilizing Non-Investment Private Participation Arrangements 127Summary of Strategic Directions 130

Improving Capital Planning to Reduce Costs 133Capital Planning for Water Utilities 133Using Modern Water Supply Planning Processes 135Asset Management Planning: Optimizing Network Investments 137Strategic Planning and Management of Drainage Networks 140Integrating Industrial Pollution Control into a Wastewater

Management System 143Managing Sludge as an Environmental and Financial Priority 146Summary of Strategic Directions 148

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S T E P P I N G U P I m p r o v i n g t h e P e r f o r m a n c e o f C h i n a ’ s U r b a n W a t e r U t i l i t i e s

Strategic Action Plan 151

A P P E N D I X E S

Overview of World Bank’s Urban Water Program in China 155

Summary of Water and Wastewater Standards 157

Technical Notes 163

Glossary 171

References 175

List of Boxes

2.1 International Performance Comparisons 122.2 Wastewater Technical Terms 192.3 MOC’s Analysis of Wastewater Treatment Operational Performance 202.4 Overview of Tianjin Drainage System in 2005 212.5 Brazil National Sanitation Information System (SNIS) 23

3.1 China’s Administrative System and Definition of Cities and Towns 263.2 China’s Water Resources 323.3 Financial Sustainability Ladder 35

4.1 South Korea: Wastewater Treatment Coverage vs. Economic Development 384.2 Ecosystem Restoration in the Chesapeake Bay, United States 41

5.1 Agencies Involved in the Urban Water Sector 475.2 Role of National Government Agencies in Colombia 545.3 Water Utility Performance Benchmarking 575.4 Application of Discharge Standards in China 595.5 Full Cost Wastewater Pricing for Different Treatment Levels in U.S. and Europe 605.6 World Health Organization Framework for Safe Drinking Water 645.7 Grading the Safety of Water Supply Systems in New Zealand 66

6.1 General Functions of Key Municipal Agencies 716.2 Municipal Governance Models in California 786.3 Singapore Public Utilities Board 806.4 Challenges Faced by Water Supply and Wastewater Companies in

Chongqing, China 826.5 Drainage Collection Systems in U.S. and U.K. 85

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6.6 Municipal and Regional Water Services in Latin America 906.7 Case Study of Ningbo, China 91

7.1 Concept of Utility Cost Recovery 957.2 International Comparison of Cost Recovery Ranges for Water Supply 987.3 Social Acceptability of Water Tariffs in OECD Countries 1007.4 Special Purpose Municipal Investment Vehicles in Shanghai and New York 1077.5 Financing Wastewater and Water Supply Infrastructure in the United States 1137.6 Brazil’s River Basin Restoration Program 115

8.1 Definition of Key Private Participation Terms 1188.2 Integrated Water Projects with Private Partners 1228.3 World Bank Toolkit on Private Participation 1248.4 High Profile BOT Projects in China 1268.5 Mixed Capital Company in Cartagena, Colombia 129

9.1 Capital Costs in the Water Industry: England and Wales 1349.2 Water Supply Planning in State Council Decree No. 36 (2000) 1369.3 Integrated Resource Planning (IRP) Concepts 1389.4 Asset Management Planning (AMP) 1399.5 Comparison of Separate and Combined Drainage Collection Systems 1419.6 Drainage Collection Systems and Water Pollution Control 1429.7 Applying the Polluter Pays Principle 145

List of Tables

1.1 Urban Water Market Segments 8

2.1 Utility Service Area with Low Water Pressure 162.2 Non-Revenue Water for Chinese Utilities 172.3 Net Income to Revenue Ratio in 1997 and 2004 18

3.1 Urban Water Market Segments 313.2 Approximate Urban Water Sector Investments 33

4.1 Chinese Urban Water Utilities in 2020 39

5.1 Examples of Broad Policy Goals 535.2 General Supervision Responsibilities of Provincial Agencies 555.3 Summary of China’s Municipal Wastewater Discharge Standards 58

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6.1 Water Supply Utility Models 736.2 Common Wastewater Utility Models 736.3 Options for Integrating Wastewater Services 876.4 Options for Aggregation 89

7.1 Summary of Urban Water Utility Financial Status in China 967.2 Weighted Average Water Supply Tariffs by City Category, 1998 and 2004 977.3 Water and Wastewater Tariff History in Tianjin 1037.4 Suggested Municipal Government Capital Contribution Policy 1047.5 Urban Infrastructure Fund in 2004 1067.6 Per-Capita Urban Infrastructure Fund by City Type 1087.7 Indicative Ranges of Urban Water Sector Financing Sources, 1991–2005 108

8.1 Investment by Project Type 1198.2 Private Participation in the Water Supply Sector 1208.3 Private Participation in the Wastewater Sector 1208.4 Types of Entities in Private Arrangements 1218.5 Distribution of Private Participation Activity by City Type 1228.6 Wastewater Treatment Fee and BOT Price 1278.7 Responsibility Allocation for Common Arrangements 128

10.1 Summary Strategic Action Plan 152

List of Figures

1.1 Overview of the Conceptual Framework 21.2 Key Policy Themes 51.3 Strategic Directions for Key Policy Themes 61.4 Structure of Report 9

2.1 Annual Investment in Urban Water and Wastewater Infrastructure 132.2 Urban Water Supply Coverage 132.3 Urban Water Supply 142.4 Wastewater Treatment Capacity 142.5 Trends in Industrial and Urban Wastewater Discharge Flows and Loads 152.6 Actual Water Supply and Installed Treatment Capacity 17

3.1 China’s Economic Transformation and Urbanization 273.2 Urbanization Trends and Projections 283.3 Average Water Quality in Chinese Rivers from 1991–2002 333.4 Estimated Wastewater Investments in the 11th Five-Year Plan Period 34

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C o n t e n t s

4.1 Strategic Directions for Key Policy Themes 43

5.1 Overview of Chapter Five 465.2 Overview of Government Administration 465.3 Overlapping Functions among Agencies 50

6.1 General Municipal Structure 706.2 Typical Parent Bureau Models 726.3 Balancing Service Standards, Tariffs, and Subsidies 756.4 Example of a Municipal Drainage System 83

7.1 Water Supply Tariffs 977.2 Wastewater Tariffs 977.3 Combined Tariff as Percentage of Household Income in 2004 1017.4 Total Annual Expenditure for Urban Construction and Maintenance 1057.5 State Bond Program Funding for Wastewater 1117.6 China State Bond Program in Water Supply Sector 1127.7 China State Bond Program in Water Supply and Wastewater by City Size 112

8.1 Private Participation Investment Trends 120

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Providing high quality urban services is fundamental to sustainingChina’s growth. As China transitions to a market economy, municipalutilities—including those providing water and wastewater services, areevolving into commercially viable companies under government over-sight. Great challenges confront the reform process for China’s waterutilities, including rapid urbanization and emerging inequality coupledwith severe water scarcity and degradation. Cities and their water util-ities must provide services within a complex mosaic of policies and reg-ulations provided by national and provincial governments. In China, asthroughout the world, water is also a sensitive political issue. Gov-ernments are keen to provide good water service, but also attuned tothe need to ensure that tariffs are socially acceptable. This report pres-ents a strategic framework and set of recommendations for addressingthese challenges and accelerating improvements in China’s urbanwater utilities.

Since 1990, China has had remarkable success in increasing thestock of water infrastructure, expanding water supply coverage, andincreasing the percentage of wastewater that is treated. The WorldBank is proud to have contributed to these accomplishments by pro-viding around $5 billion in financing (disbursed or committed) to sup-port thirty-four urban water projects throughout China. In addition tofinancing, the Bank aims to provide value by improving planning, pro-moting financial sustainability, supporting institutional reforms, andundertaking analytical studies.

Drawing upon the World Bank’s experience in China, as well as theBank’s global knowledge, this report paints an attainable vision for theurban water sector in the year 2020. This vision entails the provision ofsafe and reliable drinking water for all, comprehensive stormwaterdrainage, and the collection and treatment of all municipal wastewater—provided by efficient and financially sustainable water utilities. The stra-tegic framework and set of recommendations presented in this report

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Foreword


xii

provide a starting point for achieving the 2020 sector vision. The devel-opment of specific policies and programs within this strategic frame-work will naturally need further research and testing, but the directionis clear and requires coordinated action from national, provincial, andmunicipal governments, as well as water utilities.

The World Bank stands ready to deepen our partnership with Chinathrough continued financing of urban water projects, as well as con-ducting additional research, sharing international experience, andengaging in policy dialogue at all levels of government. We trust thatthis report will serve as the foundation for a new generation of WorldBank support for China’s urban water sector.

David DollarChina Country Director, World Bank

Jamal SaghirDirector, Energy, Transport and WaterDepartment, World Bank

Christian DelvoieDirector, East Asia and Pacific SustainableDevelopment Department, World Bank

Keshav VarmaSector Director, East Asia and PacificUrban Development, World Bank

This study has been undertaken by a core World Bank team led byGreg Browder and comprising Lixin Gu, Mingyuan Fan, YoonheeKim, Shiqing Xie, John Smithson, Da Zhu, and Guoqian Wang.TheBank team was supported by the Tsinghua University Water PolicyResearch Center, in particular Dr. Fu Tao and Dr. Chiang Miao. TheTsinghua Center prepared background research papers, provideddata, organized stakeholder workshops in China, and reviewed andtranslated the report. David Ehrhardt, from the Castalia consultingfirm, provided advice on the strategic framework for the study and theincorporation of international experience into the analysis. The prin-ciple author of the report is Greg Browder, and the co-authors areShiqing Xie, Yoonhee Kim, Mingyuan Fan, and David Ehrhardt.

The study benefited greatly from extensive consultations withChinese stakeholders. Five consultations were held in China, including(a) an initial consultation in Beijing to define the scope of the study(October 2005); (b) mid-term consultations to provide feedback on thepreliminary recommendations (March 2006, in Beijing, Tianjin, andNingbo); and (c) final consultation in Beijing (September 2006). Thefinal version of this report was discussed with the Ministry ofConstruction in May 2007.

Key national government agencies that participated in the consulta-tions include the Ministry of Construction, the State EnvironmentalProtection Agency, Ministry of Water Resources, Ministry of Finance, andthe National Development and Reform Commission. The China NationalWater and Wastewater Association also participated in the consultations.In addition, representatives from water utilities, consulting firms, andmunicipal governments provided feedback during the consultations. Thestudy team is grateful to the Tianjin and Ningbo municipal governmentsfor organizing and paying for the consultations in their cities.

Valuable comments on a draft of this report were provided by staffof the World Bank, including Michel Kerf, Bert Hoffman, Jonathan

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Halpern, Menahem Libhaber, Aldo Baietti, William Kingdom, AxelBaeumler, Mats Anderson, Raja Iyer, Thomas Zearley, Takuya Kamata,Genevieve Connors, Alexander Danilenko, and Songsu Choi. Usefulcomments were also received from international consultants with longexperience in the Bank’s China program, including Dan O’Hearn, PeterJacques, George Taylor, and Hew McConnel. Editing and documentpreparation services were provided by Robert Livernash. Desktoppingservices were provided by Circle Graphics.

World Bank management provided valuable support and guidancefor the study, including David Dollar, Christian Delvoie, Keshav Varma,Hsiao-Yun Elaine Sun and Jamal Saghir. The study team would like toexpress its appreciation to Jamal Saghir, who participated in the finalround of consultations in September 2006 in Beijing, and helped pre-sent the study’s findings and recommendations.

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ADB Asian Development BankAMP Asset Management PlanningBOD Biochemical Oxygen DemandBOT Build Own TransferCDB China Development BankCOD Chemical Oxygen DemandCSO Combined Sewer OverflowsCWWA China Water Works AssociationDBO Design Build OperateDDD District Drainage DepartmentDRC Development Reform CommissionEPB Environnent Protection BureauGDP Gross Domestic ProductGDPST Gross Domestic Product

Secondary and TertiaryIRP Integrated Resource PlanningJBIC Japan Bank for International

CooperationJV Joint VentureMFB Municipal Finance BureauMDD Municipal Drainage DepartmentMOC Ministry of ConstructionMOF Ministry of FinanceMOPH Ministry of Public HealthMOU Memorandum of UnderstandingMWR Ministry of Water ResourcesMWWC Municipal Wastewater CompanyN Nitrogen

NDRC National Development ReformCommission

NTU Nephelometric Turbidity UnitsOECD Organisation for Economic

Co-Operation and DevelopmentO&M Operations and MaintenanceP PhosphorousPB Price BureauPHB Public Health BureauPPP Purchasing Power ParityPRC People’s Republic of ChinaPSP Private Sector ParticipationRMB China Yuan Renminbi SEPA State Environmental Protection

AgencySOE State Owned EnterpriseSS Suspended SolidsTOT Transfer Own TransferUDIC Urban Development Investment

CompanyUNEP United Nations Environment

ProgrammeVAT Value Added TaxWHO World Health OrganisationWRB Water Resources BureauWS Water SupplyWW Wastewater WWTP Wastewater Treatment Plant

List of Acronyms

China has made remarkable progress in ex-panding its urban water supply and waste-water infrastructure since 1990. Driven byabout RMB 438 billion ($54 billion) in spend-ing, water supply and wastewater coverage inChina’s 661 designated cities has increaseddramatically. The share of the urban popula-tion served by municipal water supply utilitiesincreased from 50 percent in 1990 to 88 per-cent by 2005. Over the same period, waste-water treatment capacity has tripled. As of2006, municipal plants had the capacity totreat 52 percent of the wastewater generatedin urban areas. Industrial water use has de-creased, and the growth in domestic water usehas slowed due to increases in water tariffsand conservation measures. Municipal pollu-tion discharges into the environment, al-though still high, have decreased. Addressingfuture challenges, however, will require notonly more investment, but new approaches to:

� Enhance governance and regulation atthe national, provincial, and municipallevels

� Boost utility operational and financialperformance

� Increase user fees � Ensure adequate fiscal support� Explicitly recognize the constraints

facing lower capacity cities and towns

This study reviews China’s accomplish-ments in providing urban water services,identifies the major challenges, and recom-mends directions for the future. It aims toprovide an assessment of where the sectorstands today and to create a strategic frame-work for policy discussions, project design,and reform efforts. The scope of the study islimited to urban water supply and waste-water (including stormwater) management.It only touches upon the important associ-ated issues of water resources and waterquality management. The World Bank isassisting China in other endeavors toaddress these issues.

China’s government has embarked on sec-tor reforms to achieve the nation’s environ-mental and public health objectives. TheState Council, National Development andReform Commission (NDRC), Ministry ofConstruction (MOC), State EnvironmentalProtection Agency (SEPA), and othernational government agencies have issued avariety of directives on water pricing, utilityregulation, wastewater treatment, privatesector participation, and other reform prior-ities. A vision of the sector is emerging wherewater supply and wastewater services areprovided by utility companies operatingunder an effective regulatory system. Thesecompanies are generating revenues through

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Executive Summary

user fees set at cost recovery levels, accessingcapital markets for finance, and performingat high levels. The vision entails the provisionof safe and reliable drinking water to all resi-dents, economically efficient stormwaterdrainage, and the collection and treatment ofall municipal wastewater. This vision isattainable for all cities by 2020, althoughlarge and prosperous cities may achieve thesegoals faster than China’s thousands of smallerand less affluent cities and large towns.

Sector ChallengesIn its quest to achieve this sector vision,China will confront the following challenges:

Responding to rapid urbanization. China isexperiencing the greatest wave of urbaniza-tion in history. The official urban populationis expected to increase from about 550 mil-lion in 2005 to about 900 million in 2020.Providing urban water services to new resi-dents and dealing with new spatial patterns ofurban development, particularly in boomingmetropolitan areas, will be a demanding task.

Dealing with urban diversity. China in-cludes a wide spectrum of cities and towns,from large and rich super cities such as Bei-jing and Shanghai to thousands of smallerand poorer cities and towns. China’s poli-cies, standards, and approaches for urbanwater services will need to be tailored tomeet the economic and environmental real-ity of different types of cities. To deal withthis issue, this study has classified Chinesecities into two groups:

� High-capacity cities. This includes allcities with a per-capita GDP greaterthan RMB 24,000 ($3,000) regardlessof population, or any city with a popu-lation greater than 500,000 and percapita GDP of RMB 12,000 ($1,500.)

As of 2005, there were approximately150 such cities with a total populationof 200 million—about one-third of theurban population.

� Low-capacity cities. This includes allother cities and towns in China, includ-ing around 500 designated cities, andthe 1,635 county capital towns, with atotal population of around 400 million.

The concept of “high” and “low” capacitycities, and the criteria used to classify them,has been constructed to facilitate policy dis-cussion. The intention is to underscore thatsome cities—that is, “high-capacity” cities—can aspire now to standards of urban waterservices enjoyed by high-income countries,such as those belonging to the Organisationof Economic Co-operation and Development(OECD). In contrast, “low-capacity” citiesface constraints typical of lower-middleincome countries around the world, and itwill take time and government support totransition to higher service standards.

Meeting investment demands. The growthin urban population, combined with aspira-tions to improve the quality of water ser-vices, will require an accelerated capitalworks program. As shown in Table 1, theestimated investment needs for 2006–10alone are expected to be approximately

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TABLE 1. Approximate Sector Investments

Total EstimatedInvestment Investment1991–2005 2006–10

Sector US$ RMB US$ RMBInvestment billion billion billion billion

Water Supply 25 200 20 160Wastewater 29 230 34 270Total 54 430 54 430

equal to investments over the last 15 years.Financing these investments, and ensuringinvestment efficiency, is a major challenge.

Confronting water scarcity and degrada-tion. China is characterized by water scarcityin the northern regions of the country and byseverely degraded water quality throughoutthe country. Per-capita water availability inthe 3-H basins of north China (Hai, Huai,and Huang) is around 500 m3/year, which iswell below the 1,000 m3/yr standard forwater stress. In 2003, over 40 percent ofChina’s river stretches were classified asseverely polluted. China’s coastal waters suf-fer from widespread eutrophication, includ-ing large-scale, toxic red tide of algae. Inspite of extensive efforts to improve waterquality and ensure reliable water supplies,seasonal shortages and polluted waterresources will continue to pose problems.

Water UtilityPerformanceThe financial and operational performanceof water utilities (both water supply and

wastewater) provides a focal point for evalu-ating urban water services. Figure 1 illus-trates at a conceptual level where China’sutilities stand now, and where they could beby 2020. The key findings related to utilityperformance are summarized below.

Wide spectrum of utility performance.Many Chinese utilities operate at levels sim-ilar to most middle-income countries, butbelow the average for advanced industrialcountries (e.g. OECD countries) However,there is a very wide distribution of perform-ance: some utilities perform well, whilemany others operate well below their poten-tial. Although there is some correlationbetween city size and utility performance,and city wealth and utility performance, therelationship is not particularly strong. Table2 provides an example based on percentageof water service area with low water pres-sure. This observation highlights the poten-tial for quickly improving performance if thepractices of the well-performing utilities areadopted by other cities.

Financial performance. In 2004, 60 per-cent of water supply utilities in China

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E x e c u t i v e S u m m a r yDi

strib

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Chi

nese

util

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Bad Belowaverage

Average Aboveaverage

Good

Performance relative to OECD utilities

Year 2005

Dist

ribut

ion

of C

hine

se u

tiliti

es

Year 2020

Bad Belowaverage

Average Aboveaverage

Good

Performance relative to OCED utilities

FIGURE 1. Illustrative Evolution of China’s Water Utilities

reported negative net incomes, indicatingthat most of the companies were experienc-ing financial stress. Although there is nocomprehensive data for the wastewater sec-tor, the financial state of wastewater entitiesis certainly more precarious than that ofwater supply utilities. The national weightedaverage water supply tariff has increasedmore than 50 percent since 1998, and nowstands at around 1.5 RMB/m3 ($0.20). Start-ing in the late 1990s, most cities begancharging wastewater tariffs, and the 2005national average is 0.75 RMB ($0.10). Theserates, particularly for wastewater, are stillinsufficient to cover the full operating, main-tenance, and capital costs. In addition, thecollection of wastewater fees is a problem inmany cities, particularly from industries.Most utilities still rely on municipal govern-ment equity contributions to finance a sig-nificant part of their investments.

Operational performance. China’s watersupply utilities generally provide 24-hourservice, but the quality of the service is vari-able. As shown in Table 2, one-quarter of thewater utilities are unable to provide ade-quate water pressure to more than 40 per-cent of their service area. Around 60 percentof China’s 661 cities face seasonal watershortages, and over 100 cities have severewater constraints. On average, around 20 percent of the water produced at thewater treatment plant is lost through leakydistribution pipes. Although a 20 percent

leakage rate appears good by internationalstandards, this is largely because of China’scompact, high-density distribution net-works. When the leakage rate is calculated interms of water loss per kilometer of pipeline,Chinese utilities have exceptionally highrates of water loss. Many cities have sig-nificant excess water treatment capacity, reflecting poor water supply planning prac-tices. On a national scale, there is at least 50 percent excess treatment capacity.

China is rapidly constructing wastewatertreatment plants; as of 2005, 364 out of 661 cities had plants, with a national ca-pacity to treat around 45 percent of allwastewater. The average plant hydraulic uti-lization rate, however, was only 65 percent.The relatively low utilization rates stem froma variety of problems, including inadequatewastewater collection, poor planning, and ashortage of operating funds. Wastewaterinfluent concentration is also often signifi-cantly lower than the design value, furthercontributing to the underutilization. Expan-sion and renovation of wastewater collectionnetworks has lagged behind treatment plantconstruction. Inadequate collection systemsin many cities result in excessive stormwaterinflow and groundwater infiltration into thedrainage pipes, stormwater drainage prob-lems, and overflows of untreated wastewaterinto receiving water bodies.

Information gaps. Analysis of China’swater utilities is complicated by the lack of

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TABLE 2. Percentage of Utility Service Area with Low Water Pressure

Large and Rich Cities Medium Cities Small and Poor Cities City Type (%) (%) (%)

Average 12 10 16Best 25% of Utilities 0 0 0Worst 25% of Utilities 45 33 46

information on utility performance. TheChina Water Works Association and occa-sional surveys by the Ministry of Construc-tion provide some information, but utilityperformance assessments are still inadequateand incomplete. The problem is particularlyacute for wastewater, where many waste-water utilities are either government depart-ments or operate on a quasi-department basiswith significant municipal government bud-get support. This study relies on a myriad ofdifferent—and often incomplete—sources ofinformation. Although the general picturethat emerges is clear, the resolution of somespecific features may be blurry.

Benefits of ImprovingWater Utility PerformanceAs shown in Figure 1, with the right govern-ment policies and programs, Chinese waterutilities could perform at a level equal to orhigher than utilities in OECD countries. Thedistribution of utility performance couldalso be much smaller. Water utilities shouldimprove as China’s economy grows andbecomes more sophisticated and moreclosely resembles OECD countries. More-over, China’s water utilities must dramati-cally improve if China is to meet futurechallenges. The benefits of achieving the2020 vision are considerable and include:

Environmental improvements. RestoringChina’s heavily polluted waters will takedecades and will require continuous effortsto control municipal, industrial, and agricul-tural pollution. Pollutant loads from indus-trial and domestic sources have decreasedfrom around 22 million tons of COD in 1995to 13 million tons in 2004. By 2020, totalindustrial and domestic pollution loadscould be reduced to 3 million tons of COD orlower. Based on other countries’ experience,

receiving water quality will improve aftercontrolling municipal and industrial pollu-tion, but sustaining a healthy ecosystem is amore complex endeavor that involves man-aging urban and agricultural runoff, as wellas toxic chemicals.

Protection of public health. Water pollu-tion endangers public health through a vari-ety of mechanisms, including (a) pollutingdrinking water sources; (b) contaminatingseafood, particularly in the extensive coastalaquaculture zones as well as capture fish-eries; and (c) transmitting diseases throughcontact in rivers, lakes, and coastal waters.Quantifying the linkage between water pol-lution and public health is complex andbeyond the scope of this study, but thehealth impacts of water pollution are clearlya major issue in China. The unreliable andlow-quality water service in many citiesincreases the risk of exposure to pathogensand toxic chemicals, and is a significantpublic health risk. Unreliable water suppliescan also impact public health by hinderingbasic washing and sanitation. Improvingdrinking water quality will certainly reducethe rates of illness and morbidity, althoughmore research is needed to quantify theimpacts.

Economic benefits. Providing urban waterservices is an important part of the nationaleconomy. In 2005, annual capital invest-ments in the sector accounted for about 0.4 percent of GDP, and operating costs forat least another 0.6 percent of GDP. If utili-ties can improve the efficiency of their capi-tal investments by one-quarter—a target thisstudy finds very plausible—economic sav-ings to the country would be on the order ofRMB 100 billion ($12.5 billion). Most impor-tantly, economic activity, particularly forindustries and commerce, depends vitally onan adequate water supply. Environmental

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E x e c u t i v e S u m m a r y

improvements and protection of publichealth also generate direct and indirect eco-nomic benefits.

Enhance equity. Inequality is a seriousand growing problem in China along threedimensions: (1) between rural and urbanresidents; (2) among cities, particularly be-tween those in coastal provinces and otherparts of China; and (3) among residentswithin cities. Adopting specific policy meas-ures for urban water services that take intoaccount and help compensate for these dif-ferences will help to alleviate some of thesocial tensions associated with inequality.

Achieving a Sustainable BalanceA water utility’s performance depends on anumber of factors that must be bundledtogether in a balanced manner to ensuresustainability and efficiency. The key com-ponents of the bundle are conceptually pre-sented in Figure 2. The next few paragraphsdiscuss the components in general, followedby a summary of the situation in China.

Service standards. A water utility’s servicelevel depends partly on the applicable na-tional standards, such as drinking water ormunicipal wastewater effluent. Municipalgovernments also have a large influence onservice targets by specifying requirements

such as separate stormwater and wastewatercollection systems; the level of water supplyreliability; and water supply and wastewatercoverage targets. The higher the service standards—all other things being equal—thehigher the utility’s costs. In most countries,there is a strong correlation between thelevel of economic development and the ser-vice levels that can be sustained. For ex-ample, Korea did not start its nationalwastewater management program until themid-1980s when it had reached a GDP percapita of $7,500.

Utility operational efficiency. The moreefficient a utility, the lower the overall costsfor a given service level. Efficiency is neededacross all business areas, including capitalplanning decisions, staffing levels, quality ofoperations and maintenance, and commer-cial practices such as billing and collection.Until the 1980s, most water utilities inOECD countries were government monopo-lies that had little incentive to improve effi-ciency. Since then, however, the cost ofproviding water services has increased sig-nificantly due to requirements for environ-mental improvements, high-quality watersupplies, and constraints on water resources.Many utilities have come under pressure tocontinuously reduce costs and provide betterservice. The response in many countries hasbeen to make utilities more autonomous andcommercial (corporatization), or to bring inprivate firms to provide some or all of theservice.

User fees. Water users, and wastewaterdischargers, are required to make at leastpartial payments for the services provided bya utility. Revenues from users depend notonly on the tariff levels, but also on the abil-ity to bill and collect what is due. The tariffstructure is also important in providing theright economic signals and ensuring equity,

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Costs Costrecovery

Service standardsand

utility efficiency

User feesand

fiscal transfers

FIGURE 2. A Sustainable Utility Balance

while at the same time generating sufficientrevenue for the utility. This study estimatesthat, in OECD countries, at least half of thewater utilities receive sufficient user rev-enues to cover all operation and mainte-nance costs and partial capital costs.

Fiscal transfers. Many water utilitiesthroughout the world, and most wastewaterutilities, rely to some measure on govern-ment transfers. These transfers can take var-ious forms, such as grants or concessionaryfinance by national governments, municipalgovernment equity contributions, operatingbudget, etc. In the United States, for exam-ple, the federal government has providedover $75 billion (RMB 600 billion) in grantfunds since 1972 to support wastewatertreatment plant construction.

China’s Water Utilities Have Not YetReached a Sustainable BalanceThe fundamental finding of this study is thatmost of China’s water utilities are confront-ing a combination of factors that have notallowed them to achieve a sustainable bal-ance. Service standards, particularly nationalstandards, are set at levels equal to or aboveOECD countries and may be beyond thecapacity of many of China’s cities to attain.Many utilities, particularly for wastewater,operate at low levels of efficiency under thesupervision of municipal governments with alack of accountability, transparency, and cus-tomer orientation. These factors drive up thecost of providing the service.

Many utilities are unable to cover theircosts. This renders them incapable of achiev-ing service targets, and constrains themfrom investing in the human resources orinfrastructure necessary to meet those tar-gets in the future. User fees, while graduallyincreasing, are still below the cost-recoverylevel, particularly for wastewater. Govern-

ment transfers, whether through capital oroperating contributions, are typically notenough to cover the shortfall in user fees.Utilities cope by deferring asset renewal andexpansion, not servicing their debts, or cut-ting back in maintenance and operations.

To solve these problems, confront futurechallenges, and achieve China’s vision forthe sector, the following sections layout astrategic framework centered on five inter-related themes presented as presented inFigure 3.

Adopting Goal-basedSector GoveranceIn the past, under China’s planned economy,performance was measured in terms ofachievement of physical targets, such askilometers of pipeline or treatment plantcapacity. The focus for the future should beon utility performance to achieve China’sgoals, including improving the environment,protecting public health, and providing goodquality service to all at reasonable cost. Thisstudy recommends the following approaches

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Sector governance

Utility governanceand structure

Privateparticipation

Financialsustainability

Capitalplanning

2020SectorVision

FIGURE 3. Sector Policy Star

to move toward goal-based governance forthe sector:

Improve National Policy CoordinationThere are four main sector agencies at thenational level that guide the urban water sec-tor: the Ministry of Construction (MOC),State Environmental Protection Agency(SEPA), Ministry of Water Resources (MWR),and Ministry of Public Health (MOPH). TheNational Development and Reform Commis-sion (NDRC) and Ministry of Finance (MOF)provide overall development policy and finan-cial supervision to the sector. While the StateCouncil issues key national policy statements(such as the historic 2000 Circular on“Strengthening Urban Water Supply, WaterSaving, and Water Pollution Prevention and Control”), the various specialized sectoragencies each issue a multitude of opinions,notices, circulars, etc. These are not alwaysconsistent, provide ambiguous guidance tocities, and may even be contested by othersector agencies. Figure 4 illustrates conceptu-ally the overlapping areas of responsibility.

Prominent examples of areas of policyincoherence include the disconnect betweenSEPA guidance on the application of waste-water discharge standards and MOC con-

cerns on whether high levels of wastewatertreatment are technically and financiallyviable for many cities. Many cities have estab-lished “Water Affair Authorities” that reportto MWR and are mandated to provide inte-grated water management and superviseurban water utilities, yet MOC still issuesmost of the policy guidance related to urbanwater utilities. MOPH, in conjunction withChina’s National Standardization Admin-istration, issued new drinking water stan-dards in 2007 that will require water supplyutilities to take actions to upgrade theirsystems. In 2005, MOC also issued “sectorrecommended” water supply standards.Moreover, each sector agency produces avariety of sector reports, but often from a lim-ited perspective. MOC may report on infra-structure construction progress, for example,while SEPA focuses primarily on pollutioncontrol. A national-level “status report” ofwhere the sector stands in terms of providingadequate urban (and rural) water supplieswould be great help for policy makers.

Differences of opinion and perspectiveamong different sector agencies—and otherstakeholder groups—are natural and neces-sary for good governance in the water sector.There must also be forums for open debate,mechanisms for policy research, and proce-dures for coordination and reconciliation ofcompeting views. This study recommendsthat the State Council establish a NationalWater and Sanitation Committee under aDeputy Prime Minister, with one ministryserving as the Secretariat. The committeewould not be a new agency, but rather becomposed of representatives from the rele-vant national agencies, as well as otherstakeholder groups. The committee couldmeet on a monthly or quarterly basis, withspecialized ad hoc working groups. It couldcoordinate national policy formulation, inte-

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MoPH MOC SEPA

MWR Urban water

resourcemanagement

Water supplyquality standards

Wastewaterstandards

Water qualitymanagement

FIGURE 4. Overlapping Areas of Responsibility

grate decision-making among the differentsector agencies, and monitor sector per-formance and development. In order to befocused and effective, the committee’s man-date should be limited to water supply andsanitation, in both urban and rural areas.

Strengthen Provincial Government OversightAlthough urban water services are theresponsibility of the municipal government,it is important to have an effective oversightand monitoring mechanism to ensure thatcities and their utilities meet their obliga-tions. China is too large for the national gov-ernment to oversee thousands of utilities,and provincial governments are best placedto provide utility oversight and regulation.Provincial agencies already have many keymandates for utility oversight, including (a)utility supervision (construction depart-ments); (b) approval of municipal tariffs(price department or DRC); (c) channelingnational concessionary finance (DRC); (d)overseeing environmental compliance (EPB);(e) overseeing drinking water compliance(public health department); and (f) approvalof large construction projects (DRC). Theefforts of provincial agencies, however, areoften hampered by lack of funds and realauthority over municipal governments, aswell as lack of coordination among provin-cial agencies.

This study recommends that provincialgovernments increase the budget and capacityof their provincial agencies and more vigor-ously exercise their oversight role for urbanwater services. Similar to the national gov-ernment, provincial governments also needto improve policy coordination among thedifferent sector agencies. This study alsorecommends that provincial governmentsestablish “Provincial Water and Sanitation

Committees” or create new “Provincial WaterOffices” that would consolidate urban waterregulatory and oversight functions into oneoffice.

Set Appropriate Water andWastewater StandardsChina should aim to have standards that are:

� Affordable to ensure the service isfinancially sustainable

� Enforceable to allow regulators to com-pel compliance

� Efficient to enable policy objectives tobe met in a least-cost manner

The way China applies standards nowdoes not fully meet these criteria, particu-larly for low-capacity cities. For example,SEPA’s Circular No. 110 issued in 2005requires all municipal wastewater treatmentplants that discharge into key water resourceprotection areas and enclosed water bodiesto meet Class 1A standards. This standardrequires expensive tertiary treatment for thereduction of two nutrients, nitrogen andphosphorous. The standard also mandatesextremely low levels for biological oxygendemand and suspended solids (10 mg/l).Although such high standards may be war-ranted on environmental grounds givenChina’s highly degraded waters, it does notmeet the requirements of affordability andefficiency. The standard effectively requiresmany cities to go from no wastewater treat-ment to technologically advanced andexpensive plants. This will help reduce waterpollution, but may not be economically effi-cient. Much of China’s water pollutioncomes from runoff of fertilizer applied toagricultural land, large-scale livestock oper-ations, and urban stormwater runoff. Pol-lution control measures for these sources are

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just beginning in China, and putting moreresources into these activities would yieldgreater marginal returns than tighteningmunicipal treatment standards.

This study recommends that China usetransitional wastewater standards for low-capacity cities and manage water quality froma watershed perspective. Cities and townsthat cannot afford Class I or Class II stan-dards could start by ensuring full collectionof wastewater and low-cost, simple waste-water treatment. As their level of economicdevelopment improves, these cities couldupgrade their treatment facilities and transi-tion into compliance with national stan-dards. Provincial governments could be incharge of determining which cities andtowns should be subject to transitional stan-dards. Provincial governments, and theirspecialized agencies, should also be respon-sible for developing economically efficientwater quality improvement plans and en-suring that adequate administrative andfinancial mechanisms exist to implementhigh-priority pollution control activities.

China’s updated drinking water standards,promulgated in 2007 (GB5749-2006), havefeatures that this study recommends forwastewater management. The standard con-tains 42 items that are classified as “regularparameters” and apply to the whole country.The remaining 64 “non-regular parameters”will only apply to cities that meet certain cri-teria. The non-regular parameters includeless common microbiological and toxicolog-ical compounds, particularly pesticides andsynthetic organic compounds. As of 2007, thecriteria for cities that must meet all require-ments have not been specified, but presum-ably these will be larger and more affluentcities. By 2012 all cities must meet the stan-dards for both regular (42) and non-regular(64) parameters. The standard is flexible in

that it distinguishes between higher andlower capacity cities, and provides discretionto the provincial government regarding howto apply the standard (42 regular or 106 regular and non-regular parameters). Thestandard also requires all cities to providereasonable minimum water quality by com-plying with all regular parameters, whichaddresses the core issues. Finally, the stan-dard uses a transitional approach, whichallows cities to gradually upgrade their facil-ities by 2012.

The new drinking water standard has ele-ments of flexibility, transition, and dis-cretion that are a great step forward fromprevious approaches. However, this studyrecommends a more realistic time frame forcompliance with the new standard. High-capacity cities could be required to meet thefull standard (106 items) by 2012 at a mini-mum. Meanwhile, provincial governmentsshould ensure that all cities comply with theregular parameters (42) as soon as possible.The timing for lower capacity cities to meetthe full standard should be realistic andcould be left to the discretion of provincialgovernments. This study also recommendsthat provincial agencies undertake compre-hensive and systematic evaluations of thesafety of municipal drinking water systemsand grade their performance. The informa-tion should be made public, and municipal-ities should be encouraged to improve theirwater safety grade.

Improving MunicipalUtility Governance and StructureMunicipal governments and their utilitiesoperate within the framework provided bynational and provincial policies. Different

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models of structuring the urban water sectorhave emerged throughout China, some ofwhich function better than others. In gen-eral, however, there is still huge potential forimproving the efficiency of urban water util-ities by modifying utility governance andstructure. We have three recommendations:

Streamline and Coordinate Municipal Utility GovernanceMunicipal governments will need to improvetheir capacity to govern and regulate publicutilities, while at the same time empoweringthe utilities to play the leading planning,financing, and operating role in the sector.In many cities, multiple city agencies makefundamental decisions and provide advice tothe mayor and his vice mayors—on infra-structure targets, financing, tariffs, andbudget transfers—without having a holisticview of the sector. Creating more integrated,accountable, and transparent city gover-nance structures for the sector would helputilities achieve a more sustainable balance.It would also provide them with the institu-tional space to become modern organiza-tions responsible for their own destiny, butunder the leadership of the government. Insome countries, cities have created “WaterBoards” to help overcome coordinationproblems. These boards are typically ap-pointed by the municipal government andempowered to make decisions (or recom-mendations) on key utility proposals, suchas tariffs, budget transfers, capital pro-grams, etc. This study recommends that high-capacity cities experiment with stream-lined utility governance structures, such as aWater Board or a multi-sector Public UtilitiesCommission. Lower capacity cities shouldmake a concerted effort to coordinate the dif-ferent government agencies overseeing waterutilities.

Empower Municipal Utilities and Hold Them AccountableAlthough most water utilities are becomingmore autonomous and commercialized,many still tend to function as implementingagents of government bureaus and respond topolitical directives. Moreover, water utilities,like many other state-owned-enterprises,have a culture of complacency and do notstrive for excellence. This study recommendsthat municipal governments empower utilitiesto take more responsibility for key corporatefunctions such as strategic master planning,capital improvement plans, developing fi-nancing strategies, formulating cost-recoverystrategies, human resource development,monitoring and regulatory compliance, etc.Some water utilities in China, particularly inlarger and richer cities, are already close tobecoming international standard water com-panies; the majority, however, are still under-performing. A culture of continuous utilityimprovement should be encouraged by na-tional, provincial, and city governments. Thiscan be realized through a commitment totransparency, customer orientation, monitor-ing and evaluating performance against otherutilities and improvements over time, and thejudicious use of the private sector. Profes-sional organizations and research instituteshave an important role to play in fostering anew culture of excellence.

Manage Wastewater as a Network Utility BusinessMany cities in China have the view thatdrainage is a public good that should befinanced and managed by a governmentdepartment, whereas wastewater treatmentis a commercial activity and should be paidfor by user charges and managed by a com-pany. This view is contrary to internationalpractice. Approximately two-thirds of invest-

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ment costs and about half of the operatingcosts of a typical wastewater system arerelated to the complex pipe networks andpumping stations scattered throughout thecity. Collecting and conveying wastewater tothe treatment plant is a prerequisite for suc-cessful wastewater management. Moreover,wastewater utilities have no control overindustrial pollution discharges into the mu-nicipal system. The industrial dischargerscan adversely affect the drainage network aswell as interfere with the treatment process,potentially resulting in noncompliance withwastewater discharge standards and con-taminated sludge (i.e. residual solids) fromwastewater treatment plants.

The typical institutional arrangement forwastewater in China is fragmented. Frag-mentation of the service usually takes twoforms: (1) separation of drainage collectionand treatment; and (2) in large cities, drain-age collection is split between district andmunicipal drainage bureaus. This fragmen-tation often leaves the city without an entitywith overall responsibility for the planning,financing, and operating of the wastewatersystem, including front-line responsibilityfor industrial dischargers. Moreover, theseinstitutional arrangements hide the trueoverall cost of wastewater service, which canbe significantly more expensive than watersupply. Obscuring the costs inhibits costrecovery. In OECD countries, integratedwastewater utilities, often combined withthe water company and considered part ofthe same service, are the norm. Integratedwastewater utilities should be the target inChina as well.

This study recommends that municipalgovernments explore options for integratingwastewater service and recovering collectionsystem costs from users. Some options forintegrating the service include:

� One utility company owns andmanages all drainage network andtreatment plant assets.

� The treatment company enters into alease contract for the drainage network.

� The treatment company enters intomanagement contracts with the gov-ernment drainage bureaus.

� A “Wastewater Group” is formed thatputs all organizations under a singlemanagement team.

Pursue Opportunities for Aggregating Urban Water ServicesWater utilities are typically organized alongadministrative boundaries. Aggregating ser-vices across administrative jurisdictions orfunctions can potentially generate benefitsfrom economies of scale, more professionalmanagement, and improved access to fi-nance. Many Chinese cities and towns, how-ever, are trying to independently addresstheir urban water problems, rather thancooperating with their neighbors. Potentialapproaches for aggregating service include: i)creating water and wastewater utilities withregional infrastructure in metropolitanareas; ii) creating multi-city water conces-sions where one utility serves a number ofsmall cities or towns with separate infra-structure; and iii) combining water andwastewater utilities in the same city. TheStudy recommends that provincial andmunicipal governments explore options forextending urban water infrastructure to subur-ban towns, as well creating regional water util-ities which service multiple towns and cities.

Moving Up the FinancialSustainability LadderFinancial sustainability can be conceptual-ized as a ladder. As utilities take over more

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financing responsibility and rely more onuser fees rather than government transfers,they move up the ladder. Moving towardcost-recovery tariffs and greater reliance oncapital markets for investment generatesstrong incentives for utility efficiency. It alsoenhances accountability to users who mustpay for the service and to lenders who re-quire repayment. Cost-recovery tariffs alsoallow the utility to operate in a more com-mercial manner and reduce its dependenceon government transfers. The pace andextent to which utilities can move up theladder depend in part on the city’s level ofeconomic development.

Ensure Utility Cost Recovery from User FeesThis means that a utility can generate suffi-cient revenues from user fees to cover itsoperating and maintenance costs and debtservice. Revenue from user fees should alsobe adequate to fund a percentage of the util-ity’s capital needs, preferably enough to atleast systematically renew its existing assetbase. A utility’s debt service costs can bereduced by government equity contribu-tions, grants, and concessionary finance.This study recommends that all cities haveuser fees that cover the utility’s costs andadopt financing strategies along the followinglines:

� High-capacity cities. Water supply andintegrated wastewater utilities (i.e.drainage and treatment utilities)should finance all capital investmentsthrough capital markets, private in-vestment, and internally generatedcash with full cost recovery tariffs. Theone exception is that municipal gov-ernments may wish to continue financ-ing drainage investments to control the

growth in tariffs. Under this scenario,the combined (water supply and waste-water) weighted average tariff wouldneed to more than double by 2010from the 2005 national average ofaround 2.5 RMB/m3 ($0.30) to over 6 RMB/m3 ($0.75).

� Low-capacity cities. Water supply utili-ties, and especially integrated waste-water utilities, will continue to needequity contributions, grants, and con-cessionary finance to keep tariffs atsocially acceptable levels. Moreover,low-capacity cities should be subject toless stringent transitional water andwastewater quality standards to reducecosts. Under this scenario the com-bined (water supply and wastewater)weighted average tariff would need to at least double by 2010—from a2005 national average of around 2.0 RMB/m3 to around 4.0 RMB/m3.

Raising tariffs is one method of increasingrevenues. Of equal importance is improvingfee collection and utilizing efficient rate struc-tures. Although Chinese cities are rapidlyinstalling water meters at the household level,smaller cities are lagging in this respect. Col-lection of wastewater fees is a common prob-lem. In China, wastewater tariffs are includedon the water bill and collected by the watersupply company. In some cases, the watercompany does not diligently collect thewastewater tariffs nor pass the funds on tothe wastewater utility. Collecting wastewatertariffs from large industries with their ownwater source is also difficult. Municipal gov-ernments should work to ensure these short-comings are resolved and the wastewatercompany receives its entitled revenue.

Designing appropriate tariff structures isan important element in helping utilities

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increase revenues, protect the poor, and sendthe correct economic signals. The pace atwhich tariffs can be increased is inhibited bythe potential impact on the lower incomesegment of the population. There is consider-able international experience with designinglow-income support programs that could beapplied in Chinese cities to allow an acceler-ation of tariff increases while protecting thepoor. Tariff structures, which are predomi-nately volumetric-based, could also be ad-justed to send better economic signals,improve the reliability of utility revenues,and potentially increase overall utility rev-enues. These measures include increasingblock tariffs, fixed and variable tariff compo-nents, and load-based wastewater tariffs.

Make More Use of Debt FinancingChina’s strong economy has created a highlevel of liquidity in the domestic banking sys-tem, and Chinese banks are encouraged tolend to creditworthy municipal utility com-panies. This has created a golden opportu-nity for water utilities to tap into domesticcredit markets to finance investments.Utility companies in many economicallyadvanced countries take on high levels ofdebt, often over 50 percent of total assets,because they operate in a low-risk environ-ment. Chinese utilities, in contrast, typicallyhave much lower debt-to-asset ratios, andrely more heavily on municipal governmentsfor finance. Because aggregate informationon water utility capital financing is lackingin China, this study produced its own gen-eral estimate of financing sources in Table 3.

Because municipal governments in Chinacan not borrow directly and there are manycompeting uses for governments funds, fi-nancing capital works through utility debt isgenerally more attractive than governmentcontributions. Moreover, to the extent that

utility debt service is paid by user fees, debtfinancing is more economically efficient as the users pay directly for the service,whereas municipal government funds comethrough general taxation.

Many Chinese banks, however, are hes-itant to lend directly to utility companiesbecause of concerns about repayment capac-ity. This study therefore recommends thatChinese cities should transform their finan-cially stressed utilities into creditworthy enter-prises that can fund an appropriate share oftheir capital program through commercialdebt. As China’s financial markets evolve andbecome market-oriented and sophisticated,improving the credit status of municipal util-ities will become even more important. Thenational government can also facilitate better access to debt financing by allowinglonger maturity bank loans and providinggreater latitude to water utilities to issueenterprise bonds.

Create Incentive-BasedConcessionary Finance ProgramsChina’s national government provides signif-icant levels of finance to the urban water sec-tor. The two main instruments are the China

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TABLE 3. Indicative Ranges of Urban WaterSector Financing Sources: 1991–2005

Water Waste-Supply water

Financing Source (%) (%)

Municipal Government 20–30 40–50Domestic Banks 20–30 10–20State Bond Program 10–20 20–30Private Sector 10–20 10–20China Development Bank 10 5International Financial 5 10

Institutions (WB, ADB, JBIC)

Development Bank (CDB), which offers long-term loans, and the NDRC-administeredstate bond program, which offers long-term,low interest loans and grants. These twosources account for around 25 percent of allsector financing. These financing mech-anisms, however, could be further refinedthrough structured programs similar toother countries that promote policy objec-tives by adopting clear priorities, eligibilitycriteria, appraisal standards, legal cov-enants, project monitoring, reporting, andprogram evaluation. Creating incentive-based grants and loans can be a strong driverfor reform. Concessionary finance is also animportant tool for ensuring equity, particu-larly for smaller cities and towns with morelimited financing alternatives. Currently,most of the CDB and state bond funds go tolarger prefecture level cities.

This study recommends that the nationalgovernment restructure existing concession-ary finance programs (or develop new ones)for the urban water sector. There are manydifferent options that need to be studied andpursued, but the following principles shouldguide the reforms:

� National government funding for theurban water sector should be signifi-cantly increased.

� More funding should be channeled tolow-capacity cities and towns.

� Provincial governments should takethe lead in designing and administer-ing concessionary finance program(s).

� The program(s) should be structured to provide the right incentives, withcarefully designed eligibility criteria,appraisal procedures, and monitoringand evaluation activities.

� A range of financing instrumentsshould be considered, including loans,

grants, revolving loan programs, creditenhancements, output-based aid, etc.

Use the Private Sector to Help ImproveMunicipal UtilitiesCities throughout China have turned to the pri-

vate sector to finance, construct and operate

water supply and wastewater treatment plants.

There are over 50 water supply projects, and

well over 100 wastewater projects in China

with private sector participation. (the exact

number is not known). Some municipal water

supply companies are also forming joint ven-

tures with private companies. This flurry of

private participation brings new stakeholders,

capital, and expertise into the sector, but it also

needs to be managed properly to ensure sus-

tainable arrangements.

This study has two general recommenda-

tions on private participation. First, municipal

governments and their utilities should engage

with the private companies as part of an over-

all reform process to ensure a sustainable util-

ity balance. Most importantly, if user fees and

fiscal transfers are inadequate, then regardless

of whether ownership and/or operation is pub-

lic or private, the service will not be sustain-

able. BOT arrangements need to be handled

with special care to ensure that overall sector

funding is adequate to meet the obligations of

the BOT contract and the requirements of the

water supply and drainage networks.

Second, the general approach in China is

that private companies must “pay to play,”

meaning they must invest their own funds if

they are to participate in the sector. There

are, however, many non-investment models

that could beneficially be employed in China,

including management, affermage, lease, and

design-build-operate arrangements. These non-

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investment private arrangements are particu-

larly attractive for cities that (a) do not have

financing constraints, but want to improve the

performance of their utility; or (b) cities where

the investment risks are large, particularly in

low-capacity cities.

Improve Utility CapitalPlanning to Lower CostsThe urban water business is capital intensive,so good decisions on infrastructure invest-ment can lower costs and improve service.Many cities and utilities in China have defi-ciencies in planning, often rooted in inappro-priate policies, institutions, and incentives.Another contributing factor is that utilities arestill building up their expertise and learningfrom international and domestic experiences.This study identifies two important areas forcapital planning.

Water supply planning. Water supply plan-ning needs to become more sophisticated andparticipatory to meet complex challenges.New and innovative options are being pursedto address water shortages, such as develop-ing new water sources, long-distance watertransfers, reallocation from agricultural tomunicipal use, water reuse, demand manage-ment through tariffs, reducing water leakage,encouraging water conservation, etc. Whilethese actions have a potential role to play inmeeting urban water needs, most cities stilldo not employ sophisticated water planningmethodologies that explicitly consider multi-ple objectives, uncertainty, and risk in orderto determine the optimal resource mix formeeting their urban water demand. In partic-ular, economic, financial, and environmentalobjectives are often not fully factored intowater supply planning exercises, which tend

to be driven by physical planning approachesor are policy-driven.

Investments in water supply and drainagenetworks. Investments in water supply anddrainage networks need to be better planned.Upgrading and expanding water supply andwastewater pipes and pumping stations willconstitute around 70 percent of future in-vestments. The proper planning of these in-vestments holds huge potential for savings.Developing asset management programs(AMP)—which collect information on existingassets (particularly buried pipes), use sophis-ticated methodologies for analyzing the data,and link investments to overall service goals—are becoming standard practice for utilitiesaround the world. This approach should beused in China too. Utilities should also care-fully consider the costs and benefits of two different types of drainage systems: (1) com-bined systems, which convey both wastewaterand stormwater; and (2) separate drainagesystems. Separate drainage systems, whichare increasingly popular in China, can cost upto double combined systems, and the environ-mental benefits may not in some cases bejustified. Low-capacity cities should avoidseparate collection systems.

A Strategic Action PlanTable 4 provides a summary of the keystrategic recommendations. Designing poli-cies and programs to implement thesestrategies requires sustained attention andcommitment by all levels of government,utilities, professional organizations, advo-cacy groups, businesses, and citizens. To thisend, the World Bank stands ready to assistChina with financing, project and programdesign, studies, and policy dialogue.

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TABLE 4. Strategic Action Plan

Responsible Parties

State Council and National Agencies

Provincial Government and Agencies

National and Provincial Agencies

Municipal Governments and Agencies

Municipal Governments and Utilities

State Council, NDRC, and National Agencies

Time

2008–10

2008–12

2008–12

2008–12

2008–10

2008–10

Strategic Recommendation

Adopting Goal-Based Sector Governance

Improve National Policy Coordination:• National Water and Sanitation Committee

Strengthen Provincial Oversight:• Increase Agency Funding and Capacity• Provincial Water Committee or Office

Set Appropriate Water and Wastewater Standards• Low Capacity Cities Use Transitional Standards

Improving Municipal Governance and Sector Structure

Streamline Municipal Utility Governance: • Water Boards or Multi-Sector Commissions

Empower Municipal Utilities• Utilities Take Over Core Corporate Functions• Increase Accountability and Transparency

Manage Wastewater as a Network Utility Business• Integrated Drainage and Treatment Management• Charge Users for Drainage Service

Exploit Opportunities for Aggregation of Services• Metropolitan Utilities with Regional Infrastructure• Utilities Serving Multiple Cities

Moving Up the Financial Sustainability Ladder

Ensure Utility Cost Recovery from User Fees• Tariffs Cover O&M, Debt, and Asset Renewal• Governments Partially Finance Drainage Works• Concessionary Finance for Low-Capacity Cities

Make More Use of Debt Financing• Enhance Utility Credit Status through Cost Recovery

Improve Concessionary Finance Programs• Increase National Government Funding • Develop Incentive-Based Programs• Target Low-Capacity Cities

(Continued)

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TABLE 4. Strategic Action Plan (Continued)

Responsible Parties TimeStrategic Recommendation

Private Participation to Improve Municipal Utilities

Private Participation to Improve Municipal Utilities• Private Participation As Part of Sector Reform• Utilize More Non-Investment Arrangements

Improve Capital Planning to Reduce Costs

Improve Capital Planning• Improve Water Supply Planning• Develop Asset Management Planning (AMP)• Strategic Selection of Drainage System

Municipal Governments and their WaterUtilities

Water Utilities

2008–on

2008–on

How can China sustain and improve urbanwater services as it makes the transition to amarket economy, undergoes rapid urbaniza-tion, and confronts extreme water resourcedegradation? This study provides a pano-ramic view of the sector, identifies key chal-lenges and strategic approaches for thefuture, and aims to assist Chinese policymakers in formulating a reform agenda forthe next decade. It also seeks to establish aframework for World Bank policy discus-sions with China’s government, therebyenhancing the effectiveness of Bank support.

China is experiencing the greatest wave of urbanization in history. The urban pop-ulation has increased from 300 million in1990 to around 550 million in 2005, and isexpected to grow to as much as 900 millionby 2020.1 In addition to limited water sup-plies across much of the country, China alsohas some of the most polluted rivers in theworld and its coastal waters are on the brinkof ecological collapse. Urbanization and itsintersection with water resources and waterquality—one of China’s great developmentchallenges—is the subject of this report.

A decade ago, the World Bank’s ChinaUrban Environmental Service Managementreport provided an overview of the chal-lenges. This 1995 report highlighted the poorstate of water supply infrastructure and the

almost complete absence of municipalwastewater treatment. Water prices wereunsustainably low and public utilities ineffi-cient. Since then, the situation has improvedsignificantly. Large investments have beenmade in upgrading water supply and waste-water infrastructure, and water and waste-water tariffs have increased. Domestic andinternational private companies are nowactively involved in the sector. There are still,however, many large and complex financial,institutional, and technical challenges ahead.

Given China’s size and diversity, the studyidentifies strategic directions to pursuerather than specific solutions. It providesillustrative examples from Chinese and inter-national experiences. Clearly, Chinese mu-nicipalities, provinces, and the nationalgovernment will need to develop their owntailor-made solutions.

The scope of the study is limited to urbanwater services. As used here, urban areasmean China’s 661 designated cities, all of which have populations greater than200,000 people. This analysis can also beextended to large towns and towns sur-rounding large cities. Urban water servicesmean the provision of water supply, storm-water drainage, and wastewater manage-ment. Since stormwater and wastewater areclosely linked through combined drainage

1

1 IntroductionObjectives and Scope

systems in most Chinese cities, the term“wastewater” refers to both services unlessotherwise noted. The study focuses prima-rily on the issues of utility performance, notwater resources and the environment. TheWorld Bank is working with China in otherendeavors to help address critical waterresource and environmental issues.

Conceptual FrameworkFigure 1.1 provides an overview of the con-ceptual framework.

The key elements in the conceptual frame-work are the following:

Current Performance. We first examinethe current performance of urban utilities.Chinese urban utilities currently perform, onaverage, in a manner consistent with othermiddle-income countries such as Brazil orRussia. Water supply coverage is generallygood, although the quality and reliability ofthe service is highly variable among cities.Most cities have well-developed sanitarydrainage systems. The overall wastewater

2


FIGURE 1.1 Overview of the Conceptual Framework

Improved Performance of Urban Water Utilities: 2020 VisionBenefits: 1) Improve public health and environment 2) Reduce costs 3) Enhance equity for poor cities 4) Relieve financial burden on municipal governments 5) Promote economic development

Current Performance • WS coverage = 90%

• WW treatment capacity = 52%

• High variation in WS utility performance

• WW not managed as utility business

• Underinvestments in WS and WW networks

Challenges• Rapid urbanization

• Urban diversity

• Efficiently meeting investment needs

• Water scarcity and degradation

• Achieving financial sustainability

Policies for Better Performance• Goal-based sector

governance

• Municipal utility governance and structure

• Financial sustainability

• Efficient utilities

Achievements over Last Decade✓ Significant infrastructure

investment

✓ Tariff increasing toward cost recovery

✓ Local and international PSP

✓ Stabilization in water demand

✓ Reduction in water pollution

China’s Unique Context

✓ Rapid economic growth: planned to market economy

✓ Three levels of government:

National → Provincial → Local, highly decentralized

✓ Unitary political system: policy compliance promoted by party

✓ Under-developed legal system and capital markets

treatment rate, while still low, is rapidly ex-panding. However, most urban wastewatermanagement systems are not operated asutility businesses. Many such systems per-form poorly, both financially and opera-tionally. The combination of tariffs andgovernment subsidies is generally adequateto sustain operations, but there is systemicunderinvestment in water distribution andwastewater collection networks.

Achievements. The achievements inChina’s urban water sector over the lastdecade have been remarkable. China’s urbanwater industry—in parallel with the coun-try’s overall rapid development—has beentransformed through investments equal toaround 0.4 percent of annual GDP.2 Waterservices are no longer perceived as beingprimarily a public good to be provided by thegovernment, but rather as a quasi-privategood provided in a commercial manner withusers bearing most of the costs. Domesticand international companies are keenlyinterested in China’s urban water marketand private investment is flowing into thesector. Finally, China has made significantprogress in stabilizing overall water demandas industry has become more efficient, andconsumers are reacting to higher prices andwater conservation efforts. Significantstrides have been made in controlling overallmunicipal and industrial pollution. Receiv-ing water quality, while still bad, does notappear to have deteriorated over the last tenyears.

Challenges. In spite of China’s achieve-ments, the challenges are daunting:

� Urbanization. The country’s urban population is expected to increasefrom around 550 million in 2005 to at

least 900 million in 2020, fueling thedemand for more infrastructureinvestments.

� Urban Diversity. China is a large and diverse country, with a wide spectrum of wealth among its cities. Cities suchas Shanghai strive to become economi-cally dynamic global centers of excel-lence, while smaller and poorer cities, mainly in the west and northeast of thecounty, confront economic stagnation,unemployment, and deteriorating infrastructure. Crafting realistic sectorpolicies to meet the wide variety ofurban situations in China is a complexbut necessary endeavor.

� Water Scarcity and Degradation. Much of China is arid, and water pollution isa problem throughout China. Securing reliable high-quality water supplies, and improving water quality in rivers,lakes, and costal waters, will require asustained national effort.

� Investment Needs. Overall investmentneeds are large and growing, due to increases in urban populations and national aspirations to address waterpollution and scarcity issues by adopt-ing higher service standards.

� Utility Financial Sustainability. Thelarge investment needs, combined with higher operating costs, will putpressure on cities and their utilities tobecome more efficient and financiallysustainable.

China’s Specific Context. Meeting futurechallenges will require policy approachesthat fit the country’s political and economiccontext. Four broad factors dominate China’sdevelopment and influence the overall evolu-tion of the urban water sector. First, China istransitioning from a planned economy to a

3

I n t r o d u c t i o n

market economy. This transition has fueledan unprecedented spurt in economicgrowth, with annual GDP growth averagingclose to 10 percent per year over the lastdecade.3 The transition has also left a legacyof government institutions and policies thatoriginated during the planned economy erastruggling to define their role in a more mar-ket-based economy. Second, China has aunified political system headed by the Com-munist Party that has evolved in a specifichistorical context. Government policy ismade and implemented through a com-bination of legal mechanisms and partyinfluence. Third, China has a complex multi-tiered government administrative systemthat is highly decentralized. Local govern-ments play a dominant role in infrastructureservice provision and financing, whilenational and provincial governments focusprimarily on policy and regulatory matters.Finally, given the size and sophistication ofChina’s economy, it has a relatively under-developed legal system and capital marketstructure, though they appear to be evolvingquickly.

2020 Sector Vision. A vision of what thesector could look like in 2020, if appropriatepolicies and programs are pursued, is pre-sented in this study and includes:

� Large and rich cities provide high-quality water and wastewater services,and establish stormwater quality man-agement programs. Utilities operate atinternational standards and rely oncapital markets and user fees, butwastewater utilities still receive somemunicipal government capital contributions.

� Smaller and poorer cities provide reli-able water supply and treat all waste-

water to an intermediate level. Utilitiesare financially sustainable and rely onuser fees for their revenues, but alsoreceive municipal equity contributionsand national concessionary finance tomaintain acceptable tariff levels.

The benefits of adopting the strategic recom-mendations and achieving the sector visionare significant and warrant attention fromnational, provincial, and municipal govern-ments. Improved utility performance, interms of increasing the amount of waste-water collected and treated, and improvedwater supply quality and reliability wouldresult in environmental and public healthbenefits. Improved efficiency would lowercosts for a given level of service and helprelieve the financial strain on cities andtheir citizens. The study recommends spe-cific policies for addressing the disparitiesamong cities in China, such as conces-sionary finance programs and appropriateservice standards. Finally, improving invest-ment and operational efficiency in a sectorthat accounts for around 1.0 percent ofChina’s annual GDP will help promote over-all economic development.4

Key Policy Themes and Strategic DirectionsThe key elements of the urban water sector,as presented in Figure 1.2, are interrelatedand must be in balance for urban water util-ities to perform efficiently. Definitions of keyterms are presented in the glossary.

Goal-Based Sector Governance. In thepast, under China’s planned economy, per-formance was measured in terms of achieve-ment of physical targets, such as kilometersof pipeline or wastewater treatment plant

4


capacity. The focus of the future should be onefficient urban water utility performance asa means to achieving the nation’s goals,including improving the environment, pro-tecting public health, and providing goodquality service to all at reasonable prices.New targets—such as improvements inambient water quality, safe drinking waterand reliable service, and cost-efficient service delivery—should take the place ofphysical targets. This requires developingconsistent policies, setting appropriatewastewater discharge and water supply qual-ity standards, and ensuring effective regula-tory systems at the national and provinciallevels. Because standards in China may beunattainable for many cities and regulatorysystems are weak, municipal governmentsand their utilities do not have strong incen-tives to provide high quality and efficientservices.

Municipal Utility Governance and Struc-ture. Provision of urban water services isthe responsibility of local governments inChina. The policies and practices of the

municipal government set many of theparameters in which the utility operates,including tariff and subsidy policy, appoint-ing utility management, determining theextent of utility transparency and account-ability, and defining the scale, scope, andauthority of urban water utilities. Manyurban water utilities are not able to performefficiently because municipal governmentsdo not provide a suitable framework of poli-cies, practices, and organizations.

Financial Sustainability. Two financialparameters dominate in the urban waterindustry: cost recovery levels and access tofinancing. A significant problem confrontingmany urban water utilities is the lack of bal-ance between standards, such as drinkingwater supply and wastewater treatment stan-dards, and the utility’s ability to recover itscosts. High standards result in expensiveinvestments that utilities are not able tofinance or sustain due to low levels of costrecovery. Although there is scope for increas-ing user fees, there are limits to the rate ofincrease that would be socially acceptable.The study suggests that a utility’s costs—andthus required cost recovery levels—can bemanaged through a combination of appropri-ate standards, improved utility efficiency,municipal government equity contribu-tions, and more effective national conces-sionary programs. Even with lower utilitycosts for a given level of service, there is a clear need to increase revenues in most Chinese cities, particularly for wastewaterservices. Provided there are adequate costrecovery levels, Chinese utilities also shouldbe able to take greater advantage of China’slarge and liquid capital markets.

Private Participation. The potential forwater utilities to perform well is deter-

5


FIGURE 1.2 Key Policy Themes

Sector governance

Utility governanceand structure

Privateparticipation

Financialsustainability

Capitalplanning

2020SectorVision

mined largely by three factors: (a) sector gov-ernance; (b) municipal utility governanceand structure; and (c) level of financial sus-tainability. These factors provide the in-centives that ultimately determine waterutility performance. Rather than addressthese fundamental issues, many munici-pal governments—encouraged by national policy—turn to the private sector to help pro-vide better service. The study suggests thatmunicipalities should first understand theroot causes of municipal utility under-performance and then select, design, andimplement the appropriate private sectorarrangement as part of an overall reform program.

Capital Planning. More than any otherutility business, capital investment decisions

have a profound effect on overall water andwastewater costs. There is considerable po-tential for lowering costs through improvedcapital planning, particularly for water supplyplanning, water distribution and wastewatercollection network renovation, selection ofcombined versus separate drainage collectionsystems, and indus-trial wastewater treat-ment plant sludge management.

For each of the five general policy themes,the study develops strategic directions (seeFigure 1.3) for consideration by national,provincial, and municipal governments, aswell as utility managers. These recommenda-tions need to be further developed and refinedbefore their actual application, but they pro-vide a set of interconnected policy enhance-ments to help improve the performance ofurban water utilities.

6


FIGURE 1.3 Strategic Directions for Key Policy Themes

Policy Themes Strategic Directions

Goal Based Sector Governance • Improve National Policy Coordination• Shift from Physical Targets to Policy Goals• Set Appropriate Water Supply and Wastewater Standards• Enhance Provincial Government Oversight

Municipal Utility Governance and Structure • Streamline Municipal Utility Governance• Foster Efficient Utilities• Manage Wastewater as a Network Utility Business• Exploit Opportunities for Service Aggregation

Financial Sustainability • Achieve Utility Cost Recovery• Make More Use of Debt Financing• Improve National Concessionary Finance Programs

Private Participation • Ensure Private Arrangement Fits Into Sector Reform Plan• BOT Treatment Plants Fit Into Utility Network Business• Make More Use of Non-Investment Arrangements

Capital Planning • Utilize Integrated Water Planning Methodologies• Develop Asset Management Planning (AMP)• Strategically Plan and Manage Drainage Systems• Manage Sludge as Environmental and Financial Priority

Urban Water Market SegmentsTo facilitate policy analysis and internationalcomparisons, we developed definitions of dif-ferent urban water market segments inChina. China’s national policies in the urbanwater sector tend to be general in nature.They are often directed at the highest capac-ity cities, which then serve as models forother cities. China’s statistics generally organ-ize data by city population size and geograph-ical region, which is a useful first step, but donot explicitly consider the level of economicdevelopment.

Three Categories Used for Empirical Anal-ysis. Chinese cities vary widely in terms ofpopulation, wealth, and climatic conditions.We examined the variables that influence acity’s capability to provide good water andwastewater service. We assumed that the per-centage of installed wastewater treatmentcapacity (i.e., capacity of treatment plant(m3/day) as a percentage of municipal waste-water) in 2005 is a good proxy for the city’stechnical and financial capacity. The percent-age of wastewater treatment was used as adependent variable, and correlated with thefollowing independent variables: population,GDP per capita, and climate. The statisticalanalysis revealed good correlation betweenthe level of economic development (GDP percapita) and the percentage of wastewatertreatment, and also between population andwastewater treatment percentage. The weakcorrelation between city size and per-capitaGDP indicates that there are many relativelyaffluent smaller cities. Hence, both city sizeand level of economic development need to betaken into account when considering capac-ity to deliver water services. The correlationbetween climate and wastewater treatment

percentage is relatively weak; cities in thewater-rich south of China are as likely ascities in the water-poor north to have waste-water treatment. Based on this analysis, wedeveloped the following typology to helpstructure the discussion about different watermarket segments.

� Category I: Large and Developed Cities: (a) population greater than 2 million;and (b) GDP per capita greater than$3,000.

� Category II: Medium Cities: All citiesthat are not Category I or Category IIIcities—these generally (although notexclusively) fall between the incomeand size boundaries of Category I andIII cities.

� Category III: Small and Developing Cities: (a) population less than 0.5 million;and (b) GDP per capita less than$1,500.

These categories are different than thoseused by the Ministry of Construction (MOC).The MOC only considers a city’s popula-tion, and not its level of economic develop-ment. In 2005, China had 661 officiallydesignated cities. In addition, there were1,636 county-level towns—with 96 millionurban residents—that serve as the seat ofcounty governments.5 The Ministry of Con-struction (MOC) has collected summarydata on water supply and wastewater ser-vices for these “county towns;” most of themshare similar characteristics with CategoryIII cities. All are under 500,000 in populationand generally have GDP per capita less than$1,500. Unless otherwise noted, data on Cat-egory III cities does not include the countytowns (disaggregated information was notavailable). For policy-related issues, how-ever, county towns and Category III citiescan be considered as a group.

7


Table 1.1 presents the China urban watermarket segments used in the study, andsummarizes population and urban waterservice coverage for each segment.

High- and Low-Capacity Cities. The clas-sification of cities into three categories is use-ful for empirical analysis, but unwieldy forgeneral policy discussions. Moreover, thereare some Category II and III cities with per-capita GDP above $3,000 that bear moreresemblance to Category I cities. Likewise,there are some Category I and II cities withper capita GDPs below $1,500. Rather thancreate multiple city categories, we used thefollowing classification when discussing pol-icy recommendations:

� High-Capacity Cities. This includes allcities with a per-capita GDP greaterthan $3,000 regardless of population, aswell as cities with a population greaterthan 500,000 and per capita GDP of atleast $1,500. As of 2005, there wereapproximately 150 such cities with a

total population of 200 million—aboutone-third of the urban population.

� Low-Capacity Cities. This incorpo-rates all other cities and towns inChina—including around 500 desig-nated cities and the 1,636 county capi-tal towns—with a total population ofaround 400 million.

The concept of “high-” and “low-” capacitycities, and the criteria used to classify them,is intended to facilitate the policy discussion.The intention is to underscore that somecities—“high-capacity” cities—can aspire toOECD standards of urban water services. Incontrast, “low-capacity” cities face many ofthe constraints typical of lower-middleincome countries around the world. Thestudy explores the policies and approachesfor these two different types of city.

Report OrganizationThe study organization is illustrated in Fig-ure 1.4. Chapter 2 provides an analysis of

8


Average AverageWastewater Water

Number Total Per Capita Treatment Supply of Population GDP Coverage Coverage

Market Segments Cities (million) (RMB) (%) (%)

Category I: Large and 21 90 35,900 61 93Developed Cities

Category II: Medium Cities 331 201 19,100 38 91

Category III: Small and 310 58 7,300 21 86Developing Cities

County Towns 1,636 96 NA 11 82

Source: MOC, China Urban Construction Statistics Yearbook (2005).

TABLE 1.1 Urban Water Market Segments

the achievements and current performanceof China’s urban water utilities. Chapter 3 dis-cusses the challenges ahead, while Chapter 4describes a vision of what the sector couldlook like in 2020 and the benefits of achiev-ing the vision.

Chapters 5–9 are the key policy chaptersand are organized around the four key policythemes. Each chapter generates a set of strate-gic directions that China should pursue forenhancing the performance of its urban waterutilities. Chapters 5–8 deal primarily with pol-icy-related issues. Chapter 9 discusses sometechnical issues related to capital planning.Chapter 10 summarizes the recommendedstrategic directions.

Data SourcesInformation on sector financial and opera-tional performance in China is difficult toobtain or nonexistent. The decentralizednature of municipal infrastructure service,and the nontransparent sector managementcombined with relatively weak regulatorysystems, has resulted in a shortage of reli-able data. We relied on a myriad of differ-ent—and often incomplete—sources of data.Although the general picture that emerges isclear, the resolution of some of the specificfeatures is not. Key sources of informationinclude: (a) annual statistical yearbooks andreports by the MOC and State Environ-mental Protection Agency (SEPA); (b) ChinaWater Works Association yearbooks; (c) the2005 North China Water Study jointly spon-sored by the World Bank and the MoC; and(d) studies produced by the Asian Develop-ment Bank on China’s urban water sector.

The research benefited from extensiveconsultations with Chinese stakeholders,which partly compensated for the patchydata. Five consultations were held in China,including: (a) an initial consultation to definethe scope of the study in Beijing (October2005); (b) mid-term workshops to providefeedback on the preliminary recommenda-tions in Beijing, Tianjin, and Ningbo (March2006); and (c) final consultation in Beijing(September 2006). During the consultations,the Chinese stakeholders were allowed toquantitatively and qualitatively evaluate therelevance of the strategic issues and the ap-propriateness of the approaches.

The study also utilizes the World Bank’sextensive project experience over the past twodecades. As shown in Annex 1, the World Bankhas played an active role in the sector andaccumulated extensive experience in a varietyof settings. In total, the Bank has financed over

9


FIGURE 1.4 Structure of Report

Chapter 1: Introduction • Study Objectives• Conceptual Framework

Chapter 10: Strategic Sector Action Plan • Action at the National, Provincial, Municipal, and Utility Levels • Approaches for Different City Categories • Time Frame for Implementation

Chapter 5: Goal-Based Sector Governance Chapter 6: Municipal Utility Governance and Structure Chapter 7: Moving Up the Financial Sustainability

Ladder Chapter 8: Using the Private Sector to Improve

Municipal Utilities Chapter 9: Improving Capital Planning to Reduce Costs

Chapter 2: Sector Achievement and PerformanceChapter 3: Sector Challenges Chapter 4: Sector Vision and the Path Forward

25 projects with urban water components inChina since 1987. We also used general (i.e.non-China) World Bank reports on water sup-ply and sanitation to identify key concepts anduseful international experience.

Notes1. The estimated urban population of 550 million

includes 340 million people living in 661 desig-nated cities, about 110 million living in 1,464county towns, and another 100 million in 18,428towns. The figure does not include floating pop-ulation in urban areas. The floating populationmeans non-registered urban residents; estimatestypically range from 50–100 million people. The2020 estimate is based on an annual growth rateof 1.25 percent and a target of around 55 percenturbanization rate.

2. Sector investment figures were derived fromthe China Urban Construction Statistics Year-

book (2005) and GDP figures from the WorldDevelopment Indicators (2006).

3. World Bank Development Indicators (2006), on-line version.

4. Based on note 2 above, the sector investmentsaccounted for around 0.4 percent of GDP in 2004.Revenues from water and wastewater tariffs areestimated to account for around 0.5 percent. Forestimating sector revenues, an average water sup-ply tariff of RMB1.4 and wastewater tariff of RMB0.5 were used. The water supply amounts aretaken from the China Urban Construction Statis-tics Yearbook (2005), and the wastewater wateramounts were estimated at 45 percent of watersupply. Information on government transfers foroperating expenses (as opposed to tariffs) is notavailable, but should account for at least 20% ofrevenue from tariffs (0.1 percent of GDP), thus thetotal minimum percent of GDP is 0.4 percent(investments) + 0.5 percent (tariff revenue) +0.1 percent (government transfer) = 1.0 percent.

5. MOC, County Towns Statistical Brief (2004).

10


Chinese cities have made remarkable prog-ress in building infrastructure and expand-ing water supply and wastewater services.But many of China’s water and wastewaterutilities can significantly improve theirperformance with respect to operationalefficiency, financial sustainability, and cost-effective investments.

As shown in Box 2.1, on average, the per-formance of Chinese utilities is comparableto other middle-income countries such asBrazil or Russia, but still far below OECDcountries such as the United Kingdom.Moreover, there is a wide variation in per-formance among utilities, both between andwithin the urban water market segments—indicating that the potential exists forrapidly increasing performance within theexisting institutional and policy context. AsChina’s economy grows and becomes moresophisticated, China should also ensure thatits utilities’ performance improves over time.

Briefly, China’s urban water situation hasthe following characteristics:

� Urban water supply coverage has in-creased from 50 percent in 1990 to 90 percent by 2005, and overall munic-ipal water use has remained stable.Many Chinese cities still suffer fromseasonal water shortages.

� Chinese cities have well-establishedwater utility companies, but many utili-ties have excess treatment capacity,need to renovate their distribution net-works, and are struggling financially.

� Urban wastewater treatment capacityhas increased to 52 percent by 2005, butoverall municipal pollutant loadingshave only decreased slightly since 2000due to rapid urbanization.

� In 2005, 60 percent of China’s citieshad wastewater utility companies.Most companies are relatively new.They are responsible for wastewatertreatment, while government bureausprovide drainage services. In manycities, treatment plants are underuti-lized, drainage networks need to beexpanded and renovated, and waste-water services are underfunded.

� Lack of information and transparencyon sector and utility performance com-plicates the identification of problemsand reduces accountability, particu-larly for wastewater.

Sector AchievementsAs described below, the sector has beencharacterized by large increases in urbanwater infrastructure, increased water supply

11

2 Sector Achievement and Performance

coverage, stabilized urban water use, in-creased wastewater treatment capacity, andstabilized pollutant loads.

Large Increases in Urban Water InfrastructureInvestments in water supply and wastewaterinfrastructure have increased dramaticallysince 1990 (see Figure 2.1). The total sector

investment over the period 1990–2005 isestimated to be around RMB 438 billion($54 billion), split about evenly betweenwater supply and wastewater.1 Investment inChina’s urban water infrastructure has aver-aged around 0.4 percent of GDP over this pe-riod. In 2004, annual revenues from waterand wastewater fees consisted of about 0.5percent of GDP.2 During the 1990s, spending

12


Sources: Prepared by Alexander Danilenko (2006), World Bank. Chinese data based on Chinese Water Works Association Yearbook (2005); UK dataon OFWAT annual performance report (2005); Brazil data on SNIS (2006); Russian data on Goskomstat (2006); and World Bank estimates.

The table below shows how China’s urban water utilities compare with other middle-incomecountries such as Brazil and Russia, as well as the United Kingdom. Chinese cities have somecharacteristics that impact utility performance. First, China has much more compact systems withan average of 1,100 people per kilometer of distribution network, which is almost triple the rate ofRussia and Brazil. This helps explain why non-revenue water percentage is low, even though leak-age per kilometer is high. Second, the percentage of domestic customers in China is much lowerthan in the other countries, indicating that Chinese utilities have a large industrial customer base.Similar to utilities in Brazil and Russia, many Chinese water supply utilities cover their operatingcosts, but only barely.

BOX 2.1 International Performance Comparisons

Comparisons between China and other countries (2004)

Key Indicators China Brazil Russia UK

Water coverage in urban areas (%) 86 81 99 100

Wastewater coverage in urban areas (%) 43 38 90 100

Population per km of distribution network 1100 357 400 >200

Water metering (% of connected 90 88 <30 <50population metered)

Domestic water tariff ($/m3) $0.15–$0.30 $0.65–$0.80 $0.35–0.45 $2.20–2.70

Water production (liters per capita/day) 303 274 450 300

Domestic water consumption supplied by 46 71 68 80municipal utilities (%)

Total average non-revenue water (%) 18 46 40 15

Total average non-revenue water (m3/km 54 42.3 20 5network a day)

Operating cost coverage ratio 1.0 1.0 1.0 1.2

Payment collection rate (%) 85 94 90 99.5

FIGURE 2.2 Urban Water Supply Coverage

FIGURE 2.1 Annual Investment in Urban Water and Wastewater Infrastructure

on water supply outpaced wastewater, butsince 2000 investments in wastewater haveincreased dramatically.

The rapid increase in urban water infra-structure reflects the general municipal in-frastructure trend. Since 1995, China’sGDP has almost tripled while overall annualmunicipal infrastructure spending, includingroads, has increased six-fold.3 Water supplyand wastewater account for only 10 percent of total municipal infrastructure spending.4

There are a number of driving forces account-ing for the explosion of municipal infrastruc-ture construction:

� A rapid increase in urban populationand economic development

� A backlog of deferred infrastructure investments before China’s economy experienced its current high growthstage

� The government’s expansionary fiscalpolicy as a method of stimulating do-mestic demand and reducing depend-ency on export-led growth

� A recognition by China’s municipalleaders that infrastructure provides anecessary foundation for economic development

Increase in Water Supply CoverageAs shown in Figure 2.2, piped water supplyby municipal water utilities has increasedover the past 15 years in terms of both thenumber of urban population served andwater supply coverage rate. China’s urbanwater supply coverage has increased fromless than 50 percent in 1990 to about 90 per-cent in 2004. Category I and II cities have cov-erage rates over 90 percent, while CategoryIII cities have 86 percent coverage on aver-age.5 The coverage for county towns is esti-mated at 82 percent, although this may behighly variable.

Stabilized Urban Water UseFigure 2.3 shows the total amount of waterused in urban areas from 1991 to 2004.Industrial water use has decreased signifi-cantly, while domestic water use has in-creased in line with population growth,resulting in an overall stable water demandin spite of rapid economic growth. Control-ling urban water demand has been achieved

13

S e c t o r A c h i e v e m e n t a n d P e r f o r m a n c e

23

35

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200420001995

through a combination of increases in watertariffs, water conservation measures, and in-dustrial restructuring over the last 15 years.Industrial water demand has decreased byabout 30 percent since 1995. The decrease indemand has been caused by several factors,including the following:

� Industrial restructuring caused many unprofitable and inefficient state-owned enterprises to be replaced bymore modern and efficient export-oriented enterprises.

� The government empha-sized industrial water re-cycling and cleaner pro-duction for all industries.6

� Increased municipal watertariffs triggered a priceelasticity effect, drivingdown overall industrial demand.

� Many water-consuming in-dustries were relocatedoutside of the core cityarea and may no longer beserved by municipal waterutilities.

Domestic water use has approximatelydoubled over the last 15 years. At present, it isapproximately equal to industrial water useat the aggregate national level (see Figure2.3). The urban population has increased by1.8 times over the same time period, indicat-ing that per capita domestic water use hasonly slightly increased, in spite of higherhousehold incomes. When income rises, par-ticularly when starting from a low level suchas in China, the income elasticity effect usu-ally results in higher water use. In Chinesecities, however, water prices have also beenrising, thus eliciting a price elasticity effectand dampening demand. Meanwhile, munic-ipal governments have actively promotedwater conservation. In sum, the overall trendfor urban water use appears to be graduallyincreasing, in line with the urbanization level.The demand-dampening factors—such as in-creasing prices, including the associated costof wastewater, along with conservation ef-forts—should continue to hold in the future.

Increase in Wastewater Treatment CapacityAs shown in Figure 2.4, the ratio of munici-pal wastewater treatment plant (WWTP) ca-

14


FIGURE 2.3 Urban Water Supply

0

10

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60

1991 1993 1995 1997 1999 2001 2003

Wat

er s

uppl

y (b

illion

m3 )

Total water supply

Residential

Industry and others


FIGURE 2.4 Municipal Wastewater Treatment Capacity


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2010(target)

200420001996

FIGURE 2.5 Trends in Industrial and Urban Wastewater Discharge Flows and Loads

pacity to overall wastewater volume in urbanareas has increased from 15 percent in 1990to about 52 percent in 2005. However, the in-stalled capacity is not always fully utilized sothat the percentage of pollution collectedand treated may be significantly lower.

Figure 2.4 shows that the total installedcapacity of municipal wastewater treatmentplants has doubled over the last decade,reaching approximately 52 percent of treat-ment capacity for total municipal waste-water (that is, from both domestic and in-dustrial sources). By the end of 2004, 364 outof the total 661 cities in China had built 708 WWT plants with a total treatment capacity of 49 million m3 per day. In 2000,China’s State Council set a target of 60 per-cent urban wastewater treatment by 2010.The 11th Five Year plan (2006–2010) hasproposed a more ambitious goal of 65 per-cent by 2010.7

Category I cities have made the mostprogress, with an average treatment capacityof 61 percent in 2004. Some Category Icities—such as Beijing, Shanghai, andTianjin—have nearly completed their waste-

water treatment plant construction. Thetreatment capacity rates in Category II andIII cities are 38 percent and 21 percent re-spectively, while the treatment capacity ratein county towns is only 11 percent.

Stabilized Pollutant LoadsFigure 2.5 shows total pollutant loads fromindustrial and urban domestic sources.Industrial pollution loads have decreasedsignificantly since 1995 due to industrial re-structuring, a focus on clean production, andconstruction of industrial wastewater treat-ment facilities backed by strong environmen-tal enforcement. Urban domestic pollutionloads appear to have slightly increased since1995. Although Chinese cities are rapidlyincreasing wastewater treatment coverage,the urban population is also expanding rap-idly. The urban population increased from352 million in 1995 to 564 million in 2005.Taking into account increases in both popula-tion and treatment coverage, the number ofurban residents without wastewater treat-ment stayed approximately the same from1995 to 2005.

15


Source: OECD Environmental Performance Review of China (2005).

0

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200420032002200120001999199819971996 1995 200420032002200120001999199819971996

Water Supply Utility PerformanceThis section describes some of the key perfor-mance issues confronting water supply utili-ties, including:

� Water supply reliability and quality� Overcapacity in treatment facilities

and high leakage rates in distributionsystems

� Financial sustainability

Most cities have well-established munici-pally owned water supply companies, manyof which belong to the China Water WorksAssociation (CWWA). The association pro-duces annual yearbooks that compile self-re-ported information on a number of key per-formance indicators. In addition, the WorldBank and the Ministry of Construction jointlymanaged a pilot benchmarking study in 2004that investigated the performance of twelvewater supply utilities located in representa-tive cities. The MOC also undertakes a peri-odic survey of water utility performance,some of which is publicly available. To the ex-tent possible, the data are analyzed across thethree different urban water market segments.

Water Supply ServiceTable 2.1 indicates that many water utilitiessuffer from widespread problems with low

water pressure. On average, Category III citesperform the worst, with 16 percent of theservice area suffering from low pressureproblems. What is most striking about Table2.1 is that the lowest performing quarter ofutilities have on average low water pressurein around 40 percent of their service area—regardless of city category. Water is gener-ally supplied 24 hours a day in Category 1cities. However, the reliability of service isoften much lower in Category II and III. Thebenchmarking study indicated that watersupply service was continuous in all citiesexcept two, both of which were Category IIIcities. One of the cities provided water sup-ply service 18 hours per day, and the othercity provided only 12 hours per day due to acombination of a shortage of water re-sources and lack of funds.8

China suffers from scarcity and unevendistribution of water resources. Many citiesare forced to suffer seasonal droughts or in-vest in expensive long-distance water sourcesto secure a reliable and high-quality watersource. In 2004, MOC reported that seasonalwater shortages affected more than 400 ofChina’s 669 cities; about 110 cities were fac-ing serious shortages requiring drasticwater-use restrictions.9 Water pollution inChina’s surface water is severe, particularlyin the northern part of the country. Due to alack of alternatives, however, many Chi-nese water utilities are forced to abstractwater from polluted rivers and lakes, resultingin higher operation costs and lower waterquality. Many cities, particularly in the northof China, also rely on unsustainable extractionof groundwater as an important raw watersupply source.

The quality of water provided by Chinesemunicipal water utilities is difficult to ascer-tain due to the weak regulatory and publicreporting systems. The CWAA Yearbook re-

16


Category I Category II Category III Cities (%) Cities (%) Cities (%)

Average 12 10 16

Best 25% of Utilities 0 0 0

Worst 25% of Utilities 45 33 46

Source: China Water Works Association Yearbook (2005).

TABLE 2.1 Utility Service Area with Low Water Pressure

FIGURE 2.6 Water Supply and ProductionCapacity (Municipal and Self-Supply)

ports close to 100 percent compliance withdrinking water quality standards, includ-ing total coliforms, chlorine residual, and tur-bidity. The benchmarking study reported thatfive of the twelve plants in the surveyed citiesproduced turbidity levels above 1.0 NTU,which creates concerns for human consump-tion. Poor water quality is generally due tooutdated water treatment technology andhigh levels of pollution in the raw water.Water quality monitoring is generally poorand the data is consequently unreliable.10

Investment Efficiency, TreatmentPlants, and Distribution SystemsThere is significant overcapacity of watersupply treatment facilities in many cities(see Figure 2.6). At the national level, theratio of installed treatment capacity overwater consumption at peak time reachedabout 1.5 in 2004, which means that watertreatment capacity is 50 percent more thanneeded at peak consumption. The primaryreason for this overinvestment is that munic-ipal water utilities did not take into account

the overall reduction in demand that oc-curred during the 1990s due to the dampen-ing factors discussed above. While manycities have overinvested in water supplytreatment facilities, there is significant un-derinvestment in water distribution net-works, with consequent service delivery andsustainability problems.

Chinese cities have high population den-sities, with most residents living in multi-story apartment blocks. This results incompact distribution systems, with an ex-traordinarily large number of customers perkilometer. Table 2.2 shows that the averagenon-revenue water rate is around 20 percentfor most cities. Chinese cities report highbilling and collection rates, so most of thenon-revenue water comes from physicalleakages. At first glance, the percent of non-revenue water appears to be exceptionallygood by international standards. There isconsiderable variation within city cate-gories, however, and the lowest performingquarter of utilities in Category II and IIIcities average around 35–40 percent leakage.

If the actual volume of losses per km ofdistribution pipeline is accounted, Chineseutilities do not perform well, with an averageof around 50–75 m3/km per day, twice theleakage rate in Brazil and Russia and morethan 10 times the rate in the U.K. The lowest

17



0

50

100

150

200

250

300

1991

milli

on m

3 per

day

Total daily water supply

Total WS capacity

200320011999199719951993

Category I Category II Category III Cities Cities Cities

Average 17 (68) 22 (75) 24 (53)

Best 25% of Utilities 11 (32) 10 (18) 9 (11)

Worst 25% of Utilities 23 (120) 36 (178) 39 (121)


TABLE 2.2 Non-Revenue Water For Chinese UtilitiesPercent of water produced and lost (m3/km-day)

performing utilities average around 150 m3/km-day. The generally poor distribution per-formance is further confirmed by the highpipe breaks per year. For instance, the aver-age breakage rate in the pilot benchmarkingcities was around 2 breaks/km/year (4 citieswith 4 breaks/km-year), compared to 0.2, 0.5,and 3.5 breakage rates in the U.K., Russia,and Ukraine respectively.11

There are a number of reasons why the per-formance of distribution networks is so poorin many cities. Many pipelines are old andneed rehabilitation, plus many newer pipe-lines built prior to 1990 were constructed withpoor quality materials and substandard con-struction methods. There has been limitedfunding to support the maintenance and reha-bilitation of these pipelines, and until very re-cently private firms were not allowed to investin distribution networks. Finally, the assetmanagement systems of most water utilitiesare rudimentary and many utilities do nothave the expertise to cost-effectively prioritizedistribution system renovations.

Water Utility Financial PerformanceTable 2.3 shows that the financial situation of most water utilities is not good, and even

appears to be deteriorating. According tothe CWWA data, over 60 percent of 531 waterutilities in 1997 experienced positive net in-come. In 2004, however, the number ofwater utilities with positive net income haddeclined to 40 percent. Table 2.2 also showsthat the range between cities within the samecategory is actually higher than between thedifferent city categories. This indicates thatthe financial status of a water utility companyis only loosely correlated with city size andwealth, and that even small and poor citiescan have financially sustainable water util-ities if they are well-governed and managed.Some common reasons for the high per-centage of unprofitable water supply utilitiesinclude:

� Water tariffs, though increasingrapidly, are generally still below cost-recovery levels

� Large investments programs have resulted in high debt service costs

� Water demand has experienced slowerthan expected growth

� Some utilities may have an accountingloss but have a reasonable cash flow tomaintain operations

The financial status of a water utility isfundamentally affected by its billing and col-lection performance. The CWWA Yearbookreports high rates of collection, but it is notclear what percentage of customers are actu-ally metered and billed. The benchmarkingstudy attempted to determine the level ofmetering in the 12 surveyed cities, but en-countered difficulties in data reliability anddefinitions. Metering coverage is defined asthe percentage of “connections” with meters.Although six cities report 100 percent meter-ing, the benchmarking study noted that theaverage population per metered connectionis 25, indicating that either (a) one meter

18


1997 (531 cities) 2004 (661 cities)

Profits/Sales Average Category I Category II Category III

>10% 10 0 7 4

10% to 0% 48 38 41 32

0% to −10% 16 33 18 26

>−10% 23 29 33 38

Total 100 100 100 100


TABLE 2.3 Net Income to Revenue Ratio in 1997 and 2004

often serves more than one household, and/or (b) some households are not metered.Overall, Chinese utilities have made impres-sive efforts to meter their customers and themetering level undoubtedly increased signif-icantly over the last decade, albeit startingfrom a very low level.

Self-Supply Water UsersAlthough located within the service areas ofmunicipal water utilities, many large indus-tries and their residential compounds have anindependent water supply. Self-supplied mu-nicipal and industrial water use is estimatedat around 12 percent of total urban use.12

This percentage can be much larger in north-ern cities with groundwater supplies. Self-supplied users are generally required to pay anominal water resource fee, but can generallyproduce their water at much lower cost thanthe municipal utility. Industrial self-supplywithin the service area of a municipal waterutility can cause problems, including (a) watersupply company revenues are reduced and theper-unit cost of municipal water supply in-creases; (b) industries often overexploitgroundwater due to its low price; and (c) it isdifficult to collect wastewater fees from self-

supplied users because they cannot becharged through the normal route of the mu-nicipal water supply bill.

Wastewater UtilityPerformanceChina has embarked on a national programto treat urban wastewater and the rapid in-crease in treatment capacity is impressive.This section describes some of the key per-formance issues confronting urban waste-water management, including:

� Wastewater treatment plant performance

� Inadequate drainage collection networks

� Underfunding of wastewater services

Wastewater companies have only been es-tablished in most Chinese cities since 2000.Their scope of service is generally limited to wastewater conveyance and treatment.Drainage collection, whether through com-bined or separate stormwater and sanitarydrains, is usually provided by the municipal(or district) drainage bureau. Box 2.2 pro-

19


� Drains/Sewers. There are four types of drains: (a) stormwater drains, which carry stormwater only; (b) sanitary drains, which carry wastewater only; (c) combined drains, which carry stormwater and wastewater;and (d) interceptors, which connect with combined drains and convey the wastewater to the treatment plantduring dry periods.

� Pumping Stations and Overflows. Drains may require pumping stations in the networks to make them hydraulically stable. Overflows are incorporated into a combined drain to spill excess water from an overloaded pipeline (during and following heavy rain) into a convenient watercourse.

� Drainage Networks. A drainage network is divided into a hierarchical system of drains commonly called tertiary drains (at the building level), which connect to secondary drains (typically along smaller roads) andthen to primary drains (typically along larger roads). The classification is usually somewhat arbitrary.

� Wastewater Treatment Plants. The treatment plants treat wastewater conveyed through an interceptor or asanitary drain. During rain events, the interceptor typically contains a mixture of stormwater and wastewater.

BOX 2.2 Wastewater Technical Terms

vides a definition of wastewater technicalterms. The fragmentation of wastewaterservices, and its relative immaturity, has re-sulted in an almost complete lack of utilityfinancial and operational information toevaluate the sector. Until 2005, the ChinaNational Wastewater Association served asthe professional association for the sector,but it did not produce annual yearbooks ofkey information similar to the China WaterWorks Association Yearbook. In 2006, thetwo organizations joined to form the ChinaNational Water and Wastewater Association.The joint World Bank-MOC benchmarkingstudy in 2004 and a similar World Bankstudy in 2001 looked at a number of waste-water utilities, but due to the lack of infor-mation and transparency, the data collectedwas often unreliable and of low quality.

Wastewater Treatment Plant PerformanceBox 2.3 shows the MOC’s assessment ofwastewater treatment plant performance.The benchmarking study indicated that thetreatment plants operate, on average, at 60 percent of their hydraulic design capacity.Since most treatment plants are in the earlystages of their operational life, the average

hydraulic utilization rate appears reason-able, but there is a large variation among theplants. Around one-third of the plants oper-ated at a hydraulic capacity utilization rateof less than 50 percent and another thirdwere near 100 percent utilization. One-third of the plants had influent biochemicaloxygen demand (BOD) and suspended solids(SS) concentrations well below designstandards, indicating significant underuti-lization of load capacity. The treatmentplant records showed that they operatedmostly in compliance with discharge stan-dards. In 2004, the China National AuditingOffice issued a report stating that 60 out of78 audited wastewater treatment plantswere underutilized due to the lack of oper-ating funds or delays in construction ofauxiliary facilities.13

Drainage Collection NetworksThere is very limited information on collec-tion system performance in China. MOCrecords indicate that the total length of col-lection system pipelines has increased signif-icantly, from a national total of 139,000 ki-lometers in 1995 to 358,000 kilometers in2005.14 The MOC figures do not make a dis-tinction between separate or combined (san-

20


By the end of 2004, the national urban wastewater treatment plant operation rate averaged 65 percent, five per-centage points higher than in 2001, but some completed plants have not fully displayed their benefits. By theend of June 2005, out of 364 cities with plants, 38 cities’ plant operation rate was lower than 30 percent,including 17 cities with plants that were not yet commissioned. Of this total, seventeen were prefecture levelcities, two were large cities with a population over 500,000, and six were in cities within key river basins. Ananalysis showed that the reasons for the failure of the completed plants to function properly were primarily thefollowing: (a) in some cities, management systems were still not in place; (b) wastewater fees were too low toensure operation; (c) collection networks were incomplete; (d) treatment plants were oversized, and (e) waste-water treatment plants were complex and difficult to operate.

Source: MOC, Circular on Treatment of Urban Wastewater (2005).

BOX 2.3 MOC’s Analysis of Wastewater Treatment Operational Performance

itary and stormwater) drainage pipelines.Many cities are clearly struggling with the de-velopment and operation of their collectionnetworks. Box 2.4 provides information onTianjin’s drainage collection system anddemonstrates some of the challenges. SinceTianjin is a Category I city, the problemsfaced by Category II and III cities may beeven more severe.

Wastewater Financial PerformanceThe wastewater sector in a typical city is oftenfragmented among different service pro-viders, including public departments provid-ing local drainage services and more com-mercially oriented companies providing

wastewater conveyance and treatment ser-vices. Most wastewater companies are still intheir infancy, but undoubtedly face many fu-ture financial challenges. The China DrainageAssociation, unlike the China Water WorksAssociation, does not collect financial infor-mation from its members, and thus there is nonational database on the financial status ofwastewater companies—which would in anycase only be a partial perspective, as drainageservices would not be included in most cases.According to the above MOC analysis and theanalysis presented in Chapter 7 (FinancialSustainability), wastewater tariffs are verylow, and the wastewater sector is strugglingwith financial sustainability issues.

21


A comprehensive assessment of the drainage collection system was conducted in Tianjin as part of a World Bank-financed project. The assessment revealed that although Tianjin is moving relatively quickly in constructing thenecessary wastewater treatment plants, there is a need to improve the drainage collection system, as the follow-ing data show:

Extent of Drainage System: The total length of drainage pipelines is 4,753 km, of which:� Stormwater: 1,982 kms;� Sanitary: 1,928 km; and� Combined: 1,042 kms.

Drainage Coverage: Fifty-nine percent of the city area is covered by stormwater drainage and 69 percent bysanitary drainage.

Asset Condition: Twenty-five percent of pipelines have exceeded their service life. There are 186 pump stations,of which 94 (50 percent) have equipment that exceeded service life.

Flooding: There are 36 key floodprone street intersections. Among them, 9 have adequate stormwater drainage,12 have been partially improved, and 15 suffer frequent flooding. All 33 large underpasses in Tianjin aresubject to flooding.

Wastewater Collection: The separation of stormwater and wastewater drains is incomplete at the lateral level,resulting in stormwater going into wastewater drains and wastewater going into stormwater drains The lowconstruction standards lead to frequent breaks and blockages.

Wastewater Treatment: The installed wastewater treatment capacity is 930,000 m3/day, a 59 percent coverage.The goal by 2010 is to collect and treat at least 90 percent of the wastewater.

Source: Tianjin Drainage Study, Tianjin International Engineering Consulting Corporation (2005).

BOX 2.4 Overview of Tianjin Drainage System in 2005

The Challenge of Industrial Wastewater.Industries account for about half of the 50 billion m3/year of urban water use,15 andChina aggressively pursues industrial pollu-tion control. By 2001, over 61,220 industrialwastewater treatment plants had been con-structed; official data indicate an 86 percentcompliance rate with the 2001 standards.16

Since most of the plants had been con-structed before municipal wastewater man-agement systems were in place, the relevanteffluent standard is to discharge directly intothe receiving water body. For industries with-out their own treatment plants, they shouldnaturally discharge into the municipal collec-tion system. Industries with their own waste-water treatment systems need to decidewhether to discharge into the municipal sys-tem (with lower BOD and SS discharge stan-dards) or continue to treat for discharge di-rectly into the environment. Any industry thatdischarges to the municipal system mustmeet pretreatment requirements in order tominimize impacts on the municipal waste-water collection and treatment systems. Mostcities have not yet developed integratedstrategies to deal with the following issues: (a)ensuring adequate pretreatment prior to dis-charge into the municipal system; (b) deter-mining which industries should convert fromself-treatment to discharge into the municipalsystem; and (c) treating complex wastewaterwith a high percentage of industrial waste.

Chapter SummaryThis chapter has identified a number ofissues regarding the achievement and per-formance of China’s urban water utilities,including:

� Starting from a low base in 1990,Chinese cities and their utilities have

rapidly expanded water supply andwastewater treatment coveragethrough large-scale infrastructureconstruction programs.

� There is a wide variation in utility performance, both between and withindifferent city categories. Some cities are able to provide high-quality ser-vice, while other cities struggle. Thisindicates that underperformance stemspartly from poor sector governance andregulation, which allows some citiesand their utilities to provide substan-dard service.

� There is a lack of data and transpar-ency to evaluate utility performance,particularly for wastewater. The situa-tion undermines efforts to identifyproblems and ensure accountability,thereby restricting the scope for im-proving utility performance. Box 2.5shows how Brazil has addressed theissue of utility performance informa-tion, which could serve as an inspira-tion for a similar program in China.

Notes1. China Urban Construction Statistics Yearbook

(2005)2. See Chapter 1, Footnote 4.3. China Urban Construction Statistics Yearbook

(2005)4. ibid5. See Technical Notes, Chapter 1.6. For example, the national “Cleaner Production

Promotion Law” was passed in 2002.7. The “11th Five-Year Plan on Urban Wastewater

Treatment and Reuse Infrastructure Construc-tion” set a national target of 65% wastewatertreatment rate, including: 80% for provincialcapitals; 60% for prefecture level cities; 50% forcounty-level cities; and 30% for county capitaltowns. Source: CIECC (2006).

8. World Bank (2005). North China Water QualityStudy Report Component A: “Water Utility Case

22


Study,” pg. 21. The two cities were Yuncheng inShanxi Province and Bozhou in Anhui Province.

9. See Xinhua News Agency September 28, 2003,“Water from Shanxi to Ease Shortage in Bei-jing”at: http://www.china.org.cn/english/2003/Sep/76227.htm. The article reports that: “Beijing is one ofthe many cities on the Chinese mainland withwater shortage problems. About 420 of 600 citieson the Chinese mainland suffer water shortages,according the Ministry of Water Resources. Atotal of 110 cities are in acute shortage, resultingin 200 billion yuan (US$24 billion) to 300 billionyuan (US$36 billion) in lost industrial output eachyear, figures provided by the ministry show.”

10. World Bank (2005). North China Water QualityStudy Report Component A: “Water Utility CaseStudy.”

11. Alexander Danilenko (2006) “BackgroundPaper on North China Water Quality Study.”

12. China Urban Construction Statistics Yearbook(2005)

13. General Office of China National Audit Office(2004)

14. China Urban Construction Statistics Yearbook(2005)

15. See Figure 2.316. OECD (2005), Environmental Performance Re-

view of China.

23


Brazil’s National Information System for Water Supply and Sanitation (SNIS) was created in the mid-1990s underthe Water Sector Modernization Project (PMSS), a federal program financed by the World Bank. SNIS is a federaldatabase maintained by the Ministry of Cities. It aims to promote (a) planning and implementation of public poli-cies; (b) guidance in the allocation of financial resources; (c) assessment of utility performance; (d) managementimprovement through increased efficiency and effectiveness; (e) guidance on regulatory activities; (f) benchmark-ing and yardstick comparison; and (g) dissemination of sector data to the public domain.

The SNIS database covers information on 279 regional and municipal utilities, consisting of water supply datafor 4,186 municipalities (95 percent of the population) and sewerage data for 968 municipalities (71 percent ofthe population). SNIS reports have been compiled and published annually covering the period 1995 to 2005.Utilities provide data on their water supply and sanitation services, including operational, managerial, financialand service quality information through a tailored software package. SNIS products include databases; softwarefor data collection; diagnoses of service provision coverage and performance; an annual performance nationalsector overview; a glossary of technical terms and indicators; and an internet site with over 4,000 visitors permonth. The database is used by a wide variety of institutions, including governments, utilities, regulatory enti-ties, research and financial institutions, and international development agencies.

SNIS provides a tool to monitor and supervise utility performance. For utilities, the database provides per-formance benchmarking and comparison with other utilities. It allows state and municipal governments to pressutilities to enhance their performance. In addition, SNIS contributes to enhancing transparency by inviting thegeneral public, media, politicians, NGOs, and others to participate in discussions on the sector generally and onservice provision more specifically. Finally, the federal government has recently started to use SNIS in order tohelp prioritize sector financing demands.

Lessons learned from SNIS include the following: a) establishing a national information database takes time andperseverance; b) it requires leadership and coordination even though it is undertaken collectively; c) incentivesand obligations to improve responsiveness and accuracy of data are important, although voluntary mechanismshave worked relatively well (a degree of “peer pressure” to be included in the database now exists among serviceproviders and local governments); d) the system has become the yardstick of the Brazilian water industry; e) SNISallows Brazil to take its benchmarking to a regional and international level; and f) once such a system is established,it becomes self-perpetuating.

Source: Presentation by ANA (Miranda and Marinho) at World Bank Water Week (2003)

BOX 2.5 Brazil National Sanitation Information System (SNIS)

China not only needs to improve the perfor-mance of its urban water utilities, but itmust also prepare for the pressing challengesof the future, including:

� Responding to rapid urbanization. Chinais experiencing the greatest wave of ur-banization in history; the official urbanpopulation is expected to increase fromabout 550 million in 2005 to about 900 million in 2020.1 Providing urbanwater services to new residents anddealing with new spatial patterns ofurban development will be a demand-ing task.

� Dealing with urban diversity. China hasa wide spectrum of cities and towns,from large and rich super cities such asBeijing and Shanghai to hundreds ofsmaller and poor cities. China’s poli-cies, standards, and approaches forurban water services will need to betailored to meet the economic and en-vironmental reality of different types ofcities.

� Confronting water scarcity and degra-dation. Water is scarce in the north ofChina and water quality throughoutthe country is severely degraded. Inspite of extensive efforts to improve

water quality and ensure reliablewater supplies, seasonal shortagesand polluted water supplies will con-tinue to pose problems.

� Meeting investment demands. Thegrowth in urban population, combinedwith aspirations to improve the qualityof water services, will require an accel-erated capital works program. The estimated investment needs for 2006–10 alone are expected to be aroundRMB 400 billion ($50 billion)—approximately equal to investmentsover the last 15 years. Financing theseinvestments, and ensuring investmentefficiency, is a major challenge for the sector.

� Improving utility financial sustainabil-ity. Some water supply utilities, andmost wastewater utilities, rely heavilyon municipal government funding.Utilities that rely more on user feesgenerally increase transparency and accountability, become better able toaccess capital markets, and operate at a higher level of efficiency.

This chapter examines these challenges and their implications for the urban watersector.

25

3 Sector Challenges

Responding to Rapid UrbanizationChina’s rapid urbanization has been accom-panied by economic growth and transforma-tion. Much of this urbanization is centeredon large metropolitan areas, with rapid de-velopment of towns and peri-urban areas.These trends have the following implications:

� Water services will need to be providedto a large influx of urban residents.

� Economic growth will help cities both to expand service and upgradestandards.

� New patterns of spatial growth willprovide opportunities to aggregateservice provision and lower costs, pro-vided local governments can cooperate.

To understand these issues, Box 3.1 describesChina’s different government levels and how“cities” and “towns” are administered.

26


In China, the governance structure is a hierarchical and decentralized system in which functional responsibili-ties are delegated through a four-tiered system: (1) central level; (2) provincial level; (3) prefecture level; and(4) county level.

The county level is the basic building block of the decentralized administrative and fiscal system. A prefecture-level entity is composed of a number of county-level entities; similarly, a provincial-level entity is composed ofa number of prefecture entities. There are 32 provincial-level entities in China, including 23 formal provinces,5 autonomous regions where ethnic minorities dominate, and 4 “municipalities:” Beijing, Shanghai, Tianjin, andChongqing. This does not include Hong Kong, Macau, and Taiwan. There are no prefectures in a municipality.In actual practice, the administrative relationships are more complex, but the four-tiered explanation providesthe basic framework.

The term “city” has a dual—and often confusing—meaning in China. In the Chinese system, a “city” can refer toan administrative jurisdiction, which can cover both rural and urban areas. For example, a prefecture-level city in theadministrative sense is composed primarily of rural areas with a number of urban centers. On the other hand, a “city”can also refer to a specific urban area. This study uses the latter definition of city and only considers urban areas.

As of December 31, 2004, China has 661 “designated” cities (i.e. major urban areas): 4 municipalities, 283 citiesthat are the capitals of prefecture-level entities, and 374 cities that are the capitals of county-level entities.Administration of the cities is carried out by city governments (sometimes referred to as municipal governments).The city is further divided into urban districts, which provide more local administration and public service func-tions. Reflecting the dual definition of cities in China, the mayor of a city that is the capital of a prefecture entityhas two functions: (1) direct responsibility for the city government; and (2) oversight responsibility for the county-level entity within the prefecture. In 2005, approximately 340 million people lived in designated cities.

In total, there are around 2,010 county-level entities in China. As noted in the proceeding paragraph, 374 of thesecounty-level entities have large urban areas that are designated as “cities.” The remaining 1,636 county-level enti-ties each have an urban area, which is the seat of government; in this study, they are called “county-towns.” In2005, approximately 96 million people lived in county-towns, resulting in an average population of around 60,000.

Towns are another type of urban area in China. In total, there are 18,256 towns in China—including the 1,636 townsreferred to as “county-towns.” Towns are administratively and fiscally subservient to county-level governments. In2005, approximately 100 million people lived in towns (excluding county towns), resulting in an average populationof around 6,000.

Source: Adapted from Wikipedia (http://en.wikipedia.org/wiki/Political_divisions_of_China)

BOX 3.1 China’s Administrative System and Definition of Cities and Towns

FIGURE 3.1 China’s Economic Transformation and UrbanizationRapid Urbanization Accompanied byEconomic Growth and TransformationAround 1980, China started a transformationfrom a planned economy to a market econ-omy. The country’s real GDP then grew an av-erage 9.6 percent a year in the period from1979 to 2005.2 The evolutionary trend from arural agricultural society to an industrializedand urban country is reflected in Figure 3.1.The increase in China’s urbanization level isroughly consistent with the change in thecountry’s macroeconomic structure, wherethe secondary and tertiary sectors now ac-count for 85 percent of China’s GDP, com-pared with about 65 percent in the early1980s. The urbanization rate has more thandoubled over the last 25 years, and reached 43percent in 2005. In 2005, the total officialurban population was around 550 million,including 340 million in 661 cities, 96 millionin county-towns, and around 100 million intowns. This does not take into considerationan additional “floating” population of 80 to120 million people. This rapid increase in theurban population has strained urban waterand wastewater infrastructure, and created alarge demand for upgrading and expansion ofservices.

Urban residents have become signifi-cantly richer over time. With their increasedability to pay, they have demanded betterwater services. The average urban income percapita rose from 1,500 RMB ($187) in 1990to RMB 10,493 ($1,300) in 2006. In contrast,rural per capita income in 2006 was onlyRMB 3,255 ($406). Moreover, unlike urbanresidents, most rural residents do not receivesubsidized health care or education, andonly a small percentage participate in pen-sion systems.3 Given the disparities inwealth between rural and urban house-holds, there is a strong incentive for ruralresidents to migrate to the cities. In the past,

this natural economic attraction has beendampened by government efforts to controlrural-urban migration by denying unautho-rized rural migrants legal status, thus com-plicating access to basic services in the citysuch as housing, schools, and health care.The system of control is slowly being re-laxed, which is resulting in widening dispar-ities of urban income as poor rural migrantscome to urban areas.

Fueled by the country’s rapid industrial-ization, the migration of farmers fromrural to urban areas, and sustained eco-nomic high growth, current urbanization isexpected to continue over the next fewdecades. Assuming an urbanization rate of1.5 percent, which is not particularly highwhen compared with the historical experi-ence of other countries at similar stages ofeconomic development, this could result inover 900 million urban residents by 2020(see Figure 3.2). Under any scenario, the ab-solute increase in urban residents in the next15 years will be immense and will createhuge demands for urban infrastructure, in-cluding water, wastewater, and stormwater

27

S e c t o r C h a l l e n g e s

Source: Chreod, “Metropolitan Regions: New Challenges for an Urbanizing China” (2005).

10

15

20

25

30

35

40

45

1980

Urba

n as

% o

f tot

al p

opul

atio

n (p

erce

nt)

65

70

75

80

85

90

GDPS

T %

of G

DP

Urban as % of total population

Secondary + tertiary GDP as % of GDP

20042000199519901985

facilities. Rapid economic developmentalso provides municipal governments withavailable financing sources to tackle thesehuge investment challenges for the watersector.

Urbanization Taking Place in Metropolitan AreasChina has over 50 metropolitan regions intotal, which are anchored by cities with over1 million non-farming residents and en-compass adjacent counties and districts.These metropolitan regions are the eco-nomic development powerhouses of thecountry. Although the metropolitan re-gions hold only 29 percent of the country’stotal population (370 million), they con-tribute to 53 percent of China’s GDP and 62 percent of all non-farming GDP frommanufacturing, construction, and services.GDP per capita within 50 kilometers of themetropolitan centers is 160 percent higherthan the national average. This rate fallsdramatically at a distance of 50 to 100 kilo-meters from the metropolitan core and

drops again beyond 100 kilometers. Be-yond 100 kilometers, it remains relativelystable no matter how far out from thecenters.4

China’s metropolitan regions can be bro-ken into four tiers by the relative size of thenon-farming population. The first tier of threemetropolitan regions in China includesShanghai (17 million non-farming popula-tion), Beijing (14.5 million), and Guangzhou(13.7 million). The second tier consists of 11 metropolitan regions with urban popula-tions ranging from 5 million to 10 million.The third tier, with populations ranging from2 to 5 million, consists of 20 regions. The re-maining 19 regions belong to the fourth tier.While first- and second-tier metropolitanregions are located along the coast, many ofChina’s medium and small metropolitanregions are located inland.

The spatial urban expansion pattern inChina differs considerably from that in NorthAmerica and many European countries.Rural populations and immigrants, unfet-tered by mobility restrictions, poured intothe cities in these countries. Urban devel-opment then grew outwards into the sub-urbs as residents sought cheaper and betterhousing and companies attempted to lowerbusiness costs and avoid congestion.

In China, urban households and state-owned enterprises (SOEs) faced strict con-straints on labor and capital mobility andhad much more limited relocation choices.Urban households were tied to the citythrough the household registration system(hukou). The vertically integrated state-owned-enterprises (SOEs) maintained local-ized supply chains in order to promote localeconomic development. Moreover, heavysubsidies as well as the allocation of free orcheap urban land to SOEs gave them littleincentive to relocate to lower-cost suburban

28


FIGURE 3.2 Urbanization Trends and Projections

Source: China Statistical Yearbook (2005).

20

25

30

35

40

45

50

55

60

1990

Scenario 1 (0.5%)

Perc

ent Scenario 2 (1%)

Scenario 3 (1.5%)

564M

302M

923M

857M

796M

352M

459M

2020201520102005200420001995

areas. Nevertheless, with rapid economicdevelopment, pressures started to build inmany regions, partially due to industrial re-location from the central cores to new sub-urban industrial parks, and partially due togovernment efforts to promote relocation toimprove housing conditions and reduce in-ner city residential density. As a result, manymetropolitan regions in China have recentlyexperienced a complex mix of both centrifu-gal and centripetal growth patterns. Theirspatial pattern is a combination of highdensity in central areas, which can createproblems such as traffic congestion and airpollution if not properly managed, and dis-persed suburban areas, which increase thecost of infrastructure provision.

The characteristics of China’s metropoli-tan development have important implica-tions for the urban water sector. Much of thewater infrastructure in the core urban areas,particularly water and drainage pipelines,needs to be renovated. Given the heavy traf-fic congestion, this will be a complex task.The suburban areas are expanding outwardquickly and require new infrastructure,which will be expensive given the relativelylow population densities. Finally, China’sadministrative and fiscal system is decen-tralized, and the suburban districts andcounties surrounding the core urban areastend to independently develop their water in-frastructure without taking advantage of thebenefits that might accrue from aggregationof water services at the regional level.

Towns Expanding Rapidly in theCountryside and Peri-Urban AreasTowns have grown rapidly in China, with thetotal number increasing from fewer than3,000 in 1980 to over 18,000 in 2005.5 Townsplay two important roles in China’s urban-ization process. First, in some instances they

are integral parts of the booming metropoli-tan areas. As a whole, towns now hold 52percent of China’s metropolitan population,and are playing an increasingly importanteconomic and social role. In many metropol-itan areas, land-intensive and pollution-generating industries are being relocatedfrom inner urban areas to towns due tolower land cost and labor availability. Unlikecities, which control migration, towns inmetropolitan areas generally welcome ruralmigrants as a source of cheap labor. Second,the central government has new develop-ment policies to encourage rural residents tomove to towns located in the countryside inorder to improve their quality of life withbetter services. China’s 10th Five-Year Plan(2001–05) called for the rapid developmentof small towns as the main focus of the ur-banization strategy.

The fast development of towns through-out China has two major consequences for theurban water sector. First, towns located onthe fringe areas of metropolitan regions areeconomically and environmentally linked tothe core urban areas. Their urban waterservices will need to be at a level consistentwith the core urban area. In many instances,this is most economically achieved throughthe provision of regional infrastructure.Second, towns located in rural areas willneed to develop low-cost and sustainableapproaches to their urban water services,particularly for wastewater management.

Dealing with Urban DiversityNot only are China’s cities rapidly growing,but inequality is increasing both betweencities and within cities. These trends havethe following implications:

29


� China’s policies, standards, and approaches for urban water serviceswill need to be tailored to meet theeconomic and environmental reality of different types of cities.

� As users pay more for urban water services, more attention will need to be paid to protecting the urban poorthrough special programs.

Growing InequalityThe Gini coefficient is a parameter used byeconomists to measure income inequality: thehigher the Gini value, the more unequal theincome distribution. The overall Gini coef-ficient in China has increased from below0.3 in the early 1980s to 0.45 in 2005.6 Forcomparison, the Gini coefficient of Japan,which is one of the egalitarian countries, is0.25 while Brazil, which is considered one theworld’s more unequal countries, has a coeffi-cient of 0.59. A major driver of income in-equality is the urban-rural income gap. Theratio of urban to rural per capita income in2005 stood at around 3.0.7 There are, how-ever, increasingly important urban incomedisparities along two dimensions:

Coastal vs. Inland Disparity. The proc-ess of reform and opening was spearheadedon the coast with preferential treatmentgranted to engage in trade, host foreign in-vestment, and generally develop a marketeconomy. Inland regions and the northeastwere hindered in their transition not only bydelayed policy relaxation but by a legacy ofbigger and more entrenched state enterprisesthat remained shielded from market disci-pline to protect vested interests. The coast alsohas a natural geographic advantage in confer-ring ready transportation links to the outsideworld and ready economic links to HongKong and Taiwan.

Within-City Disparity. In the past, incomegaps in China were mainly between city andcountryside residents. Since 2000, however,the income gap among urban residents hasrisen quickly; the urban Gini coefficient in2005 was estimated at 0.4.8 Given China’srapid industrialization and urbanization, atleast a short-term increase in the Gini coeffi-cient could be expected. Moreover, the highlevels of economic growth indicate thaturban residents in general are becomingwealthier, although the income gap may bewidening.

Urban Water Market SegmentsThe disparities between different types ofcities were discussed in Chapter 1 in the con-text of “urban water market segments.” Thesummary table from Chapter 1 is presentedbelow in Table 3.1.

Table 3.1 shows that generally, the smallerand less affluent the city, the lower the levelsof wastewater treatment and water supplycoverage. Moreover, Chapter 2 indicated that,on average, Category III city water utilitiesperformed poorly along most key variables,including water supply reliability, water qual-ity, and financial performance.

Implications of Urban Diversity for the Urban Water SectorThe wide range of urban situations in Chinacalls for adjusting national policies, stan-dards, and concessionary finance programsto meet the economic realities of the smallerand poorer cities. China’s current nationalpolicies, such as drinking water quality andwastewater discharge standards, are oftendirected at the highest capacity cities andonly loosely enforced. Similarly, most of thenational concessionary finance funds go thelarger prefecture-level cities. Low-cost, easy-

30


to-operate water supply and wastewater sys-tems in smaller and poorer cities—wherereasonable standards are enforced—aremore realistic than universally high stan-dards requiring expensive technology inmany of China’s cities.

The widening income disparities withinmany Chinese cities also complicate tariff in-creases. Urban households in China mustnow pay for services once provided by thestate, or state-owned enterprises, such ashousing, health care, education, and publicutilities. Lower- and middle-income house-holds are struggling to meet these new ex-penses. Growing income disparities arefeeding discontent—making increases inwater tariffs politically complicated. Findingways to increase utility revenues, while stillprotecting the poor and avoiding discontentamong middle-income families, is a di-lemma facing most Chinese cities.

Confronting WaterScarcity and DegradationThe combination of high population density,rapid economic growth, and acceleratingurbanization has created a water resourcecrisis in China. Although this study does not focus on water resources, this broadertopic has important impacts on urban water services:

� Water resource constraints and waterquality degradation will require citiesand their utilities to adopt more sophisticated and non-traditional approaches to ensuring reliable andcost effective ways of meeting thegrowing urban water demand.

� The extreme degradation of water qual-ity in China’s rivers, lakes, and coastalareas is caused by a combination of

31


AverageWastewater Average Water

Total Per Capita Treatment SupplyNumber Population GDP Coverage Coverage

Market Segments of Cities (million) (RMB) (%) (%)

Category I Cities:Population > 2 million 21 90 35,900 61 93GDP-capita > $3,000

Category II Cities—In Between Category I 331 201 19,100 38 91and Category III Cities—

Category III Cities Population < 0.5 million 310 58 7,300 21 86GDP-capita < $1,500

County Towns 1,636 96 NA 11 82

Sources: MOC, China Urban Statistics Yearbook (2005); and MOC, County Towns Brief (2004).

TABLE 3.1 Urban Water Market Segments

sources, including municipal, indus-trial, urban and agricultural runoff, aswell as livestock operations. China’senvironmental regulators will need tostrike a cost-effective balance betweenmunicipal and industrial pollutioncontrol, and managing agriculturaland nonpoint sources of pollution.

Water ScarcityChina suffers from an uneven temporal andspatial distribution of water resources (seeBox 3.2). Many cities are forced to sufferseasonal droughts or invest in expensivelong-distance water sources to secure a re-liable and high-quality water source. Chi-nese cities are also experimenting with nontraditional water sources such as waste-water reclamation, desalinization, brackishwater use, etc. Demand management tools—including water conservation and waterpricing—are also being increasingly used.Although all these approaches, as well as

others, are potentially viable, cities and theirutilities will need to improve their overallwater supply planning approaches to ensurethe optimal combination of alternatives to reduce overall costs and ensure good service.

Water Quality DegradationIn spite of improved municipal and indus-trial water pollution control (see Figure 2.5),China’s surface water quality does not ap-pear to have improved over the last decade.Figure 3.3 shows that the percentage of sur-face water rated higher than Category V (i.e.the most heavily polluted water bodies) hashovered around 35 percent.

Moreover, water quality in China’s coastalareas and key lakes appears to be declining,due in part to higher levels of nutrient load-ing, resulting in algae blooms and eutrophi-cation. Water quality is affected by a numberof other activities other than municipal pol-lution, such as discharges from over 18,000towns, polluted agricultural runoff, live-

32


Water resources are scarce in China. Per capita freshwater availability in China was only 2,210 m3 in 2004, aboutone-quarter of the world’s average. The per-capita water availability in the highly populated 3-H basins in thenorth of China (Huai, Huang, and Hai) is only 500 m3/person—below the internationally accepted threshold of1,000 m3/person for severe water stress. Groundwater overdraft is a major problem in many places in China;many cities and the surrounding agricultural communities are relying on unsustainable groundwater resources.

Although municipal and industrial water demands have priority over agricultural water use, many cities stillexperience frequent water shortages. According to the China Economic and Social Development Report (2004),more than 400 cities in China face water shortages; in 110 cities, these shortages are severe.

Water resource distribution in China is extremely unbalanced among regions and seasons. Water shortage prob-lems are most acute in dry seasons in the northern and western regions. South China has about 80 percent of thetotal water resources, while the North has only 20 percent. In comparison, the North has about 47 percent of thetotal population and produces 45 percent of the GDP. In addition, 60–80 percent of annual precipitation occurs inthe four summer months, which contributes to flooding in the summer in the South, while the North has an ex-tremely dry winter. China has an extensive and almost fully developed reservoir system operated by local, provin-cial, or national water resource agencies to help maintain water availability, but the fundamental constraint is thelack of sufficient runoff water in the North. Water resource agencies have responded to this situation by develop-ing long-distance water transfer schemes, the most prominent of which is the South-North water diversion project.Drought emergency measures are also frequently applied in Chinese cities to deal with short-term water shortages.

BOX 3.2 China’s Water Resources

stock waste, and industries dischargingwastewater outside of municipal bound-aries. China’s water pollution problems areserious and will remain so in the future.

Meeting InfrastructureInvestment NeedsChina will need to significantly expand itsstock of infrastructure to respond to rapidurbanization, rehabilitate existing assets, and

implement national programs for waste-water treatment and drinking water safety.This will generate pressure to:

� Finance new investments, particularlythrough debt and equity marketsrather than the municipal governmentbudget

� Ensure that service standards are cost-effective and affordable

� Make good capital planning decisionsthat minimize costs while meeting service standards and regulations

Huge Future Sector Investment RequirementsTable 3.2 summarizes total investments overthe period 1991–2005, and estimated invest-ment over the period 2006–2010. From 1991to 2005, around RMB 430 billion ($54 billion)was spent in urban water infrastructure.

This study estimates that around thesame amount, RMB 430 billion ($54 billion)will be spent during the 11th Five-Year-Planperiod (2006–2010), indicating that the rapidacceleration of infrastructure spending thatbegin in the early 1990s will continue intothe future.

Wastewater Investments. Investment inwastewater started slowly, but surpassed

33


Total Investment 1991–2005 Estimated Investment 2006–2010

Sector Investment US$ Billion RMB Billion US$ Billion RMB Billion

Water Supply 25 200 20 160

Wastewater 29 230 34 270

Total 54 430 54 430

Source: MOC, Urban Construction Yearbook (2005); projections based on World Bank estimates.

TABLE 3.2 Approximate Urban Water Sector Investments

FIGURE 3.3 Average Water Quality in ChineseRivers from 1991–2002

Source: World Bank, Water Quality Management Policy (2006).

All China I – II

All ChinaIII – IV

All ChinaV – V*

0

10

20

30

40

50

60

70

80

90

100

1991 20011999199719951993

water supply by 2000, and the growth rate isaccelerating. The 11th Five-Year WastewaterSector Plan (2006–2010) prepared under theauspices of the MOC estimates the total in-vestment requirements necessary to meetthe 11th Five-Year-Plan target of 70 percenturban wastewater treatment is around RMB300 billion ($38 billion). Given financing andimplementation constraints, this study esti-mates the actual amount will be lower. Fig-ure 3.4 shows the estimated breakdown incosts for different types of wastewater in-vestments. In comparison with past capitalworks programs, more emphasis is being puton drainage networks (63 percent of costs)and sludge management facilities (14 per-cent). Wastewater treatment plants onlyaccount for around 16 percent of total costs.

Water Supply Investments. The 11th Five-Year Plan, for the first time, did not analyzethe water supply sector. The national govern-ment now considers water supply to be acommercial activity and theoretically should

not be supported by the government. Manywater supply companies, however, are stillprovided with significant capital subsidies inthe form of equity contributions to overcomefinancing constraints and keep tariffs lows.We estimate that water supply investmentswill continue to increase gradually over thenext five years, driven primarily by the grow-ing urban population, the need to rehabili-tate distribution networks, and the need toupgrade treatment plants in large cities to ac-commodate higher drinking water qualitystandards.

Improving UtilityFinancial SustainabilityImproving utility financial sustainability willhelp utilities finance future investments andimprove performance. The concept used inthis study is presented in Box 3.3, and usesthe imagery of “climbing up the ladder” of fi-nancial sustainability. Improving financialsustainability for an urban water utility de-pends on many factors that are often be-yond the control of the utility, including (a) tariff setting; (b) subsidies; (c) environ-mental and service standards; and (d) fi-nancing options. A financially strong utilitygenerally is a result of good sector and util-ity governance, coupled with sound utilitymanagement.

Status of China’s Water UtilitiesChapter 2 provided a general overview ofthe financial status of urban water utilities;Chapter 7 will provide a more in-depth anal-ysis. Most of China’s water supply utilitycompanies fall in the middle or lower end ofthe financial sustainability ladder. Althoughsome richer cities have water supply com-panies that are marginally creditworthy,

34


FIGURE 3.4 Estimated WastewaterInvestments in the 11th Five-Year Plan Period

Source: China International Engineering Consulting Company, 11th Five-Year Sector Plan (2006).

Water reuse (9 Bil RMB), 3%

Sludge (43 BilRMB), 14%

Rehabilitation (11Bil RMB), 4%

WWTP (49 BilRMB), 16%

Network (188 BilRMB), 63%

most cities still subsidize their companies.Fund shortages often prevent utilities fromundertaking necessary asset renewal activi-ties. Wastewater companies are generally fi-nancially weaker than water supply com-panies. Many wastewater companies are notresponsible for wastewater collection, whichin many cases is operated by a municipal

drainage department that relies solely ongovernment budget transfers.

Benefits of Moving Up the Ladder. Less reliance on government funding, and moreon user fees and capital markets can generatestrong forces for improving efficiency. A pre-dictable and adequate source of revenues

35


Financial sustainability reflects a utility’s capacity to meet its financial needs. There are several different levelsof financial sustainability. Figure 5.1 presents a “financial sustainability ladder” and defines the following rungs:(a) unviable loss-making utilities, which meet the minimum financial sustainability threshold through both cap-ital and operational subsidies; (b) pay-as-you-go recovery of cash needs, in which only capital financing needssubsidies; (c) cost recovery, in which utilities are profitable in any given year, but profitability is not sustainablein the long term, for example from insufficient renewal of assets; (d) sustainable cost recovery, in which utilitiessustain the impact of long-term costs, including asset renewal; (e) marginally creditworthy, which requires util-ities to have reliable refinancing sources and secure access to loans; and (f) creditworthy, the top level, whichrequires utilities to become creditworthy and the country’s banking system and capital markets to function well.

BOX 3.3 Financial Sustainability Ladder

Creditworthy

Marginally creditworthy

Sustainable cost recovery

Cost recovery

Pay-as-you-go recovery of cash needs

Unviable loss-making utilties

All the utilities in the ladder are viewed as potentially financially sustainable. But their levels of financial sustain-ability are quite different. In general, the higher the financial sustainability level, the better the utility’s capacityto meet ongoing cash needs, to cushion unanticipated cost increases and sudden financial shocks, and to fulfillcapital financing requirements for further business expansion. A utility can move upward in the sustainabilitylevels by fundamentally reducing risks or unpredictability of funding sources at each stage.

Source: World Bank Water and Sanitation Working Note 7 (2005), “Financing Water Supply and Wastewater Investments: Estimating Revenue Requirements” by AldoBaietti and Paolo Curiel.

from user fees is usually more secure than re-lying on government transfers. Reliance onuser fees is also more likely to increase ac-countability as customers will demand betterservice. If tariffs are low and the utility re-ceives its budget directly from the govern-ment, it is less likely to be responsive to the needs of water users. Accessing financingthrough capital markets, as opposed to government equity contributions, requiresutilities to demonstrate a greater degree offinancial discipline, transparency, and ac-countability. Finally, governments are lessable to politically manipulate utilities fortheir short-term interests, such as keepingtariffs artificially low or using utility employ-ment as a source of patronage.

Limits to Moving Up the Financial Lad-der. Although this study promotes the objec-tive of urban water utilities moving up thefinancial sustainability ladder, there are ob-vious constraints to the pace at which thiscan occur. The lack of social acceptance byusers may limit the pace and extent of tariffincreases, particularly if the utilities areseen as being unaccountable and inefficient.In China, capital markets are still not fullydeveloped and politically directed lendingcan undermine capital market discipline.Finally, municipal leaders may reap sig-nificant benefits from their control of theutility and be reluctant to allow the utility toquickly move up the financial sustainabilityladder.

Chapter SummaryThe five key challenges facing China and itsurban water utilities in their efforts to im-prove performance are:

� Responding to rapid urbanization.Providing urban water services to newresidents and dealing with new spatialpatterns of urban development will be a demanding task.

� Dealing with urban diversity. China’s policies, standards, and approaches for urban water services will need to be tailored to meet the economic and environmental reality of different typesof cities.

� Confronting water scarcity and degrada-tion. In spite of extensive efforts to im-prove water quality and ensure reliablewater supplies, seasonal shortages andpolluted water supplies will continueto pose problems.

� Meeting investment demands. Financ-ing these investments, and ensuringinvestment efficiency, is a major chal-lenge for the sector.

� Improving utility financial sustainabil-ity. Relying more on user fees, and lesson government transfers, will helputilities increase transparency and ac-countability, improve access to capitalmarkets, and operate at a higher levelof efficiency.

Notes1. See Chapter 1, Endnote 1.2. World Development Indicators (2006)3. The 2006 figures are based on a 2006 article from

the U.S. China Business Council website, “China’sEconomy” at http://www.uschina.org/info/chops/2006/economy.html. The 1990 data is from an ar-ticle “How to Make China Even Richer” in theEconomist (March 23, 2006).

4. Chreod (2005)5. China Statistical Yearbook (2005)6. Mai and Weimer (2005).7. ibid.8. Xinhua News Agency. “Urban Income Gap Widens

to Alarming Level.” February 7, 2006.

36


If China is successful in improving the per-formance of its urban water utilities andmeeting future challenges, there will be sig-nificant environmental, public health, andeconomic benefits. This chapter presents asector vision for the year 2020 whereby:

� High-capacity cities provide high-quality water and wastewater services,and establish stormwater quality man-agement programs. Utilities operate atinternational standards and rely oncapital markets and user fees, butwastewater utilities still receive some municipal government capitalcontributions.

� Low-capacity cities provide reliablewater supply and treat all wastewaterto an intermediate level. Utilities are fi-nancially sustainable and rely on userfees for their revenues, but also receivemunicipal equity contributions and na-tional concessionary finance to main-tain acceptable tariff levels.

The benefits of realizing this 2020 vision aresignificant and include:

� Water quality improvements in China’sheavily degraded rivers, lakes, andcoastal areas

� Protecting public health by providingsafer water and improving raw waterquality

� Economic benefits by operating moreefficiently and reducing costs for agiven service level

� Promoting economic development andequity

The level of economic development in a citywill have a profound effect on the evolution ofits water utilities. Thus, the sector vision willneed to take into account the different typesof cities in China. The role of the governmentis to design and implement policies and pro-grams that enable cities to improve the per-formance of their urban water utilities asquickly as possible—and in particular sup-port the smaller and poorer cities. By com-parison, Box 4.1 provides an example of the evolutionary track of Korea’s wastewater sector.

Sector Vision in 2020If China’s urban water sector continues toevolve, improving service, increasing invest-ment, and meeting the challenges outlinedearlier, by 2020 the sector might look as follows.

37

4 2020 Sector Vision and Path Forward

All of China’s 661 cities and over 2,000large towns have urban water systems thatprotect public health, contribute to the im-provement of water quality, and provide ef-ficient stormwater drainage. Services areprovided through municipal utility compa-nies, many of which have established part-

nerships with the private sector. Some citieshave combined their water and wastewaterutilities into single organizations, and ex-panded service into the surrounding townsand counties. Municipal governments havestreamlined their governance system to en-sure that key decisions such as tariff levels,

38


From 1980–2000, South Korea experienced a period of rapid urbanization and economic growth that bears somesimilarity to China’s current development path. The figure below shows that South Korea’s urban wastewatertreatment coverage increased over time and with economic development. The figure expresses GDP per capita interms of constant year 2000 U.S. dollars (adjusted for purchasing power parity to help take into account currencyfluctuations and distortions). Several points are noteworthy:

� South Korea embarked on a national wastewater management program in the mid-1980s when adjustedGDP per capita was around $7,000. South Korea then took around 20 years to achieve wastewater treat-ment coverage of 80 percent. China embarked on its municipal wastewater program around 2000 when itsadjusted GDP per capita was $4,000, and it may also take around 20 years to reach its national objectives.

� Category I cities in China had almost reached Korean levels of adjusted GDP per capita and wastewater treat-ment by 2005. Category III cities, however, have much lower adjusted GDP per capita ($3000), but are drivenby national policy to start their wastewater management programs at a much lower level of economic devel-opment than Korea’s cities or the Category I cities.

One of the challenges facing the Chinese government is how to expedite the transition of cities to higher servicelevels within their economic development constraints and priorities.

BOX 4.1 South Korea: Wastewater Treatment Coverage vs. Economic Development

0

10

20

30

40

50

60

70

80

90

GDP per capita, PPP (constant, 2000 int’l$)

WW

T co

vera

ge ra

tio (p

erce

nt)

1980

5,000 7,000 9,000 13,000 15,000 19,000

1990 20001985 1995

China’s Category III cities

China’s Category I cities

Source: World Development Indicators and South Korea Ministry of Environment Statistical Yearbook

budget transfers, investment approval, and financing strategy are taken in a coordinatedmanner. Special programs have been estab-lished to ensure that water is affordable forthe urban poor. Information on utilities ispublicly and easily available and citizensand government use the information tomonitor their utilities. Table 4.1 provides asummary of how urban water utilitieswould be performing in 2020.

Vision for High-Capacity CitiesAs discussed in Chapter 1, high-capacitycities include all Category I cities (popula-tion greater than 2 million and GDP percapita greater than $3,000) and the affluentCategory II medium-sized cities. These

cities have high-quality water supplies thatmeet international drinking water stan-dards. They have comprehensive waste-water systems that collect and treat all of thewastewater at the secondary level or higher.Sanitary sewer overflows are minimized andstormwater pollution control programs arebeing established. The utilities finance all oftheir investments through capital markets,except for stormwater drainage, which is stillpaid for by the municipal government. Theutilities have adequate revenues from users tomeet their operational, debt service, and assetrenewal costs. In some cases, municipal gov-ernments have established “Water Boards”that are responsible for tariff regulation;some of these boards even regulate other

39

2 0 2 0 S e c t o r V i s i o n a n d P a t h F o r w a r d

High-Capacity Cities

Service Levels Financing Sources Revenue Sources

Water Supply

Wastewater

Low-Capacity Cities

Water Supply

Wastewater

TABLE 4.1 Chinese Urban Water Utilities in 2020

• Full coverage, continuous supply, adequatepressure

• Low level of non-revenue water• Compliance with all 2007 drinking water standard

parameters

• Full separate/combined collection coverage• Wastewater treatment at Class 1B or

1A standards• Storm water quality management programs

• Full coverage, continuous supply, adequatepressure

• Reduced level of non-revenue water• Compliance with all primary 2007 drinking

water parameters

• Full combined collection coverage• Low-cost wastewater treatment (Class 2 or 3)

• Capital markets• Internal Cash• Municipal equity for

drainage

• Capital markets• Internal cash• Municipal equity• National conces-

sionary finance

• Water users with lowincome help


• Industries according topollution loads.



• Industries according topollution loads.

municipal utilities such as gas, district heat-ing, power distribution, etc.

Vision for Low-Capacity CitiesAll Category III cities (population less than500,000 and GDP per capita less than $1,500),less affluent medium-sized Category IIcities, and all large towns are considered “low-capacity” cities. These cities and large townshave made tremendous strides in improv-ing water services. Water is provided withadequate pressure throughout the day. Al-though drinking from the tap will not resultin illness, most residents still purchase bot-tled water or boil the water first. All of thewastewater is collected and treated, al-though many cities have low-cost treatmentsystems that do not fully meet the highestnational standards. The water utility is gen-erally self-financing—with occasional assis-tance from the municipal government, butthe wastewater sector receives significantfinancial assistance from municipal gov-ernment funding and national concession-ary finance programs. Revenues from usersare sufficient to cover all the costs of utili-ties, including asset renewal.

Effective Sector GovernanceThe leadership, oversight, and financial as-sistance of the national and provincial govern-ments have been crucial for realizing theseachievements. The national government hasmade the provinces responsible for ensuringmunicipal governments provide adequatewater services. The national government hasalso significantly increased the level of con-cessionary finance, and channels the fundsthrough the provinces. Provincial govern-ments have responded by establishing solidoversight programs that assist and monitormunicipal utilities, and ensured that fundsfrom the national government are used ef-ficiently to meet the nation’s objectives.

Benefits of Achieving the Sector VisionAs outlined in the 2020 sector vision, im-proving the performance of China’s utilitieswould generate the following benefits:

Environmental ImprovementsIt will take decades to restore China’s heav-ily polluted waters, but there can be contin-ued improvement over the next 15 years.According to Figure 2.5, the total COD loadfrom domestic and industrial sources in2004 was approximately 13 million tons. Ifthe sector vision is achieved, this pollutioncan be reduced by at least 75 percent overthe next decade, which will have a signifi-cant impact on water quality in China’saquifers, rivers, lakes, and coastal waters,and allow aquatic ecosystems to begin aprocess of renewal. Based on other coun-tries’ experience, receiving water quality willimprove after controlling municipal and in-dustrial pollution, but sustaining a healthyecosystem is a more complex endeavor thatinvolves managing urban and agriculturalrunoff, as well as toxic chemicals. Box 4.2provides an example from the ChesapeakeBay in the United States. Correcting decadesof pollution in China will take an equallylong time, but controlling municipal and in-dustrial pollution is a critical step in a longjourney.

Improvements in Public HealthWater pollution endangers public healththrough a variety of mechanisms, includ-ing (a) polluting drinking water sources;(b) contaminating seafood, particularly in theextensive coastal aquaculture zones as wellas capture fisheries; and (c) transmittingdiseases through contact in rivers, lakes,and coastal waters. Quantifying the linkage

40


between water pollution and public healthis complex and beyond the scope of thisstudy, but is a major issue in China. The un-reliable and low quality water service inmany cities is a public health concern.Although Chinese custom is to drink boiledwater, typically as tea, exposure to bio-logically unsafe water and toxic contami-nants is a significant public health risk.

Unreliable water supplies can also impactpublic health by hindering basic washingand sanitation. Although China does not ap-pear to have a serious water supply qualityproblem—except in cases of emergenciessuch as industrial pollution accidents—theimpact of water services on public health isnot well understood. Achieving the sectorvision will undoubtedly improve public

41


The Chesapeake Bay is one of the ecological treasures of the United States but has been under severe stressover the last century due to pollution, overexploitation of fisheries, and shoreline development. The Chesapeakewatershed contains 16 million people and covers parts of six states in the mid-Atlantic region. The firstChesapeake Bay Agreement was signed in 1983 and the Chesapeake Bay Program evolved as one of thenation’s top ecosystem restoration priorities.

Since 1983, all cities in the watershed have constructed wastewater treatment plants, some of which removethe two major nutrients, nitrogen and phosphorous. In spite of spending billions of dollars to control municipalwater pollution, the Bay’s ecosystem is still close to collapse due to urban and agricultural runoff, lack of nutrientremoval in some wastewater treatment plants, shoreline development, and atmospheric deposition of nutrients.

The Chesapeake Bay Foundation, a nongovernmental organization, produces annual “State of the Bay Reports”that grade overall ecosystem health based on a scale of 1 to 100. By this measure, the overall ecosystem statusof the Chesapeake Bay has only improved marginally since the 1970s. The complexity, cost, time, and politicalcommitment necessary to restore the Chesapeake Bay underscores that improving degraded water bodies (suchas the Bohai Sea in China) can take many decades, and success is still uncertain.

BOX 4.2 Ecosystem Restoration in the Chesapeake Bay, United States

Source: Chesapeake Bay Foundation (2006).

Specific ScoresScale: 1 (worst) – 100 (best)

Pollution Nitrogen = 14 Phosphorus = 29 Dissolved oxygen = 16 Water clarity = 15 Toxics = 27

Habitat Forest buffers = 56 Wetlands = 42 Underwater grasses = 18

FisheriesRockfish = 71 Oysters = 4 Crabs = 38 Shad = 10

100 Pristine

Saved

Stable

Improving

Dangerouslyout of balance

90

80

70

60

50

40

30

20

10

01600 1940 1960

23 27

29

4040 by 2010

19801983 2003 20062010

2020 2050 2060

50

70

health by reducing water pollution and im-proving the quality of water supplied bywater utilities.

Cost Reductions for a Given Level of ServiceThe cost of providing urban water services isdriven mainly by service standards and the ef-ficiency of the utility. The sector vision callsfor service standards to be calibrated to theeconomic and financial capacity of the cities.Once appropriate standards are set and imple-mented, then the economic cost of theservice is very much dependent on the effi-ciency of the utility in making investmentdecisions and operating its facilities. Thereis huge scope for reducing costs of urbanwater services in China. Improving the effi-ciency of capital planning could conserva-tively reduce overall investment requirementsby one-quarter, or RMB 100 billion ($16 bil-lion), over the period 2006–10.1

Relieve Financial Burden onMunicipal GovernmentsThe sector vision calls for shifting more of thefinancing burden to the utility companies andaway from municipal governments. It esti-mates that approximately 30 percent of allfunding for water and wastewater infrastruc-ture over the last decade has been provided bymunicipal governments.2 If this trend were tohold in the future, municipal governmentswould have to fund around RMB 130 billion($16 billion) over the period 2007–10 alone.Municipal governments have limited financialresources, which are generally more effi-ciently spent on providing public goods thatpromote economic development and im-prove the quality of life, such as roads, parks,education, and public safety. Achieving thesector vision would move the financing bur-den away from the municipal government and

toward utilities that rely on user fees as a rev-enue base.

Promote Economic DevelopmentAll of the benefits identified above have di-rect and indirect economic benefits thatwould help promote overall economic de-velopment in China. Improvements in pub-lic health would reduce medical costs andimprove worker productivity. Environmen-tal improvements would directly improvesome economic sectors such as aquacultureand fishery yields. Most fundamentally, im-proving investment efficiency would allowscare capital to be employed in other, moreproductive uses.

Enhance EquityInequality is a serious and growing issue inChina along three dimensions: (1) betweenrural and urban areas; (2) among cities, par-ticularly between the coast and other areas;and (3) within cities. The key policies andprograms embedded in the sector vision willhelp overcome these inequalities. Appro-priate wastewater discharge and water qual-ity standards will help reduce costs forsmaller and poorer cities. National conces-sionary finance programs that target poorercities and ensure efficient utilities will re-duce costs. Although user fees will need tobe increased, special programs will be for-mulated to protect the urban poor.

Strategic Directions and the Way ForwardAchieving the sector vision presented in thischapter will require enhanced policies andprograms to improve utility performance.These enhancements are illustrated in Fig-

42


FIGURE 4.1 Strategic Directions for Key Policy Themes

ure 4.1 and discussed in the following chap-ters. The themes are interrelated and must bein balance for urban water utilities to per-form efficiently.

Notes1. Water treatment and wastewater treatment

plants currently have around 30 to 50 percent ex-

cess capacity, as shown in Chapter 2. Assuming

the same planning inefficiencies hold for water

supply and drainage networks due to the absence

of asset management planning, current sector in-

vestment inefficiency is conservatively estimated

at 25 percent. Between 2006–10, the estimated

sector investment is RMB 430 billion; 25 per-

cent of this amount is RMB 107 billion.

2. See Table 7.7 for sector financing information.

The 2006–10 sector investments are estimated at

RMB 430 billion.

43


Policy Themes Strategic Directions

Chapter 5:

Goal Based Sector Governance

• Improve National Policy Coordination

• Shift from Physical Targets to Policy Goals

• Set Appropriate Water Supply and Wastewater Standards

• Enhance Provincial Government Oversight

Chapter 6:

Municipal Utility Governance and Structure

• Streamline Municipal Utility Governance

• Foster Efficient Utilities

• Manage Wastewater as a Network Utility Business

• Exploit Opportunities for Service Aggregation

Chapter 7:

Financial Sustainability

• Achieve Utility Cost Recovery

• Make More Use of Debt Financing

• Improve National Concessionary Finance Programs

Chapter 8:

Private Participation

• Ensure Private Arrangement Fits Into Sector Reform Plan

• BOT Treatment Plants Fit Into Utility Network Business

• Make More Use of Non-Investment Arrangements

Chapter 9:

Capital Planning

• Utilize Integrated Water Planning Methodologies

• Develop Asset Management Planning (AMP)

• Strategically Plan and Manage Drainage Systems

• Manage Sludge as Environmental and Financial Priority

China can get better performance from itswater utilities by improving the rules, poli-cies, and effectiveness of national and pro-vincial government organizations. Areas forimprovement include:

� Increasing policy coordination andagency effectiveness at the nationaland provincial levels

� Moving from physical targets—such as pipelines and treatment plants—topolicy goals, including ecosystemrestoration, safe drinking water, andefficient utilities

� Setting realistic standards that are af-fordable, enforceable, and that createincentives for utilities to advance thepolicy goals

Figure 5.1 provides a schematic of the keythemes in this chapter

The chapter describes the national insti-tutions and outlines the key laws, policies,and directives governing urban water utili-ties. Like most large countries, China has acomplex and decentralized system for thegovernance of urban water services; dif-ferent agencies at different levels of gov-ernment have overlapping functions anddifferent perspectives. In the following sec-tion, we recommend establishing a “Na-

tional Water and Sanitation Committee” tohelp resolve policy coordination problems.

Better coordination among national agen-cies would help to define and monitor policygoals that go beyond the construction of in-frastructure. We suggest some higher levelpolicy objectives and monitoring indicators,including:

� Restoring ecosystem functions inrivers, lakes, and coastal waters

� Protecting public health by providingsafe drinking water

� Delivering more efficient provision ofutility services

Setting and enforcing realistic standards thattake into account the wide variety of eco-nomic development and environmental set-tings is central to achieving policy objectives.This chapter points out that China’s watersupply and wastewater standards meet or ex-ceed the highest international standards, andproposes more explicit use of less stringent“transitional standards” that allow low-ca-pacity cities to meet national standards overtime. The chapter concludes by recommend-ing that provincial governments improve pol-icy coordination, increase funding, and buildcapacity for the provincial agencies that over-see urban water utilities.

45

5 Goal-Based SectorGovernance

Overview of SectorGovernance StructureChina has four basic levels of administration:national, provincial, prefecture, and county

(see Figure 5.2).1 National governments over-see provinces, and provincial governmentsoversee prefectures. The prefecture govern-ment and its agencies have two functions: (1)they directly govern the prefecture-level city

46


FIGURE 5.1 Overview of Chapter Five

Provincial government oversight Agency coordination

Shift from physical targets to policy goals

Appropriate water and wastewater standards

Sector Structure Laws, Policies, and Directives

FIGURE 5.2 Overview of Government Administration

Source: ADB, National Guidelines on Wastewater Tariffs and Management (2003).

Line accountabilityFunctional supervision and reporting

National level

National ministries Provincial-levelgovernment

Provincial departments Prefecture-levelgovernment

Prefecture bureaus District & county-levelgovernment

District & countybureaus

and provide public services; and (2) theyoversee county-level governments withintheir jurisdiction. Each province, prefecture,and county has an urban area which servesas the center of administration, and is re-ferred to in this study as a “city” or a “munic-ipality.” The actual provision of municipalservices is the responsibility of the city and isdiscussed in Chapter 6. As shown in Figure5.2, each agency has two lines of reporting:(1) line accountability to the responsible gov-ernment entity (prime minister, governor, ormayor); and (2) functional supervision andreporting to the agency above it.

This chapter focuses on national andprovincial organizations and policies, while

Chapter 6 deals with municipal-level agen-cies and urban water utilities. The term“agency” is used in the general sense to meana government organization, whether it is anational ministry, state-level agency, provin-cial department, or municipal bureau in theChinese context. The description of key na-tional government agencies, and their func-tions with respect to the urban water sector,is presented in Box 5.1. Important attributesof Chinese government administration arediscussed below.

Fiscal DecentralizationThe fiscal system in China is highly decen-tralized. Municipal governments are respon-

47

G o a l - B a s e d S e c t o r G o v e r n a n c e

Government. The State Council of the People’s Republic of China is the highest body of state administration.The State Council is composed of the premier (also known as prime minister), vice-premiers (or Vice-Ministers),state councilors, ministers in charge of ministries and commissions, and the auditor-general. China’s governmentis headed by the premier and his group of vice premiers, each of whom are responsible for specific ministries.The provincial government is headed by a governor, who also has a group of vice governors responsible forspecific provincial departments. The national and provincial governments have the same set of agencies. Allof the national agencies described below are of equal administrative rank, but NDRC and MOF have broad andinfluential mandates.

National Development and Reform Commission (NDRC). NDRC provides overall economic development policy,utility price policies, and guides China in the transition to a market economy. NDRC also administers the “StateBond” program, which is the most important national concessionary finance program for the urban water sector.

Ministry of Finance (MOF). MOF manages national government financial resources, budget allocations, andsupervision of the country’s financial system.

Ministry of Construction (MOC). MOC is responsible for establishing policies, issuing directives, and super-vising the management of municipal public utilities, including urban water utilities.

State Environmental Protection Agency (SEPA). SEPA is responsible for managing the environmental qualityof air, land, and water. It oversees environmental impact assessments; develops and monitors water qualityimprovement plans; and proposes and enforces municipal and industrial wastewater discharge standards.

Ministry of Water Resources (MWR). MWR is responsible for establishing policies, issuing directives and supervisingthe management of water resources, as well as overseeing the provision of flood control and irrigation services.It is in charge of integrated water resource management, including water use and (in conjunction with SEPA)water quality management.

Ministry of Public Health (MOPH). MOPH is responsible for ensuring the safety of municipal water supply servicesin conjunction with MOC and SEPA.

BOX 5.1 Agencies Involved in the Urban Water Sector

sible for ensuring adequate funding for theirpublic utilities by setting adequate tariffs,transferring funds from the municipal bud-get, and directing commercial bank loans toutility companies. Municipal agencies arefunded by their municipal governments andoften administer large budgets. Althoughthey take policy guidance from provincialand national agencies, the municipal agencydirectors are heavily influenced by the mu-nicipal governments’ priorities and direc-tives. Municipal construction agencies, forexample, often administer large budgets onbehalf of the municipal government. In con-trast, provincial and national governmentagencies play primarily an advisory andmonitoring role in the provision of urbanpublic utility services. National and provin-cial agencies have the power to set policies,guidelines, and standards for municipal util-ities, but their ability to actually enforcethese directives through legal or fiscal con-trols is limited.

Developing Legal SystemChina’s legal system is developing along withits market economy, but the political culturedoes not lend itself well to strict legalisticenforcement of standards and regulations.China does have, however, a unified politicalsystem led by the Communist Party, and theevaluation of government officials is basedprimarily on their accomplishments andcompliance with government policies. Forexample, China established a national policyof urban wastewater treatment through aState Council Directive in 2000.2 This helpedto mobilize cities throughout China to startthe construction of wastewater treatmentplants at an exceptionally rapid pace.Mayors and their municipal agencies weremotivated by the urgency of the wastewaterproblem, but they also knew that their per-

formance evaluation and future promotionpotential would be based partly on successin infrastructure construction. One of thechallenges for China is to develop a similarincentive system for ensuring sustainableand efficient delivery of municipal services.

Key Laws, Policies, and DirectivesThe legal and policy context for China’s urbanwater sector has changed dramatically overthe last decade, and the national governmentis actively promoting reforms to meet futurechallenges. The general legal framework atthe national level is in place, complementedby policies issued by the State Council and di-rectives issued by national and provincialagencies. The key elements are as follows:

National Laws. The “Law on the Pre-vention and Control of Water Pollution” waspromulgated in 1984 and provides the legalfoundation for water pollution control. Thelaw was amended in 1996 to include (a) a re-quirement for cities to provide centralizedtreatment for both municipal and industrialwastewater; and (b) improved industrialwater pollution control, including adoptingclean technologies and controlling the massof pollutants discharged (as opposed to onlyeffluent concentrations).

The 1988 Water Resource Law was funda-mentally amended in 2002 to focus on com-prehensive water resource management.The law stresses the importance of the “user-pays” principle, and the need to conservewater by promoting water-saving technol-ogies and controlling demand. The 2002amendments call for integrating water qual-ity considerations into water resource man-agement, and empowers the Ministry ofWater Resources and its line agencies to playa more proactive role in water quality man-agement alongside SEPA.

48


State Council Policies. As noted in Box 5.1,the State Council is the highest administra-tive body in China. Policy statements by theState Council represent official governmentpolicy and set national priorities and objec-tives. The key policies related to water are:

� “Circular on Strengthening Urban WaterSupply, Water Saving, and Water Pollu-tion Prevention and Control (2000).”This historic circular has set theagenda for the period 2000–10 andcalls for China to (a) improve watersupply planning and promote waterconservation; (b) enforce the existing“Law on Water Pollution Preventionand Control” and aim to achieve atleast a 60 percent urban wastewatertreatment rate by 2010; (c) promotemarket-oriented tariff reforms to helpattract private capital; and (d) improvesector governance and regulation.

� “Decision on Reforming the InvestmentSystem (2004).” This decision allows and promotes nongovernment entities to invest in new areas of the economy, including municipal public utilities. Italso provides more flexibility and en-courages enterprises to raise capitalthrough debt and equity markets. Italso relaxes the government’s reviewprocess for new investments.

Ministerial Directives. The ministries pro-vide directives that advise and guide lowerlevel agencies on how to implement nationallevel laws and policies. Although the direc-tives are not legally binding in a strict sense,the lower-level agencies are expected tostudy, adapt, and apply the directives to spe-cific situations. Some of the key directives,which indicate how the sector is evolving,are presented below:

� Establishment of Wastewater Com-panies. In 1999 NDRC,3 MOC, andSEPA issued a notice to “ImproveWastewater Collection Capability and Establish Sound Collection andTreatment Practices” (Notice 1992).The notice called on cities to establishwastewater companies, collect waste-water fees as part of the water supplybill, and start constructing wastewatertreatment plants.

� Market Reform Policies. The “Circular on Accelerating the Marketization ofUrban Utilities” (MOC, December2002) encourages domestic and foreign investment in urban public utilitiesthrough a variety of ownership ar-rangements such as sole ownership,joint venture, or partnerships. The“Circular on Accelerating the Com-mercialization of Urban Wastewaterand Solid Waste Treatment” (MOC,NDRC, and SEPA, September 2002)provides specific references to waste-water treatment plants and promotesarrangements such as build-operate-transfer (BOT), joint ventures withmunicipal utilities, and transfer-own-transfer (TOT).

� Regulatory Reform Policies. With thedeepening of market reforms in the sector, the government recognized theneed to strengthen monitoring, regula-tion, and oversight of the sector. In2004, the MOC issued Decree 126 re-garding “Management Measures forConcession of Public Utilities,” whichlaid the basic ground rules for compet-itive and transparent awards of publicutility concessions. This was followedby another MOC Opinion in 2005 on“Strengthening Monitoring on Munic-ipal Public Utilities,” which empha-

49


sized the supervisory role of the mu-nicipal and provincial governments,the need to improve laws and regula-tions, and capacity building for utilityregulation. The opinion also noted theneed to moderate the reform pace inorder to balance efficiency and equity.

Improving NationalPolicy CoordinationThe provision of urban water services in-volves many different issues that, similar toother countries, are the domain of differentgovernment agencies in China. Coordinationinvolves ensuring the policies, plans, andregulations are consistent, and managinginput from the various government agenciesinvolved in urban water services. This studyrecommends that coordination be improvedin China, and suggests the establishment ofa “National Water and Sanitation Com-mittee” under the leadership of a vice primeminister.

Need for Improved CoordinationDifferences of opinion and perspectiveamong different sector agencies—and otherstakeholder groups—are natural and neces-sary for good governance in the urban watersector. The following paragraphs reviewsome of the key tensions that currently existamong national agencies, which are shownschematically in Figure 5.3.

MOC-SEPA Coordination on WastewaterStandards. SEPA is responsible for settingmunicipal and industrial effluent standards.As an environmental agency, its perspectiveis focused on improving environmental qual-ity. MOC is responsible for supervisingurban water utilities; it places a high priorityon utility financial and operational perform-

ance. As discussed in the next section, theapplication of stringent wastewater dis-charge standards puts significant pressureon smaller and low-income cities, whichmay actually undermine efforts to improvewastewater management. Reconciling theneed for environmental protection with en-suring the performance and sustainability ofutilities is critically needed.

SEPA-MWR Coordination on Water Qual-ity Management. The 2002 Water Law pro-vided MWR with a mandate for integratedwater resources management, includingwater quality. SEPA has historically been re-sponsible for ambient water quality stan-dards, water quality monitoring, and devel-oping water quality improvement plans.SEPA still has the sole responsibility for in-dustrial pollution control and monitoringand enforcing wastewater discharge stan-dards. Both agencies have legitimate and important roles to play in water quality man-agement. Water resources cannot be man-aged without considering water quality, andwater quality management cannot take placewithout considering pollution control. Find-ing ways in which MWR, SEPA, and MOC

50


FIGURE 5.3 Overlapping Functions among Agencies

MoPH MOC SEPA

MWR Urban water

resourcemanagement

Water supplyquality standards

Wastewaterstandards

Water qualitymanagement

can work together in planning the best wayto protect China’s water environment will bekey to meeting policy objectives.

MWR-MOC Coordination on Urban WaterResources Management. The 2002 Water Lawalso prompted the establishment of “UrbanWater Affairs Bureaus,” which are responsi-ble for supervising all water-related activitieswithin a city, including water supply, waste-water, flood control, and drainage. Somelarge cities such as Beijing, Shanghai, andShenzhen have created such bureaus underthe leadership of the local water resources bureau. As shown in Figure 5.2, agencies typ-ically have one line of functional reportingand supervision to a higher level agency.Water affairs bureaus need to report to bothMWR- and MOC-affiliated agencies, with themost direct line to the MWR. Creating wateraffairs bureaus allows water to be managed inan integrated manner, but there still need tobe strong linkages with the MOC on issues related to utility management.

MOC-MOPH Coordination on WaterSupply Quality Standards. MOPH proposednew draft water quality standards in 2001,and MOC issued draft water quality stan-dards in 2005. As discussed in the next sec-tion, the National Standards Commissionand MOPH have prepared draft standardsthat are expected to be approved in 2007.4

Monitoring drinking water quality falls un-der the jurisdiction of both sector agencies.Coordination between MOC and MOPH insetting, monitoring, and enforcing drinkingwater quality standards is important for thesector.

Coordination with NDRC on use of StateBond Funds. As discussed in Chapter 7, statebonds are grants or low-interest loans pro-

vided to cities for infrastructure develop-ment, including water infrastructure. Thestate bond program is administered byNDRC. MOC, SEPA, and MWR and their af-filiated agencies at the provincial level alsohave legitimate interests in the financing ofurban water infrastructure. Combining thesectoral expertise of the line agencies withNDRC’s administration of the state bondprogram is necessary to ensure that con-cessionary finance is effective in promotingpolicy objectives.

Improving Coordination MechanismsNational-level policies are formulated by theState Council. Since the Council includesmembers from all key ministries, eachagency involved in the urban water sector isprovided an opportunity to provide input onnational policies. The administrative systemmakes it challenging, however, for differentagencies to work together to craft integratedpolicies for consideration by the State Coun-cil. Moreover, each agency is allowed toissue directives within the scope of its per-ceived mandate without necessarily inform-ing or obtaining the approval of other relatedagencies. We identified three broad optionsfor improving coordination within the na-tional government:

Establish a New Agency. A new agencycould be established with most of the im-portant functions related to urban waterservices such as setting and monitoringwastewater and water supply standards, set-ting ambient water quality objectives, ad-ministering national concessionary financeprograms, and providing technical leader-ship. In the 1970s, when efforts to improvethe environment in the United States werestalling, the government established theEnvironmental Protection Agency, which

51


became the leading national agency forwater and wastewater. Based on feedbackduring study consultations, however, creat-ing a new agency in China does not appearpractical due to efforts to control the size ofthe national government and the complexityof realigning agency responsibilities.

Reallocate Responsibility Among Exist-ing Government Agencies. There are variousscenarios for changing the mandates of thekey agencies to consolidate more functionsin fewer agencies. Although this would po-tentially reduce the need for coordination, itmay be politically difficult as agencies arereluctant to cede their authority. Vesting anagency with new authority without explicitlyredefining the role of the agency that wasformerly responsible can also create confu-sion. This study does not recommend anyspecific reallocation of responsibilities. Ifimproved policy coordination cannot beachieved in the future, then considerationshould be given to reallocating functions toreduce the number of agencies involved inthe sector.

Establish a National Water and San-itation Committee. This study recommendsthat the State Council establish a NationalWater and Sanitation Committee under adeputy prime minister. The main role of thecommittee would be to provide coordinationamong the sector agencies. The committeewould not be a new agency, but rather a for-mal committee composed of representativesfrom relevant government agencies, as wellas other stakeholder groups, with one min-istry appointed as the secretariat. Its man-date would be limited to water supply andsanitation (including wastewater) in bothrural and urban areas. The committee couldmeet on a monthly or quarterly basis, with

specialized ad hoc working groups, andwould have the general functions of policycoordination and monitoring of sector per-formance and development. Of particularimportance would the compilation, analysis,and synthesis of information across differentsector agencies, ideally resulting in annualreports on water supply and sanitation.

Shifting from PhysicalTargets to Policy GoalsChina’s policy environment in the sector isevolving quickly, but is still heavily focusedon the rapid construction of infrastructure.Although increases in the stock of infrastruc-ture are required, the physical works areonly a tool to achieve broader policy goals.Prior to the 1980s, China had a plannedeconomy where governments and state-owned enterprises were provided with phys-ical production targets and their perform-ance was evaluated based on productionquotas; economic efficiency was not neces-sarily a priority.

The legacy of the planned economy still hasa profound impact in today’s China. National,provincial, and municipal governments oftenfocus on constructing infrastructure ratherthan efficiently providing good service tomeet China’s broader policy goals. For exam-ple, MOC’s annual yearbook records informa-tion related to physical infrastructure (e.g.kilometers of pipelines or treatment plant ca-pacity) and sources of financing, but does notprovide indicators on utility financial per-formance, compliance with standards, or op-erational efficiency. Provincial governmentsapply pressure on cities to construct waste-water treatment plants, but there is only lim-ited effort to ensure comprehensive collectionand adequate wastewater treatment.

52


These deficiencies are recognized withinthe government. Developing the necessaryinstitutional arrangements to shift the focusfrom construction to efficiently setting andmeeting policy goals, however, is a complexendeavor. A useful starting point is a clearerarticulation of the policy goals and the spe-cific parameters by which these goals wouldbe monitored. Table 5.1 provides some ex-amples for consideration.

Strengthening ProvincialGovernment OversightProvincial government agencies have impor-tant roles to play in overseeing municipalutilities, including:

� Approval of municipal tariff adjustments

� Approving large investment projects� Overseeing compliance with water

supply and wastewater standards� Helping to channel concessionary fi-

nance through the state bond program

Improving the capacity and funding of pro-vincial agencies to better execute their exist-ing mandates is important to achievingChina’s objectives. Similar to the nationalgovernment, it is also important to improvecoordination among provincial agencies. Wesuggest new institutional arrangements atthe provincial level, including either:

� Creating a “Provincial Water andSanitation Committee” to improve coordination

� Establishing a “Provincial WaterOffice” to consolidate functions in oneagency

Role of the Provincial and Prefecture Gov-ernments. The provincial government has

historically played an advisory and oversightrole to the municipalities, maintaining con-trol through the selection and approval ofmunicipal leaders. This approach was for-mulated after the founding of the People’sRepublic of China in 1949 to enhance centralgovernment authority in a large and region-ally diverse country, while at the same timeallowing municipal governments to cre-atively respond to local issues. The Chinesefiscal and administrative system is relativelydecentralized, with most of the tax revenuescollected and spent at the local governmentlevel. The central government provides over-all policy direction in the infrastructure sec-tor, but allows considerable discretion tolocal governments in the pace and extent inwhich they implement general policies.

The prefecture government is under thesupervision of the provincial government, butalso administers its own prefecture-level cityand oversees counties within its jurisdiction.Each county-level city or county-town (i.e. thecapital of the county) reports to the mayor ofthe prefecture—who is also simultaneouslythe mayor of the prefecture-level city. In turn,the mayor of the prefecture reports to theprovincial governor. There are 287 prefec-ture-level cities,5 374 county-level cities, and

53


Policy Goal Parameter

Restoring Ecosystems in Rivers, Lakes, and Coastal Areas

Protecting Public Health by Providing Safe Water

Efficiently Providing Utility Services

TABLE 5.1 Examples of Broad Policy Goals

• Meeting time-bound water qualityand ecosystem improvement targets

• Improvements in water safety asdemonstrated in holisticassessments

• Continuous improvements in keyutility operational and financial parameters

1,636 county capital towns. Hence, a signifi-cant part of the oversight activity actuallytakes place at the prefecture level.

Need for Provincial-Level Oversight. Citiesand their utilities need to be supervised by ahigher level of government to ensure compli-ance with national and provincial policiesand standards. The provincial government isgenerally the best place for comprehensiveutility oversight for the following reasons:

Provinces are the Right Size. Given China’ssize, comprehensive utility oversight at thenational level is impossible. Conversely,municipal utility oversight at the prefecture

level is complicated by the large number ofprefectures (287) and the limited amount ofutility regulatory and oversight expertise inChina. In addition, the 287 prefecture-levelcities cannot provide oversight of their ownutilities, which defaults to the provinces. Theprovinces in China are equivalent in size andpopulation to many countries around theworld. In most countries, the national gov-ernment agencies play the key regulatoryand oversight roles for the urban water sec-tor. The MOC has also emphasized that theprovincial construction agencies should “beresponsible for guiding and supervisingmunicipal public utility monitoring withintheir jurisdictional regions.”6 Box 5.2 pro-

54


In Colombia, urban water services are provided by more than 1,700 decentralized and diverse municipal utili-ties. Although the majority of these water utilities are government-owned, private sector participation has beenintroduced in 14 of the largest cities and several medium and small municipalities. Monitoring and controllingsuch a large number of suppliers in the water sector calls for rigorous organization. Colombia has opted for alargely centralized approach, which is briefly summarized below:

� Water standards:● The Ministry of Social Protection (MPS) sets potable water standards on a national basis● National wastewater effluent standards are set by the Ministry of Environment, Housing and Urban

Development (MAVDT)� Tariffs and service standards:

● Service standards such as coverage, continuity, and customer services are defined by the local govern-ment or by providers themselves

● Since 1991, the Water and Sanitation Regulatory Commission (CRA) has been responsible for developingtariff rules, efficiency indicators, and coordinating the service quality standards.

� Monitoring and Enforcing:● The Domestic Utility Services Superintendency (SSPD) is responsible for monitoring and enforcing com-

pliance with water, tariff, and service standards.

Alongside its role of monitoring and enforcing compliance, the SSPD uses benchmarking to assess the perform-ance of water utilities in Colombia. For example, reports on water quality are released annually by the SSPD andmade available to the general public. This benchmarking information assists policy makers when designing reg-ulation and national standards. The benchmarking is also used by the general population, visitors, and non-governmental organizations to understand and improve water services in Colombia.

Source: Prepared by Castalia for this study.

BOX 5.2 Role of National Government Agencies in Colombia

vides information on the role of nationalagencies in Colombia, which is equivalent inpopulation to many provinces in China.

Conflicts of Interest for Municipal Agen-cies. As shown in Figure 5.2, municipal agen-cies report to both the municipal govern-ment and their parent agency at the nexthighest level of government. For example, ina prefecture-level city, the municipal envi-ronment bureau reports to the mayor andthe provincial environment bureau. In theevent of environmental noncompliance of awastewater treatment plant, the municipalenvironment bureau is often hesitant to in-form the provincial environment bureau, asit may negatively affect the position of themayor or their colleagues in the construc-tion bureau. These conflicting roles often in-hibit the flow of information upwards. Sinceprovincial agencies do not report to munici-pal governments, they should tend to bemore objective in their monitoring and en-forcement activities.

The oversight responsibility of the pro-vincial governments includes (a) municipalutility supervision through the Construction

Bureau; (b) approving large investment pro-grams through the DRC; (c) reviewing and ap-proving water and wastewater tariffs throughthe Price Bureau or DRC; and (d) formulatingregional water pollution control and water re-source management plans through the WaterResource Bureau and/or EPB. Hence, the pro-vincial government already has significantoversight responsibilities for prefecture-levelcities. The provincial government also moni-tors the prefecture government’s oversight ofcounty-level cities and towns.

Constraints on Provincial Agencies. Pro-vincial government agencies already havesome important oversight responsibilities,as summarized in Table 5.2, but the agenciesface constraints in exercising their man-dates, including:

Weak Incentive and Enforcement Mecha-nisms. In many countries, legal and financialpenalties are often used by higher levels of government to drive the behavior ofmunicipalities. China, however, has a non-legalistic oversight system that evaluates mu-nicipal leaders based on their overall compli-

55


Provincial Agency General Supervision Responsibility

Provincial Construction Department Supervise municipal utilities

Provincial DRC Approve large investment projects

Provincial Price Department Approve municipal tariff adjustments

Provincial EPB Approve environmental impact assessmentsMonitor and enforce discharge standardsDevelop water quality improvement plants

Provincial Water Resources Department Manage regional water resource infrastructureAllocate water resources within province

Provincial Public Health Department Monitor and enforce drinking water quality

TABLE 5.2 General Supervision Responsibilities of Provincial Agencies

ance with national policies and achievementof planning targets. Threatening a municipalgovernment withfinancial or legal sanctionswill typically only occur in the most egre-gious of situations. One of the challenges forChina is to develop an incentive system forensuring sustainable and efficient delivery ofmunicipal services. Evaluating the opera-tional and financial performance of utilitiesis much more complex than simply verifyinginfrastructure construction. Programs forevaluating and benchmarking urban waterutility performance are generally weak at alllevels of government in China.

Low Supervision Budgets. Many of the keyprovincial agencies, including constructionand environmental agencies, do not havelarge budgets and have limited staff and ex-pertise. Their municipal-level counterpartsin the large cities, who implement projectsor actually monitor and enforce regulations,generally have access to more on-budget andoff-budget financial resources. For example,municipal construction bureaus have largecapital projects and are actively involved inreal estate development. Provincial authori-ties, in contrast, rely primarily on a limitedprovincial government budget to undertaketheir activities. The shortage of funds can in-hibit comprehensive regulatory oversight,staff development, and attracting top-levelprofessionals.

Strengthening Provincial GovernmentOversight Capacity. Provincial governments,with the support and encouragement of thenational government, could take the follow-ing steps:

� Increase Agency Funding and Capacity. In most cases, provincial agencieswould need to bolster capacity and re-ceive funding before assuming a more

active and effective role. The appropri-ate level of funding would vary basedon the particular province and agency,but would be a small fraction of themoney that is invested in urban waterinfrastructure. Funding could comefrom a combination of general provin-cial budget and/or charges on munici-pal utilities. National agencies couldtake a lead role in helping to developprograms to build the capacity of theircounterpart provincial agencies.

� Establish Provincial Utility Bench-marking Programs. Public utilitymanagement and regulation at boththe municipal and provincial levels ishindered by the absence of systematicand reliable data to evaluate utility per-formance. Over the past decade, inter-national experience in the use of waterand wastewater utility benchmarkinghas grown and there are now acceptedmethodologies for evaluating utility fi-nancial and operational performance(see Box 5.3). Provincial governmentagencies could take the lead in ensur-ing comprehensive utility benchmark-ing programs. In most cases, it wouldprobably be more effective to subcon-tract or enter into partnerships withprofessional organizations to actuallyundertake the benchmarking.

� Improve Oversight of Municipal TariffRegulation. The provincial price bu-reau, often under the provincial DRC,typically has the authority to reviewand endorse tariff adjustments ap-proved by municipal governments. Thereview process, however, is often per-functory and undertaken with the viewof the impact oninflation and how thetariff compares with other cities. Thereview process can be expanded to

56


how best to structure and monitor thecontract. The authority of the provin-cial government regarding municipalarrangements with private companiesis ambiguous. To protect the interest ofthe public and the municipality, how-ever, we suggest that provincial gov-ernment agencies, either through the DRC or construction department, establish clear procedures and rulesfor provincial review of public-private partnerships.

� Improve Provincial Policy Coordination. Similar to the national government,provinces should establish a “Provin-cial Water and Sanitation Committee” composed of relevant governmentagencies and headed by a vice gover-nor. We suggest that some provincesestablish a “Provincial Water Office,”which would take over functions re-lated to utility regulation and oversightthat are currently scattered across dif-ferent agencies. The office would havethe mandate and funding to improvemunicipal and provincial regulation bydeveloping enhanced procedures andregulatory tools, and leading reforms

57


evaluate the pro-cess and analyticalrigor by which municipalities set tar-iffs, and ensure that the best practicefor economic regulation is utilized.

� Proactively Manage National Conces-sionary Finance Programs. Provincialgovernments could develop mecha-nisms tosupervise and guide nationalconcessionary finance programswithin their provinces. As discussed inChapter 7, the NDRC-administeredstate bond program and China Devel-opment Bank (CDB) provide conces-sionary finance to the water and waste-water sectors. These two programsshould be significantly promoted orscaled up. However, provincial author-ities should develop mechanisms toensure that the funding is channeled to municipalities that can effectively utilize the funds and meet well-definedperformance criteria.

� Oversee Private Sector Participation(PSP). As discussed in Chapter 8, many cities and their municipalities inChina are struggling with the decisionwhether to enter into a partnershipwith a private water company, and

Water sector performance assessment and benchmarking helps a regulator to quantify the relative performanceof water utilities. Using well-established empirical procedures, the regulator can measure performance, identifyperformance gaps, suggest actions, and provide resources to overcome such gaps. The performance data col-lection is needed not only for the current operations, but also for documenting past performance, establishinga baseline for productivity improvements, and making comparisons across water and wastewater utilities.Rankings on the basis of performance indicators can inform (a) utility managers of their performance vs. otherutilities; (b) policy makers; (c) fund investment providers (multilateral organizations and private investors); and(d) customers regarding the cost-effectiveness of different water utilities. The International BenchmarkingNetwork for Water and Sanitation (IBNET) and other similar performance assessment tools are used by manynational, regional, and municipal water regulators around the world.

Source: Prepared by Alexander Danilenko (2006), World Bank.

BOX 5.3 Water Utility Performance Benchmarking

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in the sector. The office could also sup-port large-scale training and capacity-building programs related to utilitymanagement and regulation at themunicipal level.

Setting AppropriateWater and Wastewater StandardsStandards are a key tool in converting policygoals into action. China should aim to havestandards that are:

� Affordable to ensue the service is finan-cially sustainable

� Enforceable to allow regulators to com-pel compliance with unambiguousrequirements

� Efficient to meet policy objectives in aleast-cost manner

China’s water supply and wastewater dis-charge standards do not fully meet these cri-teria. Every society aspires to have a perfectenvironment with high public health stan-dards and unpolluted water resources. However, unrealistic standards and nonen-forceable regulations can be harmful if theycreate an attitude of indifference among util-ities, industries, and regulators. Standardsand regulations should be tailored to matchthe environmental requirements, as well asthe level of economic and administrative ca-pacity. This section proposes the followingapproaches to standards:

� Use transitional standards for low ca-pacity cities to allow them to improveservice as they develop economically

� Improve water safety and ambientwater quality through more compre-hensive approaches, such as holistic

water safety assessments and water-shed management

Municipal Wastewater Discharge Standards

Existing Standards. China has well-developed environmental quality standardsfor surface waters, as shown in Annex 2.Both SEPA and MWR have extensively sur-veyed the receiving water bodies and classi-fied the quality of different river stretches(see Figure 3.3). The wastewater dischargestandards for industries and municipalwastewater treatment plants are also pro-vided in Annex 2. Table 5.3 provides a sum-mary of the standards.

The provincial EPB is responsible fordetermining which standard to apply for amunicipal wastewater treatment plant. Sec-ondary treatment (i.e. involving biologicaltreatment) is a minimum requirement for allcities. Class 1A standards are required forplants discharging into sensitive receivingwater bodies. Meeting Class 1A requires ad-ditional treatment to reduce nutrients andsuspended solids. Box 5.4 discusses a recentSEPA guidance note that requires all cities inkey water resource protection areas to meetClass 1A standards.

Analysis of Existing Standards. Three issues—affordability, enforceability, and ef-ficiency—affect the application of waste-water standards.

Class 1A Class 1B Class 2

BOD (mg/l) 10 20 30SS (mg/l) 10 20 30Total-P (mg/l) 0.5 1.0 3.0Total-N (mg/l) 15 20 30 (NH-3N only)

TABLE 5.3 Summary of China’s MunicipalWastewater Discharge Standards

Affordability. Many of the smaller andlower income cities (including larger towns)may not be able to afford secondary waste-water treatment, let alone Class 1A stan-dards requiring tertiary treatment. In addi-tion to the investment costs, sustainingoperations is a major challenge for thesecities. The larger and richer cities can affordto, and should be required to, comply withthe national discharge standards; it may takethe low-capacity cities in China a decade ormore to achieve comprehensive wastewatermanagement. Two ways to help overcome fi-nancial constraints for low-capacity citiesare(1) provide the cities with subsidies, and(2) use transitional standards to lower costs.

Box 5.5 shows the difference in costs be-tween different levels of wastewater treat-ment in the United States and Europe. Thecosts in Box 5.5 represent the full capital andoperating costs of wastewater collection and

treatment. They are not directly comparableto China due to the difference in purchasingpower parity. Box 5.5 shows diminishingmarginal returns in terms of pollution re-duction as the level of treatment increases.

Enforceability. The procedures for deter-mining which wastewater standard to applyin China are relatively clear, and summarizedin Box 5.4. All cities must meet a minimum ofClass 2 discharge standards; Class 1A or Class1B standards may be required based on thewell-defined surface water quality class of thereceiving water body (see Annex 2). Each mu-nicipality thus has well-defined obligationsthat it must fulfill. This is similar to the UnitedStates or European Union, where all citiesmust have a minimum of secondary treat-ment or higher based on the receiving waterbody. However, the level of economic devel-opment in the U.S. and E.U. is much higherthan in China, and many cities have received

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In 2005 SEPA issued Circular No. 110, which provides guidance on the application of discharge standards formunicipal wastewater treatment plants. Key points include:

1. All plants that discharge into important river basins and enclosed water bodies such as lakes or the BohaiSea shall be required to meet Class 1A standards. Important river basins include, among others, the Hai,Huai, Huang, and Liao basins; these basins include most of the cities in North China.

2. Plants that discharge into Class III water bodies or Class II sea areas are required to meet Class 1B standards.(See Annex 2 for information on water quality classes).

3. Other areas may meet Class 2 standards, and gradually increase control requirements based on localconditions.

An analysis done by the World Bank for a 100,000 m3/d wastewater treatment plant in a poor city in the Liao RiverBasin indicated that a shift from Class 1B to Class 1A standards would result in a 15 percent increase in total life cyclecosts. The reduction in BOD is insignificant, but the percentage of nitrogen and phosphorus removed wouldincreased from around 75 percent to 90 percent. Nutrient pollution from agricultural runoff in the Liao River Basinis a major problem yet still largely uncontrolled. Reducing pollution from agricultural sources would potentially bemuch more cost-effective than upgrading to Class 1A standards. Moreover, like many cities in China, this particularcity has no existing wastewater treatment plant, but is expected to immediately construct a complex and expensivefacility and achieve discharge standards that most cities in Europe and North America are not required to meet.

Source: Adapted from SEPA, “Discharge standards for municipal wastewater treatment plants” Circular 110 (2006).

BOX 5.4 Application of Discharge Standards in China

significant subsidies from national govern-ments to help construct wastewater facilities.High levels of wastewater treatment may notbe affordable for many low-capacity cities.This complicates enforcement; environmen-tal regulators may be hesitant to issue sanc-tions or compel cities to construct facilitiesthat are clearly beyond their technical and financial capacity to sustain.

Efficiency. Two issues undermine the effi-ciency of the existing water pollution controlregime in China. First, some cities invest inhigh levels of wastewater treatment that areexpensive to construct and operate, whileother lower income and smaller cities post-pone construction of treatment plants or donot fully operate them. As shown in Box 5.5,there are decreasing returns in terms ofpollution reduction per unit investment ashigher levels of wastewater treatment areutilized. There are many cases in Chinawhere a large city has expensive tertiary

treatment, but is surrounded by smaller citiesand towns that may not be able to affordexpensive plants or construct drainage net-works. Second, little attention is paid to con-trolling nonpoint sources of water pollution.These are major sources of water pollutionand include agricultural runoff loaded withfertilizers and pesticides; livestock opera-tions, in particular pig farms; urban runoff;and industries outside of municipal bound-aries. Focusing on obtaining uniformly highlevels of wastewater treatment in cities maybe administratively easy, but it is not eco-nomically efficient to ignore other sources ofpollution. Larger pollution reductions forthe same cost could potentially be achievedby controlling nonpoint sources.

New Approaches for Wastewater Stan-dards. Some new approaches for balancingaffordability, enforceability, and efficiencyare suggested below:

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BOX 5.5 Full Cost Wastewater Pricing For Different Treatment Levels in U.S. and Europe(Includes collection and treatment costs)

Total unit cost (US$ m–3)

2.5

2.0

1.5

1.0

0.5

0.0% RemoveBODTSS

>80402515TN>90907515TP

PrimaryTreatment

EnhancedPrimary

Treatment

SecondaryTreatment

TertiaryTreatment

Source: UNEP, Water Pollution Control-A Guide to Water Quality Management Principles (1997).

3060

>95>9590-9580-90

90-9550-70

� Use Transitional Standards. Cities andtowns that are not able to afford Class1 or 2 discharge standards could startby ensuring full collection of waste-water and low-cost treatment. As thelevel of economic development im-proved, these cities could upgrade their treatment facilities and transitioninto compliance with national stan-dards. There are a wide variety of low-cost treatment methods that comeclose to meeting Class 2 standards andcould be utilized on an interim basis.This study suggests that provincial gov-ernment agencies work with cities todevelop appropriate wastewater treat-ment approaches on a case-by-casebasis to treat 100 percent of the city’swastewater as soon as possible at anaffordable level. The result would bean overall reduction in urban waterpollution and lower costs.

� Manage Water Quality on a Watershed/River Basin Basis. Environmental protection bureaus in most provinceshave prepared master plans for waterpollution control for important basins.For example, with the financial assis-tance of the European Union, a com-prehensive plan was prepared for theLiao River Basin in Liaoning Province.What is lacking, however, are man-agement systems that include admin-istrative and financial mechanisms toensure that priority pollution activitieswithin a basin are implemented. Mu-nicipal governments that can afford to,or have progressive political leader-ship, will respond to these plans. How-ever, many important pollution controlactivities are underfunded and thusnot fully implemented.

Drinking Water Quality StandardsThe raw water sources for many of China’scities are heavily polluted. Much of the watertreatment technology is rudimentary, andthere are deficiencies with many of the watersupply distribution systems. Although Chi-nese urban residents are fortunate that thereliability and coverage rate of water supplyis quite high, the quality of the water issometimes questionable. As noted in Chap-ter 2, there is limited public informationavailable to judge the quality of the tap waterin Chinese cities. The majority of urbanresidents—even in the Category 1 cities—do not drink water directly. Rather, thewater is used for cooking, cleaning, andwashing. If it is used for drinking, it is almostalways first boiled. Drinking boiled water isboth a cultural tradition and a response tothe uncertain quality of the water from thetap.

Drinking Water Standards. Standards fordrinking water (GB5749-85) were first prom-ulgated in 1985. The 1985 standard covered35 conventional indicators, including:

� Microbiological, in particular coliformbacteria

� Toxicological, such as heavy metalslike arsenic and chromium

� General chemical parameters, such asiron and hardness

� Physical parameters, such as color, turbidity, and taste

The 1985 standard focused primarily on en-suring that drinking water quality does notproduce immediate and obvious publichealth problems, particularly gastrointesti-nal diseases. The 1985 standards were equiv-alent to U.S. or E.U. standards that were ineffect during that period. Since 1985, both

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the U.S. and E.U. have revised their drinkingwater standards to take into account othercontaminants, many of which increase therisk of cancer. New emphasis has beenplaced on synthetic organic compounds,such as pesticides and solvents. New biolog-ical pathogens have also been identified aspriorities, such as giardia and cryptosporid-ium. Both MOC and MOPH have respondedto this trend and proposed new standards. In2001, the MOPH issued a proposed newstandard with 96 contaminants. MOC fol-lowed in 2005 with a new recommendedstandard that includes 101 contaminants.7

The agency ultimately responsible for set-ting national standards in China is the“Standardization Administration,” which inconjunction with the MOPF issued a newdrinking water standard (GB5749-2006) thattakes effect on July 1, 2007.8 The new stan-dard increases the total number of con-trolled items from 35 to 106. The standardcontains 42 items that are classified as “reg-ular parameters;” applies to the whole coun-try; and represents minor upgrades from the1985 standard (GB5749-85). The remaining64 “nonregular parameters” will only applyto cities that meet certain criteria. The non-regular parameters include less common mi-crobiological and toxicological compounds,particularly pesticides and synthetic organiccompounds. As of early 2007, the criteria forcities that must meet all requirements havenot been specified, but will presumablyapply to larger and more affluent cities. By 2012, all cities must meet the standardsfor both “regular (42) and nonregular (64)”parameters.

Analysis of Drinking Water Standards.The approach taken by the new standard(GB5749-2006) contains some elements thatthis study recommends for the wastewater

sector. The standard is flexible in that it dis-tinguishes between higher and lower capac-ity cities, and provides discretion to theprovincial government regarding how toapply the standard (42 or 106 parameters).The standard also requires all cities to pro-vide a reasonable minimum quality of waterby complying with all regular parameters,which addresses the core issues. Finally, the standard uses a transitional approach,which allows a city to gradually upgradetheir facilities by 2012. Although the newstandards are an innovative policy tool, thefollowing analysis identifies importantissues that will still need to be taken intoaccount.

Affordability. The China Water WorksAssociation estimates that in order toupgrade treatment facilities to meet theproposed new standards for approximately 20 percent of water supply systems (100 mil-lion m3/year), at least 50 billion RMB ($6.25 billion) will be required.9 New sophis-ticated treatment technology will be needed,including activated carbon filtration andozone disinfection. Some large cities such as Chongqing, Guangzhou, Shanghai, andHangzhou have already started to upgradetheir treatment plants. The cost of improvingdistribution systems or protecting and up-grading raw water sources is not included inthis estimate.

Although some high-capacity cities maybe able to meet the new standard by 2012,compliance will be out of reach for most ofChina’s lower capacity cities. The costs forupgrading just the treatment plants for thelarge cities will be large. Many lower capac-ity cities will struggle financially and techni-cally to fully comply with the 42 “regular”parameters by 2012. The extent to which ad-ditional costs can be recovered through user

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tariffs may be limited. In China, water sup-ply and wastewater tariffs are included onthe same water bill. As cities expand theirwastewater infrastructure and recover morecosts from users, the water bill will increase.As noted in Chapter 7, the rate at which thewater bill can increase is limited by concernsabout social acceptability.

Enforceability. It will be a challenge tomonitor and enforce compliance with the2007 drinking water standard. The largenumber of parameters and advanced labora-tory analy-sis required will make monitoringdifficult. As noted in Chapter 2, the currentdrinking water quality monitoring system isrelatively weak, and increasing the numberof parameters will make monitoring morecomplex. Countries that have adopted simi-lar standards, such as the United States,have found that compliance monitoring andenforcement is very challenging.

Similar to wastewater, if achieving thedrinking water standards is financially unvi-able then enforcement becomes more diffi-cult. Public health regulators may be hesi-tant to issue sanctions or compel cities tomeet standards that are beyond their techni-cal and financial capacity to achieve. Hence,even if the monitoring data exists to shownoncompliance, the standards may not en-forceable for lower capacity cities.

Efficiency. Water standards are one ele-ment that determines overall water safety.The World Health Organization (WHO) hasdeveloped a framework for safe drinkingwater that is presented in Box 5.6. A compre-hensive economic cost-benefit analysis forthe new Chinese standard was not under-taken. An economic cost-benefit analysiswould examine the health and economic im-pacts associated with the standard, and com-

pare the benefits with the costs in terms ofadditional capital and operating costs.Rather, the standards are based on generalWHO guidelines and examples from othercountries.

Most utilities in China will respond tomore stringent water standards by usingmore advanced and expensive treatmentprocesses. Although upgrading treatmentplants may be necessary in some cases, therealso are many other ways of improving watersafety, including protecting the source of theraw water supply; improving transmissionand distribution systems to minimize infil-tration; expanding operational monitoring;and improving emergency management pro-cedures. The WHO guidelines note that sinceincremental improvements and prioritizingaction in areas that pose the greatest overallrisk to public health are important, there areadvantages to adopting a “holistic” gradingscheme for the relative safety of drinkingwater supplies.

New Approaches to Water Supply Stan-dards. Some new ideas for balancing afford-ability, enforceability, and efficiency aresuggested below:

� Adjust the Transitional Period. The newdrinking water standard has elementsof flexibility, transition, and discretionthat can be used to make it more effec-tive. This study suggests that a realistictime frame for compliance with thefull standard (106 items) for high-capacity cities would be 2012 at a min-imum. In the meantime, provincialgovernments should strengthen theirmonitoring capacity to ensure that allcities comply with the 42 “regular parameters” as soon as possible. Thedates at which lower capacity cities

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64


Health-Based Targets. These should be established by a high-level authority responsible for health in consultationwith others, including water suppliers and affected communities. As part of an overall water and health policy,they should take into account the overall public health situation and contribution of drinking water quality to dis-ease due to waterborne microbes and chemicals. They must also take into account the importance of ensuringaccess to water, especially among those who are not served.

System Assessment. The final water quality delivered to the consumer will be based on a number of factors,including raw water sources and activities in the watershed, transmission infrastructure, treatment plants, stor-age reservoirs, and distribution systems. Understanding the changes in water quality throughout the system isa complex but essential task.

Operational Monitoring. This type of monitoring focuses on frequent and scheduled monitoring to ensure thatthe water supply system is operating properly, and to take immediate corrective actions if needed. Operationalmonitoring should be based on simple and rapid observations such as turbidity, coliform counts, chlorine residual,etc. More complex tests are generally taken as part of the surveillance monitoring.

Management and Communication. A management plan details system assessment and operational monitoringand monitoring plans. The plan describes actions in both normal operation and during “incidents” that pose apublic health threat.

Surveillance. The surveillance agency is responsible for an independent and periodic review of all aspectsof safety, whereas the water supplier is responsible at all times for regular quality control. Surveillance con-tributes to the protection of public health by assessing compliance with water supply plans and promotingimprovements in the quality, quantity, accessibility, coverage, affordability, and continuity of drinking watersupplies.

WHO notes that national drinking water standards should be based on a variety of environmental, social, cultural,and economic conditions affecting potential exposure, and that this may lead to national standards that differ con-siderably from WHO’s own guidelines. A program based on modest but realistic goals—including fewer waterquality parameters of priority health concerns—may achieve more than an overambitious one, especially if thetargets are upgraded periodically.

Source: World Health Organization, Guidelines for Drinking Water Quality (2004).

BOX 5.6 World Health Organization Framework for Safe Drinking Water

Surveillance

Health based targets

Water safety plans

Systemassessment Monitoring

Management andcommunication

Health outcomes

would be required to meet the fullstandard should be realistic and couldbe left to the discretion of provincialgovernments.

� Establish a System for Grading Drink-ing Water Safety. We suggest thatprovincial agencies undertake com-prehensive and systematic evaluationsof the safety of municipal drinkingwater systems and grade their per-formance. The information should bemade public, and municipalities areencouraged over time to improve theirperformance. Box 5.7 shows how thisapproach is used in New Zealand.

Summary of Strategic DirectionsThe strategic directions for national andprovincial government identified in thischapter are summarized below:

� Improving National Policy Coordina-tion. Key policy functions related to public utility management (MOC), environmental management (SEPA),concessionary finance (NDRC), publichealth protection (MOPH), and water resources management (MWR) need tobe better integrated to improve policy coherence. Rather than creating a newagency, we recommend that a “Na-tional Water and Sanitation Com-mittee” be established under the leadership of a deputy prime ministerto improve policy coordination andserve as a focal point for matters re-lated to urban and rural water supplyand sanitation issues.

� Shifting from Physical Targets toPolicy Goals. National and provincialgovernments should set policy-based

goals that reflect higher level objectivesand identify parameters for measuringprogress. The objectives should be re-lated to (a) ensuring efficient deliveryof urban water services; (b) improvingthe quality and ecosystem functions of China’s rivers, lakes, and coastal waters; and (c) protecting public health and sus-taining economic growth throughwater supply services. Governmentpolicies and programs should be structured to achieve these higher level objectives rather than physicaltargets related to infrastructureconstruction.

� Enhancing Provincial GovernmentOversight. Provincial governmentshave an important, but often neglected,role in sector governance. Provincialgovernments should increase the au-thority, budget, and capacity of provin-cial government agencies to oversee thesector, including (a) monitoring utilityperformance; (b) supervising municipaltariff regulation; (c) managing nationalconcessionary finance programs; and(d) overseeing private sector participa-tion. Provincial governments could im-prove policy coordination by establish-ing a “Provincial Water and SanitationCommission,” or creating a new “Pro-vincial Water Office” that would con-solidate all key urban water regulatoryfunctions into one office.

� Setting Appropriate Water and Waste-water Standards. Setting standards thatare affordable, economically efficient,and enforceable is fundamental toachieving national policy objectives. Forwastewater discharge standards, transi-tional standards should be used for lowcapacity cities that require full waste-

65


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The Ministry of Health (MoH) is the regulatory body responsible for the regulation of public healthin New Zealand under the Health Act 1956. Following problems with drinking water supplies, in 1992it began a strategy to improve the quality of drinking water and the management and monitor-ing of quality standards. The strategy, which follows the World Health Organization guidelinesfor safe drinking water, allocates the following responsibilities to the MoH:

� Setting safety standards for drinking water� Providing a management plan and guidelines for meeting the standards� Ensuring that adequate barriers to potential contamination are in place to minimize risk to

public health� Grading water supplies of all communities of over 500 people (smaller supplies may be

graded in the future)

The grading provides a measure of the extent to which a community drinking water supply achievesand ensures a consistently safe and wholesome product. The grading is simple and easy to under-stand since it consists of two letters:

� The first letter (a capital letter from A down to E, with the exception of the highest grade, whichis A1) represents the source and treatment grading.

� The second letter (which is lower case) represents the grading of the water in the distributionzone. Systems that incorporate a bulk water distribution zone have two separate distributiongrades: one for the bulk water distribution zone, and one for the community reticulationzone. Each community has a minimum grading requirement that depends on its size.

The grading assessment is based on the following categories:

� Water source� Treatment� Distribution� Risk of contamination� Final drinking water quality

After an examination is carried out by drinking water assessors (designated by the Ministry ofHealth), grading questionnaires are completed in conjunction with the drinking water supplier.Compliance with the standards is assessed on a running annual basis.

The Ministry of Health is also responsible for publicly communicating the grading results byissuing press releases and annual reports, such as the “Microbiological Quality of DrinkingWater.” In addition, the MoH manages a national database of all community drinking water sup-plies, which contains a record of the details of each water system and monitoring data, as well asa Register of Community Drinking Water Supplies, which is available in all public libraries.

The implementation of the water quality grading system has led to significant improvements inthe quality of the water supply in New Zealand. Its simplicity and availability have made it a usefultool for public information, so that when communities were awarded a low grade, public pressureresulted in efforts and political commitments to increase the quality of water supply. While only50 percent of the communities had water supply systems that complied with the standards in thelate 1990s, by 2007 about 75 percent of the communities were in compliance.

Source: Prepared by Castalia for this study.

BOX 5.7 Grading the Safety of Water Supply Systems in New Zealand

water collection but allow for low-costtreatment. Water quality managementefforts should be focused on prioritizingand implementing pollution control ef-forts from a river basin perspective. Thenew drinking water standards allowcities to transition to full compliance by2012, but this date should be flexiblyapplied for lower capacity cities. Watersafety grading schemes, which includebut go beyond water quality compliancemonitoring, should be used to evaluatemunicipal water systems.

Notes1. The four-level hierarchy is the common simplifi-

cation of a more complex system. For exampleBeijing, Shanghai, Tianjin, and Chongqing arereferred to as “municipalities,” but have similarstatus to a province. There are around 23 sub-provincial municipalities such as Dalian, Shen-zhen, Ningbo, etc., which have a higher statusthan a prefecture. There are also county-level“cities,” which have a higher status than regularcounties.

2. State Council “Circular on Strengthening UrbanWater Supply, Water Saving, and Water Pollu-tion Prevention and Control” Issued November 7,2000.

3. In a move symbolic of China’s transition to amarket economy, the SPDC name was changed toNational Development and Reform Commission(NDRC) in 2003.

4. See the article “China Revises National DrinkingWater Standard” in the on-line magazine China.org: http://french.china.org.cn/english/government/196216.htm.

5. This includes the four municipalities of Beijing,Tianjin, Shanghai, and Chongqing.

6. See MOC’s (2005) “Opinion on StrengtheningMonitoring on Municipal Public Utilities”(Jiancheng No. 154), which states: “Constructionadministrative authorities of all provinces andautonomous regions shall be responsible forguiding and monitoring the municipal publicutility monitoring within their jurisdictional regions.”

7. See Footnote 4 above.8. Ibid.9. See the article “China’s new standard for drink-

ing water creates billion-dollar market” in thePeoples Daily On-Line at http://english.people.com.cn/200511/07/eng20051107_219462.html.

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Municipal governments and their utilitiesoperate within the framework provided bynational and provincial policies. Within thisframework, municipal governments can im-prove the performance of urban water utili-ties by:

� Ensuring that service standards, tariffs,and fiscal support are properly balancedto allow utilities to recover their costs

� Putting pressure on utilities to consis-tently lower costs and improve service

� Adjusting the geographical scope andfunctions of utilities to improve effi-ciency, particularly for wastewater

China’s vast size, combined with decentral-ization, has resulted in a rich diversity ofarrangements for providing municipal ser-vices. This section explores and describesthat diversity, and recommends ways to im-prove the structure and governance of mu-nicipal utilities. As background, it presentsgeneric models for understanding the exist-ing municipal sector structure. Balancingservice standards, tariffs, and fiscal transfersis a difficult process, particularly in largecities. The chapter analyzes how this is donein China and suggests new approaches, in-cluding quasi-autonomous public utilityboards or commissions. Many utilities in

China still function as government depart-ments rather than modern commercial util-ities. The chapter’s third section discusseshow municipal governments can instill a cul-ture of “competitive utility management” byfirst empowering utilities, and then insistingon accountability through monitoring, trans-parency, customer orientation, and involv-ing the private sector.

Urban water is both a “network industry”and a “natural monopoly.” As a “network in-dustry,” the quality and cost of service de-pends heavily on the complex system ofpipes and pumping stations. Many Chinesecities have fragmented the responsibility forwastewater between government drainagedepartments and wastewater treatmentcompanies. The chapter’s fourth section en-courages Chinese cities to consolidate drain-age collection and treatment functions, andoperate the service as a network utility busi-ness similar to water supply. As a “naturalmonopoly,” there tends to be increasingeconomies of scale—up to a point, for urbanwater services. Most Chinese cities, however,independently provide water services withintheir boundaries regardless of their size. Thefinal section encourages municipal govern-ments to exploit opportunities for aggre-gating urban water services and achievinggreater efficiency.

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6 Improving UtilityGovernance and Structure

FIGURE 6.1 General Municipal Structure

Overview of MunicipalSector StructureUnder the former planned economy inChina, the municipal government was re-sponsible for all economic activity within itsjurisdiction. Government agencies with spe-cific mandates evolved to manage theplanned economy, including industrial de-velopment, housing, pricing of goods andservices, and allocation of resources. Withthe rapid development of the market econ-omy in China, municipal governments nowfocus on providing essential public services,supervising public utilities, and promotingthe local market economy. In the public util-ity field, municipal governments are in theprocess of transition from being less of aservice provider and more of a service regu-lator, but the legacy of the planned economyera still remains, and in some cases hindersthe development of modern water andwastewater utilities.

Figure 6.1 presents the administrativestructure of a typical Chinese city. Box 6.1provides a brief description of the functionsof the different municipal agencies. Giventhe diversity and number of cities in China,

the typical models presented in this reportare necessarily generic. The descriptions areintended to provide a basis for analysis andgeneral strategic recommendations. Annex 3provides some diagrams on how specificcities organize their urban water services,and reflects the actual complexity and diver-sity at the municipal level.

A Typical HierarchyThis section explains the typical hierarchy inmunicipal government. Typically, the hierar-chy includes a “leading group” under theleadership of the mayor, a parent bureau re-sponsible for overseeing the utility; a waterresources bureau or a separate raw watersupply company with the water resourcesbureau as the parent bureau; wastewaterutilities, usually provided either by a munic-ipal wastewater company, a private com-pany, or a joint venture between a privatecompany and a municipal wastewater com-pany; a price bureau that administers thetariff adjustment process for urban waterutilities; an environmental protection bu-reau, which monitors wastewater discharges;and a public health bureau, which monitorswater supply quality.

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PartySecretary

Mayor andVice Mayors

MunicipalPeople’s Congress

WaterResourceBureau(WRB)

PublicHealthBureau(PHB)

EnvironmentProtection

Bureau(EPB)

DevelopmentReform

Commission(DRC)

PriceBureau

(PB)

FinancialBureau

(FB)

ConstructionBureau

Waterabstractionregulator

Drinkingwater qualityregulator

Wastewaterdischargeregulation

Investmentapproval Tariff

administrationBudgetallocation

Public works

Mayor’s Leading Group. All significantgovernment decisions ultimately fall under thejurisdiction of the mayor and the set of vicemayors, collectively referred to as the “leadinggroup.” There are typically three to five vicemayors, including an executive vice mayor.Each vice mayor is responsible for specificgovernment agencies. Policy coordination be-tween the different government agencies is ex-pected to take place within the leading groupunder the leadership of the mayor.

Parent Bureau. All urban water utilitieshave a “parent bureau” that is responsiblefor overseeing the utility. The parent bureauappoints and monitors the senior manage-ment of the utility and provides service reg-ulation. All issues requiring a decision fromthe leading group or other municipal gov-ernment agencies are typically done throughthe parent bureau, including (a) budget allo-cations from the MFB, (b) investment ap-proval by the DRC, and (c) tariff adjustments

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I m p r o v i n g U t i l i t y G o v e r n a n c e a n d S t r u c t u r e

Construction Bureau. The construction bureau is responsible for overseeing the provision of basic infrastructurefor a city, including roads, parks, water, wastewater, solid waste, gas, heating, etc. It also often plays an importantrole in guiding real estate development. There are usually departments for public works such as roads, parks,drains, solid waste, and utility companies for water, wastewater treatment, and heating. There is a wide varietyin the ways cities are organized to provide infrastructure services. In large cities, a construction commissionmay be responsible only for policy and planning, while a construction bureau (the terms urban managementbureau or municipal engineering bureau are also used) is responsible for construction and management.

Development and Reform Commission (DRC). The DRC evolved from the former planning commission, andis responsible for approving all municipal government investment proposals and leading the reform from aplanned economy to a market economy. All major infrastructure investments must be reviewed and approved bythe DRC. The DRC also takes a leading role in allocating and managing investment funds for government-sponsoredinvestment projects, including foreign-funded projects.

Municipal Finance Bureau (MFB). The finance bureau is responsible for overseeing the financial affairs of thecity, including taxation, budget allocation and control, and disbursement of foreign funds. It provides equity con-tributions for water and wastewater investments, as approved by the DRC, and in some cases allocates operat-ing budget support for urban water utilities.

Price Bureau. In the past, the price bureau administered the pricing system for all goods and services. Its rolehas been gradually transformed to administering public utility prices and managing local inflation. In many cities,the price bureau has been incorporated into the DRC, ackowledging that economic reform requires market forcesto determine prices.

Environmental Protection Bureau (EPB). The EPB is responsible for overall environmental management in themunicipality, including approving environmental assessment reports, monitoring and controlling industrialdischarges into both the environment and municipal drainage system, and monitoring municipal wastewatertreatment plants.

Water Resources Bureau (WRB). The WRB is responsible for flood control, riverbank works, irrigation, and de-velopment of raw water supplies. Since water resource infrastructure tends to be large scale, the provincialWRBs are generally large and well-funded. Municipal WRBs focus more on local flood control, irrigation, andintercity canals. In some cities, the municipal WRB has been transformed into a “water affairs bureau” responsiblefor water and wastewater services.

BOX 6.1 General Functions of Key Municipal Agencies

FIGURE 6.2 Typical Parent Bureau Models

water management, including water,wastewater, flood control, water reuse,and raw water supply.

� Model 3: Water and WastewaterReport to Different Parent Bureaus.Some large cities have separated thepolicy and implementation functionsfor urban construction and manage-ment into two bodies. A “constructioncommission” provides policy and plan-ning, and sometimes directly overseesmunicipal utility companies. An“urban management bureau” super-vises public works departments suchas roads and parks, and in some casesmay also supervise water and waste-water utility companies.

Organization of Water Supply Utilities.Raw water supply is usually provided by thewater resources bureau or a separate raw

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Parent Bureau Model 1 Parent Bureau Model 2

Parent Bureau Model 3

Public utilities Public works

Water supply,bus, heating, gas

Wastewater,roads, parks, solid wastes

Construction orUrban Management

Bureau

Water supply Wastewater Irrigation andflood control

Water AffairsBureau

UrbanManagement Bureau

Water supply,bus, heating, gas

Wastewater,roads, parks,solid wastes

ConstructionCommission

by the price bureau. Decisions by these gov-ernment agencies are usually discussed andapproved by the vice mayor and if necessarythe leading group. There are three commonarrangements for parent bureaus (see Fig-ure 6.2).

� Model 1: Water and Wastewater Havethe Same Construction Parent Bureau.This is the most common arrangementfor smaller cities. The wastewater andwater supply utilities report to samebureau. The bureau oversees all of thepublic works and utility companies inthe city.

� Model 2: Water and Wastewater Havethe Same Water Affairs Parent Bureau.Some large cities—such as Beijing,Shanghai, and Shenzhen—have cre-ated “water affairs bureaus” that areresponsible for all aspects of urban

water supply company with the water re-sources bureau as the parent bureau. Table6.1 shows the common methods of organiz-ing water supply service. The most commonmodel involves a municipal water supplycompany providing both treatment and dis-tribution services. Many cities are turning tothe private sector to help with water supplytreatment, either through a BOT (build-operate-transfer), TOT (transfer-operate-transfer), or joint venture with the municipalwater supply company. In a few cases, thereare joint ventures with municipal water sup-ply companies for the complete service.

Organization of Wastewater Utilities. Theorganizational structure of wastewater utili-ties is more complicated than water supply,and is discussed in detail in a later section.Table 6.2 provides a general overview of how

wastewater services are organized. In mostlarge cities, each district has its own drainagedepartment. Wastewater treatment is usuallyprovided either by a municipal wastewatercompany, a private company, or a joint ven-ture between a private company and a munic-ipal wastewater company. In some cases,mainly in small cities, one municipal waste-water company may provide both collectionand treatment. Wastewater reuse companies,when they exist, are usually subsidiaries of thecompany providing wastewater treatment.

Tariff Regulation. This includes the rulesand organizations that set, monitor, enforce,and adjust tariffs for urban water utilities.For water and wastewater tariffs, the utilitycompany submits the tariff application tothe parent bureau, which reviews and ad-justs as necessary, and then forwards the

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Frequency Treatment Plant Distribution Network

Most Common Municipal Water Supply Company (MWSC)

Common Private Company or JV with MWSC MWSC

Less Common Joint Venture Between MWSC and Private Company

TABLE 6.1 Water Supply Utility Models

City Size Local Drains Main Drains Wastewater Treatment

Larger Cities District Drainage Municipal Wastewater CompanyDepartment (DDD) (MWWC)

Larger Cities DDD MWWC Private BOT orJV with MWWC

Larger Cities DDD Municipal Drainage Department (MDD) Private BOT

Smaller Cities MDD Private BOT

Smaller Cities MWWC

TABLE 6.2 Common Wastewater Utility Models

application to the price bureau. The pricebureau does not actually make decisions ontariffs but rather administers the tariff ad-justment process. For the tariff adjustmentprocess, an expert advisory group composedof officials from key agencies is established,often under the direction of the DRC, to pro-vide an opinion on the proposed tariff ad-justments. Public hearings are held, and theprice bureau forwards a tariff recommen-dation to the mayor’s leading group for a decision. The final tariff adjustment is ap-proved by the provincial price bureau (for aprefecture-level city) or the prefecture pricebureau (for a county-level city). In additionto the utility’s revenue requirements, otherimportant factors in the tariff-setting proc-ess are the level of local inflation and publicacceptability.

Service, Environmental, and Public HealthRegulation. This includes ensuring that theutility meets the defined service standardsand complies with applicable environmentalor public health regulations, such as waste-water discharge standards and water supplyquality standards. The parent bureau is re-sponsible for defining and monitoring ser-vice standards, and is also the front lineagency for monitoring compliance with reg-ulations. The EPB undertakes monitoring ofwastewater discharges and the municipalpublic health bureau (PHB) monitors watersupply quality. When a utility breaches astandard, the conflict between the parent bu-reau and the regulatory agency is often re-ferred to the leading group for resolution.

Municipal Utility Fiscal PolicyThis includes the fiscal principles and prac-tices of the municipal government withrespect to utilities, including capital contri-butions, operating subsidies, and tax incen-

tives. Municipal government funding ofwater and wastewater utilities is importantfor two reasons:

� Capital Funding: Cities typically make equity contributions to water andwastewater companies and provide cap-ital funding for drainage departments.

� Operating Budget: Cities provide op-erating budgets for drainage depart-ments, and occasionally providefunding support for water supply and wastewater companies in financialdistress.

The parent bureau requests budget supportto the MFB on behalf of the company or de-partment during the annual budget planningprocess. As discussed in Chapter 7, there is an “urban construction and maintenancetax” in Chinese cities that automatically goesfor urban infrastructure. In addition, themunicipal government can transfer generalbudget funds to the parent bureau. The allo-cation of government funds is determined bythe leading group and implemented by theMFB. In most cases, the budget is trans-ferred from the MFB through the parent bu-reau to the company or department.

Facilitating Cost RecoveryMunicipal governments in China can ensurethat their utilities recover costs and providesustainable service by improving mecha-nisms for setting service standards, tariffs,and fiscal transfers. In this study, utility costrecovery means that a utility has sufficientrevenues to meet its obligations and needs,such as O&M, debt service, and making a

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FIGURE 6.3 Balancing Service Standards, Tariffs, and Subsidies

contribution to finance capital works. Chap-ter 7 discusses how most urban water util-ities in China are struggling with costrecovery, particularly for wastewater.

Inadequate coordination among multiplemunicipal government agencies is one rea-son why many Chinese cities struggle withutility cost recovery. Some cities are able tocoordinate the decisions of multiple agen-cies to achieve a sustainable balance, butmany are not. Cities throughout the worldface similar problems. This section recom-mends that China start experimenting withnew approaches for improving municipalutility governance, including:

� Municipal public utility boards withthe power to set tariffs, approve capital

spending programs and financing strat-egies, and oversee utility management

� Municipal utility advisory groups withthe mandate to advise the municipalgovernment on key utility managementissues

The board or advisory group concept couldpotentially be extended to other municipalutilities such as gas, district heating, andpublic transport.

Getting Services, Tariffs, and Fiscal Support RightFigure 6.3 sets out a process that shows howgovernments can achieve a sustainable bal-ance between services to be provided, tariffs,and fiscal support. The diagram shows that

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Cost recovery tariffs

Customertariffs

Social andenvironmentalconsideration

Coverage andservice standards Subsidies

Capital Operating

NoReconsider

Finalservice/tariff/subsidy

bundle

Utility efficiencies

Willingness to payAffordabilityEquity

Satisfied withservice, tariff

subsidy bundle?

Source: Castalia, Sector Note on Water Supply and Sanitation for East Asia (2004).

once service standards are set, with a givenlevel of efficiency the cost of providing ser-vices is essentially determined. The cost ofservice must be met from tariffs, unless gov-ernments are willing to either provide cap-ital or use fiscal transfers to keep tariffs atsocially acceptable levels. The approach out-lined in Figure 6.3 is straightforward, butthere are many factors that may lead theprocess to establish an inconsistent mix ofservice objectives, tariffs, and fiscal support.It is common for tariffs or fiscal transfers tobe inadequate to cover the costs of service atthe level set by the standards. The two majorconstraints stem from political commitmentand institutional coordination, each ofwhich is discussed below.

Political and Institutional Constraints toRecovering Costs. Some municipal leadersmay not want the utility to have an adequatecombination of tariffs and fiscal support forthe following reasons:

� Short-term political considerationsmay outweigh the need to raise tariffsor allocate more fiscal resources. Thecosts of raising tariffs or allocatingmore fiscal resources will be felt imme-diately, while the benefits of maintain-ing and renewing utility assets takesome time to materialize.

� Some municipal governments may ac-tually want a lower-cost, lower-qualityservice package rather than pay a highcost to achieve compliance with inap-propriate national standards.

� Some municipal governments may notwant to subsidize inefficiency, with theintention of driving down costs by re-ducing the amount of cash available tothe utility.

The lack of coordination and capacityamong government agencies is a key reasonwhy cities in China have problems gettingthe bundle of services, tariffs, and fiscal sup-port right. There are number of agencies, op-erating under the leading group, with eachinfluencing a utility’s ability to recover costs.The level of coordination between theseagencies and within the leading group is notsufficient in many cases to ensure sustain-able urban water services. Moreover, manyurban water utilities are subservient to theparent bureau and do not take an active andindependent role in facilitating coordina-tion. Following the steps presented in Figure6.3, typical agency coordination and capac-ity problems include the following:

Setting Appropriate Service Standards. Asdiscussed in Chapter 5, the application ofChina’s wastewater discharge standards andproposed new water supply quality stan-dards may need to be adjusted to provide af-fordable and enforceable transitional stan-dards for low-capacity cities. Even withinthe current standards, however, municipalgovernments and their utilities have flexibil-ity to make important decisions regardingservice levels, such as combined or sepa-rated stormwater and wastewater drains,level of flood protection, reliability of thewater supply, etc. The utility parent bureau,with approval from the DRC, typicallymakes these decisions. The utility is then re-quired to make the infrastructure invest-ments, but the municipal government oftendoes not have a clear idea of the associatedcosts or how they will be recovered.

Maximizing Efficiency. Many Chineseurban water utilities do not have strong in-centives to operate efficiently. The third sec-tion in this chapter discusses how to makeChinese utilities more efficient by empower-

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ing them to take control of core corporatefunctions, while simultaneously increasingtheir accountability, transparency, and cus-tomer orientation. Managing wastewater asa network utility business (section four), ex-ploiting opportunities for service aggrega-tion and economies of scale (section five),and appropriate private sector participation(Chapter 8) are also methods for improvingefficiency and lowering costs.

Full Cost Recovery Tariffs. Based on thetargeted service levels, and the investmentand operational efficiency of the utility, thefull cost recovery tariffs can be calculated.This requires the utility (or its consultant) toundertake comprehensive technical and fi-nancial modeling, but these skills are oftenlacking in Chinese utilities or their parentbureaus. The tariff calculations are oftendone after the investments are made, andbased on standard formulas rather thancomprehensive financial modeling.

The cost recovery tariff can be assessedagainst social and environmental considera-tions. If the government considers the result-ing tariff to be too high, then it can providecapital or operating fiscal support to lowerthe tariff. Setting the type and level of fiscalsupport involves trading off the social desir-ability of restraining tariffs against other fis-cal priorities. Programming fiscal support toutilities in Chinese cities is typically done aspart of the overall budgeting process by themunicipal finance bureau, under the direc-tion of the leading group. Although the utilityparent bureau can make a request to the mu-nicipal government, the budgeting is usuallydone as part of a more comprehensive budgetprocess and often without explicit considera-tion of the funding needs of the utility.

For a given level of fiscal support, the gov-ernment can then design a tariff that allowsfor cost recovery while achieving social ob-

jectives. The challenge in most Chinesecities, however, is that the level of fiscal sup-port is not always clear or dependable. In ad-dition, the tariff setting process managed bythe price bureau (or DRC) considers otherfactors such as local inflation and social ac-ceptability. The tariff ultimately is decidedby the mayor and his leading group, whichmay have political reasons for limiting tar-iffs. Often, the result is tariffs that—given ac-tual fiscal transfers—may be inadequate forthe utility to recover its costs.

Approaches to Improving MunicipalUtility Governance. A government may em-bark on serious water sector reforms, settingservice standards, tariffs, and fiscal transfersthat are appropriate and consistent. It maydemand efficiency from its urban water ser-vice providers. But the real challenge is mak-ing these reforms last. There are strong in-centives and plausible justifications forgovernments to change policy or fail to exe-cute its functions properly over the long run.An essential part of locking in good reformsoften involves governments choosing to limittheir own flexibility by designing institu-tional arrangements that protect reformsand limit direct political involvement in util-ity management and regulation.

Cities throughout the world face munici-pal utility governance challenges similar toChina, and some have devised institutionalarrangements to help overcome these prob-lems. Box 6.2 shows that even within onestate in the United States, California, thereare many ways of organizing the governanceof a utility. The following approaches couldbe considered for cities in China with munic-ipally owned public utilities, and apply notonly to urban water but potentially to otherutility services, such as gas, district hearting,and public transportation.

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Provision of urban water services in California is the responsibility of the local government. The ser-vices must meet the minimum requirements of the federal government as stated in the Clean WaterAct and Safe Drinking Water Act. State agencies are responsible for ensuring municipalities com-ply with national standards and have the authority to promulgate more stringent standards as ap-propriate. Local governments have different approaches to providing urban water services, asdemonstrated below for the four largest water utilities in the state:

Municipal Utility Commission: Los Angeles. The Los Angeles Department of Water and Power(LADWP), the largest municipal utility in the nation, was established more than 100 years ago to de-liver reliable, safe water and electricity supplies to some 3.8 million residents and businesses inLos Angeles. As a revenue-producing proprietary department, LADWP transfers about 7 percentof its annual estimated electric revenues and 5 percent of its water revenues to the city of LosAngeles general fund. LADWP’s operations are financed solely by the sale of water and electric serv-ices. Capital funds are raised through the sale of bonds. No tax support is received. A five-memberBoard of Water and Power Commissioners establishes policy for LADWP. The board members areappointed by the mayor and confirmed by the City Council for five-year terms.

Municipal Utility Advisory Board: San Diego. The San Diego Water Department provides water toover 1.2 million customers, as well as selling bulk treated water to neighboring cities. TheMetropolitan Wastewater Department provides collection and treatment services for the City of SanDiego, as well as treatment services for 15 other cities. The San Diego City Council is responsible foreconomic regulation of both departments and authorizes tariff adjustments. San Diego also has a“Public Utilities Advisory Commission” appointed by the mayor and confirmed by the City Council.The commission advises the city government on water and wastewater issues. Both the WaterDepartment and Wastewater Department operate on funds from tariffs and service charges; its fundsare administered in an enterprise account separate from the City of San Diego’s General Fund. Thecity issues both separate water supply and wastewater revenue bonds.

Municipal Utility Board-East Bay Municipal Utility District (EBMUD). The utility provides water to29 cities with over 1.3 million, and 640,000 people in 8 cities, in the eastern part of the SanFrancisco Bay Area. EBMUD is a special utility district separate from any city government. It is gov-erned by a seven-member Board of Directors. The directors are elected for four-year terms. Theboard has the power to set tariffs and provides economic regulation and management oversight.EBMUD relies primarily on user fees, although it does have the authority to issue a surcharge onproperty taxes to provide for drainage services and issues its own bonds.

Private Company: San Jose Water Company. The San Jose Water Company is a privately ownedutility listed on the New York Stock exchange serving over 1 million people, as well as providingservices to other cities such as billing or distribution system monitoring. The City of San Jose hasentered into a contract with San Jose Water to provide water supply services, but economic regu-lation is provided by the California Public Utilities Commission (see below).

California State Public Utilities Commission (PUC). The Commission regulates privately ownedtelecommunications, electric, natural gas, water, railroad, and passenger transportation compa-nies. It is responsible for ensuring that customers have safe, reliable utility services at reasonablerates and are protected against fraud. Over six million Californians receive water and wastewaterservices from private companies. The PUC monitors their operations, sets water rates, and ensurescompliance with water quality standards.

BOX 6.2 Municipal Governance Models in California

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� Municipal Utility Board. Many largecities throughout the world haveelected to establish quasi-independentboards appointed by the municipalgovernment and responsible for thegovernance of their city’s water andwastewater utilities. Typical functionsinclude setting tariffs, approving capi-tal investment programs and financingstrategies, appointing management,and monitoring compliance with regu-latory and service standards. Thismodel is often used in large cities withgovernment-owned utility companiesor departments. The approach allows a reasonable level of expertise and accountability to develop among boardmembers. There are various ways of selecting board members, for example:● Nongovernment specialists ap-

pointed by the mayor based on pro-fessional expertise, such as legal, fi-nancial, engineering, business, etc.

● Government officials appointed bythe mayor or based upon their posi-tion in the government

● Elected or nominated members fromdifferent jurisdictions or interest groups

● A combination of the above

Because board members typically do nothave to satisfy interest groups on issuesother than water, and are generally ap-pointed, they have more freedom to take atleast a medium-term perspective toward theutility business. The expertise of the boardcan contribute to improved utility efficiencyin operations and capital planning. The ef-fectiveness of a municipal board, however,ultimately depends on the selection of qual-ified board members, and the government’swillingness to allow the board a sufficientlevel of autonomy and provide the necessary

level of fiscal and tariff support. Box 6.3 ex-plains how Singapore has adopted this ap-proach with the Public Utility Board (PUB)

� Municipal Utility Advisory Group. Incities where the formal establishmentof a water board would not be politi-cally possible, an alternative approachis to create a formal “advisory group.”This would a formal group with a clearcharter. The same options for selectingboard members also apply to advisorygroup members. The group would pro-vide formal recommendations to themayor’s leading group on the similarissues as a board. Typical functions in-clude setting tariffs, approving capitalinvestment programs and financingstrategies, appointing management,and monitoring compliance with regu-latory and service standards. It is inter-esting to note that the Singapore PUBhas mainly advisory powers, but is ex-tremely influential given the expertiseof its members and the government’scommitment to provide high quality,sustainable water services.

Private Participation and Municipal Utility GovernanceThe majority of urban water services in Chinaare provided by either government depart-ments or municipal utility companies that op-erate as public service corporations. Chapter8 describes how private participation is ex-panding rapidly in China. Most private partic-ipation in China has been in the form of BOTcontracts for water supply or wastewatertreatment plants with municipal utilities orthe city. There are also an increasing numberof joint ventures between private companiesand municipal water supply utilities.

The emerging partnership between pri-vatecompanies and municipal water utilitiesthroughout China makes the need for improv-ing municipal utility governance even moreurgent. Private companies with contracts forBOT plants will demand payment for services,regardless of the financial health of the munic-ipal utility. If the government does not adjustoverall sector funding levels, through tariffs orfiscal transfers, then the financial situation ofthe municipal utility may deteriorate. Like-wise, companies involved in joint ventureswith municipal utilities will require adequatereturns on their investment. If municipal gov-

ernments are not prepared to ensure this, thenthe joint venture will not be sustainable.

Fostering Efficient Urban Water UtilitiesMany of China’s urban water utilities per-form below their potential because of a lackof pressure to improve performance. Al-though the water supply and wastewaterbusiness is typically classified as a “naturalmonopoly,” there are ways that municipalgovernments can help ensure that utilities

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The Public Utilities Board (PUB) was established in 1963 and was originally responsible for providing the country’sutility services, including water, power, and gas. In 2001, the board’s regulatory authority for electricity and pipedgas industries was transferred to the Energy Market Authority of Singapore. At the same time, the water anddrainage functions of the Ministry of the Environment (now called the Ministry of the Environment and WaterResources) were transferred to the board.

PUB is a statutory board under the Ministry of the Environment and Water Resources (MEWR). It is the wateragency that manages Singapore’s water supply, water catchment, and sewerage in an integrated way. Statutoryboards of the Singapore government are organizations that have been given autonomy to perform an opera-tional function. They usually report to one specific ministry.

PUB is governed by an 11-member board of directors and is chaired by a permanent secretary of the MEWR.The other board members include the PUB chief executive, and nine members appointed by the MEWR anddrawn from business, academic, and engineering fields. The PUB has full corporate autonomy, but relies heavilyon the government for financial support. The government funds the capital development and operating expendi-tures for drainage and wastewater treatment. In 2004, 23 percent of the PUB’s operating expenses were providedby a government operating grant, and 85 percent of its capital expenditures were funded by the government. PUBmakes recommendations regarding tariffs and budget transfers to the MEWR. The government is responsible forbudget allocations and tariff setting based on the recommendations of MEWR and the PUB.

PUB was named “Water Agency of the Year” at the Global Water Awards 2006, and is considered one of themost technologically advanced water utilities in the world, with low rates of non-revenue water, desalinizationprojects, watershed management, and advanced wastewater reuse programs. However, it is under pressure toimprove its financial sustainability and control costs. In 2004, PUB was reorganized to improve efficiency andadopted a new approach termed “price minus.” The price minus philosophy aims to inspire PUB employees tobe cost-conscious and adopt a value-creation approach in decision making. PUB seeks to bring maximum valueto customers at a minimum cost by doing more with less. Price minus is not a cost-cutting exercise; rather, itseeks increased value to partners and customers while driving down costs at the same time.

Source: From PUB Website: http://www.pub.gov.sg

BOX 6.3 Singapore Public Utilities Board

strive to consistently lower costs and im-prove performance, including:

� Empowering utilities with more au-thority so they can be held accountable

� Closely monitoring performance� Promoting transparency and customer

orientation� Judicious use of private sector

participation� Adjusting utility scope and scale to

take advantage of economies of scale

Empowering Municipal UtilitiesMany utility companies are under the directcontrol of their parent bureau, and operatemore as a government department then acompany. While this may be appropriate forsmaller cities, larger cities generally needmore professional and specialized manage-ment. Moreover, since parent bureaus arepart of the municipal government, they aremore likely to respond to short-term politi-cal pressures than autonomous and com-mercialized utility companies. Some urbanwater utilities in China, particularly in largerand richer cities, are already close to beinginternational standard water companies.Most companies, however, still operateunder the direct control of the parent bu-reau. These utility companies should be em-powered to take over core corporate func-tions such as strategic master planning,capital improvement programs, developingfinancing and cost recovery plans, humanresource development, and crafting appro-priate private sector arrangements. Themanagers of a utility have to be held ac-countable for continuous improvements inperformance. For this, they must be giventhe authority to propose strategic initiativesand manage the utility under the guidance ofthe municipal government. Box 6.4 shows a

typical situation in Chongqing between theparent bureau and urban water utilities.

Monitoring PerformanceGood information on operational and finan-cial performance is necessary to place com-petitive pressure on utilities. This informa-tion can be used to compare performancewith other similar utilities and to track im-provements over time for a single utility. Asdiscussed in Chapter 2, information on util-ity performance is very limited in China.Many utilities do not collect adequate infor-mation, nor are they required to do so by themunicipal governments. Moreover, evenwhen information exists it is often notshared with the public, provincial agencies,or even within the municipal government.Chapter 5 called for the provincial govern-ment to initiate province-wide utility bench-marking programs. Municipal governments,in parallel, should insist on enhancing utilityperformance monitoring programs.

Transparency and Customer OrientationAlthough public hearings for tariff adjust-ments are organized by the price bureau,public involvement and knowledge of keyutility planning and management issues istypically limited. To generate competitivepressure, the information must be easilyavailable to the public. Urban water utilitiesshould be required to have open and trans-parent decision-making processes on key is-sues. This would involve opening up parentbureau or utility board meetings, makingmeeting minutes available to the public, anddeveloping stakeholder and customer out-reach programs to solicit opinions on keyissues. Many urban water utilities could im-prove their customer support functions andbetter monitor overall customer satisfaction

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levels. The results of performance bench-marking programs should be available to thepublic and the press. Annual reports, finan-cial statements, and capital improvementplans should also be made publicly availablethrough Internet websites.

Private Sector InvolvementChapter 8 discusses in detail how the privatesector can help improve the competitivenessof municipal urban water utilities. Thethreat of private sector involvement canoften make municipal utility managementand workers act in a more competitive fash-ion just to keep their jobs and positions.Alternatively, when a municipal utility isstriving to improve performance, it may turn

to a private company to provide some ser-vices, e.g. outsourcing tasks such as meterreading, drain cleaning, or hiring manage-ment consultants to stay competitive.

Adjusting Utility Scope and ScaleAdjusting the types of services and the ser-vice area of a water utility can often providequick gains in efficiency. The next sectiondiscusses how integration of wastewater col-lection and treatment can improve trans-parency and efficiency of the overall service,and the following section discusses how cre-ating larger urban water utilities that covermultiple jurisdictions can generate econo-mies of scale that drive down costs. Anothervariation on this theme is that large cities

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Under a World Bank-financed project, consultants were contracted to provide institutional strengthening ser-vices to two water companies and three wastewater companies in Chongqing.

Overall, the companies were found to be functioning well within the existing regulatory framework. They pos-sessed many positive attributes. The two water companies were providing water 24 hours per day, and the threenew wastewater companies (treatment plus main conveyance) were actively engaged in constructing neededassets. The companies had existing policies, practices, and procedures in place to support operation, and allwere adhering to enterprise accounting systems. The companies’ leaders were talented and dedicated, and thestaff highly motivated.

Initial assessments found, however, that none of the companies had sufficient authority to manage them-selves autonomously, although the water company enjoyed somewhat more autonomy. All were constrainedby local government influences that limit the companies’ practical control over key management functions. Theoperational companies were overstaffed and underskilled, and their planning processes were largely “reac-tive;” planning was mainly geared chiefly to responding to government-driven operating goals, guidelines, andpriorities. The organizational structure of the companies did not confer business planning, budgeting, and tar-iff responsibility on these units. The operating utilities operated largely as cost centers with parent bureausdoing the planning and tariff analysis for them.

The consultants assisted the companies in five key areas: business planning, financial management, tariff fore-casting, water and wastewater operations, and human resources management. The consultants concluded thatalthough technical assistance can support companies in overcoming technology and management constraints,the application of additional technical assistance will produce diminishing results unless policy constraints tothe companies achieving full autonomy are not released.

Source: MWH consulting firm, Institutional Strengthening and Training Report for World Bank-fianced Chongqing Project (2005).

BOX 6.4 Challenges Faced by Water Supply and Wastewater Companies in Chongqing, China

FIGURE 6.4 Example of a Municipal Drainage System

may wish to create medium-sized utilitycompanies, which would allow the munici-pal government to easily compare the per-formance of the companies and generatecompetitive pressures for improvement.

Managing Wastewater as a Network Utility BusinessThe prevailing view in China is that drainageis a public good and wastewater treatment isa commercial activity. Consequently, drain-age services are typically provided by a gov-ernment department and a company is re-

sponsible for wastewater treatment. This ap-proach is contrary to typical internationalpractice, where wastewater is managed asnetwork utility business, including collection,conveyance, and treatment; and there is par-tial or full cost recovery for the full service.

Ideally, wastewater management shouldbe the responsibility of only one utility.Since cities in China may have institutionalconstraints to quickly merging departmentsand companies, interim approaches are sug-gested at the end of this section.

Fragmented Service DeliveryFigure 6.4 shows the typical layout of an urbandrainage system in a Chinese city. (Box 2.3 de-

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Urban roads

Municipal drains (combined or separate)

District drains (combined or separate)

Municipal interceptors

District IIDistrict IIDistrict II

District IDistrict IDistrict I

WWTP

Flow direction

District IVDistrict IVDistrict IV

River

Wet-weather overflow

District IIIDistrict IIIDistrict III

fines wastewater terms used in this study.)There are currently many ways of organizingwastewater services in a city (See Table 6.2). Ingeneral, the larger the city, the more districtsand the more fragmented the drainage collec-tion. The service fragmentation seen in manycities—based on an historical evolution of acomplex system—is as follows:

District Drainage Departments (DDD). AChinese city is composed of multiple dis-tricts, typically ranging from two to six dis-tricts based on the size of the city. Each dis-trict government has its own drainagebureau that is responsible for drainage alongits streets. The district road department istypically responsible for the construction ofroads and drains, and then turns over the op-eration of the drains to the drainage bureau.At the district level, there may be combineddrains, separate sanitary and stormwaterdrains, or a combination of both.

DDDs are generally overstaffed and havelow professional capacity. These depart-ments, however, have an important role toplay in managing wastewater. Most of thedrains in a city, in terms of length, are man-aged at the district level. The departmentsare responsible for ensuring that the drainsflow freely and drainage pump stations op-erate properly. In addition, the departmentsensure proper connections to the combined,sanitary, or stormwater drainage systems.

Municipal Drainage Departments (MDD).Large roads and drains that pass throughmultiple districts are typically the responsibil-ity of the municipal government. MDDs tendto be overstaffed and inefficient, but have theimportant role of maintaining the maindrains and pumping stations in the city.MDDs also oversee the district drainage bu-reaus to make sure the city has an effective

overall drainage system. In the past, Chinesecities were not required to treat their waste-water and all cities used combined drains. Thecombined stormwater and sanitary drainagewas collected and disposed into the nearestwater body, such as a canal, river, lake, orocean. With the advent of wastewater treat-ment, MDDs were often charged with convey-ing the wastewater to the treatment plant. TheMDDs constructed “wastewater interceptors,”which intercepted dry weather flows (i.e. nostormwater) from combined drains and con-veyed the wastewater to the plant.

Wastewater Companies. According to na-tional policy, cities are required to establishwastewater companies that receive revenuefrom wastewater tariffs, and operate on acommercial basis.1 Cities have responded tothis policy in different ways. Three commonarrangements include:

� The MDD is turned into a company and made responsible for wastewatertreatment.

� A new municipal company is estab-lished that is responsible for waste-water treatment and interceptors.

� There is a BOT arrangement with a pri-vate company for wastewater treatment.

Sources of InefficiencyOrganizational arrangements that reduce effi-ciency and increase cost include fragmentedresponsibility, underperforming drainage de-partments, and inadequate funds for drainage.

Fragmented Responsibility. Most citieshave a vast network of combined drains,stormwater drains, sanitary drains, and in-terceptors that are managed by different en-tities. The city of Tianjin, for example hasaround 5,000 kilometers of drainage pipe-lines. This poses numerous problems. First,

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different flows are often confused, withwastewater going into the stormwater drains,and stormwater going into the sanitarydrains, thus undermining efforts to collectand treat the wastewater. Second, localdrainage networks at the district level areoften incomplete, resulting in inadequatecollection of wastewater and localized flood-ing. District drainage departments often lackthe funds and expertise to manage the assetsin a modern and comprehensive manner.Third, the operation, maintenance, and assetmanagement of the collection network is notconducted on a systemwide basis. Theseproblems significantly reduce the efficiencyand effectiveness of the overall wastewatermanagement program.

Integrated wastewater utilities (combingcollection and treatment) are the norm inmost countries. Many cities have combinedtheir water and wastewater utilities to pro-vide full water cycle service. Box 6.5 providesan overview of how the United States andUnited Kingdom organize their drainage col-lection systems.

Underperforming Drainage Departments.Drainage departments are often overstaffed,underfunded, and lack professional manage-ment and technical staff. They were createdin a different era when the government bu-reaus were utilized as sources of socialwelfare and support. Drainage departments understandably have problems attractingcapable management and technical experts.Yet drainage is fundamental to good waste-water management.

Inadequate Funds for Drainage. Approxi-mately two-thirds of investment costs andaround half of the operating and mainte-nance costs of a typical wastewater systemcome from the complex system of drainagepipelines and pumping stations scatteredthroughout a city. In almost all cities, thewastewater tariff is used primarily or exclu-sively for wastewater treatment and fundingfor drainage services are provided by themunicipal government. When municipalgovernments face fiscal constraints, manychose not to fully fund the operation, main-

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United States. Of the more than 19,000 collection systems in the United States, the U.S. Environmental ProtectionAgency estimates that about 4,800 are satellite collection systems. Satellite collection refers to a situation wherethe municipality (or a private developer) that owns the collector sewers may not provide treatment of wastewater,but only conveys its wastewater to a collection system that is owned and operated by a different municipal entity.Municipal drainage systems are coming under regulatory control in the U.S., including satellite systems, and arebeing monitored for overflows that discharge into the environment. As stormwater management for water qualitypurposes is becoming increasingly important in the U.S., there is a growing trend to establishing single-purpose“stormwater utilities,” which charge users based on the estimated amount of runoff from their property. There areover 400 stormwater utilities in the U.S. that charge based on the quantity of land and impervious surface.

United Kingdom. Water companies in England and Wales are responsible for both wastewater and stormwatercollection. These private companies recover their costs for stormwater management through user fees. Theeconomic regulator, OFWAT, does not require the companies to utilize any particular approach for charging cus-tomers, but encourages the use of site-area based charges.

Source: EPA and OFWAT websites.

BOX 6.5 Drainage Collection Systems in the U.S. and U.K.

tenance, and timely renewal of the drainagenetworks.

Forces Driving Service FragmentationThe factors driving most cities to have mul-tiple organizations providing different partsof the wastewater service include:

� Incorporating district drainage depart-ments into a municipal company isproblematic, as they operate underdifferent administration systems.

� Transforming municipal or districtdrainage departments into modern, efficient integrated wastewater utilitieswould be challenging on many fronts, including culture, overstaffing, and pension obligations.

� The common perception in China isthat drainage is a public good whilewastewater treatment is a commercialactivity and thus the two servicesshould be managed separately.

� Integrating the various entities intoone company would reveal the truecost of wastewater and stormwatermanagement, which is likely to bemore expensive than water supply.

� Carving out wastewater treatment as aseparate commercial activity may helpto facilitate private financing for treat-ment plants.

� Finally, national government policieshave evolved to support separatingwastewater treatment as a commercialactivity to attract private financing andtechnical expertise.2

Options for Creating More Integrated Wastewater UtilitiesAlthough some cities may be successful increating modern and efficient wastewatertreatment companies, some of the key chal-

lenges lie in collecting and conveying waste-water; reducing sanitary and combinedsewer overflows; accessing financing; andrecovering costs for the entire system, notjust wastewater treatment. Maintainingfragmented responsibility for wastewaterservice reduces accountability and affectsoperational and investment efficiency. Asnoted above, there may be institutional con-straints in some Chinese cities to shiftingquickly to a single integrated wastewaterutility. There are, however, a range of op-tions to encourage a more integrated ap-proach, some of which could be used on an interim basis. Some of these potential op-tions are summarized in Table 6.3 and dis-cussed below.

� Company Ownership. Wastewater ismanaged in a manner similar to watersupply, with one utility company pro-viding wastewater (and stormwater) collection and treatment.

� Company Lease. The ownership ofdrainage collection assets would re-main with the municipal or districtgovernments. The wastewater com-pany, however, would be responsiblefor operating and maintaining the net-work through a lease contract. Themunicipal or district governmentswould be responsible for financingcapital works associated with the net-work, but the company would play thelead role in planning and constructingthe facilities.

� District Management Contract. Thewastewater company would enter into a management contract with thedrainage department(s) for the opera-tion of the drainage system. The owner-ship of drainage collection assets would

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remain with the municipal or districtgovernments. The municipal or districtgovernments would be responsible forfinancing capital works associated withthe network, but the company wouldplay the lead role in planning and con-structing the facilities.

� Municipal Wastewater Group. All of theexisting organizations—wastewatertreatment companies, municipaldrainage departments, districtdrainage departments, etc.—remain intact but are put under an umbrella“Municipal Wastewater Group.” Thegroup’s management responsibility in-cludes planning, financing, construct-ing, and recovering costs, as well asensuring overall service efficiency andquality.

Exploiting Opportunitiesfor Service AggregationAlmost every city in China provides its ownwater and wastewater services independ-ently, regardless of size. There is significantpotential for improving efficiency and re-

ducing costs by (a) merging water supplyand wastewater companies; (b) creating re-gional urban water utilities that service met-ropolitan areas; and (c) creating multi-cityurban water utilities.

The potential efficiencies stem mainlyfrom achieving economies of scale in theconstruction, financing, and management ofurban water infrastructure. The transactioncosts in aggregating services are often high,and the approach may be difficult in manycities. The potential benefits, however, arelarge in some cases. Municipal governmentsshould aggressively exploit opportunities foraggregation where they exist.

Existing SituationAs noted in Box 3.1 there are 661 “designatedcities” and 1,636 county-level towns with anaverage population of 60,000. Moreover,there are 18,256 towns in China that fallunder the jurisdiction of the county govern-ment. China’s counties and cities have con-siderable fiscal and administrative author-ity, with the provincial or prefecturegovernment generally only providing anoversight role. The tendency for the majority

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Option Drainage Network Treatment Plant

Company Ownership

Company Lease

DepartmentManagementContract

MunicipalWastewater Group

TABLE 6.3 Options for Integrating Wastewater Service

Company invests, owns and operates

Company leases and operatesGovernment invests and owns(No drainage departments)

Drainage department management contract with companyGovernment invests and owns

Drainage departments report to group management

Company owns and operates

Company reports to groupmanagement

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of cities, county-towns and small towns is todevelop their own water supply and waste-water utilities. Local leaders generally preferto own and manage their own infrastructureservices, and inter-jurisdictional coopera-tion in China is difficult due to the high de-gree of decentralization. Two challengesemerge from this decentralized approach:(1) servicing metropolitan areas, and (2)servicing small towns.

Servicing Metropolitan Areas. Metropol-itan areas are growing quickly and havebecome the economic powerhouses of thecountry. China has at least 53 metropolitanregions anchored on cities with over 1 mil-lion people. Towns on the fringes of thesemetropolitan areas contain around 50 per-cent of the metropolitan population and playan important social and economic role in theregion. Pollution-generating industries arebeing relocated from inner urban areas tothe surrounding areas. The surroundingcounties, and their towns, often lack finan-cial and technical capacity, and cannot takeadvantage of economies of scale in the pro-vision of urban water infrastructure. Tack-ling the water pollution and water supplychallenges in the wider metropolitan regionis critical in meeting China’s economic de-velopment and environmental goals.

Servicing Small Towns. The majority ofthe over 18,000 towns do not lie within theeconomically dynamic metropolitan areas.Yet these urban areas are significant sourcesof pollution and many lack a reliable high-quality water supply. The Chinese govern-ment has placed a high priority on improv-ing the quality of life in these towns tobalance the rapidly growing urban-rural dis-parities. These towns, however, often have

limited resources and expertise to developadequate urban water systems.

Potential Benefits of AggregationAs shown in Table 6.4, there are several op-tions for aggregating urban water services.The potential benefits of aggregation includethe following:3

� Increased efficiency througheconomies of scale

� Enhanced professional capacity in alarger scale operation

� Improved access to finance and/or private sector participation

� Improved access to water resourcesand integrated water resources management

Options for Aggregating Services in ChinaEven when the aggregation of urban waterservices may provide economic benefits,there are often institutional constraints thathinder efforts to examine and pursue prom-ising options. Box 6.6 shows that manycountries in Latin America are also dealingwith similar issues.

From an international perspective, Chinahas a high level of fiscal and administrativedecentralization. This potentially hinderspolicy measures to encourage aggregation ofservices. The following options, however,could be examined by municipal leaders.

� Combining Water and WastewaterUtilities. The provision of water andwastewater services are closely related,and involve the same core set of techni-cal, management, and financial skills.Most cities in China have shied awayfrom combining the two services, aswater supply has long been organized

as a commercial activity while waste-water is still considered a semi-publicgood that needs to be subsidized. Citiesshould consider combining the twoservices, particularly if they commit tomanaging wastewater as a commercialbusiness. There will be transition costs,including shedding of staff and man-agement, but there is significant poten-tial for increased efficiencies.

� Creating Water Utilities in MetropolitanAreas. The potential for expandingwater supply and wastewater servicesfrom the core urban area of large citiesinto the surrounding towns is enor-mous. Expanding the service area cre-ates many administrative, financial,and governance questions, althoughwith proper government leadershipthese problems can be overcome.

There are many international examplesto draw upon. Box 6.7 shows howNingbo is extending its water supplyservice to surrounding towns andcities.

� Creating Multi-City Water Utilities.Smaller cities and towns outside thevicinity of metropolitan areas can alsobenefit from a partnership with largerand more experienced utilities. Asshown in the Brazil example (Box 6.6),cities can often be induced to formpartnership arrangements with outsideutilities to provide a variety of services,such as concession contracts, leases, or management contracts. These ser-vices could potentially be provided byeither the private sector or the munic-ipal utilities, which want to expandtheir business.

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Key Characteristic Range of Possibilities with Increasing Aggregation

Scale

Scope

Process

Source: Adapted from World Bank. 2005. “Models of Aggregation for Water and Sanitation Provision.” World Bank Water and Sanitation Working Note 1.Washington, DC: World Bank.

TABLE 6.4 Options for Aggregation

What can be the scale of aggregation?

What services can be aggregated?

What operating functions can be aggregated?

What process can be followed?

• Metropolitan area including core city and surrounding towns• All cities or towns in a county or prefecture

• Raw water supply• Water supply service• Water supply and wastewater• Water supply, wastewater, and energy or others (solid waste)

• Management• Planning and construction• Operations• Financing• All functions with merging of assets and staff

• Voluntary• With incentives (financial, political, and so forth)• Mandatory

Summary of Strategic DirectionsThe strategic directions identified in thischapter are summarized below.

� Streamline Utility Governance toFacilitate Cost Recovery. Chinese citiesshould experiment with new models ofutility governance that can better bal-ance service standards, tariffs, andwhere necessary fiscal transfers. Someoptions are (a) municipal utilityboards; and (b) municipal utility advi-sory groups.

� Foster Efficient Water Utilities. Munic-ipal utilities, particularly in large cities,should be empowered to take over core

strategic functions, which in manycases are currently the responsibility ofthe parent bureau. With increased au-thority, the government should alsohold utilities more accountablethrough improving performance mon-itoring, insisting on transparency andcustomer orientation, and where ap-propriate using the private sector toenhance utility efficiency.

� Manage Wastewater as a Network Utility Business. Many cities have frag-mented the responsibility for waste-water collection and treatment. To improve efficiency, municipal govern-ments should consider consolidating the service. Some options include (a)an integrated wastewater company;

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Prior to 1990, many Latin American countries—including Argentina, Chile, Colombia, Panama, and Peru—organizedtheir water industries as national monopolies under the direct control of the central government. Growing dis-satisfaction with the performance of the national monopolies, combined with wider pressure for devolutionacross all areas of government, created the conditions for a move toward more decentralized control in the 1980sand 1990s.

On the whole, decentralization was not a studied response to the specific problems of the water sector, butrather the byproduct of wider state reform. In countries such as Argentina, Colombia, and Peru, this has entaileda sudden fragmentation of the industry into literally hundreds of small municipal providers.

A number of problems have since arisen. The first of these is the loss of economies of scale. Aside from theinvestment economies, the scarcity of resources may also make it undesirable to dilute technical capacity acrossa large number of service providers. The questionable commercial viability of many of the business units isclosely related, which leads to difficulties in attracting private sector investment. Finally, municipal control of thesector has made it difficult to drive regulation and PSP from the center. Brazil, however, offers an interestingcontrast.

Water supply in Brazil is the constitutional responsibility of the municipal government. However state-level(i.e. provincial level) water companies service around 80 percent of the urban population. These companies werecreated as a result of voluntary agreements with municipalities that gave the companies the right of service pro-vision. The agreements were facilitated by the national government, which offered an attractive investmentfinancing package for municipalities through a national program named “PLANSA.” The recent expiration ofthe PLANSA agreements has left a great deal of legal ambiguity regarding state vs. municipal responsibility forwater service.

Source: World Bank. 2005. “Ten Years of Water Service Reform in Latin America.” World Bank Paper No. 3. Washington, DC: World Bank.

BOX 6.6 Municipal and Regional Water Services in Latin America

(b) a wastewater company with a leasecontract for drainage; (c) managementcontracts between drainage depart-ments and wastewater company; and (d) a consolidated “WastewaterGroup,” where all organizations reportto the same management.

� Exploit Opportunities for Service Aggregation. Economies of scale andgreater efficiency can potentially beachieved through (a) combining waterand wastewater utilities; (b) formingmetropolitan urban water utilities; and(c) creating multi-city urban water utilities. Municipal governmentsshould consider whether such aggre-

gation is appropriate or advisable, and pursue opportunities where theyexist.

Notes1. See the “Notice to Improve Wastewater Co-

llection and Establish Sound Collection andTreatment Practices” issued in September 1999by NDRC/MOC/SEPA (Notice 1992).

2. See the 2002 MOC/NDRC/SEPA “Circular onAccelerating the Commercialization of UrbanWastewater and Solid Waste Treatment” whichdiscusses the commercialization of wastewatertreatment, but not collection.

3. Excerpted from World Bank. 2005. “Models ofAggregation for Water and Sanitation Provision.”World Bank Water and Sanitation Working Note 1. Washington, DC: World Bank.

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The Ningbo Water Supply Company (NWSC) currently serves 1.3 million people in the four core urban districtswith a treatment capacity of 820,000 m3/day. In the surrounding suburban districts, 1.3 million people obtainwater from 29 small town water supply systems with an estimated capacity of 610,000 m3/day, or through self-supply with an estimated capacity of 460,000 m3/day. Due to poor groundwater quality, all of the small town andself-supplied water systems draw upon local surface water sources, which are heavily polluted and subject tosalinity intrusion.

The Ningbo municipal government has decided to tackle the problem from a regional perspective and hasdeveloped a long-distance water transfer scheme to bring water to the city and its surrounding areas. Themunicipal government has also directed NWSC to incorporate the small town water supply systems, supplywater to all industries, and improve service quality. The incorporation of the small towns and self-suppliedusers should benefit them through higher water quality and service, tapping into economies of scale in invest-ment and management expertise, and overcoming financing constraints.

The municipality is still working through the terms of the incorporation with the small towns, and is consideringthree options: (1) transfer of assets and service responsibility; (2) management of the small town system whileownership of assets remains with the suburban district government; and (3) sale of treated water to the smalltowns. With the assistance of a World Bank loan, Ningbo is developing a 50-kilometer ring main for the treatedwater, with the core urban area inside the ring main, and the surrounding small towns provided through outwardradiating spokes from the ring main.

Source: World Bank, Ningbo Water and Environment Project Appraisal Document (2005).

BOX 6.7 Case Study of Ningbo, China

Most Chinese urban water utilities receivesignificant financial support from the mu-nicipal government. While it might seemthat this support would strengthen the watersector, this chapter suggests that in factgreater utility self-reliance would be a betterstrategy. Less reliance on government fundsand more on user fees and capital marketscan generate strong forces for improving ef-ficiency and ensuring sustainability because:

� User fees are generally more reliablethan government transfers.

� Utilities will be more accountable tousers.

� Governments are less able to directself-reliant utilities to pursue short-term interests at the expense of longerterm objectives.

� Capital markets—a vital source ofinvestment capital for the sector—require financial discipline, trans-parency, and accountability.

Box 3.3 in Chapter 3 presents the conceptof a “financial sustainability ladder.” Util-ities that rely exclusively on governmentfunding for capital and operating expensesare at the bottom of the ladder; utilities thatgenerate sufficient revenues from user fees

and finance investments through capitalmarkets are at the top. This chapter providesthe following strategic guidance on howChina’s urban water utilities can move upthe financial ladder. In essence:

� Municipal governments should alwaysensure that utilities recover their coststhrough user fees. However, by provid-ing capital contributions, governmentscan limit a utility’s costs, and so limitthe required tariff levels.

� Over time, user fees should increase,municipal capital contributions de-crease, and utilities should rely more on domestic debt markets.

� National concessionary financing pro-grams should be expanded and restruc-tured to provide incentives for cities tocomply with policy objectives.

Government must ensure the right bundleof service levels, utility efficiency, tariffs, andfiscal transfers to have sustainable urbanwater services. Chapters 5 and 6 examinedthe policies and institutional arrangementsat the national, provincial, and municipallevel that are necessary for “getting thebundle right.” This chapter focuses on tarifflevels and fiscal transfers.

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7 Moving Up the Utility FinancialSustainability Ladder

Achieving Utility Cost RecoveryMany urban water utilities in China experi-ence financial and operational stress because:

� User fees are well below the full cost recovery level, forcing utilities to relyon unreliable municipal capital contri-butions and government payments.

� Even when provided, government pay-ments are not enough to fill the gap be-tween the true cost of service and therevenue from users.

� Concerns about affordability for the lowest income groups, and social acceptability, limit the extent and rate at which tariffs can be increased.

� Tariff structures are not optimized toprovide the correct economic signalsand increase utility revenues.

The financial and operational perform-ance of urban water utilities can be im-proved by:

� Ensuring that water and wastewaterutilities (including drainage bureaus)can meet their financial obligationsthrough user fees only, with govern-ment funding limited to capitalcontributions.

� Adjusting tariff structures to ensuremore reliable and higher utilityrevenues.

� Developing better low-income supportprograms, which allow tariffs to beincreased at a faster pace.

Inadequate Utility Cost Recovery1

The term “utility cost recovery” as used inthis study means that a utility can meet itsrevenue needs from a combination of user

fees and government transfers. Cash coststypically include operation and mainte-nance, debt service, and asset renewal. A re-turn on equity is also required if there is aprivate equity investment. Box 7.1 explainsthe financial terms and concepts used in thisreport in more detail. The general status ofChinese water utilities is described below.

Water Supply Utilities. The figure in Box7.1 shows the financial status of typicalwater supply utilities in China. The utilitiesreceive capital contributions from the mu-nicipal government and borrow from do-mestic banks, and thus have a moderate levelof financing autonomy. They also relymainly on user tariffs, and thus have a highlevel of revenue autonomy. Water supplyutilities generally have a moderate cost re-covery ratio, as the combination of user feesand government payments (when they oc-cur) typically result in inadequate revenue tocover costs. This is reflected in Table 2.3,which shows that two-thirds of water supplyutilities did not make an accounting profit in2004. The water supply utilities generallycope by foregoing asset renewal invest-ments.

Wastewater Utilities. Wastewater servicein most cities is fragmented between drain-age departments and wastewater com-panies. Drainage departments rely exclu-sively on government payments and capitalcontributions, and thus have no revenue orfinancing autonomy. Drainage departmentsalso have a low cost recovery ratio, as gov-ernment payments are typically inadequateto cover maintenance and asset renewalneeds.

Wastewater companies generally havemoderate levels of financing because they re-ceive some capital contributions from the

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95

M o v i n g U p t h e U t i l i t y F i n a n c i a l S u s t a i n a b i l i t y L a d d e r

Using a cash-needs approach, the following figure schematically represents a utility’s annual rev-enue requirements.

O&M Costs. Represent the minimum amount of cash necessary to maintain operations at a rea-sonable level over a short-term perspective.

Partial Capital Costs. Utilities generally try to have enough cash from revenues to finance minorcapital works. Major capital projects are typically financed through a combination of cash from rev-enues, debt, and/or municipal government contributions.

Debt Service. Debt service refers to the cash necessary to make principle and interest payments ondebt obligations. As the amount of utility debt financing increases, debt service increases. Somelenders also require utilities to establish “reserves” in the event of an unexpected business shock.If the municipal government provides contributions for capital works, then debt service is reduced.

Financing Autonomy. This concept reflects the percentage of investment financing that comesfrom loans or internal cash versus government contributions. Sixty percent financing autonomymeans that 60% of the funds come from loans or utility cash reserves, and 40% from governmentequity contributions.

Revenue Autonomy. This shows the percentage of annual revenue that comes from user fees ver-sus government payments. A ratio of 60% percent means that 60% of the revenue comes fromusers and 40% from government payments.

Utility Cost Recovery Requirement. This is the amount of cash necessary to meet O&M, definedpartial capital costs, and debt service requirements. The higher the level of financing autonomy, thegreater the debt service, and the higher the required utility cost recovery level.

Utility Cost Recovery Ratio. This is the ratio of actual utility revenues from user fees and govern-ment payments divided by the utility’s cost recovery requirement. A ratio of 60 % means that theutility’s revenues (from user fees and government payments) only meets 60% of its requirements.

Full Cost Recovery. This is the amount of cash necessary to meet all of a utility’s needs, assum-ing no government financial support; that is, no government payments or capital contributionsto the utility.

BOX 7.1 Concept of Utility Cost Recovery

Annual utility cashrevenue requirement

Debt service costs

Revenue Autonomy: Tariff/(Tariffs + Government payments)

0% 100%

O&M costs

Partial capital cost

Financingautonomy

WS tariff

WW tariff

WW GOV

WS GOV

Financing autonomy: Debt/(Debt + Government contribution)

government and also borrow from commer-cial banks. The wastewater companies typi-cally have moderate levels of revenue auton-omy and rely on a combination of user feesand government payments. The combina-tion of wastewater tariffs and governmentpayments typically result in moderate costrecovery ratios. Wastewater companies copeby foregoing asset renewal, maintenance,and in some cases just not operating thetreatment plant.

The figure in Box 7.1 shows the financialstatus of a typical wastewater sector, includ-ing both drainage departments and waste-water companies, in a Chinese city. Theoverall level of cost recovery, financing, andrevenue autonomy is low. This precarious fi-nancial situation can potentially undermineChina’s national wastewater managementprogram. Table 7.1 summarizes the generalfinancial status of urban water utilities inChina.

Asset Renewal. Many of the water supplydistribution and wastewater drainage net-works in Chinese cities need to be renovated.As discussed in Chapter 9, utilities need to es-tablish modern asset management programsto ensure that asset renewal is done in a sys-tematic and cost-effective manner. The cur-rent system of tariff setting in China is basedon the objective of having the utility make asmall accounting profit as reflected in the

company’s income statement, where depreci-ation is typically taken as a proxy for the cap-ital costs. Depreciation, however, is based onhistorical costs and many of the assets are soold that the accounting valuation is of littleuse. Developing asset management plans thataccurately assess the renewal costs are essen-tial to a utility’s long-term sustainability.

Low User Fees. Since 1998, waster supplyand wastewater tariffs have increasedthroughout China. The weighted averagewater supply tariff has risen from 0.93RMB/m3 in 1998 to 1.36 RMB/m3 in 2004 (seeTable 7.2). The rate of tariff increase is approx-imately equal to China’s overall growth inGDP over the same period. Although the in-crease in tariffs may have increased water util-ity revenues, the overall financial position ofwater utilities appears to have deterioratedover the period 1998 to 2004 (see Table 2.3).This may be attributable to higher O&M anddebt service costs associated with the watersupply investment boom during the 1990s.Wastewater tariffs have also risen significantlysince 1998 when few cities had wastewatertariffs. By 2005, 475 of the 661 designatedcities have wastewater tariffs, but many of thecities have very low rates, with close to 25 per-cent having tariffs less than 0.3 RMB/m3.

Figures 7.1 and 7.2 show the weighted av-erage water supply and wastewater tariffsbased upon a selection of 128 cities in 2005.

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Utility Type Utility Cost Recovery Revenue Autonomy Financing Autonomy

Water Supply Company Medium High Moderate

Wastewater Company (Mainly Treatment) Medium Medium Medium

Drainage Department Low Low Low

TABLE 7.1 Summary of Urban Water Utility Financial Status in China

Based on a review of World Bank-financedprojects, this study estimates that the indica-tive full cost recovery weight-average tariff forwater supply should be a minimum of 2.0 RMB/m3, and 3.0 RMB/m3 for wastewater.These estimates assume commercial loans

are used to finance capital works, and userfees are adequate to cover O&M, debt service,and annual asset renewal requirements. Theestimate for water supply excludes the costfor developing the raw water supply (i.e.water resource engineering fee), which canvary significantly depending on a specificcity’s circumstances. The cost of raw watersupply development is typically heavily subsi-dized through a local or provincial water re-sources bureau. The estimate for wastewaterincludes both collection and treatment.

The two figures indicate that water supplytariffs are generally below full cost-recoverylevels. Wastewater tariffs are generally notadequate to even meet wastewater treatmentcosts, which are estimated to range from 1.0 to 1.5 RMB/m3. A utility can derive rev-enues from other sources besides a volumet-

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Average Water Tariff 1998 2004 % Increase

Category I: Super Cities 1.00 1.72 72

Category II: Medium Cities 0.93 1.33 43

Category III: Developing Cities 0.85 1.24 46

National Average 0.93 1.36 47

Source: China Water Works Association Yearbooks (1999) and (2005).

TABLE 7.2 Weighted Average Water Supply Tariffs by City Category(Unit: RMB/m3)

2.202.502.80Maximum

0.600.700.88Minimum

0.360.380.57Stnd. dev.

1.241.331.72Average

CategoryIII

CategoryII

CategoryI

0

5

10

15

20

25

30

0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6 More

Num

ber o

f city

RMB

WS full costrecovery >2.0

Based upon 128 sample cities, as of July 2005. See Annex 3 Technical Notes for Analysis.

FIGURE 7.1 Water Supply Tariffs(RMB/m3)

0.651.171.05Maximum

0.100.080.22Minimum

0.140.190.22Stnd. dev.

0.320.400.65Average

CategoryIII

CategoryII

CategoryI

0

5

10

15

20

25

30

0.1 0.3 0.5 0.7 0.9 1.1 1.3 1.5 1.7 1.9 2.1 2.3 2.5 2.7

Num

ber o

f city

RMB

Full cost oftreatment

Full cost treatmentand collection >3.0 RMB

Based upon 128 sample cities, as of July 2005. See Annex 3 Technical Notes for Analysis.

FIGURE 7.2 Wastewater Tariffs(RMB/m3)

ric tariff, including fixed fees, developercontributions, bulk water sales, etc. From autility perspective, the important parameteris total revenues. Nevertheless, the weightedaverage tariff provides a good general indi-cator of the level of cost recovery from users.

Box 7.2 provides an international com-parison of water supply tariffs and cost re-

covery levels. China’s water supply averagetariff is RMB1.36/m3 ($0.17). Taking into ac-count purchasing power parity, the adjustedprice is $0.68, which is below the full cost re-covery tariff level for a typical OECD coun-try. Box 7.2 also indicates the likely range forcost recovery in developing and industrial-ized countries. Cost estimates are lower for

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Indicative Tariff Levels. The following table indicates the ranges for probable degree of cost recovery in the de-veloping and industrialized countries. Cost estimates are lower for developing countries, reflecting lower laborcosts. The estimates are for water supply only, and do not include wastewater.

Probable Degree of Cost Recovery. The following table provides information on the extent to which tariffs meetcost recovery objectives by income level.

BOX 7.2 International Comparison of Cost Recovery Ranges for Water Supply

Tariff Levels Developing Countries Industrialized Countries

<$0.2/m3 Tariff insufficient to cover basic O&M costs Tariff insufficient to cover basic O&M costs

<$0.2–$0.4/m3 Tariff sufficient to cover operation and some maintenance costs Tariff insufficient to cover basic O&M costs

<$0.4–$1.0/m3 Tariff sufficient to cover O&M and most investment costs Tariff sufficient to cover basic O&M costs

>$1.0/m3 Tariff sufficient to cover O&M and investment needs in the face Tariff sufficient to cover full cost of modern waterof extreme shortages. systems in most high-income cities.

Percentage of Utilities Whose Average Tariffs are:

Groups of Water Utilities Too Low to Cover O&M Enough to Cover O&M Enough for O&M and Partial Capital

Global 39 30 30

High Income 8 42 50

Upper Middle Income 39 22 39

Lower Middle Income 37 41 22

Lower Income 89 9 3

Source: World Bank, “Water Electricity, and the Poor,” Komives et al. (2005)

developing countries, reflecting lower laborcosts. The estimates are for water supplyonly, and do not include wastewater.

User Cost Recovery for Wastewater Ser-vices. Approximately two-thirds of invest-ment costs and around half of the operatingand maintenance costs of a typical waste-water system come from the complex systemof pipelines and pumping stations scatteredthroughout a city. The common perceptionin China is that drainage (i.e. collection ofstormwater and wastewater) is a pure publicgood, and the funding and operation of thedrainage facilities should be provided by thegovernment through a traditional public de-partment approach. Wastewater treatment,however, is viewed as a commercial activityby which payment can be made for the treat-ment services rendered and should be pro-vided by a commercial company. In almostall cities, the wastewater tariff is used forwastewater treatment, and funding fordrainage services is provided by the munici-pal government. Since many municipal gov-ernments face severe fiscal constraints,many chose not to fully fund the operation,maintenance, and timely renewal of thedrainage networks.

The classification of drainage as a publicgood can be contested. Drainage of waste-water can be considered as an extension ofthe water supply service and subject to auser-pays principle. It is more difficult toapply a strict “user-pays” principle tostormwater drainage. In many countries,stormwater services are paid for by a prop-erty tax based on the size of the property, as-suming that the amount of stormwaterrunoff is related to property size. This ap-proach would not work well in China, asmost people live in apartments and munici-pal governments do not levy property taxes.

Another perspective is that the municipalgovernment can pay the utility for the ser-vice provided.

Social AcceptanceThe extent and pace to which water andwastewater tariffs can be raised is based pri-marily on social acceptance. Social accept-ance depends on a number of political, cul-tural, and economic factors, including theoverall percentage of household incomeused to pay for water services. Box 7.3 pro-vides an overview of water tariff levels inOECD countries as they relate to householdincome levels.

Household Incomes. The general range ofwhat is often considered “affordable” forwater services is 3 to 5 percent of householdincome.2 Figure 7.3 shows the financial im-pact of different tariff levels based upon theannual household income in China. The av-erage 2004 urban household disposable in-come in China was approximately 28,000RMB. With an estimated 2004 average com-bined tariff of about 2 RMB/m3 (1.36RMB/m3 for water supply and 0.64 RMB/m3

for wastewater), the percentage of watercharges to the annual household income isonly around 1 percent.3

If the tariff increases to 3.5 RMB/m3—which is this study’s minimum estimatedcost recovery tariff for water supply andwastewater treatment, water charges willrepresent 1.7 percent of the average house-hold income. However, at that level, twolow-income groups—about 20 percent oftotal urban residents—will pay more than 3 percent of their household income (that is,above the dashed line in Figure 7.3). The fullcost recovery tariff for water and wastewaterservices is probably closer to 5 RMB/m3 orhigher. The full cost recovery level would

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100

Note: Representing 10 percent or less than 10 percent lowest income group.

Many OECD countries have seen a real increase in household water charges in recent years. The factors behindthis trend include continued pollution of water resources (necessitating more expensive treatment), combinedwith additional national legislation and EU directives that require higher standards of wastewater treatment. Thistrend toward higher prices is likely to continue and will therefore continue to generate pressure on the perceivedaffordability issue of water services in OECD countries.

There are several methods available for measuring the affordability of water services. “Macro-affordability”indicators are developed by relating national average household water charges to either average householdincome (disposable or gross) or average household aggregate expenditure. “Micro-affordability” indicators dis-aggregate the former by income groups. Available evidence of affordability indicators suggest that, in abouthalf of the OECD countries (15 out of 30), affordability of water charges for low-income households is either asignificant issue now or might become one in the future, if appropriate policy measures are not put in place.

BOX 7.3 Social Acceptability of Water Tariffs in OECD Countries

Macro and Micro Affordability Indicators, Selected OECD Countries

Macro Indicator: Percentage Micro Indicator: Burden of lowestCountries Year of Household Income Income (%)1

England & Wales 99–00 1.2 3.75

Mexico 2000 n.a. 3.84

Hungary 1999 2.1 2.53

Scotland 99–00 0.7 2.24

France 1995 0.9 2.18

Netherlands 1999 1.4 2.38

Denmark 1998 1.1 1.9

Italy 1995 0.7 0.9

USA 2000 0.5 2.18

The trade-offs between efficiency and equity objectives of water services usually occur when moving from anunmeasured to metered charging structure, when rebalancing tariffs away from fixed charges toward volumet-ric charges, and when increasing fees and tariffs toward full-cost pricing. There is considerable experience inOECD countries with policy measures to address water affordability for vulnerable groups, while attempting tomake water pricing reveal the full economic and environmental costs of water services.

Social measures to address affordability issue can be categorized into two groups: (1) income support measuresand (2) tariff-related measures. The income support measures tackle individual customer’s ability to pay from theincome side through income assistance, water services vouchers, tariff rebates and discounts, bill re-phasing andeasier payment plans, arrears forgiveness, etc. Tariff-related measures keep the size of water bills low for certaingroups (e.g. refinement of increasing-blocking tariffs, tariff choice, tariff capping). A common approach, called a“life-line tariff,” is to provide qualified low-income households with low rates up to a certain quantity (for example,10 m3 per month per household).

Source: OECD, “Social Issues in the Provision of Water Services,” (2003).

still be affordable to 60 percent of totalurban residents (i.e., under the dashed line).

Based on this analysis, there appears to beconsiderable potential for increasing tariffs inChinese cities from the 2004 average of 2.0 RMB/m3. The lowest 10 percent incomegroup, however, had an average disposableincome of only 8,500 RMB. If the tariffreaches 5 RMB/m3, water charges would con-sume about 8 percent of annual income.Moreover, Figure 7.3 is for the average house-hold across China, but there are significantdifferences among cities in China. For exam-ple, the average household income in a richcity could be above 40,000 RMB, while for apoor city it might be closer to 20,000 RMB.

Most Chinese cities have programs forlow-income households where the cost ofbasic services, such as water and electricity,are explicitly considered in a monthly sti-pend for eligible households. Increases inwater tariffs could potentially be accom-modated through this instrument. Onedrawback, however, is that that are manymigrants who may not have official status inthe city and thus are not eligible for low-in-come assistance. Moreover, the income sup-plement approach requires the household toexercise budget discipline—which may ornot occur, and could still result in financialdifficulties paying the water bill. As shown inBox 7.3, there are other programs that canhelp low-income groups.

Social Acceptability. Even if a tariff is “af-fordable,” it may not be socially acceptable.There are a number of social concerns inChinese cities that may limit the rate and ex-tent of tariff increases. First, as China movestoward a market economy, families are ex-pected to pay for many essential services thatwere once free. These include housing, med-ical care, education, and basic utility ser-

vices. Although Chinese household incomesare rising rapidly, so are basic expenses;many urban families feel beleaguered withtheir new financial obligations. Second, asdiscussed in Chapter 3, there is growingurban inequality in China as migrants floodinto cities and a new class of rich urbanitesdevelops. Increasing prices for utility ser-vices, without putting in place effectiveprograms to help low-income residents, mayreinforce concerns about inequality and fair-ness. Third, given the low levels of trans-parency and perception of inefficiency as-sociated with municipal utility companies,the public may be reluctant to pay for ser-vices unless they are confident their money isused in an efficient and accountable manner.These three factors may cumulatively workto dampen the pace at which water andwastewater tariffs can be increased.

Tariff StructuresThe tariff structure is important in allocat-ing the cost of service, as well as sending eco-

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0

2

4

6

8

10

12

2 3 4 5 6

Combined tariff level (RMB/m3)Pe

rcen

tage

of a

nnua

l hou

seho

ld in

com

e AverageLowest income (10%)Low income (10%)Lower middle income (20%)Middle income (20%)

AffordabilityThreshold (3%)

See Annex 3, Technical Notes, for Analysis.

FIGURE 7.3 Combined Tariff as Percentage of HouseholdIncome in 2004

nomic signals about the resource value ofthe water. The establishment of a tariff leveland structure typically has the followingobjectives: (1) cost recovery, (2) economicefficiency, (3) equity, and (4) affordability.Chinese cities, with the encouragement ofthe national government, are experimentingwith new types of tariff structures to addressits severe water problems. The multiple ob-jectives in setting water tariffs, however, areoften in conflict, and Chinese cities arestruggling with striking an appropriate bal-ance among the different criteria. Table 7.3provides an illustrative example of the tariffstructure for Tianjin. Water tariffs in Chinatypically have the following attributes:

Volume-Based Charges. Both water andwastewater tariffs are based on the actualquantity of water delivered, with the waste-water tariff included on the water supplybill. The water supply company typically re-mits the wastewater tariff to the local fi-nance bureau, which then passes it on to thewastewater company, often through the par-ent agency such as the construction bureau.A notable exception is self-supplied indus-tries, where it is not possible to collect waste-water fees directly from the water supplycompany. Self-supplied water accounts foraround 12 percent of total urban water sup-ply on a national level, and in some cities inthe north of China it can account for up to

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Tariff Users 2000 Jan 01–Aug 01 Sept 01–Sept 02 Oct 02–Dec 03 2004

Water Supply Residential 1.4 1.8 2.2 2.6 2.9

Administrative 1.8 2.2 3.0 3.6 4.4

Industry 1.8 2.2 3.0 3.8 4.6

Commercial 2.2 2.6 3.0 3.8 4.6

Financial & Construction 2.2 2.6 3.4 3.8 4.6

Hotel & Recreation 2.4 3.5 5.0 5.0 5.6

Special Sector 2.4 3.5 6.0 9.0 18

Wastewater Residential 0.2 0.4 0.4 0.5 0.6

Administrative 0.4 0.6 0.6 0.8 1.0

Industry 0.2 0.4 0.4 0.8 1.0

Commercial 0.4 0.6 0.6 0.8 1.0

Financial & Construction 0.4 0.6 0.6 0.8 1.0

Hotel & Recreation 0.4 0.6 0.6 0.8 1.0

Special Sector 0.4 0.6 0.6 0.8 1.0

Source: Tianjin Construction Administration Commission (2006).

TABLE 7.3 Water and Wastewater Tariff History in Tianjin (Unit: RMB/m3)

30 percent. Collection of wastewater feesfrom self-supplied industries can be prob-lematic, as the wastewater companies typi-cally do not have the authority to collect thetariffs directly. In some cases, the environ-mental protection bureau, which regulatesindustries, or the water resources bureaucollects the wastewater fees on behalf of thewastewater company.

Metering. The majority of Chinese urbanresidents live in apartment blocks. In thepast, water companies used “bulk meters”that measured the flow into the apartmentbuilding, and the building management wasresponsible for paying the water bill. Chinanow has a policy of universal household me-tering, and water companies are rapidly in-stalling meters. Some cities are experiment-ing with pre-paid debit cards that residentsmust put into their meters in order to con-tinue to receive service.

Movement toward a Two-Part WaterSupply Tariff. There is a move to a two-parttariff for water supply, which includes: (1) afixed capacity charge based on the size of theconnection to cover fixed costs and a certaindegree of cost recovery for investments; and(2) a variable charge based on the volume ofwater used. Since 1999, at least fourteenpilot cities have adopted a two-part tariff forwater supply.4

Increasing Block Tariffs as a DemandManagement Tool. A number of pilot citieshave also adopted increasing block tariffs fordomestic users to promote water conserva-tion. For example, each household is allo-cated 10 m3 per month and all water deliv-ered within this amount is charged thestandard domestic rate. For the next incre-ment of water from 10–20 m3/ month, the

tariff is doubled. Wastewater fees, however,do not have an increasing block rate. The ob-jective of the increasing block tariff is tosend economic signals reflecting the scarcityvalue of water, while ensuring that water tomeet basic needs remains affordable.

Cross Subsidies. There are significantcross-subsidies in Chinese water tariffs. In-dustrial and commercial users subsidize res-idential users. In a survey of cities acrossChina, the average ratio of the non-domestictariff to the domestic tariff was approxi-mately 1.5. Cross-subsidies are partly avestige of the planned economy, when state-owned-enterprises subsidized basic domes-tic services. Cross-subsidies are also used tohelp with social affordability, as raising tar-iffs for industrial and commercial users maybe politically easier than residential users inmany cities.

Water Resource and Water DevelopmentTariffs. In addition to tariffs for the watersupply and wastewater utilities, the waterbill also typically includes a water resourcefee and a water development fee. The waterresource fee goes to the local water resourcesbureau, which has overall responsibility forwater resources management. The water de-velopment fee is based upon the allocatedcost of the raw water supply infrastructure.Often, the raw water supply infrastructure—such as reservoirs and conveyance facil-ities—is heavily subsidized by the govern-ment at either the municipal or provinciallevel. In a few cases, however, the water de-velopment fee can be quite high; for exam-ple, in Tianjin the fee is RMB 1.5/m3 ($0.18).

Polluter-Pays Principle. Wastewater tar-iffs in China are based on volume of waste-water discharged, typically measured on

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the quantity of water supplied. An AsianDevelopment Bank study on wastewater tar-iffs recommended that in the future, Chinesecities transition to a two-part tariff for indus-try and certain types of commercial estab-lishments.5 The two-part tariff would becomposed of (1) volume charges and (2) pol-lutant loading charges. The pollutant load-ing charges, which are used in many OECDcountries, could be either (a) set on the clas-sification of the industry/commercial estab-lishment with an appropriate adjustmentfactor for the volume of the wastewater; or(b) the actual measure or estimated mass ofpollution discharged on a case-by-case basis.

Achieving Utility Cost RecoveryIn order to improve the performance and sus-tainability of urban water utilities, this studyrecommends the following approaches:

� Utilities Should Recover Their CostsThrough User Fees. Many urban waterutilities still rely on municipal govern-ment payments to partially cover theircosts. Water supply and wastewatertariffs should be increased, and tariffstructures adjusted to ensure utilitycost recovery. Municipal governmentscan adjust a utility’s costs, and thus the

extent of tariff increases, through theircapital contribution policy. The follow-ing guidelines are presented:

� Wastewater Tariffs Should Pay forDrainage. Cities should increase thewastewater tariffs so that it covers the utility’s cost for drainage services.Even though stormwater and sanitarydrainage are two different services, theyare provided by the same utility (and inthe case of combined drains, throughthe same pipeline network). The munici-pal government will probably need tostill provide equity contributions to fundmajor drainage capital works, but atleast all O&M and minor capital worksshould be covered through user fees.

� Tariff Structures Should Be Optimized.Tariff reforms should be acceleratedwith more usage made of two-part tar-iffs (fixed and variable), and wastewatercharges based on both volume and pol-lutant loading. Two-part tariffs wouldallow cities to more vigorously pursuedemand management efforts withoutundermining a utility’s revenue base.Wastewater charges based on flow andpollutant loading would increase waste-water revenue and provide better eco-nomic signals to dischargers.

� Develop New Low-Income AssistancePrograms. To address affordability andsocial acceptance issues, cities shouldexperiment with new support prog-rams such as vouchers, rebates, life-line tariffs, etc.

Accessing DomesticCredit MarketsThis section first reviews municipal infra-structure spending and financing in general,

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Type of City Water Supply Wastewater

High Capacity No Capital Contributions Limited Capital Contributions for Drainage

Low Capacity Limited Capital Capital Contributions Contributions for Drainage

National Concessionary National Concessionary Finance Finance

TABLE 7.4 Suggested Municipal Government Capital Contribution Policy

followed by a focus on urban water, and sug-gests that urban water utilities should be em-powered to make more use of domestic debtmarkets. The key points are:

� Chinese cities are experiencing a boomin infrastructure construction that is expected to continue, particularly forurban water. Financing infrastructureis a major concern for municipal governments due to their limited fis-cal resources and inability to borrow directly.

� The urban water sector relies on a mix of financing sources, including the municipal government, domesticbanks, national and internationalconcessionary finance, and the privatesector.

� China’s booming economy has createdthe potential for urban water utilitiesto rely more on domestic debt marketsand less on government. Greater use ofcredit markets would improve utilityfinancial discipline, transparency, andaccountability. Increasing cost recov-ery, mainly from users, to improverevenue reliability and debt servicecapacity is the key to accessing debtmarkets.

Municipal Infrastructure SpendingAnnual municipal infrastructure spendinghas increased dramatically over the lastdecade, as shown in Figure 7.4. Water andwastewater accounted for only 11 percent oftotal spending in 2004. The largest sector wasroads and bridges at 44 percent. Many fac-tors account for the explosion of infrastruc-ture construction, including the (a) rapid in-crease in urban population and economicdevelopment; (b) backlog of deferred in-frastructure investments incurred before

China’s economy reached the current highgrowth stage; (c) the government’s expan-sionary fiscal policy as a method of stim-ulating domestic demand and reducing dependency on export-led growth; and (d) recognition by China’s leaders that infra-structure provides a necessary foundationfor economic development.

Municipal Financing SourcesTable 7.5 provides a breakdown of sourcesfor urban infrastructure funding for Cate-gory I and III cities. Around 90 percent of thefunds are used for construction, with the bal-ance going toward maintenance. Since ur-ban water utilities are part of the overallmunicipal infrastructure sector, and theconstruction bureau often serves as the par-ent bureau (see Chapter 6), the followingparagraphs look at municipal infrastructurefunding sources in general.

Land Transfer Fees. Category I cities relyon land transfers to finance around 30 per-

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Source: MOC, Urban Construction Statistics Yearbook (2005).

0

100

200

300

400

500

1995

Billions (RMB)

20042000

FIGURE 7.4 Total Annul Expenditure for Urban Construction and Maintenance

cent of their urban infrastructure needs, tak-ing advantage of their booming propertymarkets and the government’s control ofland. Category III cities have less propertydevelopment potential, and thus the poten-tial for land sales is more limited and ac-counts for 22 percent of total funds. Thelong-term prospect for financing infrastruc-ture development through land sales is un-clear but will probably be constrained bytwo factors. First, the national government isexercising stricter control over local land de-velopment to preserve agricultural land andminimize social unrest due to dislocation.Second, much of the prime real estate has al-ready been developed, and as the real estatemarket evolves over time the quality andvalue of the land available may decrease.

Domestic Loans. Governments in Chinaare not allowed to borrow directly, eitherthrough commercial banks or municipalbonds.6 Municipally owned utility compa-nies, or special purpose urban infrastructureinvestment companies (UDICs), are allowed

to borrow. Domestic bank lending accountsfor approximately 25 percent of all munici-pal infrastructure funds. Category I citiesmake greater use of domestic loans thanCategory III cities, indicating their generallyhigher level of creditworthiness.

Chinese banks have a high degree of li-quidity and are anxious to lend to credit-worthy borrowers. Many banks, however, donot have high modern credit analysis expert-ise; loans to the public utility sector are oftenmade at the request and with the implicitguarantee of the municipal government. ThePeople’s Bank of China typically limits loanmaturity to eight years for capital invest-ments, and three years for working capital.7

Utility companies often struggle to repay theshort-term debt, and it is quite common forthe utilities to make interest payments onlyand periodically roll over the principle. Theprinciple rollover effectively turns short-term debt into longer-term debt, but also in-creases the interest rate risk, as well as therisk that the bank may call in the principlepayment at an inopportune time.

Urban Development Investment Com-panies (UDIC). Since municipal govern-ments are not allowed to borrow directly inChina, many cities have established UDICs,which invest in infrastructure on behalf ofthe municipal government. These compa-nies receive preferential access to propertydevelopment rights, and thus are able to se-cure loans from domestic banks. At least inthe short term, this model works well inCategory I cities with booming propertymarkets such as Shanghai, but it may not beviable for most cities in China. The ShanghaiUDIC model has some similarities with spe-cial purpose investment vehicles in othercounties. Box 7.4 compares arrangements inNew York and Shanghai, with the funda-

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Category I Cities Category III CitiesFund Sources % of total % of total

Urban Maintenance and Construction Tax 6 9

Municipal Financial Allocation 8 13

Domestic Loan 26 18

Land Transfer Fee 30 22

Self-raised 20 17

Others* 10 20

Source: MOC, Urban Construction Statistics Yearbook (2005)

TABLE 7.5 Urban Infrastructure Fund in 2004 (US$: million)

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The Shanghai UDIC was established in 1992 as a municipal investment and stock-holding companyto raise funds on behalf of the Shanghai Municipal Government. The company has invested in over40 large infrastructure projects (mostly for water and wastewater), and at present has total assetsof more than 240 billion RMB ($30 billion).

In the core urban areas of Shanghai, there are four water supply companies. The ShanghaiMunicipal Sewerage Company (SMSC) is responsible for major drainage works and wastewatertreatment plants, and is the holding company for three operating companies. The assets and sharesof the water supply and sewerage companies are consolidated on the balance sheet of the ShanghaiWater Assets Operation and Development Company (SWAOD), which is the water/wastewater sub-sidiary of the Shanghai UDIC. SWAOD is responsible for raising funds for the investment programsof these companies, and shoulders part of the debt service burden. SWAOD receives its fundingfrom a variety of sources, including some funds transferred from its owner, UDIC.

The World Bank has been actively involved in the Shanghai urban water sector since the late1980s. As part of an adaptable program loan approved in 2003, the World Bank has been support-ing SWAOD to develop the first corporate bond issue in the wastewater sector in China. This bondissue of 1.5 billion RMB was issued in mid-2006. The World Bank has also supported the ShanghaiUDIC in its development of a “district financing vehicle” (DFV) to mobilize financing and provide proj-ect management support to the surrounding districts in Shanghai for their urban environmental in-frastructure. A new DFV subsidiary of the UDIC was established in 2005 with this special purposeobjective.

The New York City Municipal Water Authority was created in 1984 as a public benefit corporationfor the purpose of issuing debt through revenue bonds to finance capital improvements for the waterand sewer system. A second public benefit corporation, the New York City Water Board was alsoformed to lease the water system from New York and to maintain the system for a term of 40 yearsor for the life of the outstanding revenue debt. The Board was also granted the authority to set ratesand charges as necessary to meet its operating, maintenance, and debt service requirements. Theactual service delivery is provided through the New York City Department of Environment.

The arrangements were developed with a view to isolating the credit of the water and sewer sys-tem from that of the city (which at the time was rated Baa) by providing bankruptcy protection andautomatic rate setting. To protect it from bankruptcy, (a) the Board and Authority did not have theability to file for bankruptcy; (b) the lease agreement established the Board’s ownership of the rev-enues; (c) the city’s annual lease payment was subordinated; (d) financing agreements providedfor an operating reserve fund and debt service fund; and (e) the systems revenues could not becombined with the city’s should the city declare bankruptcy.

With regard to tariff setting, the legal structure provided for independent third parties, the rateconsultant and consulting engineer, to ensure that the rates were not subject to political manipu-lation. Additional protection measures included the following: (a) if the Board did not set adequaterates, the Authority could petition for the appointment of a receiver on behalf of the Board; (b) cashflow requirements were monitored on a monthly basis and rate adjustments made as necessaryover the course of the year; (c) rate setting was formula driven, with rates and charges equal to115% of projected debt service plus 100 % of operating expenses, and required reserves; and (d)in order to take on additional debt, revenues for the last two years and for the next five years, asprojected by the rate consultant, had to pass the previous test.

Sources: World Bank, Shanghai Urban Environment Management Project (APL-2)Project Appraisal Document (2005); and World Bank, “PrivateParticipation in Infrastructure in China.” Bellier et al. (2003).

BOX 7.4 Special Purpose Municipal Investment Vehicles in Shanghai and New York

mental difference that the New York CityWater Authority repays its debt through userfees that are closely monitored and con-trolled by lenders.

Municipal Financial Allocations. Munic-ipal governments provide funding for infra-structure through their general budget. In2004, this accounted for 13 percent of totalfunding for infrastructure in Category IIIcities, but only 8 percent in Category I cities.Category I cities have more access to othersources of funding, and thus rely less onscarce municipal financial resources.

Urban Construction and MaintenanceTax. The urban construction and mainte-nance tax is a local tax levied on the VAT,consumption tax, and business tax, and is as-sessed at 7 percent of each respective tax inurban areas. The tax revenue is typically re-served for maintenance purposes only, suchas for road or drains. The tax typically ac-counts for 6–9 percent of total funds.

Self-Raised and Other Funds. Self-raisedand other funds refer to revenue that is notincluded in the official municipal budgetand includes “self-owned” funds by localgovernments, enterprises, and institutions.Private sector investment falls under thiscategory. The category “others” includes for-eign direct investment, utility fees, water re-source fee, etc. These two categories accountfor 30 to 40 percent of all infrastructurefunding, yet are not well-defined or under-stood. This highlights the fact that infor-mation on municipal finance in China is typically not very transparent.

Wide Variance in Infrastructure Per-Capita Spending. Table 7.6 shows thatCategory I cities have annual per-capita in-

frastructure spending of RMB 2,500, ap-proximately four times higher than theCategory III cities, and double the CategoryII cities. This wide variance in infrastructurefunding underscores the difficulties thatlow-capacity cities have in financing and af-fording municipal infrastructure.

Financing Urban Water InfrastructureFinancial information for urban water can-not be easily disaggregated from the infra-structure statistics. Table 7.7 lists the keyfinancing sources and their approximate

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City Type Average (RMB)

Category I 2,428

Category II Cities 1,107

Category III Cities 672

Source: MOC, Urban Construction Statistics Yearbook (2005).

TABLE 7.6 Per-Capita Urban InfrastructureFund by City Type

Water WastewaterFinancing Source Supply (%) (%)

Municipal Government 20–30 40–50

Domestic Banks 20–30 10–20

State Bond Program 10–20 20–30

Private Sector 10–20 10–20

China Development Bank 10 5

International Financial 5 10Institutions (WB, ADB, JBIC)

See Annex 3, Technical Notes, for Analysis.

TABLE 7.7 Indicative Ranges of Urban Water Financing Sources, 1991–2005

financing percentages. The table was assem-bled from sources of variable reliability, andthus indicative ranges are provided. The ac-tual mix of financing sources will vary fromcity to city.

Municipal Government. For water sup-ply, this study estimates that around 20 to 30 percent of total funding comes from themunicipal government (or a UDIC) in theform of an equity contribution. For waste-water, almost all drainage infrastructure isfunded through the municipal government(or a UDIC). Wastewater treatment is con-sidered more of a commercial good and themunicipal government typically providesless financial support. Overall municipalgovernment financing for wastewater couldbe as high as 50 percent.

Domestic Banks. State-owned commer-cial banks are estimated to provide around20 to 30 percent of the financing for watersupply, but less for wastewater. The watersupply companies, and the wastewater treat-ment companies, are commercial entitiesand have the potential capacity for repay-ment. Since many of the drainage collectionworks are managed by public bureaus, theydo not have the ability to borrow directlyfrom commercial banks.

Private Sector. The role of the private sec-tor is discussed in Chapter 8. We estimatethat around 10 to 20 percent of water supplyand wastewater financing has been providedby private companies. Most of the privatesector investment in wastewater has been forBOT treatment plants.

International Financial Institutions. Themajor international financial institutions

in the sector over the last 10 years have beenthe World Bank, Asian Development Bank(ADB), and the Japan Bank for InternationalCooperation (JBIC). Over this period, WorldBank loans have totaled around $1.8 billion,with $1.5 billion for the wastewater sectorand $300 million for water supply. The ADBhas committed around $1.0 billion in financ-ing for the sector, approximately split be-tween wastewater and water supply.8 JBICalso has a large water sector program inChina. In total, however, the international fi-nancial institutions have probably only fi-nanced between 5 and 10 percent of overallurban water infrastructure costs since 1991.

State Bond Program and China Develop-ment Bank (CDB). The state bond programis administered by NDRC, and provides con-cessionary finance to support around one-quarter of all investments in the urban watersector. The CDB is the national developmentbank and has also been very active in the sec-tor. Chapter 6 discusses these importantfunding sources in more detail.

Increasing Debt FinancingChina’s strong economy has created a highlevel of liquidity in the domestic banking sys-tem, and Chinese banks are encouraged tolend to creditworthy municipal utility com-panies. This has created a golden opportu-nity for water utilities to tap into domesticcredit markets to finance investments. Util-ity companies in many economically ad-vanced countries take on high levels of debt,often 60 to 70 percent of total assets, becausethey operate in a low-risk environment.Chinese utilities, in contrast, typically havemuch lower debt to asset ratios, and relyheavily on the municipal governments for fi-nance. Chinese urban water utilities should

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also strive to make more use of domesticdebt markets, particularly the banking sys-tem, but also potentially corporate bonds orborrowing from pension or insurance funds.

Because municipal governments in Chinacannot borrow directly and there are manycompeting uses for governments funds, fi-nancing capital works through debt is gener-ally more attractive than government contri-butions. Moreover, to the extent that utilitydebt service is paid by user fees, debt financ-ing is more economically efficient as theusers pay directly for the service, whereasmunicipal government funds come throughgeneral taxation. Many cities are also turn-ing to equity investors, through stock mar-kets or private deals, to fund investmentprograms. Equity financing is generallymore expensive than debt financing, becauseequity investors need to take into accounthigher risks. Companies are legally obligatedto service their debt obligations before theyissue dividends, and thus equity investorsface higher risks. Greater use of credit mar-kets would improve utility financial disci-pline, transparency, and accountability aslenders would take an interest in the finan-cial health of a utility. Municipal govern-ments and their utilities should therefore:

� Improve Access to Debt Markets ByIncreasing Cost Recovery. MostChinese banks are hesitant to lend di-rectly to utility companies because ofconcerns about repayment capacity.Increasing cost recovery, mainly fromusers, would increase a utility’s capac-ity to service debt, as well as improverevenue reliability. Chinese citiesshould transform their financiallystressed utilities into creditworthy en-terprises that can fund most of theircapital program through commercial

debt. As China’s financial marketsevolve and become market-orientedand sophisticated, improving the creditstatus of municipal utilities will be-come even more important.

Improving ConcessionaryFinance ProgramsThis section reviews financing support pro-vided by the national government for thesector, and discusses ways in which that sup-port could be improved. The national gov-ernment has two primary instruments: theChina Development Bank (CDB), and thestate bond program. Each program plays animportant role in the urban water sector buteach also has its limitations. For example,CDB provides long-maturity commercial-based loans, but can only be accessed bycreditworthy cities or utility companies.State bond funding provides low-interestloans or grants, but the program is not well-structured to meet policy objectives.

In order to meet sector financing needs,particularly for low-capacity cities, thenational concessionary finance programsshould be expanded and restructured to pro-vide incentives for good utility performance.

The China Development Bank ProgramThe market for long-term infrastructuredebt financing in China is dominated at thenational level by the China DevelopmentBank (CDB). CDB is a “policy bank” that actsas an intermediary for the central govern-ment. At the end of 2004, CDB’s total loanportfolio was valued at RMB 1,409 billion($175 billion), of which 22 percent is forwater resources, environment, and publicutilities. CDB’s water supply and wastewater

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loans, reported at RMB 13.5 billion ($1.7 bil-lion) and RMB 5.3 billion ($0.66 billion) re-spectively, constitute only 1.5 percent ofCDB’s 2004 total portfolio.9 CDB has pro-vided around 10 percent of water supply and 5 percent of wastewater sector funding.

CDB is pursuing an aggressive growthpolicy and plans to significantly expand itsloan portfolio over the next decade.10 As partof this expansion, it is targeting the urban in-frastructure sector, and has recently signedtwo separate Memorandums of Understand-ing (MOUs) with the Ministry of Construc-tion and the State Environmental ProtectionAgency, each with indicative financingamounts of RMB 50 billion ($6.2 billion).The memorandum with the MOC focuses onurban resource conservation and town de-velopment. The memorandum with SEPA isfocused primarily on environmental priori-ties under the 11th Five Year Plan.

In the absence of municipal bonds, CDBoperates as a financial bridge between themunicipal government and the capital mar-ket. Local governments have not establisheda standardized credit system and effectiverisk prevention mechanisms: they lack thecreditworthiness, conditions, and relevantpolicies necessary for bond issuance. CDBraises funds by means of financial bonds.These are issued in the name of the projectsinvolved to promote institutional improve-ment, cultivate the concept of creditworthi-ness in local finance, and thus create the nec-essary conditions to issue municipal bondsin the future. The bonds are guaranteed bythe central government and are typicallyoversubscribed.11

The State Bond ProgramThe state bond program was initiated in 1998with the objectives of stimulating domesticdemand and promoting economic develop-

ment in less economically developed regions.The bonds are issued by the Ministry ofFinance, and then distributed by the Na-tional Devel-opment and Reform Commis-sion (NDRC) as long maturity, low-interestloans, which in some cases may be convertedto grants. Between 1998 and 2004, aroundRMB 900 billion ($115 billion) was disbursedthrough the state bond program. The futureof the program is unclear; increasing finan-cial deficits at the central government levelhave started to raise concerns about the risksassociated with the program. The issuance ofstate bonds declined from RMB150 billion($18.8 billion) in 2002 to RMB110 billion($13.8 billion) in 2004. Although the overallprogram may decrease in the future, NDRChas indicated that urban water and envi-ronmental protection will continue to remaina priority.

Figures 7.5 and 7.6 show the evolution ofthe state bond program’s financing forwastewater and wastewater infrastructure.Around RMB 61 billion ($7.5 billion) of statebond funding has been directed to the waste-water sector, accounting for around one-

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Source: Study Research Brief, “Analysis of State Bond Program for Urban Water” by Tsinghua (2006).

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quarter of total investments. The originalNDRC policy was to focus state bond fundson wastewater treatment, while municipalgovernments were responsible for the net-works. In addition, cities were required tostart collecting wastewater tariffs. After afew years, NDRC realized that cities werenot investing enough in networks, and ad-justed the state bond program to focus onnetworks on the assumption that the privatesector or the city could finance treatmentplants based upon future tariff revenues.State bond funding for water supply infra-structure, which totals around RMB 34 bil-lion ($4 billion), accounts for around 10–20 percent of total water supply investments.

As of 2005, the state bond program hadfinanced over 2,200 water supply projectswith an average investment of 15 millionRMB ($2 million), and close to 2,000 waste-water projects with an average investment of31 million RMB ($4 million). Figure 7.7shows that over two-thirds of total financingin both water supply and wastewater weredirected at prefecture (or higher level) cities.

Program LimitationsBoth CDB and the state bond program havebeen important sources of finance for theurban water sector, but also have some lim-itations in their use as policy instruments, asdescribed below:

CDB Only Finances Creditworthy Proj-ects. CDB is the only commercial bank withthe mandate to provide long-maturity loansthat are essential for infrastructure finance.Although CDB is a “policy bank,” it is ex-pected to operate in a commercial mannerand only extends loans to borrowers it con-siders creditworthy. Consequently, CDB haslent more for water supply than wastewater,as water supply companies are generally ona stronger financial footing than wastewatercompanies. In addition, CDB also tends tolend more to high capacity cities, which havemore credit capacity than low capacitycities. CDB is a useful policy tool for bring-ing financial market discipline to utilities,and thus promoting transparency, account-

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FIGURE 7.7 China State Bond Program inWater Supply and Wastewaterby City Size

ability, and efficiency. It is not, however, ina good position to help low-capacity cities fi-nance their infrastructure needs, particu-larly for wastewater.

State Bond Funds Do Not Target Low-Capacity Cities. The state bond program, incontrast to CDB, is designed to provide con-cessionary finance to lower capacity citiesand less creditworthy projects. More statebond funds have gone to wastewater thanwater supply. Most of the state bond fundinghas been directed toward prefecture-levelcities. Due to constraints on funding, and theneeds of prefecture-level cities, the programhas provided only limited support to county-level cities and towns. However, the lowercapacity cities and towns have the greatestneed for concessionary finance, particularlyif they are expected to comply with highstandards for drinking water quality andmunicipal wastewater treatment.

Lack of Incentives for Good Performance.The state bond program does not providesignificant policy leverage in the urbanwater sector. The program distributes na-tional government funding, but with mini-mal impact on creating proper incentives toimprove sector performance. Although theprovincial government assists in the alloca-tion of state bond funds, project implemen-tation is left to the municipal government.The program lacks clear eligibility criteria,rigorous appraisal procedures, strict compli-ance monitoring, and effective evaluationtechniques. The large number of projects,over 4,200 since 1998, and relatively smallfinancing amount for each project providelittle leverage over the city. Moreover, ad-ministration at the national and provinciallevels is very streamlined and covers multi-ple sectors, not just urban water.

International Examples ofConcessionary FinanceMost OECD countries have structured con-cessionary finance programs to support theurban water sector, particularly for waste-water, which is considered more of a “publicgood” than water supply. Box 7.5 provides asummary of the U.S. program, which origi-nally relied on “construction grants” andthen shifted to state-administered revolvingfunds. Box 7.6 presents a summary of theBrazilian financing program for reducingpollution in river basins, which relies on an“output-based aid” approach. Rather thanproviding construction grants, the Braziliangovernment pays cities for actual pollutionreduction. In most cases, national govern-ments attempt to structure concessionaryfinance programs to try to create the rightincentives for cities to respond to nationalpolicies.

Improving China’s ConcessionaryFinance ProgramsThe financing needs in the urban water sectorare large and growing, and lower capacitycities in particular need the assistance of thenational government. In many countries—most of them considerably richer thanChina—the national government providessignificant financial support to cities forwater and wastewater investments. The pro-vision of concessionary finance provides anopportunity for the government to providethe right incentives for good performance.This study recommends that China:

� Develop Dedicated, StructuredConcessionary Finance Programs.There are many options for improvingthe efficiency (or restructuring) thestate bond and CDB programs. The

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Construction Grant Program. In the United States, the Water Pollution Control Act of 1948 first established agrant program to assist localities with planning and design work, and authorized loans for treatment plant con-struction. In 1956, a construction grant program replaced the loan program. Progress in the construction ofwastewater treatment plants was slow, and water quality continued to deteriorate. In the Federal Water PollutionControl Act Amendments of 1972, Congress totally revised the existing clean water law and established nationalstandards for treatment, mandating that all publicly owned treatment works achieve a minimum of secondarytreatment or more stringent treatment by July 1, 1977. Grants were administered by the federal EnvironmentalProtection Agency (EPA) and were provided through states to local municipalities in a complex three-stepprocess (feasibility, design, and construction). In the mid-1980s, grants for wastewater treatment plant construc-tion were a target of government budget cutters, and Congress authorized a shift to state revolving funds start-ing in 1991. One of the perverse incentives under the construction grant program was that many municipalitiesoverinvested in treatment plant facilities as they received matching grants from the federal government rangingfrom 50 to 75 percent of total project costs.

State Water Pollution Control Revolving Funds (SRF). Under the SRF program, federal capitalization grants areprovided annually to all 50 states. These grants are used as seed money for state-administered loans for waterquality projects. States provide matching funds equal to 20 percent of the federal capitalization grant and use theSRF to provide a range of loan assistance to communities, including construction loans made at or below marketrates (interest-free loans are permitted), refinancing of local debt obligations, and loan guarantees or purchasingof insurance. Loans are typically to be repaid to the SRF within 20 years, beginning one year after project com-pletion, and the locality must dedicate a revenue stream (from user fees or other sources) to repay the loan to thestate. States may use 4 percent of their capitalization grants for administrative expenses. States manage SRFsusing EPA guidance and regulations, assisting construction of municipal water pollution control facilities (as underthe previous grant program) and implementation of programs to reduce nonpoint source pollution and clean updegraded estuaries. Like the grant program, states decide which projects will receive assistance, using a priorityranking system that considers water quality conditions and other factors reflecting a state’s policies and now alsoincludes financial elements such as interest rates and the recipient’s dedicated source of repayment. Communitiesof all size are eligible to seek SRF assistance, and small communities have no special priority. Nonetheless, since1989, 63 percent of all loans and other SRF assistance (23 percent of total funds loaned) have gone to small com-munities.

Cities have made substantial progress toward meeting the goals and requirements of the law, and more than90 percent of community wastewater treatment plants provide secondary treatment or better. Yet, water qualityreports continue to indicate that wastewater treatment plant discharges are a significant source of water qualityimpairment. The SRF authorizations provided in 1987 expired in 1994, but pressure to extend federal funding hascontinued, in part because estimated investment needs remain high (more than $180 billion). Congress hascontinued to appropriate funds, and the anticipated shift to full state responsibility has not yet occurred. From1972 through 2005, Congress appropriated more than $75 billion in assistance for wastewater treatment plantconstruction, including $24 billion in SRF capitalization grants since 1989. States and localities have investedapproximately the same in non-federal resources. The success and popularity of the wastewater SRF program ledCongress to use it as the model for establishing a drinking water SRF program in 1996; it has provided $8.6 billionin project aid.

Source: Claudia Copeland, U.S. Congressional Research Office with authors’ elaboration.

BOX 7.5 Financing Wastewater and Water Supply Infrastructure in the United States

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In 2001, the Brazilian Government through the National Water Agency (Agencia Nacional De Aguas-ANA) established a program to promote the restoration of water quality in key river basins. The pro-gram is called PRODES (Programa Nacional De Despoluicao de Bacias Hidrograficas). It providespayments to wastewater plant owners—either public of private—that demonstrate effective waste-water treatment. Rather than provide grant money to finance the construction of the facilities,PRODES spreads the payments out over a 5-to-7-year period contingent on effective operation ofthe wastewater treatment plant, which is certified by an independent third party. The program issometimes referred to the “treated sewage purchase program.” It rewards efficiency and results.

To be eligible for PRODES financial support, the wastewater treatment plant must be located in ariver basin where there is a legally established and operational “Basin Committee.” The plant must bepart of the investment program approved by the Basin Committee and it must meet the discharge re-quirements specified by the committee. The National Water Agency, utilizing national governmentfunds, will pay up to 50 percent of the total estimated cost of the wastewater treatment plant, basedon a predetermined formula set to reflect actual pollution reduction levels. In 2002, PRODES was pre-sented with 148 proposals with an estimated cost of R$1 billion, with 40 percent from ANA’s budget.

The PRODES program is one variant of a type of support referred to as “output-based aid,”where payment is made for services rendered and not to finance the construction of infrastruc-ture. This puts the burden on the investor and operator to meet the standards and provides astrong incentive for performance.

Source: ANA Presentation at World Bank Water Week Conference, 2003.

BOX 7.6 Brazil’s River Basin Restoration Program

study recommends that the followingprinciples guide the reforms:● National government funding for the

urban water sector should be signifi-cantly increased.

● More funding should be channeled tolow capacity cities and towns.

● Provincial governments should takethe lead in designing and administer-ing concessionary finance program(s).

● The program(s) should be structuredto provide the right incentives, withcarefully designed eligibility criteria,appraisal procedures, and monitor-ing and evaluation activities.

● A range of financing instrumentsshould be considered, includingloans, grants, revolving loan pro-gram, credit enhancements, and output-based aid.

Summary of Strategic DirectionsThe strategic directions for enabling urbanwater utilities to move up the financial sus-tainability ladder identified in this chapterare summarized below:

� Achieve Utility Cost Recovery. Urbanwater utilities should be allowed to re-cover their costs through user fees.Municipal governments can adjust autility’s cost, and thus the extent of tar-iff increases, through capital contribu-tions. Wastewater fees should cover atleast the O&M and asset renewal costsof drainage services. Water supply andwastewater tariffs will need to be sig-nificantly increased in most cities, butthe impact on users can be managed

by optimizing tariff structures to in-crease economic efficiency and utilityrevenues, and designing low-incomeassistance programs.

� Improve Access to Debt Markets ByIncreasing Cost Recovery. Debt is thepreferred form of financing for urbanwater utilities. Most Chinese utilities,however, have low credit capacity.Chinese cities should transform their financially stressed utilities into credit-worthy enterprises that can fund mostof their capital program through com-mercial debt. As China’sfinancial mar-kets evolve and become market-orientedand sophisticated, improving the creditstatus of municipal utilities will becomeeven more important.

� Develop Dedicated, Structured Con-cessionary Finance Programs. Thelevel of national government fundingfor the urban water sector should be increased. The existing state bond andCDB programs should be restructuredinto sector-specific programs to pro-vide better incentives for improvingutility performance and meeting na-tional goals. The principles that shouldguide reforms include a focus on low-capacity cities and towns, provincialgovernment leadership, creating good

incentives through program design,and using a broad range of financialinstruments.

Notes1. Since financial information on water and waste-

water utilities is not readily available in China,much of the general analysis in this section isbased on general experience of the World Bankin conducting financial appraisals for Bank-financed project. See Annex 1 for a list of WorldBank-financed projects.

2. See the World Bank publication “Water, Elec-tricity, and the Poor” by Komives et al. (2005),p. 41.

3. See Annex 3 Technical Notes, Figure 7.3 formore information.

4. See the World Bank-MOC Report “North ChinaWater Quality Management Study. ComponentE: Regulatory and Institutional Study” (2006).

5. See the ADB report on “Final Report on Na-tional Guidelines in Urban Wastewater Tariffsand Management Study” (2003).

6. See the ADB report on “Managing UrbanChange: Strategic Options for Municipal Gov-ernance and Finance in China” (2000).

7. See the 2003 report by Bellier et al. “Private Par-ticipation in Infrastructure in China” (2003).

8. See the 2005 ADB report on “PRC Water Sup-ply, Sanitation, and Waste Management Port-folio Rivew.”

9. From the 2006 Tsinghua University Brief on theCDB/state bond program. (Internal Document)

10. Based on the Bank’s interview with CDB on May17, 2006.

11. From CDB webpage at www.cdb.com.cn

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Private participation can potentially helpmunicipal urban water utilities improve per-formance, accountability, transparency, andreinforce the municipal government’s com-mitment to cost recovery. Private participa-tion in China’s urban water sector has grownrapidly over the last 10 years. Private partici-pation has generally involved (a) investmentsin water supply and wastewater treatmentplants; (b) joint ventures between a privatecompany and the municipal utility company;and (c) a focus on high-capacity cities.

China’s cities and municipal utilities canbetter utilize private participation to helpimprove efficiency and performance in thefollowing ways:

� Select a private participation option thatcomplements an overall reform process

� Ensure BOT treatment plant contractsallocate risks properly and do not undermine the financial viability of the network business

� Commit to achieving utility costrecovery—with or without privateparticipation

� Utilize a wider variety of private par-ticipation models, particularly non-investment approaches such as affermage, leases, and management contracts that increase efficiency andlower costs

Box 8.1 provides definitions for the termsused in this chapter. The first section looks attrends in China, and shows that the privatesector is primarily involved in BOT treatmentplants, although joint ventures between pri-vate companies and municipal utilities arebecoming more common. The second sectionunderscores the need for cities to understandthat engaging the private sector is not apanacea for resolving more fundamental util-ity governance problems, but an appropriateprivate participation option can potentiallyhelp expedite and lock in reforms. The thirdsection stresses the need for BOT treatmentplant arrangements to fit into an overall net-work business plan. The final section identi-fies the potential for using non-investmentforms of private participation, such as affer-mage, leases, and management contracts tohelp improve utility efficiency without neces-sarily requiring the private company to takethe investment risk.

Private ParticipationTrends in ChinaData on private participation is difficult to ob-tain in China since there is no authoritativenational database. This study draws upon twomajor sources: (1) a market survey in 2004conducted by Global Water Intelligence (GWI)

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8 Using the Private Sector to Help Improve MunicipalUtility Performance

that identified 126 projects; and (2) a surveyreported in a Tsinghua University report thatidentified around 300 projects. The twosources collected and presented informationin different ways. Although both sources arevaluable, a detailed picture of private partici-

pation is still lacking. Both the GWI andTsinghua reports are incomplete surveys, andthus the extent of private participation inChina is probably higher than indicated in thetables below. This chapter therefore focusesprimarily on general trends.

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Water Services. Water services include any aspects of providing water supply, wastewater management, orreclaimed water use.

Arrangement. Rules and institutions establishing and enforcing the rights and obligations of the operator, cus-tomers, the contracting authority, and other government authorities with respect to water services. The rulesare set out in contracts, laws, regulations, licenses, and related documents. Examples include managementcontracts, affermage, leases, concessions, divestiture, and build-own-transfer (BOT).

Operator. A private domestic or foreign company or government-owned company operating outside of its jurisdiction and providing services under an arrangement. In this study, municipal water utilities operatingoutside of their city and seeking to maximize their profits are considered an operator.

Joint Venture or Mixed Capital Company. An arrangement under which the operator is partly owned by the con-tracting authority, and in which the two parties jointly share most of the risks.

Management Contract. An arrangement under which the operator provides management services to the utility in return for a fee.

Affermage Contract. The operator operates and maintains water assets at its own expense but does not finance investment in infrastructure assets. The government delegates the management of the water service tothe operator in return for a specified fee, often based on the volume of water sold. The private company’s profitis equal to revenue from the fee, less operating and maintenance costs.

Lease Contract. Similar to an affermage contract, the operator operates and maintains water assets at its ownexpense but does not finance investment in infrastructure assets. The operator retains revenue from the customertariff and pays the contracting authority a specified lease payment.

Concession Contract. An arrangement in which the contracting authority is the legal owner of the infrastructureassets (at least after the contract ends), but the operator is responsible for financing and managing investment, aswell as operating and maintaining the business.

Divestiture. An arrangement in which the operator is the legal owner of the infrastructure assets for an indefiniteterm and is responsible for financing and managing investment, as well as operating and maintaining the business.

Build-Own-Transfer (BOT) Contract. Typically used for water supply or wastewater treatment plants. An operatorfinances, builds, owns, and operates the facilities for a specific period of time, after which ownership is transferredback to the contracting authority. BOT payments are typically based on the volume of water treated at the plant.

Design-Build-Operate (DBO) Contract. Similar to a BOT, but the contracting authority provides financing andretains ownership of the facilities during the contract period.

Transfer-Own-Transfer (TOT). Similar to a BOT, but the contracting authority sells an existing facility to theoperator for a specified period of time (transfers). When the contract period ends, ownership reverts back to thecontracting party.

Source: Adapted from the World Bank Toolkit on Private Participation in Water Services (2006).

BOX 8.1 Definition of Key Private Participation Terms

Rapid Private Participation GrowthTable 8.1 summarizes the extent of privateparticipation in China as of 2004 based onthe GWI report. Using the GWI report,Figure 8.1 shows the evolution of privateparticipation, which started in the early1990s and has experienced rapid growthover the last five years. International com-panies were the first to enter the market, butdomestic companies have become more ac-tive since around 2000. Although the data inFigure 8.1 are somewhat erratic, the generaltrend is increasing participation by domesticfirms. The GWI data clearly missed many ofthe smaller domestic transactions. Manyinternational companies have establishedChinese subsidiaries or joint ventures withdomestic companies, so the distinction be-tween international and domestic com-panies is increasingly becoming blurred.Private investment accounts for around 10to 20 percent of all water supply and waste-water investments over the last decade.

Private Participation in Water SupplyTable 8.1 from the GWI survey indicates thatmost of the private participation for water

supply takes the form of water supply treat-ment projects. The data from the Tsinghuastudy, as shown in Table 8.2, presents pri-vate participation from the perspective ofwho owns the assets. Around half of the pri-vate participation projects involved stocktransfers from the municipal utility com-pany to private investors, with the utilitymaintaining management control. Themotivation for stock transfer is apparently to raise funds and also develop a broaderconstituency for ensuring the sustainabilityof the utility. Joint ventures, divestitures,and BOT/TOT are also common arrange-ments. The Tsinghua data do not clearlydistinguish where the private participationactivity involves water treatment only, orboth treatment and distribution. Based onTable 8.1, however, it appears that most pri-vate participation involves water treatmentplants only.

Private Participation in WastewaterPrivate participation has been mainly limitedto wastewater treatment. Table 8.3 showsthat BOTs are the most common arrange-ment, but joint ventures, stock transfers, and

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U s i n g t h e P r i v a t e S e c t o r t o H e l p I m p r o v e M u n i c i p a l U t i l i t y P e r f o r m a n c e

% of Total PrivateNumber of Participation Project Costs % of

Project Type Project Projects (RMB million) Total Costs

Water Supply Treatment 61 48 16,152 45

Wastewater Treatment 44 35 8,560 24

Water Supply and Distribution 11 9 5,160 14

Others 10 8 5,704 16

Total 126 100 35,586 100

Source: Global Water Intelligence, “Water Market China” (2005).

TABLE 8.1 Investment by Project Type

was based on a 2006 survey. Second, theTsinghua survey was much more likely tocapture smaller domestic private participa-tion than the GWI report, which was pre-pared for an international audience.

Water Supply and WastewaterTreatment Plants PredominateThe tables above show that the market isdominated by water supply and wastewatertreatment projects. Prior to 2002, foreigncompanies were only allowed to invest in rawwater supply, water treatment, and waste-water treatment.1 Private sector involvementin a treatment plant is a logical choice formany companies in China. Treatment ser-vices are well-defined and the conditionsand terms of payment, including price, canbe determined up-front to assess whether aproject is feasible. The private company doesnot have to take the commercial risk involvedwith low tariffs, but rather will be paid by the

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Number ofType of Private Participation Projects Percent

Stock Transfer: Partial sale of municipal 66 51%utility shares

Joint Venture between municipal utility 41 32%and private company: treatment and(sometimes) distribution

Divestiture: Sale of municipal utility 15 12%facilities to private company.

BOT or TOT for treatment facilities 7 5%

Total 129 100%

Source: Study Research Brief, “Progress on China’s Urban Water Marketization Reform,Tsinghua (2006).

TABLE 8.2 Private Participation in the Water Supply Sector

Number ofType of Private Participation Projects Percent

BOT or TOT for treatment facilities 119 72%

Joint Venture between municipal 17 10%utility and private company for wastewater treatment

Stock Transfer: Partial sale of 15 9%wastewater treatment company shares

Divestiture: Sale of municipal 15 9%wastewater treatment facilities to private company

Total 166 100%

Source: Study Research Brief, “Progress on China’s Urban WaterMarketization Reform, Tsinghua (2006).

TABLE 8.3 Private Participation in theWastewater Sector

divestiture of treatment facilities also occur.The number of reported wastewater treat-ment projects in Table 8.3 (166 projects) ismuch higher than in Table 8.1 (44 projects)for two reasons. First, wastewater treatmentplant construction is proceeding rapidly. TheGWI results were based on a survey con-ducted in 2004, whereas the Tsinghua data

FIGURE 8.1 Private Participation Investment Trends


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# for domestic

# for foreign

municipal utility for services the companyprovides. The attractions to the public au-thority are also clear. The municipal utility orgovernment does not have to finance theconstruction of the treatment plant. In addi-tion, utilizing a private participation arrange-ment insulates wastewater treatment fromwastewater collection, which is often stillmanaged mainly as a public works programrather than a utility service. Many municipalgovernments also feel that it is preferable tohave a private company responsible forwastewater treatment rather than try to uti-lize an often inefficient and technically weakdrainage department.

Joint Ventures with MunicipalUtilities are CommonTable 8.4 from the GWI survey indicates thatthe most common entity is a “municipaljoint venture,” which is a combination of alocal municipal utility and a private com-pany. The Tsinghua data indicates thatjoint ventures are prevalent for water sup-ply (Table 8.2). The Tsinghua data indicatesthat BOTs are the most common arrange-ment for wastewater treatment (Table 8.3).However, many of these BOTs may also be

joint ventures between the municipal utilityand a private company.

Joint venture arrangements help to reducerisk for the private company because it sharesthe same financial risk as the municipality it-self. Contract adjustments are generally eas-ier when both sides are suffering financially,rather than when one party is benefiting. Amunicipal joint-venture may, however, takeaway some of the incentives for efficiency andcost reductions as the municipal utility is es-sentially entering into a contract with itself.Such arrangements can work, and may be ap-propriate in some cases, but they require agood regulatory system to ensure they func-tion properly.

Water Supply Distribution Market Opening UpIn 2002, the national laws were modified toallow foreign companies to invest in the con-struction and management of urban waterdistribution and wastewater collection sys-tems, but they must do so through a jointventure with a Chinese partner holding a ma-jority share.2 Large international companiesquickly took advantage of this opening, withSuez investing in Chongqing, and Veolia en-tering into joint ventures in Shenzhen and thePudong District of Shanghai. Box 8.2 pro-vides a summary of illustrative and high-profile water supply joint ventures in China.As of 2004, at least 20 companies have in-vested in water distribution projects. The po-tential for investment in the water supplybusiness is large, since it provides private de-velopers with the opportunity to apply theirexpertise in distribution system operationsand commercial practices to extract efficien-cies and ultimately profits. For the waste-water business, including both collection andtreatment, private companies are still reluc-tant to enter into the market due to the severeshortage of sector funding.

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Entity Type Number of Projects

Municipal Joint Venture 76

Foreign Company 12

Domestic Company 12

Unknown 26

Total 126


TABLE 8.4 Types of Entities in PrivateArrangements

been concentrated in Category I cities. Thereare a number of private participation projectsin Category II cities, which can also includeaffluent medium-sized cities. The level of pri-vate participation activity in Category IIIcities is limited both in terms of number ofprojects and investments. The GWI marketsurvey utilized as the source of data for thisanalysis, however, may not have includedsome of the private participation projects inthe smaller cities. Private companies may behesitant to engage in low-capacity cities dueto the low level of economic development,constraints on sector funding, and the associ-ated investment risk.

To date, most private participation inChina has included equity investments, andhas naturally flowed to Category I cities and

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Investment in concessions combining production and distribution networks first started in the 1990s. The mar-ket for these types of projects took off in 2002 when the government issued revised foreign investment guide-lines that took utility networks off the “prohibited list” of sectors. Earlier projects were able to work around therestrictions, as they were considered to be small-scale experiments. Two recent projects in Shanghai Pudongand Shenzhen, undertaken as joint ventures with Veolia Joint Ventures, are on a much larger scale.

Shanghai Pudong. In 2001, the Shanghai Water Bureau invited foreign companies to acquire a stake in theShanghai Pudong Water Company (SPWC), one of four water supply companies serving Shanghai. Pudong,Shanghai’s economic center, has 1.7 million people and a daily water demand of 1.2 million m3/day. The distri-bution network covers 319 km2. The Shanghai Municipal Government sought a single foreign company as a part-ner to acquire a 50 percent stake in SPWC for a 50-year period. Veolia, the winning bidder, will undertake watersupply, distribution, and commercial services through the new joint venture company. The bidding was basedon the amount offered for the existing assets, although consideration was also given to the ability of the com-pany to improve management and extend capacity. Veolia offered a price of $240 million, considerably higherthan the other bidders and three times the estimated net asset value of SPWC. The contract contains no spe-cial provisions relating to tariffs, and the joint venture company will use the city-wide tariffs determined by theShanghai Municipal Government.

Shenzhen. In late 2003, Beijing Capital and Veolia acquired a 45 percent stake in Shenzhen Water Group (SWG) for50 years at a price of $400 million. The JV company provides water supply and distribution services, managementand customer services, and collection and treatment of wastewater to Shenzhen’s Economic Zone. SWG currentlyhas a water supply capacity of 1.7 million m3/day and wastewater treatment capacity of 1.1 million m3/day. Thecontract was awarded through a competitive bidding process.


BOX 8.2 Integrated Water Projects with Private Partners

% of Projects % of# of Total Costs Project

City Type Projects Projects ($ million) Costs

Category I 54 43 23,576 66

Category II 54 43 10,440 29

Category III 18 14 1,560 4

Total 126 35,576


TABLE 8.5 Distribution of Private Participation Activity by City Type

Private Participation Concentrated in High-Capacity CitiesTable 8.5 shows the distribution of privateparticipation by city category, and indicatesthat private participation investments have

affluent Category II cities. Investments havealso tended to focus on activities where com-mercial risk can be minimized, such as BOTarrangements for water and wastewatertreatment plants. Other options for exploit-ing private sector involvement that does notrequire investment—such as lease contractsor management contracts—have not beenfully explored. These options may be espe-cially appropriate for low-capacity cities, orwastewater services, which carry a high de-gree of financial risk for investors.

Engaging with the PrivateSector as Part of theReform ProcessThe government needs to ensure the correctbundle of service standards, utility effi-ciency, tariffs, and government transfers inorder to have sustainable urban water ser-vices. This holds true whether the service isprovided by a government department, mu-nicipal utility company, a joint venture, or a private company. In China, most of theprivate participation arrangements do not dis-place the municipal utility, but rather the pri-vate company becomes a partner with themunicipal utility, either through a contractualarrangement for a treatment plant or througha joint venture in the business.

Engaging in a partnership with a privatecompany can potentially bring benefits, in-cluding financing, expertise, and improvedefficiency. As importantly, including a privatepartner can bring another party into thepolicy discussion that has a vested interest inutility financial sustainability and perform-ance. Engaging with the private sector alone,however, will not resolve the more funda-mental problems associated with municipalutility governance. Municipal governments

should first commit to an overall reformplan, and then determine if, and how, to uti-lize the private sector to facilitate the reformagenda.

The World Bank has prepared a “toolkit”on private participation in the water sectorthat distills experience from around theworld. Some summary highlights from thetool kit that are relevant to China are pre-sented in Box 8.3. The key message is thatprivate participation should be an instru-ment to achieve reform goals, and the pri-vate participation arrangement should becarefully selected and designed to achievethose goals.

Engaging with the private sector can eitherbe part of the solution or part of the problemin helping to improve urban water services.Private participation, particularly if it in-volves financing, quickly brings out the truecost of the service as private companies re-quire a return on investment commensuratewith the risk. Municipal governments, in con-trast, typically do not require a return on investment and thus provide an implicit sub-sidy. Private participation often involves anupgrading of the service that may entailgreater overall costs, even if that service canbe provided at a lower cost by a private oper-ator. Municipal governments must make acommitment to ensure the right bundle ofservices, efficiency, tariffs, and fiscal supportwhen they engage the private sector. In someChinese cities where municipal governmentsare not making adequate commitments to reform, the following scenarios may arise:

� BOT contracts require payments forwater supply or wastewater treatment,which in the absence of increased sec-tor funding can reduce funds availableto improve water supply or drainage networks.

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� Joint ventures between municipal util-ities and private companies share thesame financial fate. If revenues are notadequate to generate sufficient returnsto the shareholders of the private com-pany, then the long-term viability ofthe venture is at risk.

BOT Treatment Plants as Part of a Network BusinessBOT arrangements for water supply andwastewater treatment plants in China are ex-tensive and growing. If properly structured,and undertaken within a sound overall sector

framework, this can potentially bring bene-fits, including financing, expertise, and lowercosts. This section highlights two issues thatare critical to effective arrangements:

� The risks associated with treatmentplant performance and costs should befully understood and allocated to theparty best able to manage the risks.

� Municipal governments should ensurefunding is sufficient to cover bothtreatment costs and network costs.

Need Proper Risk AllocationA challenge for any BOT contract is under-standing and allocating risk between the mu-nicipality and the operator. If the risks are

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The World Bank has prepared a toolkit on “Approaches to Private participation in Water Services” that distillsinternational experience and provides guidelines for approaching private participation. Some key points relatedto the Chinese situation include:

� Understand Municipal Utility Limitations. When utilities are not performing well, either financially or operationally, the root causes are often in the system of rules and incentives, which can cause decisionmakers to act against the public interest. For example, municipal leaders may know that higher tariffs are necessary for good service, but refuse to allow the increase, because the political and social pain ofthe increase will be felt immediately, whereas it may be years before the higher revenues translate intobetter service.

� Private Participation Potential. Often reform fails because governments have not been able to changethe system of government regulation and control, which is the heart of the problem. By engaging a private firm and giving it defined responsibilities for the provision of water services, governments widen their reform options. A private firm can potentially help in transforming decision making and accountability by better aligning the interests of all parties, government and private, with the public interest. Engaging a private firm can potentially (a) create a focus on service and commercial performance; (b) make it easier to access finance; and (c) boost policy clarity and sustainability.

� Selecting a Private Participation Option. There are a wide variety of private sector participation options, withdifferent allocations of responsibility and risk between the public and private parties. Designing the arrange-ment is not just a matter of choosing between pre-specified options. A good process will (a) identify the key risks involved in providing the service; (b) determine which party is best placed to bear each risk; and(c) design an arrangement that allocates the risk accordingly.

Source: World Bank, Approaches to Private Participation in Water Services (2006)

BOX 8.3 World Bank Toolkit on Private Participation

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high or poorly understood and allocated tothe operator, then sophisticated operatorswill increase the price. If during operationseither the municipal government/utility orthe private company reaps a disproportion-ate share of the benefits or costs, the con-tract is unlikely to be honored and willprobably require a renegotiation or collapse.

Many of the risks can be addressedthrough good planning to quantify the issuesand sophisticated contracts to allocate therisk. This is not always done in China, partlydue to the lack of experience, as well as lackof incentives to ensure efficient private par-ticipation arrangements. Many of the BOTcontracts have not been competitively bid,nor open to public scrutiny. The nationalgovernment has recognized these problems,and MOC has prepared guidelines for issuingcontracts, prepared model contracts, andcalled for strengthening government super-vision of private participation arrange-ments.3 Adoption of these guidelines by localgovernments, however, is still incomplete.

Box 8.4 provides a summary of illustrativeand high-profile water supply BOT projects.The Chengdu and Beijing cases described inBox 8.4 reflect the dilemma many cities facein determining how to structure an appro-priate off-take agreement for water supplyplants. The higher the minimum guaran-teed purchase quantity (e.g., m3/day), theless risk the operator takes; conversely, thelower the guaranteed purchase quantity, the more favorable for the municipal utility.Poor raw water quality and droughts are alsoimportant risks that are often not taken intoaccount in contracts.

Cities awarding BOT wastewater treat-ment projects have struggled with under-standing and allocating risks associated withlow flows and pollutant loading. In somecases, cities have guaranteed a high aver-age daily minimum inflow—for example,

70 percent of design capacity, only to find thatactual flows are less than predicted due to in-adequate collection systems and/or poor flowestimates. Pollutant concentrations are alsoan important risk. If the pollutant loadingsare higher or lower than expected, actual op-erational costs are affected. For example,high BOD concentrations will increase theaeration costs and high suspended solid con-centrations will increase sludge handlingcosts. In 2006, the Ministry of Constructionissued a “Model Concession Agreement forUrban Wastewater Treatment” that dealswith some of these risks, but the use of themodel agreement is voluntary.4

Ensure Sector Cost RecoveryA BOT contract locks the municipal gov-ernment or utility into making set paymentsto the operator. The treatment plant, how-ever, is just one part of a much larger net-work business that includes water supplydistribution or wastewater collection. Unlessoverall funding to the overall business in-creases—through user fees or governmenttransfers—the quality and sustainability of theservice may be undermined.

As shown in Table 8.6, the wastewatertreatment fee throughout China is insuf-ficient to cover the actual BOT contractprice. In some cases, the revenue from thefee may cover the contractual obligationsas all water users in the city must pay thewastewater treatment fee, even if theirwastewater is not treated. For example, aBOT treatment plant may only cover halfthe city, but all of the city residents pay the fee.

Table 8.6 indicates that wastewater feesare being channeled to the BOT operator,and in many cases the municipal govern-ment must also subsidize the operator. Theresult is that investment and operation of

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Shanghai. In 1996, the contract for the Da Chang water treatment plant was awarded to a consortiumof Bovis Construction and Thames Water Overseas Ltd. It was the first wholly owned BOT project inthe water sector in China and the first to secure limited recourse financing. The project was signedbefore many governing regulations became effective and broke new ground politically and institu-tionally. Subsequent projects have built upon the experience gained by both sides with Da Chang.

The contract was signed with the Shanghai Municipal Waterworks Company (SMWC) and in-cluded a 400,000 m3/day treatment plant and pumping station. The deal was negotiated directlywith the Shanghai Municipal Government and did not undergo a competitive bidding process. Amunicipal circular specified the supply and off-take responsibilities of the related utility companies,and the municipal government provided the concessionaire with a Letter of Support to confirm itscommitment and facilitate debt financing. The project was structured to cover the BOT consor-tium’s interest and principle on bank loans, and repayment of investors’ equity with a fixed returnof 15 percent. The tariff that the Thames consortium charged SMWC was higher than the retailwater tariff for domestic consumers at the time (RMB 1.03). The central government authority—theState Development Planning Commission—did not review and approve the contract at the time.

In 2002, the Chinese State Council declared that guaranteed rates of return were illegal for pri-vate utility contracts. The commitment to a 15 percent rate of return specified in the Thames con-tract was withdrawn and the two sides entered into renegotiation. These ended with Thames de-cision to sell its stake back to the local water company in 2004.

The Chengdu No. 6 water treatment plant BOT (400,000 m3/d with a 27 km long transmissionmain) was approved in 1998 and was the first “official” BOT project implemented under the na-tional BOT circular—and still the only BOT project to be recognized by the central government inthe water sector. The project was awarded through competitive bidding to a Vivendi-Marubeniconsortium. The Asian Development Bank played an important role in both formulating the struc-ture of the project and in providing financing.

Project revenues were backed by a take-or-pay guarantee from the municipal water company,Chengdu Water Company. The concession agreement was signed by the consortium and theChengdu Municipal Government. One problem encountered has been the gap between estimatedand the much lower actual demand for water. The city does not need the entire contracted vol-ume of water, but is abiding by the contract and looking for ways to increase demand, includingextending the distribution system to satellite cities and encouraging industries to switch from theunsustainable use of groundwater to the municipal supply.

The Beijing No. 10 Water Plant project was awarded through competitive bidding to the Anglian-Mitsubishi Consortium in 2002, and includes the construction of a water treatment plant with a ca-pacity of 500,000 m3/a day, and construction of 76-km raw water pipeline. The bids were awardedon the basis of lowest tariffs, with a guaranteed minimum level of water supply to the BeijingMunicipal Waterworks Company. Above this amount, the water company would not be obligedto use the water supplied by the plant, and the consortium would therefore bear the market risk.The bidding for the project was very competitive, and the winning bid had an unexpectedly lowprice (1.4 RMB/m3). The central government was not involved in the project, and the BeijingMunicipal Government was not a direct signatory to any of the project contracts. The project raninto problems securing financing with local and international banks, due mainly to the low tariffsand the high level of market risk, and appears unlikely to proceed.


BOX 8.4 High-Profile BOT Projects in China

the important drainage network depends onoften unreliable and insufficient municipalgovernment transfers. The situation forwater supply treatment plants is similar, al-though perhaps not as dramatic, as watersupply companies and municipal gov-ernments have stronger incentives formaintaining the distribution networks thatdeliver water to the customer.

Utilizing Non-InvestmentPrivate ParticipationArrangementsWith or without private financing, munici-pal governments and their utilities can tapinto private sector expertise to improve effi-ciency, service quality, and lower costs.Primarily to mobilize financing, Chinesepolicy encourages private participation. Thisapproach has the following constraints:

� Improving utility performance, not fi-nancing, is the challenge in some cities.

� Private firms will not invest in un-profitable areas, such as wastewater

drainage or water utilities that are notfinancially viable.

� Private firms are reluctant to invest inlow-capacity cities.

There are a number of arrangements fortapping into the benefits of private participa-tion without requiring private investment,such as lease, affermage, management, anddesign-build-operate contracts.

Limitations on Private Sector InvestmentsThe prevailing view in China is that privatecompanies need to “pay-to-play” if they wishto be active in the urban water market. Mostprivate participation takes the form of pri-vate financing and operation of water supplyor wastewater treatment plants; in caseswhere the private sector is involved in jointwater supply business ventures, the privatepartner usually brings significant capitalinto the joint venture (see Box 8.2). Notwith-standing the potential benefits of equityinvestments, there are limitations or draw-backs that should also be taken into account,including the following:

Equity Costs. In well-functioning finan-cial markets, equity is always more expen-sive than debt. This is because companiesare required to meet their obligations tolenders before paying dividends to share-holders. Shareholders, who provide theequity, take higher risks than lenders andtherefore demand higher returns.

Transaction Costs. Utilizing private in-vestment also entails considerable transac-tion costs. The investor needs to be carefully,and preferably competitively, selected andthe process can be controversial. If in thefuture, the operator decides to withdraw,

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Average Average Ratio BOT Wastewater RegionPrice Fee (%)

Municipalities under 0.99 0.75 76Central Government

Coastal Areas 0.80 0.55 68

Northeast 0.55 0.46 83

Middle and West 0.50 0.33 66

Source: Study Research Brief, “Progress on China’s Urban WaterMarketization Reform, Tsinghua (2006).

TABLE 8.6 Wastewater Treatment Fee and BOT Price (RMB/m3)

then there are inevitable legal and financialcomplications that must be dealt with. In theend, the municipal government and utilitymust decide whether the operator can bringsufficient cost reductions and service im-provements to justify the higher financingcosts, transaction costs, and risk. In manycities, this threshold may not be met.

Unprofitable Businesses. Private invest-ors will not invest in non-commercial ven-tures. Wastewater drainage in most cities isoperated as a non-commercial activity, andneither wastewater tariffs nor governmentpayments are adequate to generate accept-able returns on investment in drainage networks. As shown in Table 2.3, around 60 percent of the water supply companies inChina recorded net losses in 2004, indicatingthat many cities may not offer the prospectfor good returns on investment.

Low-Capacity Cities. Table 8.5 shows thatrelatively small amounts of private investmenthave gone into Category III cities. Lower ca-pacity cities are naturally less attractive to pri-vate sector investors than larger, more affluent

cities. Higher risk levels in low-capacity citieswill make the cost of private sector investmenteven higher, and therefore less likely.

Developing Non-InvestmentArrangementsFortunately, the limitations to private sectorinvestment do not necessarily exclude citiesfrom using private expertise to enhance effi-ciency, lower costs, and improve service.Table 8.7 shows some common private par-ticipation arrangements. The table demon-strates that there are a wide variety of privateparticipation options—many of which do notrequire investment—that can be used to in-crease efficiency and potentially reduce costs,such as management contracts, design-build-operate (DBO) contracts, leases, etc. The ac-tual range of options is much broader than in-dicated in Table 8.7, as tailored privateparticipation arrangements can be made foreach situation. Box 8.5 presents an interest-ing example of a mixed public and privatecapital for a water utility in Colombia.

Non-investment arrangements have sig-nificant potential in China, particularly forlow-capacity cities or in cases where improv-

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Asset Capital Commercial ContractArrangement Ownership Investment O&M Costs Risk Duration

Arrangements Not Requiring Private Investment

Management Public Public Public Public ShortAffermage Public Mainly Public Private Mainly Public Medium-LongLease Public Mainly Public Private Mainly Private Medium-LongDBO Treatment Plant Public Public Private Mainly Public Medium

Arrangements Requiring Private Investment

Concession Public Private Private Private LongDivestiture Private Private Private IndefiniteBOT Treatment Plant Public Private Private Mainly Public Long

TABLE 8.7 Responsibility Allocation for Common Arrangements

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Cartagena, located on the Caribbean coast, is one of Colombia’s larger cities with a population of around onemillion inhabitants. In 1993, the Mayor decided to liquidate the municipal utility, which was providing lowlevels of service, was over-staffed and inefficient, and was unable to finance an estimated $230 million worthof new investments necessary to improve service and expand coverage. The Cartagena District Council decided to create a “mixed-capital,” or joint venture, company for the operation and management of the watersystem. A private operator from Barcelona Spain (AGBAR) was chosen as the operator owning 46 percentof the shares, with Cartagena District owning 50 percent, and private shareholders the remaining 4 percent.This privately managed joint venture company was named Aguas Cartagena (ACUACAR). Although thismodel is commonly used in Spain, this was the first time such an arrangement had been tried in LatinAmerica.

ACUACAR’s Board of Directors is composed of five members, two nominated by Cartagena District, two nom-inated by AGBAR, and one nominated by the private shareholders. Decisions in the Board have to be approvedby at least four members, effectively meaning that the District and AGBAR must reach consensus. The GeneralManager of ACUACAR is nominated by AGBAR and needs to be approved by the Board.

Originally, ACUACAR had an operations and management contract for a period of 26 years. The contract included various performance targets that required ACUACAR to improve the quality of service and mainte-nance, reduce unaccounted-for-water, and improve the collection rate. It stipulated that 50 percent of net income would be declared as dividend to shareholders. In addition, AGBAR would receive a managementfee calculated as a percentage of revenues and set to decrease over time. The District retained the responsi-bility for financing future capital investment needed to expand water and wastewater coverage, while ACUACARwas responsible for implementing capital expenditures.

The 1995 arrangement between ACUACAR and the District evolved over time and now takes the form of a partial concession contract, known as an “operation with investment” contract, under which significant investments are undertaken by ACUACAR to expand coverage and improve the operating efficiency of thenetworks. A major part of the investments are provided by the municipality (with financial support from thenational government) with the balance by ACUACAR. The operator, bolstered by improved cash generation,mutually agreed annual tariff increases, and growing consumer confidence has taken a pragmatic, step-wiseapproach to investment. Over a six year period, more than $47 million (or 35 percent of total investments)has been invested by ACUACAR without contractual mandates. Under this new arrangement, the operatorinvests up to a level that can be recovered from tariffs, with the rest of the investments coming from localand national governments.

The ACUACAR arrangement has produced significant improvements, including:

� Physical: water coverage increased from 68 percent to 99 percent, and sewerage from 56 percent to 85 percent; drinking water quality standards are consistently met; and 24 hour service coverage increasedfrom 65 percent to 100 percent.

� Commercial: Modern commercial and management information services were introduced; all customersare metered; and staffing has been reduced from 1300 employees to around 270.

� Customer Service: ACUACAR now has three offices within reach of all customers; customers can pay their bills in banks and supermarkets; and attention to customer concerns and complaints has increased.

Source: Libhaber et al (2003). “A Public-Private Partnership for the Provision of Water and Sewerage Services in Cartagena, Colombia: Looking Back at the First SevenYears,” Internal Report, The World Bank.

BOX 8.5 Mixed Capital Company in Cartagena, Colombia

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ing utility performance—and not financing—is the main problem. Some underutilized butpromising arrangements and where theywould be applicable are discussed below.Box 8.1 provides more detailed descriptionsof each arrangement.

� Management Contracts. Where the pri-mary objective of the city or the utilityis to improve utility performance. Theoperator is typically paid for time in-puts only, with incentive features, suchas bonuses if targets are met or penal-ties in the case of poor performance.

� Affermage Contracts. Where there isconsiderable investment risk, and tar-iffs are not sufficient to cover the O&Mcosts. The operator is paid a fee forservice delivery (such as cubic metersof water), which is de-linked fromtariff revenues.

� Lease Contracts. Where there is consid-erable investment risk, but tariffs areat least sufficient to cover O&M costs.The operator is allowed to keep the tariff revenue but then pays the con-tracting authority for the right to usethe infrastructure assets.

� DBO Treatment Plant Contract. Wherethe utility has attractive financing forconstruction, but looks to the operatorto minimize cost and operate effi-ciently. Potential attractions include(a) costs may be lower than a BOT dueto better financing terms; or (b) costsmay be lower because of operator effi-ciency and expertise in considering allaspects of design, construction, andoperation together.

The list above is just the commonly usedoptions for non-investment arrangements.There are many different ways of putting to-

gether a private participation arrangement,with varying degrees of private investmentand operational involvement. Box 8.5 pro-vides an interesting example of a mixed cap-ital arrangement in Cartagena, Colombia.

Summary of Strategic DirectionsThe strategic directions for private participa-tion identified in this chapter are:

� Use private participation as an instru-ment of reform. Private participationarrangements in the urban water sec-tor can either be part of the problem,or part of the solution. Municipal gov-ernments should commit to an overallreform plan, and then determine if,and how, to utilize the private sector tofacilitate the reform agenda. The pri-vate participation arrangement shouldbe carefully selected and designed toachieve the reform objectives.

� Ensure BOT Arrangements Fit Into aNetwork Business. BOT arrangementsfor water supply and wastewater treat-ment plants in China are extensive andgrowing. Two factors are critical tosuccess: (1) cities should ensure fund-ing is sufficient to cover both treat-ment and network costs; and (2) risksassociated with treatment plant per-formance and costs should be fully understood and allocated to the partybest able to manage the risk.

� Use More Non-Investment Arrange-ments. Private companies currentlyneed to “pay-to-play” in China. Re-quiring private companies to invest ininfrastructure may not be necessary orfeasible in some cities. Alternativearrangements that do not require

investment but can improve per-formance and lower costs should beexplored, including management, af-fermage, lease, and DBO contracts.

Notes1. “Water Market China” by Global Water Intelli-

gence (2004).2. “Water Market China” by Global Water Intelli-

gence (2004).3. Three major circulars from the Ministry of

Construction (MOC) have defined the overall pol-icy: (1) MOC Circular No. 272 (2002): Quickening

the Process of General Adoption of Market Prin-ciples for the Municipal Public Utilities Sector;(2) MOC Decree No. 126 (2004): ManagementMeasures for Concession of Urban Public Utilities;and (3) MOC Opinion 154 (2005): Strengtheningthe Monitoring of Municipal Public Utilities. Theyaddress the general principles of granting andstructuring private participation arrangements,private participation management guidelines,and the need for municipal monitoring of privateparticipation agreements.

4. See the following brief from Pinsent Masons lawfirm for information on the model agreement:www.pinsentmasons.com/media/7288360 48.pdf

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The urban water business is capital-intensive,so good decisions on infrastructure invest-ment can lower costs and improve service.Many cities and utilities in China do not plantheir capital investments well. This poor plan-ning is often rooted in inappropriate policies,institutions, and incentives. Another factor isthat China’s urban water business is develop-ing quickly, and utilities are still building uptheir expertise and learning lessons frominternational and domestic experiences. Thischapter starts by describing the importanceof capital investment efficiency, and thenhighlights how Chinese utilities can reducecosts and improve performance by applyingthe following modern planning approaches:

� Integrated Resource Planning to selectthe best package of supply and demandmanagement options to meet a city’swater needs

� Asset Management Planning to system-atically and cost-effectively renovatewater distribution and wastewatercollection networks

� Strategic Planning and Management of Drainage Networks to achieve themost cost-effective manner of reduc-ing pollution and ensuring financialsustainability

� Managing Sludge as an Environmentaland Financial Priority to ensure the en-vironmental benefits from wastewatertreatment are not dissipated throughinappropriate sludge management

� Integrating Industrial Pollution Controlinto a Municipal WastewaterManagement System to achieve theoverall least-cost solution to waterpollution control and to improvewastewater utilities’ compliance witheffluent and sludge standards

Capital Planning for Water UtilitiesCapital planning decisions in the urbanwater sector are exceptionally important.The water sector is the most capital-intensiveutility in the economy. Even in countrieswith developed urban water systems, annualinvestments average around 40 percent ofrevenues, whereas the next most capital-intensive utility sectors—electric servicesand communications—only average around15 percent.1 Moreover, most of the assets inthe water sector have a very long life, with facilities such as pipelines typically lasting 50 years or longer. Making well-informed

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9 Improving Capital Planning to Reduce Costs

capital investment decisions has a profoundeffect on service quality, cost, and affordabil-ity. Box 9.1 provides a discussion of capitalcosts for water services in England andWales.

As Chinese cities accelerate capitalspending on urban water infrastructure—estimated to exceed over RMB 400 billion($50 billion) during the 11th Five-Year-Planperiod—it is imperative to improve the qual-ity of capital planning. Around 70 percent ofthe investments will be for water supply dis-tribution and drainage networks, yet thelevel of attention and expertise applied to

network planning in China is low. Watersupply and wastewater treatment plants ac-count for the remaining 30 percent of thesector’s capital program. Choices aboutwastewater treatment technology are influ-enced by relatively high national dischargestandards, which increases costs. Manycities are also upgrading their water treat-ment plants with advanced and expensivetechnology to respond to new drinking waterquality standards.

Capital planning requires long-term fore-casts of population and economic growth.These forecasts, coupled with government

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A significant portion of a water service provider’s costs are accounted for by capital costs. To estimate the trueeconomic cost, it is necessary to know the value of the infrastructure assets, the rate at which the assets need tobe replaced, and the required rate of return on assets. Most utilities have poor information on their asset values,because the assets are long-lived, and episodes of inflation and technological change often mean that the recordedbook value bears little relationship to the real asset value. Depreciation rates may be a poor estimate of the rate atwhich assets actually need to be replaced, and there is often ambiguity about the appropriate rate of return.

In England and Wales, water utilities were required to calculate Modern Equivalent Asset (MEA) values, anduse techniques designed to estimate the real cost of renewing and replacing assets over time. There has alsobeen empirical work on estimating the cost of capital, which has resulted in a regulatory determination of therate of return to be used in tariff setting. Since water technologies do not differ greatly around the world, it isprobably reasonable to use England and Wales data as a basis for estimating the real economic cost structureof water service provision.

Capital costs amount to 80 percent of the total cost of water provision. Almost all of this cost is sunk in infra-structure assets, which helps explain why the water sector is such a strong natural monopoly. It also means thatto achieve full cost recovery through tariffs, a provider could be expected to need a working ratio of 0.20. In otherwords, if total costs are 100, then capital costs will be 80 and operating and maintenance costs will be 20. If atariff is to cover total costs, it will be 100 also.

The water industry in England and Wales achieves full cost recovery through a tariff that produces a workingratio of 0.5. The explanation for this apparent contradiction is that when the British government privatized the waterindustry in 1989, it realized that to set tariffs at a level that would allow utilities to earn a return on capital on the fulldepreciated MEA value would result in tariffs more than doubling. This would have been politically unacceptable,so the government decided to set tariffs to allow a return on only a fraction of the assets that existed at privatiza-tion. In 2004, the depreciated MEA value was GBP 204 billion, compared to the regulatory value for tariff setting ofGBP 32 billion. The result was that the government sold the water companies for a small fraction of MEA bookvalue, effectively locking in the pre-existing implicit subsidy policy by not requiring a return on existing assets.

Source: Castalia, “Sector Note on Water Supply and Sanitation for East Asia” (2004)

BOX 9.1 Capital Costs in the Water Industry: England and Wales

policies, affect water demand and waste-water generation. The evolution of demandfor these services influences the sizing andphasing of capital works projects. Long-termforecasts in China are difficult due to rapidpopulation and economic growth in mostChinese cities. Most cities and their utilitiesin China do not pay enough attention to ac-curate demand forecasts, but rather rely onstandard values, such as per capita wateruse, and short-term city master plans. Theresult is often facilities that are either over-sized or undersized, and a lack of apprecia-tion of risks for future service provision.

Using Modern Water Supply Planning Processes2

Water supply planning in China and else-where has evolved over time and is becom-ing more sophisticated. Past planning effortsfocused on constructing infrastructure tosupply water. Current Chinese policies advo-cate using a variety of options to meet waterneeds such as demand management, con-servation, water reuse, reallocation betweenagricultural and urban uses, etc. This sectionsuggests that new methodologies should beused to select the best combination of op-tions to meet a city’s water needs, taking intoaccount economic, financial, environmental,and political factors.

Historical Approach to Water PlanningDuring the 1990s, many Chinese cities dra-matically overestimated future water de-mand and constructed water treatmentplants with excess capacity. Figure 2.6 showsthat the installed treatment plant capacity isequivalent to 250 percent of total daily water

production, indicating that on a nationallevel treatment plants are about twice aslarge as necessary. This nonessential invest-ment in treatment plant capacity raises over-all service cost without generating benefits.Although China has been able to control thegrowth in water demand over the past dec-ade, the overinvestment in water treatmentplants also reflects a deficiency in water sup-ply planning.

The water resource and construction bu-reau planners of the 1990s used a traditionalsupply planning approach that emphasizedmaintaining system reliability, while assum-ing that water demand is a “given” and can-not be altered. This approach assumes ahigh level of system reliability and risk (i.e.,avoidance of water shortages at all costs).The final plan typically recommends con-struction of large-scale water developmentschemes and construction of new water sup-ply infrastructure by the water utility. Be-cause such planning is conducted internally,the public, outside experts, and other gov-ernment agencies typically have little or noinvolvement in the planning process.

New Water Policies and ProgramsChina’s cities, particularly in the arid northand west, are running short of water re-sources. In 2004, the MWR reported that sea-sonal water shortages affect more than 400 ofChina’s 669 cities, and around 110 cities arefacing serious water shortages requiringdrastic water use restrictions.3 The nationalgovernment has responded to this challengewith new policies, with the clearest policystatement set out in the historic 2000 StateCouncil Circular on “Strengthening UrbanWater Supply, Water Saving and WaterPollution Prevention and Control.” Box 9.2presents the key points related to urbanwater supply planning and management in

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I m p r o v i n g C a p i t a l P l a n n i n g t o R e d u c e C o s t s

the circular. Government agencies at the na-tional, provincial, and municipal levels haveresponded and the following new policiesand actions are being pursued:

� National and provincial water resourcebureaus are constructing large inter-basin projects, the most notable ofwhich is the south-north water diver-sion project—potentially the most ex-pensive water project in history.

� Cities throughout China have estab-lished “water conservation offices,”with the mandate to set and enforceplans for domestic, commercial, andindustrial water use. Water conserva-tion statistics are now published in theMOC’s Construction Yearbook.

� MOC encourages cities in the aridnorth and west to reuse at least 20 per-cent of treated wastewater withinurban areas.

� Local and provincial governments areclosing or moving inefficient andwater-intensive industries; new indus-trial developments must demonstratethat they are “water-friendly.”

� Some large cities are experimentingwith increasing water supply block tariffs to dampen demand.

Limitations on Policy ImplementationAlthough government agencies are vigor-ously pursuing China’s national water poli-cies, a number of challenges are emerging,such as:

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The key points are:

Section 2: Comprehensive planning to optimize and guarantee urban water supply

� In the formulation of regional water resource plans, urban water use shall have first priority.� Urban water plans shall include medium and long-term perspectives, considering water demand and sup-

ply, water resources, water conservation, protection of water resources, water reuse, and where necessarylarge-scale inter-basin water diversions.

� Improve groundwater management, control groundwater overabstraction, and conjunctively manage surface water and groundwater.

� Encourage the use of non-traditional waster resources such as wastewater reuse, rainwater harvesting, use of saline water, and desalinization.

Section 3: Encourage water conservation and build water efficient cities

� Optimize the economic structure and city plan to match local water resource and environmental conditions.

� Promote and enforce urban water savings, with clear targets for water use and savings.� Water-short cities shall close and move water-intensive industries, and enforce industrial water-use

efficiency� Promote domestic and commercial water conservation through design of buildings and water-saving

equipment.� Reduce leakage in urban water supply distribution networks.

Source: State Council Circular on Strengthening Urban Water Supply, Water Saving and Water Pollution Prevention and Control (2000).

BOX 9.2 Water Supply Planning in State Council Decree No. 36 (2000)

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� Inter-basin diversion projects are not always planned in the most economi-cally efficient manner. Cost recoverylevels are low and financial sustainabil-ity is often problematic, and environ-mental and social impacts may not befully factored into the planning proc-ess. Large water resource developmentschemes are typically heavily subsi-dized. Recovering even partial costsfrom users is difficult due to the limi-tation on the extent and rate at whichurban water supply tariffs can increase.

� Many urban wastewater reuse projectsare not well-planned. Common prob-lems include (a) supply exceeding de-mand, particularly during the rainyseason when the demand for landscapeirrigation is low; (b) wastewater reuseplants frequently not meeting the qual-ity requirements of industrial cus-tomers; and (c) wastewater reuse com-panies requiring large subsidies andstruggling financially due to low re-claimed water tariffs and demand.4

� Increasing block tariffs may dampenwater demand, but they potentiallyalso reduce water utility revenues, thusputting financial stress on the utilities.

� Groundwater management efforts arecomplicated by the reluctance of largeindustries to switch from low-costgroundwater to higher cost municipalwater supplies, as well as the lack of effective controls on agriculturalgroundwater use in many areas.

Developing an Integrated Approachto Urban Water Supply PlanningThe initiatives identified above—water trans-fers, wastewater reuse, demand managementthrough pricing, groundwater management,water conservation, and others—are all vi-

able options for meeting urban water needsin the right context. The challenge Chinesecities and agencies have is in developing aprocess for selecting the right combination ofoptions so that the integrated package bestmeets the city’s, or region’s, economic, finan-cial, environmental, and social objectives.During the 1980s, many electricity and natu-ral gas utilities faced similar challenges andresponded by developing a process know as“integrated resource planning.” This ap-proach has been adopted by sophisticatedwater utilities around the world, and shouldbe pursued by Chinese cites as well. Themajor attributes of integrated planning arepresented in Box 9.3.

Asset ManagementPlanning: OptimizingNetwork InvestmentsPlanning, operating, and maintaining ade-quate water supply distribution and drain-age collection networks are fundamental tothe cost and quality of urban water services.In China and elsewhere, the networks areoften neglected because they are buried un-derground. This section suggests that Chi-nese utilities move quickly to adopt modernasset management techniques to guide therehabilitation of their vast pipeline networksand other infrastructure.

Importance of NetworksNetworks are critical but often neglectedelements in the delivery of urban water ser-vices. Inadequate water distribution net-works can result in water loses and lowerpressure, contamination of water supply, andhigher operating costs. Reducing water lossesin the distribution network can often forestallor eliminate the need to develop new and ex-

pensive raw water supply and treatment facil-ities. Inadequate drainage networks can re-sult in increased flooding, infiltration ofdrains by groundwater or stormwater (in thecase of sanitary drains), and discharge of un-treated wastewater into the environment.

Why Networks are Allowed to Decay.Water and drainage networks tend to be neg-lected because most of the pipelines areburied, and can continue to function in theshort term even if they are in desperate needof renovation. As a capital-intensive industrywith low operating and high capital costs,water utilities can continue to function even when revenues are only sufficient tocover operating costs by temporarily ignor-

ing asset renewal needs. In contrast, when autility in a less capital-intensive industrysuch as electric power falls short of revenue,it cannot purchase fuel, production is cur-tailed, and a crisis is created. Deferred assetrenewal and maintenance in the water sec-tor, however, inevitably catches up with theutility in lower service levels and even largerand more expensive capital programs.

Large Network Investment Requirements.The 11th Five-Year-Plan estimates necessaryinvestments in drainage networks alone ataround RMB 190 billion ($24 billion).Investment needs for water supply distribu-tion networks are also large. Investmentneeds take different forms, including (a) ex-

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Water agencies in China and throughout the world are facing supply issues that are very different from the past.Plentiful supplies of water are no longer available, even in “water-rich” regions. Environmental constraints,political realities, financial constraints, and public desires have all changed the traditional supply-side planningscenarios. IRP is not a well-defined procedure for developing optimal water management plans. Instead, it is aconceptual approach that must be developed further into a planning process specific to the context. The keyattributes of the process include the following:

� It is conducted in an open and participatory manner, with an emphasis on the cooperation of the many institutions and stakeholder groups involved in water resource policy and planning.

� It identifies a broad range of traditional and innovative supply-side and demand-side alternatives for meetinga city’s water needs, such as water transfers, water reclamation, water trading, groundwater storage, desalin-ization, demand management through pricing, industrial and domestic water conservation techniques, desalinization, etc.

� It establishes multiple criteria for evaluating options, including economic, financial, social, and political, andexplicitly recognizes uncertainty and risks.

� It considers multiple long-term and short-term scenarios, includes drought management as part of the plan,and accepts that 100 percent reliability of water supply may not be economically efficient.

� It evaluates the different combinations of options, or the “resource mix,” against multiple criteria in a systematic and transparent manner.

IRP develops the best “integration of options” to allow the city to meet its water supply needs, while creating aflexible plan that allows for changing economic conditions. The IRP process is typically conducted every fiveyears or as necessary.

Source: “Urban Water Demand and Management Planning” by Duane Baume, et. al. (1998).

BOX 9.3 Integrated Resource Planning (IRP) Concepts

panding network coverage to outlying areas;(b) upgrading and renovating networkswithin established areas; and (c) for drain-age works, separating combined drainsand/or constructing wastewater inceptors.Careful planning and optimization of net-work investments will have an important im-pact on service quality and affordability.

The Concept of Asset Management PlanningUpgrading water and drainage networks inan efficient manner is a formidable chal-lenge. A utility may have thousands of kilo-meters of buried pipes that were installed

over decades. Many of the pipes may be ofunknown age, material, and condition;moreover, the importance of any specificpipe or asset on overall service performanceis often only dimly perceived. Water utilitieshave responded to this challenge by utilizingan approach known as “Asset ManagementPlanning” (AMP), which is described in Box 9.4. AMP is also utilized in other infra-structure sectors, particularly in transport.AMP is applicable to all of the utility’s assets,and not limited to the networks. Water utili-ties face a special challenge, however, in thatthe basic information on the network isoften lacking.

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By utilizing AMP methods, utilities can minimize the total cost of acquiring, operating, maintaining, and replac-ing their capital assets, while achieving desired service levels. Basic elements include:

Collecting and Organizing Information. An inventory of assets typically include (a) descriptive information, including age, size, material, and location; (b) assessment of asset condition, along with information on oper-ating, maintenance, and repair history, and the assets’ expected and remaining useful life; and (c) asset value,including historical cost, depreciated value, and replacement cost.

Analyzing Data to Set Priorities. Utilities use analytical techniques to identify trends, help assess risks and set pri-orities, and optimize decisions on maintenance, repair, and replacement. For example, managers use life-costanalysis to decide which assets to buy considering total costs over the life of the assets, not just the initial purchaseprice. Life-cost analysis takes into account factors such as installation costs, operating efficiency, maintenanceneeds, etc. to get a cradle-to-grave picture of asset costs. Managers also use risk assessment to determine howcritical the assets are to their operations, considering both the likelihood that an asset will fail and the consequencesin terms of costs and impact on the utilities desired level of service if the asset does fail. Based on this analysis,managers set priorities and target resources accordingly.

Integrating Data and Decision-Making Across the Organization. For example, financial and engineering datashould be compatible and each asset should have a unique identifier that is used throughout the utility. All appro-priate units within an organization should participate in key decisions, which ensure that relevant information isconsidered and encourages managers to take an organization-wide view when setting goals and priorities.

Linking Strategy for Addressing Infrastructure Needs to Service Goals, Operating Budgets and Capital Budgets.The utility’s goals for its desired level of service—such as product quality standards, frequency of service disrup-tions, customer response time, etc.—are the driving consideration in its strategy for managing its assets.Decisions on asset maintenance, rehabilitation, and replacement are, in turn, linked to the utility’s short-term andlong-term financial needs and reflected in the operating budget and capital improvement plan.

Source: U.S. General Accounting Office, “Water Infrastructure: Comprehensive Asset Management Has Potential to Help Utilities Identify Needs and Plan FutureInvestments,” (2004).

BOX 9.4 Asset Management Planning (AMP)

The importance of comprehensive assetmanagement for water utilities has only re-cently gained prominence in OECD coun-tries, and is still not fully appreciated inChina. If successfully applied in China, AMPwould reap enormous benefits, including:

Higher Levels of Capital Efficiency.Collecting, sharing, and analyzing data oncapital assets has allowed utilities to makemore informed decisions on how best tomanage the assets. In particular, utilities areusing AMP to allocate their maintenanceresources more effectively and make betterdecisions about when to rehabilitate or re-place existing assets. This is of particular im-portance in China, as water and wastewaterutilities throughout China embark on mas-sive renovation of their networks.

Stronger Basis for Tariff Increases. AMPprovides the foundation for justifying tariffincreases to help pay for needed improve-ments. Asset renewal should represent a sig-nificant part of a utility’s annual revenueneeds. The current system of tariff setting inChina is based on the objective of having theutility make a small accounting profit as re-flected in the company’s income statement,where depreciation is typically taken as aproxy for the capital renewal costs. Depre-ciation, however, is based on historicalcosts, and many of the assets are so old thatthe accounting valuation is of little use. Infact, the lower the asset value, the lower thedepreciation cost, and typically the lowerrevenue a Chinese utility is entitled to.Developing AMPs that accurately assess theasset renewal costs will assist the utility insecuring an adequate revenue stream toensure sustainability—and benefit the con-sumer and the city in the long run.

In order to reduce overall service costs,Chinese cities and their water utilitiesshould develop modern asset managementprograms before major rehabilitation worksare undertaken. Since AMP is a relativelynew concept, high-capacity cities shouldwork with experienced consulting firms todevelop modern AMPs as examples for othercities in China.

Strategic Planning and Management of Drainage NetworksDrainage networks have an important role toplay in urban wastewater management, bothin terms of overall cost and water pollutioncontrol. This section suggests that Chinesecities should carefully consider whetherseparate drainage collection systems can bejustified, both from a financial and water pol-lution control perspective. In support of pol-lution control, many cities need to pay closerattention to the performance of the drainagesystem and stormwater quality management.

Existing SituationOlder urban areas in China use a combineddrainage system, but many cities now favorconstructing separate stormwater and sani-tary drainage systems (see Box 2.2 for a de-scription of wastewater terminology). AMOC/SEPA 2000 “Circular on Urban SewageTreatment and Pollution Control” suggests:

“. . . for new urban areas, separate storm-water and sanitary systems shall beconsidered. In older urban areas whererenovation is difficult, combined drainsshall be maintained with reasonable in-terception rates (i.e., percentage of wetweather flow conveyed to treatment

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plant). Combined systems should beadopted in cities with little precipitation.For sensitive receiving water bodies, citiesshould consider collection and treatmentof the initial stormwater flush.”

This guidance is generally sound. How-ever, it does not elaborate on what factorsshould be taken into consideration for “sep-arating” drains or “treating” stormwaterflush. Due to the paucity of information ondrainage networks at the national level, it isnot possible to estimate the percent of com-bined or separated networks, nor their geo-graphical distribution in China. Based onWorld Bank project experience, most drain-age systems appear to be a mixture of sepa-rate and combined areas, and the generaltendency is for cities to construct separatesystems in new development areas (see Box 2.4 on Tianjin’s drainage system).

Combined vs. Separate Drainage SystemsCombined sewers overflow during heavyrain, with only part of the wastewater con-

veyed to the wastewater treatment plant andthe remainder discharged into a nearby re-ceiving water body. The general view inChina is that separate stormwater andwastewater drainage results in less pollutionbecause, theoretically, there are no com-bined sewer overflows (CSO) when it rains.The view that separate networks are superiorwas widely held throughout the world untilrecently. For example, the 1972 UnitedStates Clean Water Act recommended sepa-rate drainage networks. Over the last decade,however, the impact of urban stormwaterrunoff in contributing to pollution loads hasbecome clear, and there has been a reevalu-ation of the relative benefits of the two sys-tems. The emerging scientific consensus ispresented in Box 9.5.

Drainage and Water Pollution ControlIn China, wastewater sector performance isgenerally evaluated on the quantity of waste-water treated. Information on the reductionin pollutant loading (e.g., tons of BOD) isusually not highlighted in performance as-sessments. The performance of the drainage

Based on an extensive literature review, a recent study concluded that:

� A separate system does not necessarily result in less pollution to the environment than a com-bined system. Separate systems appear to be better at removing BOD and nutrients, but com-bined systems are superior in reducing heavy metals and settleable solids.

� Increasing the capacity and performance of the wastewater treatment plants shifts the balanceof the benefits toward the combined system.

� Stormwater treatment (efficient overflows, retention reservoirs, constructed wetlands, etc.)are applicable in both systems.

� Separate systems require two networks, which makes it inherently more expensive to con-struct and maintain, even with the costs of interceptors and CSOs in the combined system. Aneffective combined system typically requires higher treatment plant capacity.

Source: Brombach et al, “A New Database on Urban Runoff Pollution: Comparison of Separate and Combined Sewer Systems, in Water Science andTechnology (2002).

BOX 9.5 Comparison of Separate and Combined Drainage Collection Systems

system is hardly monitored or considered inthe evaluation of an urban wastewater man-agement system in China. The performanceof the drainage system, however, is a criticalpart of the water pollution control infra-structure. Box 9.6 shows some of the maindrainage collection parameters that aremonitored in other countries, and should be-come part of China’s water pollution controlregulatory system as well.

Improving Drainage Networks in ChinaChina could improve the efficiency and sustainability of water pollution control asfollows:

� Lower capacity cities should utilizecombined drainage systems to reduceoverall costs. Higher capacity citiesshould carefully analyze whether a sep-arate, combined, or hybrid drainagesystem provides the best combinationof cost and pollution reduction, and inparallel develop a long-term strategyfor stormwater quality management.

� Performance measures on drainage sys-tems should be collected, analyzed, andmade available to the public. MOCshould prepare guidelines on how tohelp cities analyze and upgrade the per-formance of their drainage collectionsystems in a cost-efficient manner.

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Many OECD countries have come to the realization that wastewater treatment plants are onlyone dimension of urban water pollution control. To achieve their water quality objectives, theyalso need to focus on the following issues:

� Stormwater Quality Management. Stormwater contains pollutants from urban runoff suchas oil and grease from streets, fertilizers and pesticides, and with combined drains waste-water from combined sewer overflows (CSOs). For separate systems, cross-connections be-tween stormwater and sanitary drains are widespread, and there are many instances of indi-viduals or business negligently or accidentally pouring pollutants into a stormwater drain.Typical approaches include constructing stormwater retention areas where the stormwatercan be treated by a treatment plant or natural wetlands; strict drain connection regulationsand enforcement; and public education.

� Combined Sewer Overflows (CSOs). During rain events, combined drains overflow, sendingpollution into the environment. Regulatory agencies in some countries are now requiringutilities to monitor and report the frequency and magnitude of CSOs, and where necessaryto develop CSO reduction programs.

� Sanitary Sewer Overflows (SSOs). Even when drainage systems are separated, sanitarysewers are prone to overflow due to blockage, pumps not operating properly, undercapac-ity, etc. Regulatory agencies in some countries are now requiring utilities to monitor and re-port the frequency and magnitude of SSOs, and where necessary to develop SSO reductionprograms.

� Infiltration and Inflow (I&I). Infiltration of groundwater or inflow of stormwater into sanitarydrains can undermine the performance of a wastewater management system by (a) increas-ing costs of wastewater treatment; (b) increasing the frequency of SSOs; and (c) increasingthe required capacity of pipes and wastewater treatment plants.

BOX 9.6 Drainage Collection Systems and Water Pollution Control

Integrating IndustrialPollution Control Into a WastewaterManagement System5

China’s national pollution control efforts focused first on industry, and then later onmunicipalities. Grafting the existing indus-trial pollution control regime onto the newreality of municipal wastewater manage-ment poses many challenges. This sectionsuggests that wastewater utilities should bemore active in managing industrial dis-chargers, including utilizing pollution-basedcharges.

Industrial Water Pollution Control in ChinaDuring the 1990s, one of China’s environ-mental priorities was controlling industrialwater pollution, Since then, dramatic prog-ress has been made. Figure 2.7 shows thattotal pollutant discharge by industries hasdecreased from around 16 million tons ofCOD in 1995 to around 5 million tons in2004. Industrial wastewater still accounts,however, for around half of all wastewaterflows and one-third of COD discharges inChina. This remarkable achievement is in response to a national government policy requiring all large industries to have waste-water treatment by 2000, as well as economicrestructuring and use of clean technology,

SEPA and EPBs at lower levels of govern-ment have had a strong regulatory and mon-itoring role in the control of industrialwastewater, but have had less influence inthe control of municipal domestic waste-water, which is typically the responsibility ofthe local construction bureau and its associ-ated utilities. This division of responsibilityfunctioned during the 1990s. With the ad-

vent of centralized municipal wastewatertreatment plants after 2000, two issues haveemerged: (1) how to find the least-costcombination of industrial and municipalwastewater treatment; and (2) how best tomonitor and regulate industries. These twoissues are discussed below.

Overall Cost MinimizationAnnex 2 presents the industrial pollutionstandards (GB8978-1996), which can begrouped into two categories: (1) dischargeinto the environment or a municipal drain-age system without a municipal wastewatertreatment plant (Levels 1 and 2); and (2) dis-charge into a drainage system with a munic-ipal wastewater treatment plant (Level 3). Inaddition to the general industrial pollutioncontrol standards, there are also some spe-cific industry standards.6

The challenge for many cities is to inte-grate the existing industrial pollution con-trol approach into a broader municipalwastewater management system, whichincludes both domestic and industrial waste-water. Most large industries within munici-pal systems built their own wastewater treat-ment facilities before centralized municipalplants were constructed. Industries can alsoelect to pre-treat (if necessary) to meet Class3 standards for discharge to a municipalwastewater treatment plant. The Class 3standards also have COD (300 mg/l) and sus-pended solid limits (400 mg/l). Large munic-ipal wastewater treatment plants, however,can generally treat standard pollutants suchas BOD or suspended solids at lower costsand more reliability than smaller industrialtreatment plants.

Currently, wastewater utilities have lim-ited incentives to encourage more pollutantloading from industries. In most cities, thewastewater tariff is based only on flow, and

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receiving higher levels of pollution would in-crease operating costs without boosting rev-enues. In Chapter 7, we encouraged cities toestablish wastewater tariffs based on bothflow and pollutant loading, as well as fixedand variable costs. In most countries, pollu-tant loading (or trade effluent) charges areapplied to industrial customers and to se-lected commercial customers dischargingtrade effluent, especially, restaurants, laun-dries, etc.; that is, the volume charge is notsimply water volume discharged, but insteada measure of pollution volume (load). Theindustrial classification reflects the type ofindustry and therefore the characteristics ofthe trade effluent discharged by individualcustomers in that group or “band.” Thisavoids the need for sampling of individualcompanies effluent and makes the chargeseasier to administer and more predictablefrom the customer perspective.

For larger industrial customers, a moresophisticated approach should be used. Asuitable tariff structure for the municipalwastewater treatment plant that reflects therelevant prices by unit volume and by unit ofpollutant load can guide each industry inminimizing its total costs (for both pretreat-ment and municipal treatment), and lead toward a global least-cost solution for theservice area as a whole. In addition, it canhelp the wastewater utility recover more ofits costs by using excess capacity at the treat-ment plant. Box 9.7 illustrates how, in prin-ciple, the wastewater fee could be set forlarge industries. With this approach, indus-tries would then be allowed to make the fi-nancial decision as to whether they shouldcontinue to treat onsite or discharge to awastewater treatment plant. Several issuesarise under this approach:

� The municipal wastewater utility mustbe allowed the flexibility to set or nego-

tiate prices and service conditions with industries, and to grant waivers to theexisting limits on parameters such asBOD and SS.

� A higher level of trust and adherence to the terms of contract agreements isalso required. For example, the indus-try’s own effluent monitoring reports(hourly or daily) should be accepted as a basis for municipal wastewatercharges, while the infrequent (monthlyor quarterly) EPB or wastewater utilitysampling results should be consideredas an audit rather than as the basis forcharging.

� Highly toxic substances, such as heavymetals or dangerous synthetic organiccompounds (e.g., PCP), should con-tinue to be managed at the industrythrough pretreatment and industrialprocess control.

Monitoring and RegulationIf the industrial tariff is based on dischargequality as well as discharge volume, then dis-charge permitting systems become essential.Even in the absence of such a charging sys-tem, the discharge permit is a very valuabletool in the wastewater management system,particularly for control of heavy metals orother toxic substances. This would require anew allocation of responsibilities betweenthe EPB and the wastewater utility.

EPB is responsible for setting standardsfor the discharge of effluent to both sewersand watercourses. From the historical con-text, this responsibility is fully understand-able, since without wastewater treatment,the sewers simply acted as conduits to con-vey all effluent to the nearest suitable water-course. However, as wastewater treatmentplants are added, the situation changes andit becomes important for the managers of

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the treatment plants to control discharges tosewers in a manner conducive to the capabil-ity of the plant to treat waste. Over-strengtheffluent must be prevented from entering thedrainage system if it is likely to damage thetreatment process or the fabric of sewers, orcreate undue hazards for staff working onthe drainage system. This suggests that thewastewater utility should be actively in-volved in the licensing and monitoring of in-dustrial wastes discharged to the municipalsystem.

The EPB should continue to set and en-force standards for industries dischargingwaste that go directly into watercourses, as

well as for discharges from municipal waste-water treatment plants. EPB should monitorthe compliance of the wastewater utility inthis respect, taking enforcement action asnecessary in just the same way as other en-terprises causing pollution are dealt with.The wastewater utility, however, should bethe primary party setting and monitoring thepermit conditions that optimize treatmentbetween industrial on-site treatment andthat provided by the municipal treatmentplant Since the wastewater utility may nothave full legal authority to sanction indus-tries not meeting their discharge permit requirements, the support of EPB or the par-

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The polluter pays principle (PPP) states that “the polluter should bear the expenses of carrying out the pollutionprevention and control measures decided by public authorities to ensure that the environment is in an accept-able state.”

This is a general reformulation of the price equity principle that people should pay the costs at the wastewatertreatment plant (WWTP) to treat their effluent discharge. The Mogden Formula, as applied by Thames Water inthe UK, can be simplified and expressed as a charge that is the sum of a uniform flow cost and pollutant treat-ment costs. The pollution element varies based on the level of COD and SS in the specific discharge, relative todomestic strength effluent characteristics:

Charge = V + B × Or + S × Sr

Where: V = Yuan/m3 charge for collection and flow elementB = Yuan/m3 charge for secondary treatmentS = Yuan/m3 charge for sludge processing and disposal

Or = Ratio of an industry’s COD concentration to the average COD domesticSr = Ratio of an industry’s SS concentration to the average SS domestic

Suspended solids (SS) are included to cover those instances where it may be the determining factor, otherwisethe formula (B × Or) covers the secondary treatment of COD and the cost of sludge treatment, incorporating bothCOD and SS removal and disposal.

The calculations, sampling, and analysis required are relatively complicated and in practice are applied to onlythe largest industrial polluters in a service area, and only after the wastewater utility has gained considerable experience and knowledge about industrial dischargers. The introduction of such a formula would allow industry tomake their choice between two options: (1) on-site pretreatment (to remove heavy metals, toxins, etc) followed bycentralized municipal treatment; or (2) advanced on-site treatment, conveyance, and disposal to the environment.

Source: ADB, “National Guidelines in Urban Wastewater Tariffs and Management” (2003).

BOX 9.7 Applying the Polluter Pays Principle

ent bureau may remain necessary in enforc-ing permit compliance.

A New Approach to MunicipalIndustrial Pollution ControlThe overall cost of industrial and municipalwastewater treatment could be reduced, andeffectiveness improved by:

� Charging industrial and commercialcustomers for both wastewater flowand pollutant quantity, and for largeindustrial dischargers, allowing thewastewater utility to directly negotiatethe terms and conditions of the waste-water discharge permit.

� Empowering the wastewater utility tobe the lead organization for permittingand monitoring industrial dischargesto the utility’s collection system, whilethe EPB monitors all discharges to theenvironment, including those of thewastewater utility.

Managing Sludge as an Environmental and Financial PriorityThe many new wastewater treatment plantsthroughout China have helped to reducewater pollution, but have also created awidespread problem of sludge management.A wastewater treatment plant treats waste-water and discharges clean water, but thereare also residual solids from the treatmentprocess that are called “sludge” that need tobe properly disposed.

The best way to treat and dispose ofsludge depends on the raw wastewater char-acteristics, wastewater treatment process,local regulations, and numerous site-specificconditions. Furthermore, the capital costs

and often demanding operational require-ments of sludge-handling facilities mayequal or exceed those of the preceding (liq-uid) wastewater treatment facilities. Sludge-management facilities are expected to ac-count for around 11 percent of total capitalcosts for the wastewater sector during the11th Five-Year-Plan period—as opposed to13 percent for wastewater treatment plants.Sludge management is an important envi-ronmental and financial issue that manycities and their wastewater utilities are juststarting to address.

China’s General Policy on Sludge ManagementThe 2000 MOC/SEPA Circular entitled“Policy on Technology of Urban Sewage andTreatment Pollution Control” provides gen-eral guidelines for sludge management. Thepolicy calls for wastewater utilities to treatsludge as a resource. Treatment plants withcapacity greater than 100,000 m3/day are en-couraged to use anaerobic digestion to gen-erate biogas, as well as reduce the volumeand weight of the sludge. Cities should alsoexplore opportunities for aerobic compost-ing, where the compost can be beneficiallyreused as soil conditioner. Utilities can dis-pose of sludge residuals through either disposal in a modern sanitary landfill orthrough application on agricultural land—provided the sludge meets the required stan-dards. Although this guidance is generallysound, there are a number of challenges:

Challenge of Anaerobic Digestion. Mostlarge wastewater utilities around the worldstabilize their sludge through a process ofanaerobic digestion. This process producesbiogas (mainly methane), which can be usedto provide supplemental power to operatethe wastewater treatment plants. The proc-

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ess also helps to reduce the sludge volumeand weight, which reduces final disposalcosts. Many wastewater utilities in Chinastruggle with the operation of their digestionfacilities. Many installed sludge digesters donot operate because of inadequate quantitiesof sludge due to low BOD/SS concentrationsin influent; poor quality sludge due to toxiccompounds in industrial discharges; andlack of maintenance due to insufficientfunds. Although the larger and more sophis-ticated utilities can, and do, operate their fa-cilities efficiently, many utilities strugglewith their sludge digesters. Sludge digestionfacilities are capital-intensive and opera-tionally complex.

Challenge of Composting. Some citieshave turned to aerobic composting as an al-ternative to anaerobic digestion, often inconjunction with solid waste composting fa-cilities. Composting generally has lower capital costs than digestion, but has higheroperating costs. If the compost can be soldas soil conditioner, then part or all of the op-erating costs can be recovered. In areaswhere there are significant industrial dis-chargers, the sludge may contain toxicchemicals and may not be suitable for com-posting. Moreover, finding reliable marketsfor the composted sludge is often difficult.

Challenge of Sludge Disposal. Beforesludge can be disposed, it needs to be stabi-lized and dewatered. Stabilization is pro-vided to eliminate odor and reduce thethreat to human health, and can be accom-plished through either chemical, anaerobic,or aerobic processes. Dewatering is neededto reduce the weight and volume of thesludge and is usually provided by machines(centrifuges, pressure filters, etc.) or in dry-ing beds. Wastewater utilities usually have

the option of disposing sludge in a landfill orapplying the sludge onto agricultural land.

Many smaller Chinese cities do not havemodern sanitary landfills, so the sludge isoften disposed in open dumps. In caseswhere a modern sanitary landfill exists, thesludge is often not adequately dewatered,causing excessive leachate production at thelandfill. Land application is an option if thesludge meets the standards for agriculturalland, but the costs of conveying the sludge tothe agricultural land, and proper applicationcan be prohibitive in many cases.

Suggestions for Sludge ManagementProper planning and management of sludgefrom wastewater treatment plants is criticalfor ensuring environmental objectives andcontrolling costs. The following general ap-proaches are recommended:

� Improve Regulation of Sludge Manage-ment. EPB and utility parent bureausshould ensure that every wastewaterutility properly treats and disposes of its sludge in an environmentally safemanner.

� Manage Sludge as a Resource in High-Capacity Cities. High-capacity citiesshould develop and implement sludgemanagement plans that make benefi-cial use of the sludge, such as throughanaerobic digestion to produce biogasor disposal through land application.Composting is an attractive option forsmaller high-capacity cities. Managingsludge as a resource may increase over-all operating costs for the utility, butcan result in a net benefit to society.

� Safe Disposal of Sludge in Low-CapacityCities. Most low-capacity cities do nothave the financial or technical capacityto manage sludge as a resource. The

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transitional objective for these citiesshould be to minimize the cost of envi-ronmentally safe sludge disposal. Low-cost chemical stabilization and sludgedewatering methods should be em-ployed, with disposal at a modern sani-tary landfill. If a city does not have asanitary landfill, it should be requiredto construct one in conjunction withthe wastewater treatment project, either as a standalone facility or aspart of a municipal landfill.

Summary of Strategic DirectionsThe following approaches to improving cap-ital planning have been highlighted in thischapter:

� High-capacity cities and their utilitiesshould develop new water supply plan-ning approaches, drawing upon inte-grated resource planning techniques.This includes evaluating a wide rangeof traditional and innovative optionsand selecting the best “set of options”as evaluated against economic, finan-cial, environmental, and social criteria.Integrated resource planning requiresan open and participatory process withall institutions and stakeholders in-volved, and explicit recognition of un-certainty and risk.

� High-capacity cities and their utilitiesshould establish modern asset man-agement planning programs. Asset management planning will help ensurethat the renovation of water supplyand wastewater collections—thelargest investment challenge ahead—is done in a cost-effective manner.

Chapter 6 called for cities to managewastewater as an integrated network utilitybusiness. This chapter highlights a numberof areas where integration of key functions iscritical to meeting pollution control objec-tives, including:

� Strategically plan and managedrainage networks to control waterpollution. Low-capacity cities shouldutilize combined stormwater andwastewater drains to control costs andhelp reduce stormwater pollution.High-capacity cities should carefullyconsider whether separate, combined,or hybrid collection networks providethe best combination of cost and pollu-tion reduction, particularly in the con-text of establishing storm-water qualitymanagement programs. The perform-ance of drainage systems should bebetter monitored and regulated, in-cluding combined sewer overflows,sanitary sewer overflows, and infiltra-tion and inflow.

� Incorporate industries into the munic-ipal wastewater management system.Industries should be charged for boththe flow and amount of pollution discharged into municipal drains. Inhigh-capacity cities, utilities should be allowed to negotiate the terms andconditions of industrial discharge per-mits, and monitor and enforce compli-ance in coordination with EPB. EPBshould focus on ensuring that thewastewater utility meets the applicableeffluent and sludge standards.

� Manage sludge as an environmentaland financial priority. The regulationof sludge management by EPB shouldbe improved. High-capacity citiesshould strive to manage sludge as an

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energy and organic resource by utiliz-ing digesters and land disposal whereappropriate. Low-capacity citiesshould utilize low-cost sludge treat-ment processes and dispose into amodern sanitary landfill; sludge dis-posal should be considered as part ofan overall solid waste managementprogram.

Notes1. Baumann, Duane, et. al., “Urban Water Demand

Management and Planning” (1998)2. Baumann, Duane, et. al., “Urban Water Demand

Management and Planning” (1998)

3. See Chapter 2, Endnote 9.4. Based on World Bank-MOC “North China Water

Quality Study Report: Component C UrbanWater Reuse Study” (2005).

5. This section draws heavily on the ADB report “National Guidelines in Urban Wastewater Tariffsand Management” (2003).

6. Specific standards are also enforced for severalindustrial sectors, for example: pulp and paper(GB3544-92), shipbuilding (GB 3552-83, GB4286-84), offshore petroleum development (GB4914-85), dyeing and finishing of textiles (GB4287-92),meat packing (GB13457-92), ammonia produc-tion (GB13458-92), iron and steel (GB13456-92),ordnance manufacture (GB14470-93), phosphatefertilizer (GB15580-95), and caustic alkali andpolyvinyl chloride (GB15581-95).

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China needs to improve the performance ofits urban water utilities to confront the chal-lenges of:

� Rapid urbanization� Urban diversity� Water scarcity and degradation� Large capital investment demands

Improving the operational and financialperformance of urban water utilities willbring significant economic, environmental,and public health benefits. This study pres-ents a vision whereby in 2020 utilities inhigh-capacity cities are efficiently providingwater and wastewater service that ranksamong the best in the world. Utilities in low-capacity cities and towns are also efficientlyproviding reliable and safe water supply andcollecting and treating all municipal waste-water. Lower capacity cities are complyingwith transitional water and wastewater ser-vice standards that offer significant im-provements from current levels, while takinginto account these cities’ level of economicdevelopment.

To achieve this vision by 2020, govern-ments at the national and provincial levels

need to take bold and proactive measures toestablish a better sector governance frame-work that focuses on achieving policy objec-tives. City governments need to promotesound governance and sensible structuresfor their municipal water utilities. In theproper institutional setting, China’s urbanwater utilities can flourish and improve theirfinancial sustainability, better engage withthe private sector, and make smart capitalplanning decisions.

Table 10.1 provides a summary of thethemes and key strategic directions pre-sented in this study. To implement a strat-egy, responsibilities need to be assigned anddeadlines set. Table 10.1 suggests whoshould do what and by when. Designing poli-cies, programs, and specific actions to im-plement the recommended strategies will re-quire sustained attention and commitmentby all levels of government, utilities, profes-sional organizations, advocacy groups, busi-nesses, and citizens. The Bank can assist thegovernment in addressing the strategic is-sues identified in this study through Bank-fi-nanced projects, analytical and advisoryservices, and policy dialogue.

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10 Strategic Action Plan

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Key Actors

State Council, NDRC, MOF,MOC, MWR, SEPA, MoPH

SEPA, MoPH, MOC

Provincial governors andprovincial agencies

Mayors, leading municipalagencies, and urban waterutilities

Time Frame

2008

2008–10

2008–10

2008–10

2008–12

2008–12

2008–15

2008–15

TABLE 10.1 Summary Strategic Action Plan

Approaches

Establish “National Water and Sanitation Committee”

Prepare goal-based policy papers with monitoring parameters

Use transitional standards for low-capacity cities

Increase coordination and funding for provincial agencies Establish provincial water offices

High-Capacity Cities: Municipal Utility Board/GroupLow-Capacity Cities: Better agency coordination or utility reports directly to the mayor

Improve performance monitoring, transparency, and customer orientation High-Capacity Cities: Empower utility by reducing the influence of the parent bureau and allow utility to take over corporate functionsLow-Capacity Cities: Parent bureau provides utility with more autonomy and authority

Put collection and treatment under one management system, improve cost recovery, and charge for drainage services

Consider metropolitan urban water utilitiesConsider multi-city, regional water utilitiesMerge water and wastewater utilities

Theme 1: Improving Sector Governance

Strategic Direction

Improve Policy Coordination

Shift From Physical Targets to Policy Goals

Set Appropriate Water andWastewater Standards

Enhance Provincial GovernmentOversight

Theme 2: Improving Municipal Utility Governance and Structure

Streamline Municipal UtilityGovernance

Foster Efficient Utilities

Manage Wastewater asNetwork Utility Business

Exploit Opportunities for ServiceAggregation

Municipal governments andurban water utilities

State Council, NDRC,provincial governor, national and provincialagencies

Mayors, leading municipalagencies, and urban waterutilities

2008–15

2010–15

Ensure user fees meet utility revenue requirements for O&M, debt service, and percentageof capital investments (at least equal to asset renewal). As necessary, provide capital subsidies to reduce debt service with the following guidelines:

High-Capacity Cities: Partial drainage capital contributionsLow-Capacity Cities: (a) Drainage capital contributions; (b) Partial capital contributions for water and wastewater; (c) Greater use of national grants and low-interest loans

Revise tariff structures taking into account block tariffs, fixed and variable tariff compo-nents, and load-based wastewater tariffs

Enhance credit status through higher levels of cost recovery so utilities can borrow more

Increase national government concessionary (i.e. low-interest, long maturity loans or grants

Restructure state bond program (or create a new program) to provide better incentives to comply with national policies

Allow provincial governments to take a leading role in administering concessionary financeprograms

Ensure private participation arrangement fits into an overall reform plan

BOT arrangements should be compatible with network business requirements, with adequate funding available for both networks and treatment plants

Use more non-investment private arrangements, including management, affermage/lease,DBO contracts

Theme 3: Move Up the Financial Sustainability Ladder

Achieve Utility Cost Recovery

Make More Use of DebtFinancing

Improve National ConcessionaryFinance Programs

Use Private Sector to ImproveMunicipal Utility Performance

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Approaches

Adopt more advanced water supply approaches that identify the best combination of options, taking into account economic, financial, environmental, and social objectives, andexplicitly consider uncertainty and risk. Encourage participatory and transparent planning

Develop asset management planning (AMP), with a focus on rehabilitating water distribu-tion and drainage networks

Strategically plan and manage drainage networks taking into account (a) separate or combined drains; (b) storm-water quality management; and (c) reducing combined and sanitary sewer overflows

Allow wastewater utilities to actively participate in industrial pollution control through permitting, monitoring, and charging load-based charges

Manage sludge as an environmental and financial priorityHigh-Capacity Cities: Sludge digestion and explore land applicationLow-Capacity Cities: Low-cost stabilization and disposal in landfill

Key Actors Time Frame

Theme 5: Improving Capital Planning

Strategic Direction

Improve Utility Capital Planning

TABLE 10.1 Summary Strategic Action Plan (Continued)

World Bank Financing W&S Components2

Total Water Other Start ClosingProject Name Cost1 IBRD IDA Total Wastewater3 Supply Water4 Date Date

Beijing Environmental Project 298 45 80 125 31 1992 1999

Changchun Water Supply and Env Project 251 120 120 46 189 1992 1999

Tianjin Urban Development and Env Project 195 100 100 33 1992 2000

Southern Jiangsu Env Protection Project 588 250 250 76 1993 2001

Zhejiang Multicities Development Project 231 110 110 125 1993 2003

Liaoning Environment Project 338 110 110 204 24 1994 2003

Hubei Urban Environment Project 370 125 25 150 191 1995 2005

Yunnan Environment Project 308 92 25 117 137 61 1996 2004

Second Shanghai Sewerage Project 633 250 250 615 1996 2004

Third National Rural Water Supply Project 134 70 70 2 115 1997 2006

Shandong Environment Project 202 95 95 36 64 1998 2005

Guangxi Urban Envmt Project 168 72 20 92 114 22 1998 2007

Fourth Rural Water Supply and 86 16 30 46 74 1999 2006Sanitation Project

Sichuan Urban Envmt Project 325 150 2 152 179 117 1999 2007

Hebei Urban Environment Project 270 150 150 179 86 2000 2007

Second Beijing Environment Project 1,252 349 349 392 2000 2009

Chongqing Urban Environment Project 507 200 200 397 25 2000 2007

Liao River Basin Project 189 100 100 110 40 2001 2007

Huai River Pollution Control Project 207 106 106 195 2001 2007

155

A The World Bank’s Water andWastewater Lending Programin China (in US$ Millions)

A P P E N D I X

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World Bank Financing W&S Components2

Total Water Other Start ClosingProject Name Cost1 IBRD IDA Total Wastewater3 Supply Water4 Date Date

Second Tianjin Urban Dev and Envmt Project 334 150 150 176 17 55 2003 2010

Shanghai Urban Envmt Project 494 200 200 345 2003 2009

Zhejiang Urban Envmt Project 333 133 133 151 10 2004 2010

Guangdong Pearl River Delta Urban 432 128 128 390 2004 2009Envmt Project

Hunan Urban Dev Project 373 172 172 102 254 2004 2010

Tai Basin Urban Envmt Project 174 61 61 117 55 2004 2009

Ningbo Water and Envmt Project 291 130 130 128 158 2005 2010

Liuzhou Envmt Management Project 189 100 100 175 2005 2011

Chongqing Small Cities Infra Improvement 265 180 180 98 58 2005 2012

Second Phase Shanghai Urban Envmt Project 423 180 180 290 58 2005 2011

Sichuan Urban Development Project 373 180 180 28 36 2006 2013

Henan Towns Water Supply and 303 150 150 44 204 2006 2013Sanitation Project

Second Guangdong Pearl River Delta 188 96 96 89 93 2007 2012Urban Project

Second Shangdong Envmt Project 270 147 147 206 34 2007 2013

Second Liaoning Medium Cities Project 325 173 173 130 132 56 2007 2013

Total (in millions) 11,319 4,400 472 4,872 5,308 1,621 639

Notes:1. Includes price & physical contingencies, but excludes interest during construction and front-end fee.2. Includes proportional share of contingencies.3. Usually excludes industrial pollution control but includes most sanitation.4. Includes investments in canal extensions, river embankments, canal sediment dredging, flood protection etc.

1. Municipal Wastewater Discharge Standards (GB18918-2002)

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Wastewater and DrinkingWater Standards in China

BA P P E N D I X

Grade I StandardGrade II Grade III

No. Basic Parameter Standard A Standard B Standard Standard

1 COD 50 60 100 1201

2 BOD5 10 20 30 601

3 Suspended solid (SS) 10 20 30 50

4 Animal & plant oil 1 3 5 20

5 Petroleum 1 3 5 15

6 Negative ion surface active agent 0.5 1 2 5

7 Total nitrogen (as N) 15 20 — —

8 NH3-N (as N) 5 (8) 8 (15) 25 (30) —

9 Total P Built before Dec., 2005 1 1.5 3 5 (as P) Built before Jan. 1, 2006 0.5 1 3 5

10 Color (dilution magnitude) 30 30 40 50

11 pH 6~9

12 Bacillus coli (count/l) 103 104 104 —

Notes:• Prior to 2002, Grade 1B standards applied to discharges into Class I, II, or III receiving waters, and Grade 2 standards applied to discharges

into Class IV or Class V receiving waters. Lower interim standards (Grade 3) could apply for primary treatment where secondary treatment facilities are to built in the future.

• In 2002, SEPA mandated that all cities and towns shall meet Grade 1B standards.• In 2006, SEPA Circular 110 [2005] No. 110 states: The effluent from a municipal WWTP which is discharged into important river basins

which are decided by the State and provincial government and into closed or half closed water basins such as lakes, reservoirs shall meetClass 1A discharge standard. The effluent discharged into GB3838 surface water Class III function water basins (excluding appointed drinkingwater sources and swimming areas) and GB3097 sea water Class II function water areas shall meet the Class 1B discharge standards.

Highest Allowable Discharge Concentration of Water Pollutants from Sewage Treatment Plants (Daily Average) Unit: mg/l

2. Industrial Wastewater Discharge Standards (GB8978-1996)Industrial Wastewater treatment plant effluents must conform to the National ComprehensiveEmission Standards of Wastewater as presented below. Class One shall apply to any effluent dis-charged into natural water bodies, and Class Three to those discharged to a municipal wastewatertreatment plant.

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Ref. Pollutant Class One Class Three

1 PH 6 to 9 6 to 9

2 SS ≤ 70 ≤ 400

3 CODCr ≤ 100 ≤ 500

4 BOD5 ≤ 20 ≤ 300

5 Oil ≤ 5 ≤ 20

6 P ≤ 0.1 ≤ 0.3

7 N-NH3 ≤ 15 —

8 Volatile hydroxybenzene ≤ 0.5 ≤ 2.0

9 Sulfide ≤ 1.0 ≤ 1.0

10 Fluoride ≤ 10 ≤ 20

11 Total Cu ≤ 0.5 ≤ 2.0

12 Total Zn ≤ 2.0 ≤ 5.0

13 Total Mn ≤ 2.0 ≤ 5.0

14 Total Hg* ≤ 0.05 ≤ 0.05

15 Total Cd* ≤ 0.1 ≤ 0.1

16 Total Cr* ≤ 1.5 ≤ 1.5

17 Cr6+* ≤ 0.5 ≤ 0.5

18 Total As* ≤ 0.5 ≤ 0.5

Note: Specific standards are also enforced for several industrial sectors: pulp and paper (GB3544-92), shipbuilding (GB 3552-83,GB4286-84), off-shore petroleum development (GB4914-85), dyeing and finishing of textiles (GB4287-92), meat packing (GB13457-92), ammonia production(GB13458-92), iron and steel (GB13456-92), ordnance manufacture (GB14470-93), phosphate fertilizer (GB15580-95), and caustic alkali andpolyvinyl chloride (GB15581-95).

Comprehensive Wastewater Discharge Standards (Unit mg/L except pH)

3. Surface Water Quality Standards (GB3838-2002)Surface water is categorized according to six classes as described below. The table of parameters ison the following page.

� Class I—Mainly applicable to the source of water bodies and national nature preserves. � Class II—Mainly applicable to class A water source protection area for centralized

drinking water supply, sanctuaries for rare species of fish, and spawning grounds for fish andshrimps.

� Class III—Mainly applicable to class B water source protection area for centralized drinkingwater supply, sanctuaries for common species of fish, and swimming zones.

� Class IV—Mainly applicable to water bodies for general industrial water supply and recre-ational waters in which there is not direct human contact with the water.

� Class V—Mainly applicable to water bodies for agricultural water supply and for general land-scape requirements.

� Class V+—Not to be used

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W a s t e w a t e r a n d D r i n k i n g W a t e r S t a n d a r d s i n C h i n a

Ref. Parameter Class I Class II Class III Class IV Class V

1 pH 6 to 9 6 to 9 6 to 9 6 to 9 6 to 9

2 DO ≥ 7.5 6 5 3 2

(or 90% sat)

3 COD Mn ≤ 2 4 6 10 15

4 CODCr ≤ 15 15 20 30 40

5 BOD5 ≤ 3 3 4 6 10

6 N-NH3 ≤ 0.015 0.5 1.0 1.5 2.0

7 Total Phosphorus (P) ≤ 0.02 (0.01)* 0.1 (0.025)* 0.2 (0.05)* 0.3 (0.1)* 0.4 (0.2)*

8 Total Nitrogen (N) ≤ 0.2 0.5 1.0 1.5 2.0

9 Copper (Cu) ≤ 0.01 1.0 1.0 1.0 1.0

10 Zinc (Zn) ≤ 0.05 1.0 1.0 2.0 2.0

11 Fluoride (F) ≤ 1.0 1.0 1.0 1.5 1.5

12 Selenium (Se) ≤ 0.01 0.01 0.01 0.02 0.02

13 Arsenic (As) ≤ 0.05 0.05 0.05 0.1 0.1

14 Mercury (Hg) ≤ 0.00005 0.00005 0.0001 0.001 0.001

15 Cadmium (Cd) ≤ 0.001 0.005 0.005 0.005 0.01

16 Chromium (Cr6+) ≤ 0.01 0.05 0.05 0.05 0.1

17 Total lead (Pb) ≤ 0.01 0.01 0.05 0.05 0.1

18 Total cyanide (CN-) ≤ 0.005 0.05 0.2 0.2 0.2

19 Volatile phenol ≤ 0.002 0.002 0.005 0.01 0.1

20 Oil ≤ 0.05 0.05 0.05 0.5 1.0

21 Anionic detergent ≤ 0.2 0.2 0.2 0.3 0.3

22 Sulphide ≤ 0.05 0.1 0.2 0.5 1.0

23 Coli forms (number/L) ≤ 200 2000 10,000 20,000 40,000

Environmental Quality Standards of Surface Water (GB3838-2002) Unit: mg/l (excluding pH)

4. Standards for Drinking Water Quality (Draft GB 5749—2006)The Standards will replace the Standard of GB 5749-85 “Sanitary Standards of Drinking Water” onthe date of enforcement. The main changes are increases in the number of parameters from 35 itemsof the Standard of GB5749-85 to 106 items, adding 71 items and revising 8 items, including.

� The number of microorganism indices increases from 2 items to 6 items,� The number of drinking water disinfectants increases from 1 item to 4 items;� The number of inorganic chemicals in the toxicological indices increases from 10 items to 21

items,� The number of organic chemicals in the toxicological indices increases from 5 items to

53 items� The number of sensory character and general physical-chemical indices increases from

15 items to 20 items. The standard for turbidity is revised.

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4.1 Regular Parameters

Limit

Shall not bedetected




0.01

0.005

0.05

0.01

0.001

0.01

0.05

1.0

10 or 20(groundwater limited)

0.06

0.002

0.01

0.9

0.7

0.7

Limit

15

1 or 3

No strange odor and pecu-liar taste

None

No less than 6.5 and nogreater than 8.5

0.2

0.3

0.1

1.0

1.0

250

250

1000

450

3 or 5 when oxygen demandof raw water is greater

0.002

0.3

Value for guidance

0.5

1

Item

3. Sensory character and generalchemical indices

Color (Pt-Co Color Unit)

Turbidity (NTU- NephelometricTurbidity Units)

Odor and Taste

Visible matter

pH (pH unit)

Aluminum (mg/L)

Iron (mg/L)

Manganese (mg/L)

Copper (mg/L)

Zinc (mg/L)

Chloride (mg/L)

Sulfate (mg/L)

Total Dissolved Solid (mg/L)

Total Hardness (measured asCaCO3, mg/L)

Oxygen Demand (CODMn Method,measured as O2, mg/L)

Volatile phenol (measured as phenol, mg/L)

Anion Synthetical Detergent (mg/L)

4. Radioactive Indices?

Total � Radioactivity (Bq/L)

Total � Radioactivity (Bq/L)

Item

1. Microorganism indices

Total Coliform Bacteria(MPN/100mL or CFU/100mL)

Thermotolerant Coliform Bacteria(MPN/100mL or CFU/100mL)

Escherichia Coli(MPN/100mL orCFU/100mL)

Total number of bacteria colony(CFU/mL)

2. Toxicological indices

Arsenic (mg/L)

Cadmium (mg/L)

Chromium (six, mg/L)

Lead (mg/L)

Mercury (mg/L)

Selenium (mg/L)

Cyanide (mg/L)

Fluoride (mg/L)

Nitrate (measured as N, mg/L)

Chloroform (mg/L)

Carbon Tetrachloride ( mg/L)

Bromate (When use Ozone, mg/L)

Formaldehyde (When use Ozone,mg/L)

Chlorite (When use ChlorineDioxide as disinfectant, mg/L)

Chlorate (When use com-pounded Chlorine Dioxide as dis-infectant, mg/L)

• MPN means most possible number; CFU means colony forming unit. Escherichia Coli and Thermotolerant Coliform Bacteria shall be further testedwhen total Coliform Bacteria is detected in water sample. It is not necessary to test Escherichia Coli and Thermotolerant Coliform Bacteria whentotal Coliform Bacteria is not detected in water sample.

• Higher Turbidity standard used when conditions of water source and purification technologies are limited.

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Limit Value ofFinished Residual Concentration Residual Concentration

Contact Period Water from of Finished Water at the EndName of Disinfectant with Water Plant from Plant of Network

Chlorine gas and free chlorine At least 30 min 4 ≥ 0.3 ≥ 0.05 preparation (free Chlorine, mg/L)

Monochloramine At least 120 min 3 ≥ 0.5 ≥ 0.05 (Total Chlorine, mg/L)

Ozone (O3, mg/L) At least 12 min 0.3 0.02If add Chlorine,

total chlorine≥ 0.05

4.2 Regular Indices and Requirements of Disinfectants in Drinking Water

Item Limit Value Item Limit Value

1. Microorganism indices Chlorothalonil (mg/L) 0.01Giardia (unit/10L) <1 Furadan (mg/L) 0.007Cryptosporidium (unit/10L <1 Lindane (mg/L) 0.002

2. Toxicological indices Chlorpyrifos (mg/L) 0.03Stibium (mg/L) 0.005 Dichlorfos (mg/L) 0.001Barium (mg/L) 0.7 Atrazine (mg/L) 0.002Beryllium (mg/L) 0.002 Deltamethrin (mg/L) 0.02Boron (mg/L) 0.5 2,4- Dicholrophenoxyacetic acid (mg/L) 0.03Molybdenum (mg/L) 0.07 Dichlorodiphenyltrichoroethane (mg/L) 0.001Nickel (mg/L) 0.02 Ethylbenzene (mg/L) 0.3Silver (mg/L) 0.05 Dimethylbenzene (mg/L) 0.5Thallium (mg/L) 0.0001 1,1-Dichloroethylene (mg/L) 0.03Cyanogen Chloride (measured as CN-, mg/L) 0.07 1,2-Dichloroethylene (mg/L) 0.05Monochloro-Dibromo- Methane (mg/L) 0.1 1,2-Dichlorobenzene (mg/L) 1Dichloro-Monobromo-Methane (mg/L) 0.06 1,4-Dichlorobenzene (mg/L) 0.3Dichloroacetic acid (mg/L) 0.05 Trichloroethylene (mg/L) 0.071,2-Dichloride Ethane (mg/L) 0.03 Trichlorobenzene (Total amount, mg/L) 0.02Dichloromethane (mg/L) 0.02 Hexachlorobutadiene (mg/L) 0.0006Trihalomethane See Note 1. Acrylamide (mg/L) 0.00051,1,1-Trichloride Ethane(mg/L) 2 Tetrachloroethylene (mg/L) 0.04Trichloroacetic acid (mg/L) 0.1 Toluene (mg/L) 0.7Chloral (mg/L) 0.01 Di(2-ethylhexyl) phthalate (mg/L) 0.0082,4,6-Trichlorophenol (mg/L) 0.2 Epichlorohydrin (mg/L) 0.0004Tribromomethane (mg/L) 0.1 Benzene (mg/L) 0.01Heptachlor (mg/L) 0.0004 Styrene (mg/L) 0.02

4.3 Table 3 Non-regular Indices and Limit Values of Water Quality

(Continued)

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Item Limit Value Item Limit Value

4.3 Table 3 Non-regular Indices and Limit Values of Water Quality (Continued)

Malathion (mg/L) 0.25 Benzo(a)pyrene (mg/L) 0.00001Pentachlorophenol (mg/L) 0.009 Chloroethylene (mg/L) 0.005Benzene Hexachloride (Total amount, mg/L) 0.005 Chlorobenzene (mg/L) 0.3Hexachlorobenzene (mg/L) 0.001 Microcystin-LR (mg/L) 0.001Dimethoate (mg/L) 0.08 3. Sensory character and general

chemical indicesParathion (mg/L) 0.003 Ammonia Nitrogen (measured as N, 0.5

mg/L)Bentazone (mg/L) 0.3 Sulphide (mg/L) 0.02Methyl-Parathion (mg/L) 0.02 Sodium (mg/L) 200

1. For Trihalomethane (sum of Chloroform, Monochloro-Dibromo- Methane, Dichloro-Monobromo-Methane, and Tribromomethane). The sum of theratios, which are between actual concentrations of each compound under this category and its limit values, shall not be greater than 1.

Chapter 1 Table 1.1: Urban Water Market SegmentsThe table represents urban water market seg-ments based on a city typology developed by theStudy. Total urban population refers to tempo-rary and permanent residents in urban areas,and excluding counties under the jurisdiction ofprefecture level cities. Temporary residents in-clude immigrants who have lived for over oneyear in the city, excluding soldiers in service andarmed policemen. GDP per capita refers to theGDP figure for urban population. Data on totalurban population is from MoC’s China UrbanConstruction Statistics Yearbook (2005), whileGDP per capita of 2004 is from The Yearbook ofChina’s Cities (2005).

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Technical NotesCA P P E N D I X

Production Capacity Length of WS Total WS Population(10,000 m3/day) Pipelines (km) (10,000 m3) Served (10,000)

Municipal WS 16,792 299,926 3,422,718 26,616 88%Self-Supplied 7,961 58,484 1,480,037 3,724 12%Total 24,753 358,410 4,902,755 30,340

Average wastewater treatment coverage ratio isthe ratio of the volume of wastewater treated overthe total wastewater generated in the urban area.It is not always clear if the “volume” of waste-water reported is the actual flow into the plant orthe installed capacity of the plant (which may beunderutilized). The volume of treated wastewaterrefers to wastewater treated by both municipaltreatment plants and industrial treatment plants.

Water supply coverage ratio includes bothwater coverage by public water utilities and self-supplied coverage. It is calculated as populationserved divided by total population. Municipalwater supply serves 88% of total populationwith an access to water supply, while the actual volume of self-supplied water reaches 29% oftotal volume as is shown below.

Coverage ratio for wastewater and water supplycomes from MoC’s China Urban ConstructionStatistics Yearbook (2005). Information oncounty capital towns is from MoC’s StatisticalYearbook for County Towns (2004). Out of 661

officially designated cities, cities were furtherdivided by GDP per capita threshold ofUS$3,000 and US$1,500 and the following table shows the number of cities per income category.

Similarly, cities were grouped by populationcategory of 2 million and 0.5 million and the following summarizes the number of cities perpopulation category.

The tables show that wastewater treatment rateis positively correlated with income level: thehigher the income level is, the higher the treat-ment rate is. Similarly, it is positively correlatedwith population category. Following the analy-sis above, the table below summarizes citytypology based on the income level and popula-tion and corresponding number of cities, totalpopulation and wastewater treatment ratio.

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Income Category Number of Cities

Rich 81GDP per capita > $3000

Middle 224GDP per capita: $1500~$3000

Poor 356GDP per capita < $1500

Total 661

Population Category Number of Cities

Large 28Population > 2 million

Medium 134Population: 0.5~2 million

Small 499Population < 0.5 million

Total 661

Average Income Category WWT Rate

Rich 57%GDP per capita > $3000

Middle 35%GDP per capita: $2000~$3000

Poor 22%GDP per capita < $2000

Result: Strong Correlation Between City Income and WW treatment rate.

Using the same income and population categoryabove, correlation between GDP per capita and wastewater treatment ratio, urban popu-lation and wastewater treatment ratio were further examined and are summarized in the following tables.

Population Category Average WWT Rate

Large 54%Population > 2 million

Medium LargePopulation: 1~2 million 51%

MediumPopulation: 0.5~1 million 40%

Small 26% Population < 0.5 million

Result: Moderate Correlation Between Size and WW treatment rate.

Large Population > Medium Population: Small Population < 2 million 0.5~2 million 0.5 million

Rich 21 30 30 # of CitiesGDP per capita > $3000 90 31 0.6 # of pop (million)

61% 55% 57% % of WWT

Middle 5 60 159 # of CitiesGDP per capita: $1500~$3000 15 57 36 # of pop (million)

38% 47% 31% % of WWT

Poor 2 44 310 # of CitiesGDP per capita < $1500 12 35 58 # of pop (million)

23% 31% 21% % of WWT

Chapter 2: SectorAchievement and Performance Table 2.1: Percentage of Utility ServiceArea with Low Water PressureThe data is provided in the China Water WorksAssociation 2005 Yearbook, encompassing mostof the 661 Chinese cities. Study City typologywas applied in the data and the average of eachcategory was calculated. Ave. of Hi 25% and Ave.of Lw 25% represent the average of highest andlowest quartile.

Table 2.3: Net Income to Revenue Ratioin 1997 to 2004The figures for net profits and total revenuecome from the China Water Works AssociationYearbook in 1998 and 2005. The Yearbook doesnot describe exactly how net revenues aredetermined, or if depreciation is explicitly con-sidered as a cost. This ratio is often referred to as “return on sales (or revenues).

Figure 2.4: Municipal WastewaterTreatment CapacityThe 2005 MOC Yearbook makes a distinctionbetween “municipal wastewater treatmentplants” and “other wastewater treatment plants”(presumably industrial WWTPs). The waste-water treatment capacity bar charts in Figure2.6 show the municipal WWTP capacity, i.e. 49 million m3/day in 2004. The “other WWTP”capacity was 24 million m3/day in 2004.

The 2005 MOC Yearbook provides informa-tion on “total wastewater discharge” (35,564million m3/year). The MOC Yearbook also pro-vides information on “actual municipal waste-water treated” (11,602 million m3/year, or 65%of installed capacity) and “actual other waste-water treated” (4,677 million m3/year, or 50% of installed capacity)

The wastewater treatment rate in Figure 2.4is therefore calculated as follows:

� Total Annual Wastewater Discharged/(Actual Municipal Wastewater Treated+Actual Other Wastewater Treated).

� In 2005: (35,646 million m3)/(11,602 mil-lion + 4,677 million) = 45%

Figure 2.6: Water Supply and TreatmentCapacity: Municipal and Self-SupplyThis figure combines data from both municipalwater supply utilities and private self-supply. In2004, for example, the national water treatmentcapacity for municipal utilities was 167 millionm3/day; the national total for self-suppliers was79 million m3/day. Actual water supplied bymunicipal utilities was 93 million m3/day, and40 million m3/day for self-supply.

Chapter 3: SectorAchievement and Performance

Figure 3.1: China’s EconomicTransformation and Urbanization Urban as % of total population is the ratio ofurban population over the total population.Urbanization data drives from population divi-sion of the Department of Economic and SocialAffairs of the United Nations Secretariat, WorldPopulation Prospects: The 2002 Revision andWorld Population Prospects and the 2003 Revi-sion. GDPST % of GDP is the ratio of secondaryand tertiary GDP as % of total GDP. Both GDPand base population data is from the ChinaStatistical Yearbook 2004.

Figure 3.2: Urbanization Trends and Projections Urbanization rate is the ratio of population liv-ing in the urbanized areas over the total popula-tion. The data source on urbanization rate andbase population (total and urban population) isChina Statistical Yearbook (2005). China’s totalurban population in 2005 is estimated to bearound 550 million, according to China Statis-tical Yearbook. The urban population of 550 mil-lion is also often cited by Chinese government invarious public documents. It includes not onlyurban population in 661 cities but also that inlower administrative levels such as county-towns and towns, which are not captured in thestatistical data of 661 cities. In fact, according tothe Ministry of Construction (MoC)’s ChinaUrban Construction Statistical Yearbook, totalurban population in 661 cities is around

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341 million. Thus, over 200 million people areestimated to be living in urbanized countytowns or towns.

Urbanization projection assumes that therate of urbanization over the next 15 years isapproximately 1% per annum, which has beenurbanization target set by the Chinese govern-ment, 0.5 % (lower case scenario) and 1.5%(upper case scenario) per annum. With 1% ofincrease per annum, urban population increasefrom 550 million in 2005 to around 850 millionin 2020. Scenario 1 in the Figure shows the urbanization rate of 0.5%, Scenario 2 andScenario 3 are based on the urbanization rate of 1% and 1.5% respectively.

Table 3.2: Approximate Urban Water Sector InvestmentsEx-post investment figure from 1996 to 2004 forwater supply and wastewater is derived from the MoC’s China Urban Construction StatisticsYearbook (2005) and GDP data from WorldDevelopment Indicator. The estimated invest-ment figure for 2006-2010 is derived from theassumption that the annual investment in watersupply will increase by 10% and the investmentin wastewater sector will increase by 15%.

Chapter 4: Sector Vision and Path Forward

Box 4.1: The Case of South Korea:Wastewater Treatment Capacity vs. Economic Development Wastewater coverage ratio for Korea is from theMinistry of Environment of Korea’s Statistics ofSewerage (2005). Constant GDP per capita wascalculated on the purchasing power parity basis,in order to minimize distortion from the ex-change rate and to reflect the real standard of liv-ing among countries. Constant GDP per capitaPPP, denominated in international US$, forKorea is was taken from the World Bank’s Devel-opment Data Platform (DDP) from 1975 onwards.

PPP data for China is not yet available, al-though some efforts have been made to measurePPP in selected cities of China, mostly due to

the technical complexity and data collection re-quirements. In order to approximate China’sconstant GDP per capita PPP in internationalUS$, purchasing power parity conversion factor(LCU per international $) was used from theDDP dataset. It was applied to GDP per capitain local currency unit, resulting in GDP percapita PPP in current international US$. By ap-plying deflator, the GDP per capita figure thenturned into real international US$ for compar-ison with the Korea’s GDP per capita data.

However, converted constant GDP percapita PPP in international US$ has some lim-its: since the same conversion factor was ap-plied to all Chinese cities with different levels ofeconomic development, the figure can distortthe GDP per capita to some degrees, misrepre-senting the standards of living in some cities.For instance, for China’s developed cities, GDPper capita PPP tends to be overestimated, as theconversion factor of China’s average was ap-plied to high capacity cities, while figures forChina’s developing cities are underestimated.

Chapter 7: Moving up theUtility Financial Sustainability Ladder

Table 7.2: Weighted Average WaterSupply Tariffs by City Category Water supply tariff analysis covers 128 citiesacross China, the 1998 tariff is based on theChina Water Works Association 1999 Yearbookand the 2005 data is from the H2O’s report onChina’s water sector published in 2005 (http://www.h2o-china.com). The 128 cities belong toeach city category as follows:

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# of Cities in Each Category %

Category 1 17 13.3%Category 2 85 66.4%Category 3 26 20.3%Grand Total 128

The weighted average water supply takes intoaccount different sectors (residential, commer-cial, industrial and special use), the amount ofwater use of each sector and differing tariffsapplied to those sectors. The tariff excludesother cost, such as water resources fee.

Figure 7.1: Water Supply TariffsThe data is from 128 cities reported in theH2O’s report on China’s water sector publishedin 2005 (http://www.h2o-china.com). The fullcost water supply estimate is based on a reviewof World Bank-financed projects where finan-cial analysis showed that water supply tariffs isgenerally 2.0 RMB/m3, or above in order to meetutility costs, including World Bank loan. Sincemany water companies require equity contribu-tions from the municipal government, use fullcost recovery (i.e. no government capital subsi-dies) should be greater than 2.0 RMB/m3.

Figure 7.2: Wastewater TariffsThe data is from 128 cities reported in theH2O’s report on China’s water sector publishedin 2005 (http://www.h2o-china.com). The waste-water treatment cost of 1.0–1.5 RMB/m3 isbased on World Bank-financed projects and ananalysis done by the China International Engi-neering Consulting Company (CIECC) and pre-sented in the 11th Five Year Plan study. The de-tails are provided below. Note that the CIECCestimate considers depreciation but not financ-ing charges. Since the maturity of bank loans

(5-8 years) is typically much shorter than depre-ciation maturities, financing costs would drivethe full cost recovery levels above 1.0 RMB/m3.Wastewater collection costs typically make up at least two-thirds of capital costs, and half of operating costs. The full cost recovery tarifflevel for wastewater collection and treatment istherefore at least 3.0 RMB/m3 or greater (1 RMBfor treatment and 2 RMB for collection).

Figure 7.3: Combined Tariff asPercentage of Household Income in 2004 Urban households in China are categorized intoseven different income groups: (1) lowest income (10 percent); (2) low income (10 per-cent); (3) lower middle income (20 percent); (4) middle income (20 percent); (5) upper middle income (20 percent); (6) high income (10 percent), and finally the (7) highest income(10 percent). Data for average income, incomefor highest and lowest quartile as well as highestand lowest 10% are provided in the WorldDevelopment Indicator. Three assumptionswere made in the tariff side: a) each person con-sumes 125 liters per day and tariff which in-cludes both water and wastewater charge; b) tariff is on average 2 yuan per cubic meter;and c) there are 3 people in each household.

Figure 7.4: Annual Expenditure for Urban Construction and MaintenanceTotal annual expenditure for urban constructionand maintenance is the sum of investment offixed assets, maintenance, debt payment, taxand fees and other expenditures. The data is de-rived from the MoC’s China Urban ConstructionStatistics Yearbook (2005), covering officiallydesignated 661 cities. Investment of fixed assetsaccounts for 79.2% of total expenditure in 2004,followed by maintenance (10%) and debt pay-ment (7.2%). Exchange rate was set at1USD=8.06RMB.

Table 7.5: Urban Construction andMaintenance Fund in 2004The table presents a list of fund sources forurban construction and maintenance, consistingof urban maintenance and construction tax,municipal financial allocation, domestic loan,

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Indicative Cost for Typical Wastewater Treatment Planin China

Item RMB/m3

Energy 0.16Chemicals 0.10Salary 0.08Maintenance 0.15Depreciation 0.40Administration 0.09Total 0.98

Source: CIECC, 11th Five Year Plan (2006).

land transfer fee, self-raised and others. Urbanmaintenance and construction tax is one of localtaxes imposed according to Temporary Reg-ulations of People’s Republic of China on UrbanMaintenance and Construction Tax. It is leviedbased on actual value–added tax, consumptiontax and business tax paid by taxpayer. Differentrates apply different places. The rate comes to7% in urban areas, 5% in counties and townsand 1% beyond these places. Others category in-cludes foreign direct investment, various feessuch as fee for expansion of municipal utilitiescompany, tariff, and water resources fee. Inorder to analyze the sources of fund by city cate-gory, 15 cities in Category 1 and 20 in Category3 were randomly selected as a sample base andthe sources of fund of each city were further an-alyzed and the average of each source was cal-culated. The data is from the MoC’s ChinaUrban Construction Statistics Yearbook (2005).

On the expenditure side, sectoral break-down of urban construction and maintenanceexpenditure consists of: 1) non-utility (38%); 2) utility (18%); and 3) roads (44%). Non-utilityincludes expenditures on public traffic, floodcontrol, landscaping, environmental sanitationand others. Utility consists of water supply, gas,sewerage and heating as indicated in the chart.

Table 7.6: Per-Capita Urban Maintenanceand Construction Fund by City Type To analyze per capita urban M&C fund by citytype, sampling was done for each city category:For category II and III, 30 cities were randomlyselected in each category and average per-capitaurban maintenance and construction was calcu-lated. For category I, all 21 cities were includedin the calculation.

Table 7.7: Indicative Ranges of UrbanWater Sector Financing Source: 1991–2005No official data on sector financing is know to theStudy team. An estimate was made as follows:

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Sector US$ millions

Roads 24,643Non-utility 21,681Utility 10,112• Water supply 2,498• Gas 1,535• Sewerage 4,171• Heating 1,909

Water Supply Wastewater(RMB Billion) Percent (RMB Billion) Percent

Total 202 236State Bond 34 17% 61 26%CDB 14 7% 5 2%Private Sector 36 18% 24 10%International Development Banks 12 6% 24 10%Municipal Governments 53 26% 91 39%Domestic Banks 53 26% 30 13%

202 100% 236 100%

i) Total investment for each sector is known from the MOC 2005 Yearbook.ii) Estimates exist for:

a) State Bond-from Tsinghua Research Brief (2006)b) CDB funding from Tsinghua Research Brief (2006)c) Private Sector from Global Water Intelligence Report (2004)d) International Development Banks: World Bank (Annex 1); ADB (2005); JBIC

iii) Municipal Government and Domestic Bank funding information were not available. The following assumptions were therefore made:a) For WS: Municipal Governments Finance 50% and Domestic Banks Finance 50%b) For WW: Municipal Governments Finance 75% and Domestic Banks Finance 25%

Chapter 8: Using the Private Sector to HelpMunicipal Utility Performance

Table 8.1: Investment by Project Type

The Global Water Intelligence Report (GWI) on the China Water Market (2004) provided information on 126 projects with private participation. These projects were then analyzed and classified into the following categories: WT (water treatment), WWT (wastewater treatment), WT+DN (water treatment and distribution networks) andothers.

Figure 8.1: PSP Investment TrendsThe private participation data in the GWI reportwas further analyzed to look at trends over timeand international/domestic investors. As isnoted earlier, the 2004 figure includes only thefirst half of the year. In addition, there are sixdomestic projects and three foreign projectswhich detailed information is missing and thusare omitted in the figure.

Chapter 10: Strategic Action Plan Table 10.1: Summary Strategic Action Plan

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Affermage: A contract under which the governmentdelegates the management of the water service to aprivate company in return for a specified fee, oftenbased on the volume of water sold. The company’sprofit is equal to revenue from the fee, less operat-ing and maintenance costs. The company operatesand maintains water assets at its own expense butdoes not finance investment in infrastructure assets.

Arrangement: Rules and institutions establishingand enforcing the rights and obligations of an oper-ator, customers, a contracting authority, or othergovernment authorities, with respect to water ser-vices. These rules are set out in contracts, laws, reg-ulations, licenses, and related documents. For anexample, see Management Contract or Build-Own-Transfer.

Asset Management Planning: The active man-agement of capital assets in order to minimize thetotal cost of acquiring, operating, maintaining, andreplacing them. This is usually achieved through thecollection and organization of asset information,the analysis of asset data to set priorities, and the in-tegration of data across the organization.

Build-Own-Transfer: Typically used for water sup-ply or wastewater treatment plants. An Operatorfinances, builds, owns, and operates the facilities fora specific period of time, after which ownership istransferred back to the contracting authority. BOTpayments are typically based on the volume of watertreated at plant.

Category I Cities: Large and developed cities witha population greater than two million and a GDP per

capita greater than $3,000 (RMB 24,0000). Definedfor this Study only.

Category II Cities: Medium-sized cities that are notin Category I or III, usually with a population in therange of 0.5 million to 2 million and a GDP percapita in the range of $1,500 (RMB 12,000) to$3,000 (RMB 24,000). Defined for this Study only.

Category III Cities: Small and developing citieswith a population less than 0.5 million and a GDPper capita less than $1,500 (RMB 12,000). Definedfor this Study only.

Concession Contract: An Arrangement in which acontracting authority is the legal owner of the infra-structure assets (at least after the contract ends), butthe operator is responsible for financing and manag-ing investment, as well as operating and maintainingthe business.

Concessionary Finance: Grants or preferentialloans offered by a national or provincial gov-ernment to municipal urban utilities, usually as anincentive to comply with government policy. Con-cessionary finance can also be offered to local gov-ernments in support of services with public goodsaspects.

Coordination: Ensuring the policy decisions andimplementation plans are consistent, and managinginput from the various bodies involved in water sec-tor activities.

Utility Cost Recovery: The point at which a utilityis able to cover its cash costs of service through a

171

Glossary

combination of user fees and government transfers.A utility’s cash costs of service typically include operation and maintenance, debt service, and a percentage of capital expenditures. A return on equity is also required if there is a private equity investment.

Cost Recovery Ratio: This is the ratio of actual util-ity revenues from user fees and governmentpayment, divided by the utility’s cost recoveryrequirement. A ratio of 50 percent means that theutility’s revenues only meet half of its requirements.

Debt Service: The cash necessary to make principleand interest payments on debt obligations. As theamount of utility debt financing increases, the debtservice increases. Some lenders also require utilitiesto establish “reserves” in the event of an unexpectedbusiness shock. If the municipal governmentprovides contributions for capital works, then debtservice is reduced.

Design-Build-Operate: Similar to a Build-Own-Transfer, but the contracting authority providesfinancing and retains ownership of the facilitiesduring the contract period.

Designated Cities: Major urban areas in Chinasuch as municipalities, capitals of prefectures, andcapitals of counties. As of 2005, China had 661 des-ignated cities.

Divestiture: An Arrangement in which the operatoris the legal owner of the infrastructure assets for anindefinite term and is responsible for financing andmanaging investment, as well as operating andmaintaining the business.

Drainage Networks: A drainage network is dividedinto a hierarchical system of drains. Tertiary drains(at the building level) connect to secondary drains(typically along smaller roads), which connect toprimary drains (typically along larger roads)—butthe classification is usually somewhat arbitrary.

Drains/Sewers: There are four types of drains: (1) stormwater drains which carry stormwater only;(2) sanitary drains which carry wastewater only;

(3) combined drains which carry stormwater andwastewater; and (4) interceptors which connectwith combined drains and convey the wastewater tothe treatment plant during dry periods.

Financing: Funding provided to meet expenditurerequirements and to be returned to the fund-provider in the future. Funding provided as loans orequity must be repaid with interest or profit. Fund-ing provided as grants or municipal governmentequity contributions does not need to be repaid.

Financing Autonomy: The extent to which a utilityis able to finance investments from loans or internalcash generation as opposed to from governmentcontributions. Sixty percent financing autonomymeans that sixty percent of the funds come fromloans or utility cash reserves, and forty percent fromgovernment equity contributions.

Full Cost Recovery: Revenues from user fees suf-ficient to meet all of a utility’s needs revenues re-quirements assuming no financial support fromgovernment, i.e. no payments or capital contribu-tions made by a government agency to the utility.

Government Bureaus: Municipal agencies chargedwith functional responsibilities such as financialaffairs, construction, and water resources.

High Capacity Cities: All cities with a GDP percapita greater than $3,000 (RMB 24,000) regardlessof population size, as well as all cities with a popu-lation greater than 500,000 and a per capita GDP ofat least $1,500 (RMB 12,000). Defined for this Studyonly.

Joint Venture Company: An Arrangement underwhich an operator is partly owned by a contractingauthority, and in which the two parties jointly sharemost of the risks.

Lease Contract: Similar to an Affermage contract,an operator operates and maintains water assets atits own expense but does not finance investment ininfrastructure assets. The Operator maintains re-tains revenue from a customer tariff and pays thecontracting authority a specified lease payment.

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Low Capacity Cities: All cities that are not high ca-pacity cities as defined above. Defined for this Studyonly.

Management Contract: An Arrangement underwhich the Operator provides management servicesto the utility in return for a fee.

Mixed Capital Company: A Joint Venture betweenthe government, which provides public capital, anda private company, which provides private capital.

Municipal Fiscal Policy: The financial principlesand practices by the municipal government in rela-tion to urban water utilities, including capital con-tributions, operating subsidies, and tax incentives.

Municipal Utility Governance: The exercise of amunicipal government’s ownership interest in a util-ity, including determination of the scale and scopeof utility service, appointment of management, thesetting of service standards and the monitoring ofperformance.

Municipal Wastewater: Refers to wastewater pro-duced by domestic, commercial, and industrialsources (and stormwater) within the administrativeboundaries of a city.

Non-Revenue Water: Water produced and lostwithout revenue. Losses can be physical (for exam-ple, through leakage) or commercial (for example,through non-payment of bills). Non-Revenue watercan also refer to unbilled but authorized consump-tion (for example, through free public taps).

O&M Costs: The amount of cash necessary to main-tain operations at a reasonable level over a short-term perspective.

Operator: A private domestic or foreign company,or government-owned company operating outsideof its jurisdiction and providing services under anArrangement. Municipal water utilities operatingoutside of their city in China seeking to maximizetheir profits are considered Operators.

Policy: The government’s goals for the sector, to-gether with the principles and general practices the

government has decided the sector should follow toachieve these goals.

Pumping Stations/Overflows: Drains may requirepumping stations in the networks to make them hy-draulically stable. Overflows are incorporated into acombined drain to spill excess water from an over-loaded pipeline (during and following heavy rain)into a convenient watercourse.

Sector Governance: The national and provincialgovernment organizations that control and managethe sector, together with the rules and policies thoseorganizations develop.

Service Aggregation: The grouping of municipali-ties or operators into a single entity for the provisionof some type of urban service, such as water supplyor wastewater collection and treatment.

State Bond Program: A key national concessionaryfinance program in China, run by the National De-velopment Reform Commission.

Tariff Regulation: The controls on urban waterutilities intended to overcome the problem thatwater is an essential monopoly service. Tariff regu-lation is the rules and organizations that set, mon-itor, enforce, and change allowed tariffs for urbanwater utilities.

Transfer-Own-Transfer: Similar to a BOT, but theContracting Authority sells an existing facility to theOperator for a specified period of time (transfers).When the contract period ends, ownership revertsback to the Contracting Party.

Urban Water Utility: A company or government de-partment that provides any of the following services:water supply, wastewater collection and treatment,water reuse, and stormwater drainage. A waste-water utility in China typically provides bothstormwater and wastewater services.

Utility Management: Serving customers by operat-ing existing utility systems, maintaining assets,planning and implementing new investments, andmaking sure that operations, maintenance, and newinvestment can be financed.

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G L O S S A R Y

Revenue Autonomy: The extent to which overallcash comes from user fees as opposed to govern-ment payments. A ratio of sixty percent means that60% of the cash comes from users and 40% fromgovernment payments.

Wastewater: Refers to both stormwater and waste-water, including domestic and industrial waste. The

two are closely linked since many Chinese cities haveeither fully or partially combined drainage systems.

Water Services: Includes any aspects of providingwater supply, wastewater management, or re-claimed water use.

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� Analysis of China Development Bank’sLending Program for Urban Water

� Analysis of China State Bond Program forUrban Water

� Note on China’s Drinking Water Standards� Note on China’s Water Pollution Control Law� Progress on China’s Urban Water

Marketization Reform, Tsinghua

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Component C: Urban Water Reuse Study, Preparedby CDM International and National EngineeringResearch Center

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Component E: Water Sector Regulatory and Institu-tional Study, Prepared by Tsinghua Water PolicyCenter

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Stepping Up: Improving thePerformance of China’s Urban Water Utilities

As China transitions to a market economy, municipal utili-ties are evolving into commercially viable companies undergovernment oversight. Great challenges confront the reformprocess for China's water utilities, including rapid urbaniza-tion and emerging inequality, coupled with severe waterscarcity and degradation.

Cities and their water utilities must provide services withina complex mosaic of policies and regulations provided bynational and provincial governments. In China, as through-out the world, water is also a sensitive political issue.Governments are keen to provide good water service, butalso attuned to the need to ensure that tariffs are sociallyacceptable. This report presents a strategic framework andset of recommendations for addressing these challenges andaccelerating improvements in Chinas urban water utilities.

Drawing upon the World Bank’s experience in China, as wellas the Bank’s global knowledge, the report provides a com-prehensive assessment of urban water services, includingpolicy, regulatory, institutional, financial, and technicalissues. The report will prove a valuable resource for policymakers, utility companies, and anyone interested in thedevelopment of the world’s largest water market.

ISBN 978-0-8213-7331-6SKU 17331